Request By:
Earl Kilbourne
Chairman
Coalition of State Employee Organizations
P.O. Box 203
Frankfort, Kentucky 40602
Opinion
Opinion By: Frederic J. Cowan, Attorney General; James M. Ringo, Assistant Attorney General
This is in response to your letter on behalf of the Kentucky Coalition of State Employee Organizations which questions the legality of the transfer of funds from the Kentucky Retirement System's Retirement Allowance Account to the General Fund by the 1988 General Assembly. Acts 1988, Chapter 437, Part VIII, Fund Transfer.
By way of background, the 1988 Executive Branch Budget submitted by the Governor requested, in regard to Agency Transfer Funds, that $3.2 million be transferred from the Kentucky Employees Retirement System's Retirement Allowance Account (KRS 61.580) to the General Fund for each year of the biennium, fiscal year 1988-89 and fiscal year 1989-90. See 1988 General Assembly - Final Budget Memorandum, p. iii (copy attached).
However, the General Assembly, in enacting the Budget Bill (HB 516), directed instead that $1.8 million be transferred from the account in fiscal year 1988-89 and $1.5 million in fiscal year 1989-90 for each year of the biennium as requested by the Governor.
In explaining this fund transfer, the 1988 Budget Bill provides:
PART VII
FUND TRANSFER
1. It is the finding of the General Assembly of the Commonwealth of Kentucky that the financial condition of state government requires the following action.
2. Notwithstanding the requirements of the statutes set forth below, there is hereby transferred from the agency and special funds enumerated below to the General Fund the following amounts in fiscal years 1988-89 and 1989-90. 1988-891989-901. Kentucky Retirement$1,800,000$1,500,000Systems(KRS 61.580 and 61.565)
Notwithstanding KRS 61.565, the above amounts of the employer's share of General Fund deductions made for retirement contributions to the Kentucky Employees Retirement System and the State Police Retirement System shall be transferred to the General Fund. No further transfer shall be made.
KRS 61.580, regarding the Retirement Allowance Account of the KERS, provides:
The retirement allowance account shall be the account in which shall be accumulated all employer contributions, amounts transferred from the members' contribution account, and to which all income from the invested assets of the system shall be credited. From this account shall be paid the expenses of the board in administering the system, retirement allowances and any other benefits payable after a member's retirement and from this account shall be transferred to the members' contribution account the interest credited annually to each member's individual account as provided by KRS 61.575.
KRS 61.565 requires and provides for the state employer to make actuarially determined annual contributions to the retirement system. These employer contributions are commonly referred to as the "employer match. " The statute further provides that these contributions rates shall be determined by the Board of Trustees of the KERS on the basis of the annual actuarial valuation. KRS 61.565(3). The Board is then required to advise each employer of any change in the employer contribution rate and the employer must include in the budget sufficient funds to pay the employer contributions as determined by the Board. KRS 61.565(4).
In Com. Ex Rel. Armstrong v. Collins, Ky., 709 S.W.2d 437 (1986), the Kentucky Supreme Court held that the General Assembly could not transfer or divert funds from the Kentucky Employees Retirement System's Retirement Allowance Account (KRS 61.580). In reaching such a conclusion, the Court stated:
What we decide is simply that the transfers of funds which are merely temporary, determinable suspensions of the operation of the statutes relating to appropriations of public funds are within the legislative authority as set out in SB 294 and Ky. Const. Sec. 51, the amendment section.
However, the transfers of funds which relate to appropriations of private contributions cannot be termed suspensions or modifications of the operation of the statutes. Because the General Assembly has no authority to transfer private funds to the general fund, the transfer of money from agencies in which public funds and private employee contributions are commingled, and cannot be differentiated, is unconstitutional. Diversions from the Kentucky Employees Retirement System, County Employees Retirement System, State Police Retirement System, and Teachers' Retirement System fall within this category, as do Workers' Compensation and Workers' Claims Special Fund. (Emphasis added.)
By way of footnote 11, p. 447 of the decision, the Court specifically referenced the fund in question of the KERS as KRS 61.580, the Retirement Allowance Account.
As we understand it, the employer's match (KRS 61.565) is ordinarily placed in a Special Deposit Trust Fund known as a 72 Fund (which is like an escrow account) and paid into the Retirement Allowance account (KRS 61.580) on a bimonthly basis during the biennium.
In an effort to avoid the unlawful transfer of commingled public and private funds from the retirement allowance account, which was found to be unconstitutional in Armstrong v. Collins, the Finance and Administration Cabinet established an additional Special Deposit Trust Fund - 72 Fund account in which to place that portion of the employer's match which the General Assembly had appropriated to the retirement allowance account but directed to be transferred back into the general fund.
These funds, the $3.3 million, were then and are being transferred from this separate 72 Fund - Special Deposit Trust Fund account on a bimonthly basis back into the General Fund as directed by the General Assembly.
KRS 61.565 directs that the employer's match be placed in the retirement allowance account (KRS 61.580). The 1988 Budget Bill directs that $3.3 million of the statutorily required employer's match be transferred back into the general fund. Whether this accounting prestidigitation of placing these transferred funds into an additional Fund 72 account sufficiently overcomes the unconstitutional transfer of commingled private and public funds under Armstrong v. Collins is ultimately a question the courts must answer.
