Why Moody's sees latest California pension ruling as credit negative

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LOS ANGELES — A California appellate court ruling that appears to favor a strict test for pension reforms to current employee benefits is a credit negative, says Moody’s Investors Service.

“The ruling is credit negative for the state and its local governments, because it increases the body of case law aligning with California’s historically stringent legal protections for public pension benefits,” wrote Tom Aaron, a Moody’s analyst in a Monday report.

A series of decisions by the California Supreme Court that severely restrict the state’s ability to enact pension reform on current employees are collectively known as the California Rule. It’s been interpreted so that any pension reduction must be offset with a comparable benefit.

Attorneys interviewed by the Bond Buyer immediately after last week’s ruling took a more favorable view calling the ruling a small victory for supporters of a less stringent interpretation of the California Rule.

The Court of Appeals in California’s First Appellate District ruled Jan. 8 that the pensions of current employees can be cut without providing an offsetting new benefit, but the legal justification that a reduction is needed for the successful operation of the retirement system must be “substantive.”

One potential justification that may meet this very high standard, according to to the appellate court, would be an impending "total pension system collapse," Aaron wrote.

The ruling came in Alameda County Deputy Sheriffs’ Association et al. v. Alameda County Employees Retirement Association, a case that challenged anti-spiking rules outlined in pension reform signed by Gov. Jerry Brown in 2013 that applied to current workers as well as new employees.

The new ruling for the three consolidated cases sets a higher bar than the appeals court ruling in the Marin County case two years ago that said pensions can be cut if the employee is not deprived of a reasonable pension, Aaron wrote.

The Supreme Court of California is expected to take up the issue this year, but has not set a date to begin deliberations. It agreed in December to hear the Marin case and another filed by a firefighter’s union, but had said it was waiting for cases, including the Alameda case, to wend their way through the appeals process.

The ruling could make "the state's highest court less wiling to lessen the restrictions of the California Rule in its upcoming review, leaving California governments with little flexibility to cut their pension costs," Aaron wrote.

The ratings agency has calculated the state's adjusted net pension liability at $193 billion or 117% of its revenue, well above the median of 82% for the 50 U.S. states, according to the report.

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