Magnitude of the Fiscal Storm: Potential Effects and the Agencies Impacted

This session will discuss the magnitude of claims, those agencies directly impacted, and  the limitations on our ability to estimate the full scope of liability. Panelists will frame our understanding of the total liability versus the general fund capacity of local  agencies, the potential effects on public services, and the current response strategy of  local leadership. The session will also discuss the direct and indirect ratings implications,  potential risks of financial contagion, and the impact on the cost of financing.

Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.

Mike Fine (00:09):
As Robert indicated, to school folks, you know us well; to the non-school folks, we are a strange state agency, created 30-plus years ago to have an independent voice in guiding school districts through what we know today is the receivership process. The good news is it's been used 10 times in the last 30-some years to assist school districts or community colleges here in California as an alternative to bankruptcy when they are in severe fiscal distress. The good news is it's 10 times, the bad news is it's 10 times, but we were created out of the outcome of the first one of those that many remember, which was the Old Richmond Unified School District, now renamed to West Contra Costa Unified School District. And so our agency focuses predominantly on preventing that from happening. Probably 80% of our work is around providing assistance to school districts, charter schools, community colleges, the legislature, county offices of education and others to prevent some form of fiscal crisis.

(01:32):
We get in while the problem is small and tackle it from there.

(01:39):
Since AB 218 was passed, we've had it on our list of our annual testimony in the legislature that I give each January or February as a risk factor that is trending in school districts specifically. A couple of years ago, I chose to hand out my speaker notes to the panel so that they could have all the information, but I could focus my comments. I chose to focus them on 218 because at that point, our risk partners across the public agency had good data. We started to collect data on claims. As 218 was going through its process, staff wrote many times that the potential fiscal impact was significant, in the billions of dollars, but they had no way to quantify that in a meaningful fashion.

(02:42):
Ultimately, as we know, the legislation was passed and Governor Newsom signed it. This is not the first time this legislation had been proposed; Governor Brown actually vetoed it on a couple of occasions. California is not unique in this regard. There are 30-plus states and territories that have what we call revival statutes, where we revive the potential for a claim by either temporarily or permanently waiving the statute of limitations or any kind of claim presentation process. I chose that year to focus on what we were beginning to see as potentially dire fiscal impacts for local school districts. Our agency focuses on education and community colleges, so we weren't focused on our municipal partners—counties, cities, special districts, and others—as much at that point in time, but we knew that certainly counties faced some of these same risks because they manage foster programs and juvenile detention systems, and we knew that those were focus areas for past victims and potentially today's claimants.

(04:09):
As a result of that, the legislature responded by putting in the budget trailer bill a requirement that FCMAT study the topic and provide a report. That's what we've done. The real outcome of this report is that we have increased the awareness in Sacramento, specifically under the capital dome, of the potential here. Many of you have understood the potential. Folks like Helen and our risk partners understood this all along, but we have broadened that understanding in the legislature in an attempt to address some items. As the slide indicates, it gives you some history on 218. One of the things that is least understood about 218 is it had a deadline in it—so everybody thought. Everybody interpreted this December 31 deadline as the cutoff for all the claims we would get.

(05:16):
The reality is that's not exactly what the legislation set. For victims that were 40-plus years old, yes, there was a deadline, assuming you had already acknowledged the harm that you experienced. But one of the things the legislation did was move the date from 26 to 40. So we have a 14-year tail, as I like to call it. For that period of time that we're in right now, claims can continue to be presented. We also have what we call repressed memory claims for those over 40.

(06:10):
For our victims that haven't fully come to terms with the injury and the harm, they are given additional time after they recognize that harm to file a claim. The bottom line is new claims are presented under the revival statute every day. Well past what people interpreted as a deadline, new claims come in. In fact, if you look at the claims history that Mike and Dave and John and others see on a regular basis, you would see the data going up month after month. That represents a challenge. The other challenge is that not too many years after 218 was passed, we had AB 452. 452 basically eliminated the statute of limitations on childhood sexual assault altogether on a prospective basis.

(07:13):
As our insurance colleagues will speak to, it was one thing to go back and revive the statute to open up claims we didn't know we were exposed to, but from today forward, anything could be happening out there and we will forever have some exposure to that. This is why we in FCMAT, when we wrote our report, stepped a little bit out of the scope that the legislature had given us and looked at some preventive measures, because the only answer to 452 is prevention. These offenses against kids are simply unacceptable. Straightforward, just as simple as that. They should be unacceptable to us as a society, and yet they continue.

