Monday, March 28, 2011

New Public Pension Reporting Legislation Introduced in House, Senate

As expected, legislation (HR 567) was once again introduced in the House of Representatives by Congressman Devin Nunes (R-CA) on February 9th to require State and local government sponsors of public pension plans to provide specific funding information to the US Treasury Department. Failure to do so would cause the offending State or political subdivision to lose Federal tax benefits with respect to any State or local bond issues. No hearings specifically on the legislation have been held before the House Ways and Means Committee, to which the bill has been referred, but there have been three hearings before other House Committee showcasing the legislation. A companion bill (S 347) has been introduced in the Senate by Senator Richard Burr (R-NC). While not a cosponsor of the legislation, Senator Orrin Hatch (R-UT), the new Ranking Member of the Senate Finance Committee, to which the bill has been referred, recently gave a speech on the Senate floor warning that public employee pension plans will bankrupt state and local government if nothing is done. He said he plans to work with his Senate colleagues who “have a proposal to address the problem.” NCTR, NASRA and seven other national organizations representing public sector organizations have sent a personal letter to every member of Congress opposing the legislation.

The new legislation, HR 567, entitled the “Public Employee Pension Transparency Act” (PEPTA), is identical to the bill (HR 6484), which was introduced on December 2, 2010, by Mr. Nunes, who is now the 5th ranking GOP member of the House Ways and Means Committee. As before, Mr. Nunes was joined in introducing the bill by Congressman Paul Ryan (R-WI), also a senior member of Ways and Means as well as the Chairman of the House Budget Committee, and Congressman Darrell Issa (R-CA), the Chairman of the House Oversight and Government Reform Committee. The legislation now has 44 cosponsors in addition to these three. All but one – Congressman Mike Quigley (D-IL) -- are Republicans, and four, including Ryan and Nunes, are members of the House Ways and Means Committee.

Reporting Requirements

Were the legislation to become law, an Annual Report as well as potential Supplementary Reports would be required to be filed by the plan sponsor of a State or local government employee pension benefit plan (other than a defined contribution plan) with the Secretary of the Treasury. The Annual Report would have to include the following:

  1. A schedule of the funding status of the plan;
  2. A schedule of contributions by the plan sponsor for the plan year;
  3. Alternative projections for each of the next 20 plan years relating to the amount of annual contributions, the fair market value of plan assets, current liability, the funding percentage, and other matters specified by the Treasury Department to “achieve comparability across plans;”
  4. A statement of the actuarial assumptions used for the plan year; 
  5. A statement of the number of plan participants who are retired or separated from service and are either receiving benefits or are entitled to future benefits and those who are active under the plan;
  6. A statement of the plan's investment returns; 
  7. A statement of the degree to which unfunded liabilities are expected to be eliminated; and
  8. A statement of the amount of pension obligation bonds outstanding.
While it is true that several of these statements are already required to be developed as part of the plan sponsors’ current reporting obligations in connection with their Comprehensive Annual Financial Reports (CAFRs), several are not, such as the 20 years worth of alternative projections; a statement of the “degree and manner“ in which the plan sponsor expects to eliminate any unfunded current liability; and a statement of outstanding pension obligation bonds.

In addition, it is difficult to know what such other statements required by the Treasury Department to achieve “comparability across plans” might look like and what kind effort might be required to produce them.

Finally, as Paul Zorn with GRS has noted, it also depends on how the term “current liability” is defined. If current liability is defined as “the liability currently used by public pension plans,” then several of the statements, as previously noted, are already required by the Governmental Accounting Standards Board (GASB) to be reported. But what if “current liability” is defined to mean the liability based only on salary and service to date (i.e., determined using the traditional unit credit actuarial cost method)? As Paul points out, then none of the numbers would already be developed and reported because no state and local plans use that method.

Therefore, the legislation’s annual reporting requirement could potentially impose significant costs and confusion in terms of the development of the required statements.

