(Bloomberg) — Along with death and taxes, Californians have counted on another inevitability: once pension promises are made to public employees, they can’t be rolled back.
That belief, which has guided officials as they deal with mounting bills to cash-strapped retirement plans, was shaken in August when a state appellate court said benefit cuts are permissible if the pensions remain "reasonable" for workers.
The Marin Association of Public Employees, which lost its lawsuit seeking to prevent the county from reducing the final salary levels used to calculate pension payments, says it will ask the state’s Supreme Court to overturn the ruling. If upheld, it would give California and its local governments a way to cut costs just as lackluster investment returns threaten to leave them under pressure to pump more money into retirement plans.
"It signals that there are potentially additional reform options on the table that never were there before," says Thomas Aaron, senior analyst at Moody’s Investors Service. "That offers an additional way for governments facing budgetary challenges to try and bring their costs down."
State and local pensions across the U.S. have $1.8 trillion less than needed to cover all the benefits owed in the decades ahead, according to Federal Reserve Board data. The need to make up for such shortfalls has contributed to credit-rating cuts to Illinois, New Jersey and Chicago. Such financial pressure has also been acute in California, where it helped bankrupt the cities of Stockton, San Bernardino and Vallejo.
Efforts to reduce retirement costs have focused on steps such as steering new employees into 401(k)-style plans or persuading unions to consent to measures such as increasing retirement ages or cutting cost-of-living adjustments. While the California court case has no impact beyond the state, it could inspire challenges elsewhere by local governments seeking to push through changes over the objections of workers.
"Courts around the country faced with similar litigation would likely hold in a similar fashion," wrote Bank of America Merrill Lynch analysts led by Philip Fischer in a note to clients.
The case in Marin County, a community north of San Francisco that’s among the wealthiest in the U.S., centers around the formula for calculating retiree payouts. Empowered by state law that sought to prevent "pension spiking" — which involved boosting compensation at the end of one’s career in order to elevate pension checks — the county in 2013 barred elements such as payments for waiving health insurance from being included in the formula that determines how much retirees receive.
The union sued, saying such factors are considered part of workers’ regular pay and that the county violated legal precedents known as the California rule. Established through court decisions, the guideline prevents benefits for current employees from being decreased unless they received an offsetting advantage.
The appellate court in San Francisco upheld the trial court’s decision against the union that the new calculations didn’t violate workers’ rights. It also said that lawmakers have the power to change the formula before retirement.
“While a public employee does have a ’vested right’ to a pension, that right is only to a ’reasonable’ pension-- not an immutable entitlement to the most optimal formula of calculating the pension,” the court said.
The judges didn’t define what’s reasonable. That’s sure to lead to lawsuits if officials try to adjust benefits outside of collective bargaining for their current workforce, says Rollie Katz, executive director of the Marin union, which plans to appeal by Sept. 26, the deadline.
"There have been promises made. That’s pretty fundamental in our society," says Katz, whose organization represents 1,300 members from custodians to office assistants. "They need to be kept."
The ruling may give them an incentive to find ways to limit benefits, said Chuck Reed, a former mayor of San Jose, California, who’s pushing pension overhauls nationwide through a group called the Retirement Security Initiative.
"Going from an absolute ’no’ to a ’yes, if it’s reasonable’ is a huge shift in the political debate as well as the legal debate," Reed says. "In order to save their jurisdictions from insolvency, some systems will be motivated to try to make some changes."
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