(08:19):
Whether we have direct involvement in schools or provide a service to schools, we would all stand up and say, "This is unacceptable." And victims should be properly compensated. There's no question about that. This isn't an anti-victim pre-conference or report from FCMAT. In fact, we want to be very respectful of our victims. We do know more about some claim activity where some of it may be coerced or false, and we will let the judicial system deal with that. But for the true claims, which represent the most of what we've seen to date, we absolutely believe these victims should be compensated.

(09:24):
We've alluded to this report, and I've already given you the background, but let me put some dollars around it. This is a very difficult thing to do. There's no central database with regard to claims. They're not all categorized the same. Some of the risk pools treat AB 218 claims as only retroactive claims from a given date back. It is difficult to put a value around these claims because they're at different stages in the adjudication process. In many cases, not a lot of information is known. As Robert alluded to, in few of these cases are there witnesses still around or access to records. All of that, from a defense perspective of a public agency, is non-existent.

(10:34):
It's difficult to value these. At the time of our report, nine months ago, we valued the exposure to school districts in California at two to $3 billion. That is a conservative number. We believe today, even more so, it's a conservative number because we've learned even more in the last nine months. School districts may have different forms of risk protection, but what you need to understand is the oldest claim we're aware of is from the 1940s. The victim is in their 90s. While that particular school district had high-quality insurance at the time by a reputable carrier, they've been out of business for decades. So the school district is left with full exposure. Many claims settled in recent years are from the 60s and 70s, predating public entity risk pools. Most of those agencies had good coverage for the time period, but the problem is we are 40 and 50 years later in a different environment.

(12:25):
For non-school agencies, it was very difficult. We talked to a number of counties—some that had one or two claims, others that had thousands. We simply described the municipal environment of counties, cities, and special districts to be a multiplier of the school district value. Many large counties are self-insured without necessarily a risk partner, taking a few more risks than school districts, which tend to be more conservative.

(13:20):
School district exposure consists of the self-insured retention, or claims that exceed their limits—whether that's 30 million or 55 million. Fiscal impacts vary across the 1,100 or so school districts in California. As FCMAT, we try to pay close attention to this because if a district is experiencing financial crisis, we are going to be engaged with them. Obviously, we have a lot of conversations with school districts; we don't serve our municipal partners per se, so we don't have the same daily contact.

(14:26):
The local impacts vary, but all school districts and public agencies are feeling the financial burden through premium increases and reinsurance costs. They are also seeing issues with availability of coverage and aggregate limits.

(15:13):
There is also the nature of a public entity risk pool: when you have membership in it, you have joint and several liability. If you were a member in a pool for 10 years and they now experience claims, they're going to come back to you as a member, even if you've moved on. We call those retroactive premiums or special assessments. Some pools have done several hundred million dollars worth of these. Thus, public agency programs and services will be impacted. In the K-12 world, they are very limited in the dollars they can raise locally.

(16:14):
They are dependent upon the dollar they get per student from the state and a shrinking federal contribution. I'll give you two examples of school districts. One of the larger districts in the state had a jury judgment for two of six victims, all the same perpetrator—a teacher. I should say this: the perpetrators are not all teachers. We have bus drivers, custodians, walk-on coaches, and volunteers on the perpetrator list. This is not a teacher-unique issue.

(17:17):
There was a $135 million jury judgment for two of six victims. The jury apportioned 90% responsibility to the district for failure to supervise. Ultimately, there was a post-award settlement of 45 million. In this case, the district went back to the plaintiff's counsel and said, "We will exercise our rights to pay you over 10 years." They didn't like that, so they negotiated a different settlement for an immediate payment. 14 million was covered by insurance, and the rest came from the district's reserves.

(18:19):
At that time, the district had about 70 million in reserves. Their exposure would have been somewhere around 120 million. They then planned budget cuts of about 10 million a year to cover the rest. The 45 million story is a little different when the district is exposed to 30 million plus legal costs. The next example is a 350-student school district with three victims and an aggregate risk estimated at about $20 million. These were claims from the 70s, so there was no insurance. They settled for around nine million plus costs. The district will use up nine of their 12 million in reserves and make general fund program cuts to replenish those over time.

(19:30):
A neighboring district just received permission to sell a school site to pay their settlement. That's a unique situation because they had started the sale process years ago, meeting statutory requirements that are no longer in place. You start to see that this varies by location. The same would be true of our municipal partners.