Then there are the potential Supplementary Reports. These would be required in any case in which either the value of plan assets in the Annual Report is determined using a standard other than fair market value, or the interest rate or rates used to determine the value of liabilities or as the discount value for liabilities are not interest rates based on US Treasury obligation yield curve rates.

The Supplementary Report would be required to include certain information specified in the Annual Report -- specifically , a schedule of the funding status of the plan; 20 years worth of alternative projections; a statement of plan investment returns; and the degree and manner the plan sponsor expects to eliminate its current unfunded liability -- but determined by valuing plan assets at fair market value and by using certain Treasury yield curves based on the following three periods: benefits reasonably determined to be payable during the 5-year period beginning on the first day of the plan year; benefits reasonably determined to be payable during the following 15-year period; and benefits reasonably determined to be payable thereafter.

Clearly, these statements would be new for most plans. Here, the concern is not just the time and cost involved with their preparation, but the substantially increased, artificial liability measurements that the use of the Treasury yield curves would produce, which, along with the unsmoothed valuation of assets, would significantly understate funding levels. The results will be a set of measures that differ substantially from those used to fund plans or required for accounting and financial reporting purposes under GASB. They will only serve to confuse the public, not provide clarity with regard to public pension accounting.

Loss of Federal Tax Exemption for State, Local Bonds

Finally, there is the matter of what could happen if a report fails to be filed in a timely manner or there are errors in the report.

Actually, despite the requirement that the plan sponsor is to file the Annual Report and any Supplementary Reports, it is the failure of “State or local government employee pension benefit plans” to meet reporting requirements that triggers the penalty. This clearly raises the question of whether only the plan files the report, of whether each employer covered by the plan must file its own report.

As for the penalty itself and how it is to be applied, the legislation says that in the case of a plan’s failure to meet reporting requirements, then, “with respect to any plan maintained with respect to employees of one or more States or political subdivisions of one or more States, no specified Federal tax benefit shall be allowed or made with respect to any specified bond issued by any such State or political subdivision (or by any bonding authority acting on behalf, or for the benefit, of such State or political subdivision) during the noncompliance period.”

Needless to say, it appears somewhat unclear as to whose bonds could be affected in the case of a “failure to meet reporting requirements.” Does the language mean that any plan covering State or local government employees that fails to report appropriately will trigger a loss of Federal tax benefits for every bond issued by that State and any of its political subdivisions -- or just for the bonds issued by the sponsor of the plan that failed to report? This would be particularly important when a number of employers are covered by a single plan, or in the case of cost-sharing plans.

Depending upon how the language is interpreted, the impact on governmental finances could be devastating. Also, there is a question as to whether the loss of the Federal tax exemption would apply to all bonds, whenever issued by the noncompliant State or local government, during the noncompliance period, or only to those bonds issued during the noncompliance period. (The bill language provides that “no specified Federal tax benefit shall be allowed or made with respect to any specified bond issued by any such State or political subdivision (or by any bonding authority acting on behalf, or for the benefit, of such State or political subdivision) during the noncompliance period.”)

Depending on the answer to this question, the legislation could totally undercut investor confidence in the municipal bond market and have a devastating effect on muni-bond holders, an increasing number of whom are individual investors.

The Senate

This year, there is also a Senate companion bill, S 347, introduced by Senators Richard Burr (R-NC) and John Thune (R-SD). The bill is cosponsored by six other Senators – Isakson (R-GA), Grassley (R-IA), Kyl (R-AZ), Coburn (R-OK), Ensign (R-NV) and Chambliss (R-GA). Five of the bill’s supporters (Grassley, Kyl, Coburn, Ensign and Thune) are also members of the Senate Finance Committee, to which the bill has been referred.

Senator Burr was a former member of the House of Representatives for 10 years before being elected to the Senate in 2004, where he is a member of the Senate Health, Education, Labor, and Pensions (HELP) Committee. Senator Thune is also a former member of the House, having represented South Dakota from 1997 to 2003 before defeating then-Senate Minority Leader Tom Daschle. Thune is a member of the Finance Committee, as well as a member of the Senate Budget Committee.

