Prospective Changes in a Pension Plan Which Disadvantage Current Employees Are Not Required to be Accompanied by Comparable New Advantages

By Liebert Cassidy Whitmore
Sep 28, 2016

The County Employees Retirement Law of 1937 allows, but does not require, a county to establish and operate a retirement plan for its employees. Twenty of the state's fifty-eight counties have elected to do so. Each county plan is administered by a retirement board

In the aftermath of the severe economic downturn of 2008-2009, public attention focused on unfunded public pension liabilities. One area that drew the most criticism was "pension spiking" which is the practice of increasing an employee's retirement allowance by increasing final compensation or including various non-salary items (such as unused vacation pay) in the final compensation figure used in the employee's retirement benefit calculations, and which has not been considered in prefunding of the benefits.

In response to many of these issues, the California Legislature passed AB 340, the California Public Employees' Pension Reform Act of 2013 (PEPRA). Concurrent with PEPRA, the Legislature passed AB 197 to exclude from the definition of compensation earnable any compensation determined by the county retirement board to have been paid to enhance a member's retirement benefits. This provision was codified at Government Code section 31461 and was intended to prevent pension spiking.

Marin County was one of the first to implement the PEPRA. The Marin County Employees' Retirement Association adopted a policy changing the definition of "compensation earnable" and "pensionable compensation," used to determine an employee's final compensation for the purpose of determining the employee's retirement benefit. Through the policy, the Association specified new items of pay and benefits that would be excluded from the definition of compensation earnable and pensionable compensation.

Less than three weeks after the PEPRA took effect, five recognized employee organizations and four individuals commenced an action against the Marin County Employees' Retirement Association. The lawsuit alleged that, among other things, the value and associated costs of these now excluded payments had been factors in determining the wage and benefits packages offered to members of the Association through collective bargaining. In short, employees and their unions argued that the Pension Reform Act, and resultant change to the Association's compensation earnable and pensionable compensation definition, impaired members' vested contract rights, in violation of the California and United States Constitutions.

The Court of Appeal began by citing the "contracts clause" of the United States Constitution which provides that states are prohibited from passing a law impairing the obligation of contracts. Public employment gives rise to certain obligations which are protected by the contract clause, including the right to the payment of salary which has been earned. Accordingly, a pension is treated as a form of deferred salary that the employee earns prior to it being paid following retirement.

However, the Court rejected the employees' argument. While affirming that public employees have a "vested right" to a pension, the Court explained that the right is not an immutable entitlement to the "most optimal formula of calculating the pension." In reaching this conclusion, the Court relied on prior case law, reiterating that pension rights are a "limited" vested right, and that, until retirement, an employee's entitlement to a pension is subject to change. The Court explained that a governing body may make reasonable modifications and changes to a pension before the pension becomes payable. Until that time the employee does not have a right to any fixed or definite benefits but only to a "substantial or reasonable pension."

To determine whether changes to pension rights are reasonable, courts must look to the facts of each case to assess what constitutes a permissible change. To meet a "reasonableness" test, alterations of employees' pension rights must bear some material relation to the theory of a pension system and its successful operation. In addition, changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantage.

The Court of Appeal recognized previous case law, including the California Supreme Court case of Miller v. State of California (1977) 18 Cal.3d 808 which held that pension rights are not immutable and a government entity may make reasonable modifications and changes in the pension system.

Further construing prior cases, the Court of Appeal then stated that to be sustained as reasonable, alterations to an employee's pension rights must bear some material relation to the theory of a pension system and its successful operation. In addition, prior precedent held that where modification resulted in disadvantage to employees, there must be an accompanying comparable new advantage. However, the Court of Appeal concluded that these prior cases were not intended to give the word "must" a literal and inflexible meaning. To support this conclusion, the Court of Appeal cited to previous Supreme Court precedent that used the term "should" instead of the more restrictive "must." The Court of Appeal largely relied on another Supreme Court case, Allen v. City of Long Beach (1955) 45 Cal.2d 128, in reaching its conclusion that changes in a pension plan which result in a disadvantage to employees "should," but are not required to be, accompanied by comparable new advantages.

The Court of Appeal held that the Association's implementation of the amended version of section 31461 does not qualify as a substantial impairment of the plaintiff's contracts of employment, thus there was no violation of the contracts clause. The Court stated that the plaintiffs "adopt an unrealistic notion of the immutability of employees' vested rights." The Court found that the Pension Reform Act, and the Association's change to the compensational earnable and pensionable compensation definition thereunder, was reasonable, and thus did not violate state or federal constitution.

Note:

The Court's decision pertained only to current employees and only prospectively. The Court did not address the power of either the state or local employers to decrease the pensions of retired employees.

A similar version of this article, authored by Erin Kunzeof Liebert Cassidy Whitmore's San Francisco office, was published on the California Public Agency Labor & Employment Blog on August 23, 2016.

Marin Association of Public Employees v. Marin County Employees' Retirement Association (2016) 2 Cal.App.5th 674.