The California Rule Court Case: What Can Be Changed on Public Pensions?

To be precise: what is allowed to lower pension benefit formulas for current employees?

In yesterday’s post, I ended with some coverage from the California Supreme Court case regarding some changes to what’s included in a pension formula.

I will repeat part of what was in yesterday’s post.

P&I Online: California High Court Hears Pension Reform Arguments:

The California Supreme Court is expected to issue an opinion re-examining the so-called California rule for calculating public pension benefits, which has been adopted by nearly a dozen other states.

The virtual oral arguments held online Tuesday centered on whether pension benefits offered when a worker is hired become a vested right, leaving the state’s employers unable to change the way pension benefits are calculated.

At issue in the case — involving the $8.8 billion Alameda County Employees’ Retirement Association, Oakland, Calif.; the $9.3 billion Contra Costa Employees’ Retirement Association, Concord, Calif.; and $816 million Merced County (Calif.) Employees’ Retirement Association — is whether state’s 2012 pension reform law, as it applied to county pension plan participants hired before the law’s Jan. 1, 2013, effective date, was unconstitutional.

After the reform law took effect, all three pension plans applied the changes — which excluded certain pay items that had formerly been used to calculate employees’ total compensation for pension purposes — to new hires and existing employees.
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A good portion of the argument centered on whether plan participants accepted employment based on a promise that they would receive a pension benefit based on all the types of pay that could have been included in the calculation when they were hired. Among the pay items no longer included under the 2012 state law are cash outs of vacation time and other leave pay in the final compensation calculation and payment for additional services outside of normal working hours.

It would be interesting to see how much overtime and vacation time factored into that benefit formula. What percentage boost was that?

Let’s look at some other coverage and commentary.

Other coverage of the case

CalMatters: Round 2 of pension reform kicks off before California Supreme Court:

The court isn’t supposed to take current events under consideration when they rule on legal matters, but the state’s lawyer was happy to remind them of the latest headlines.

“Public services are being cut across California, some jurisdictions have already announced layoffs and furloughs of public employees and many counties and cities are struggling to pay for their pension liabilities,” Rei Onishi, legal affairs secretary to Gov. Gavin Newsom, told the seven justices.

“The question presented by this case is whether on top of legitimate pension liability, should taxpayers along with their children and even grandchildren, be forced to also shoulder the burden of financing abusive practices to artificially and unlawfully inflate pensions.”
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“I hear you to be saying, better to let (a pension system) go insolvent, better that a county go bankrupt, than make changes to existing employees,” said Groban. “Does the argument go that far?”

Essentially yes, said Mastagni. “Were the county unable to make its obligations then bankruptcy is the forum where contracts are impaired,” he said. Barring that, the county can just negotiate directly with the public-sector union.

That’s different from the “adjust the pension contributions” line from yesterday’s post.

LA Times: California Supreme Court hears suit on public pension law aimed at saving billions

The California Supreme Court grappled Tuesday with whether to uphold a state law designed to help reduce a shortfall of hundreds of billions of dollars in state and local pension systems.

During a hearing, the state’s highest court did not clearly indicate which way it would rule. Only four of the court’s seven justices asked questions, and those who did speak challenged both sides in the dispute.

The court is considering a challenge by unions to a 2012 law that forbade the practice of “pension spiking” for all government employees. The practice involves inflating a future pensioner’s pay, usually at the end of their career, by cashing in years of accumulated vacation or sick pay or volunteering for extra duties.
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David E. Mastagni, representing the Alameda County Deputy Sheriff’s Assn., argued the words “pension spiking” amounted to an “inherently subjective political term.”

He said employees were recruited and told they could depend on the pension rules in place. “My clients were promised they would have deferred compensation,” he said.

Justice Joshua P. Groban, appearing frustrated, asked the lawyer to imagine a “massive economic downturn” and a “doomsday scenario” when pension systems are “on the brink.” He wanted to know: Can there never be any changes?

Mastagni said counties in such cases could ease financial pressures by negotiating additional employee contributions.

