Filed 3/26/20 Lenhart v. San Diego City Employees’ Retirement System CA4/1

NOT TO BE PUBLISHED IN OFFICIAL REPORTS

California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115.

COURT OF APPEAL, FOURTH APPELLATE DISTRICT

DIVISION ONE

STATE OF CALIFORNIA

PATRICK A. LENHART et al.,

Plaintiffs and Appellants,

v.

SAN DIEGO CITY EMPLOYEES’ RETIREMENT SYSTEM,

Defendant and Respondent.

D074645

(Super. Ct. Nos. 37-2011-00096587- CU-BC-CTL; 37-2013-00077705- CU-OE-CTL; 37-2016-00024265- CU-BC-CTL)

APPEAL from a judgment of the Superior Court of San Diego County, Joan M. Lewis, Judge. Affirmed.

Law Office of Michael A. Conger and Michael A. Conger for Plaintiffs and Appellants.

Noonan Lance Boyer & Banach, David J. Noonan, Genevieve M. Ruch; Law Office of Steven Sanchez and Steven W. Sanchez for Defendant and Respondent.

This is our court’s latest opinion arising out of a course of events that began in 2003 when the San Diego City Employees’ Retirement System (SDCERS), which administers the pension system for the City of San Diego (the City), raised the price at which employees could purchase pension service credits (PSCs) but delayed the price increase during a window period of August 15 to October 31, 2003. During the window period, employees were allowed to enter into PSC contracts at the former price, which SDCERS had already determined was below the price necessary to cover the City’s costs. When SDCERS decided to charge the City for the underfunding caused by the window-period PSC contracts, the City filed suit challenging that decision, and in 2010 this court concluded that SDCERS acted unlawfully in deciding to charge the City for the underfunding. (City of San Diego v. San Diego City Employees’ Retirement System (2010) 186 Cal.App.4th 69 (City of San Diego).) As it could not charge the City for the underfunding, SDCERS voted to address the underfunding by rescinding or reforming certain PSC contracts that employees entered into during the window period. However, based on the City’s prior decision to cover the underfunding associated with PSC contracts entered into by employees who had already retired as of November 20, 2007, SDCERS did not include those employees in the contractual rescission and reformation. The impacted employees then filed several lawsuits against SDCERS, including the lawsuit at issue in this appeal.

In Baidya et al. v. San Diego City Employees’ Retirement System (March 30, 2016, D066678) [nonpub. opn.] (Baidya)), this court addressed consolidated appeals in cases filed by employees against SDCERS, including the instant case. The instant case was filed by “safety member” employees, a class of employees comprised of police officers, firefighters and lifeguards. In Baidya, we affirmed the judgments in favor of SDCERS with the exception of a single cause of action for breach of contract in the instant action, which we remanded to the trial court for further proceedings. Specifically, SDCERS premised its rescission and reformation of the PSC contracts on our holding in City of San Diego that SDCERS was not authorized to enter into PSC contracts unless those contracts were cost neutral to the City as required by applicable municipal law. (City of San Diego, supra, 186 Cal.App.4th at pp. 80, 82.) Plaintiffs contended that although SDCERS would be justified in rescinding PSC contracts that were not cost neutral to the City, SDCERS was not authorized to rescind or reform the PSC contracts entered into by safety members during the window period because a 2007 actuarial study showed that those PSC contracts were cost neutral to the City. In Baidya, we held that if, as plaintiffs alleged, the PSC contracts were cost neutral to the City, plaintiffs would have a valid claim for breach of contract against SDCERS. We accordingly reversed the order sustaining the demurrer to plaintiffs’ breach of contract cause of action.

On remand, the trial court held a bench trial on the single remaining breach of contract cause of action. As the trial court stated, the issue to be decided was “whether or not the Safety Members’ purchase of PSCs during the window period was cost neutral to the City.” The trial court determined it was plaintiffs’ burden to prove cost neutrality. After considering the evidence, the trial court found that the PSC contracts that safety members entered into during the window period were not cost neutral to the City, even in light of the 2007 actuarial analysis cited by plaintiffs. The trial court accordingly found against plaintiffs and in favor of SDCERS.

The main dispute at trial was the approach for determining whether the PSC contracts entered into during the window period were cost neutral to the City. Plaintiffs contended that the cost neutrality calculation should not include the PSC contracts of safety members who were later excepted from SDCERS’s rescission and reformation process because they had retired before November 20, 2007. As plaintiffs pointed out, the actuarial study performed in 2007 showed that if those PSC contracts were excluded from the calculation, the remaining PSC contracts were cost neutral to the City. It was also clear from the evidence, however, that if the trial court rejected plaintiffs’ methodology, so that all of the safety member PSC contracts during the window period were considered in determining cost neutrality, the window-period PSC contracts of safety members as a whole were not cost neutral to the City. Plaintiffs also contended that, in the alternative, the trial court should look at each plaintiff on an individual basis to determine whether that plaintiff’s PSC contract was cost neutral to the City and should grant relief in those specific instances where the individual’s PSC contract was cost neutral. The trial court rejected both of plaintiffs’ contentions, concluding that neither approach was supported by expert testimony about proper actuarial methods. The trial court accordingly looked to the window-period PSC contracts of safety members as a whole, and concluded that the contracts were not cost neutral to the City, and it therefore found against plaintiffs.

