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Can Public Pension Benefits Be Taken Away?

Can Public Pension Benefits Be Taken Away?

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August 25, 2010

COLORADO – State legislators are beginning to challenge one of the ironclad tenets of public pension policy: that states cannot legally reduce pension benefits for current and future retirees.

Lawmakers in Colorado, Minnesota and South Dakota voted earlier this year to limit cost-of-living increases they previously had promised to thousands of current and future retirees, who courts historically have protected from benefit reductions. Not surprisingly, retirees in each state have filed lawsuits asking judges to restore their annual benefit increases to what they were previously.

Lawmakers, state retirement systems, public employee unions and others in the pension policy arena are closely watching the outcome of the legal challenges. If the courts do not reinstate the retirees’ benefits, a flood of states could follow the lead of Colorado, Minnesota and South Dakota. The reverse also would be true. “If the plaintiffs are successful, it may discourage legislators in other states from attempting to diminish benefits,” says Keith Brainard, research director at the National Association of State Retirement Administrators.

California Governor Arnold Schwarzenegger and New Jersey Governor Chris Christie, among other officials, favor scaling back pension benefits already promised to current employees and retirees. And a lively debate on the issue is underway in Illinois, where lawmakers reduced the cost-of-living adjustment for newly hired workers. Interest is keen everywhere: Lawmakers from around the country packed a session on modifying public pension benefits at the recent annual meeting of the National Conference of State Legislatures in Louisville.

Up to now, states trying to trim the rising cost of worker retirement benefits have taken the legally safer — and politically easier — approach of targeting benefit cuts at newly hired employees. Steps states have taken this year include increasing the amount employees contribute toward their own pensions, raising the retirement age and adjusting the formula upon which benefits are based.

But many state lawmakers and pension administrators have concluded that cutting benefits for new employees alone will not save enough money in the short term to keep pension plans solvent over time. So they are searching for ways to zero in on the benefits of current retirees and employees.

Colorado lawmakers, facing projections showing the state’s pension system would run out of money within 30 years, approved a package of benefit reductions that lowered the annual 3.5 percent cost-of-living increase for retirees in 2010 to zero. In future years, the increase will be set at 2 percent, barring another sharp decline in investments. If the changes stand, the average retiree would lose more than $165,000 in benefits over the next 20 years, the retirees say in court papers.

South Dakota reduced the cost-of-living increase from 3.1 percent to 2.1 percent this year; future-year amounts will be tied to how well the system’s investments perform in the market. Minnesota eliminated a 2.5 percent cost-of-living increase and set it at between 1 and 2 percent for its different employee pension funds.

History is on the employees’ side. State statutes, constitutions and case law consistently define a public pension as a contract between the state and its employees that cannot be impaired. For example, Alaska’s state constitution makes it clear that “membership in employee retirement systems of the state or its political subdivisions shall constitute a contractual relationship. Accrued benefits of these systems may not be diminished or impaired.” Eight other states protect workers in their constitutions. They are Arizona, Hawaii, Illinois, Louisiana, Michigan, New Mexico, New York and Texas.

In states without constitutional guarantees — Colorado, Minnesota and South Dakota fall into this category — statutes and court cases consider retirement benefits an unbreakable contract between the state and workers. That same protection is in the contract clause of the U.S. Constitution, which says: “No state shall … pass any … law impairing the obligations of contracts.”

Courts have determined that cost-of-living increases, which keep pension income on pace with inflation, are part of a worker’s benefits that cannot be diminished. (Generally, increasing benefits faces no legal hurdles.) The principle of safeguarding the purchasing power of pension income through a cost-of-living adjustment is well established. Social Security, the federal government’s retirement program, instituted automatic annual cost-of-living increases in 1975. The amount of the increase has averaged about 3.3 percent a year, although for the first time in 2010, there was no increase because the consumer price index did not rise.

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