Pension plans of businesses and most tax-exempt organizations are subject to federal rules which permit them to discontinue accruals of benefits at any time, so long as previously accrued benefits are preserved. (Internal Revenue Code section 411.) By contrast, pension plans of governmental employers are typically subject to protections under court decisions based on federal or state constitutions provisions forbidding the “impairment of contracts,” which may require the preservation of not only past but future benefit accruals. The leading cases in this area come from California, although courts in other states have often looked to them in interpreting similar constitutional provisions in other states. See, e.g., Betts v. Board of Administration, 21 Cal.3d 859, 864 (1978).
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 has provided additional guidance on this issue, although it seems to raise as many questions as it answers.
The case dealt with the Los Angeles City Employees’ Retirement System (“LACERS”). LACERS provides pension benefits for employees of the City of Los Angeles. In addition, it maintains an account described in section 401(h) of the Internal Revenue Code (“401(h) account”), which provides for retiree health benefits.
The maximum monthly amount of the medical plan premium subsidy has historically been determined annually by the Board of Administration of the Los Angeles City Employees’ Retirement System (“Board”), in its discretion, subject to certain maximum limitations. Employees received an amount that was based on their length of service. If an employee worked full-time for the City for at least 25 years, or attained age 55 after working for the City for at least 10 years, the employee would receive 100% of the maximum subsidy. The maximum subsidy was usually, but not always, enough to cover the Kaiser two-party non-Medicare Part A and Part B premium.
On June 3, 2011, Ordinance number 181734 (“the freeze ordinance”) was approved. Under the freeze ordinance, an employee who retired after June 30, 2011 had two choices. The employee could elect to contribute 4% of salary in exchange for a vested right to an increase in the maximum medical plan subsidy provided at an amount not less than the dollar increase in the Kaiser two-party non-Medicare Part A and Part B premium. If the employee did not make such an election, the employee would receive a maximum monthly medical plan premium subsidy capped at $1,190.
The retirees sued to roll back the freeze ordinance. The court held that the freeze ordinance was unconstitutional, and ordered that benefits be calculated without reference to it. At the same time, the court expressly declined to specify any particular level of benefits that would be considered vested and thus protected by the California constitution.
The case is confusing in its implications for future policy. For example:
- The retiree health benefits in this case were funded through the pension plan. Many employers fund their retiree health benefits through a voluntary employees’ beneficiary association (“VEBA”), or do not prefund them at all. Was it the employer’s decision to prefund benefits that made them vested, or could an employer’s practice of providing retiree health benefits on a pay as you go basis create a similar vested right? If the prefunding was what caused the vesting, this might discourage employers from prudently prefunding benefits.
- The court held that retirees who worked full-time for the City for at least 25 years must receive 100% of the maximum subsidy, but did not specify what that maximum subsidy must be. Could the City reduce the maximum to $0.01? Or to the $1,190 current maximum subsidy, with no increases, even though the court stated that, “it is likely that the frozen benefit amount ($1,190) would be far outpaced within the next decade”?
- The issue arose because those employees who did not contribute the 4% would receive less than the maximum retiree health benefit, regardless of their age or years of service. But what if the maximum benefit under the plan had been frozen, and an entirely new plan had been set up to receive the 4% contributions and provide an additional benefit? Would that have satisfied the contractual requirements?
Clearly many questions remain to be answered by appeals in this case, or by future developments in California.