(20:15):
Important to note, school districts receive an annual cost of living adjustment (COLA). The forecast for next fiscal year is just over 3%, though I estimate it will be in the 2% range. Between premium increases and retroactive premiums, it eats up a significant portion of that adjustment, leaving other rising costs like utilities, health insurance, and technology to share what remains.

(21:13):
In our report, we made 22 recommendations: two on data to build a central database, some on financing, one to study a statewide risk pool, and 11 on prevention. FCMAT's assignment was about the financing recommendations, but as I shared with the legislature, the recommendations about prevention are actually more important as a parent. In our role to guide the legislature, however, we focused on financing.

(22:25):
Our report includes a roadmap on how to finance the indebtedness created by settlements and judgments.

(22:36):
It's an acknowledgement that public agency indebtedness is nuanced and that there are challenges with timing, judicial validation, and constitutional debt limits. It also reviews the special constitutional protections afforded to school districts and community colleges. The legislature followed through with that in the early 1990s with what we call the receivership statutes.

(23:26):
What our report doesn't do is limit the rights of childhood sexual assault survivors. We didn't say to abandon 218. We feel victims should be compensated. It was describing a path in which to do that. We also didn't address tort reform, which is one of the things that makes a revival statute in California different than the other 30-plus states. Most of those other states have some form of tort reform and different juries; California seems to have a unique mindset for jury awards.

(24:36):
And we didn't ask the state to appropriate any funds. I knew that would cause the legislature to stop reading if I suggested they pay for the problem they created with AB 218. Financing recommendations three through six were specific to timing. You'll hear about the nuanced things regarding validations—the timing of when you can start the process versus when a judgment must be paid.

(25:35):
The last bullet there deals with the validation process. Recommendations seven through 11 were specific to funding options, considering limited exceptions to the prohibition on lease financing. This was an awkward recommendation since we originally put that prohibition in place. We also suggested extending local repayment intercept mechanisms and expanding the state's I-Bank to ensure they could finance these claims.

(27:01):
None of these recommendations ended up in legislation in this session.

(27:08):
With respect to receivership, we recommended an alternative approach. Today, the local governing board's authority is removed if the state provides resources. Current leadership should not be blamed for an offense that happened decades ago. We proposed an alternative that would be more appropriate for the current time and recommended extending the maximum repayment on receivership statutes from 20 years to 30 years to help with affordability.

(28:13):
Senate Bill 848 took on all 11 prevention recommendations from our report and was signed by the governor a few weeks ago. We're very pleased with that.

(28:44):
Senator Allen introduced Senate Bill 832 but abandoned it after being attacked by plaintiff's counsel on social media. Senate Bill 577 by Senator John Laird included a number of recommendations, including some tort reform. He ultimately pulled his bill, making it a two-year bill while he continues to negotiate. One of our great successes this past year is that we've increased awareness significantly.

(29:54):
We've dealt with some of the AB 452 issues by strengthening prevention. It will take a few years before all that's effective. The legislature also asked that the state start to collect payment information from school districts on any AB 218-related expenses.

(30:25):
Because most risk pools pay the victim and then deal with what the school district pays back, we'll have to see how this comes out. We'll start to collect some meaningful data. With that, Helen.

Helen Cregger (30:53):
Thanks, Mike. I'm always glad our school districts have you and FCMAT in their corner. I'll go through things fairly quickly. From the rating agency perspective, to date, we have not taken any rating actions as a direct result of AB 218, but it remains an area of focus. Across the state, local governments are generally healthy with growing economies. In fact, school districts and cities are sitting on robust reserve levels added during the pandemic. We expect those to be spent down, but right now we have fairly liquid governments.

(32:01):
Local governments also have the ability to issue judgment obligation bonds or enter into agreements to pay settlements over time. But it will remain an ongoing issue. The legislation opened up an indefinite period for future claims. Right now, there are fairly uneven disclosure practices, but in the future, it could be an item like cyber risk that issuers routinely report on. The lack of a state database increases uncertainty. For example, some districts face claims regarding Boy Scout meetings that happened on their premises.

(33:17):
A statewide database would give us clearer insight. Longer term, AB 218 settlements will add to strains like moderate population growth, declines in enrollment, and slower revenue growth. Mike spoke about the increase in insurance premiums compounding other rising costs. Data suggests that while the addition of new claims may have been slowing, a recent increase suggests 2025 may see a ramp-up again.