Plaintiffs appeal from the judgment. They contend that substantial evidence does not support the trial court’s finding that the PSC contracts entered into by plaintiffs during the window period were at a rate that was too low to be cost neutral to the City. In support of their challenge to the sufficiency of the evidence, plaintiffs contend that the trial court erred in failing to apply either of the two methods of calculating cost neutrality that plaintiffs advanced at trial. Plaintiffs also contend that the trial court erred in assigning to them the burden of proof on the issue of cost neutrality, as the issue of contract illegality is an affirmative defense that should have been proven by SDCERS.

We conclude that substantial evidence supports the trial court’s decision in favor of SDCERS, as the trial court properly determined cost neutrality by analyzing the window-period PSC contracts of safety members as a whole, and under that approach there is no dispute that the PSC contracts were not cost neutral to the City. Further, although we conclude that the trial court erred in assigning the burden of proof on the issue of cost neutrality to plaintiffs rather than to SDCERS, the error was not prejudicial. Accordingly, we affirm the judgment.

I.

FACTUAL AND PROCEDURAL BACKGROUND

A. The City’s PSC Program

The City’s pension plan is “a defined benefit plan in which benefits are based upon salary, length of service, and age. . . . The plan is funded by contributions from both the City and its employees.” (Lexin v. Superior Court (2010) 47 Cal.4th 1050, 1063, citations omitted.) “In 1993 the City established the purchase of service credit program . . . to allow employees to purchase service credits for periods of actual service or authorized leaves of absence that were otherwise ineligible for service credits. . . . [¶] In 1997 the PSC [program] was expanded to include the purchase of service credits for periods that were not actually worked[,] . . . allowing employees to purchase up to five years of general service credit in addition to any other specific credit for which they were eligible (such as military service, approved leaves of absence, and part-time employment). . . . [¶] It is undisputed that from its inception the PSC program was to be cost neutral to the City.” (City of San Diego, supra, 186 Cal.App.4th at p. 73.)

During the time period relevant to this appeal, the pricing for the PSC program was based on a flat rate structure, under which employees could purchase a year of service credit by paying an amount equal to a certain percentage of their annual salary. Because of the differences in the pension benefits available to safety members and general members of the City’s pension plan, and because of the different characteristics of those groups of employees, it was determined that the percentage of annual salary used to calculate the price for safety members to purchase PSCs would be different from the percentage used for general members. “When the City established the PSC program in 1997, SDCERS’s actuary advised the board that a two-tiered rate structure, 15 percent for general member employees and 26 percent for safety member employees, would be sufficient to meet the requirement that the purchase price for service credits paid by employees be equivalent to the employer and employee cost. SDCERS’s board approved the rate structure at its March 1997 meeting.” (City of San Diego, supra, 186 Cal.App.4th at p. 75.) Thus, as of 1997, a safety member could purchase a year of service credit by paying an amount equal to 26 percent of his or her annual salary.

B. In 2003, Actuary Rick Roeder Recommended an Increase in Pricing for the PSC Program to Make it Cost Neutral to the City

Between 1997 and 2002, the City made certain amendments to its pension plan that caused “an increase in the value of years of service employees had purchased under the PSC program based upon the rates the [SDCERS] [B]oard set in 1997.” (City of San Diego, supra, 186 Cal.App.4th at p. 75.) In 2003, an actuary retained by SDCERS, Rick Roeder, performed an analysis to determine whether the pricing for the PSC program should be changed. Roeder’s report to SDCERS stated that the current percentages of annual salary used for pricing PSCs was “outdated in the sense that they were set by the Board prior to certain benefit increases.” Roeder explained that his analysis showed that the City was “currently subsidizing a significant amount of the added liabilities associated with service purchase,” even though, as Roeder testified, the PSC program was supposed to be cost neutral to the City. Under cost neutral pricing, “if it was perfect, the increased amount of assets would exactly offset the increased amount of liabilities.” Roeder’s analysis showed that to achieve cost neutrality, safety member PSCs should be priced between 36 and 37.5 percent of annual salary for a year of service credit (depending on mortality assumptions), and general members should be priced at a rate between 26.9 and 27.8 percent. According to Roeder’s testimony, his analysis in 2003 concluded that “the 26-percent rate for all safety members who purchased the PSC was underpriced relative to the cost to the City,” and that 37 percent was his “estimate as to the cost neutral rate.”

C. The City Increased the Pricing for the PSC Program in 2003 but Provided a Window Period During Which the Previous Pricing Applied

On August 15, 2003, SDCERS adopted Roeder’s recommendation by increasing the pricing at which safety members could purchase PSCs to 37 percent of the member’s annual salary for each year of service credit, and 27 percent for general members. However, even though it knew that it was underpricing the PSCs, SDCERS did not immediately implement the price hike. Instead, it provided for a window period between August 15 and October 31, 2003, during which employees could purchase PSCs under the old pricing structure. SDCERS then sent a notification to all City employees telling them that PSC contracts resulting from applications received before November 1, 2003, would be priced under the old rates, which for safety members was 26 percent of their annual salary for each year of service credit. As shown by documentation presented at trial, during the window period the City entered in 509 PSC contracts with safety members, for a total purchase of 1,013 years of service credit.

D. In 2007, the Actuarial Firm Cheiron Analyzed Whether the PSC Program Was Cost Neutral to the City During Several Time Periods

In 2007, SDCERS asked actuary Gene Kalwarski of the firm Cheiron to analyze whether the PSC program had been cost neutral to the City with respect to PSC contracts entered into during several different time periods, including the window period between August 15 and October 31, 2003. Cheiron performed its analysis based on the actuarial assumptions and calculations used in Cheiron’s annual actuarial valuation of the City’s pension plan dated June 30, 2006.

