The Alameda County Pension Case – a Closer Look
Aug 3, 2020
While the League reacted positively to the decision, it is important to understand the context for the Court’s ruling, and reasoning in the case.
The Court’s Ruling in Context
PEPRA made various changes to the laws governing the pension plans of the state’s public employees. Most of the changes applied only to employees hired after PEPRA’s effective date. However, two changes affecting employees employed prior to PEPRA (legacy employees) prompted legal challenges.
The first was PEPRA’s elimination of the option for employees enrolled in CalPERS to purchase up to five years of service credit – commonly known as “airtime” – to increase the amount of service factored into their pension at retirement. Cal Fire Local 2881 sued, arguing that legacy employees obtained a vested contractual right to the airtime benefit, and that PEPRA’s elimination of the benefit violated the constitutional protections against the impairment of contracts.
Last year, in Cal Fire Local 2881 v. California Public Employees’ Retirement System, the California Supreme Court rejected the lawsuit. The Court ruled that airtime was not a contractually-vested benefit for various reasons, including the fact that it could not be considered “deferred compensation” for actual public service. Since only vested benefits are entitled to constitutional protection, the Court’s conclusion resolved the case, and it had no reason to consider the circumstances under which a vested benefit might be modified consistent with the Constitution.
The second change to result in a legal challenge was PEPRA’s modification to the definition of “compensation earnable” under the County Employees Retirement Law of 1937 (CERL). “Compensation earnable” is the amount of salary that is used to calculate pension benefits at retirement.
For employees in the 20 California counties that administer their retirement systems under the CERL, PEPRA modified the definition of “compensation earnable” to exclude certain pay items that were previously included, such as leave cash-outs and other specialty pay items. Several unions representing employees in counties governed by the CERL sued, arguing that legacy employees have a contractual and constitutional right to have their pension benefits determined based on the pre-PEPRA definition of compensation earnable.
Last week, in Alameda County Deputy Sheriff’s Association v. Alameda County Employees’ Retirement Association, the California Supreme Court again rejected the legal challenge and upheld PEPRA’s change even as applied to legacy employees. Although the direct effects of the case are limited to county retirement systems, the Court’s reasoning in the case could have important implications for cities.
The Court’s Reasoning
The plaintiffs in the case argued that legacy employees were entitled to have their pension benefits calculated according to the pre-PEPRA definition of compensation earnable (i.e., with the specialty pay items included) for two reasons. First, they cited litigation settlement agreements with the county retirement boards that incorporated the pre-PEPRA definition, and they argued, based on these agreements, that the legacy employees had both a contractual and equitable right to have their pension benefits calculated with the specialty pay items included.
The Court disagreed, noting that the CERL constrains the authority of the county retirement boards. The boards are required to comply with the CERL when calculating pension benefits and they cannot confer any contractual rights to employees that would be inconsistent with the CERL. Since PEPRA amended the CERL, the Court held the plaintiffs had no contractual or equitable right to have the specialty pay items included in the calculation of their pension benefits.
The second argument the plaintiffs raised was that the legacy employees acquired a constitutional right to have their pension benefits calculated with the pre-PEPRA definition of compensation earnable. The plaintiffs based this argument on a body of judicial precedent known as the “California Rule” of pension benefits. The California Rule grants constitutional protection to vested contractual pension rights, and significantly limits the circumstances under which a pension plan can be modified without violating the constitution. The Court summarized the Rule as follows:
“An employee’s vested contractual pension rights may be modified prior to retirement for the purpose of keeping a pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system. Such modifications must be reasonable. To be sustained as reasonable, alterations of employees’ pension rights must bear some material relation to the theory of a pension system and its successful operation, and changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages.”