Senator Thune is also the Chairman of the Senate Republican Policy Committee, which publishes a variety of policy papers that are used by Republican Senators and their staffs to prepare for committee deliberations, floor debate, and votes. One such paper, prepared last August and entitled “Taxpayers Cannot Afford More State Bailouts,” says that “Unsustainable and underfunded pension obligations are robbing state budgets and draining funds from vital state government programs. Every state bailout, ostensibly for daily operating funds, allows the states to continue to pour money into these unsustainable pension plans.” Every week the Senate is in session, Republican Senators hold a policy lunch meeting, hosted by Thune, at which they discuss issues before the Senate, review the anticipated agenda, and discuss policy options.

Although he has not added his name as a cosponsor of the legislation, Senator Orrin Hatch (R-UT), the new Ranking Member of the Senate Finance Committee, recently gave a speech on the Senate floor warning that public employee pension plans will bankrupt state and local government if nothing is done.

Senator Hatch is extremely critical of defined benefit plans while singing the virtues of defined contribution plans. “The rest of the world has moved toward 401(k) style plans,” he explained to his colleagues, because in DC plans, “costs are lower and more predictable” and they “fit well with an increasingly mobile and dynamic workforce.” State and local governments, on the other hand, “have remained wedded to expensive, traditional pension plans for far too long,” Hatch asserts.

Calling them “old-style, traditional pension plans,” Senator Hatch describes public sector DB plans as “costly, guaranteed lifetime retirement package, often with little or no cost-sharing by the public employee.” He lauds “forward-looking states” that have begun moving to 401(k) style plans. “In my home state of Utah, the traditional pension plan is being replaced,” Hatch insists.

Senator Hatch made it clear that it was his intention, “as Ranking Member of the Finance Committee, to find a way to address the public pension crisis.” In an apparent reference to the Burr legislation, he noted that “Some of my colleagues here in the Senate have a proposal to address the problem, and I will be working with them as well.” This could suggest that he will press for hearings on the legislation in the Senate Finance Committee.

Senator Hatch’s condemnation of public plans is particularly disappointing, given his past support for state and local government pensions. For example, in the late 1990’s, he was the primary Senate sponsor, along with Senator Kent Conrad (D-ND) , of legislation to provide a permanent moratorium on the application of the IRS non-discrimination rules to public pensions. In support of the legislation, Senator Hatch stressed that State and local government pension plans face a high level of scrutiny: “State law generally requires publicly elected legislators to amend the provisions of a public plan. Electoral accountability to the voters and media scrutiny serve as protections against abusive and discriminatory benefits.”

The one bright spot in all of this is Senator Hatch’s statement that “I have not yet settled on what I believe are the best solutions.” He states that “we are working hard and talking to the experts about the best way to proceed. “ NCTR intends to be among the “experts” with whom he consults, and has already met, along with other public sector organizations, with his new top pension counsel for the Finance Committee to discuss Hatch’s concerns.

Current Status

There is a large coalition of supporters for the Nunes/Burr legislation, including Grover Norquist (Americans for Tax Reform) and Randy Johnson of the U.S. Chamber of Commerce. In an October 27, 2010 interview on CNN, Norquist explained that he is "in favor of moving all of our entitlement programs from defined benefit plans, which is what we have at present, what General Motors had for their pension setup, to defined contribution, basically to 401(k)’s." Norquist says that “The federal government could do that both with their employees, we do that with postal employees, which are a large chunk of government employees and we could do it with Social Security."

A new supporter for the cause is the National Federation of Independent Businesses (NFIB), who says that the bill “will protect small business owners from the costs associated with state and local governments' failure to address funding problems of their plans.”

While there are no hearings on the legislation currently planned by the House Ways and Means Committee or the Senate Finance Committee, the legislation has been discussed at three hearings in the House of Representatives before other Committees.

