Rating agencies weigh in on California pension ruling

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Moody’s Investors Service viewed this month's California Supreme Court ruling on public pensions as positive for governments in the state, while S&P Global Ratings said the court sidestepped the most salient question.

“The decision by the state's highest court is credit positive for California (Aa3 positive) and its local governments because it preserves a key element of the Public Employees' Pension Reform Act of 2013 (PEPRA) that has helped contain unfunded liability growth,” Moody’s analysts wrote Friday.

PEPRA, championed by former Gov. Jerry Brown, mainly affects the benefits of employees hired after it took effect. It also eliminated the ability of current and future employees to purchase up to five years of service credit toward their pensions.

The court ruled March 4 in CalFire Local 2881 et al. v. California Public Employees’ Retirement System et al. that the opportunity to purchase additional retirement service credit, colloquially known as “air time,” was not a right protected by the contract clause of the state constitution.

The opinion explicitly excluded any analysis of the so-called California Rule, a series of court rulings dating to the 1950s that have prevented the reduction of pension benefits of government retirees and current employees, and changes to current employees’ benefit formulas, unless the changes are offset by a comparable advantage.

The court's ruling essentially maintains the status quo, but it eliminates any legal uncertainty surrounding the past elimination of ARS for current employees as part of PEPRA, Moody’s analysts wrote.

S&P Global Ratings said in a March 6 report that the court “sidestepped the issue by placing the case outside the application of the rule and remained silent on any discussion of the rule itself.”

S&P analysts wrote they “view the increasing burden of pension liabilities as a clear and escalating risk factor for credit quality.”

But S&P noted that the high court will have another opportunity to provide more flexibility to local governments struggling under the weight of their pension liabilities as it has agreed to hear oral arguments in a Marin County case.

Multiple lower court judges had issued an interpretation of the California Rule as a protection of “substantial and reasonable benefits,” moving away from a fully rigid application of the contract clause even to future service, S&P analysts wrote.

The Marin County case was the first where the “substantial and reasonable benefits” opinion was highlighted, S&P analysts wrote.

“This framework could provide California's state and local governments a mechanism for maintaining promised and competitive benefits while managing the increasing costs of pensions in the current challenging demographic and economic environment,” S&P analysts wrote.

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