California Union Gives Up Pension ‘Spiking’

Published September 1, 2006

A contract recently negotiated between the California Department of Personnel Administration (DPA) and Service Employees International Union (SEIU) Local 1000 provides state workers with a salary hike of 3.5 percent this year and a 2 to 4 percent cost-of-living increase in 2007 … and some relief for California taxpayers.

In exchange for the wage hike, the union–which represents 87,000 of California’s state employees–signed off on a plan that would alter the way pension benefit amounts are calculated for new hires. The new formula discourages “pension spiking” just before retirement in order to boost annual pension payouts. With this change, the state takes a small first step toward reforming its costly pension system.

California’s defined-benefit system determines pension allocations through a formula that takes into consideration age, years of service, and peak annual salary (the highest annual amount an employee has earned). Because most employees obtain several promotions throughout their career, typically the peak annual salary arrives near the end of an employee’s tenure, most likely the year just before retirement. This arrangement creates an incentive for employees to accept promotions and then abruptly retire. This leverages the higher salary of the new position into the pension payout and leaves taxpayers to pick up the tab, a big one.

Spiking Adds $100M Annually

Pension spiking is common in California and costs taxpayers an estimated $100 million a year. Add the cost of training replacements for those retirees, and the taxpayers’ burden is much higher. A 2004 report in the Sacramento Bee highlighted the problem by exposing several state employees who took on new positions for the sole reason of inflating their pension benefits. One ex-California Highway Patrol officer stayed in his final position for only six months and still qualified for the higher benefit calculation, which produced a 17 percent jump in his already-generous annual pension.

The costly peak-salary rule that enabled a fatter payout for the officer is unique to the Golden State. The other 49 states avoid such spikes by taking several years’ salary into account in the final pension calculation. Most states use a three-year average of highest annual salary. Others, including Indiana and Minnesota, require a five-year average.

California has gone without a salary average formula since 1990, when a back-room deal put the peak-salary rule in place. That rule was enacted as part of an accord between the state worker unions and the administration of Gov. George Deukmejian (R).

The administration, eager to enact new pension accounting rules with little legislative resistance, dangled the peak-salary measure as a peace offering. The union accepted, and the truce was made. The accounting bill, amended to include the peak-salary rule, was hurried through the legislature without debate. The bill passed with virtually no opposition.

Only Tom McClintock (R-Thousand Oaks), a state Assembly member at the time, voted against it. McClintock, a Republican, is currently a state senator and candidate for lieutenant governor in this November’s general election.

Early Retirements Climb

Since the peak-salary rule’s implementation, California has experienced a great increase in the number of retirements and a decrease in the average age of those who retire.

In the rule’s first year, retirements nearly doubled–from fewer than 3,700 employees to more than 6,400. Since that time, the state has averaged around 6,000 retirements per year, with an average retirement age of 59, two years under the median retirement age for the American workforce as a whole.

Realizing the state was encouraging an experienced workforce to leave, the DPA pushed for the elimination of the peak-salary rule.

Under the new contract agreement, the state will eliminate the peak-salary option for new employees. Workers hired after January 1, 2007 will have their benefits tabulated under a three-year salary average. Proponents of the agreement say it will help maintain a more cost-effective workforce by discouraging employees from taking positions temporarily in order to spike their pensions.

‘Must Stop Expensive Promises’

Noted state Assemblyman Keith Richman (R-Chatsworth), “California politicians must stop making expensive promises to their employees that taxpayers can’t afford to keep. Adoption of a now-universal pension-spiking protection is a baby step on the long road to sustainable, fiscally responsible public employee retirement benefits.

“Without significant leadership and meaningful reforms,” Richman said, “the cost of retiree benefits will continue to erode California’s commitments to education, public safety, transportation, health care, and other vital public services.”

Richard Rider, chairman of San Diego Tax Fighters, also believes the pension-spiking reform is a small but positive step for California. He cautions, “Since it applies only to new hires, it will take decades to take full effect, while our problems are overwhelming us today. Hopefully county and local governments in our state will adopt this reform as well.

“But even this minor concession will be fiercely fought by the unions,” Rider continued, “who will expect some blackmail payoff in exchange for them allowing the reform to go through.”

SEIU’s members approved the new contract by a 94 percent vote and say they are thoroughly satisfied by the outcome.

“It’s a solid contract for us, and for the people we serve,” said SEIU Local 1000 President Jim Hard. “We achieved our goals.”

Anthony P. Archie ([email protected]) is a public policy fellow in business and economic studies at the Pacific Research Institute.