SAN IPSE CAPITAL OF SILICON VALLEY

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1 CITY OF je: ^2 SAN IPSE CAPITAL OF SILICON VALLEY TO: HONORABLE MAYOR AND CITY COUNCIL COUNCIL AGENDA: 5/02/2017 ITEM: 3.3 Memorandum FROM: Jennifer Schembri SUBJECT: SEE BELOW DATE: April 24, 2017 Approved Date SUPPLEMENTAL SUBJECT: ORDINANCE IMPLEMENTING CHANGES FROM THE ALTERNATIVE PENSION REFORM FRAMEWORK AGREEMENT AND MEASURE F REASONS FOR SUPPLEMENTAL The reason for the supplemental memorandum is to provide the City Council with the comments from the Federated City Employee's Retirement System's Board and Counsel. ANALYSIS The attached letter is the response from the Board's counsel that provides their comments on the proposed amendments. (Attachment A) On April 13, 2017, the City Administration submitted the proposed ordinance to the Federated City Employee's Retirement System's Board (Federated Board) for its consideration. On April 20, 2017, the Federated Board approved a motion to endorse the comments on the ordinance provided by their counsel, Reed Smith. These comments have been attached to this memo. DIRECTOR OF EMPLOYEE RELATIONS For questions, please contact Jennifer Schembri, Director of Employee Relations at (408) Attachment A - Letter from Jeffrey Rieger dated April 13, 2017

2 ReedSmitii From: Jeffrey R. Rieger Direct Phone: MEMORANDUM Reed Smith LLP 101 Second Street Suite 1800 San Francisco, CA Fax reedsmith.com By Electronic Mail To: Board of Administration of the Federated City Employees' Retirement System Date: April 13,2017 Subject: Proposed Plan Amendments to Implement Measure F and the City's Framework Agreement with its Non-Safety Bargaining Units BACKGROUND The voters of San Jose passed Measure B on the June 5, 2012 ballot. The measure significantly amended the City Charter provisions relating to the Federated City Employees' Retirement System ("Plan"). Following passage, the City adopted several ordinances amending the Municipal Code's Plan provisions, to carry out the measure's terms. The City's key bargaining units immediately challenged Measure B, and many of its provisions were invalidated in an April 30, 2014 Judgment entered by the Superior Court. The parties filed cross-appeals from the trial court's rulings, and the matter has been pending appeal for over two years. During this period, however, Measure B was formally repealed by a second Superior Court ruling and a related May 10, 2016 City Council Resolution. The repeal has left several Plan provisions (especially those related to "Tier 2" members) in legal limbo. In November, 2015, the City and its Federated bargaining units reached an Alternative Pension Reform Settlement Framework Agreement ("Framework"). The Framework replaces the Measure B Tier 2 with a new Tier 2, creates a Medical Panel in lieu of the Board of Administration to determine all disability applications and makes several other changes to the Plan. The Framework anticipated that formal repeal of Measure B and its enabling ordinances would be accomplished through another measure, Measure F on the November 8, 2016 ballot, and enabling ordinances to be adopted by the City Council consistent with Measure F. The voters approved Measure F on November 8, For over a year now representatives of the City and its bargaining units have met and conferred over the terms of the Measure F enabling ordinances. Along the way, the parties requested that the Board authorize its counsel to assist them in crafting language for the ordinances that would meet legal requirements and minimize administrative burdens for the Office of Retirement Services. At the Board's direction we have provided written input and attended meetings with the bargaining parties. The parties generally were receptive to our recommended changes designed to resolve ambiguities or avoid conflicts with other retirement laws. The parties generally were not receptive to our recommendations that they believed might be inconsistent with their intent under the Framework. ABU DHABI ATHENS BEIJING CENTURY CUY CHICAGO DUBAI FRANKFURT HONG KONG HOUSTON KAZAKHSTAN LONDON LOS ANGELES MUNICH NEW YORK PARIS PHILADELPHIA PITTSBURGH PRINCETON RICHMOND SAN FRANCISCO SHANGHAI SILICON VALLEY SINGAPORE TYSONS WASHINGTON, D.C. WILMINGTON FCERS

