DATE:	January 7, 2005
TO:	Honorable Mayor, City Council and City Manager
FROM:	City Attorney Michael J. Aguirre
SUBJECT:	City Employees’ Pension Reform

INTRODUCTION

The San Diego City Council must act to reduce the $1.167 billion unfunded accrued actuarial liability (”UAAL”) in the City’s employee pension plan. If the Council does not decisively act, the retirement contribution will consume 36.51% of payroll in FY 2009, as compared to 13.43% in FY 2004.

The Council’s decision to create pension benefits without corresponding payment sources is the root cause of the pension deficit. The Council must take all steps necessary to reverse those funding decisions. The City Attorney is advising the City Council to seek a roll-back of all retroactive benefits, a reduction to actual value for all subsidized purchase of service credits, and the elimination of the DROP program. The City Attorney is also advising that the City issue pension obligation bonds. However, the proceeds from those sales should be used to fund settlements with plan participants and not for investment arbitrage. The City Attorney advises these objectives be pursued through the collective bargaining process.

If the Council is unwilling or unable to reduce the $1.167 billion UAAL through the collective bargaining process, the specter of a Chapter 9 bankruptcy filing is very real. The City Attorney is proposing a long-term solution for dealing with the employee pension deficit which rests on a simple theme: pension fund participants should get what they paid for. The City Council must undo past benefit increases for which no funding was provided in order to put the pension on sound financial footing.

THE REMEDY

When the City Council chose to increase retirement benefits, in 1996, 2000, and yet again in 2002, it chose to make those benefit enhancements retroactive. Specifically, a general member employee who had been making retirement contributions based on the annual factors in effect at the time the retirement contributions were made (2.0%, 2.25%, or 2.5%), would receive his/her full complement of service years at the new, higher factor. Employees were not required to contribute to the cost associated with the application of the new factor to past years of service. This created an enormous past service liability to the pension system which is passed on to the City of San Diego as part of the UAAL.

On April 20, 2004, Rick Roeder, actuary to SDCERS, delivered a letter to the Mayor’s Pension Reform Committee. In that letter, Mr. Roeder stated that the cumulative value of the retroactive benefit increases, as of June 30, 2003, was $467.3 million. When examining the sources of the $1.167 billion unfunded actuarially accrued liability, Mr. Roeder calculated that the past service liability associated with retroactive benefit increases made up approximately 40% of the unfunded liability. This cost will be born entirely by the City and future generations of taxpayers.

In order to correct this situation, the Council must take an appropriate position in this year’s “meet and confer” negotiations with City labor unions by insisting that these unfunded liabilities be unwound. Specifically, the City Attorney is calling upon this Council to undo the retroactive increases of the past and give the employees the level of benefits they are entitled to, based upon the contributions they made at the time the benefits were earned.

The City Attorney is not suggesting employees forfeit benefits that were paid for. Rather, the proposal is for the years that contributions were made based on a specific factor, that factor remain in effect when calculating an employee’s ultimate retirement benefit.

Furthermore, in addition to retroactive benefits, City employees also received a windfall when they purchased service credits from SDCERS. Simply stated, the SDCERS Board of Administration failed, or refused, to heed the actuary’s advice and continued to subsidize the cost associated with the purchase of service credits. According to Mr. Roeder, the approximately 1,500 members who have purchased service credits since June 30, 2003, alone, added $22-$25 million to the UAAL. The City Attorney is proposing that the cost to an employee to purchase service credits not be subsidized but rather be actuarially neutral.

Lastly, the City Attorney supports the Manager’s proposal to issue pension obligation bonds. However, simply injecting that money into the system would be ill advised. Instead, the City Attorney proposes using that money to settle out existing members of SDCERS with actuarially determined lump sum payments. The City Attorney is also proposing that the DROP program be eliminated. These reforms will put the system on a stable footing while you determine the shape and structure of the pension system for the next generation of City workers.

LEGAL SUPPORT

A. The Nature of Vested Rights

The doctrine of public employees having a vested right to their public pension was discussed at length by the California Supreme Court in Kern v. City of Long Beach, 29 Cal.2d 848 (1947). In that case, the Court held that public pensions were protected by the contracts clauses of both the California Constitution and the Federal Constitution. The Court found that “[a]lthough there may be no right to tenure, public employment gives rise to certain obligations which are protected by the contract clause of the Constitution, including the right to the payment of salary which has been earned. Since a pension right is an ‘integral portion of contemplated compensation it cannot be destroyed, once it has vested, without impairing a contractual obligation.’” Kern, 29 Cal.2d at 853. The Court also observed that the right to a pension vests upon the very first day of employment. Id. at 852.

This doctrine was further developed by the Court in Allen v. City of Long Beach, 45 Cal.2d 128 (1955). In that case, the City of Long Beach attempted to change existing employees’ contribution rates to the retirement system from two to ten percent. The City of Long Beach also attempted to change the benefit from a fluctuating benefit based on the salaries of current similarly situated employees to a fixed benefit based on an individual employee’s last salary. The Court held that these changes were impermissible modifications to the vested benefits of the existing employees. In so holding, the Court discussed at length the conditions that must be met in order to make a permissible modification to an existing pension benefit. “An employee’s vested contractual pension rights may be modified prior to retirement for the purpose of keeping a pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system. . . . To be sustained as reasonable, alterations of employees’ pension rights must bear some material relation to the theory of a pension system and its successful operation, and changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages.” Allen, 45 Cal.2d at 131.