(34:31):
About half of these 412 claims have been settled for about $1 million. Some of the larger cases include Los Angeles County, with billions in judgments. LAUSD was first out the gate with a large issuance of judgment obligation bonds. The district thinks it will face around $650 million in claims, assuming settlements of $1 million per claimant, but we've seen larger settlements than that. This is a claim on current resources; in LAUSD's case, debt service is about $30 million annually—within their capacity, but it represents resources cut from other areas.

(36:00):
The City of Santa Monica has settled with 229 individuals for about 229 million. They relied on interfund borrowing and insurance reserves. We have a negative outlook on that city's AAA rating, but that reflects overall fiscal strains and not exclusively their AB 218 challenges.

(36:35):
These graphs show the liquidity for local governments. For school districts, we see the ramp-up in 2022 through 2024 as they received federal and state grants. We also look at capacity to borrow; leverage ratios in California exceed national peers, largely driven by pensions. Fixed costs remain generally under 15%. This is important because judgment obligation bonds cannot be put on the tax base; they are general fund obligations.

(37:55):
While entities are sitting in a healthy position, AB 218 settlements compound longer-term challenges like enrollment declines. This graph shows ending general fund balances through 2028 for our five largest school districts. One strength in California is the requirement to budget three years into the future. We see plans to reduce reserves, but the fact that they're making these projections allows them time to adjust.

(39:20):
They are already focusing on making spending cuts to avoid reductions in reserves. Any significant AB 218 settlements will compound those challenges.

(40:17):
Regarding rating changes, in the second quarter of 2025, national downgrades exceeded upgrades for the first time since 2020. California followed this trend, but our school districts exhibited greater rating stability. Many districts are engaging in rigorous planning to face these challenges. 218 is not good news, but it's one we continue to monitor. We hope that the new budget line item for AB 218 payments will provide a better view into how it impacts budgets. I'll pause there for questions.

Audience Member 1 (42:29):
The jobs bonds, they cannot be taxpayer-funded? I missed that.

Helen Cregger (42:35):
Yes, I don't believe so. They have to be funded from general operations.

Audience Member 1 (42:41):
For the school district?

Helen Cregger (42:42):
Yeah. If you went out to voters and asked for approval of general obligation bonds to pay them, then they could, but there's a question of the receptiveness of increasing taxes to pay a large judgment.

Mike Fine (43:11):
Straight back.

Audience Member 1 (43:18):
Do you have any sense of the legislature's appetite to take up reforms when they reconvene to address the issue with meaningful reforms that will contain exposure for these issuers?

Mike Fine (43:37):
I don't think the legislature has any appetite to pay the bill. I see them fine-tuning some items that make it easier for local government to pay the bill. I see maybe some go-forward fine-tuning around tort items, but not major. There has been a meaningful conversation about caps, which is further along than I would've said six months ago. But I don't know if there's an appetite to get it across the finish line. The plaintiff's bar is very outspoken.

(45:11):
It would all be in policy or regulatory adjustments.

Helen Cregger (45:20):
We talked as we planned this session that there is some discretionary funding.

Mike Fine (45:26):
K-12 got a $1.7 billion block grant this year. It is fully discretionary. One of the things not on the list is paying liability premiums or claims, simply so it wasn't a target, but it is discretionary. If you were to ask the Department of Finance how they are helping schools with AB 218, they would point to that block grant. Total context: while they provided that, they also instituted a $1.9 billion deferral of school funding.

(46:21):
They did the block grant and the deferral at a level that is not harmful to schools. Current revenues are up, and the first draw on those revenues will go to pay off the deferrals. This is a message that they did something. School districts will need to advocate for another round of block grant. If revenues stay up through fiscal year 25-26, there'll be settle-up money under Prop 98 that can go to a one-time block grant.

(47:16):
Under Governor Brown, we had multiple years of one-time block grants. That approach is possible as we look at the rest of the fiscal year.

Audience Member 2 (48:20):
It's obvious some of these judgments could impact an agency's rating. I'm curious about the thoughts of school districts potentially having two ratings that don't have much to do with a potential judgment obligation bond.

Helen Cregger (48:52):
We have very strong protections around general obligation bonds in California. For school districts, we have issuer ratings, and we recognize the additional strength of statutory lien protection and the intercept mechanism. General obligation bonds are rated one notch higher than the issuer rating. But because judgment obligation bonds are paid from general fund resources, they are aligned with the issuer rating. Is that helpful? Thank you, Mike and Helen.

Mike Fine (50:01):
Thank you.