The defendants (including the State) attempted to convince the Court that the California Rule was inapplicable to PEPRA’s modifications to the definition of compensation earnable. They argued in part that PEPRA merely clarified and did not actually change the definition. But the Court rejected this argument, noting that compensation earnable had been judicially interpreted prior to PEPRA to include the specialty pay items, and therefore PEPRA had the practical effect of diminishing pension benefits for legacy employees who reasonably expected their pensions would be calculated with the specialty pay items included.
Ultimately, the Court found that PEPRA’s modifications to compensation earnable did not violate the California Rule. In reaching this conclusion, the Court took the important step of clarifying that the California Rule does not always require comparable new advantages to offset modifications to pension benefits that result in disadvantages to the employee.
The Court reiterated that modifications must be made for a constitutionally permissible purpose – i.e. to keep “the pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system” – and they must “bear some material relation to the theory of a pension system and its successful operation.” The Court found that PEPRA’s modifications to compensation earnable met this test, because the Legislature’s primary purpose in enacting the change was to prevent pension spiking and bring the definition of compensation earnable into closer alignment with the pension system’s underlying theory of what constitutes pensionable compensation. In other words, the Legislature was attempting to reduce manipulation and abuse by closing loopholes created by the language previously used by the CERL to define pensionable compensation.
The Court then clarified that in cases such as this, where modifications are motivated by a constitutionally permissible purpose, there is no requirement under the California Rule to offset disadvantages with comparable new advantages if it would undermine or be inconsistent with that purpose to offer comparable new advantages. The Court readily concluded that affording comparable new advantages to offset PEPRA’s modifications to compensation earnable would be “wholly inconsistent” with the Legislature’s purpose, because it would effectively restore in some form advantages that, in the view of the Legislature, were improper and unintended and should not have been available for county employees to include when calculating their pensionable compensation in the first place.
Takeaways for Cities
The Court’s clarification of the scope of the California Rule was a welcome step in the right direction for cities seeking to understand the constitutional limitations of future efforts to address rising pension costs. However, the Court was very careful to limit its holding to the specific facts of this case and therefore, any future pension reform efforts are likely to be met with further litigation. Cities who have questions about the impact of the Court’s ruling should consult with their city attorney.
The Court’s Ruling in Context
PEPRA made various changes to the laws governing the pension plans of the state’s public employees. Most of the changes applied only to employees hired after PEPRA’s effective date. However, two changes affecting employees employed prior to PEPRA (legacy employees) prompted legal challenges.
The first was PEPRA’s elimination of the option for employees enrolled in CalPERS to purchase up to five years of service credit – commonly known as “airtime” – to increase the amount of service factored into their pension at retirement. Cal Fire Local 2881 sued, arguing that legacy employees obtained a vested contractual right to the airtime benefit, and that PEPRA’s elimination of the benefit violated the constitutional protections against the impairment of contracts.
Last year, in Cal Fire Local 2881 v. California Public Employees’ Retirement System, the California Supreme Court rejected the lawsuit. The Court ruled that airtime was not a contractually-vested benefit for various reasons, including the fact that it could not be considered “deferred compensation” for actual public service. Since only vested benefits are entitled to constitutional protection, the Court’s conclusion resolved the case, and it had no reason to consider the circumstances under which a vested benefit might be modified consistent with the Constitution.
The second change to result in a legal challenge was PEPRA’s modification to the definition of “compensation earnable” under the County Employees Retirement Law of 1937 (CERL). “Compensation earnable” is the amount of salary that is used to calculate pension benefits at retirement.
For employees in the 20 California counties that administer their retirement systems under the CERL, PEPRA modified the definition of “compensation earnable” to exclude certain pay items that were previously included, such as leave cash-outs and other specialty pay items. Several unions representing employees in counties governed by the CERL sued, arguing that legacy employees have a contractual and constitutional right to have their pension benefits determined based on the pre-PEPRA definition of compensation earnable.