The first hearing was held by the Subcommittee on TARP, Financial Services, and Bailouts of Public and Private Programs of the House Committee on Oversight and Government Reform. It was carefully coordinated with the Nunes bill’s introduction in the House, and was held on that same day. Although the hearing was nominally on State and municipal debt, a memo from the Committee Majority staff to GOP members of the Subcommittee made it clear that the focus was on pensions, stating at the outset that “pensions are the largest driver of state and municipal fiscal problems.”

Nevertheless, Iris Lav with the Center for Budget and Policy Priorities did an excellent job in rebutting these charges. In her testimony, she stated that claims that states and localities have $3 trillion in unfunded pension liabilities and that pension obligations are unmanageable” overstate the fiscal problem, fail to acknowledge that severe problems are concentrated in a small number of states, and often promote extreme actions rather than more appropriate solutions.”

(Most recently, Ms. Lav has produced a report for the CBPP on the Nunes/Burr legislation entitled “Proposed Public Employee Pension Reporting Requirements Are Unnecessary.” In it, she states that the legislation “would effectively short-circuit and override the GASB process by issuing a federal edict on how pension funds are to report liabilities.” It would be “unsound policy,” she argues, “to substitute heavy-handed and unnecessary federal intrusion (which seems designed in part to advance ideological goals) for the GASB standards and the financial market discipline that induces state and local governments to comply with those standards.”)

The House version of PEPTA was also discussed at a February 14th hearing by the Subcommittee on Courts, Commercial and Administrative Law of the House Judiciary Committee on “The Role of Public Employee Pensions in Contributing to State Insolvency and the Possibility of a State Bankruptcy Chapter.” Witnesses included Joshua Rauh, former Goldman Sachs economist and currently an Associate Professor of Finance with the Kellogg School of Management at Northwestern University. Democratic staff was offered the opportunity to invite one witness, and they chose Keith Brainard, NASRA’s Research Director, who very effectively called Rauh’s underfunding numbers into question.

(In this regard, it is well to note a recent article in the February 2011 issue of Government Finance Review (GFR, a publication of the Government Finance officers Association ) by Ronald D. Picur, professor emeritus of accounting at the University of Illinois at Chicago, and Lance J. Weiss, a senior actuarial consultant with Gabriel, Roeder, Smith and Company, entitled “Addressing Media Misconceptions about Public-Sector Pensions and Bankruptcy.” This article also calls into question much of the work of Rauh and other of his colleagues. As this article notes, some of Rauh’s most frequently cited works are working papers that have not undergone the same academic scrutiny and vetting associated with submission to refereed academic journals. Such a vetting process, using acknowledged experts in the discipline to serve as referees to review the findings without knowing the authors, helps to emphasize objectivity and independence. As a result, none of this research has been subject to scrutiny by the appropriate subject-matter experts —namely actuaries who practice in the public sector -- before being cited as the “gold standard” for public pension facts by the media and others.)

Finally, the Nunes legislation came up most recently in another hearing by the Subcommittee on TARP, Financial Services, and Bailouts of Public and Private Programs on March 15th entitled “State And Municipal Debt: The Coming Crisis? Part II.” However, as with the first hearing, it was all about public pensions, with the Majority staff briefing memo once again claiming that “The largest threat to state and municipal fiscal security is government-sponsored pension plans.”

Dean Baker, the co-founder and co-director of the Center for Economic and Policy Research (CEPR), testified at this hearing and strongly disagreed. He also criticized the proposed Nunes legislation. Dr. Baker told the Subcommittee that:

  • Most of the pension shortfall is attributable to the plunge in the stock market in the years 2007-2009.
  • The argument that pension funds should only assume a risk-free rate of return in assessing pension fund adequacy ignores the distinction between governmental units, which need be little concerned over the timing of market fluctuations, and individual investors, who must be very sensitive to market timing.
  • The size of the projected state and local government shortfalls measured as a share of future gross state products appear manageable.
These conclusions are more fully set forth in his recent CEPR paper entitled “The Origins and Severity of the Public Pension Crisis.”

