U.S. appeals court says Baltimore pension reform legal

WASHINGTON Wed Aug 6, 2014 6:36pm EDT

WASHINGTON Aug 6 (Reuters) - The U.S. Court of Appeals for the Fourth Circuit upheld a major reform made to Baltimore's police and firefighter pension plan on Wednesday, shedding light on how judges may view the recent raft of changes in public retirement funds around the country.

The court vacated a previous decision that the reform had violated the U.S. Constitution's contract clause, and also decided the change was permissible under Maryland's state constitution.

In 2010 Baltimore adopted a tiered system of annually increasing pension benefits for retired public safety workers - with retirees over the age of 65 receiving the largest cost of living adjustment of 2 percent - and ended a system of giving retirees bonuses when pension investments had good years.

When the pension funds' investments had earned more than 7.5 percent in a year, benefits increased, and the increases compounded in the future. That led to an average annual increase of 3 percent, according to court documents.

The tiered system "would not require the city both to bear the burden of poor investment performance and to forego some of the investment gains in years of strong performance," wrote Judge Barbara Milano Keenan in Wednesday's decision.

Facing huge budget deficits from the 2007-09 recession and financial crisis, Baltimore moved in step with other municipalities and states to change its pensions in the hopes of driving down costs. From 2009 to 2011, 43 states reformed their retirement systems after the financial crisis ravaged the funds' largest revenue source, earnings on investments.

Baltimore's firefighter and police unions sued, saying the city was illegally violating a contract with the tiered system, also following a national trend.

Most states treat public pensions as contracts. The first wave of nationwide pension reforms sidestepped the possibility of violating federal or state laws by only applying to new hires. When modifications did not save enough money, some governments then changed benefits for current retirees and employees, prompting public workers to sue.

Divergences in how retirement systems operate and in state laws mean there is no clear legal path to how the disputes will resolve. Court battles have recently put Illinois pension changes in limbo, for example.

The U.S. District Court for Maryland concluded that Baltimore's "elimination of the variable benefit constituted a substantial impairment of certain members' contract rights, and that the impairment was not reasonable and necessary to serve an important public purpose."

But the appeals court said the reform was a "mere breach of contract, not rising to the level of a constitutional impairment or obligation."

It also dismissed the notion that allowing the reform to go through would give a city "unfettered discretion to breach its contracts with public employees," because of protections in Maryland law.

"This contention lacks merit because, under Maryland law, the city is only permitted to make reasonable modifications to its pension plans," wrote Keenan. "Any reduction in benefits 'must be balanced by other benefits or justified by countervailing equities for the public's welfare.'" (Reporting by Lisa Lambert; editing by Andrew Hay)