LOS ANGELES -- A California court decision last month about other post-employment benefit liabilities could be a credit negative for states and local governments, according to Fitch Ratings.

On Sept. 13, Los Angeles Superior Court Judge Luis Lavin overturned a freeze on retiree health care for some Los Angeles employees, which was contested by the employees’ unions.

The court decision, although narrow and subject to appeal, “is the most recent indication that local and state governments may not have as much ability to control OPEB liabilities and consequently have less overall budget flexibility than is traditionally assumed,” Fitch analysts said in a report Wednesday.

“We have generally viewed OPEB as more flexible than pensions, given local governments’ demonstrated ability to make timely and material downward adjustments,” Fitch said.

Earlier this year, the city approved ordinances that gave covered employees the option of receiving a capped health-care subsidy or contributing 4% of their salary to cover the benefit. The Los Angeles City Attorneys Association and Engineers & Architects Association took the matter to court, saying the city unconstitutionally impaired a contractual obligation to its employees.

Judge Lavin ruled in favor of the city employees, saying the freeze ordinance constitutes an “impairment of a vested right to a substantial or reasonable benefit.”

Although only affecting a small portion of the city’s workforce, the decision demonstrates that a local government’s right to seek budgetary savings through adjustments to retiree benefits is in question, Fitch said. The decision shows that enacted pension and OPEB reforms could be successfully challenged in court or other forums.

The ruling could have far-reaching implications because managing the growth of benefit costs is a challenge at all levels of government across the country. California transit system workers, for example, were excluded from statewide pension reform due to a challenge under a narrow provision of federal grants legislation.

In addition, Detroit’s emergency manager has proposed to put OPEBs in a group of unsecured debt that includes general obligation bonds.

“These counterpoints raise important concerns,” analysts said.

“When thinking about budget flexibility, it is important to think in terms of avoidable versus unavoidable costs,” Fitch said. “Where state courts elevate OPEB to the same standing as pensions, overall budget flexibility will be reduced for locals in those states.”

Los Angeles, rated AA-minus with a stable outlook by Fitch, has taken steps to pre-fund its OPEB liability and is relatively well-positioned compared to other local governments that, for the most part, are only funding costs annually, Fitch said.

Analysts believe the fiscal ramifications for the city, if the court decision is appealed and upheld, are minimal.

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