CHICAGO — A Minnesota judge this week kept alive a lawsuit filed by retirees against the state’s public pension funds that challenges legislation enacted earlier this year curbing benefit increases for current retirees.

At a hearing Wednesday, Ramsey County District Court Judge Gregg Johnson put off issuing a judgment in the case as requested by lawyers from the attorney general’s office, which is representing the defendants. The defendants include the state, the pension funds, their top managers, and Gov. Tim Pawlenty.

Legal documents in the case can be found at http://minnesotapensions.com/.

Johnson said discovery can continue in the case that was filed May 17 after state legislation was enacted limiting future benefit increases for participants in the funds covering teachers, state employees and local government employees.

The lawsuit argues the legislation violates both state and federal laws governing contractual obligations and the taking of private property for public use. The complaint contends that the average employee in one of the funds stands to lose $28,000 in benefits over the next 10 years as a result of the new law. Lawyers are seeking class action status to represent an estimated 75,000 retirees.

“This case is about whether the state is required to live up to the obligation of its contracts whether it’s to a contractor who built a road or to its workers,” said Stephen Pincus, an attorney with Stember Feinstein Doyle Payne & Cordes LLC, which is representing the Minnesota retirees. The firm is also representing retirees involved in similar lawsuits pending in Colorado and South Dakota.

Lawyers from the attorney general’s office contend that based on past court rulings, the Minnesota Legislature has authority to modify retirement benefits and that the formula governing benefit increases is not guaranteed as a contract in state statutes.

Elected officials, pension fund managers, and participants in the public pension sector are following the Minnesota and other cases closely as more attention is paid to the strains unfunded pension liabilities pose to governments amid ongoing fiscal struggles. The Pew Center on States earlier this year warned that states face a combined $1 trillion pension funding shortfall based on 2008 figures.

While governments must overcome political and policy hurdles to alter retirement benefits, they face an even tougher legal obstacle depending on the degree of legal protections afforded to pension benefits in state statutes and constitutions.

In the Minnesota case, a new law signed in May by Pawlenty eliminated a 2.5% annual increase in benefits. The change was among a series of reforms enacted that also increased employee contributions. The changes are expected to save the pension system $2 billion over the next five years, according to a credit report issued by Moody’s Investors Service ahead of a recent state general obligation sale.

The legislation lowered annual increases to a range of 0% to 2%, and in most cases those limits remain in place until the pension achieves a 90% funded ratio.

“The 2010 Pension Legislation violates the vested right of all class members to receive annual post-retirement adjustments to their pension benefits according to the formula in effect when they began receiving a pension,” the lawsuit reads.

The suit asserts that a 90% funded level is unlikely to be attained by some of the funds for many years based on their funded ratios for fiscal 2009. The Public Employees Retirement Association’s rate was 70% funded at the close of fiscal 2009. The ratios of the various funds last year ranged from a low of 54% to a high of 70%.

Between 1993 and 2002, Minnesota used a formula to calculate benefit increases based on the health of the funds and inflation. It shifted last year to a guaranteed 2.5% annual increase.

In its motion seeking an immediate judgment against the defendants, the attorney general argued that the formula for calculating annual increases is not protected under contract laws, and therefore the new law does not impair the terms of the state’s contract to provide pension benefits. State officials contend that statutes say only that retirees are “eligible” for annual increases.

The state’s filing further argues that the changes protect the fiscal stability of the pension system and represent a “reasonable and appropriate legislative response to preserve the funds’ fiscal stability.”

The state also argued that the law does not violate state and federal laws governing the taking of private property because the legislation affects only future benefits, not benefits currently in hand.

Minnesota was among a handful of states that adopted various pension reforms over the last year, although most have changed benefits only for future employees in part to avoid legal challenges. Some who follow the sector believe the legal front could shift with new challenges mounted depending on the financial health of a government.

The constitution in Illinois, which has a $62.4 billion unfunded pension liability for a funded ratio of just 50.6%, establishes participation in the state’s pension plans as a contractual relationship for which benefits cannot be “diminished or impaired.”

However, amid questions over how the pensions would fare in the event Illinois can’t make its payments, a recent opinion authored by Sidley Austin LLP takes the position that funds, and not the state, is the guarantor of benefit payments.

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