However, we believe that this subsequent executive branch accounting maneuver, which may serve to differentiate that portion of the employer's match the General Assembly directed to be transferred from the retirement allowance account, does not cure the constitutional problem.
The employee's retirement plan is part and parcel of his employment contract and constitutes an inviolable contract of the Commonwealth between the employee and his employer, the State. KRS 61.692.
In accordance with the KERS retirement plan, the employee's contribution or share (KRS 61.560) is mandatorily deducted from his salary and placed in the Member's Contribution Account (KRS 61.575). At the same time, the employer's match (KRS 61.565) is placed in the Retirement Allowance Account (61.580). Pursuant to the employment contract and its pension plan, the retirement fund contributions, required by the above statutes, and the rights thereto, are commingled at the time of the appropriation (enactment of the Budget Bill). Since the employer's match materially relates to the employee's private contributions, the transfer of funds could not be termed suspensions or modification of the retirement statutes. Armstrong v. Collins. All of these statutes are part of the inviolable contract the state has with its employees. KRS 61.692.
The Court in Armstrong v. Collins further stated that because the General Assembly had no authority to transfer private funds to the general fund, the transfer of funds from the KERS retirement allowance account, in which public funds and private mandatory employee contributions are commingled and cannot be differentiated, was unconstitutional.
The 1988 Budget Bill's transfer of funds from the KERS retirement allowance account is the same as the invalid transfer of the 1984 transfer of funds struck down in Armstrong v. Collins and is invalid for the same reasons. It was the transfer of the retirement funds themselves that the court found unconstitutional and not the accounting process used by the executive branch.
Equally as important, we believe the fund transfer was unconstitutional as an unlawful impairment of contract, in violation of Section 19 of the Kentucky Constitution and Article 1, Section 10, Clause 1, of the United States Constitution. Both constitutional provisions prohibit ex post facto laws and, any law which would impair a contractual obligation.
In addition to violating the above provisions of the Kentucky and United States Constitutions, the fund transfer also violates KRS 61.692, which mandates that the KERS retirement statutes shall be an inviolable contract between the state and its employees. Such provision was not suspended by the language of the Budget Bill.
KRS 61.692 provides:
It is hereby declared that in consideration of the contributions by the members and in further consideration of benefits received by the state from the member's employment, KRS 61.510 to 61.705 shall constitute an inviolable contract of the Commonwealth, and the benefits provided therein shall not be subject to reduction or impairment by alteration, amendment or repeal. (Emphasis added.)
This office has previously stated that the state public retirement statutes constitute an inviolable contract of the Commonwealth and its employees and the benefits provided by those statutes could not therefore be subject to reduction or impairment by alteration, amendment or repeal. OAG 78-4 and OAG 81-416 (copies enclosed).
In OAG 78-4, we stated that new concepts dealing with public pensions are predicated upon the theory that such pensions are actually a part of compensation (deferred in nature) to which the public employee is entitled for services rendered.
In addition to this expectation of future benefits, the state public retirement system statutes provide that the pension fund be administered on an actuarially sound basis and requires that the board of trustees of the retirement system determine the employer's normal contribution and past service contribution rates on an annual actuarial basis. KRS 61.565.
In other words, the employee has a contractual interest not only in future benefits but in the security and integrity of the source of funds available to pay future benefits on a long term basis. This inviolable contract includes the retirement program as a whole (KRS 61.510 to 61.705). And, again, KRS 61.692 was not suspended by the Budget Bill.
In discussing the contract rights of eighty-five retired teachers under a pension plan which was found to be actuarially unsound and the Fund, which had been set apart for the collective payment of annuities, had been reduced to a negligible sum, the Court in Board of Education v. City of Louisville, 288 Ky. 656, 157 S.W.2d 337, 343 (1941) stated:
The question is, What shall be done about it to protect the rights of the eighty-five retired teachers? It is to be borne in mind that this was not a strictly private co-operative insurance scheme. It was established by law, operated by law, administered by a public body according to law, and the teachers compelled to participate in it by law. The payments were not mere contributions in the ordinary sense of that term. They were mandatory deductions from their salaries before the same were paid -- in the nature of a tax collected from them. Compare the Unemployment Compensation Act, Section 4748g-3, Kentucky Statutes, Supplement 1939; Unemployment Compensation Commission v. Savage, 283 Ky. 302, 140 S.W.2d 1073. The system so set up by the law having proved to be unsound, in morals and good conscience those who were compelled to participate in it and taxed accordingly until they became incapacitated and entitled to the benefits ought not to be turned out empty-handed. They had a contract with an agency of the Commonwealth of Kentucky entitling them to the benefits for which they had paid. The strength of every contract lies in the right of the promisee to rely upon the constitutional security against impairment of its obligations by legislation and in the right to resort to courts of public justice for the redress of its violation. Secs. 14, 19, Ky. St." (Emphasis added.)
