The city of Chattanooga, TN, will be allowed to continue changing cost-of-living adjustments (COLAs) for its public safety pension plan, according to a 6th U.S. Circuit Court of Appeals ruling earlier this month. The Tennessee city passed an ordinance in 2014 reducing COLAs for retirees in the Chattanooga Fire and Police Pension Fund (CFPPF) until the plan is 80 percent funded. As of this September, the CFPPF was only 52 percent funded.
Chattanooga’s actuaries estimate the city will save $227 million by 2040 as a result of the COLA restrictions, allowing the plan to improve its funding level by curbing the outflow of payments to retirees instead of driving up inflows of contributions from today’s taxpayers.
This decision will likely be welcomed by other jurisdictions looking to modify COLAs, though it is far from uncontroversial.
The 6th Circuit held that the CFPPF COLA was not explicitly included in the provisions of the law that outline vested benefits. A benefit is considered vested if the state or municipal statute creates a contractual relationship between the government and the pensioner, and it is unconstitutional for states to pass any law impairing contracts. However, since the COLA was not a vested right — according to the 6th Circuit — it could be amended.
In the U.S., pension benefits were originally considered gratuities that could be rescinded by the government. But the Kern v. City of Long Beach decision in 1947 found that pension benefits constituted a contractual relationship because “the mere fact that [pension benefits are] dependent on certain contingencies does not prevent a contract from arising.
Under this reasoning, also called the “California Rule,” an employee agrees to the pension benefits in place when they were hired, just as they agree to a salary, and they are entitled to those benefits as if they were a contract. Since then, many state courts across the U.S. have followed similar logic, with the exception of decisions such as US Trust Co. v. New Jersey, where the US Supreme Court held that it is acceptable to impair contractual obligations, but only to “serve an important public purpose.”
However, the 6th Circuit did not need to apply US Trust logic in its decision because it found the COLA was not a contract in the first place. This decision follows similar cases of COLA reductions — including Berg v. Christie and Tice v. South Dakota — which also predicated their arguments on a presumption against statutes creating contractual obligations.
The importance of this line of argumentation cannot be understated. According to the 6th Circuit, pensions are deferred compensation, but, like most other policies, they should not be set in stone before first clearing the hurdle of “unmistakable” legislative intent.
Because “there was no unmistakable evidence of [Chattanooga’s] intent to be bound to the fixed COLA,” the Court found, the ordinance does not create a contract. City code says pensioners’ benefits “will be increased,” but the term “will” only imposes a duty to comply until the statute is changed, according to the ruling.
The court also found that if the purpose of a COLA is to prevent the erosion of pension benefits due to inflation, fixing the value at 3 percent, as many other pension systems do, contradicts the purpose of a COLA. Inflation has only averaged 1.7 percent in the past decade. A COLA above the rate of inflation amounts to an additional benefit increase.
The logic of the court is clear and understandable — but is it not consistently held across the country. Rulings in Heaton v. Quinn and Byrne v. Montana sided with the pensioners in similar cases where a state or municipality sought to curb COLAs in order to try and improve the solvency of a pension fund. After all, it is difficult not to sympathize with pensioners. The very logic behind a COLA is predicated upon fluctuating economic conditions and ensuring the preservation of the purchasing power of money.
Perhaps more importantly — separate from logic of the court —freezing or reducing COLAs alone may not be sufficient to ensure the solvency of pension systems. Thus, while it can be an important element of reforms to prevent pension crises in the near-term, such changes in isolation may paper over greater risks in the long run.
Simply reducing COLA payments today in order to kick the can on meaningful, structural reforms is not real pension reform. On the flip side, COLA reductions — to the degree they are legally allowed and do not undermine retirement security — could be one piece of a larger pension reform package. After all, should a pension fund become insolvent there might not be a monthly pension check to get a COLA on in the first place.