3 April 13, 2017 Page 2 We have now been asked to advise the Board regarding the current draft of the proposed ordinances, which is the draft accompanying this Memorandum. This Memorandum discusses the most important remaining issues that we raised with the parties, but which have yet to be addressed in the proposed Municipal Code amendments. 1 We recommend that the Board adopt this Memorandum as its "report or recommendation" to the City Council pursuant to Municipal Code section and transmit it to the Council. ADMINISTRATIVE ISSUES The increased complexity of the Plan will make administration of the Plan more difficult. Members who earn retirement benefits under the same terms generally are described as belonging to a retirement "tier." Until Measure B passed, there was only one tier in this Plan. Although some benefits changed over the years, the changes were incremental and therefore posed fewer administrative challenges than the amendments that are contemplated now. The new amendments will essentially result in at least four tiers: (1) Tier 1 for members who were never impacted by Measure B; (2) a new tier for members who were previously hired into Measure B's Tier 2, but will be reclassified as Tier 1 (these members will earn the same benefits as other Tier 1 members, but will have different contribution rates); (3) a new Tier 2; and (4) a new tier for members who were previously hired into Measure B's Tier 2, but will be reclassified as new Tier 2 (these members will earn the same benefits as other Tier 2 members, but will have different contribution rates) See SJMC Further, there will be additional distinctions with respect to COLA adjustments within Tier 2 (section ) and Tier 2 members associated with certain bargaining units are subject to different terms than other Tier 2 members in some cases. Thus, as a practical matter, there will be more than four tiers for ORS staff to administer. ha consultation with ORS staff, we believe that the increased administrative complexity of the Plan will lead to higher administrative costs to be paid by the City and Plan members. For example, staff is currently in the process of implementing a new pension administration system, a five year project with a projected cost exceeding $7 million. Designing, testing and implementing that system has also required substantial efforts of retirement staff, drawing resources away from the ordinary administration of the Plan. Some aspects of the system will have to be redesigned once these new Plan amendments become effective and, of course, the City will also have to ensure that its reporting systems comply with the complex new rules. The added administrative complexity of the Plan likely will result in higher rates of We do not discuss in this Memorandum whether any of the proposed Plan amendments impair members' vested contractual rights under the California and United States Constitutions. We assume for purposes of this Memorandum that the bargaining units had full authority to enter into the Framework and bind their individual members. The Board has no role in determining the constitutionality of the City's benefit plans. In addition, because the Board has no anticipated role in the proposed "Voluntary Employees' Beneficiary Association" ("VEBA") plan under the Framework, we do not believe the Board needs to comment on that aspect of the Plan amendments, other than to acknowledge that approval of the Internal Revenue Service is a condition precedent to the effectiveness of the VEBA and the Board's authority to allow the transfer of assets out of the health care trust fund.

4 April 13,2017 Page 3 errors by retirement staff and the City, as well as more confusion among Plan members. If the amendments pass in their current forms, it will essential for the City and the ORS to engage in substantial efforts to establish sensible reporting systems that limit the error rate. THE MEDICAL PANEL The Framework and proposed ordinances contemplate that the Board will cease to determine whether to grant or deny members' disability retirement applications; instead those determinations would be made by a panel of physicians, subject to appeal to an independent Administrative Law Judge. Based upon our review, we believe there are significant roadblocks to implementing the ordinances as proposed: Qualifications: To qualify for the Medical Panel, the physicians must never have served as a "Qualified Medical Examiner" ("QME") or an "Agreed Medical Examiner" ("AME"). SJMC (B). It appears that those requirements will make it difficult to appoint qualified physicians to the Medical Panel. Indeed, in anticipation of the new amendments going into effect as of January 1, 2017, at the bargaining parties' request, the Board has already conducted a "Request for Proposal" ("RFP") process and did not receive any qualified responses. It appears that the non-qme/ame requirement has eliminated from consideration most physicians who might otherwise be willing to serve on the Medical Panel. New Disability Procedural Deadlines: The Framework establishes new procedural deadlines for the disability application process: (1) members must submit all necessary medical documentation within one year of separation from service; and (2) the Medical Panel must make a final determination within four years after the member applies for disability. See SJMC These new deadlines will be challenging to administer. Uncertainty regarding whether and when an applicant has reached "maximum medical improvement" ("MMI") (thus indicating permanence in his or her claimed disability) historically has caused the longest delays in processing disability applications, but the new deadlines do not account for that uncertainty. Although the Medical Panel would have authority to grant exceptions to the deadlines, there will be increased administrative burdens associated with tracking the new deadlines and having the Medical Panel consider granting exceptions from those deadlines. Increased Administrative Costs: The administrative costs of the Medical Panel are likely to be greater than any savings resulting from the Medical Panel, because (a) it is not clear that the Medical Panel will grant any fewer disability applications than the Board currently grants and, if it does, it is not clear that those denials will withstand judicial review, and (b) the compensation paid for the services of the threeperson Medical Panel will be substantial and there will be additional administrative costs (legal and expert witness fees, transcripts, staff time, etc.) related to the proposed administrative appeal process. Office of Administrative Hearings: The proposed ordinance amendments (and Measure F itself) contemplate that all interested parties will have the right, in every case, to appeal the Medical Panel's determination to an Administrative Law Judge ("ALJ") at the State of California's Office of Administrative Hearings ("OAH"). See SJMC (C). Administrative Law Judges hold legal

