A California statewide ballot initiative proposal, The Pension Reform Act of 2014 was filed on October 15, 2013. The proposal if passed would amend the California constitution to provide that employees have no vested rights in future pension and retiree health benefit accruals, but only to benefits accrued based on past employment. As such, it would cause the vesting of public retirement plans in California to be more comparable to the vesting of private retirement plans under the Employee Retirement Income Security Act of 1974 (“ERISA”). The proposal, if adopted, would be particularly significant inasmuch as California has historically been a leader in the recognition of the right of public employees to vesting in future benefit accruals.
In California, vesting in public sector plans is based on both the United States constitution’s prohibition against any state passing a law “impairing the obligation of contracts” (U.S. Const., Art. I, § 10) and a parallel proscription contained in the California constitution (Art. I, § 9). See Allen v. Board of Administration, 34 Cal.3d 114, 119 (1983). As discussed below, the contract clauses have been interpreted to protect reasonable pension expectations to be derived from future service as well as benefits accrued through any date in time. As such, the vesting accorded to employees covered by government plans is much broader than is the case in the private sector where plan participants are protected against any reduction in accrued benefits only through the point of any modification of a plan’s benefit provisions. See, e.g., Code section 411(a).
The vesting concept has been developed and firmly embedded in California law through a long line of cases starting with Kern v. City of Long Beach, 29 Cal.2d 848 (1947), with two of the more important of such cases being Allen v. City of Long Beach, 45 Cal.2d 128 (1955) and Betts v. Board of Administration, 21 Cal.3d 859 (1978).
In Kern, it was decided that a public employee’s pension constitutes an element of compensation, that a vested contractual right to pension benefits accrues upon acceptance of employment and that such a pension right may not be destroyed once vested without impairing a contractual obligation of the employing public entity. Kern, supra, at 852-853.
In Allen v. City of Long Beach, which is considered to be the landmark case in this area, the vesting concept was described as follows:
An employee’s vested contractual pension rights may be modified prior to retirement for the purpose of keeping a pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system. [Citations.] Such modifications must be reasonable, and it is for the courts to determine upon the facts of each case what constitutes a permissible change. To be sustainable as reasonable, alterations of employees’ pension rights must bear some material relation to the theory of a pension system and its successful operation, and changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages. [Citations]. . .
Allen, supra, at 131.
See also Carman v. Alvord, 31 Cal.3d 318 (1982) and Miller v. State of California, 18 Cal.3d 808 (1977).
In Betts, it was affirmed that vesting applies not only to benefits that are in effect when an employee’s employment commences but also to improvements in benefits that occur during his or her service. Betts, supra, at 866. Betts also reaffirmed the holding in Abbott v. City of Los Angeles, 50 Cal.2d 438 (1958), that the comparative analysis of disadvantages and compensating advantages in any modifications to a plan must focus on the particular employee or employees whose vested pension rights are involved. Betts, supra at 864. See also Olson v. Cory, 27 Cal.3d 532 (1980).
Thus the law as developed in California as applicable to public employees’ rights in their pensions provides that an employee becomes vested in the particular level of benefits provided during his or her term of employment (conditioned upon fulfilling any service conditions to be eligible for such benefit) and that while such benefits can be modified in accord with changing conditions in a manner consistent with maintaining the integrity of the system, any such changes that result in a disadvantage to employees must be accompanied by a comparable new advantage to the same employees.
These principles were further examined by the California Supreme Court in Legislature v. Eu, 54 Cal.3d 492 (1991). Eu, the case which upheld the constitutionality of term limits as enacted as part of Proposition 140 in 1990, examined the legality of a specific provision in Proposition 140 to the effect that no pension or retirement benefits were to accrue as a result of service in the State Legislature for legislators serving new terms in the Legislature on or after November 1, 1990. The provision further provided that “[t]his Section shall not be construed to abrogate or diminish any vested pension or retirement benefit which may have accrued under an existing law . . ., but upon adoption of this Act no further entitlement to nor vesting in any existing program shall accrue to any such person, other than Social Security. . . .” Incumbent legislators challenged the constitutionality of this provision in Proposition 140 as being an improper impairment of their vested right to continued future participation in the pension program that was in place for their benefit at the time Proposition 140 was passed. Based on the long line of California cases alluded to above, the court held that the incumbent legislators had acquired a vested right to earn additional pension benefits under the plan in existence at the time of the passage of Proposition 140 through continued service in future terms and that prospective cessation of that right was an unconstitutional impairment of contract. The court also held that purported comparable advantages in the form of participation in Social Security were in fact illusory and not sufficient to support the prospective cessation of benefits.