To determine whether the PSC program was cost neutral to the City for the specific group of contracts at issue (e.g., safety member contracts during the window period), Cheiron calculated the present value of the pension benefits associated with each individual PSC contract, and it then subtracted the amount the employee paid under the PSC contract (adjusted for interest). The resulting figure represented the City’s actuarial loss or gain from that specific PSC contract. To determine whether the PSC program was cost neutral as a whole for that group of contracts, Cheiron then added together the actuarial loss or gain for all of the contracts. As shown by the charts accompanying Cheiron’s analysis, with respect to the category of PSC contracts entered into by safety members during the window period (i.e., August 15 to October 31, 2003) the City incurred an actuarial loss of $1,876,526. Therefore, as Kalwarski explained at trial, Cheiron’s 2007 analysis determined that the PSC program for safety members during the window period was underfunded by approximately $1.8 million and was not cost neutral to the City.

E. SDCERS Unsuccessfully Attempted to Charge the City for the Unfunded Actuarial Liability Associated With the PSC Program

Following Cheiron’s 2007 analysis, SDCERS determined that it would charge the City for the unfunded liability resulting from the PSC contracts. (City of San Diego, supra, 186 Cal.App.4th at p. 77.) The City challenged that decision by filing a petition for writ of mandate, ultimately resulting in our City of San Diego opinion, in which we affirmed the trial court’s decision that “[i]t was unlawful to charge City for the shortfall that resulted for the service credits that were purchased between the establishment of new rates in August 2003 and November 1, 2003.” (Id. at p. 78.) We explained that “[i]t is undisputed that the enabling legislation passed by the City for purchase of service credits specifically dictated that the total cost of such purchases would be borne by the employees. Charging the City for SDCERS’s underfunding exceeded SDCERS’s authority as it was in violation of this legislation and exceeded its powers to administer retirement benefits.” (Id. at pp. 79-80.) In the course of our opinion, we explained that “City employees were not entitled to purchase service credits at a rate that did not reflect the full cost of those credits.” (Id. at p. 82.)

As relevant here, during the City’s litigation of its petition for writ of mandate, the City narrowed the relief it sought. Specifically, the City filed a first amended petition, which indicated that it was only challenging SDCERS’s attempt to recover underfunding for ” ‘all persons who have not yet retired as of the date the petition in this matter was first filed,’ ” i.e., November 20, 2007. (City of San Diego, supra, 186 Cal.App.4th at p. 77.) In effect, by amending its petition the City agreed that it would cover the cost of the underfunding created as a result of window period purchases of employees who had retired before November 20, 2007.

F. SDCERS Adopted Rule 4.90 to Rescind and Reform Window Period PSC Contracts

In response to City of San Diego, SDCERS Board adopted Board Rule 4.90 (Rule 4.90) in November 2010 that remedied the underfunding created by the PSC window-period contracts by forcing a rescission or reformation of those contracts to make them cost neutral to the City. Consistent with the City’s decision to cover the underfunding associated with members who had already retired as of November 20, 2007, Rule 4.90 stated that the PSC contracts affected by the rescission or reformation did “not include contracts purchased for City service credit by any City Member who retired from City service on or before November 19, 2007.” Rule 4.90 set forth a number of options for the employees that it impacted, which included: (1) rescinding the service credit purchase and receiving a refund; (2) requesting that the service credits purchased be reduced to the amount of credits that could have been purchased by the employee’s contributions had the credits been priced at the higher post-window-period rates; or (3) paying, with interest, the difference between the price of the service credits at the window-period rate and the amount that those service credits were priced at the post-window-period rate.

G. City Employees Affected by Rule 4.90 Filed Lawsuits Against SDCERS, Including the Instant Action, Resulting in Our Baidya Opinion, Which Remanded Plaintiffs’ Cause of Action for Breach of Contract

Several lawsuits against SDCERS were filed and litigated by the members of the City’s pension plan who were impacted by Rule 4.90. In Baidya, supra, D066678, several cases against SDCERS were consolidated for appeal, including the instant action. Addressing the trial court’s ruling sustaining the demurrer to the breach of contract claim asserted in the instant action, we concluded in Baidya that the trial court erred in sustaining SDCERS’s demurrer. As we explained in Baidya, “Plaintiffs contend that subsequent actuarial analysis shows that the safety members who purchased PSC credits during the window period did not underpay for those service credits, and accordingly, SDCERS had no legal basis to refuse to perform the PSC purchase agreements entered into by the safety members. [¶] The allegation that safety member employees did not underpay for their service credits bought during the window period in 2003 is set forth in paragraph 39 of the Lenhart complaint. There, Plaintiffs describe a statement that appeared in an actuarial report prepared for SDCERS in 2007. According to Plaintiffs, SDCERS’s actuary concluded in 2007 that ‘the 2003 increase in the safety member PSC rate to 37 percent of annual compensation caused safety members to overpay by $1,047,024 during the window period and $1,637,409 thereafter. In other words, SDCERS was told that it was not administering the PSC program for safety members in a cost neutral manner and was overcharging safety members.’ ” (Baidya, supra, D066678.) Based on this allegation, we analyzed whether plaintiffs stated a cause of action for breach of contract. Initially, we noted that “the parties do not take issue with the premise that SDCERS may have been legally justified in rescinding the window-period PSC purchase agreements if those agreements did not reflect the full cost of the service credits and, accordingly, were not cost neutral to the City.” (Baidya, supra, D066678.) We therefore explained that “crucial issue” for the breach of contract cause of action was “whether the purchase agreements were unlawful in that they exceeded SDCERS’s statutory authority by creating a PSC benefit that was not cost neutral to the City,” and we agreed with plaintiffs that “if, as they allege, the service credits were cost neutral to the City, SDCERS had statutory authority to enter into them, and thus the window-period purchase agreements are valid and enforceable.” (Baidya, supra, D066678.)

