State and Local Pension Plans and Fiscal
Distress: A Legal Overview
Jennifer Staman
Legislative Attorney
March 31, 2011
Congressional Research Service
7-5700
www.crs.gov
R41736
CRS Report for Congress
P
repared for Members and Committees of Congress
State and Local Pension Plans and Fiscal Distress: A Legal Overview
Summary
Controversy has arisen over the funded status of many state and local government pension plans.
It has been reported that several of these plans have not fully funded their future obligations and
they could face substantial future shortfalls. While there is considerable debate over the extent
and the possible causes of these shortfalls, some estimates have placed the combined unfunded
liabilities anywhere from hundreds of billions of dollars to over $3 trillion. Governments facing
investment losses combined with lower revenues are looking at ways to address these shortfalls
and protect their fiscal stability. State governors and legislators in several states have proposed
and enacted various modifications to their pension plans. There have been calls for modification
of federal, state, and local laws affecting these pension plans and the benefits provided to
participants and beneficiaries. This report provides an overview of how public pension plans are
regulated at the federal and state level, discusses selected legal issues that may arise in attempting
to remedy or prevent public pension plan underfunding by modifying public pension plan
benefits, and addresses possible federal regulation of state and local public pension plans.
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State and Local Pension Plans and Fiscal Distress: A Legal Overview
Contents
Introduction ................................................................................................................................ 1
Regulation of Public Pension Plans ............................................................................................. 2
Benefit Accrual and Vesting Requirements ............................................................................ 3
Can State and Local Governments Modify Pension Benefits? ...................................................... 4
Public Pension as a Contractual Right ................................................................................... 5
Attachment of Pension Rights ............................................................................................... 8
Federal Legislation Affecting State and Local Governmental Pension Plans............................... 10
Contacts
Author Contact Information ...................................................................................................... 11
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State and Local Pension Plans and Fiscal Distress: A Legal Overview
Introduction
Public pension plans, also referred to as governmental plans, are generally plans that provide
retirement or deferred income to employees of the U.S. government, a state government or its
political subdivision, or any agency or instrumentality of those governments.1 According to a
2010 GAO report,2 approximately 20 million employees and over 7 million retirees and survivors
are covered by state and local government pension plans, typically through a traditional defined-
benefit plan.3 Recently, questions have been raised about the funded status of many public
pension plans, as it has been reported that many of these plans are facing substantial future
funding shortfalls. Concerns have been raised that these liabilities could jeopardize the fiscal
stability of state and local governments.
While there is considerable debate over the cause and the extent of public pension plan
underfunding, some of the estimates have placed the combined unfunded liabilities anywhere
from hundreds of billions of dollars, to over $3 trillion.4 In an effort to address these issues,
legislators and others have argued to reform public pension plans and the benefits they offer. In
2010 alone, over 20 states introduced or passed legislation aimed to reduce or otherwise modify
pension plan benefits for current or future retirees,5 and more proposals have been introduced this
year. This report provides an overview of how public pension plans are regulated at the federal
and state level. It discusses selected legal issues that may arise in attempting to remedy or prevent
public pension plan underfunding, in particular, by changing plan benefits. This report will also
briefly address possible federal regulation of state and local public pension plans.
1 29 U.S.C. § 1002(32); 26 U.S.C. § 414(d). For purposes of this report, the term public pension plan, or governmental
plan, will only refer to a retirement plan of a state or its subdivision, and not a federal retirement plan. For information
on pension benefits provided by the federal government, see CRS Report 98-810, Federal Employees’ Retirement
System: Benefits and Financing, by Katelin P. Isaacs
2 U.S. GOV’T ACCOUNTABILITY OFFICE, GAO-10-754, STATE AND LOCAL GOVERNMENT PENSION PLANS: GOVERNANCE
PRACTICES AND LONG-TERM INVESTMENT STRATEGIES HAVE EVOLVED GRADUALLY AS PLANS TAKE ON INCREASED
INVESTMENT RISK 1 (2010).
3 A defined benefit plan is a pension plan under which an employee is promised a specified future benefit, traditionally
an annuity beginning at retirement. In a defined benefit plan, the employer bears the investment risk and is responsible
for any shortfalls. See 29 U.S.C. § 1002(35).
4 See, e.g.,The Role of Public Employee Pensions in Contributing to State Insolvency and the Possibility of a State
Bankruptcy Chapter, Before the Subcomm. on Courts, Commercial, and Administrative Law, 112th Cong.