It should be noted that while the courts have consistently protected retirement benefits, they have also drawn a consistent bright line of demarcation between retirement benefits and employment benefits. While the former are accorded protection under the contracts clause, the latter are subject to the standard meet and confer obligations under the Meyers-Millias-Brown Act for represented employees and general at-will doctrine for unrepresented. See e.g., Vieler v. State of California, 104 Cal.App.3d 392 (1980). Thus, employment benefits are subject to negotiations and can be modified by a public employer while retirement benefits are subject to the parameters discussed above.

The vested rights doctrine has been extended to both the benefits and the funding plan attendant to the pension plan. In Board of Administration v. Wilson, 52 Cal.App4th 1109 (1997), the court held that state employees possess not only a vested right to pension benefits, but a vested right to an actuarially sound system as well. In Wilson, the Governor attempted to delay by one year the state’s payments to PERS. The court found that such action rendered the funding of PERS actuarially unsound and, in turn, impaired employees’ vested right to a sound system. Because the change in funding was not met with a comparable new advantage, the attempted change to the funding scheme was set aside by the court. Wilson, 52 Cal.App.4^th at 1153.

B. Modifying Existing Vested Rights

In light of this long line of established case law, the City of San Diego faces a difficult challenge in attempting to roll back or undo existing benefits for current employees. However, given these perilous financial times for municipalities with defined benefit plans, this office feels the courts will be receptive to our attempt to re-establish financial security to not only the City, but to the pensioners who also depend on the City’s financial stability.

The success of any attempt to roll back benefits is dependent upon reaching an agreement to do so with the labor unions. This office understands that this will not be an easy task. However, given the real possibility of a filing under Chapter 9, this may be the only opportunity employees will have to provide input into the level of pension benefits that they will ultimately receive. Once such an agreement is made, the City will surely face challenges from individual members based on the vested rights doctrine discussed above. However, the City would then be in a position to assert that an individual’s personal vested right to contest a change to his/her vested pension rights was ceded to his/her recognized collective bargaining representative. In Relyea v. Ventura County Fire Protection Dist., 2 Cal.App.4^th 875 (1992), the court held that an individual’s right to self-representation does not confer a right to bargain employment terms and conditions with an employer. In other words, an individual employee cannot independently bargain the terms and conditions of employment which are subject to collective bargaining. Therefore, if the unions entered into an MOU which rolled back pension benefits for current employees, a court should find that an individual employee does not have standing to contest the package adopted by the union.

As stated, this theory depends upon the adoption of roll backs by the respective unions. However, the City is in perilous financial times. This plan gives employees the chance to share and participate in crafting a solution. Without a solution, employees run the risk of a solution being mandated upon them by the bankruptcy court. Unlike the bankruptcy court, which will more than likely mandate an arbitrarily reduced percentage, this plan eliminates the forfeiture resulting from a strict percentage-based reduction and instead, makes reductions based on amounts actually contributed to the system.

Finally, it should be noted that the benefit increases in 2002 affected general employees and union presidents, not public safety employees. In 2002, the general members’ retirement factor was increased from 2.25% to 2.50%. The increases implemented in 2000 were part of a class action settlement to the Corbett litigation. That agreement would have to be modified. However, because an individual’s right to those benefits is again based in contract i.e., the Corbett settlement agreement, the court should be receptive to the argument that an individual’s contract right was ceded to the union. And, as discussed above, because the union stands in the shoes of the individual, an employee does not have standing to contest the modification of the terms of the Corbett settlement agreement.

THE ROLE OF THE CITY ATTORNEY

Pursuant to Charter Section 40, the City Attorney is “the chief legal adviser of, and attorney for the City and all Departments.” Accordingly, the City Attorney represents the entity, the City of San Diego. As such, his actions are governed by Rule 3-600 of the California Rules of Professional Conduct. Under Rule 3-600, an attorney who represents an entity “shall conform his or her representation to the concept that the client is the organization itself, acting through its highest authorized officer, employee, body, or constituent overseeing a particular engagement. . . In dealing with an organization’s directors, officers, employees, members, shareholders, or other constituents, a member shall explain the identity of the client for whom the member acts, whenever it is or becomes apparent that the organization’s interests are or may become adverse to those of the constituent(s) with whom the member is dealing. The member shall not mislead such a constituent into believing that the constituent may communicate confidential information to the member in a way that will not be used in the organization’s interest if that is or becomes adverse to the constituent.”

The City Attorney has made it clear, and will continue to make it clear, that the “client” is the City of San Diego, including the citizens of this great city; for it is the citizens that established the rules by which we operate, and it is the citizens that elect the City Attorney. Let there be no doubt that if at any time any attorney in this Office receives information from a “director, officer or employee” whose interests are adverse to those of the City, the obligation, first and foremost, is to the City of San Diego.

CONCLUSION

What the City Attorney has presented for your consideration is a first step in a long, constructive process to fiscal recovery. It is out of respect for the hard working men and women of this City that the City Attorney submits this plan which ensures that employees receive pension benefits they know are fully funded.

Michael J. Aguirre

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