Reducing Pension And Retiree Health Benefit Costs

Reducing Pension And Retiree Health Benefit Costs Thursday, October 1, 2015 General Session; 4:15 5:30 p.m. Jack W. Hughes, Liebert Cassidy Whitmore DISCLAIMER: These materials are not offered as or intended to be legal advice. Readers should seek the advice of an attorney when confronted with legal issues. Attorneys should perform an independent evaluation of the issues raised in these materials. Copyright 2015, League of California Cities. All rights reserved. This paper, or parts thereof, may not be reproduced in any form without express written permission from the League of California Cities. For further information, contact the League of California Cities at 1400 K Street, 4 th Floor, Sacramento, CA 95814. Telephone: (916) 658-8200. League of California Cities 2015 Annual Conference, City Attorneys Track San José Convention Center

Notes: League of California Cities 2015 Annual Conference, City Attorneys Track San José Convention Center

Reducing Retirement and Health Benefit Costs and Analyzing Vested Rights I. Introduction The Public Employees Pension Reform Act of 2013 ( PEPRA ) became effective on January 1, 2013. 1 While PEPRA may eventually reduce long-term retirement costs, it will take many years before the savings are realized and actually felt by public agencies. Much of the savings from PEPRA are also being overshadowed by increasing retirement costs based on the California Public Employees Retirement System s ( CalPERS ) changes to smoothing and amortization policies and skyrocketing health care costs. Many public agencies are still looking for ways to reduce and control their future unfunded liabilities and expenditures. The paper will discuss cost savings methods such as reducing or eliminating the amount of the employee contribution paid by the employer, requiring employees to pay a portion of the employer s share through cost sharing, and tiering benefits. Recent trends in case law has also made it increasingly likely that an agency can modify or reduce employee and retiree health benefits without impairing vested contractual rights. Specifically, recent published and unpublished court decisions have consistently held that benefits are not vested in nearly every case that comes before them. These decisions have increased the likelihood that agencies can successfully alter employee and retiree health and retirement benefits to reduce expenses without impairing vested rights. For example, employers may be able to require employees and retirees to pay a larger portion of their health care premiums or switch to less expensive plans. However, employers must analyze documents granting employee benefits to determine whether employees or retirees have a vested right to continue receiving a particular benefit. II. Pension Reform and Retirement Contribution Savings A. Public Employees Pension Reform Act and Cost Savings 1 Gov. Code, 7522 et seq.

Most public agencies have been living with PEPRA for nearly three years now. PEPRA is applicable to most public agencies, except charter cities and charter counties that have their own independent retirement systems that are not subject to a state-wide scheme. 2 PEPRA made several changes that reduced long-term pension costs. As most employers are aware, the formulas for new members are typically lower than for classic members. Employers are also restricted in their ability to adopt supplemental defined benefit plans after December 31, 2012 and may not enroll employees hired on or after January 1, 2013. 3 As discussed in more detail below, PEPRA also eliminated Employer Paid Member Contributions ( EPMC ) for new members and made cost sharing easier. New members are required to pay 50% of total normal cost of their retirement benefit. 4 PEPRA also requires new members to have final compensation determined based on a 36-month period. 5 Many employers had previously contracted to have final compensation determined based on a 12-month period. Moreover, if an employer did not contract to have final compensation determined based on a 12-month period for classic members before January 1, 2013, the agency cannot elect a 12-month final compensation period, even for classic members. 6 Despite PEPRA s changes, cost savings have not been quickly realized. Part of the reason savings have not been realized is due to the inherent nature of the changes, which will take time before employers see a real reduction in total retirement costs. However, in addition to the slow nature of the changes, CalPERS reduced its discount rate, which is an actuarial assumption regarding return on investment, from 7.75% to 7.5%. Some other retirement boards have made similar moves. Lowering the discount rate increases employer contributions because the shortfall must be made up, in part, by employer contributions. CalPERS also altered its smoothing and amortization policies to require gains and losses to be amortized over a fixed 30- year period with increases or decreases in the rate spread directly over a 5-year period. CalPERS 2 Gov. Code, 7522.02. 3 Gov. Code, 7522.18. 4 Gov. Code, 7522.30(c). 5 Gov. Code, 7522.32(a). 6 Gov. Code, 7522.32(b).