(2011)(statement of Joshua Rauh) (“Under their own accounting rules, state and local governments have around $1.3
trillion of unfunded pension liabilities. Using valuation methods and accounting practices that are consistent with
financial economics, Robert Novy-Marx and I have calculated that the already-promised part of these unfunded
liabilities actually amounts to over $3 trillion, more than the approximately $2.6 trillion of recognized debt on state and
local government balance sheets.”); But see Leigh Snell, Setting the Record Straight About Public Pensions,
Government Finance Review 9 (Feb. 2011) (“Public pension plans are not in crisis …organizations representing public
pension plans, plan sponsors, and plan participants have been advising Congress that state and local governments are
moving aggressively to address sustainability challenges confronting their pension plans….”).
5 See Ronald K. Snell, National Conference of State Legislatures, Pensions and Retirement Plan Enactments in 2010
State Legislatures, Nov. 23, 2010.
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State and Local Pension Plans and Fiscal Distress: A Legal Overview
Regulation of Public Pension Plans
Employment-based retirement benefits6 are largely governed by two federal laws, the Employee
Retirement Income Security Act (ERISA) and the Internal Revenue Code.7 In general, these two
laws address two types of pension plans: defined benefit and defined contribution plans. Under a
defined benefit plan, an employee is promised a specified future benefit, traditionally an annuity
beginning at retirement. Benefits often are based on average pay and years of service. To fund the
plan, an employer makes contributions to the common pension fund that are actuarially expected
to grow through investment to cover the promised benefits. Under the terms of the plan,
employees may make contributions as well. Most public pension plans are traditional defined-
benefit plans.
A defined contribution plan (e.g., a 401(k) plan) is one in which the contributions are specified,
but not the benefits. A defined contribution plan (also called “an individual account” plan) is one
that provides an individual account for each participant that accrues benefits based solely on the
amount contributed to the account and any income, expenses, and investment gains or losses to
the account. The employee bears the investment risk in a defined contribution plan. Some state
and local governments maintain defined contribution plans, and there have been proposals in
various states to switch from a defined benefit to a defined contribution plan.
Enacted in 1974, ERISA provides a comprehensive federal scheme for the regulation of pension
and other employee benefit plans offered by private-sector employers. While ERISA does not
require an employer to offer employee benefits, it does mandate compliance with its provisions if
such benefits are offered. Title I of ERISA imposes various federal standards aimed at protecting
the interests of plan participants and beneficiaries, including reporting and disclosure, vesting,
participation, funding, fiduciary duty, and civil enforcement requirements. Title IV of ERISA
created a plan termination insurance program, under which pension benefits are paid to plan
participants and beneficiaries up to a statutory maximum if the benefits cannot be paid by the
employer. Public pension plans are generally exempt from these provisions of ERISA, 8 but may
be subject to federal regulation under the Internal Revenue Code.9
The Internal Revenue Code grants certain tax benefits to “qualified” retirement plans.10 Among
these tax advantages, employer contributions to a qualified plan on behalf of its employees are tax
deductible for the employer. In addition, qualified retirement plan participants do not pay tax on
6 This report does not address Social Security, which is funded in part by is funded by payroll taxes paid by covered
workers and their employers. See CRS Report RL33544, Social Security Reform: Current Issues and Legislation, by
Dawn Nuschler.
7 It should be noted that other federal laws govern various aspects of public pension plans. For example plans may be
subject to the Civil Rights Act of 1964, the Age Discrimination in Employment Act (ADEA), and the Family and
Medical Leave Act.
8 While it is often expressed that governmental plans are exempt from ERISA, this statement is technically incorrect.
Governmental plans may be subject to Title II of ERISA, which amended the Internal Revenue Code to impose
requirements for plan qualification that a plan must meet in order to receive favorable tax treatment. These qualification
requirements in the Code parallel many of the provisions in Title I of ERISA. However, as discussed infra,
governmental plans are exempt from a number of these qualification requirements.
9 It should be noted that there are different types of governmental plans subject to different requirements under the
Internal Revenue Code. See, e.g., 26 U.S.C. § 403(b); 26 U.S.C. § 457. This report will not focus on these differences.
10 In general, for purposes of this report, a qualified plan generally means an employer-sponsored pension plan that
meets the requirements set forth under 26 U.S.C. § 401(a); eligible plans are described in 26 U.S.C. § 457.
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State and Local Pension Plans and Fiscal Distress: A Legal Overview
employer contributions or the benefits they accrue in the pension plan until the participant (or
beneficiary) takes a distribution. Given that state and local governments do not pay federal taxes,
the tax benefit for employer contributions is irrelevant to them. However, public pension plans
must be qualified so that the plan participants can avoid paying taxes on their pension benefits
until the benefits are actually received. In order to be a qualified plan under the Internal Revenue
Code, pension plans must meet several requirements. Governmental plans, however, are only
subject to a subset of the qualification requirements that private-sector pension plans must meet.11
In many cases, public pension plans are subject to different requirements under the Internal
Revenue Code than private-sector plans, including certain less stringent pre-ERISA requirements
for vesting and funding.