Two other court cases are also particularly instructive on the question of the application of California law to the modification of a particular provision in a pension plan under which public employees have already rendered service. The first, Pasadena Police Officers Ass’n. v. City of Pasadena, 147 Cal.App.3d 695 (1983), involved a plan amendment that for the first time put a limit on the amount of increases that could accrue under a post retirement cost-of-living adjustment. Against a claim that the amendment did not impair the vested contract rights of active employees because it was to apply only to that portion of the employees’ pensions that would accrue by rendering years of service after its effective date, the court held that such an interpretation was inconsistent with California case law and unacceptable because it involved a substantial reduction in the pensions that could have been earned after the amendment without any comparable new advantages. Likewise, in United Firefighters of Los Angeles City v. City of Los Angeles, 210 Cal.App.3d 1095 (1989), the court held that Charter Amendment H, placing a 3% cap on previously unlimited cost-of-living adjustments available to certain public employees, was an illegal impairment of the employees’ vesting rights even though it applied only prospectively to future years of service credited toward retirement after the date of the amendment.
Starting in 2011, California courts have begun applying similar reasoning to the provision of retiree health benefits, as well as pension benefits. In Retired Employees v. Co. of Orange, 52 Cal. 4th 1171, 266 P.3d 287, 134 Cal. Rptr. 3d 779 (2011), the California Supreme Court held that
under California law, a vested right to health benefits for retired county employees can be implied under certain circumstances from a county ordinance or resolution. Whether those circumstances exist in this case is beyond the scope of the question posed to us by the Ninth Circuit.
A recent case from the Los Angeles Superior Court, Los Angeles City Attorneys Association v. City of Los Angeles, confirmed that in appropriate situations, constitutional provisions could preclude the cutback of retiree health benefits.
While the California cases apply only to public plans of the State of California and its local jurisdictions, courts in other states have often looked to them for guidance in interpreting both the federal Constitution and similar provisions in other state constitutions. For example, in Hanson v. City of Idaho Falls, 92 Idaho 512, 446 P.2d 634 (1968), the Supreme Court of Idaho looked to Kern v. City of Long Beach, in addressing the characterization of a government employee’s right to benefits under her governmental employer’s pension plan. At this point, the majority of states recognize some sort of constitutional limitations on the modification of benefits under a public retirement system.
Provisions of The Pension Reform Act of 2014
The Pension Reform Act of 2014 (“Act”), if passed, would impose the following new rules:
- Pension or retiree health benefits earned and accrued for work already performed by retirees would be preserved.
- Provisions of a labor agreement in effect as of the effective date of the Act are not to be affected, but the Act would apply to any successor labor agreement, renewal or extension entered into after the effective date. There are some anti-abuse provisions for labor agreements negotiated specifically for the purpose of evading the Act.
- In theory, pension or retiree health benefits of current employees earned and accrued for work already performed would be preserved. However, the Act states that “[a]ny action by a government employer, labor agreement or voter initiative prior to the effective date of this Section shall not be found to have created a vested contractual right to future pension or retiree healthcare benefits before such work is performed by employees, unless the specific language of the underlying action, agreement or initiative expressly states that such benefits are vested or are otherwise irrevocable.” Thus, while existing employees would not lose benefits already accrued, they would lose rights previously treated as vested to have future accruals determined under a plan’s existing formula.
The application of this provision is also not entirely clear. For example, suppose that an employee would be entitled to retire after 30 years of service with a benefit equal to 2% of final compensation times years of service. If the employer decides to modify the benefit formula after 20 years, is the employee entitled to a benefit of 2% of the compensation s/he is earning on the date of the change times 20 years of service? Or is the employee entitled to 2/3 of the benefit s/he would have received under the old benefit formula, which would likely be a much higher number, as it would take into account increases in compensation between year 20 and year 30?
The question is even more acute in the case of retiree health benefits. Often, such benefits are payable only if the employee remains with the employer until eligible for a full retirement benefit. For the employee in our previous example, could the plan eliminate all retiree health benefits on the theory that they were not yet accrued (because the employee had not become eligible for a full retirement benefit)? Or would there be some obligation to preserve 2/3 of the retiree health benefit the individual would have received if s/he had continued working until retirement under the old formula?
- For future employees, or for new benefits added for existing employees, rights would be earned and vested incrementally, only as the employee actually performed work, and only in proportion to the work performed, subject to the vesting periods established by the applicable plan. As in the case of current employees, the application of the provision is unclear.
