On the “California Rule” and why it matters for WA pension reform

In a Bloomberg View article, Steven Malanga writes about an effort in California to amend the state constitution to

specifically eliminate the notion that employee benefits are a contractual right that bars all future changes. [San Jose Mayor Chuck Reed] is pushing for the amendment because workers are challenging a San Jose pension measure approved by 70 percent of the city’s voters last November. Reed, a Democrat, promoted that local initiative to lower pension costs, because he said the change was essential to preserving the city’s fiscal future and public services.

As Malanga notes,

In the private sector, pensions are governed by the federal Employee Retirement Income Security Act. Although a private employer may not cut benefits that a worker has already earned, ERISA allows a business to change the rate at which a worker accrues future benefits.

ERISA, however, doesn’t apply to government employee pensions. Instead, in the states, local laws and court decisions govern how public-worker retirement systems are treated, and in many cases the states depart, sometimes radically, from the standard set by the law.

Malanga points to an Iowa Law Review article by Amy Monahan that describes the “California Rule” on pensions. Monahan summarizes that the California Rule “(1) requires an impairment to be offset by a compensating advantage and (2) protects prospective changes.” Monahan says that 12 states follow the California Rule — including Washington.

Monahan argues that

As a legal rule, the California Rule is anomalous. It is not based on clear and unambiguous evidence that the legislature intended to create a contract, it differentiates pensions from compensation generally, and it protects not only benefits that have been earned but also the rate of future accruals.

Monahan concludes,

In some states, notably California, courts have ruled not only that retroactive reductions in pension benefits are impermissible but also that the state is prohibited from prospectively changing accrual rates for any current employees. This California Rule, adopted by many other states, improperly infringes on legislative power by holding that a legislative contract exists without ever evaluating whether there is clear and unambiguous evidence of legislative intent to form a contract. Even in the absence of a legislative contract, long-standing precedent protects earned pension benefits under the theory that earned compensation is protected by an implied contract, but there is no such basis for protecting future accruals absent an explicit agreement. Protecting such future accruals absent an explicit agreement to do so is inconsistent with contract theory, economically inefficient, and simply forces the state to make other changes to the terms and conditions of public employment that may be less desirable to employees, less effective at stabilizing public pension funds, and potentially more damaging to the state and its citizens. To the extent that courts continue to protect future accruals, they owe it to their states’ citizens to clearly set out the legal basis on which such accruals are entitled to protection.

The Washington Supreme Court will have a chance to do so soon: It will hear arguments on the public pension gain sharing and COLA cases next Thursday. Gain sharing and automatic cost-of-living adjustments were pension sweeteners offered to state employees in better days. They were subsequently repealed, but state courts have found that the Legislature had no right to do so, despite the fact that the Legislature explicitly said they were not to be considered contractual rights.