We stated, “It is undisputed that in 2003 the SDCERS Board believed that the actual cost of service credits was 37 percent of annual compensation for safety members, but it nevertheless entered into PSC purchase agreements that reflected the lower rate of 26 percent. However, Plaintiffs allege that by the time Rule 4.90 was adopted in 2010, SDCERS had received a new analysis from its actuary in 2007, which showed that the service credits were not, in fact, underpriced during the 2003 window period, and that SDCERS miscalculated when it determined that the actual cost was 37 percent of annual compensation. If indeed those allegations are subsequently proven by evidence in the Lenhart action, Plaintiffs would succeed in establishing that safety members are not paying less than the full cost of the service credits. If those facts are proven, there would be no basis for finding that the window-period purchase agreements were unlawful. Accordingly, those purchase agreements for the safety members would be enforceable contracts which SDCERS breached by rescinding and reforming those contracts through Rule 4.90. [¶] Because the facts pled in the Lenhart complaint, if subsequently proven, would establish that SDCERS breached the service credit purchase agreements with safety member employees who are subject to reformation and rescission of their agreements under Rule 4.90, we conclude that the trial court erred in sustaining the demurrer to the breach of contract cause of action.” (Baidya, supra, D066678, italics added.)

H. Litigation of Plaintiffs’ Breach of Contract Cause of Action After Remand

Following remand of this action to the trial court, both SDCERS and plaintiffs brought motions for summary judgment on the sole remaining cause of action for breach of contract. The trial court denied both motions.

The matter then proceeded to a bench trial, at which several witnesses testified, including a number of actuaries.

Among the actuaries who testified was Roeder, who conducted the analysis for SDCERS in 2003, which recommended that the PSC pricing be increased to a rate of approximately 37 percent for safety members to achieve cost neutrality for the City. Although Roeder was called as an expert witness by plaintiffs, his testimony was not helpful to plaintiffs’ attempt to establish that the pricing of the PSC program for safety members was cost neutral to the City during the window period. Roeder testified that even in light of Cheiron’s subsequent analysis in 2007, he still stood by his conclusion in 2003 that a rate of 37 percent was reasonable to achieve cost neutrality for safety member PSC contracts. Further, based on his review of Cheiron’s 2007 analysis, Roeder agreed that for the group of safety members who purchased PSC contracts during the window period, a rate of 26 percent was too low to achieve cost neutrality for the City.

Kalwarski, the actuary who conducted Cheiron’s 2007 analysis, was called by SDCERS as a witness. Kalwarski testified about the details of Cheiron’s analysis as set forth on the charts entered into evidence. As relevant here, one chart showed the actuarial gain or loss to the City for safety member PSC contracts entered into during the window period, reflecting a total actuarial loss to the City of $1,876,526. In other words, those PSC contracts—as a group—were underpriced, and were not priced at a rate that was cost neutral to the City. Cheiron’s chart also broke down the analysis to show the actuarial gain or loss for safety member window-period PSC contracts based on a member’s employment and retirement status as of June 30, 2006. For members who were still active employees as of June 30, 2006, the City incurred an actuarial gain of $1,047,024. For members who were “terminated vested” as of June 30, 2006, the City incurred an actuarial loss of $278,308. For members who had retired as June 30, 2006, the City incurred an actuarial loss of $2,645,243. These results are consistent with the general principal that the City incurs greater costs from a PSC contract when a service credit is bought later in an employee’s career because there is less time for the City to earn a return by investing the amount paid for the service credit. On the whole, however, Cheiron’s analysis showed that the safety member window-period PSC contracts were underfunded by over $1.8 million, and thus not cost neutral to the City.

At trial, actuary David Holland, who worked at Cheiron, testified about charts that he prepared showing Cheiron’s conclusion regarding the actuarial gain or loss associated with the individual contracts entered into by the plaintiffs in this action. As to some of the plaintiffs, there was an actuarial gain, and as to others there was an actuarial loss.

At trial, plaintiffs did not dispute that when the group of safety member PSC contracts entered into during the window period were considered as a whole, Cheiron’s 2007 analysis showed that those contracts were not cost neutral to the City, and were in fact underfunded by more than $1.8 million. However, plaintiffs advocated two alternative approaches to determining cost neutrality which did not involve considering the safety member’s window-period PSC contracts as a whole. First, plaintiffs contended that the cost neutrality calculation should not include the actuarial loss of $2,645,243 that the City incurred with respect to members who had retired as of June 30, 2006. Plaintiffs reasoned that because those employees had been excluded from the contractual rescission in Rule 4.90, and were therefore not plaintiffs in this action, they should also be excluded from the cost neutrality calculation. Second, plaintiffs argued that the trial court should examine each plaintiff’s PSC contract on an individual basis to determine whether the City incurred an actuarial gain or loss as to that specific PSC contract. According to plaintiffs, the trial court should grant relief for breach of contract to any individual whose contract resulted in an actuarial gain to the City.

