This article originally appeared on the Capitol Weekly Web site. Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. His blog is

A labor-friendly CalPERS board offered local governments an incentive eight years ago to boost public employee pension benefits, now called “unsustainable” by some.

CalPERS said it would reward higher benefits by inflating the value of the local government’s pension investment fund, making it easier to pay for more generous pensions.

Booming pension fund earnings in previous years were cited in a self-congratulatory board resolution approving the incentive in 2001. But the stock market boom had already cooled by then.

The CalPERS chief actuary, Ron Seeling, advised against the plan to inflate the market value of the assets, Tom Branan reported in the May/June 2001 issue of The Public Retirement Journal.

The California Public Employees Retirement System could not say how many of the 1,800 local government retirement plans had their assets inflated in exchange for increasing pension benefits.

The inflation incentive was approved as a bill, AB 616, was moving through the Legislature that would allow increased pension benefits for local governments contracting with CalPERS as well as for county retirement systems covered by a 1937 act.

Supporters said the legislation would allow labor unions representing miscellaneous workers to bargain for contracts increasing their pension benefits by a third, according to an Assembly floor analysis of the bill.

The supporters said a bill enacted two years earlier, SB 400, had allowed benefit increases of up to 50 percent for local government safety workers in CalPERS- mainly law enforcement- but did not cover local miscellaneous workers.

The bill, SB 400, sponsored by CalPERS in 1999 also allowed increased pension benefits for state miscellaneous and safety employees. A cut in state worker pension benefits enacted under former Republican Gov. Pete Wilson in 1991 was undermined.

The reduced “tier two” benefit formula enacted under Wilson was made optional, something new state workers had to apply for in their first 180 days on the job. Workers in “tier two” could move to the new “tier one” by paying back contributions with interest.

SB 400 also took the unusual step of authorizing a retroactive increase in pension payments to retirees, ranging from 1 percent to persons who retired in 1997 to 6 percent to persons who retired in 1974 or earlier.

Setting the pattern for what would happen two years later, the legislation only took effect if CalPERS inflated the assets of pension funds that increased benefits, pushing their estimated worth from 90 to 95 percent of market value.

What drove the big pension benefit increases?

The first Democratic governor in 16 years, Gray Davis, took office in 1999. The pension benefit increase in SB 400 was a priority of powerful public employee unions, a traditional Democratic ally.

More importantly, a ballot measure in 1984 narrowly approved by voters, Proposition 21, lifted a cap that allowed public pensions to invest only 25 percent of their funds in stocks, leaving the rest in bonds and other predictable-yield investments.

Pension funds switched to a broad “prudence” rule at the outset of a historic stock market boom in the 1980s and 1990s. CalPERS would eventually get 75 percent of its revenue from investments, dwarfing contributions from employers and employees.

By 1999 CalPERS was awash in surplus funds. The annual payments that state and local governments are required to make to CalPERS and other pension funds were dramatically reduced, sometimes all the way to zero.

But a sore point for workers was that their annual payment to the pension funds, usually 5 to 9 percent of pay, did not drop despite the surplus. The employee payments are set by legislation, not by the powerful pension boards that set employer rates.

Some local governments pay all or part of the employee pension contribution, a policy now under fire in San Diego County and other areas.

A surplus is cited in the resolution adopted by the CalPERS board in June 2001 offering pension funds the incentive to raise benefits, an accounting change boosting their assets to as much as 110 percent of market value.

CalPERS annual investment earnings averaged 15.6 percent during a five-year period ending the previous June, well above the 8.25 percent rate assumed at the time in actuarial forecasts.

The resolution said the 1,800 local plans in CalPERS had aggregate funding of 128 percent in June 1999. A few of the plans were below the 80 percent funding some think is the acceptable minimum, but 92 percent were funded at 100 percent or better.

CalPERS told the Legislature that the benefit increases in SB 400 could be paid for by “superior” investment earnings and the accounting change that boosted assets from 90 to 95 percent of market value.

Annual state contributions to CalPERS were expected to remain roughly unchanged for the next decade. But the CalPERS forecast was wrong, mainly because of a weak stock market not the cost of the increased benefits.

State payments to CalPERS, $157 million in 2000, soared to $2.5 billion by 2005 ($3.3 billion this year). Gov. Arnold Schwarzenegger briefly backed a plan to switch new state and local government hires to a 401(k)-style individual investment plan.

Now the financial crisis is raising questions about public pensions nationwide. The Washington Post reported over the weekend that there is “doubt as never before whether these public systems will be able to keep their promises to future generations of retirees.”

Last June, Schwarzenegger proposed a sweeping reduction in pension and retiree health benefits for new state workers, calling current benefits “unsustainable.” He would roll back the SB 400 increase, returning to the Wilson benefit levels.

The governor’s pension advisor, David Crane, a Democrat who helped build a global investment firm, is among those who think that current state pension benefits are based on earnings forecasts that are too optimistic.

A reform group formed by former Assemblyman Keith Richman, R-Northridge, and others, the California Foundation for Fiscal Responsibility, is talking about placing an initiative on the November 2010 ballot to cut pension benefits for new state and local government hires.

A touchstone for the pension reformers is a brief remark made by the CalPERS chief actuary, Seeling, during a seminar in Sacramento in August.

“I don’t want to sugarcoat anything,” Seeling said. “We are facing decades without significant turnarounds in assets, decades of — what I, my personal words, nobody else’s — unsustainable pension costs of between 25 percent of pay for a miscellaneous plan and 40 to 50 percent of pay for a safety plan … unsustainable pension costs. We’ve got to find some other solutions.”

This article originally appeared on the Capitol Weekly Web site. Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. His blog is