Protect Our Benefits v. City and County of San Francisco (2015) 185 Cal.Rptr.3d 410.Allowance for Retirees Dependent on "Full Funding" of Retirement Fund Impaired Retirees' Vested Pension Rights

The City of San Francisco operates its own retirement system, the San Francisco Employees' Retirement System (SFERS), which is overseen by the City's Retirement Board. SFERS administers a pension plan that is funded by contributions from current City employees, contributions from the City, and investment earnings on assets SFERS holds in trust for the retired City employees (the Fund). Each year, an independent actuary produces an actuarial valuation of the Fund. The actuary uses a "five year smoothing" technique, in which gains or losses are spread out over a five-year period. It also calculates the "funding ratio," which is the ratio of the Fund's assets to its liabilities. When assets exceed actuarial liabilities, the Fund is said to be "fully funded." The valuation can also be calculated on a "market" basis, which calculates the fair market value of the Fund's assets if the entire portfolio were liquidated on a certain date, and compares that valuation to the Fund's actuarial liabilities. The Fund was not fully funded during fiscal years 2008-2009 through 2011-2012.

Retired City employees have long been eligible to receive an annual cost of living adjustment (COLA) to their pension payments, of up to two percent, based on changes in the Consumer Price Index. In 1996, City voters adopted an initiative measure that amended the City's Charter to provide for a supplemental COLA for City retirees in addition to the basic COLA. When first adopted by the voters, the supplemental COLA was not permanent. When the funds in the reserve account were insufficient to pay the supplemental COLA, pensions reverted to the level they would have been if the supplemental COLA had never been made.

Thereafter, in 2002, City voters passed an initiative that made the supplemental COLA permanent. Once the supplemental COLA was added to an employee's pension payment, it could not be reduced. In 2008, City voters raised the maximum annual amount of the supplemental COLA from 3 percent to 3.5 percent, less the amount of any basic COLA. If the earnings in a particular year were insufficient to fund the supplemental COLA, the retirement board was to reserve and accumulate any excess earnings until it could fund one year's supplemental COLA, and then withdraw the earnings and pay the benefits.

In the 2008-2009 fiscal year, the Fund lost approximately 25 percent of its value due to the financial crisis and economic downturn, and was no longer fully funded. In 2011, City voters passed an initiative making numerous changes to the financing and scope of SFERS pension benefits and retiree health care. Specifically, Charter section A8.526-3(d) was amended to provide that "beginning on July 1, 2012 and July 1 of each succeeding year, no supplemental cost of living benefit adjustment shall be payable unless the Retirement System was also fully funded based on the market value of its assets for the previous year." The amendment did not change the requirement that excess earnings be reserved when insufficient to fund a supplemental COLA and accumulated until they were sufficient to fund a supplemental COLA.

Protect Our Benefits (POB), a political action committee representing the interests of retired City employees, filed a petition for writ of mandate challenging the constitutionality of section A8.526-3(d). It argued that the new full funding requirement impairs vested contractual pension rights under the federal and state Constitutions because it diminished the supplemental COLA benefit. The trial court denied the petition, and POB appealed. The Court of Appeal reversed in part.

Upon accepting public employment, a person acquires a vested right to a pension based on the system in effect, and to additional pension benefits conferred during his or her subsequent employment. Unlike other terms of public employment, pension rights are protected by the federal and state Constitutions' contract clauses. Once vested, the legislature can only modify pension rights in limited circumstances. For active employees, any modification must be reasonable, must bear a material relation to the theory and successful operation of the pension system, and, when resulting in a disadvantage to employees, must be accompanied by comparable new advantages. With respect to retired employees, the government's power is even further restricted because the retiree is entitled to "the fulfillment without detrimental modification" of the contract under which the retiree already performed.

The reduction of a cost of living allowance has been held to impair a pension contract when it did not provide a comparable new advantage. In this case, the Court held that retired City employees were entitled to receive a supplemental COLA when the Fund's actual earnings exceeded expected earnings, regardless of the Fund's market value or actuarial liabilities. Accordingly, since Section A8.526-3(d) conditions payment of the supplemental COLA on the Fund being fully funded based on the market value of its assets, it impaired the retiree's vested pension rights because there may be years in which the Fund is not fully funded but still earned more than was projected. Accordingly, the full funding requirement results in a detriment to pensioners, and no comparable advantage has been offered in its place.

The Court of Appeal rejected the City's argument that full funding has been a condition of the supplemental COLA since its inception. The Court analyzed the ballot materials from the 1996, 2002, and 2008 initiatives, and found nothing to suggest that the voters intended to condition the supplemental COLA on full funding. Relying on the same ballot materials, the Court also rejected the City's argument that section A8.526-3(d) merely clarified existing law.

The Court of Appeal held, however, that because the supplemental COLA was effective on November 6, 1996, employees who retired before that date did not have a vested right to the supplemental COLA, and therefore their rights were not impaired by section A8.526-3(d). While a retiree's pension benefits may be increased after retirement, the Court stated that POB failed to cite any cases that stand for the proposition that an employee who has retired has a vested right in any subsequently-enacted increases in benefits. Therefore, the Court of Appeal reversed the judgment in part, affirmed in part, and remanded to the trial court with directions to enter a new judgment consistent with its opinion

NOTE:

There have been several recent cases that have addressed the issue of what constitutes a "vested" right. In our February 2015 Fire Watch, we reported on the case of Deputy Sheriffs' Association of San Diego County v. County of San Diego (2015) 233 Cal.App.4th 573, in which the Deputy Sheriffs' Association of San Diego County argued that the enactment of the California Public Employees' Pension Reform Act of 2013 (PEPRA) on January 1, 2013 impaired its collective bargaining agreement with the County of San Diego, in violation of the state and federal constitutions, because it reduced the defined benefit formula available to employees who were hired and became covered by the agreements on or after January 1, 2013, but before the agreements expired on June 26, 2014. Instead of a defined pension benefit based on a 3% @ 55 formula, PEPRA required the County to use a 2.7% @ 57 formula. The Court of Appeal held that PEPRA did not violate the constitution's contract clause. While the contract clause prohibits the passage of a law that impairs the obligation of contracts, it only protects a public employee's vested pension rights. Here, because the employees who brought the lawsuit were hired on or after the date on which PEPRA was enacted, they did not perform any work before PEPRA took effect, and therefore their pension benefits did not vest.

Similarly, in this case, the Court of Appeal held that retirees who retired before the supplemental COLA became effective on November 6, 1996 did not have a vested right to the supplemental COLA because they did not perform any services in exchange for that benefit.

Protect Our Benefits v. City and County of San Francisco (2015) 185 Cal.Rptr.3d 410.