I. The Trial Court’s Statement of Decision

Framing the issue, the trial court explained that the issue before it “was whether or not the Safety Members’ purchase of PSCs during the window period was cost neutral to the City. If it was, then SDCERS breached its contracts with the plaintiffs when it required them to elect one of the options set forth in Rule 4.90. On the other hand, if the purchase of these PSCs was not cost neutral to the City, then SDCERS did not breach the agreements when it required compliance with Rule 4.90.” Relying on certain language in Baidya, supra, D066678, the trial court placed the burden on plaintiffs to prove that “SDCERS had the authority to enter into the window-period PSCs,” rather than placing the burden on SDCERS “to prove that the Plaintiffs’ contracts were illegal.”

Reviewing the evidence, the trial court found that there was “an absolute absence of evidence to support” plaintiffs’ contention that the PSC contracts entered into by safety members during the window period were priced in a cost neutral manner.

In reaching that conclusion, the trial court relied on (1) Roeder’s testimony that he determined in 2003 that the 26 percent rate for safety members was no longer cost neutral; and (2) Kalwarski’s testimony that Cheiron concluded in 2007 that the 26 percent rate charged during the window period for safety member PSC contracts “was underpriced by more than 1.8 million.”

With respect to plaintiffs’ contention that cost neutrality should be calculated by excluding the PSC contracts of safety members who retired on or before November 19, 2007, the trial court explained, “[A]t trial, Plaintiffs advanced an alternate theory, i.e. since Rule 4.90 . . . set forth that the ‘[a]ffected PSC Contracts do not include contracts purchased for City service credit by any City Member who retired from City service on or before November 19, 2007,’ those contracts should be taken out of the analysis performed by Cheiron. . . . Plaintiffs argued the remaining members should not be penalized because the City made a decision that they would not seek to invalidate or force rescission of contracts of retired Safety Members. Plaintiffs further argued that if the retired members were left out of the analysis it would show that the PSC rate of 26 [percent] did not result in underfunding and thus was cost neutral. [¶] However, Plaintiffs provided no actuarial evidence that excluding this category of Safety Members from the calculations was appropriate or proper. In fact, to eliminate these contracts from the analysis would be akin to saying that they were sold at a cost neutral rate. The evidence presented during the trial does not support Plaintiffs’ alternative theory.”

Addressing plaintiffs’ claim “that any individual safety member who ‘overpaid’ based on the August 2007 analysis has a breach of contract claim against SDCERS,” the trial explained that the theory fails for several reasons. First, “the 26 [percent] rate is determined for the safety member group as a whole using actuarial assumptions, group projections, and group averages. By definition, because the PSC pension benefit price is an ‘average’ price for the entire safety member group, there will be some safety members who individually have an actuarial ‘gain’ and some who have an actuarial ‘loss’ based on how their actual life experiences compare to the actuarial assumptions.” Next, “the City of San Diego case made clear that the reason that the underpriced PSC benefits were unlawful and had to be corrected was because the group price charged for those benefits created a shortfall in the money that was needed to operate the benefit program, which was contrary to the San Diego Municipal Code. . . . Because the PSC price is set for the entire safety member group, the entire group of safety member window-period PSC contracts was unlawful at the time they were purchased and subject to correction even if an individual safety member’s actual experience years after purchase showed a hypothetical ‘overpayment.’ ” Finally, “using the correct methodology, there is no evidence showing that any individual Plaintiff had actually ‘overpaid’ for the PSC benefits in 2010 or in 2011 when SDCERS implemented the correction process. Even the Plaintiffs’ own expert witness confirmed that just because a Plaintiff showed an overpayment as of June 30, 2006, [that] did not mean that such Plaintiff ‘overpaid’ as of 2010 or 2011, or the present.”

Having rejected plaintiffs’ alternate theories of determining cost neutrality, the trial court found in favor of SDCERS and against plaintiffs on the breach of contract cause of action.

Plaintiffs appeal from the judgment.

 

II.

DISCUSSION

A. Standard of Review

“In reviewing a judgment based upon a statement of decision following a bench trial, we review questions of law de novo. [Citation.] We apply a substantial evidence standard of review to the trial court’s findings of fact.” (Thompson v. Asimos (2016) 6 Cal.App.5th 970, 981.)

B. The Trial Court Properly Rejected Plaintiffs’ Two Alternative Theories for Determining Cost Neutrality

In this breach of contract case, the parties and the trial court agreed that the disputed issue at trial reduced to a single question: was SDCERS authorized to enter into the PSC contracts with plaintiffs? If the contracts were authorized, then plaintiffs would be able to establish that SDCERS breached the contracts by requiring their rescission or reformation under Rule 4.90. If the contracts were not authorized, the breach of contract cause of action would fail because there would be no valid contract on which plaintiffs could premise their claim. In turn, the issue of whether the contracts were authorized depended on the single issue of cost neutrality. As we stated in Baidya, “the parties do not take issue with the premise that SDCERS may have been legally justified in rescinding the window-period PSC purchase agreements if those agreements did not reflect the full cost of the service credits and, accordingly, were not cost neutral to the City.” (Baidya, supra, D066678.) As plaintiffs’ counsel put it during his closing argument, “[I]f they’re not cost neutral, we lose. If they are cost neutral, we win. That’s it. There’s one issue in this case.”