Aside from the requirements set out in the Internal Revenue Code, public pension plans are
primarily regulated under state statutes, local ordinances, and state constitutions. These laws
typically address the basic features of public pension plans, including eligibility, contributions,
and types of benefits provided, and the laws vary widely from jurisdiction to jurisdiction.12 While
public pension plans have no guarantor of plan benefits, states generally have constitutional or
statutory provisions that dictate how pension plans are to be funded, protected, managed, or
governed.13
Benefit Accrual and Vesting Requirements
In evaluating whether pension plan benefits may be modified, requirements for benefit accrual
and vesting are implicated. Under federal law, both ERISA and the Internal Revenue Code
provide requirements for benefit accrual, which generally refers to the rate at which benefits are
earned by a plan participant. Both federal laws prohibit private-sector pension plan amendments
that eliminate or reduce benefits already accrued by plan participants.14 This prohibition is
commonly referred to as the “anti-cutback rule.”15 However, private-sector pension plans may be
free to freeze accrued benefits, reduce the rate at which benefits will accrue in the future, or
eliminate future benefit accruals altogether. In other words, under the anti-cutback rule, past
benefit accruals are protected, but future benefits accruals can be modified. Governmental plans
are exempt from the anti-cutback rule. Therefore, analysis of the changes that may be made to
accrued benefits under a public plan is a state-by-state inquiry.
While accrued benefit refers to the amount of benefits earned, vesting occurs under federal law
when a plan participant’s accrued benefit is considered to be non-forfeitable.16 ERISA and the
11 For a list of the Internal Revenue Code requirements that public pension plans must meet, see Barry Kozak,
“Clarifying Qualification Requirements for Eligible Governmental Plans” IRS Increases Education, Compliance
Efforts,” CCH Planning Guide, Benefit Practice Portfolios (July 2008).
12 U.S. GOV’T ACCOUNTABILITY OFFICE, GAO-07-1156, STATE AND LOCAL GOVERNMENT RETIREE BENEFITS: CURRENT
STATUS OF BENEFIT STRUCTURES, PROTECTIONS, AND FISCAL OUTLOOK FOR FUNDING FUTURE COSTS 20 (2007).
13 Legal protections may also be recognized under common law. See id.
14 29 U.S.C. § 1054(g); 26 U.S.C. § 411(d)(6).
15 Certain exceptions to the anti-cutback rule may apply. For example, ERISA allows for a plan to reduce accrued
benefits by a retroactive amendment in certain cases where a plan is confronted with a “substantial business hardship.”
See, e.g., ERISA § 204(g)(1), 29 U.S.C. § 1054(g)(1) (citing ERISA § 302(d)(2), 29 U.S.C. § 1082(d)(2)).
16 There can be confusion in understanding the difference between when benefits accrue and when benefits vest. As
articulated by the Supreme Court, accrual is “the rate at which an employee earns benefits to put in his pension
account.” Central Laborers’ Pension Fund v. Heinz, 541 U.S. 739, 749 (2004). Vesting, on the other hand, is “the
process by which an employee’s already-accrued pension account becomes irrevocably his property.” Id.
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State and Local Pension Plans and Fiscal Distress: A Legal Overview
Internal Revenue Code impose two general vesting requirements on private-sector defined benefit
pension plans: one depending on age and one depending on length of service.17 Governmental
plans are exempt from these federal vesting requirements. However, in order to be qualified,
governmental plans must meet pre-ERISA vesting standards under the Internal Revenue Code,
which include the requirement that upon plan termination or complete discontinuance of
contributions, employees’ rights to benefits accrued as of the date of the termination or
discontinuance are non-forfeitable, but only to the extent that the benefits are funded.18 States
may also impose additional vesting requirements for pension benefits, and these can vary by state.
Can State and Local Governments Modify Pension
Benefits?
Recently, in an effort to alleviate pension plan underfunding and protect state and local
government budgets, governors and legislators in several states have proposed and enacted
various modifications to their pension plans.19 Over the past few years, almost two-thirds of states
have made some form of benefit and/or contribution change to their plans (e.g., reducing benefit
levels, requiring higher employee contributions, or amending age and service requirements to
lengthen the accumulation and shorten the distribution period of pension benefits).20 While the
majority of changes are directed at future participants and/or benefit accruals, some of the
changes affect current employees and retirees. Although states may not face obstacles in changing
the pension benefits available for new employees, the issue is not as clear with respect to existing
ones. As discussed below, certain legal parameters may affect the ability of state and local
governments to amend their pension plans. 21 These parameters vary by state and depend on each
state’s laws and constitutional provisions governing its retirement system, what these laws
provide with respect to the protection of an individual’s pension benefits, and when any right to a
pension benefit attaches.
