State Supreme Court Rules Pension Credits Don't Deserve Special Protection

California is free to eliminate credits it previously allowed public employees to purchase so that they could increase their retirement benefits, the state’s Supreme Court ruled on Monday.  

The case was being watched closely by those with an interest in public pensions because of its possible implications for the so-called “California Rule”—a legal construct that makes it difficult for state and local governments to roll back pension benefits for their workers.

Although the decision does not reshape how the California Rule has been understood previously, it does conclude that the credits fall outside of the rule’s protection, and suggests there could be other pension-related policies and practices that do as well.

“It rejects the broadest possible reading of the California Rule,” Alexander "Sasha" Volokh, a law professor at Emory University, in Atlanta, said of the ruling.

Grounded in past court decisions, the thrust of the California Rule is that governments can’t cut pension benefits for current employees unless they offer a comparable offset in return.

It’s built on the legal bedrock of the “contract clause” found in the U.S. Constitution and many state constitutions, which prohibits states from “impairing” contracts with the laws that they enact.

At issue in the case decided Monday were “additional retirement service,” or ARS, credits, authorized for many public employees in California back in 2003.

Informally dubbed “air time,” the program allowed workers to purchase credits to add up to five years to the amount of time they had actually worked for the purpose of calculating their pension benefits.

Years of service is one of the factors that determines pension benefits and this system provided a way for a person who worked, say, 15 years to receive benefits as if they’d worked up to 20.

The thinking with the credits is that someone who started a state job later in their career, or left one for a few years to raise kids or go back to school, would be able to use the program to raise their pension benefits and gain access to a “livable” retirement income.

Lawmakers anticipated the program would be “cost neutral” based on the price employees would pay for credits.

But an analysis by the California Public Employees' Retirement System, mentioned in the court ruling, found that between 1997 and 2007 the methodology for calculating the price of the credits underestimated their cost by between 12 and 38 percent.

In late 2012, the state Legislature enacted a pension reform package that, beginning on Jan. 1, 2013, effectively repealed the law that allowed for the purchase of the credits. It did not, however, revoke or alter credits for employees that had bought them before that time.

Cal Fire Local 2881, which represents employees for the California Department of Forestry and Fire Protection, a state agency that fights wildfires and responds to other types of emergencies, and four Cal Fire employees, challenged the elimination of the credits in court.

Monday’s unanimous state Supreme Court ruling in Cal Fire Local 2881 v. California Public Employees' Retirement System was authored by Chief Justice Tani Cantil-Sakauye.

It explains that two overarching issues were in play in the case.

One was whether the credits were a “vested” right, protected under the contract clause.

If the court had decided that the credit program cleared that legal bar, the justices would have had to consider a second question: whether the elimination of the credits amounted to an unconstitutional violation of employees’ rights.

The court decided that the credits are not protected so it did not consider this second question.

“We conclude that the opportunity to purchase ARS credit was not a right protected by the contract clause,” the court’s opinion says.

“In the absence of constitutional protection, the opportunity to purchase ARS credit could be altered or eliminated at the discretion of the Legislature,” the ruling adds.

Volokh said if the court had ruled in favor of the workers it “would've been totally in tune with the vibe” of the California Rule. "This is a bit surprising in that they say, ‘No not everything related to pensions is actually a promise,” he said.

The court acknowledges the state and others had urged them to use the case as a chance to reexamine the California Rule more broadly.

But the ruling says that because the credits, unlike “core pension rights,” fall outside the scope of benefits protected by the contract clause, “we have no occasion in this decision to address, let alone to alter, the continued application” of the rule.

The state Supreme Court decision aligns with two lower court rulings in the case.

A 1947 ruling from the state Supreme Court in the case Kern v. City of Long Beach was key in laying the groundwork for the California Rule.

The court concluded in that ruling that pension benefits constitute a form of deferred compensation and are, therefore, a contractual right afforded constitutional protections. Court rulings in the years since have followed this guideline.

In contrast, the court's latest decision characterizes the ARS credits as “optional benefits,” akin to different types of health insurance, life insurance, or certain flexible spending accounts.

Moody’s Investors Service last year found that California’s “adjusted net pension liability,” a measure of the benefits the state will owe to its retirees in future years, is about $193 billion, or 117 percent of state revenue. By comparison the median level of net pension liabilities as a percentage of state revenue was about 82 percent across all 50 states.

Volokh describes the California Rule as it has been applied as "kind of a one way ratchet.”

“The state is allowed to give you more pension benefits, but is not allowed to change the rules to be less generous,” he said. “It reduces the flexibility of states.”

About a dozen other states follow the California Rule. While the credits ruling from California’s high court will not be binding in those places, it could provide lawyers in other states with a precedent to cite in similar disputes and may offer a pathway for other courts to follow.

There are other pension cases still pending before California’s state Supreme Court. One of those, Marin Association of Public Employees v. Marin County Employees’ Retirement Association, concerns a practice known as “pension spiking.”

That’s where employees use various methods to inflate their benefits as they approach retirement. In the Marin County case, public employees are challenging a revised state formula meant to tamp down on pension spiking.

A trial court concluded that the new formula was not an unconstitutional contract violation. An appeals court agreed.

Volokh raised the possibility that the ruling in the Cal Fire case might indicate the state Supreme Court will take a similar approach when considering laws meant to curtail pension spiking.

“There are a lot of individual benefits that could fall by the wayside,” he said, “if this reasoning is used more broadly.”