There is no dispute that, according to Cheiron’s 2007 analysis, when the PSC contracts purchased by safety members during the window period at a rate of 26 percent are considered as a whole, the City incurred an actuarial loss of over $1.8 million, meaning that they were underfunded, and not cost neutral. Those figures are clearly set forth on the chart created by Cheiron as part of its analysis. Further, as the trial court noted, Cheiron’s analysis was consistent with the analysis conducted by Roeder in 2003, in which he concluded that the City should increase the 26 percent rate to 37 percent if it wanted the PSC program for safety members to be cost neutral to the City. Based on the approach of considering the cost neutrality of the window-period safety member PSC contracts as a whole, the trial court found that SDCERS was not authorized to enter into the PSC contracts with the safety members during the window period because those contracts were not cost neutral to the City. The trial court accordingly found against plaintiffs on their breach of contract cause of action.

However, on appeal, plaintiffs contend that substantial evidence does not support the trial court’s finding that the PSC contracts that SDCERS entered into with plaintiffs were underpriced. As they did at trial, plaintiffs contend that there are two alternative approaches that the trial court should have used to determine that the PSC contracts that SDCERS entered into with plaintiffs were cost neutral to the City. We consider each in turn.

1. The Trial Court Properly Rejected Plaintiffs’ Contention that Retired Members as of November 20, 2007, Should Be Excluded From the Cost- Neutrality Calculation

As we have explained, employees who retired on or before November 19, 2007, were excluded from the rescission and reformation required by Rule 4.90 because the City had agreed to cover the underfunding caused by PSC contracts entered into by those employees. Plaintiffs argue that “the contracts unaffected by Rule 4.90 . . . should have been excluded from the trial court’s analysis” of cost neutrality because the actuarial gain or loss from those contracts is “irrelevant data.” Specifically, plaintiffs contend that the data regarding the contracts of safety members who retired on or before November 19, 2007, is irrelevant because “none of the plaintiffs are in that category.” Plaintiffs point out that because, when the retired safety members are excluded from Cheiron’s analysis, “the remaining 432 safety-member PSC contracts were, as a group including the plaintiffs’ PSC contracts, overpriced, those contracts should not have been repudiated by SDCERS.”

Plaintiffs’ argument is unpersuasive because it fails to address the relevant issue with respect to cost neutrality that we described in both City of San Diego and Baidya. As we will explain, in those opinions we established that an unauthorized window-period PSC contract arises when SDCERS enters into a contract at a rate that is not cost neutral to the City, and which therefore causes an underfunding of the PSC program. Therefore, to determine whether SDCERS entered into unauthorized PSC contracts during the window period, the relevant inquiry focuses on the cost neutrality of the rate at which the entire safety member PSC program was priced.

In City of San Diego we addressed whether SDCERS could charge the City for the underfunding of the PSC program. (City of San Diego, supra, 186 Cal.App.4th at p. 72.) We held that with respect to the window-period PSC contracts, SDCERS could not look to the City to cover the underfunding because “the ordinance creating the PSC program specified that it [i.e. the program] would be paid for by the employees and would be cost neutral to the City.” (Id. at p. 81, italics added.) Therefore, “City employees were not entitled to purchase service credits at a rate that did not reflect the full cost of those credits.” (Id. at p. 82, second italics added.) In Baidya we returned to the requirement that the PSC program as a whole be administered at a rate that was cost neutral to the City. We explained that “SDCERS is mandated to administer the PSC program in a manner that is cost neutral to the City. . . . This means that SDCERS is legally mandated to price the service credits at a cost that reflect the full cost of the credits.” (Baidya, supra, D066678, italics added.) We explained that plaintiffs would have a valid claim for breach of contract if, as alleged, “SDCERS miscalculated when it determined that the actual cost was 37 percent of annual compensation,” because, in that case, “safety members [would not be] paying less than the full cost of the service credits.” (Baidya, supra, D066678.)

Thus, as we have consistently described, the issue is whether during the window period the PSC program, as a whole, was priced at a rate for safety members that was cost neutral to the City, or whether, in contrast, the program was priced at a rate that caused an underfunding of the program.

It is true, as plaintiffs emphasize, that the City decided to cover the underfunding associated with the PSC contracts purchased by safety members who retired before 2007. As a result, those members were not affected by Rule 4.90’s rescission or reformation, and they are not among the plaintiffs in this action. However, contrary to plaintiffs’ argument, the absence of pre-November 20, 2007 retirees from the group of plaintiffs in this action does not make the PSC contracts of those retirees irrelevant in calculating cost neutrality. As we have explained, the relevant inquiry for deciding whether SDCERS entered into unauthorized PSC contracts during the window period is to determine whether the 26 percent rate used to price the PSCs during that time period resulted in a program that was cost neutral to the City. Because our description of cost neutrality has consistently focused on the cost neutrality of the PSC program based on the rate charged by SDCERS, an accurate calculation of cost neutrality cannot exclude retirees’ PSC contracts because the resulting figure would exclude a significant number of the contracts entered into during the window period and accordingly would not reflect whether the PSC program was cost neutral when priced at a rate of 26 percent.