Courts have conceptualized the legislative modification of public employee pension plan benefits
in different ways. Historically, most courts viewed public pensions as gratuities that could be
amended at any time. Although it may not be controlling in the interpretation of a state law, the
Supreme Court has historically found that statutes providing retirement benefits to pensioners
create a mere “expectancy” that may be modified, revoked, or suspended by the authority
granting it through subsequent legislation.22 However, this view has now been abandoned in most
17For additional description of ERISA’s vesting requirements, see CRS Report RL34443, Summary of the Employee
Retirement Income Security Act (ERISA), by Patrick Purcell and Jennifer Staman.
18 See 26 U.S.C. § 411(e)(1) (stating that governmental plans are subject to vesting requirements of 1974).
19 See generally Randy Diamond, DB Plans in Cross Hairs in State Budget Battles, Pensions & Investments (Mar. 7,
2011).
20 See Leigh Snell, Setting the Record Straight About Public Pensions, Government Finance Review Vol. 28, p. 8 (Feb
2011).
21 See generally Mary A. Brauer, State and Local Government Pensions: In What Circumstances Can Governments
Reduce Pension Benefits? 20 Benefits Law Journal 65 (Winter 2007).
22 Pennie v. Reis, 132 U.S. 464 (1889). See also Zucker v. United States, 758 F.2d 637 (Fed. Cir. 1985), cert. denied,
474 U.S. 842 (1985); Walton v. Cotton, 19 How (60 U.S.) 355, 358 (1857); United States ex rel. Burnett v. Teller, 107
U.S. 64, 68 (1883);; McLeod v. Fernandez, 101 F.2d 20 (1st Cir. 1938), cert. denied, Toste v. McLeod, 308 U.S. 561
(1939); Steinberg v. United States, 163 F. Supp. 590, 591 (Ct. Claims 1958); Flemming v. Nestor, 363 U.S. 603, 609-
610 (1960); Stouper v. Jones, 284 F.2d 240 (D.C. Cir. 1960); United States Railroad Retirement Board v. Fritz, 449
(continued...)
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State and Local Pension Plans and Fiscal Distress: A Legal Overview
states, and public employee pension benefits are generally afforded greater protection under
current state and constitutional law.23 This is, at least in part, because many courts now
characterize public plan pensions as deferred compensation—that an employee is entitled to these
benefits for work that has already been performed.24
Public Pension as a Contractual Right
In rejecting the gratuity approach to public pensions, many state courts have found that based on
common law, state statute, or state constitution, public pension benefit plans create a contract
between the state and plan participant.25 If a contract is found to exist between the state or local
government and pension plan participants, then this can limit the ability of a state to amend its
pension plans.26 In some states, there is a specific constitutional provision addressing protection
for public pensions as contractual obligations.27 At least six states28 have a constitutional
provision that, in general, explicitly provides that membership in, or accrued benefits from, a
state’s retirement system creates a contract between the state and its employees that cannot be
impaired. One lawsuit demonstrating the effect of this type of pension protection is McDermott v.
Regan.29 In this case the New York legislature, in response to a state fiscal crisis, changed the
funding method for the state’s retirement systems. The change had the effect of reducing the
government’s contribution to the system. In finding that the state law violated the New York
constitution,30 the court explained that the amendment depleted money in the fund and arguably
destabilized the retirement system. Thus, it was an unconstitutional impairment of the pension
funds.
In the absence of a state constitutional provision expressly prohibiting the modification of
pension benefits, a state’s statutes or case law may be found to provide contractual rights for state
and local government employees to their pension benefits. 31 As noted above, if a contract is
(...continued)
U.S. 166 (1980).
23 It should be noted that a small minority of state courts still view some public pensions as gratuities. See e.g.,
Haverstock v. State Public Employees Retirement Fund, 490 N.E.2d 357, 360-61 (Ind. Ct.App.1986)(“Where employee
participation in the retirement plan is compulsory or mandatory, however, it is termed a pension. Pensions are mere
gratuities springing from the appreciation and graciousness of the state. Under such a plan, the employee has no vested
contract rights until he fulfills all conditions existing at the time of his application for benefits.”)
24 R. D. Hursh, Vested Right of Pensioner to Pension, 52 A.L.R.2d 437 (2011).
25 See Amy Monahan, Public Pension Reform: Legal Framework, Education, Finance & Policy, Vol. 5 (2010).
26 Id.
27 It should be noted that several states have provisions in their state constitutions that address protection of the state
retirement system as a whole. Among other things, state constitutions address how public pension plans should be
funded and provide that retirement system assets are exclusively for the purpose of the retirement system. See 2007
GOV’T ACCOUNTABILITY OFFICE, note 12 supra, at 19. The protections discussed here concern the protection of the
pension rights of an individual participant.
28 These states include Alaska, Arizona, Hawaii, Illinois, Michigan, and New York.
29 82 N.Y.2d 354 (1993), as cited in National Education Association Issue Brief on Pension Protections Available in
State Constitutions, available at http://www.nea.org/assets/docs/PensionProtectionsinStateConstitutions04.pdf.
