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Battle lines

Public pension plans brace for legal challenges to cuts

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Fighting: Steve Kreisberg said AFSCME is prepared to challenge any changes.

Several high-profile court cases and the prospect of more might be writing the next chapter of public pension reform, as bold — or desperate — legislators take aim at current workers' benefits, once considered untouchable.

“There is just so much pressure on state budgets, and pensions eat up more and more of them. It's going to drive more changes, and a lot will be decided in the courts,” said Amy Monahan, professor of law at the University of Minnesota, Minneapolis, who specializes in pension law.

Right now, all eyes are on New Jersey and Rhode Island, where legal challenges to dramatic pension reforms affecting current workers await decisions by the states' supreme courts. Similar cases also have been filed by employee groups in Louisiana, Michigan and New Hampshire, challenging benefit changes that include greater employee contributions, higher retirement ages or lower pension multipliers.

“It's an emerging area of law,” agreed Steve Kreisberg, director of collective bargaining at the American Federation of State, County and Municipal Employees, Washington. While he doesn't expect widespread cuts to current workers' benefits, “we're preparing for it. Any change is a deal we will fight.”

While he and other public employee advocates also are braced for skirmishes later this year in other states, including Montana and Texas, the next battleground is likely to be Ohio.

Five bills — one for each of Ohio's five public pension funds — await legislative action scheduled for Sept. 12. They would raise employee contributions or reduce pension formulas for all public defined benefit plan participants, including those in the $75 billion Ohio Public Employees' Retirement System and the $63.8 billion Ohio State Teachers' Retirement System, both in Columbus.

In New Jersey, where the Division of Investment, Trenton, oversees $67.2 billion in pension assets, legislators dared to touch what Gov. Chris Christie called “the third rail of politics” by passing a package of pension reforms in 2011 that included higher contributions from current workers and the elimination of cost-of-living adjustments. Within two months, public employee groups led by the New Jersey Education Association sued to have the changes considered contractual violations. Dismissed by a district court, the lawsuit is now before the state's superior court.

In Rhode Island, pension plan changes passed by the General Assembly in 2011 to raise the funding level of the $7.2 billion Employees' Retirement System of Rhode Island, Providence, swiftly drew four lawsuits. The suits challenge, among other things, a mandatory defined contribution plan, a higher retirement age and the correlation of COLAs to investment returns. As the legal challenges work their way up to Rhode Island's highest court, Treasurer Gina Raimondo is confident that the state's actions, which “represent the culmination of 11 months of thoughtful, fact-based analysis and input,” will hold up in court, she said in a statement after the suits were filed.

Blazing new trails

Alicia Munnell

These cases could blaze new legal paths because most states are not legally prohibited from changing benefits for current workers, particularly when it comes to benefits not yet accrued. Research conducted by the Center for Retirement Research at Boston College found only three states — Alaska, Illinois and New York — are limited by their constitutions from reducing benefits for current employees.

“I was very surprised that very few states had these provisions in their constitutions. Everyone said that benefits in the public sector couldn't be touched,” Alicia H. Munnell, retirement center director, said in an interview.

In most states, the legal framework for worker retirement benefits relies on a contracts-based approach. Under this approach, states are prohibited from passing a law that impairs existing public or private contracts.

Some governments are now interpreting contract law to allow changes if those changes would serve a greater public purpose, like avoiding fiscal calamity, or not creating a disadvantage for one group of workers, in this case new or future workers with less generous pension benefits. Other states are finding that contract clause protections apply only to benefits already accrued or to workers who are vested.

“It is a balancing test,” said James E. Spiotto, a partner in the Chicago office of law firm Chapman and Cutler LLP, who handles a lot of municipal default and bankruptcy cases. “Ultimately, the question is, "Will the government be able to pay?' I think there is some precedent (for cutting benefits if they aren't) sustainable and affordable. Governments not able to fulfill their primary mission have been able to impair contracts of all kinds.”

Even in states with clear constitutional protection or strong legal precedent, like Illinois and California, “there is certainly a willingness to challenge the interpretations of the past,” said Ron Snell, a retired senior fellow at the National Conference of State Legislatures, Denver. “Sooner or later, they will enact legislation that will be challenged, to get it clarified.”

The first issue that courts will have to address, said the University of Minnesota's Ms. Monahan, “is what's the least drastic way to achieve fiscal balance? What do you have to do first?”

The Florida Supreme Court will address that question following a 2011 circuit court ruling that said requiring any contribution from participants in the $122.7 billion Florida Retirement System, Tallahassee, violated a constitutional obligation that could not be sidestepped because of a budget crisis.

“To have the strongest case possible, a jurisdiction will need to show that they engaged in a good-faith effort to look at everything — including tax increases and service cuts — and that they tried to negotiate,” said Josh McGee, vice president for public accountability initiatives at the Laura and John Arnold Foundation, Houston. Mr. McGee consulted with state officials on pension reform efforts in Rhode Island and Illinois.

Following closely

The budget question is also driving new arguments in California, where case law typically treats even future pension benefits as contractually protected. After voters in San Jose approved a proposal to allow current employees to choose whether to pay more to keep their existing retirement plan or switch to a plan with reduced benefits and a higher retirement age, employee unions filed lawsuits challenging the move.

Ms. Monahan is watching the San Jose challenge closely, noting that a city charter gives the City Council express authority to change pension benefits.

The outcome in San Jose will help establish broader legal precedent on whether future benefits of current workers are protected, Ms. Monahan said, because it would happen in a state that has moved furthest away from an era in which pension benefits were considered “gratuities” that could be easily taken away.

In Arizona, the state's effort to raise employee contributions was rejected in court. The Arizona Education Association successfully sued after lawmakers in 2011 raised employee contributions to the $28 billion Arizona State Retirement System, Phoenix, to 53% from 50% to save public employers money. After a state Superior Court ruled the increase was an illegal salary cut, the state had to refund the extra contributions.

While these legal questions will be decided state by state, they all are being watched closely. “If one state's highest court rules, I think other states will pay attention,” said John Adler, retirement security campaign director for the Service Employees International Union, Washington. “And regardless of what happens in one state or another, I'm sure it's going to be a continuing challenge.”

Mr. Adler thinks some states might try to avoid direct legal confrontations by offering workers a choice, for example between a COLA or retiree health benefits.

Given the need for immediate benefit reductions that cannot come from newly hired or future workers alone, more changes affecting current employees are likely. While the political and popular limitations of that strategy are another matter, “not being able to touch future benefits for current workers ... ties the hands of sponsors too much. They need that flexibility,” Ms. Munnell said.

This article originally appeared in the September 3, 2012 print issue as, "Public plans brace for legal challenges to cuts".