Ample expert testimony supports the conclusion that the actuarial gain or loss for members who retired before November 20, 2007, must be included in a proper actuarial calculation of whether the safety member window-period PSC contracts were cost neutral to the City, even though those retirees were excepted from Rule 4.90. Specifically, one of plaintiffs’ own expert witnesses, actuary William Sheffler, was asked, “If the City agreed to pay the underfunding for certain people, does that somehow mean that the entire group of Safety members all of a sudden became cost neutral?” He replied, “No, it does not.” Expressing a similar view, plaintiffs’ other expert, Roeder, was asked, “Does the fact that a person was corrected or not in 2010 in any way change the fact that as of 2003, the 26-percent rate for the group was underpriced and not cost neutral to the City?” Roeder agreed that “[f]or the group as a whole, 26 percent was underpriced,” which was “an absolute true fact from [his] analysis, whether someone was corrected in 2010 or whether they were not corrected in 2010.”

In sum, based on the expert testimony at trial and our description of the cost neutrality issue in City of San Diego and Baidya, which focuses on the cost neutrality of the rate at which the safety member PSC program was priced during the window period, there is no merit to plaintiffs’ proposed approach of determining cost neutrality by excluding the actuarial gain or loss for members who had already retired as of November 20, 2007. The fact that the City decided to absorb the underfunding for certain members is a separate issue from whether there was an underfunding of the program in the first place. The undisputed evidence at trial establishes that the PSC safety member program was underfunded during the window period.

 

2. The Trial Court Properly Rejected Plaintiffs’ Contention that Cost Neutrality Should Be Determined on a Contract-by-Contract Basis

Plaintiffs’ second alternative approach to determining cost neutrality is to focus on the PSC contracts of each plaintiff on an individual basis. As shown by the calculations performed by Cheiron in the course of its 2007 analysis (and based on the actuarial assumptions made by Cheiron at the time) the PSC contracts of some of the plaintiffs resulted in an actuarial gain to the City, while the contracts of other plaintiffs resulted in an actuarial loss. Plaintiffs argue that for “[e]ach of those plaintiffs [who] actually paid more than the additional actuarial liability created by their contract” “SDCERS unjustifiably breached those lawful contracts.” As to the individuals who entered into PSC contracts that resulted in an actuarial gain to the City, plaintiffs argue that those individuals “are entitled to reversal of the judgment with a direction to the trial court to find that their individual contracts were lawful and enforceable.”

Plaintiffs’ second alternative approach lacks merit because, as we have explained above, the enforceability of plaintiffs’ PSC contracts depends on whether they were entered into at a rate that was cost neutral to the City and did not result in an underfunding of the PSC program. As shown below, all of the actuaries who testified on the issue explained that the cost neutrality of the PSC program is not determined on an individual basis, but instead looks to the program as a whole.

First, plaintiffs’ witness Sheffler testified that “cost neutrality under the PSC statute means cost neutral to the City, not cost neutral to each individual member.” Indeed, as City of San Diego explained, a relevant municipal code provision stated that even though members could make contributions to obtain additional benefits, ” ‘[t]he exercise of this privilege by a . . . member shall not require the City to make any additional contributions.’ ” (City of San Diego, supra, 186 Cal.App.4th at p. 74, quoting San Diego Mun. Code, § 24.0305.)

Second, plaintiffs’ witness Roeder testified that the single-rate pricing that SDCERS used for the PSC program generally undercharges some members and overcharges others when measured against the City’s cost for that member’s service credits. Specifically, the City’s costs are generally higher when a service credit is bought later in an employee’s career because there is less time for the City to earn a return by investing the amount paid for the service credit. However, as Roeder testified, when he concluded in 2003 that a rate of 37 percent would achieve cost neutrality for the safety-member PSC program, his calculation was “based on cost neutrality for the retirement system,” not cost neutrality as to each PSC contract on an individual basis. (Italics added.) Roeder agreed that “[c]ost neutral means cost neutral to the City; it does not mean cost neutral to each member who purchases a PSC benefit.”

Third, actuary William Fornia explained that an actuary’s job is to determine the accurate pricing of a pension fund on a group basis, not an individual basis. “It is not the practice in the industry to use group actuarial assumptions to try to perform an individual-by-individual pricing analysis and expect the result to be precise.” In setting the cost for a service credit for a pooled pension system, such as the City’s, the “goal is to be right for the entire group,” not for each individual. “[A]ny individual is going to have experience very different from what the average cost would be, or the average expected experience would be.”

Finally, Kalwarski explained that if actuarial gain and loss is calculated on an individual-contract basis and a refund is provided to those individuals whose contracts resulted an actuarial gain to the City, the underfunding of the PSC program will be made even worse because there will be no individuals who caused actuarial gain to the City to balance out the individuals who caused actuarial loss.

In sum, plaintiffs’ challenge to the sufficiency of the evidence fails because the evidence at trial showed that the cost neutrality of the PSC program is properly calculated on a group basis, not as to each individual. The relevant inquiry is whether the rate of 26 percent that SDCERS used to price the PSC contracts during the window period resulted in a PSC program that was cost neutral to the City. The actuarial gain or loss from a single PSC contract is not relevant to establish plaintiffs’ claim of breach of contract because it does not establish the cost neutrality of the PSC program as a whole.

C. Although the Trial Court Should Have Assigned the Burden of Proof on Cost Neutrality to SDCERS, the Error Was Not Prejudicial

The final issue we address is whether the trial court erred in concluding that it was plaintiffs’ burden to establish that the PSC contracts were cost neutral to the City, rather than concluding that SDCERS had the burden, as an affirmative defense, to prove that the PSC contracts were not cost neutral to the City.