NCTR Actions

In addition to assisting Congressional staff in preparing for these three hearings, NCTR has been working with other public sector organizations to get the facts out concerning the Nunes/Burr legislation. These efforts have included:

  • A January briefing of key Senate staff of the Finance, HELP and Aging Committees on the state of public pensions, provided by Nancy Kopp, Maryland State Treasurer and President of the National Association of State Auditors, Comptrollers and Treasurers (NASACT); James E. Mitchell, Jr., member of the city council of Charlotte, North Carolina, and President of the National League of Cities (NLC); and Dana Bilyeu, Executive Officer of the Public Employees' Retirement System of Nevada.
  • A personal letter to every member of Congress in opposition to the Nunes/Burr legislation from NCTR, NASRA, NASACT, NLC, the Government Finance Officers Association (GFOA), the National Association of Counties (NACo), the United States Conference of Mayors , the International City/County Management Association (ICMA), and the International Public Management Association for Human Resources (IPMA-HR).
  • A fact sheet on the Nunes/Burr “PEPTA” legislation, describing what the bill does and doesn’t do.
  • Meetings with key staff on the House Ways and Means Committee, the House Education and the Workforce Committee, the Senate Finance Committee, the Senate HELP Committee, and the Senate Special Committee on Aging.
  • NCTR Press Statements on the introduction of the Nunes legislation and the House testimony of Keith Brainard.

The “score,” or cost to the Federal government, of the legislation has not yet been determined. While its requirements for increased staffing, drafting of regulations and the creation and maintenance of a new Federal database by the Treasury Department will have cost implications for the Federal government, what remains to be seen is whether the bill will be viewed as a possible revenue saver because of its prohibition on Federal bailouts of state and local pensions, and will therefore be given a positive revenue score.

It is unlikely that the legislation will move independently in either the House or Senate. However, it is not impossible that the House leadership could support its inclusion in a larger tax bill that could advance either this year or next. Stripping provisions from such a larger measure can be very problematic.

Therefore, it is critically important that this legislation be taken very seriously. It is not just a platform for media attention, but a serious effort at establishing a Federal take-over of public pension accounting that will so inflate the perceived “cost” of public sector DB pensions that State and local governments will see themselves as having little choice but to convert to DC plans.

2011 NCTR/NASRA Joint Legislative Workshop - An Overview

Meeting later in the year than previously, NCTR and NASRA were able to successfully hold their Joint Legislative Workshop on Monday, March 7th, in Washington, DC, without freezing weather or the threat of a blizzard. Speakers included key Congressional pension staff, Treasury Department and SEC officials, and a Special Assistant to President Obama. A former Member of Congress also provided attendees with a candid assessment of the political environment facing them on Capitol Hill and some suggestions as to how best to deal with it. The workshop concluded promptly at 3:00 PM, giving some attendees time to visit their Congressional delegations. The annual event received good marks from attendees, so please be sure to plan on attending next year’s workshop if you weren’t able to make this year’s meeting.

The annual NCTR/NASRA Joint Legislative Workshop came at a particularly critical moment for public pensions in Washington, DC. From Capitol Hill to the Federal departments and regulatory agencies, the level of interest in governmental plans and concern for their continued sustainability has never been greater.

