A major court decision in the public employee retirement world was rendered last week in San Diego, where a California Superior Court held that current employees' rights to retiree medical benefits are not "vested" in the way that pension rights are guaranteed under state and municipal law. The decision shows how rapidly the ground is shifting beneath long-held assumptions among California public officials that retirement benefits were irrevocable under prior case law interpreting the state's constitution. Officials in other states will be watching this case closely if it goes to appeals, and will clearly reference it in their own efforts to roll back OPEB (other post-employment benefits) elsewhere.

The Cali context. For readers outside of California, it is important to understand first the context of this decision. In the Golden State, the Supreme Court had previously held that a public employee's rights to pension benefit formulas — not just the accrued benefits already earned, but the actual benefits formula — were vested at the time of hire. The court held then that such benefits could be bargained away or traded for something else of equal value, but vested pension benefits and formulas have long been viewed as inalienable rights that have frustrated pension reformers and elected leaders seeking to roll back the retirement benefits of current employees &mash; even on a prospective basis.

The precedential case in question did not specifically address retiree medical benefits, and there are several recent and pending cases in California and other states in which the courts have held that pensions and OPEB are close cousins but not identical twins, so there can be different answers for each. That's essentially what this judge in San Diego has held. There, the city has provided all the funding for retirees' medical benefits, employees have contributed nothing, and there are other facts and circumstances that led the court to conclude that the rights of current employees are not "vested" in the sense that they are guaranteed like a pension. He ruled that "it makes no sense" to treat them like vested pension rights.

Throughout California and in other states with similar legal doctrines concerning vested rights to retirement benefits, public officials are now looking closely at the nature of the promises they have made. As explained previously in my earlier column on the rights of current employees and opportunities to reform retirement benefits, the nature of the promise begins with the legislative documents (ordinances, resolutions, statutes) and goes to labor agreements (whether the benefits are guaranteed beyond the term of the contract) and then to the plan documents and benefits explanations of the employer (upon which the employee has purportedly relied). Needless to say, there are great variations in how these documents have positioned the promise of public employers and the extent to which there exists a contract that is protected by state or federal laws.

Moral rights — not just legal ones. This case raises an entirely new question in retirement plan reform. If the court's decision stands and it turns out that current employees enjoy no vested rights, then the question is what to do with all the benefits they have accrued already. Do those just evaporate into thin air by judicial decree? That seems unlikely. It's important to understand that the term "vested" means something different in California than the way it is commonly understood in government circles elsewhere. Employees may have vested rights to benefits earned already, which are typically protected in many states and even by federal pension law for private-sector employees (ERISA), but the term in California also applies to the assertion of a right to the continuation of a benefits formula (such as the retirement age and the pension multiplier and calculation formula). So it's possible that employees who met the city's written vesting requirements for age and service could still have rights not discussed in the newspaper reports. More importantly, the city's management team and elected leaders must now decide what's fair for workers who have toiled for years on the presumption that they would receive these benefits. As the city attorney has reportedly hinted in public statements, there may be a replacement benefit program that seeks to provide equitable resolution of these questions, which may involve multiple parties at interest. [Ed. update: The city has now negotiated a change in retiree medical benefits that will save an estimated $320 million and avoid taking their case into appeals courts.]

A $2 trillion problem looking for answers. The national total of unfunded OPEB liabilities for state and local governments is now approaching $2 trillion according to my calculations. It's no wonder that many public employers are looking more closely at the nature of their promises, and asking whether they are really on the hook for the full costs that actuaries have calculated. Don't be surprised to see other public employers seeking legal relief on this issue, and bargaining new compromises with labor unions to reformulate OPEB plans for current employees to achieve more sustainable formulas. Also don't be surprised to see labor unions capitulate to hard-nosed employer demands that workers contribute to their OPEB plan — as a way to show that employees have enough skin in the game to legally entitle them to a vested benefit. Los Angeles city workers just agreed to put 4 percent of pay into their OPEB trust, in a watershed labor agreement.