The argument may be that the funds transferred would not affect future benefits. However, there is no provision for replacement of those funds in the retirement allowance account which exists not only to assure pension benefits, but to serve as a reserve against deficiencies incurred in other years, losses under investments, and other contingencies. The retirement allowance account is the account to which all income from invested assets of the system shall be credited. More importantly, if this type of transfer is sanctioned here, larger and more frequent incursions could be made upon the employees retirement allowance account. See Valdez v. Cory, 189 Cal. Rptr. 212 (App. 1983), copy enclosed.
The exercise of the state's police power impairing the obligation of contract must be reasonable and in conformity with the necessity of the case and have a substantial basis for the action. City of Covington v. Sanitation District No. 1, Ky. 301 S.W.2d 885, 889 (1957).
In some instances, a substantial impairment of contract may be constitutional if it is reasonable and necessary to serve an important public purpose. However in applying this standard, the United States Supreme Court in United States Trust Co. v. New Jersey, 431 US 1, 25 (1977) stated:
The Contract Clause is not an absolute bar to subsequent modification of a State's own financial obligations. As with laws impairing the obligations of private contracts, an impairment may be constitutional if it is reasonable and necessary to serve an important public purpose. In applying this standard, however, complete deference to a legislative assessment of reasonableness and necessity is not appropriate because the State's self-interest is at stake. A governmental entity can always find a use for extra money, especially when taxes do not have to be raised. If a State could reduce its financial obligations whenever it wanted to spend the money for what it regarded as an important public purpose, the Contract Clause would provide no protection at all. (Emphasis added.) (Footnotes omitted.)
Language in the 1988 Budget Bill regarding the fund transfer states that "it is the finding of the General Assembly of the Commonwealth of Kentucky that the financial condition of state government requires" the action. Budget Bill, Part VII, Fund Transfer.
In Valdez v. Cory, supra, at 226, the court articulated the following factors recognized by the United States Supreme Court, which may justify a legislative impairment based upon necessity:
Both the California and United States Supreme Courts have identified factors which may warrant legislative impairment of vested contract rights on the grounds of necessity: '(1) the enactment serves to protect basic interests of society, (2) there is an emergency justification for the enactment, (3) the enactment is appropriate for the emergency, and (4) the enactment is designed as a temporary measure, during which time the vested contract rights are not lost but merely deferred for a brief period, interest running during the temporary deferment.' (Olson v. Cory (1980) 27 Cal.3d 532, 539, 178 Cal. Rptr. 568, 636 P.2d 532; Sonoma, supra, 23 Cal.3d at pp. 305-306, 152 Cal.Rptr. 903, 591 P.2d 1; Home Building & Loan Asso. v. Blaisdell (1934) 290 U.S. 398, 54 S. Ct. 231, 78 L. Ed. 413; Allied Structural Steel, supra, 438 U.S. at p. 242, 98 S. Ct. at p. 2721, 57 L. Ed. 2d at p. 735.)
We believe it is obvious that the fund transfer meets the first two factors. That is, the fund transfer was made to meet a fiscal shortfall and to prevent a budget deficit.
However, as to the third factor there is no evidence or language to show that the fund transfer from the state employees retirement allowance account was either necessary or appropriate under the circumstances.
As to the fourth factor, the Budget Bill states that no further transfer will be made. This indicates that it was a temporary measure. However, the Budget Bill made no provision for replacement of the transferred funds in the future. Under this circumstance they appear to be irretrievably lost.
Based on the analysis above, we do not believe there was sufficient reason presented to justify the legislative impairment of contract between the State and its employees.
In many states, where the contractual rights of a public employee in a state pension system are recognized, those rights are subject to a reserved legislative power to make reasonable modifications in the plan, or to modify benefits, if there is a simultaneous offsetting new benefit or some sort of substitute consideration. See 60 Am Jur 2d Pension and Retirement Funds, § 1623.
The most commonly applied version of this approach is the "California rule," which permits modifications of state pensions that are reasonable, provided they are materially related to the soundness of the pension system and that any disadvantages are accompanied by comparable new advantages. 60 Am Jur 2d Pension and Retirement Funds, § 1623, p. 953.
The 1988 Budget Bill, which directed the transfer of funds from the retirement allowance account, made no provision for any substitute consideration or comparable new advantage to the state pension plan. The fund transfer was materially related to the soundness of the pension system but in a negative manner. Funds were transferred from the pension account which exists to provide for pension benefits and to serve as a reserve against deficiencies incurred in other years, losses under investments and other contingencies.
Since the legislature made no provision for replacing these transferred funds in the future, they are not temporarily lost, they are gone. Thus, absent any substitute consideration, the transfer of funds was not reasonable under the legislature's reserved power to make reasonable modification in the pension plan.
Moreover, since the inviolable contract statute (KRS 61.692) was left in effect, as it had to be, we believe that the fund transfer constituted an unlawful impairment of the state's obligation to its employees under the KERS retirement statutes to ensure that the contribution rates are sufficient to maintain the pension fund on an actuarial sound basis.
Although the validity of the 1988 General Assembly's transfer of funds from the KERS retirement allowance account to the general fund must ultimately be determined by a court of law, it is the opinion of this office that such transfer was unconstitutional for the reasons stated above.