also changed its actuarial assumptions to reflect that retirees will be living longer. Agencies have also had to deal with the staggering increases in employee and retiree health costs. Many agencies promised fully paid employee and retiree health care years or decades ago. With health care premiums rapidly rising, many agencies are paying far more for retiree medical benefits than they had initially anticipated. B. Reducing Employer Paid Member Contributions ( EPMC ) In addition to the mandatory PEPRA requirements, employers have several other options to reduce long-term retirement costs. EPMC is a benefit where the employer pays all or a portion of a member s statutorily required contribution. 7 Some employers also report the amount paid as EPMC as additional compensation, which increases compensation earnable for the purposes of calculating pension benefits. 8 PEPRA did not alter EPMC rules for classic members. An employer may still pay all or a portion of the member contribution for a classic member. However, under PEPRA, new members must pay at least 50% of the normal cost of their retirement benefit, and the employer cannot pay any part of the member s portion on their behalf. 9 Many employers have reduced retirement costs by reducing or eliminating EPMC for classic members. Subject to an agency s obligation under the Meyers-Milias-Brown Act ( MMBA ) an employer can reduce EPMC all the way to zero, which in effect requires the employee to pay their entire member contribution on their own behalf. Employers who do not reduce or eliminate EPMC may also discontinue reporting EPMC as additional compensation, which lowers the base for retirement benefits. Typically, for CalPERS members, member contributions are 7, 8, or 9 percent of the member s payroll. Where an employer is paying all of 7 For employers with retirement systems organized under the County Employees Retirement Law of 1937, the member contribution is set by the retirement board. 8 Cal. Code Regs., tit. 2, 571. 9 Gov. Code, 7522.30(c).

an employee s contribution, or even a large potion, a reduction of EPMC can result in substantial savings to the agency. C. Requiring Cost Sharing Cost sharing is an arrangement where the agency and employees agree that the employees will pay part of the agency s contribution to the retirement system. 10 For CalPERS employers, there are two ways that the agency can agree to cost-sharing. The agency can amend their contract with CalPERS as to an entire membership class to have cost sharing, which often requires negotiations with several different bargaining groups. 11 Under the contract amendment option, employee contributions towards the employer s share are considered member contributions and are credited to the employee s member account. Alternatively, the agency and a bargaining unit can agree in a memorandum of understanding ( MOU ) to have employees pay a portion of the agency s contribution. 12 Under the MOU method, the employee contributions towards the employer share are not credited to the member account. Until January 1, 2018, employers cannot impose on represented employees who are not defined as new members that they pay 50% of normal cost. 13 Effective January 1, 2018, an employer may require that classic members pay 50% of normal cost even by imposition. However, the employer must exhaust all mandatory impasse procedures. Where cost sharing is imposed, employee contributions cannot exceed 8% for miscellaneous members; 12 % for police, fire, and county peace officers; or 11% for all other local safety members. However, it does not appear that this method of cost sharing has any advantages over the traditional model discussed above. In some cases, employers and employees agree to cost sharing without reducing EPMC. Where EPMC is reported as additional compensation, the employee maintains their retirement 10 Gov. Code, 7522.30, 20516. 11 Gov. Code, 20516(a). 12 Gov. Code, 20516(f). 13 Gov. Code, 20516.5.