Last week, in Alameda County Deputy Sheriff’s Association v. Alameda County Employees’ Retirement Association, the California Supreme Court again rejected the legal challenge and upheld PEPRA’s change even as applied to legacy employees. Although the direct effects of the case are limited to county retirement systems, the Court’s reasoning in the case could have important implications for cities.
The Court’s Reasoning
The plaintiffs in the case argued that legacy employees were entitled to have their pension benefits calculated according to the pre-PEPRA definition of compensation earnable (i.e., with the specialty pay items included) for two reasons. First, they cited litigation settlement agreements with the county retirement boards that incorporated the pre-PEPRA definition, and they argued, based on these agreements, that the legacy employees had both a contractual and equitable right to have their pension benefits calculated with the specialty pay items included.
The Court disagreed, noting that the CERL constrains the authority of the county retirement boards. The boards are required to comply with the CERL when calculating pension benefits and they cannot confer any contractual rights to employees that would be inconsistent with the CERL. Since PEPRA amended the CERL, the Court held the plaintiffs had no contractual or equitable right to have the specialty pay items included in the calculation of their pension benefits.
The second argument the plaintiffs raised was that the legacy employees acquired a constitutional right to have their pension benefits calculated with the pre-PEPRA definition of compensation earnable. The plaintiffs based this argument on a body of judicial precedent known as the “California Rule” of pension benefits. The California Rule grants constitutional protection to vested contractual pension rights, and significantly limits the circumstances under which a pension plan can be modified without violating the constitution. The Court summarized the Rule as follows:
“An employee’s vested contractual pension rights may be modified prior to retirement for the purpose of keeping a pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system. Such modifications must be reasonable. To be sustained as reasonable, alterations of employees’ pension rights must bear some material relation to the theory of a pension system and its successful operation, and changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages.”
The defendants (including the State) attempted to convince the Court that the California Rule was inapplicable to PEPRA’s modifications to the definition of compensation earnable. They argued in part that PEPRA merely clarified and did not actually change the definition. But the Court rejected this argument, noting that compensation earnable had been judicially interpreted prior to PEPRA to include the specialty pay items, and therefore PEPRA had the practical effect of diminishing pension benefits for legacy employees who reasonably expected their pensions would be calculated with the specialty pay items included.
Ultimately, the Court found that PEPRA’s modifications to compensation earnable did not violate the California Rule. In reaching this conclusion, the Court took the important step of clarifying that the California Rule does not always require comparable new advantages to offset modifications to pension benefits that result in disadvantages to the employee.
The Court reiterated that modifications must be made for a constitutionally permissible purpose – i.e. to keep “the pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system” – and they must “bear some material relation to the theory of a pension system and its successful operation.” The Court found that PEPRA’s modifications to compensation earnable met this test, because the Legislature’s primary purpose in enacting the change was to prevent pension spiking and bring the definition of compensation earnable into closer alignment with the pension system’s underlying theory of what constitutes pensionable compensation. In other words, the Legislature was attempting to reduce manipulation and abuse by closing loopholes created by the language previously used by the CERL to define pensionable compensation.
The Court then clarified that in cases such as this, where modifications are motivated by a constitutionally permissible purpose, there is no requirement under the California Rule to offset disadvantages with comparable new advantages if it would undermine or be inconsistent with that purpose to offer comparable new advantages. The Court readily concluded that affording comparable new advantages to offset PEPRA’s modifications to compensation earnable would be “wholly inconsistent” with the Legislature’s purpose, because it would effectively restore in some form advantages that, in the view of the Legislature, were improper and unintended and should not have been available for county employees to include when calculating their pensionable compensation in the first place.
Takeaways for Cities
The Court’s clarification of the scope of the California Rule was a welcome step in the right direction for cities seeking to understand the constitutional limitations of future efforts to address rising pension costs. However, the Court was very careful to limit its holding to the specific facts of this case and therefore, any future pension reform efforts are likely to be met with further litigation. Cities who have questions about the impact of the Court’s ruling should consult with their city attorney.