In California, turning to public pension funds to help the State's budget has a long – and non-partisan – history. Unfortunately, neither the fiscal problems of our state's economy, nor the tendency to turn to pension funds for relief, have distinguished between political party. As Willie Sutten said when he was asked why he robbed banks, " Because that's where the money is."

1. The most recent history began in 1981-82, with the seminal case of Valdes v. Cory [(1983) 139 Cal.App.3d 773].

The State's legislature adopted, and a democratic governor signed, urgency legislation designed to balance the fiscal year 1981-82 budget and to avoid a year-end deficit.

Part of that legislation purported to use CalPERS Reserve Against Deficiencies as the funding source for the employer contributions for the last three months of the fiscal year. (Since the creation of CalPERS in 1932, the State made its employer contributions on a monthly basis; this is an important point to remember later in my presentation.)

The Reserve Against Deficiencies was statutorily created, for a specific and express purpose: e.g., to cover significant actuarial losses, and court mandated costs.

To get the money out of the Reserve, the legislature "prohibited" the State Controller from paying the state's employer contributions for these last three months, and instead directed CalPERS Board to transfer these sums from the Reserve.

In total, this amounted to a loss to the Fund of $187 million.

The Court's decision held that the legislation was an unconstitutional impairment of CalPERS members' contract of employment. The court reached this ultimate decision based upon a number of preliminary conclusions:

In dicta, the court noted that CalPERS participants have a vested interest in the "integrity and security" of the funds available to pay future benefits. The court said that there was "[no] doubt that the Legislature intended to create and maintain the PERS on a sound actuarial basis."

While the state, as part of its sovereign power, retains the right to impair contracts to some degree, this right is limited. "Substantial" impairments are only constitutionally permissible if they are "reasonable and necessary to serve an important public purpose."

The loss of $187 million – "together with the potential long term investment yield therefrom" – was, in the court's view, "substantial." Additionally, while the legislation may have served the important public purpose of balancing the state budget, there was no evidence that the legislature considered the effect upon CalPERS or the possibility of alternative, less drastic means of accomplishing its goal.

2. The next important case arose at about the same time, involving our sister retirement system, CalSTRS: California Teachers' Association v. Cory [(1984) 155 Cal.App.3d 494].

Prior statutes had, in an effort to resolve that system's serious underfunding problem, mandated the State Controller to "transfer, in equal monthly payments", specific contributions. When the legislature and governor later made a series of slightly less appropriations to the Teachers' Fund, "in lieu of" these pre-existing statutes, the court found this to violate the teachers' vested right to the specific funding mechanism.

The governor defended this action by claiming that, because the "in lieu" appropriations were only slightly less than the statutory contributions, any impairment was not "substantial." My favorite point from this case is that it is not permissible to violate contract rights, even if only by a "little bit."

3. Fast forward in history to 1990, now with a republican governor, and California's fiscal problems not improved. But, this time our legislators tried a different approach.

Instead of the unilateral actions that were struck down in 1981-82, the legislature tried a new tack. It adopted a law which changed the frequency of the State's employer contributions from monthly to quarterly, and asked the CalPERS board to make three changes in actuarial practices:

Extend the amortization period from 30 to 40 years;

Use an actuarial earnings rate assumption of 8.75% instead of 8.5%; and

Amortize a significant actuarial gain (that occurred in the prior year when we changed from book to market value) over 5 years rather than the full amortization period.

At the same time, the legislature also passed a statute providing for a significant improvement in our benefit structure for State employees (one-year final compensation). But, the effectiveness of this new benefit was expressly conditioned upon the CalPERS Board's acceptance of the actuarial changes.

After much debate, our Board agreed to make the changes, which resulted in a significant decline in the state's contributions.

Lesson: negotiations, rather than unilateral action, can benefit both the governmental employer and the plan, and avoids litigation.

4. But, just one year later, we had a different governor, and the state's budget was still in trouble.

Let me give you some factual background: CalPERS had a special, statutorily-created program call IDDA (the Investment Dividend Disbursement Account). This was a purchasing power account that attempted to protect CalPERS annuitants from the effects of inflation. But, by its express terms, this benefit was contingent on the availability of funds in the IDDA account; and this account received funds only after a long-line of priority payments.

In 1991, the legislature repealed the IDDA benefit, and directed that all money from this account (around $1.9 billion) was to be used to reduce employer contributions in fiscal year 1991-92, and subsequent fiscal years until the account was depleted.

In an effort to offer a corresponding new benefit, the legislature also created a slightly different type of COLA benefit.

Lastly, the legislature redefined our definition of "actuary" -- from someone appointed by our Board, to someone appointed by the Governor.

• The result, obviously, was a lawsuit.
• Unfortunately, we lost this case. (Claypool v. Wilson (1992) 4 Cal.App.45h 646.) The court found that:

Ø Repeal of IDDA did not impair vested rights. The benefit was expressly contingent on the availability of funds, and thus there could be no vested right to it. Alternatively, the replacement COLA was sufficiently comparable to represent an "offsetting benefit."

Ø The loss of the IDDA money also did not impair the members' right to an actuarially sound system. Unlike the Reserve Against Deficiencies that was in issue in 1981, this account was not reserved to underwrite the soundness of the System. This account was not even included in our actuarial valuations of the Fund.

Ø The loss of control over the actuary was also uphel. The court held that there were sufficient mechanisms within the legislation to ensure that the Governor-appointed actuary would continue to be a "fiduciary" to the System.

5. The next saga in California's Raid history comes not from a legislative act to take money from the pension funds, but instead from a revolt by the plan participants – and ultimately from the State's voters – to any future raids.