30 Article V, Section 7 of the New York Constitution provides that “membership in any pension or retirement system of
the state or of a civil division thereof shall be a contractual relationship, the benefits of which shall not be diminished or
impaired.”
31 While not nearly as common as a contractual right, it should be noted that rights to a pension benefit may be based
on something other than a contract. For example, the New Mexico State Constitution provides that a pension benefit is
(continued...)
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found to exist between the state or local government and pension plan participants, then this can
limit the ability of a state to amend its pension plans. A public employee’s contractual right to an
unaltered pension benefit may be protected under the Contract Clause of the U.S. Constitution or
an analogous state constitutional provision.32 The Federal Contract Clause provides, “No state
shall ... pass any ... Law impairing the Obligation of Contracts.”33 Although the language of the
Contract Clause appears straightforward, its prohibition against state impairment of contracts is
not absolute but rather “must be accommodated to the inherent police power of the state ‘to
safeguard the vital interests of its people.’”34 The Contract Clause applies to contracts between
private parties, as well as those where the state is a party to the contract.35 However, in general,
instances where the state is impairing a contract for its own benefit invite more judicial scrutiny.36
Based on Supreme Court jurisprudence, courts typically evaluate whether a state law violates the
Contract Clause under a multi-pronged test. With respect to a public contracts, as a preliminary
matter, courts may look at whether there is a contractual obligation that has been impaired.37 In
order to determine whether a contractual relationship exists, a court may look to legislative intent
to create a contract between the state and a private party.38 As the Supreme Court has explained,
In determining whether a law tenders a contract to a citizen it is of first importance to
examine the language of the statute. If it provides for the execution of a written contract on
behalf of the state the case for an obligation binding upon the state is clear….The
presumption is that such a law is not intended to create private contractual or vested rights
but merely declares a policy to be pursued until the legislature shall ordain otherwise. He
who asserts the creation of a contract with the state in such a case has the burden of
overcoming the presumption.39
State statutes that establish retirement plans generally do not address whether a contract is
created; thus, ascertaining whether a contract exists for a public plan pensioner can, in some
cases, be difficult.40
(...continued)
a property right. It states that “[u]pon meeting the minimum service requirements of an applicable retirement plan
created by law for employees of the state or any of its political subdivisions or institutions, a member of a plan shall
acquire a vested property right with due process protections under the applicable provisions of the New Mexico and
United States constitutions.” N.M. Const. art. XX, § 22.
32 An analysis of provisions analogous to the Contract Clause in state constitutions is beyond the scope of this report.
33 U.S. Const. Art. I, § 10, cl. 1.
34 Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400, 410 (1983) (quoting Home Bldg. & Loan
Assn. v. Blaisdell, 290 U.S. 398 (1934)). See also United States Trust Co. v. New Jersey, 431 U.S. 1, 21
(1977)(“Although the Contract Clause appears literally to proscribe ‘any’ impairment, this Court observed … that ‘the
prohibition is not an absolute one and is not to be read with literal exactness like a mathematical formula.’ Thus, a
finding that there has been a technical impairment is merely a preliminary step in resolving the more difficult question
whether that impairment is permitted under the Constitution.”) (citation omitted).
35 A contract that includes a state as a party will hereinafter be referred to as a “public contract.”
36 See, e.g., McGrath v. Rhode Island Retirement Bd., 88 F.3d 12, 16 (1st Cir. 1996) (“[w]hen a state is itself a party to a
contract, courts must scrutinize the state’s asserted purpose with an extra measure of vigilance.”)(citing U.S. Trust, 431
U.S. at 25.
37 U.S. Trust, 431 U.S. at 21-22.
38 See U.S. Trust, 431 U.S. 18 f. 14 (“In general, a statute is itself treated as a contract when the language and
circumstances evince a legislative intent to create private rights of a contractual nature enforceable against the State.”)
39 Dodge v. Board of Education, 302 U.S. 74, 78-9 (1937).
40See Monahan, supra note 25.
