What the Pension Reform Decision in Arizona May Mean for Illinois

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Today the Arizona Supreme Court has handed down its much-anticipated decision in Fields v. The Elected Officials’ Retirement Plan. In Fields, the Court unanimously struck down a pension reform package enacted by the legislature in 2011, finding that the statute violated the Pension Clause of the Arizona Constitution. The decision will be much debated in Illinois, where the legislature’s 2013 pension reform package is now the subject of at least three different lawsuits.

Arizona is one of a small number of states which expressly protects public pensions as a matter of state constitutional law:

Membership in a public retirement system is a contractual relationship . . . and public retirement system benefits shall not be diminished or impaired.

The Arizona legislature established the Elected Officials’ Retirement Plan in 1985. The Plan is funded by employer and employee contributions and investment proceeds, as well as certain court fees. When the Plan was first created, post-retirement benefit increases were awarded ad hoc – there was no automatic formula. In 1990, the legislature enacted ARS 38-818, creating a statutory mechanism for calculating automatic yearly benefit increases. Section 38-818 isn’t a cost-of-living formula, strictly speaking – benefit increases are based upon how well the Plan’s investments did the previous year, subject to a yearly cap.

Section 38-818 provided that retirees were “entitled to receive a permanent increase in the base benefit” each year, as calculated by the formula. But the statute had a sunset provision set for 1994. When 1994 rolled around, the legislature allowed the increase formula to lapse, but in 1996, the legislature amended the statute by striking the sunset clause entirely. The legislature reduced the cap on yearly increases in 1996, but restored the cap to its original 4% per year in 1998. Later that year, the voters adopted the Arizona Pension Clause.

Beginning in 2000, the Arizona Plan’s funding ratio (assets divided by liabilities) started to decline. In the ten years that followed, the funding ratio dropped from 141.7% to 66.7%. Nevertheless, the statute provided retirees with a 4% benefit increase each year through 2011.

In 2011, the Arizona legislature adopted pension reform. The statute did two things.

First, the statute substantially changed the Plan’s reserve fund. Until 2011, in a year when there was money left over from investment returns after retirees were paid the maximum increase, the excess was placed in the reserve fund to finance increases in years where investments didn’t do well enough to fund additional benefits. The 2011 statute prohibited the transfer of $31 million in excess earnings to the reserve fund. As a result, retirees received only a 2.47% increase in 2011, and none at all in 2012 and 2013.

Second, the 2011 statute changed the formula for calculating future yearly increases, beginning in July 2013. The minimum rate of return necessary to trigger any increase was raised from 9% to 10.5%, and future increases were tied to the Plan’s funding ratio.

The plaintiffs filed a putative class complaint, alleging that the pension reform package violated the state Pension Clause. When the trial court agreed, the Arizona Supreme Court agreed to hear an appeal immediately, bypassing the Court of Appeals.

The Supreme Court affirmed the trial court. The question, the Court wrote, was whether the formula established by Section 38-818 for calculating yearly increases was itself a “benefit” within the meaning of the Pension Clause. The plaintiffs argued that it was, but the State and the Plan argued that retirees had only the right to receive benefits in an amount determined by the most recent formula, whatever it might be.

The Court found that the history of the state pension statutes settled the question of what the voters had in mind when they adopted the Pension Clause. Eight years before the Clause was approved, the legislature had enacted the original version of Section 38-818 providing that retirees were “entitled to receive [a] permanent benefit increase in their base benefit.” When the legislature struck the sunset provision, that phrase in quotes was left: retirees were “entitled” to receive a yearly increase, apparently in perpetuity, and that’s how the statute still read when the Pension Clause was adopted. Given that, the Court unanimously concluded that voters would have regarded the formula for calculating yearly increases as falling within the scope of the “benefits” protected by the constitution.

The Court pointed out that its holding was consistent with its earlier cases. In Yeazell v. Copins, the Court had held that an employee was entitled to have his or her pension calculated pursuant to the pension formula which existed when the employee was hired, not pursuant to any less favorable formula which might be adopted after the employee was on the job. The Court also noted that courts in New York and Illinois – two states with similar pension clauses – had likewise held that benefit formulas were constitutionally protected once a public employee was hired.

Given that the increase formula was a pension “benefit,” this only left the question of whether the 2011 amendments diminished or impaired those benefits. The Court had little trouble concluding that they had. First, by preventing the transfer of excess funds to the reserve fund, the statute had reduced 2011 benefit increases and eliminated 2012 and 2013 hikes. Second, by changing the formula for calculating future increases, the statute ensured that increases after 2013 would be significantly smaller, if indeed retirees received increases at all.

As I noted at the outset, pension reform was adopted in Illinois in 2013. The Illinois Pension Clause is virtually indistinguishable from the Arizona Clause:

Membership in any pension or retirement system of the State, any unit of local government or school district, or agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.

Evidence that the Illinois Constitutional Convention intended to protect formulas for calculating benefit increases from diminishment is quite strong, and the Illinois courts have so held, almost without exception. Nearly all of the arguments raised in the Arizona case have been debated in recent years in Illinois as the legislature wrestled with pension reform. Given the striking similarities in the law of the two states, the unanimous decision of the Arizona Supreme Court may cast a long shadow as litigation in Illinois moves forward.