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Calif. High Court Avoids the 'California Rule' in Pension Benefits Change Decision

Yuki Cruse, with Meyers Nave.

In its much-anticipated ruling in Cal Fire Local 2881 v. California Public Employees’ Retirement System, the California Supreme Court avoided opining on the long-standing pension rule, known as the “California Rule,” which is a state court interpretation of constitutional law that prohibits reduction of pension benefits unless they are offset by comparable new benefits. The Cal Fire decision was closely watched because the court’s interpretation of the California Rule could significantly impact the opportunity for pension reform in California. A narrow interpretation would keep the protective California Rule legal doctrine intact and state and local lawmakers’ ability to revise the laws governing public employee pensions would continue to be hindered. On the other hand, a broader interpretation could have created the possibility of pension reform regarding reduction of benefits that have not yet been earned.

For now, the California Rule remains intact, but the state Supreme Court is expected to hear two cases that have resulted in a split among divisions in the First District Court of Appeal. Once again, public employers are hoping the court will take the opportunity presented by these two cases to open at least a small door to modifying specific pension benefits if not also a big door to larger pension reform.

Restricting 'Air Time' Triggered the Constitutional Case

The underlying issue in Cal Fire was whether the Legislature’s 2012 pension reform law that eliminated current employees’ ability to purchase additional service credit was unconstitutional. In 2003, employees participating in the CalPERS retirement system could receive pension benefits calculated on the basis of up to five years more public employment than they actually worked by purchasing additional service credit—commonly called “air time.” CalPERS touted the “air time” credit as a self-funded program, which would result in no additional cost to taxpayers. However, CalPERS’ assumptions were incorrect. Employee contributions were far less than the actual cost of the benefits they received, resulting in additional cost to the pension plan and taxpayers.

In response to the state’s significant unfunded pension liability, in September 2012, the Legislature enacted the Public Employees’ Pension Reform Act (PEPRA), which reduced pension benefit formulas and increased employee pension contributions for new employees. PEPRA also severely restricted several forms of pension spiking, including “air time,” for both current and new employees. Pension spiking is where employees can increase their retirement allowance by increasing final compensation or including various nonsalary items in the final compensation figure used in the employee’s retirement benefit calculations.

Court Addressed Public Employees’ Vested Rights

Recognized employee organizations quickly challenged the validity of PEPRA, including Cal Fire Local 2881. The union argued the opportunity to purchase air time credit was a vested right protected by the contract clause of the California Constitution, such that PEPRA’s elimination of the opportunity for existing employees to purchase air time credit violated both state and federal constitutional contracts clause. The Cal Fire Supreme Court disagreed.

The Supreme Court pointed out that the terms and conditions of public employment, unlike those of private employment, generally are established by statute rather than by contract. The court also recognized that it is well settled that public employees have no vested right in any particular measure of compensation or benefits and that these may be modified or reduced by the proper statutory authority.

Court Set Out Two Exceptions

The court articulated two exceptions that could create rights protected by the contract clause in public employment: when the statute or ordinance establishing the benefit and the circumstances of its enactment clearly evince a legislative intent to create contractual rights; and where certain benefits of public employment, such as pension rights, are protected by implication, even in the absence of a clear manifestation of legislative intent.

The court held there was no clear evidence suggesting the Legislature made an affirmative commitment to make the opportunity to purchase air time credit available indefinitely. The court also considered that pension rights have historically been afforded constitutional protection because they are seen as deferred compensation that becomes part of the contract of employment itself because pension benefits are earned by an employee’s work. In contrast, air time credits are not akin to deferred compensation because a public employee could increase his or her pension benefit merely by purchasing the service credit and not through the employee’s time in service.

The court concluded that California’s public employees do not have a contractual right to the continued availability of the opportunity to purchase additional retirement service credit. Therefore, the question of whether PEPRA serves as an unconstitutional impairment of protected rights did not arise.

On the Horizon All Hope Is Not Lost

While the Cal Fire court did not disturb the California Rule, the court is expected to hear two cases that relate to pension spiking that may affect the rule’s application to pension benefits— Alameda County Deputy Sheriff’s Association v. Alameda County Employees’ Retirement Association, (2018) 19 Cal.App.5th 61 (Alameda County) and Marin Association of Public Employees v. Marin County Employees' Retirement Association (2016) 2 Cal.App.5th 674 (Marin County).

In Marin County, Division Two of the First District Court of Appeal narrowly interpreted the California Rule, holding there is no absolute requirement that elimination or reduction of an anticipated retirement benefit “must” be counterbalanced by a “comparable new benefit.” Further, the court held that employees have a vested right in a “reasonable” pension, but not a right to “any fixed or definite benefits” that may be “fixed by the specific terms of the legislation during any particular period.” The Marin County court recognized that the public pension system is subject to the implied qualification that a governing body may make reasonable modifications and changes before the pension becomes payable.

However, in Alameda County, Division Four of the First District Court of Appeal was critical of the Marin County court’s reliance on its “general sense of what a reasonable pension might be, rather than acknowledging that the Supreme Court has expressly defined a reasonable pension as one which is subject only to reasonable modification.” Thus, the Alameda County court found the Marin County court failed to properly weigh the justification for the impairment against the actual disadvantage to employees, which is a substantive part of the vested rights analysis.

Now that both cases—and the split among the divisions in the First District Court of Appeal—are before the Supreme Court, there is again, widely held anticipation that the court will interpret the California Rule in a way that could have a significant impact on the ability to implement pension reform—that is, if the court doesn’t find a way to skirt the issue once again.

Yuki Cruse is an associate in Meyers Nave’s Oakland office. She can be reached at ycruse@meyersnave.com or 510-808-2000.