The Colorado Supreme Court granted some good news to the state’s troubled public pensions in October by upholding a key part of an important 2010 reform law. In the process, though, the court may have made it more difficult to enact more meaningful reform down the road.
Four years ago the Colorado Legislature adopted Senate Bill 1 to reform the state’s Public Employees Retirement Association. Among other changes, the bill lowered the cap on retirees’ annual cost-of-living adjustments from 3.5 percent to 2 percent. The court upheld this particular provision, which was designed to help reduce PERA’s future financial shortfall.
SB 1’s changes applied to current as well as future retirees. A group of current retirees, unhappy with having their cost of living capped, sued. They claimed that the legislation violated the Contracts Clauses of both the U.S. and Colorado Constitutions. Those clauses prevent the government from doing anything to impair existing contracts. The retirees believed that by changing the terms of their pensions, the Legislature violated an existing contract with them.
The plaintiffs had some reason for optimism. While it has long been held that states cannot create contractual obligations through Legislation, the Colorado Supreme Court had carved out an exception for public pensions in two decisions: McPhail (1959) and Bills (1961).
The Justices drew a distinction between those cases and the current one, known by its lead plaintiff, Justus. The court decided that cost-of-living adjustments were not part of the core formula for determining benefits. They also recognized that the Legislature had changed the adjustments formula a number of times in the past. As a result, the majority ruled that the retirees had no reasonable expectation that a contract had been created.
Last month’s decision follows similar rulings concerning the adjustments in state court in Washington state, and in federal court in Maine. Those rulings were not binding in Colorado. Yet taken together with Justus, they may indicate a developing national consensus that at least cost-of-living adjustments are not protected by the Contracts Clause.
Had the court struck down the adjustments, the size of PERA’s unfunded liability would have ballooned, and an avenue of significant cost savings would have been closed off to the Legislature. To that extent, the decision is good news.
However, needed PERA reform work is not close to being done. The unfunded liability remains large. PERA admits to about $27 billion; the Independence Institute has identified the number as closer to $60 billion. PERA overestimates its likely rate of return, underestimates its future liabilities and downplays the risks associated with volatile investments such as the stock market. Under these circumstances, it is all but inevitable that at some point in the future, the state Legislature will be asked to consider more drastic reforms.
Justice Nathan Coates’ concurring opinion indicates why Justus may make it harder to implement reforms needed to ensure the retirement security of state and local government employees, including teachers. Coates noted that by framing the decision the way it did, the majority bought into the plaintiffs’ logic, and that there were elements of the plan that the Legislature would not be able to change without violating the Contracts Clause.
Coates also believes the court failed to give a persuasive reason why the adjustments were exempt from the legislative contracting exception. Taken together, these two elements effectively leave areas of the plan concerning current retirees off-limits to the Legislature. Further, the court offers no guidance as to what those areas might be.
Without such guidance, future legislatures will be less informed about what reforms will pass constitutional muster. They will be less likely to take on broad reforms unless and until drastic action is needed, and there is little margin for error.
Further, should the legislature pass any changes that the Court nullifies in defense of the Contracts Clause, the consequences for employee pensions, as well as state and school budgets, could be catastrophic.
By failing to lay out clear rules for what is permissible and what isn’t with respect to existing benefits, the Court’s ruling in Justus, celebrated for helping PERA’s finances right now, may end up making such a bleak scenario more likely in the future.
Joshua Sharf is a fiscal policy analyst for the Independence Institute, a free market think tank in Denver