For Better or Worse, the California Rule Still Limits Changes to Public Pensions

The California Supreme Court recently upheld the state’s ban on the practice of “pension spiking” by public employees while leaving in place the so-called “California Rule,” which limits reform options for the state’s public pension systems.

The case, Alameda County Deputy Sherriff’s Association vs. Alameda County Employees Retirement Association, No. S247095 (Cal. July 30, 2020), examined the constitutionality of provisions of the California Public Employees’ Pension Reform Act of 2013 (PEPRA), Cal. Gov’t. § 7522 et seq., which was designed, in part, to rein in the dramatic increase in pension costs for municipalities and school districts by prohibiting the practice of pension spiking.

Pension spiking meets the California Rule

Pension spiking occurs when employees increase their earnings immediately prior to retirement by including accumulated leave and extra hours (often at higher rates) in their final years of employment. By loading up their income in their final years of service, public employees could dramatically increase the size of their monthly pension checks after retirement.

In the Alameda case, the ban on spiking introduced by PEPRA was challenged on grounds that it violated the long-standing California Rule. The California Supreme Court established the California Rule in a series of cases in the 1950s. The basic contours of the rule state that the contract clause of the California Constitution precludes a jurisdiction from substantially modifying pension benefits in place at the start of an individual’s employment without providing additional, offsetting benefits.

The California Rule has long been a source of controversy. Public employees, retirees, unions, and their allies view the rule as a vital defense of earned benefits. Pension reformers, meanwhile, hoped the Supreme Court would use the Alameda case to weaken the California Rule as a barrier to change.

Alameda leaves the California Rule unchanged

The Court’s decision in Alameda is narrowly focused. The Court rejected arguments that the legislature’s effort to curb pension spiking with PEPRA was unconstitutional. At the same time, the Court passed on the opportunity to address the ongoing validity of the California Rule.

The plaintiffs in the Alameda case had argued that pension benefit calculations which predated any legislative action should remain intact, regardless of the new requirements in PEPRA.  The Court reaffirmed longstanding principles of the California Rule in finding that PEPRA’s restrictions against pension spiking did not violate the rule because they were enacted for “constitutionally permissible” purposes, such as closing loopholes and preventing fraud and abuse. Importantly, the Court held that PEPRA was constitutional “notwithstanding the failure of the legislature to provide for additional benefits offsetting whatever disadvantages the amendment created.”

The Court also noted that county retirement boards, which are legally responsible for implementing the pension obligations, must comply with PEPRA.  The Court noted that new pension laws may be modified “for the purpose of keeping the pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system” and was consistent with the pre-existing structure governed by state pension laws.

A context of rising costs and shrinking revenues

California’s unfunded pension liabilities—the gap between what has been promised in benefits and what has been contributed by state agencies—remain significant.  PEPRA addressed this growing gap by mandating significant rate increases for employers falling under CalSTRS and CalPERS with a goal of achieving full funding within 30 years. With a $65 billion gap in 2011, CalSTRS has mandated seven straight years of increases that have doubled many school district pension costs. As a result, the share of budgets going to pensions have been steadily rising. Taken with other rising costs and pandemic-led revenue challenges, pensions have become a source of anxiety for policymakers.

Attempts started by former Governor Brown and others to reform pension benefits continue to be frustrated by the Court’s decisions to preserve the core of the present system.

Given the magnitude and scope of the state’s pension obligations, this issue will continue to be a challenge for public institutions. Any major curtailment of the California Rule could spark significant reductions in public pension benefits, which in turn could lead to widespread retirements and departures, eliminating years of valuable experience from public service.  Yet the fiscal demands of meeting pension obligations create a classic choice between honoring contracts made in different circumstances and funding current, and often expanding, civic obligations.

Jones & Mayer is here for public sector employers

California’s governmental entities must navigate a complex legal framework while balancing public finances and employee benefits. As professionals committed to serving the public sector, the attorneys at Jones & Mayer are studying the evolution of public pensions and other matters of importance to our clients. If your agency has questions about how Alameda may impact its pension program or the rights of its employees, please give us a call at (916) 771-0635 or send us an email to schedule a conference with an attorney.