Lawsuits in Minnesota, Colorado and South Dakota aim to reverse new state laws that reduce cost-of-living adjustments for retired public employees, and the outcome could affect other states' efforts to make similar changes.
Minnesota passed a law in 2009 replacing the annual COLA — which used a formula based on the consumer price index and the state retirement systems' investment returns — with a flat 2.5% annual adjustment until state plans reach a 90% funding level.
Colorado, which had a guaranteed 3.5% annual COLA for public employees and 3.25% for Denver public school employees, froze COLA adjustments in 2010 and replaced the automatic adjustment effective 2011 with a formula capped at 2% until the funded status exceeds 103%.
South Dakota in July replaced its automatic annual COLA of 3.1% with a formula that determines the annual adjustment based on the funded status of the state's pension plans.
Other states are considering making similar changes to the COLAs.
In Ohio, a coalition of unions, retirees, pension plan administrators and others are considering asking the Legislature to reduce the annual COLA to 2% from 3% for existing and future retirees, and New Jersey Gov. Chris Christie said in September that he aims to suspend COLAs for existing retirees.
Stephen Pincus, a partner with Pittsburgh-based law firm Stember Feinstein Doyle Payne & Cordes LLC, represents the plaintiffs in the Colorado, Minnesota and South Dakota suits. In all three states, he claims, the changes violate state and federal contract and so-called takings clauses. The COLA adjustments are contractual obligations between the state and retirees, the contract argument goes. The takings clause strategy argues that private property cannot be taken for public use without just compensation.
Mr. Pincus said, however, that states facing significant budget problems could get federal courts to support the proposals out of financial necessity.
“Most states find that pensions are contracts between the employee and the employer, and if (a court) establishes that there is a contract and this contract has been substantially impaired, the state can get out of its contract if it is able to show it's reasonable and necessary to serve an important public purpose,” Mr. Pincus said in a telephone interview.
Mr. Pincus said he believes the three states have not explored other avenues for improving the funded status of their pension plans. The $5.6 billion South Dakota Retirement System, Sioux Falls, was 91.2% funded as of June 30, 2009, the most recent data available. The $36 billion Colorado Public Employees' Retirement Association, Denver, was 67% funded as of Dec. 31, 2009. The $10.1 billion Public Employees Retirement Association of Minnesota, St. Paul, was 70% funded as of June 30, 2009, the most recent data available.
University of Minnesota Law School professor Amy B. Monahan, author of the paper, “Public Pension Plan Reform: The Legal Framework,” said in a telephone interview that courts undertake a three-part analysis to determine whether a state's actions are unconstitutional under the contract clause. If the court determines a contractual relationship exists and that the contract has been broken, then changes to the contract still may be constitutional if “no other less drastic modification could have been implemented and the state could not have achieved its goals without the modification.”
It is uncertain, though, how courts will interpret the cases because there is little case history on COLA changes to serve as a precedent, Ms. Monahan said.
Ronald K. Snell, director of the state services division in the Denver office of the National Conference of State Legislatures and author of the report “Pensions and Retirement Plan Enactments in 2010 State Legislatures,” said in an interview that some states explicitly protect pension plan benefits for retirees in their constitutions and statutes.
New York, for example, amended its constitution in 1940 to identify membership in a state pension plan as “a contractual relationship, the benefits of which shall not be diminished or impaired,” according to an analysis by the National Association of State Retirement Administrators.
Arizona, Alaska, Hawaii, Illinois, Louisiana, Michigan have similar constitutional protections on pension contracts, according to NASRA, while others have specific protections through state statutes and court decisions.
Pension benefit protections in many states are more ambiguous. In Delaware, for example, courts recognize contractual rights only for vested employees who have fulfilled retirement eligibility requirements, according to NASRA.
States such as Indiana and Texas still statutorily consider pension benefit payments as “mere gratuities that do not vest and can be amended or modified at any time by the state,” according to Ms. Monahan's paper.
Mr. Snell said regardless of the outcome of the three pending cases, states could still move forward with their own plans to reduce COLAs because state courts are not bound by the decisions of other state courts.
“If it rises to the federal judiciary, it might be a different situation,” he said.
He also said that although any of the three cases could go to state appellate courts, he does not believe they would make it all the way to the U.S. Supreme Court, which could establish a nationwide precedent with its decision.
In New Jersey and Ohio — two states also considering changes to COLA payments — decisions are likely to play out very differently from one another.
Steve Baker, a spokesman for the Trenton-based New Jersey Education Association, a union representing New Jersey public school teachers, said the union has not seen a formal plan outlining Gov. Christie's intention to suspend COLA payments for retirees, but he noted that if it “violated the legal rights of our members, it would invite a legal challenge.”
“We hope that the Legislature will be wise enough to realize that making changes that are illegal invite costly legal challenges that set the state back further,” he said in a telephone interview.
In Ohio, the Ohio Federation of Teachers has worked with a coalition of stakeholders — such as the Ohio Education Association, retiree advocates and state pension plan representatives, including from the $60 billion State Teachers Retirement System of Ohio — to advance a plan that would, among other things, reduce COLAs for teacher retirees. The teachers'system was about 60% funded as of July 1, 2009.
The coalition known as Healthcare & Pension Advocates for STRS has approved a proposal that would reduce the COLA for teachers in the retirement plan by one percentage point to 2%, Sue Taylor, president of the Ohio Federation of Teachers, Columbus, said in a telephone interview.
While the Ohio teachers system adopted a separate proposal in July that also would reduce the COLA for its retirees to 2%, Ms. Taylor, who spoke as a representative of the union and not of the HPA, said the pension and health-care coalition's proposal contains differences on issues other than the COLA reduction for existing retirees. It has not yet been voted on by the retirement system board.
Michael J. Nehf, STRS executive director, did not return calls requesting an interview.
The COLA change is one of several proposals in the pension reform plan approved by the HPA, but Ms. Taylor described it as the “trigger that would give us the biggest bang for the buck in terms of (pension plan) insolvency.”
William W. Leibensperger, co-chairman of the coalition, said the COLA change might save the system $6.13 billion over a 30-year period.
Ms. Taylor said the lawsuits in Minnesota, Colorado and South Dakota were recently brought to her attention, adding that the potential for lawsuits was not discussed in the working group.
If approved by the teacher retirement system, the Ohio plan still would need legislative approval.
Building a consensus among stakeholders is no guarantee the proposal will avoid a legal challenge; Colorado tried a similar approach and the COLA issue still ended up in court.
COPERA board members spent much of 2009 holding informational meetings with stakeholder groups and others to solicit recommendations on fixing the state's underfunded pension, COPERA CEO Meredith Williams said in an interview.
He said the package of legislation approved by the Colorado General Assembly is expected to save the pension system $9 billion over the next 30 years, the timeframe the system projects it will take to get the pension system back to 100% funded status.
Mr. Williams could not say how much changes to the COLA would contribute to that $9 billion.