Former San Jose Mayor Chuck Reed is troubled that California has reached the sixth year of economic recovery with so many public pension plans less than 100% funded.

​LOS ANGELES — The two California cities that have done the most to challenge public employee pensions say court challenges have not daunted their efforts to shrink employee benefits to match revenues.

San Jose and San Diego in 2012 both put pension reform measures to voters that passed, only to see both measures challenged by public employee unions.

Cities around the state have been tracking the legal battles waged on the San Diego and San Jose pension overhauls.

San Diego's efforts to shift city employees from a defined pension benefit to a 401-(k)-style system remain intact, though not unchallenged.

In San Jose, the city has been able to keep 12 out of 15 provisions outlined in its Measure B, according to former Mayor Chuck Reed.

"We did not get everything we wanted, but we did eliminate annual budget gaps of $115 million in 2011 and 2012," Reed said. "Overall it was a great success. In politics, you always have to ask for more than you need, because you won't get everything you want."

Few cities have had more upheaval and fractures within the community over voter-approved pension reform than San Jose.

Police and firefighters waged war on the changes in a three-year-long legal battle. The San Jose City Council passed an agreement with police and firefighter unions on retirement benefits and wages in August 2015.

The revised agreement scales back what the original Measure B required employees to contribute toward retirement, offers a cheaper health-care plan for new and existing employees, gives police officers an 8% raise plus a one-time retention bonus, and reinstates the police and fire retirement plan's earlier definition of disability.

A judge will now have to invalidate parts of Measure B and insert the changes before it goes back to San Jose voters in November 2016.

Reed, who spearheaded pension reform during his two terms as mayor, said the efforts have resulted in annual savings of $30 million for the city.

As part of the negotiations, current employees took a 10% pay cut and modifications were made to retiree healthcare plans that will be in effect when current employees retire, Reed said.

San Jose is a charter city with two independent retirement plans. As a result, the city retains the discretion to change retirement benefits, Reed said.

"If you have the option to change, it cannot be vested as a contracts matter, but the trial court did not see it that way," said Reed, now special counsel with Hopkins & Carley, a San Jose law firm. "Most cities can't change current employees' benefits, because they are stuck in the California Public Employees' Retirement System."

The 84-year-old CalPERS provides retirement benefits to 1.7 million state, school and public agency members in the state. CalPERS' total fund market value stands at approximately $294 billion.

In San Diego, another charter city with its own retirement system, an ongoing legal challenge has not impaired implementation of its Proposition B pension initiative, said Gerry Braun, the San Diego city attorney's communications director.

With San Diego facing a $73 million deficit in 2012, former Mayor Jerry Saunders worked to get the measure on the ballot. Some 67% of San Diego residents voted in favor of the measure.

The Public Employment Relations Board, a quasi-judicial state administrative agency charged with administering collective bargaining statutes covering public employees, filed a lawsuit in 2012 seeking to prevent Proposition B from getting on the ballot, but failed. PERB then sought an injunction to prevent implementation and lost in that attempt too.

"PERB then kept the matter four years on its calendar and ultimately ordered the city to, in effect, unwind Prop B, which is a citizen's initiative," Braun said. "We are now, back in the judicial system, but PERB has not impaired implementation."

The central tenet of the initiative was to replace the city's defined benefit plan with a 401(k)-style defined benefit contribution plan for all new employees.

After Proposition B passed, employee unions filed an unfair practice charge with PERB alleging the city failed to meet and confer prior to Placing Proposition B on the ballot.

Saunders said at the time that the proposition was a private citizen's initiative, so the city was not required to meet and confer with the union prior to its passage.

PERB sided with the union and ordered the city to compensate all affected employees for the value of the pension benefits eliminated by Proposition B. The city has filed a request for judicial review of PERB's decision.

PERB sided with the union and ordered the city to compensate all affected employees for the value of the pension benefits eliminated by Proposition B. The city has filed a request for judicial review of PERB's decision, Braun said.