“[T]he elements of a cause of action for breach of contract are (1) the existence of the contract, (2) plaintiff’s performance or excuse for nonperformance, (3) defendant’s breach, and (4) the resulting damages to the plaintiff.” (Oasis West Realty, LLC v. Goldman (2011) 51 Cal.4th 811, 821.) Here, none of those elements are disputed. Specifically, SDCERS and plaintiffs entered into PSC contracts; plaintiffs were willing to perform those contracts; SDCERS refused to honor the contracts when Rule 4.90 forced a rescission or reformation; and the plaintiffs were damaged when their pension benefits were impacted by Rule 4.90. Instead, as we explained in Baidya, the dispute is “whether Plaintiffs entered into valid contracts with SDCERS, or, on the contrary, whether those contracts were void and unenforceable because they were unlawful under the controlling provisions of the City’s pension plan.” (Baidya, supra, D066678, italics added.) As Baidya explained, ” ‘ “[A] contract entered into by a governmental entity without the requisite constitutional or statutory authority is void and unenforceable.” ‘ . . . Thus, Plaintiffs would not have a contractual right to a benefit under the PSC program if the contracts they entered into with SDCERS were not authorized by the applicable statutory authority.” (Baidya, supra, D066678.) In short, the issue at trial in this case was not whether SDCERS breached the PSC contracts with plaintiffs, which was undisputed, but whether those contracts were illegal and thus void and unenforceable.

Plaintiffs contend that SDCERS has the burden to prove illegality because it is an affirmative defense. SDCERS, in contrast, contends that plaintiffs had the burden “to prove an exception to illegality,” since in Baidya we stated that “if, as [plaintiffs] allege, the service credits were cost neutral to the City, SDCERS had statutory authority to enter into them, and thus the window-period purchase agreements are valid and enforceable.” (Baidya, supra, D066678.)

Although we observed in Baidya that the PSC contracts would be valid and enforceable if they were cost neutral to the City, the issue of illegality is properly raised in a breach of contract action as an affirmative defense, which the defendant must prove. (Sweeney v. KANS, Inc. (1966) 247 Cal.App.2d 475, 480 [“Defendant’s contention of illegality is, of course, an affirmative defense. The burden of establishing this defense was, therefore, on the defendant.”]; In re Marriage of Iverson (1992) 11 Cal.App.4th 1495, 1502 [“under general contract rules, the burden of establishing a particular contract is illegal is on the party claiming the illegality”].) Here, SDCERS pled illegality as an affirmative defense, and it had the burden to establish that affirmative defense at trial. Therefore, the trial court should have required SDCERS to prove that the PSC contracts were not cost neutral to the City and thus were illegal and unenforceable. The trial court should not have assigned the burden of proof on cost neutrality to plaintiffs, as illegality was an affirmative defense.

Although the trial court erred in assigning the burden of proof on cost neutrality to plaintiffs, “[n]o judgment, decision, or decree shall be reversed or affected by reason of any error, ruling, instruction, or defect, unless it shall appear from the record that such error, ruling, instruction, or defect was prejudicial, and also that by reason of such error, ruling, instruction, or defect, the said party complaining or appealing sustained and suffered substantial injury, and that a different result would have been probable if such error, ruling, instruction, or defect had not occurred or existed.” (Code Civ. Proc., § 475; see also Cal. Const., art. VI, § 13 [“No judgment shall be set aside . . . in any cause, . . . for any error as to any matter of procedure, unless, after an examination of the entire cause, including the evidence, the court shall be of the opinion that the error complained of has resulted in a miscarriage of justice.”].) ” ‘ “[A] ‘miscarriage of justice’ should be declared only when the court, ‘after an examination of the entire cause, including the evidence,’ is of the ‘opinion’ that it is reasonably probable that a result more favorable to the appealing party would have been reached in the absence of the error.” ‘ ” (Pool v. City of Oakland (1986) 42 Cal.3d 1051, 1069.) In short, we ask whether it is reasonably probably that a different result would have occurred had SDCERS been assigned the burden to prove cost neutrality.

We conclude that although the trial court erred in failing to place the burden on SDCERS to prove that the PSC contracts were not cost neutral to the City, the error was not prejudicial, and no miscarriage of justice occurred. Having rejected plaintiffs’ alternate approaches to establishing cost neutrality, the evidence at trial uniformly proves that the window period safety member 26 percent rate was not cost neutral to the City. Indeed, as the trial court found, “[t]here is an absolute absence of evidence” that the PSC program for safety members was cost neutral during the window period. (Italics added.) Moreover, the trial court identified the testimony of both Roeder and Kalwarski who established that SDCERS caused an underfunding of the PSC program by pricing the safety member PSC contracts at a rate of 26 percent during the window period. As the trial court found, “[w]hen the entire safety member group is included in the analysis, the [Cheiron] study confirms that the safety member group substantially underpaid for their window-period PSC benefit purchases.”

Therefore, even when we assign the burden of proof to SDCERS to prove, as an affirmative defense, that the PSC contracts were void and unenforceable because they were at a rate that was not cost neutral to the City, the undisputed evidence at trial plainly satisfies SDCERS’s burden. As we have explained, the proper actuarial methodology looks to the cost neutrality of the PSC program as a whole. Applying that methodology, there is no dispute that the PSC contracts were not cost neutral to the City. We accordingly conclude that there is no reasonable probability that plaintiffs would have achieved a more favorable result, even had the trial court properly placed the burden on SDCERS to prove, as an affirmative defense, that the PSC contracts were void and unenforceable.

 

DISPOSITION

The judgment is affirmed.

IRION, J.

WE CONCUR:

BENKE, Acting P. J.

DATO, J.