As in the past, Jeannine Markoe Raymond, NASRA’s Director of Federal Relations, joined Leigh Snell, her counterpart at NCTR, to begin the workshop on Monday morning with a brief overview of NCTR and NASRA Federal legislative and regulatory issues for 2011. The top priority was the so-called “Public Employee Pension Transparency Act” (PEPTA), introduced by Congressman Devin Nunes (R-CA) in the House of Representatives (H.R. 567) and Senator Richard Burr (R-NC) in the Senate (S. 347). However, there were also other issues of serious concern that were addressed, including:
  • IRS Normal Retirement Age regulations, currently set to apply to public plans in the first plan year beginning on or after January 1, 2013;
  • possible re-interpretation of Revenue Ruling 2006-43 dealing with employer pick-ups and the application of the ruling to employee elections, whether they be to join a new tier (the so-called “Orange County” issue) or to purchase service credits; and
  • the Securities and Exchange Commission (SEC) rulemaking involving the possible treatment of appointed members of pension boards as municipal advisers.
SEC, Senate Finance Committee and Treasury Presentations

Jeannine and Leigh were followed by a discussion of the SEC and its relationship to the public pension community, presented by Rich Ferlauto, currently the Deputy Director of Policy in the SEC’s Office of Investor Education and Advocacy. Many NCTR members know Rich from his previous role as director of Corporate Governance and Pension Investment for the American Federation of State, County and Municipal Employees (AFSCME).

All too often, the SEC seems to relate to public pension plans primarily as institutional investors interested in corporate governance issues. Now that he is “on the inside,” Rich was able to provide a candid view of the way in which the SEC understands (1) public pensions in their role as providers of retirement security; (2) the relationship of plans to plan sponsors in the public sector; and(3) how fiduciary duty as applied to public pension trustees operates on more than simply disclosure.

Rich also described the role of his Office and what it can offer public plans, particularly as it relates to trustee education opportunities. He also stressed that when it comes to regulatory proceedings pursuant to the new Dodd-Frank financial markets reform law, plans and other interested parties should feel free to ask for meetings as well as provide written comments on proposals, even if the formal comment period for such has expired.

Rich was followed by a panel discussion featuring Tom Reeder, Senior Benefits Counsel for the Senate Finance Committee and its Chairman, Senator Max Baucus (D-MT). Tom was also the Benefits Tax Counsel for the Treasury Department under the previous Administration. Tom was joined by Michael Kreps, Pensions Counsel for the Senate Committee on Health, Education, Labor, and Pensions (HELP) and its Chairman, Senator Tom Harkin (D-IA). Michael was instrumental in arranging for the very well-received January briefing of key Senate staff (on a bipartisan basis) by State and local government officials concerning the state of public pensions that NASRA and NCTR helped orchestrate.

Tom and Michael offered their insights regarding what to expect in 2011 from their two Committees, particularly as it relates to pensions, retirement security, and related issues. While Tom said that the legislation introduced by Senator Burr and referred to the Finance Committee was not currently “on the front burner” for Committee consideration, it was nevertheless still on the stove top. As for the possibility of tax reform, he said that there was much interest in the so-called “tax expenditures” in the Internal Revenue Code, such as the home mortgage interest deduction as well as deferrals associated with retirement savings. Everything will be on the table if tax reform is pursued, he stressed.

Michael said that there was much concern among Senate staff with the press reports of imminent plan failures, and cautioned that all it would take would be a major plan failure to trigger interest by some Senators and their staff in increased Federal regulation of public plans, perhaps along the lines of a Public Employee Retirement Income Security Act (PERISA).

The final presentation of the morning was provided by George Bostick, the Treasury Department’s Benefits Tax Counsel within the Office of the Assistant Secretary for Tax Policy. As such, Mr. Bostick is responsible for developing and reviewing policy, legislation, regulations, and revenue rulings dealing with all aspects of employee benefits taxation and related matters, including qualified retirement plans such as public pensions.

George and his colleague, Mark Iwry, the senior adviser to the Secretary of the Treasury and Deputy Assistant Treasury Secretary for Retirement and Health Policy, have been very supportive of public pensions, and have devoted literally tens of hours in meetings over the last year with NCTR, NASRA and other public sector representatives on a number of issues, including the Normal Retirement Age regulations, and most recently, the question of the application of the employer pick-up rules generated by a request from Orange County, California, for a private letter ruling to permit current employees to individually elect into a new, reduced tier of benefits.