5 April 13, 2017 Page 4 degrees, not medical degrees. Under the contemplated ordinances, the ALJ would have full authority to overrule the decision of the Medical Panel. The ALJ's decision will be the final decision at the administrative level, appealable to the Superior Court by writ of mandate. Given that the primary purpose for the Medical Panel was to appoint three qualified, independent physicians to decide disability applications, we question the wisdom and efficacy of giving final authority to an attorney not necessarily experienced in medical issues. Of course, creating a new right to a full administrative appeal will add another layer of administrative costs and delays to the disability review process. That cost, and the additional legal fees that may be incurred, will be assessed as administrative expenses of the Plan, to be charged to the City and the members. Because Measure F requires the creation of a Medical Panel, many of our concerns cannot be remedied by the parties alone, but we recommend that the parties find ways to work within the confines of Measure F to establish a more workable paradigm. This would include, for example, (1) eliminating the prohibition against members of the Medical Panel having prior service as a QME or AME, and (2) finding a better way to limit the delay that accounts for the MMI issue, rather than using arbitrary deadlines. These changes can be made within the context of Measure F's current language. PURCHASE OF SERVICE CREDIT Some of the purchase of service credit provisions require the member to pay the "entire cost" or "any amounts that would otherwise result in an actuarial loss to the City." See, e.g., section These phrases are ambiguous and will require to the Board to exercise its best judgment as to what the Board believes is intended. It appears that the bargaining parties were contemplating that the full actuarial cost of the projected service credit benefit - both the member's and City's share of the normal cost contributions - would be paid by the member, plus interest at the actuarially assumed rate. We recommend that this "entire cost" amount be used and expressly stated in the proposed ordinances. CITY MANAGER DISCRETION To TERMINATE TIER 2 HEALTH PLAN Section (F) provides: "The City Manager has the authority and discretion to terminate Tier 2 retiree health benefits under Parts 16 and 17 prior to the implementation of Chapter 3.58." We understand that representative employee bargaining units have requested this amendment because they do not believe that Tier 2 members (under the amended Plan proposed to carry out the parties' "Framework" agreement and the recently approved Measure F) will want to make contributions towards the existing medical plan while the City awaits the IRS' approval of the proposed VEBA plan. We further understand that the proposed amendment gives discretion to the City Manager regarding termination before IRA approval, rather than providing for automatic termination, because the negotiating parties believe the City Manager should have some flexibility to deal with uncertainties and delays that may arise during IRS review of the VEBA plan.

6 April 13,2017 Page 5 Giving a public official discretion to unilaterally terminate a benefit plan paid for by pre-tax dollars is a typical. Accordingly, we recommend that this proposed amendment be reviewed by the parties' respective tax counsel to assure continued compliance with the Plan's tax-qualified status. Further, if a continuing Tier 2 member would have become eligible to receive benefits under the current plan but for the City Manager's termination of the plan, that member may contend that his or her participation in the current plan was a vested right that could not be impaired through collective bargaining. We believe that the law on this issue is unsettled, and we do not reach any conclusions here, but we raise the issue for consideration, particularly in light of the fact that this new provision creates the possibility that there could be a time period during which continuing Tier 2 members would not be covered by either the existing medical plan or the VEB A plan. Finally, the proposed amendment impliedly, but not expressly, suggests that upon the termination of the existing Tier 2 retiree medical benefits plan, the employee contributions previously made to that plan will remain in suspense in the 401(h) account maintained in the Federated Plan, credited to member accounts, until such time as the IRS approves transfer to another plan, or withdrawal by the affected members. We recommend that this treatment be made explicit in the proposed ordinance. DRAFTING ISSUES Confusing Descriptions: Throughout the amendments, certain groups of individuals are described with lengthy, convoluted phrases. For example, proposed new section (A)(2) describes a certain group of members as follow: [M]embers who accept employment on or after September 30, 2012 who is otherwise eligible for this plan and who was an active member in another California public retirement system, with which this plan has reciprocity under Part 21, and who has a break in service of less than six months from that covered employment and employment with the city, other than those who meet the definition of new members as defined by Government Code section (f) as may be amended, but on and after [date this ordinance becomes effective] remain in the plan but are no longer considered tier 2 members under the definition of tier 2 member under section This is typical of language that appears throughout the proposed ordinance amendments. It is difficult to understand and, we fear, difficult to administer. It invites confusion among the members, ORS and the City. We recommend that the proposed amendments include a working glossary of defined terms to streamline the language of the amendments. For example, the members described above could probably be called "New Hires with Pre-PEPRA Reciprocity." Redundancy: Throughout the amendments, we find substantial redundancy and, in some cases, that redundancy may lead to unintended consequences. For example, the new language in section is redundant of other sections and seems inappropriate for inclusion in section

7 April 13, 2017 Page 6 Allocation of Costs: The provisions that establish different rates of contributions for members who will experience a change in benefits (found in section and elsewhere) are unclear about whether the costs will be allocated on a member-by-member basis or spread out across the entire group. Section (E) and the end of (1): These provisions are unclear. They appear to missing words. The foregoing are the key provisions of the proposed Framework ordinances that we believe warrant further attention by the City and its bargaining units. We recommend that this Memorandum be adopted as the Board's report and recommendation to the City Council, pursuant to Municipal Code section