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However, if it is established that a contract exists, one must then ascertain whether a plaintiff’s
contractual rights are “substantially impaired.”41 Factors that courts have taken into account in
determining whether a substantial impairment exists include whether a statute applies
prospectively, or retroactively;42 disrupts a party’s “reasonable expectations” regarding an
agreement; 43 or “alters its terms, imposes new conditions, or lessens [a contract’s] value.”44 In the
context of public pensions, benefit formula changes, changes in plan funding sources or
methodology, and the elimination of cost of living supplement payments have all been found by
courts in certain instances to be substantial impairments of the pension contract. 45 But, in general,
state law amendments that were not anticipated to have an effect on pension benefits or on
employer rights and responsibilities may not be considered impairments.46
If a substantial impairment exists, however, the state law may still be constitutional if “it is
reasonable and necessary to serve an important public purpose.”47 This rule ensures that in
impairing a contract, the state is protecting the broad public interest, rather than its own self-
interest. 48 As the Supreme Court has explained with respect to the impairment of public
contracts, reasonableness must be considered “in light of the surrounding circumstances.”49
Necessity depends upon two considerations: first, whether the impairment was essential or
whether a less “drastic modification” was available, and also whether a state could have adopted
an alternative means to bring about the desired end without impairing contract obligations.50 As
the Supreme Court noted in U.S. v New Jersey, “a State is not completely free to consider
impairing the obligations of its own contracts on a par with other policy alternatives. Similarly, a
State is not free to impose a drastic impairment when an evident and more moderate course would
serve its purposes equally well.”51 While some courts have found that a state’s desire to reduce
41Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400, 413 (1983).
42 See, e.g., Howell v. Anne Arundel County, 14 F. Supp. 2d 752, 755 (D. Md. 1998); Pennsylvania Mortg. Bankers
Ass’n v. Zimmerman, 664 F. Supp. 186, 194 (M.D. Pa. 1987) (“contract clause does not apply to prospective state
action”).
43 See, e.g., Transport Workers, Local 290 v. SEPTA, 145 F.3d 619, 624 (3d Cir. 1998) (no impairment to public
pension plan when employees had no reasonable expectation that plan would not change); Buffalo Teachers Federation,
464 F.3d 362, 368 (2d Cir. 2006) (school district wage freeze disrupts reasonable expectations of workers so much that
it substantially impairs workers’ contracts with the city).
44 Retired Pub. Employees Council of Wash. v. Charles, 148 Wash.2d 602, 625 (Wash. 2003).
45 Monahan, supra note 25, (citing Betts v. Bd. of Admin., 582 P.2d 614 (1978); Valdes v. Cory, 139 Cal. App. 3d 773
(Cal. Ct. App. 1983); Bd. of Admin. V. Wilson, 52 Cal. App. 4th 1109,(Cal. Ct. App. 1997); Calabro v. City of Omaha,
531 N.W.2d 541 (Neb. 1995)).
46 Id. (citing, e.g., Retired Pub. Employees Council of Wash. v. Charles, 148 Wash.2d at 626 (reduction in employer
contributions acceptable under Washington State constitution’s contract clause provision because, among other things,
there was no indication that the lower contribution amounts would impair the pension system).
47 U.S. Trust, 431 U.S. at 25.
48 As noted in U.S. Trust, “A governmental entity can always find a use for extra money, especially when taxes do not
have to be raised. If a State could reduce its financial obligations whenever it wanted to spend the money for what it
regarded as an important public purpose, the Contract Clause would provide no protection at all.” Id. at 26. (citing El
Paso v. Simmons, 379 U.S. 497 (1965); Faitoute Iron & Steel Co. v. City of Asbury Park, 316 U.S. 502 (1942);
Louisiana v. New Orleans, 102 U.S. 203 (1880)).
49 U.S. Trust, 431 U.S. at 31.
50 Id. at 25.
51 Id. at 30-31.
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spending and avoid financial crisis is an important public purpose under which a modification of
a contractual right is acceptable under the Contract Clause, 52 others have found to the contrary.53
In addition, a number of state courts, such as in California, permit reasonable modifications to an
individual’s pension benefits. However, “the modification must bear some material relationship to
the purpose of the pension system and its successful operation; and any disadvantage to
employees must be accompanied by comparable new advantages” 54 (e.g., an increased pension
amount). Thus, as explained by one commentator, the idea is that public employees are not
entitled to any particular terms of a pension, but of the substance of the benefit which they could
reasonably expect to receive.55 It should be noted that courts may reach varying conclusions as to
whether a more financially sound pension plan is a comparable advantage that may accompany a
modification of pension benefits.56
Attachment of Pension Rights
While states that protect public pensions under contract principles typically evaluate a case under
the legal standard discussed above, they reach varying conclusions based on when the contract is
deemed to be formed, and what terms and conditions the contract includes.57 While courts
generally find that the pension benefits of individuals who have already retired may not be
diminished or impaired, this outcome is not as clear for current employees.58
52 See, e.g., Maryland State Teachers Ass'n v. Hughes, 594 F. Supp. 1353, 1371 (D. Md. 1984) (finding that courts lack
the resources to second guess legislature on what is necessary to ensure the financial stability of pension funds);
Subway-Surface Supervisors Ass’n v. New York City Transit Authority, 44 N.Y.2d 101 (1978) (court upheld 1975
Financial Emergency Act for the City of New York, an act that suspended all employee wage increases for a one-year
period, in light of financial crisis). See also generally Brazelton v. Kansas Public Emp. Retirement System, 607 P.2d
510 (court states, in dicta, that “[t]here may be times when changes [to a state’s retirement system] are necessary to
protect the financial integrity of the system or for some other compelling reason…”).
