September 23, 2016
On August 17th, a California appellate court ruled that the government may make reasonable modifications to public employees’ pension benefits without infringing upon their vested right to a reasonable pension. Marin Association of Public Employees v. Marin County Employees’ Retirement Association 2016 WL 4379316 (Cal. Ct. App. Aug. 17, 2016). While acknowledging that employees’ right to their pensions vests upon employment, the court emphasized that this right is limited, and that decreasing employees’ pension benefits may be necessary to combat "pension spiking," which has "long drawn public ire and legislative chagrin" and amounted to billions of dollars in unfunded pension liabilities.
Historical and Legislative Background
Under the County Employees’ Retirement Law of 1937, counties may determine whether items of their employees’ compensation qualify as "compensation earnable" or compensation to be included in retiring employees’ "final compensation" for purposes of calculating their pensions.
After the public became wary of government employees’ generous pensions, the Legislature enacted the California Public Employees’ Pension Reform Act of 2013 (PEPRA) and amended Section 31461 of the Government Code. Section 31461 now excludes several items of compensation from public employees’ compensation earnable, including "any compensation determined…to have been paid to enhance an employee’s pension benefits;" this provision is directed at inhibiting pension spiking.
Facts of the Case
The retirement board for the Marin County Employees’ Retirement Association (MCERA) adopted a policy implementing PEPRA and the amended provisions of Section 31461, excluding several items from employees’ final compensation.
MCERA employees filed suit, asserting that MCERA had assured them that the now-excluded pay items would be included in their pension calculation. Some employees claimed that they had accepted lower wages in exchange for these benefits. The plaintiffs further alleged that because pension benefits are a form of deferred compensation for work already performed, MCERA’s policy infringed upon their vested right to their pensions.
Public Employees’ Vested Right to a Pension
Public employees have a constitutionally-protected right to receive compensation earned in exchange for services already performed. This right "vests," or becomes owned by the employee, at the time of employment. MCERA employees argued that this right extends to their pensions, and because they already performed the work associated with these benefits, the county could not renege on its agreement to include the value of the employees’ services in their pensions.
The court acknowledged that public employees have a right to a pension that vests at the time of their employment, not at the time of their retirement. However, this right is not to a fixed pension, but to a "reasonable" pension. The government has the power to reasonably modify pension benefits until pensions become payable, as long as such modifications do not "substantially" impair employees’ rights. This power is particularly important in light of the Great Recession, as the financial condition of our state and country faltered to such a degree that it made our pension system unviable. Because MCERA’s policy did not abolish its employees’ pensions, but merely excluded items from pension calculations, it was deemed constitutional.
Determining a "Reasonable" Pension
Courts use a four-element test to assess whether changes can be made to an employee’s pension. First, the change must be made for the purpose of keeping a pension system flexible to permit adjustments in accord with changing conditions. Second, the change must be reasonable. Third, the change must bear a reasonable relation to the theory of a pension system. Finally, changes which result in a disadvantage to employees should be accompanied by comparable new advantages. The Court concluded that MCERA’s policy satisfied all four factors.
The court explained that MCERA’s exclusion of items from employees’ final compensation was a reasonable modification to its pension system for two reasons: (1) The policy applies only to compensation earned after January 1, 2013; and (2) The policy does not prohibit employees from being compensated for the excluded items. These changes had no immediate adverse financial impact on MCERA employees.
Courts have found the following modifications to be "reasonable:" change of retirement age, reduction of maximum pension, repeal of cost of living adjustments, reduction of the pension cap, changes in the number of years of service required to qualify for a pension, and increases in employee contributions. Thus, a reduction in promised benefits is also reasonable.
Finally, the court held that prior Supreme Court cases should be interpreted to mean that a modification in pension benefits should be accompanied by a comparable benefit; however, this was not required. In this case, the court held that the PEPRA provided the new benefit. The Court concluded that, in light of the "unquestioned need for change" to California’s unfunded pension liability, the plaintiffs’ rights were not substantially impaired by MCERA’s policy.
Both public employers and employees must be aware that employees do not have a right to particular pension benefits, even if those benefits have been previously agreed upon. Because any benefits may be reduced or eliminated prior to retirement, employees should be discouraged from relying upon additional benefits when planning for retirement. Due to the court’s analysis of what types of pension modifications are "reasonable," pension reform advocates now have a clearer idea of the types of modifications that are likely to survive a constitutional challenge, which may mean that pension reductions will become more common in the future. Given the far reaching impact of this decision, it is highly probable that California Supreme Court review will be sought.
*The authors thank Law Clerk Arielle Spinner for her contributions to this Alert.