• In 1992, partially as a result of the loss in the Claypool case, the employee organizations throughout the state formed a coalition with the goal of sponsoring a constitutional amendment that would prevent any future raids.
• Despite opposition by almost all of the editorial boards throughout California, Proposition 162 passed. It had six stated purposes:

Ø prevent "raids"

Ø prevent "political meddling"

Ø prevent a "packing" of pension boards (and there is a story behind this that I can discuss separately with anyone who is interested)

Ø strengthen fiduciary independence

Ø increase fiduciary responsibility

Ø return control over the actuary to the pension boards

6. Unfortunately, Proposition 162 is not the end of the story. Just one year later, in 1992, the legislature again sought from CalPERS relief for the state's budget woes.

• As I mentioned earlier, before 1990, all contributions to CalPERS, both from the employer and from employees, were made monthly.

Ø In 1990, as part of our negotiations, the frequency of these contributions was changed to quarterly. This had the effect of shifting the fourth quarter to the next fiscal year, so that the 1990-91 fiscal year miraculously only had three quarters.

Ø In 1991, though, when four full quarters would again be due, the legislature adopted a one-time, semi-annual payment schedule. This had the effect of moving two quarters to the next fiscal year.

Ø But, in 1992, when the state was faced with paying 6 quarters, the semi-annual payment schedule was made permanent. And, the legislature (SB 1107) added a twist, through the concept of "in arrears financing". That is, contributions that previously were due immediately after a six month period, (e.g., on July 1, for the period of January 1 through June 30) were delayed for another six months (not becoming due until January 1 of the following year).

• Given this history, is it any surprise that in 1993, the trend continued? In the midst of a hurried budget "compromise" arose SB 240. This legislation again delayed both the funding frequency and period, making contributions now due annually, 12 months in arrears. So, for the services that I, as a state employee, performed on July 1, 1995, my employer would not make contributions to the retirement fund until July 1, 1997.
• But, this time, we tried a different litigation strategy. In Claypool, we took our case directly to an appellate court, and argued the law. Instead of this route (which would have been to the same court as gave us Claypool), we started in Superior Court and argued both law and facts. We presented expert evidence – largely uncontroverted – concerning both the actuarial impact on the fund of what was in essence two years of skipped contributions, and the impact on governmental obligations of "in arrears financing".
• We won at the trial court, with the ordering the state's officers to return to quarterly payments and immediately pay all past due quarterly contributions. The court also awarded CalPERS pre-judgment interest, at the System's then-assumed earning rate (8.75%). The Governor appealed, and – with the strong record developed below – we were ultimately victorious at the appellate level as well.
• In an 83-page published opinion (Board of Administration, et al. v. Wilson, et al. (1997) __ Cal.App.2d __ [61 Cal.Rptr.2d 207, 97 Daily Journal D.A.R. 1731]), a California appeals court declared unconstitutional these legislative actions which changed the frequency and payment period for the state's contributions to its pension fund. This case represents the first California case to state, in other than dictum, that public employees have a vested contract right to an "actuarially sound" retirement system. Moreover, the court rejected for lack of proof the governor's defense of "fiscal emergency", following well-established federal case law (United States Trust Co. v. New Jersey (1977) 431 U.S. 1 [52 L.Ed.2d 92]) that the government's impairments of its own contracts must be justified under a "strict scrutiny" analysis.
• The governor based his appeal principally on criticizing the economic impact evidence as "speculative", and justifying the contract impairment under a "necessity" defense. Many additional issues (e.g., statute of limitations, laches, acquiescence, failure to mitigate) were also raised, but easily dismissed by the court.
• The appellate court's affirmation of the trial court's decision is significant to CalPERS, and perhaps other public funds nationwide, in a number of respects. First and foremost, it mandates a return to the quarterly payment schedule, thus preserving CalPERS fundamental "level contribution" system. It is this "level contribution" system that ensures that today's taxpayers are paying for the retirement expenses of today's public servants – rather than passing responsibility on to future generations.
• Second, as discussed above, the decision provides the most direct legal precedent to date for the proposition that CalPERS members have a contract right to an "actuarially sound" retirement plan. Moreover, the decision explains that "soundness" does not necessarily equate with "solvency" (i.e., the current benefit stream need not be directly jeopardized to impair "soundness").
• Third, the Court firmly rejected, under a strict scrutiny analysis, the oft-stated employer defense of "budget emergency." Even giving the Governor the benefit of any doubt that a "fiscal emergency" did in fact exist in 1992 and 1993, the Court determined that SB 1107 and SB 240 were not appropriate for the "emergency." The Court based this conclusion on (a) the over-breadth of the legislation (i.e., they represented a permanent change to the contribution flow, extending far beyond the duration of the stated "emergency"); and (b) the lack of legislative consideration of the actuarial impact on CalPERS, or of other possible less drastic alternatives. In this latter regard, the Court found the lack of input from CalPERS Board to be significant. Lastly, in response to the Governor's argument that, without SB 1107 or SB 240, more drastic action would have been necessary (e.g., layoffs, modifying future pension benefits), the Court stated:

"However, the test is not whether it [impact on CalPERS]
could have been worse. The question is whether it could have been better, i.e., whether there were less drastic alternatives."

• Finally, the Court upheld the issuance of a writ of mandate as to the contributions themselves. This is significant because it requires the appropriate state officials to transfer to CalPERS the past due quarterly contributions; payment does not require further legislative appropriation.
• The California Supreme Court denied the Governor's Petition for Review; this significant case is now final.