53 See, e.g., Bailey v. State, 500 S.E. 2d 54 (N.C. 1998)(making retirement benefits taxable in light of federal court
decision was neither necessary nor reasonable for achieving an important state interest; court explains there were
numerous other ways to comply with the decision); Calabro v City of Omaha, 247 Neb. 955, 970 (Neb. 1995)(city’s
elimination of a cost of living supplemental benefit plan unconstitutional; court states in dicta that “[t]he city has not
convinced us that terminating the supplemental benefit plan was the only viable alternative for correcting its alleged
fiscal woes.”)
54 Public Employees’ Retirement Bd. v. Washoe County, 615 P.2d 972, 975 (Nev. 1980). See also Betts v. Board of
Administration of Public Employees’ Retirement System, 21 Cal. 3d 859 (Cal. 1978).
55 Brauer, supra note 21. See also, e.g., Maryland State Teachers Ass’n v. Hughes, 594 F. Supp. 1353, 1363 (D. Md.
1984) (reduction in benefits may be permissible if benefits lost are offset by new benefits received); Public Employees’
Retirement Bd. v. Washoe County, 96 Nev. 718, 722, 615 P.2d 972, 975 (1980) (for modification to be sustained any
disadvantage to employee must be offset by new advantage).
56 See e.g., Houghton v. City of Long Beach, 330 P.2d 918 (Cal. 1958)(increase in employee contributions without a
compensating increase in pension benefits upheld because city demonstrated that the additional revenues would result
in improved financial stability for the system); cf. Singer v. Topeka, 607 P.2d 467 (1980) (court does not accept City’s
claim that the actuarial soundness of the local plan was an advantage for the plaintiff after increasing employee plan
contributions). See generally (“there can be extraordinary circumstances where the employee may be required to
increase his contributions without a corresponding increase in benefits in order to preserve the financial integrity of the
system.”).
57 Monahan, supra note 25.
58 Id.
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The ability of states to modify their pension plans for current employees varies depending when a
contract is deemed to exist, and this varies from state to state.59 For example, in some states,
courts have held that an employee’s right to a pension cannot be changed in any way that reduced
the benefit that would be payable upon the day of hire or the first day the employee could
participate in the plan.60 This view entitles plan participants the most generous amount of
protection for their pension benefits, as employees have a right to accrue benefits in the future.61
States may, however, alter the benefits available to new hires.62
In other states, reductions in pension plan benefits could be prohibited when, under the terms of a
state statute, a participant is eligible to receive a pension (e.g., the employee has fulfilled the
plan’s service requirement).63 This approach is in line with federal requirements for private sector
pension benefits. Under this view, retirement benefits must be provided for service already
performed, but prospective plan modifications may still be acceptable. It is also possible that
based on interpretation of a state statute, contractual rights to a pension take effect at other times.
For example, interpreting an Ohio statute, one court found that the right to a pension benefit
attached at retirement.64
Despite the variation in when a contractual right to a public plan pension benefit begins, as noted
above, state courts generally find that the benefits of individuals who have already retired may
not be diminished or impaired.65 However, the modification of post-retirement benefits is
currently being challenged by retired state workers in three states, Minnesota, North Dakota, and
Colorado. The litigation is based on adjustments that the state legislatures made to post-retirement
cost of living adjustments in an attempt to address pension plan underfunding.66 For example, in
Minnesota, recently enacted legislation scales back an annual cost of living adjustment. Plaintiffs
have claimed that they have a constitutional right to the use of a specific formula for future post-
retirement increases. On the other hand, the state defendants have argued that “nothing …
59 See id.
60 Brauer, supra note 21. See also, e.g., Olson v. Cory, 26 Cal. 3d 672 (Cal. 1980)(“A long line of this court’s decisions
has reiterated the principle that a public employee’s pension rights are an integral element of compensation and a
vested contractual right accruing upon acceptance of employment.”) See also Yeazell v. Copins, 98 Ariz. 109, 402 P.2d
541 (1965).
61 Brauer, supra note 21.
62 Id.
63 For example, in Petras v. State Board of Pension Trustees, a retired schoolteacher sought to claimed he had an
enforceable right to a pension calculated under the version of state law in effect when he began teaching in the state. In
denying his claim, the Delaware Supreme Court opined that “it is clear that no contract exists between an employee and
the State, concerning the state pension plan, unless and until the pension vests. This result is consistent with that
reached in other jurisdictions… Because in 1964 the period for vesting of pensions was 30 years, Petras, who had only
completed two years service before the [pension formula] provision was changed, had no vested right in that provision
or, for that matter, in the plan as a whole. The General Assembly’s modification of the pension plan, therefore, did not
violate any contractual right.”)(citations omitted). See also Baker v. Oklahoma Firefighters Pension & Retirement Sys.,
718 P.2d 348, 350-51 (Okla.1986) (contractual right begins when eligible to receive pension).
64 See State ex rel. Horvath v. State Teachers Retirement Bd., 83 Ohio St. 3d 67, 77 (Ohio 1998)(“Accordingly, under
[the state statute], a right does not become vested until it is granted, and only grants of retirement allowances, annuities,
and pensions give rise to vested rights.”).