base and future retirement benefit. However, the employer still recognizes savings through the employee s payment of the employer s share as cost sharing. Therefore, the combination of cost sharing and EPMC can be mutually beneficial to employers and employees and may create flexibility in negotiations. III. Analyzing Vested Rights to Health and Retirement Benefits for Employees and Retirees A. Sources of Vested Rights Generally, an employer cannot reduce or modify vested health or retirement benefits. Before making modifications to benefits, the employer must review all sources that may confer a vested right to benefits. Common sources of vesting include labor agreements, resolutions of the governing body, city and county codes, charters, statutes and personnel rules and regulations. The employer should also assess the strength of any possible implied promises to a specific benefit type or amount. Implied promises, which will be discussed in more detail below, may take the form of combinations of past practices, employee handbooks, recruitment publications and flyers, representations by the employer, etc. The vested portion of any particular benefit is determined by analyzing the benefits in effect when employment commences, as well as any benefits conferred during employment. 14 B. Legal Framework Governing Vested Rights The statutory and constitutional provisions governing an analysis of vested rights has not changed in recent years. Instead, recent case law has uniformly continued a trend holding that vested rights analyzed under the existing legal framework are not vested. Courts have also provided clarification that supports the position that health benefits generally are not vested. Recent decisions have uniformly taken a narrow interpretation of implied vested rights to 14 Betts v. Board of Administration (1978) 21 Cal.3d 859, 866.

continued benefits and employees have a difficult burden prevailing on a vested rights claim absent express language suggesting a vested right. The contracts clauses of the United States and California constitutions prevent State and local governments from passing laws that impair the obligation of contracts. 15 Once vested, an employees contractual right to receive benefits are protected by the contracts clauses. The starting point in determining whether benefits are vested is the language of the document itself. Whether a benefit is vested is a matter of the parties intent. 16 Courts apply a two-step test to determine whether a benefit exists. 17 First, the court will determine whether a valid contract exists promising a benefit. Second, if there is a contract conferring a benefit, is there an express or implied term that the benefit will continue for a specified period or in a particular form. If either question is answered in the negative, the benefit can be modified without impairing vested contractual rights. As the test above indicates, vested rights can be express or implied under California law. Implied terms stand on equal footing with express terms. 18 However, based on case law, employees have several hurdles to overcome in showing an implied vested right to benefits. First, express terms will prevail over implied terms. Second, vested rights will not be implied without a clear basis in the contract or convincing extrinsic evidence. Third, employees bear the heavy burden of overcoming the presumption that legislative enactments do not create vested rights. The Ninth Circuit has recently stated that a practice or policy extended over a period of time does not translate into an implied contract right without clear legislative intent to create that right. 19 The Ninth Circuit s recent statement has reduced the likelihood that employees can succeed on an implied rights theory merely because of a long-standing practice of providing benefits. 15 U.S. Const. Art. I, 10, cl. 1; Cal. Const. Art. I, 9. 16 Retired Employees Assn. of Orange County, Inc. v. County of Orange (2011) 52 Cal.4th 1171, 1177. 17 Sonoma County Association of Retired Employees v. Sonoma County (9th Cir. 2013) 708 F.3d 1109, 1115. 18 Retired Employees Assn. of Orange County, Inc., supra, 52 Cal.4th 1171. 19 Retired Employees Ass'n of Orange County, Inc. v. County of Orange (9th Cir. 2014) 742 F.3d 1137, 1142