AHHHH, now that’s reasonable. The concept is that the county or cities could negotiate with public employee unions to ask them to throw in more money, to make the pensions sustainable.

ai-CIO: California Pension Spiking Case Nears End in Court Showdown

Public sector unions in Alameda, Contra Costa, and Merced counties in California are hoping to strike down a provision in former California Gov. Jerry Brown’s 2012 pension reform law that curbed pension spiking for all employees, including those hired before the law was enacted.

The practice allows workers to increase their retirement income by cashing out balances from vacation days, sick days, or on-call days, and adding them to their final salaries. Unlike many private workers, public employees can accumulate time off throughout their entire working career.

Similar cases from public employees have pushed through judicial courts since the former state governor’s Public Employees’ Pension Reform Act (PEPRA) went into effect.

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When the state Supreme Court discloses its verdict sometime in the next 90 days, it’s expected to have wide-ranging implications for state governments, especially in regard to whether they can make adjustments to state retirement systems. Four of the current seven state justices were appointed by Brown.

That could be of interest to other states, including Illinois, which is struggling under the weight of a massively underfunded pension system, especially as the coronavirus pandemic adds pressure to government budgets. Illinois recently asked Washington for $10 billion to help fund its liabilities.

I don’t see how Illinois comes into it.

Mainly because this is all state laws and constitutions. And in Illinois, their top court already ruled on this. As I noted in posts when the rulings came down, they considered that removing automatic COLA increases and also increased retirement ages were considered impairments to the contracts. The interpretation was made based on the Illinois state constitution. It doesn’t matter what is ruled in California state courts. The Illinois Supreme Court has already spoken.

Separate from that, it is not clear to me that the ruling will come within 90 days.

Courthouse News: Battle Over Pension Padding Consumes California High Court

The California Supreme Court took up the contentious and seemingly unending battle over public employee pension reform Tuesday, questioning whether employees have a vested contractual right to pad their pensions.

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Arguing for the employees, labor attorney David Mastagni said police officers relied on the promise that they would receive significant pension benefits in exchange for lower salaries, a deal upended when AB 197 led to a 15% reduction in the pension formula.

Stopping here: I assume the 15% is an overall average, and that some people managed to spike more than 15%, and some less.

Still, it gives an idea of how large these pension boosts were. I knew that it had to be at least double digits, given the “windfall” talk seen elsewhere.

“My clients were offered a deal by the county,” Mastagni said. “They said if you accept a lower amount of salary then you can maybe make in the private sector, and agree to provide us 30 years of service as a deputy sheriff or a first responder, we will provide you with significant amounts of deferred compensation. That promise is a very important aspect of the employment agreement.”

But Onishi said the Legislature has the discretion to make changes to the County Employee Retirement Law (CERL), a statutory framework by which pensions are calculated.

“Employees were repeatedly and constantly told their pension would be calculated according to CERL,” he said.

Justice Joshua Groban piped in. “Are you arguing that any pension modification is appropriate so long as the employee hasn’t retired yet?” he asked.

Onishi answered, “I think I’m arguing something more narrow. Prospective only changes to compensation that has not yet been earned doesn’t implicate the contract clause and I think that principle alone decides this case.”

That didn’t satisfy Groban. “The vacation time was earned and accrued prior to the PEPRA amendments. That’s the essence of accrued. So when you say it hasn’t been earned yet, can you drill down on what you mean?”

Onishi said employees are free to cash out accrued vacation time, “but CERL’s rules have always been clear that when it comes to determining your pensionable compensation, the amount cannot exceed the amount of leave that you could accrue and cash out.”
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“Let’s imagine a massive economic downturn and a pension system on the brink,” he said. “A counties’ pension is going to become insolvent. I hear you to be saying even given that doomsday scenario, if there’s not a commensurate advantage, the system cannot make any cost savings changes with respect to existing employees even if the pension system is on the brink. I hear you saying, better to let the county go bankrupt than make changes to existing employees. Does the argument go that far?”

