Courts Block Efforts at Public Pension Change

By: - February 15, 2012 12:00 am

Two judges have ruled that their states cannot make existing employees contribute more to their retirement benefits. 

A pair of recent court rulings could slow down state lawmakers’ efforts to increase contributions from current employees to prop up troubled public pension plans.

Higher employee contributions were at the center of major public pension changes approved last year in Arizona and New Hampshire, which joined 10 states in boosting the share that current workers must chip in to their retirement plans through payroll deductions. The state government also pays in to the plans from taxpayer dollars, so an increase in worker contributions often means the state can reduce its cost of providing retirement benefits.

But district court judges in Arizona and New Hampshire said the higher contributions were unconstitutional because they broke the contract between employees and the state, which guarantees workers that they will not be asked to pay additional amounts after being hired unless they receive improved benefits in return. This legal precept traces to the U.S. Constitution , which bars lawmakers from diminishing or impairing a contract. 

Contract clause

“The state has impaired its own contract,” concluded Eileen Willett, a superior court judge in Maricopa County, Arizona, which includes Phoenix. “By paying a higher proportionate share for their pension benefits than they had been required to pay when hired, [state workers] are forced to pay additional consideration for a benefit which has remained the same.”

A district court ruling in one state does not bind a court in another, but legal experts everywhere are following public pension decisions because of the issues raised by the rollback of retirement benefits in nearly every state in the last few years. The arguments used by the courts in Arizona and New Hampshire could apply to similar pending lawsuits filed by employees of other states.

In Florida, a group of public employee unions is challenging the legislature’s decision to require workers to contribute 3 percent of their pay towards their retirement benefits for the first time. State troopers in Nebraska filed a lawsuit in federal court seeking to overturn the two-year, 46 percent increase in their pension contributions enacted by the legislature. New Jersey public employees are asking a federal judge to overturn the pension contribution increase lawmakers approved last year; a district court judge already tossed out increases approved for New Jersey’s judges, saying the higher contributions are tantamount to a pay cut.

“Given the tenacity of the fights going on nationwide,” says Robert Klausner, a Florida attorney who specializes in public pension law, “those who are looking for support of the contract theory will seize upon these cases as examples of overreaching by government.”

Trying to regroup

States mulling contribution increases from current employees this year may decide to regroup in light of the Arizona and New Hampshire rulings. California Governor Jerry Brown has proposed higher contributions from state workers but legal and legislative analysts have warned him to drop the idea and instead focus on requiring newly hired workers to chip in a larger share.

Altering benefits for new hires is a safer legal path; nearly every state has increased contributions from this group since the recent wave of public pension changes began in 2009. The problem with focusing solely on new hires is that it does not bring in enough money — at least initially — to make a substantial dent in the escalating costs of providing retirement benefits. With the higher contributions from existing employees, New Hampshire was poised to save about $100 million over the next two years in retirement costs. Arizona would have saved $41 million this year had it not been for the court ruling there.

Whether out-of-pocket contributions can be increased for current employees depends largely on what the law and courts say in a given state.  In some states, such as Illinois and New York, the constitution or statutes provide that an employee pension benefit plan, which courts say includes contributions, cannot be changed after the first day of work.  In other states, statutes and case law say that pension benefits do not start until an employee retires. While some benefits are shielded from changes, many states, such as Minnesota, allow the pension system to raise or lower pension contributions depending on the benefits offered and the financial needs of the retirement system. 

“Sometimes the statute is specific about the contribution rate and the courts say that rate is protected” from changes, says Amy Monahan, an associate professor at the University of Minnesota Law School who has studied public pension law. “Other pension systems don’t specify a guaranteed contribution rate. They provide that contributions will be determined based on the plan’s funding needs, as determined by actuaries. It is acknowledged that pension funding needs will vary.”

Arizona is among the handful of states whose constitution is explicit: On the day they are hired, public employees enter into a contract with the state government for pension benefits that cannot be diminished or impaired. Under that contract, employees and the state split their pension contributions 50-50. The state legislature voted last year to raise the employee share to 53 percent. Judge Willett said the increased percentage breached the contract by forcing employees to take a pay cut to receive retirement benefits that have stayed the same.

New Hampshire’s constitution does not specifically protect public pensions but it does include a provision — supported by case law — forbidding the state from impairing a contract. In rejecting the law passed by the legislature last year, Judge Richard McNamara of Merrimack County (Concord) Superior Court said that the 2 percent to 2.5 percent increase in employee contributions would substantially impair the contract “because it requires employees…to pay additional amounts — which may be an amount reserved for other expenses, like mortgages, housing and food — without receiving additional benefit.” 

Value of vesting

The ruling applies only to New Hampshire’s vested employees — those with 10 or more years of state service. Those with fewer than 10 years of service will still be required to pay more towards their benefits. Lawmakers had sought the contribution increase for all state employees.

State officials in Arizona and New Hampshire have not announced whether they will appeal the rulings; lawmakers in both states also are discussing possible legislative remedies. Arizona legislators are considering adjustments to the state budget to make up for the absence of increased pension contributions from workers.

State Senator Jeb Bradley , the New Hampshire Republican who led the pension effort in the legislature, says layoffs of state workers are inevitable unless lawmakers can come up with a fix for the lawsuit. “Between the cost of employee health care and retirement benefits, it will be impossible to deliver the services people expect from the state,” he says. “There has to be a willingness by employee labor groups to accept changes or the public is going to change it for them through diminished job openings.”  Policy makers in New Hampshire and other states, he adds, “have to stick to their guns to preserve the reliability of the retirement system. We’re going to keep after it in New Hampshire and I suspect other states will.”

One way to head off legal challenges, public pension analysts say, is to avoid legislation altogether by negotiating higher contributions with public employee unions. Vermont did that in 2010, requiring employees to work longer and pay more for benefits but giving them a fatter pension check in return. “A deal everyone makes doesn’t end up at the courthouse,” says Klausner. “It’s certainly something I’ve recommended — consult with labor. Working out the deal yourself is probably the best solution.” 

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Stephen Fehr

Stephen Fehr is a senior officer with Pew’s government performance portfolio. He is a lead writer on many of the products generated by the portfolio, specializing in state and local fiscal health.