At this time, cases analyzing vested rights have almost exclusively focused on vested rights to retiree medical benefits. Although the above analysis appears to be applicable to all benefits, it is not clear how far courts will go in extending the rationale to other types of longevity based benefits. C. Modifying Vested Health and Retirement Benefits for Employees and Retirees If retires or employees are vested, modifying the benefits is extremely difficult and the opportunities for cost savings are virtually non-existent. A union cannot bargain away vested rights. To modify a retiree s vested rights, the employer must reach an agreement with individual retirees. Of course, this will almost never be practical, especially on a large scale. For current employees, the employer must reach an agreement with individual employees, or the modification must bear a material relation to the theory of the pension system and any disadvantages must be met with comparable advantages. 20 Thus, even for current employees, vested benefits cannot be easily modified. Moreover, cost savings are unlikely since employees must receive comparable advantages to offset any disadvantages. D. Vested Rights for Future Employees With respect to future employees, they generally do not have any vested benefits. However, as will be discussed below, there are some benefits that may be subject to statutory limitations. For example, the Public Employees Retirement Law ( PERL ) 21, the County Employees Retirement Law of 1937 ( CERL or 37 Act ) 22, or the Public Employees Hospital and Medical Care Act ( PEMHCA ) 23 may restrict an employer s ability to reduce or eliminate benefits, even for future employees. 20 Betts, supra, 21 Cal.3d at 864. 21 Gov. Code, 20000 et seq. 22 Gov. Code, 22750 et seq. 23 Gov. Code, 31450 et seq.

IV. Strategies for Controlling Health Care Costs A. Reducing Medical and Retiree Medical Through Tiering In order to control employee and retiree health care costs, employers can adopt different tiers of benefits. Under a tiering system, the employer typically adopts a lower amount of benefits applicable to all employees hired after a specified date. For example, the employer may adopt MOU language that provides that all employees hired on or before June 30, 2106 shall receive a $500 contribution towards health benefits and that employees hired on or after July 1, 2016 will receive a $200 contribution. Such language results in two groups of employees receiving a different benefit amount. Similar tiering language can be drafted for retiree medical benefits. As noted above, with respect to future employees, the tiers generally will not impair vested rights. For current employees and retirees, the agency may still adopt tiering, but must first undertake a vested rights analysis to ensure that the agency is not impairing vested rights. An employee or retiree is not necessarily vested in the benefit they are currently receiving. A vested rights analysis must still be undertaken to determine what portion, if any, employees or retirees have vested in. For future employees, or where no vested rights are implicated, agencies that are not subject to PEMHCA may theoretically reduce contributions to employee and retiree medical benefits to zero. B. Special Consideration for Agencies Participating in PEMHCA Employers who participate in PEMHCA, which is also commonly referred to as CalPERS medical, have additional constraints on reducing employee and retiree health benefits because they must comply with its statutory and regulatory provisions, which will supersede contradictory language in an MOU. 24 24 Gov. Code, 22753.

Employers who provide health benefits through PEMHCA must, with limited exceptions, comply with the minimum contribution and equal contribution rules. 25 The minimum contribution rule requires that employers contribute a specified minimum monthly dollar amount to retirees and employees. The minimum monthly amount is adjusted annually by CalPERS. In 2015 the minimum contribution was $122 and in 2016 it will be $125. 26 Employers may fix the contribution for employees at or above the statutory minimum. Employers who provide health care benefits through PEMHCA are also restricted by the equal contribution rule. Under the equal contribution rule, the employer s contribution for employees and retirees must be equal within the same group or class of employees. The equal contribution rule limits the ability of employers to create tiers of benefits applicable only to future employees. Despite the minimum and equal contribution rules, employers have some flexibility for ensuring compliance with the rules while reducing health care costs. Assuming there are no vested rights to employee or retiree medical benefits, the employer may, subject to the MMBA, reduce the employer contribution to the statutory minimum for all future employees, current employees, and retirees. Where current employees or retirees have vested in a benefit amount, the employer may still negotiate to reduce the PEMHCA contribution to the statutory minimum for future employees, current employees, and retirees. Employees can have their vested rights protected by having any amount above the PEMHCA statutory minimum placed in a cafeteria plan. Retirees can have their vested rights protected by having any amount in excess of the statutory minimum contributed to a health reimbursement account. Although the employer provides different total amounts, this method likely insulates employers from employees or retirees claiming that the equal contribution rule entitles them to the additional contributions. 25 Gov. Code, 22892. The limited exceptions are the vesting schedule and the unequal method. The exceptions are beyond the scope of this paper and presentation. The exceptions also have various drawbacks that must be considered before implementation. 26 CalPERS Circular Letter No. 600-012-15.

