The “California Rule” and the “The Fall of Pacific Grove”

In my previous post, I described the “California rule,” which puts state governments in a legal straitjacket when trying to reform underfunded public pensions. Specifically, it places pensions in a privileged position relative to other types of compensation, like salary or health insurance benefits, by making them more difficult to change. This post highlights a real-world example of the California rule’s dangers.

The place is Pacific Grove, California, a town of 15,000 residents on the Monterey Peninsula’s northern tip, with an annual budget of $11 to $12 million. In 2008, John Moore, a Pacific Grove resident and retired attorney, learned that the City of Pacific Grove had issued $19 million of pension bonds two years earlier, while at the same time it gave the police union a 30% raise.

After making several requests under California’s Public Records Act, Moore uncovered a tale of self-dealing by Pacific Grove and union officials to rip off California taxpayers. The result of Moore’s investigation, “The Fall of Pacific Grove,” was published in The Pine Cone, a Monterey County paper; it’s now available online thanks to the California Public Policy Center.

In 2002, the Pacific Grove city council adopted a 50 percent pension increase for public safety workers, after being told by the city manager that the increased benefit would cost around $51,500 per year. However, the city manager withheld from the council an actuary report that estimated the benefit at over $800, 000 per year. The hidden actuary report was not discovered until 2009. The results have been predictable and dire. Pacific Grove’s pension deficit has ballooned to $45 million, plus $20 million in pension bonds, and is growing at 7.5 percent a year, according to Moore.

To make matters much worse, the California rule has made it much more difficult to address the problem. In 2010, an initiative to limit the city’s pension contribution to 10 percent of salaries qualified for the ballot. The council then adopted the initiative, and the police unions sued, claiming to have a vested right in its members’ pensions. The city could have mounted an effective defense. As Moore recounts:

On November 21, 2011, while the lawsuit was pending, the California Supreme Court ruled that vested contract rights could be implied “if there is no legislative prohibition against such arrangements.” Clearly, the Pacific Grove 1955 Charter requiring a vote of the people was such a prohibition.

But the city sat on its hands, instead.

In the trial, the City did not require the unions to prove a vested pension right. It conceded that the unions had such a right. No witnesses were called. I was there, and I had made numerous requests of the attorneys to allow me to present the evidence that demolished the allegation claiming a vested right. But no, my research did not see the light of day. So the judge simply adopted the raw assertion of the unions, together with the lack of a defense, and ruled that the police unions had vested pension rights.

Granted, in this case, the union won by default thanks to the city’s inaction. But actual events aside, the California rule does expose pension reforms to being struck down in court. In his concluding post, Moore writes:

[T]he Supreme Court of California is the great enabler and protector of pension rights for public employees; rights that contradict a democratic form of government.

If there is not a change in the so-called “California Rule,” created by the Supreme Court of California and followed by 12 other states, most California cities and counties will become insolvent, like Pacific Grove and Sonoma County. How soon it happens to other public agencies (with defined benefit programs) depends on the relative viability of their tax base.

In practice, this has made the Court the final arbiter on pension reform.

The California Rule is based on the legal theory that a statute, like an ordinance or a city charter, that has set out a pension right in the statute or charter, did so with the intention to create a vested right, not only as to pensions earned, but also as to future accruals. That “contract” is then said to be protected by the “contract clauses” of the State and Federal constitution.

But in every case where a California court has enunciated the California Rule, it has omitted any factual inquiry into legislative intent. No scholar has found a single California opinion applying the rule, where there was a showing that the legislation from which the contract was derived was based on a legislative history confirming that a vested right to future accruals was intended. The court just made it up.

In the end, this highlights the importance of Emory law professor Alexander Volokh’s recommendation of a state constitutional amendment to outright abolish the California rule in the 12 states that have adopted it.