This is part of an ongoing series called Finance 101 that goes back to the basics to help public officials.
Pensions both public and private started out as a worker’s perk – a gratuity that could be amended or removed entirely at any time. But over the last century, that perception has given way in most states to the idea that pensions are a form of deferred compensation.
Along with that change has come certain protections via either specifically in state constitutions or through a court’s interpretation of the constitution. Nearly all states have some kind of protection for pensions. Most (41) protect pensions under contract theory which prohibits states from passing a law that impairs a contract, whether public or private.
Some states (seven) have a constitutional provision that specifically states that public pension plans create a contract between the state and participant (employee) although the protections vary state-to-state. Michigan, for example, has a constitutional provision that protects benefits accrued to date while Illinois’ constitution says accrued and future retirement benefits are protected. These kinds of specific protections make it impossible (barring extreme circumstances) to change an employee’s retirement benefit. This rigidity is why unfunded pension liabilities in these states (Illinois in particular) are so alarming – because the law essentially prohibits the legislature to making any changes that could decrease that liability. The law only allows for changes to future employees, whose benefits are of course not included in that unfunded liability.
There may be an exception. In Detroit, a federal bankruptcy judge ruled that city’s pension debt was eligible for haircuts – a ruling that stated federal bankruptcy law (where contracts can be impaired) trumps state law. That ruling is being appealed but in any case, would only apply to cities in bankruptcy.
In most other states (34), court rulings have inferred intent to create such a contract although when the protection starts and what it entails varies from state to state. In California, for example, court rulings in the 1950s have led to what’s called the vested rights doctrine. “The state supreme court determined that when you essentially enter public employment and you are told that a term of your compensation is a certain benefit when you retire, that you go into your employment … you’re entitled to the benefits you were promised when you started working,” says Teague Paterson, a partner at Beeson Tayer Bodine in California and an expert on labor law.
Therefore state courts in California have been more receptive to the argument that pensions as contracts can’t be impaired. A Santa Clara County Superior Court judge ruled late last year that San Jose, which had implemented voter-approved pension cuts in 2012, was not allowed under California law to require its employees to contribute an additional 16 percent of their paychecks toward their pension or be forced to opt for a less generous plan. (The judge did rule, however, that paycuts in order to manage future benefits payments was legal.)
Fewer states (six) take the approach that pensions are protected as a matter of property. Property cannot be taken away without due process according to the U.S. Constitution. Still, these states have generally had success at amending pension benefits, notes the Center for Retirement Research’s Alicia Munnell. “Courts have generally found amendments to public pension plans to be an ‘adjustment to the benefits and burdens of economic life’ rather than the taking of private property without just compensation,” she writes in Legal Constraints on Changes in State and Local Pension Plans. “Thus, state officials have much more freedom to adjust pensions in states that have taken the property based approach to pension rights.”
Minnesota is an outlier – it is the only state that protects pensions under the promissory estoppel theory: the protection of a promise even where no contract has been explicitly stated.
Lastly, only Texas and Indiana still apply the gratuity approach to pensions and there are still caveats. In Texas, state plans are subject to change but locally-administered plans are protected under the state constitution. And Indiana’s Indiana, “the gratuity approach is followed only with respect to involuntary or compulsory plans, where the employee has no choice regarding whether to contribute to the plan or keep the compensation,” says the University of Minnesota Law School’s Amy Monanhan in her paper outlining the legal framework for pension protections.
In all, 21 states protect past and future pension benefit accruals via contract or another theory of law. Though states and localities continue to test those boundaries, the protections on the whole make it very difficult for governments (outside of limiting cost-of-living increases) to reduce any unfunded liabilities they may have accrued. Munnell notes that such a structure has led to new employees taking on much of the financial burden of retirees via far less generous benefits. She advocates changing the definition of the employer-employee contract to one that is created when the service is performed, meaning only accrued benefits would be protected. “Such a standard,” she writes, “would be much clearer than the morass of provisions that currently exists across the states, would enable state officials to undertake needed reforms, and would put public sector workers on an even footing with those in the private sector.”
The following map shows legal protections for public employee pensions in each state. Protections for past and future benefits vary from state to state; click a state for details.