65 Monahan, supra note 25.
66 Justus et al. v. State of Colorado, No. 2010CV1589 (D. Colo. filed Feb. 26, 2010); Swanson et al. v. State of
Minnesota, No.CV-lO-5285 (Dist. Minn. filed May 17, 2010); Tice v. South Dakota, No. 10-225, (S.D. Cir. Ct. filed
June 14, 2010).
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supports a promise to forever refrain from amending the [cost of living adjustment] formula.”67 It
appears that a court has not yet ruled on the merits of these cases.
Federal Legislation Affecting State and Local
Governmental Pension Plans
In order to address the issue of public pension plan underfunding, some have called for federal
action. In the past, there have been efforts to regulate public pension plans similar to ERISA. In
particular, following enactment of ERISA, various proposals were introduced that would have
required public plans to meet various federal standards, such as reporting, disclosure, and
fiduciary duty requirements.68 Legislative history indicates that Congress intentionally exempted
these plans from ERISA for various reasons, most of which center around the differences inherent
in regulating a private pension plan versus one sponsored by a state or local government.69
Because of these differences, it was concluded that additional data and study were necessary
before attempting to regulate public plans.70 Federalism concerns were also raised, based on the
idea that regulating state and local pension plans would constitute impermissible federal
interference in the affairs of state and local government. 71 However, the legal landscape has
changed due to Supreme Court decisions issued after ERISA’s enactment in 1974.72
While it appears that no proposals have been introduced in the 112th Congress to comprehensively
regulate public pension plans, there has been discussion of possible federal legislation to allow
states to declare bankruptcy, something that states cannot currently do, in order to avoid or reduce
certain financial obligations, such as pension obligations.73 Another proposal addressing public
pension plans, the Public Employee Pension Transparency Act, would require public pension plan
sponsors to file various plan financial data with the Treasury Secretary, including plan assets at
fair market value and plan liabilities at an interest rate based on the U.S. Treasury obligation yield
67 Swanson et al. v. State of Minnesota, No.CV-lO-5285, (Dist. Minn. filed Aug. 18, 2010) at 36.
68 See, e.g., H.R. 5144, Public Employee Pension Plan Reporting and Accountability Act (PEPPRA), 98th Cong. 2nd
Sess., (1984); H.R. 4928 and 4929, Public Employee Retirement Income Security Act (PERISA), 97th Cong., 1st Sess.
(1981).
69 As explained in Rose v. Long Island R. Pension Plan, 828 F.2d 910, 914 (2nd Cir. 1987):
The governmental plan exemption [to ERISA] was included for several reasons. First, it was
generally believed that public plans were more generous than private plans with respect to their
vesting provisions. Second, it was believed that “the ability of the governmental entities to fulfill
their obligations to employees through their taxing powers” was an adequate substitute for both
minimum funding standards and plan termination insurance. Finally, there was concern that
imposition of the minimum funding and other standards ‘would entail unacceptable cost
implications to governmental entities.’ (citations omitted).
70 29 U.S.C. § 1231(a)(3).
71 See, e.g., Feinstein v. Lewis, 477 F. Supp. 1256, 1261 (S.D.N.Y. 1979) (purpose of ERISA governmental exemption
was to “refrain from interfering with the manner in which state and local governments operate employee benefit
systems”), aff'd, 622 F.2d 573 (2d Cir. 1980).
72 For a discussion of Supreme Court cases addressing the lines of authority between states and the federal government,
see CRS Report RL30315, Federalism, State Sovereignty, and the Constitution: Basis and Limits of Congressional
Power, by Kenneth R. Thomas.
73 Anonymous, Members Testify on Loss-Mediation Program, “New Chapter” Option for State Debt Crisis, 30 Am.
Bankr. Inst. L.J. 10 (Mar. 2011).
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curve.74 The bonds issued by governmental entities that do not comply with the disclosure
requirements would lose their federal tax exemption. Among other things, the legislation also
states that the federal government would not be liable for any obligation related to a shortfall in
any public pension plan.
Author Contact Information
Jennifer Staman
Legislative Attorney
jstaman@crs.loc.gov, 7-2610
74 H.R. 567, 112th Cong. (2011); S. 347, 112th Cong. (2011).
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