Mastagni proposed a solution counties will probably find hard to swallow: Since the funding obligation rests with the counties, they can declare bankruptcy. But if the pension system is underfunded, they may be required to make additional contributions or re-negotiate for more contributions from employees.

The panel took the case under submission and did not indicate when it would rule.

So we’ve got that to look forward to.

I am assuming that it will not actually be definitive, but that’s as far as I’ll go in trying to predict what the court will rule.

Commentary by Dan Walters

Dan Walters at Calmatters: High court weighs timely pension case

It was purely coincidental that state Supreme Court justices heard arguments this week in a landmark case involving public employee pensions as state and local officials were beginning to wrest with the severe impacts of a pandemic-induced recession on their budgets.

However, the health and financial crises occurring outside the court’s San Francisco chambers permeated inside, both visually and, perhaps, legally.

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Rei Onishi, a legal aide to Gov. Gavin Newsom, alluded several times to the recession’s impacts as he implored the court to uphold a 2012 pension reform law, Assembly Bill 197, championed and signed by Newsom’s predecessor, Jerry Brown, that eliminated so-called “pension spiking.”

It would be unconscionable, he said, to allow public employees to artificially inflate their pensions by including various payments other than their salaries in pension calculations at a time when state and local governments are contemplating deep cuts in vital services. Onishi said upholding the law would “finally put an end to egregious pension spiking processes.”

However, in defending the law’s mandate to “exclude from the definition of compensation earnable any compensation determined…to have been paid to enhance a member’s retirement benefit,” Onishi took a narrow approach, arguing that pension-spiking was never legal so the reform law merely underscored its illegality. Thus, he sidestepped the more fundamental issue posed by the 2012 reform – whether the “California rule” protecting pension rights is as sacrosanct as long assumed.

Now that’s interesting. Maybe there won’t be a ruling on the “California rule”… or, maybe, there will be a narrowing of its implementation.

That rule – actually a series of Supreme Court cases dating as many as eight decades – holds that once a public employee is hired, whatever pension benefits then in place can never be changed. It’s an application of the state constitution’s prohibition on “impairment of contracts.”

Wait, wait, wait. Of course they can be changed. The point is they can never be adjusted downwards. But adjusted upwards? Retroactively? No problem!

The lawyers for law enforcement unions that challenged AB 197’s pension-spiking provisions, on the other hand, repeatedly argued that the inclusion of non-salary compensation in pension calculations was long understood to be legal. Therefore, they said, the legislation’s exclusion of such compensation for current employees impaired an implied contract, violated the California rule, and therefore is unconstitutional.

Union lawyer David Mastagni dismissed “pension-spiking” as “an inherently subjective political term” for practices that had long enjoyed legal blessing and suggested that in seeking its abolition, the state was “asking for a windfall.”

I really want to know how much overtime and vacation time [and what other stuff] spiked pension benefits. We see the 15% estimate in one of the stories above. Maybe that’s windfall size. If the state was “asking for a windfall”, I might expect something bigger than 15%.

Pension spiking is one of those things that can be legal or not, all dependent on the rules of the benefit formulas.

The main thing though, like double-dipping, it can look really bad to taxpayers, even if it’s legal.

Editorial from the Mercury News

Editorial: Pension-spiking showdown at California Supreme Court

With state and local governments crippled by escalating pension costs and badly underfunded retirement plans, and with the problem exacerbated by the current coronavirus recession, now is the time for the high court to set some reasonable boundaries.

At the very least, the justices should strike down the pension spiking in Merced, Alameda and, most egregiously, Contra Costa counties. Abuses were so bad that some workers were retiring with pensions 25% greater than their top pay when they were on the job.

But the case also provides the high court an opportunity to reverse more than 60 years of misguided legal doctrine that prevents the state and its local governments from making reasonable adjustments to curb pension costs.

The amount of a public employee pension is based on three factors: age at retirement, years on the job and top salary, usually the last year or the average of the final three years. At issue in the legal case is what’s included in that salary.

For years, workers in the three counties were saving up their leave time, receiving cash payments for it as they prepared to retire and then counting those large payments toward their final year’s salary used in calculating their pensions.

