Originally posted at CalPensions.
By Ed Mendel.

President Obama signed a budget bill that cut cost-of-living adjustments in military veteran pensions last month, a few days after a judge overturned a voter-approved attempt to cut cost-of-living adjustments in San Jose city worker pensions.

Why can the pensions of veterans who put their lives on the line during military duty for the nation be cut, while the pensions of everyday state and local government workers in California are legally protected from cuts?

The answer is that case law developed by California judges over decades means the pension promised on the date of hire becomes a contract, a “vested right” that cannot be cut unless offset by a new benefit of comparable value.

Military pensions lack this court protection, and so does the general federal retirement plan, Social Security. Both can be cut. The protection California courts have given state and local government pensions is exceptional.

In what some call the “California Rule,” the pension promised on the date of hire becomes an uncuttable contract not only for service already provided, but also for service the worker will provide in the future.

The “California Rule” bars what some think is the solution for unaffordable government pension costs: cutting the pensions current workers earn in the future, while protecting pension amounts already earned by time on the job.

Lower pensions for new hires, as required by recent reform legislation, can take decades to yield significant savings. Bargaining to increase worker pension contributions can yield limited or temporary savings and require offsetting pay raises or benefits.

So, the bipartisan Little Hoover Commission called for legislation authorizing cuts in pensions current workers earn in the future. An initiative proposed by San Jose Mayor Chuck Reed and others would put a similar provision in the state constitution.

Private-sector pension plans can cut pensions earned by current workers for future service. Some states base pension protection in property law, not contract law, and in some states the pension becomes a contract on the last day on the job, not the first day.

study cited by Reed and others looks at the origin of the “California Rule” and argues that it’s an error: “Statutes as Contracts? The ‘California Rule’ and Its Impact on Public Pension Reform” by Amy Monahan of the University of Minnesota Law School.

The “California Rule” has only been adopted in a dozen states, Monahan said. Two of the states, Massachusetts and Oregon, later modified the rule to allow cuts without offsetting benefits or cuts in pensions current workers earn in the future.

California courts were among the first to hold that pensions are contracts. An early ruling, Kern v. City of Long Beach in 1947, allowed some flexibility, Monahan said, resulting in three appellate cutting pensions current workers earned in the future.

Then in a “bombshell” ruling in 1955, Allen v. City of Long Beach in 1955, the state Supreme Court allowed reasonable changes consistent with the theory of a pension system if cuts were offset by a new benefit of comparable value.

Monahan argued that by imposing a highly restrictive rule without ever finding clear evidence of legislative intent to create a contract, California courts broke with traditional contract clause analysis and infringed on the power of the legislative branch.

“California courts have held that even though the state can terminate a worker, lower her salary, or reduce her other benefits, the state cannot decrease the worker’s rate of pension accrual as long as she is employed,” Monahan said.

As in the federal budget deal that cut military pensions, the cost-of-living adjustment has been the main target as a number of states struggle to manage growing pension costs.

COLA cut legal challenges (Institute for Illinois Fiscal Sustainability)

COLA cut legal challenges (Institute for Illinois Fiscal Sustainability)

Since 2010 nine states have enacted pension COLA cuts, all challenged in court, according to a summary issued this month by the Institute for Illinois Fiscal Sustainability, a non-partisan business group.

Illinois has the nation’s most troubled state pensions, only about 40 percent funded. A reform enacted in December expects to get most of its savings from eliminating automatic 3 percent COLAs, except for smaller pensions below a threshold.

Like several other states, Illinois has a provision in the state constitution that says pensions are an “enforceable” contract that “shall not be diminished or impaired.” The reform reduces employee contributions, but it’s not clear whether that offsets the cuts.

Two states paired by the legalization of recreational marijuana and having football teams in the Super Bowl next month, Washington and Colorado, also have enacted cuts in pension COLAS that are being challenged in the courts.

Deep cuts in COLAs can seriously erode the pensions of long-time retirees. The two big California state pension systems, CalPERS and CalSTRS, both have programs that keep pensions from falling too far below their original purchasing power.

The California State Teachers Retirement System provides an automatic annual increase of 2 percent of the initial monthly payment that is not tied to changes in the cost of living.

Teachers do not receive Social Security, which does keep pace with inflation. An important supplemental program, which gets about half of state CalSTRS funding, keeps pensions from falling below 85 percent of the original purchasing power.

In the giant California Public Employees Retirement System, most members receive Social Security in addition to pensions. State and non-teaching school members receive 2 percent COLAs, compounded unlike CalSTRS.

Local government employees can bargain for COLAs of 3 to 5 percent, limited to the national rate of inflation. State and school pensions can’t fall below 75 percent of original purchasing power, local government pensions below 80 percent.

In San Jose, one of the provisions of Measure B approved by 70 percent of the voters in June 2012 would have allowed the city council to declare a fiscal emergency and suspend retiree COLAs for up to five years.

A superior court judge, citing some of the same rulings as Monahan, said the COLA suspension was a violation of vested rights, along with a key provision intended to give the city the option of cutting pensions earned by current workers in the future.

The bipartisan federal budget deal cut the military pension COLA by one percentage point until age 62, when the pension would be recalculated as if the cut never happened.

The cut is expected to save about $6 billion on military pensions that cost $52 billion in 2012, nearly 50 percent more than in 2002, the Washington Post reported. A person retiring at the average age of 44 would lose about $30,000 over their lifetime.

Congress approved a bill last week exempting disabled military retirees from the COLA cut. Military and veterans groups are expected to push for a repeal of the COLA cut as the Senate works on an omnibus Veterans Affairs bill.