A decision by the California Court of Appeal appears to open a pathway to loosening state constitutional provisions prohibiting diminishment or impairment of public retirement benefits for active participants.
The ruling by the court upheld a reduction in anticipated benefits of active retirement plan participants in the Marin County Employees' Retirement Association.
As the Aug. 17 ruling states, “While a public employee does have a "vested right' to a pension, that right is only to a "reasonable' pension — not an immutable entitlement to the most optimal formula of calculating the pension.”
The ruling upheld a Marin County Superior Court decision, which sanctioned the association's cutbacks under a 2012 California State Pension Reform Act and related legislation that restricted pension spiking in the calculation of retirement benefits.
The lower court concluded that “application of the new formula to current employees did not amount to an unconstitutional impairment of the employees' contracts,” the appellate court decision said.
The practice known as “spiking” — padding salaries or adding service credits in pension benefit calculations such as by accumulating large amounts of overtime in the final year before retirement to raise retirement benefits — has significant financial consequences for a retirement plan. This unexpected increase in pay is not considered in prefunding of pensions. As a result, it immediately adds to the underfunding of pension liabilities. Such manipulation of pension benefits occurs across the country and contributes to pushing pension liabilities to unaffordable levels, threatening the sustainability of defined benefit plans. It is an abuse of the calculations used to determine pension benefits. It is an unacceptable practice that other state legislatures should seek to stop, as California has.
The two courts made the right decision. Courts in other states should use the California appellate court decision as a framework to guide their rulings on legal objections to legislative reforms designed to define earnable income for calculation pension benefits. The issue of inadequate pension funding levels is often not only a matter of insufficient contributions but of overly generous pay formulas used in the calculations of pension benefits.
“There is no dispute that the purpose of this change (by the enactment of the California legislation) was to curtail pension spiking,” the appellate court decision said.
The case began in 2013 when the Marin Association of Public Employees and four other public employee unions filed suit challenging changes to the pension calculations adopted in 2012 by Marin County and seeking to stop their implementation. The county, “which was already wrestling with its own pension difficulties, was one of the first to act to implement the Pension Reform Act,” to quote the appellate court decision.
The Marin County provision excludes certain pay categories paid after Jan. 1, 2013, from calculation of pension benefits. The appellate decision summed up the plaintiffs' legal argument, stating “the elimination of these various pay items from the calculation of (MCERA) members' final compensation will result in a reduction in members' pension benefits below what they had previously been promised,” and in “the value of the benefits,” which “are a form of deferred compensation for work already performed” and protected by both the California Constitution and the U.S. Constitution. The courts ruled the impairment was not sufficient to violate the constitutional provisions.
The union-led group plans to appeal the decision to the California Supreme Court, said Roland M. Katz, executive director.
A state court decision cannot bind a court in another state, according on an employee benefits attorney. But it can have a bearing on the formation of decisions as courts look to how similar issues have been handled in other states.
To be sustainable, defined benefit systems must have flexibility to adjust benefits. To invalidate such adaptability will lead pension plans on a course where unfunded levels become so steep that the systems become insolvent, as some multiemployer plans are close to becoming. Such a failure would do great harm to retirement income security and fiscal balances and the economy that thrives on patient capital from long-term investors like pension funds. n