- The amount employees are required to pay for pension or retiree healthcare benefits would be treated as a component of an employee’s compensation package, and could be amended through a labor agreement, an action by a legislative body, or an initiative, referendum or other ballot measure initiated by the voters or by a legislative body. Thus, even to the extent that benefits could not be cut back, employees could be forced to pay more for them.
- If a government employer found its pension or retiree healthcare plan was substantially underfunded and was at risk of not having sufficient funds to pay benefits to retirees or future retirees, or declared a fiscal emergency because the financial condition of the government employer impaired its ability to provide essential government services or to protect the vital interests of the community, the government employer would have the right to reduce the rate of accrual, reduce the rates of cost of living increases, increase the retirement age at which benefits would be paid, require employees to pay an increased share of costs, or make other reductions or modifications of benefits, provided it did not cut back on benefits already earned. The chief difference between this provision and the foregoing ones is that if its conditions were met, the collective bargaining process would be altered. If such actions were within the mandatory scope of collective bargaining, they would be submitted to collective bargaining. If the government employer and represented employees did not reach an agreement within 180 days, the government employer would have the authority to implement such actions. The only way to avoid the implementation would be if a court found that the conditions were not met.
- For any pension or retiree healthcare plan with assets equaling less than 80 percent of the plan’s liabilities, as calculated by the plan’s actuary using generally accepted accounting principles, the government employer would be required to prepare a pension or retiree healthcare stabilization plan. The pension or retiree healthcare stabilization plan shall specify actions designed to achieve 100 percent funding of the plan within 15 years while preserving basic government services. Such plan shall identify (i) the benefits to be modified, if any, (ii) the additional costs to be incurred by employees, if any, (iii) the additional costs would be incurred by the government employer, if any, (iv) the specific funding sources that to be used to pay for such additional costs, (v) the investment return rates needed to be achieved to obtain such funding level, as well as information regarding the historical rates of return earned by the applicable plan, and (vi) the impact of any existing pension obligation bonds
issued by the government employer, and any additional actions that may be needed to pay off such bonds. There are provisions for notice and public hearing with regard to such actions.
- The Act provides that the power to amend the terms of a pension or retiree healthcare benefit plan could not be prohibited or limited by labor agreement, statute, resolution, ordinance, or any other act by an executive, legislative body, pension board, or any other governmental entity. The application of this to labor agreements is a bit confusing. Presumably, a labor agreement could preclude an employer from unilaterally making changes to a pension benefit during the term of the agreement, or the provisions for a fiscal emergency as described above would be unnecessary. Thus, it appears that this provision of the Act is intended merely to prevent a statute, labor agreement, etc. from providing that a benefit could never be modified in the future (e.g., by a subsequent statute or a new labor agreement).
The likelihood of passage for The Pension Reform Act of 2014 is uncertain. The California Public Employees’ Retirement System (“CalPERS”) indicated its opposition to the Act. However, it is unclear how voters will respond at the polls.
Technical Issues With The Pension Reform Act of 2014
Even if The Pension Reform Act of 2014 passes, it is unclear what its effect would be. As described in the “Background” section, above, many of the court decisions were based on the federal constitution as well as the constitution of California. While The Pension Reform Act of 2014 would amend the relevant section of the California constitution, it is unclear whether the courts would find that the federal constitution would nevertheless protect benefits that The Pension Reform Act of 2014 is intended to make negotiable.
Effect on Other States
Legislators in states with strong constitutional protections for retirement and retiree health benefits of existing employees can be expected to follow the situation in California with interest. In some jurisdictions, retiree pension and health benefits have been insufficiently funded over the years, and may now represent a large expense for cash-strapped jurisdictions. Even in instances in which such benefits have been responsibly funded, a change in the earnings rate on investments or in the work force can result in a funding deficit. A mechanism for decreasing future benefit accruals or increasing employee contributions may be tempting.
On the other hand, even if The Pension Reform Act of 2014 passes and is upheld in California, it will not be a panacea for all states. The California constitution can be amended by a simple majority vote in an election, while many other constitutions are harder to amend. For example, some require a supermajority in the legislature, or passage by the legislature in more than one year, to amend.
In addition, the effect on attraction and retention of employees will need to be considered. Some government jobs have private sector analogs. However, some of the more critical government functions do not have analogs in the private sector. A potential police officer, for example, may need to commit to a career in government service for life, unless s/he is willing to retrain entirely mid-career. A retiree health plan may be less effective in attracting such an employee if s/he knows that it could be eliminated until shortly before the employee’s retirement.