Current San Diego Mayor Kevin Faulconer cited comments by Fitch Ratings and S&P Global Ratings in what he described as the city's commitment to conservative financial practices in the fiscal 2016-17 budget, which he signed on June 14.

Fitch assigns San Diego its AA-minus implied GO rating; S&P assigns its AA issuer credit rating; and Moody's Investors Service assigns its Aa2 issuer credit rating.

San Diego and the San Diego Employees' Retirement System have taken action to reduce risk and benefit costs, according to Katie Keach, the city's communications director.

Keach ticked off the steps the city took to reduce its deficit and deal with pension liability.

Before San Diego's defined benefit pension plan was closed in 2012, the city negotiated several new benefit tiers with its labor organizations that reduced the annual cost of benefits and future liabilities, Keach said.

The "normal cost," or annual cost of employee benefits, has declined significantly since fiscal year 2007, she said. SDCERS' independent pension board has systematically taken risk off the table by reducing the discount rate five times over the past decade to 7%. The fiscal year 2016 valuation is in progress.

"The city has paid at least the full actuarially-determined contribution, and above the ADC in some years, at the beginning of the fiscal year on July 1," Keach said. "This has been the city's policy and practice since 2006."

That's the year the Securities and Exchange Commission sanctioned the city for committing securities fraud by failing to disclose to the investing public important information about its pension and retiree health care obligations in the sale of its municipal bonds in 2002 and 2003.

The city also closed the other-post employment defined benefit plan in 2005 for new employees and in 2012 for existing employees, transferring them, (with some options and exceptions for those ready to retire) into a defined contribution plan.

As a result, Keach said, the liability dropped from $1.1 billion in 2011 to $537 million in fiscal year 2015.

The most recent pension system actuarial valuation of June 30, 2015 reports an unfunded liability of $2 billion. The city's annual costs of employee benefits have declined significantly since 2007. The city is aggressively paying off the liabilities of the closed plan, which was amortized over 15 years in 2012 with level dollar payments. In addition, OPEB reform in 2012 moved employees into a defined contribution plan.

"We believe these significant city reforms to the pension plan and to OPEB, and the City's fiscal policy for payment of the full pension ADC, in addition to reforms put in place by SDCERS, the independent pension system, are strong measures to reduce risk and aggressively pay down plan liability," Keach said.

The so-called California rule, an interpretation of the California constitution that has been interpreted to mean that pension benefits of current employees can't be modified, makes it difficult to enact the sort of changes made by San Diego in the state.

"We need to change the constitution to do something about current employees – and that is where the billions of unfunded liabilities are for California," Reed said.

Reed, a Democrat, had joined with former San Diego Councilman Carl DeMaio, a Republican to promote a statewide pension reform measure, but pulled their measure from November's ballot after supporters suggested the measure might have better luck on a less crowded 2018 ballot and receive more support in a less favorable economic environment, Reed said.

"We are focused on trying to get control of the cost of new employees," Reed said. "It is very simple to put a cap on what local governments can spend on defined benefits. It intentionally avoids the issue of dealing with current employees."

He thinks the constitution will be challenged at some point, but said it is a matter of how much pain California cities have to go through before that happens.

"I know the weaker cities will be hurt in the next recession," Reed said. "Our cities and school districts don't have the money to pay the increasing CalPERS and [California State Teachers' Retirement System] costs."

"In the next recession, when revenues soften up, there is going to be a lot of pain," he said. "And sometimes, this is what motivates change."

Making pensions -- and therefore cities -- sustainable is in the employees' best interest, Reed said.

"I think we can preserve pensions and not bankrupt cities and the states in which they operate," he said. "I am a board member on the Retirement Security Initiative. We don't advocate for defined benefit or 401(k), just for making pensions sustainable. Right now defined benefit pensions are unsustainable – certainly for local governments."

Being in the sixth year of economic recovery with so many plans are less than 100% funded is troubling, Reed said.

"This spiral of losing ground in the recession, and not quite making it back, is deadly," he said.

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