In order to avoid PEMHCA s restrictions altogether, or to adopt a contribution tier below the minimum contribution, an agency would have to withdraw from PEMHCA, which is in itself a difficult process. The agency must pass a resolution opting out of PEMHCA for the following calendar year, which must be filed with CalPERS within 60 days after CalPERS announces its plan premiums for the following year. Of course, the agency must bargain the withdrawal from PEMHCA in advance of filing the resolution. The election to withdraw becomes irrevocable after the resolution is filed and the agency cannot elect to become subject to PEMHCA for five years after the termination date. 27 V. Drafting and Interpreting Bargaining Agreement Language Agencies that are drafting bargaining agreements, policies, or resolutions concerning retirement and health benefits can avoid vested rights claims by carefully drafting language to clearly indicate that there is no intent to create vested rights. Granting documents should include language that states there is no intent to create a vested right and that the employer retains the right to amend, reduce, modify, or eliminate the benefit at any time. Agencies should also bear in mind that courts generally apply traditional principles of contract interpretation to MOUs and other granting documents when analyzing vested benefits. 28 As noted above, in interpreting contracts, there is a well-established rule that implied terms cannot prevail over express terms. 29 Based on this rule, an express statement that a right is not vested likely cannot be defeated by extrinsic evidence such as established past practice, job announcements, or declarations from employees and union officials stating that they understood or were advised that the benefit was intended to be vested. Express language should also help agencies prevail at the early stages of litigation if employees do bring a lawsuit based on an implied vested rights theory. 27 Cal. Code Regs., tit. 2, 599.515. 28 City of El Cajon v. El Cajon Police Officers' Assn. (1996) 49 Cal.App.4th 64, 71. 29 Retired Employees Assn. of Orange County, Inc., 52 Cal.4th at 1179.

Granting documents should not refer to future benefits or retirees. As mentioned above, recent case law has trended decidedly away from finding vested rights. International Brotherhood v. City of Redding, provides the only recent published case finding that a right to retiree health benefits may be vested. 30 The language at issue in International Brotherhood stated, [t]he City will pay fifty percent (50%) of the group medical insurance program premium for each retiree and dependents, if any, presently enrolled and for each retiree in the future. The court noted that the presently enrolled language referred to those retirees enrolled during the term of the MOU. The court went on to state that the most reasonable interpretation of for each retiree in the future is that the benefit was promised to active employees when they retired. In other words, the language regarding future retirees created a vested right in favor of employees who were covered by the MOU, even if they did not retire during the term of the MOU. If the benefit only applied until the expiration of the MOU, the in the future language would be unnecessary. Thus, references to future benefits or retirees should be avoided. Given the enormous costs and repercussions of imprecise drafting, agencies should ensure that their intent is clearly set forth in MOUs and other granting documents. 31 VI. Conclusion It remains to be seen to what extent and how fast PEPRA will lead to cost savings for public agencies, but it is likely that it will take several years before any noticeable reductions are felt. However, agencies have other tools to lower their short and long-term retirement and health benefits costs. Many agencies are reducing EPMC and increasing cost sharing to reduce employer costs. Employers can also create different benefit tiers based on hire date to reduce benefits costs. Moreover, recent case law tends to suggest that health care benefits generally are 30 International Brotherhood v. City of Redding (2012) 210 Cal.App.4th 1114. The case was decided at the demurrer stage and the language at issue was never analyzed on the merits after the appellate court ordered the lower court to overrule the demurrer. 31 For example, some agencies have inserted language in their MOUs that state, employees shall have no vested right to continue receiving this benefit beyond the expiration of the MOU or the parties do not intend to create any vested right to continued receipt of the benefit.

not vested and that employees and retirees do not have vested rights to continued benefits absent express language or convincing extrinsic evidence to the contrary. This recent case law has made it more likely that agencies can reduce health and retirement benefits without impairing vested rights.