Counting so-called “terminal pay” was legally questionable. But it had been going on for more than a decade until it was explicitly prohibited by a law signed by Gov. Jerry Brown in 2012.

The original version of that law contained a loophole that would have explicitly permitted such pension spiking. But when this news organization exposed the loophole lawmakers scrambled on the final day of the 2012 legislative session to pass an additional bill to fix the problem.

Labor unions soon filed lawsuits challenging that additional law, arguing that they were told they could spike their pensions when they started working and that it thus became a “vested right” that the state could not take away.

Attorneys for the governor’s office, first for Brown and now for Gavin Newsom, argue that counting such terminal pay was never legal to begin with so the workers don’t have a protected right to an illegal benefit.

The unions’ argument seeks to take advantage of misguided state Supreme Court precedence. In a string of cases dating back more than six decades, the high court has ruled that most pension benefits enjoy constitutional protections against being reduced. The decisions have been dubbed the California Rule because their constraints on the state Legislature are greater than in most other states.

Butting in here for a moment: if the high court of California allows this particular cut, then the rule should be renamed the “Illinois rule”, because they actually have the case history to back up what most people meant by the California rule.

Pension reformers, including Brown, have been urging the justices to reconsider the rigidity of the California Rule. The issue is not the pension benefits a worker has previously earned; but rather whether the worker is entitled to keep earning at the same generous level for their future work.
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The 2012 legislation was an attempt to inject some minimal limits on out-of-control behavior. It would be a travesty for the Supreme Court to permit those practices to continue.

The above editorial was run before the court hearing. However, I imagine the Mercury News would have to change little on the editorial after the hearing.

My question: what about the other spikers?

I have nothing to predict with respect to the California court ruling. The Illinois Supreme Court was very easy to predict – anything that makes the pensions less valuable to current employees (and retirees) must be struck down as unconstitutional.

But California doesn’t have the same history, or state constitution, as Illinois.

I’m not a lawyer, so I’m not arguing from an educated perspective with respect to the law.

My understanding is that “cashing in” unused vacation days, as well as using overtime pay to set initial pension pay was in use in California for at least a decade, if not longer. Maybe not all employers, but enough.

I could be wrong about the following (if I am, please email me: marypat.campbell@gmail.com), but it seems to me that the employees didn’t do the calculation of initial pension benefits; it was done by the pension plan itself when they applied for retirement benefits. I’m sure that pensioners thinking they got too little for pension benefits would call up to complain and get things adjusted, as I saw when people complained about getting what they thought was too-small annuity payments when I worked at TIAA (I have some fabulous stories about that.)

I assume the vast majority of these pension payments were automatically calculated, factoring in the unused vacation days and using various pension boosters, without needing the pensioner to do anything.

The reason I mention this is that there definitely exist people in California whose initial pension benefits, before any COLAs, included all the things that Rei Onishi, legal affairs secretary to Gov. Gavin Newsom, argued were illegal boosters.

So, if Onishi’s assertion is correct, then there are a bunch of California retirees who have retirement benefits they’ve been drawing above what was “legal”. If the court is to agree with Onishi that the items used for spiking were illegal… shouldn’t overpayments to those folks be clawed back?

If people had been collecting these “too high” pensions for a decade or more, and that was illegal, obviously they have to pay those overpayments back…. [and their current pensions would be adjusted downwards].

That said, that’s not the question here — it’s the legality/constitutionality of the pension reform bill that went into effect in 2013, and these changes were applied then. Questions of using “illegal” benefit formulas prior to the law’s effective date aren’t being asked in this case, per se.

Josh Groban video

Mainly because one of the Justices on the case is named Joshua Groban. I’m sure there’s no close connection, and he probably gets this crap all the time, but why not?

I have this one on my wallowing playlist (it starts with Patsy Cline’s “I Fall to Pieces”, to give you an idea), which has a story behind it.

It makes me smile now, but I wasn’t smiling back then.

I wish I could say the same of California pensions, but I can’t.