George has been very willing to listen to public plan concerns with the possible implications of action in the pick-ups area, depending on its nature, with respect to other employee elections, such as the purchase of service credits, and the broader implications that any decisions might have with regard to future plan design decisions. While he was unable to present what the final resolution of this matter might look like, he did indicate the sensitivity of the discussions and the need for action in the near future.

George also touched on a number of other issues, including the IRS governmental compliance initiative, the pending revision of the definition of a governmental plan – it is still “imminent” -- and the status of any final decisions dealing with the normal retirement age issue, including a discussion of the perceived problems in this area pursuant to the pre-ERISA vesting rules, and the likelihood of any possible “grandfathering.”

A Word from the White House

The luncheon speaker was Brian Deese, Deputy Director of the National Economic Council and Special Assistant to the President for Economic Policy. Mr. Deese helps to coordinate policy development on a number of the Administration’s economic priorities including tax policy, retirement security, clean energy and manufacturing, and the auto industry. He was asked to discuss the growing interest in Washington with the operations and funding of public pensions, and the degree to which they are perceived as fitting in with the overall budget picture at the State and local level.

Mr. Deese proved to be very knowledgeable with regard to public pension issues. He assured attendees that the Administration was aware of the concerns with funding, but felt that the issues were long-term in nature and that States were taking appropriate steps to address sustainability. He was asked if he thought that public pensions were sufficiently transparent at the present, and replied that he thought that while the goal should always be to improve transparency, regardless of subject matter, he believed that the current GASB review of public pension accounting and disclosure was the appropriate place for this issue to be decided. He also distinguished between transparency and clarity, observing that the former, which should be the goal, was not always necessarily synonymous with the latter.

A View from the House of Representatives – Past and Present

Following lunch, the next presentation was made by Aharon Friedman, Pensions Tax Counsel to the House Committee on Ways and Means and its Chairman, Dave Camp (R-MI). Mr. Friedman was joined by Michele Varnhagen, Director of Labor Policy for Democrats on the House Committee on Education and the Workforce and a long-time pension adviser to Congressman George Miller (D-CA), the Committee’s Ranking Member.

This panel provided a view of retirement security in general and the PEPTA legislation in particular from the perspective of the House of Representatives and its new GOP majority. Mr. Friedman is very interested in the discount rate used by public pensions, and conversant with arguments on both sides of the issue. However, he said that at the present, Chairman Camp had not yet taken a position on PEPTA, and that there were no current plans to hold hearings on the legislation in the Ways and Means Committee.

Michele touched on what she sees as the future of retirement security from a Federal policy perspective, and raised the on-going concerns of her boss with the adequacy of 401(k) plans as a primary retirement vehicle. She also expressed concerns with the amount of misinformation in the media on public plans, and encouraged NCTR and NASRA members to be sure to educate their Congressional delegations as to the true condition of public pension funding.

The conference wrapped up on a high note with a rousing presentation by Earl Pomeroy, one of the best friends that the public pension community has ever had on Capitol Hill. Mr. Pomeroy lost his campaign to be re-elected last November to his seat in Congress representing North Dakota, and is currently with the law firm of Alston and Bird. He discussed the misinformation campaign surrounding the PEPTA legislation and the problems with what he referred to as “zero-risk” pension funding being advocated by Congressman Nunes and others. He also provided attendees with some inside tips and pointers on how best to get their messages across in Hill meetings. As someone who has heard the arguments and concerns of his former colleagues with the perceived weaknesses of public pension plans, his was a very special and valuable presentation.

The Conference ended at 3:00 PM, and many attendees then went to Capitol Hill to meet with their Congressional delegations. NCTR and NASRA provided new “Getting the Facts” presentation folders that included a fact sheet on public pensions, as well as a recent issue brief discussing the level of state and local contributions to pensions measured as a percentage of state budgets, with a chart showing employer (taxpayer) contributions to pensions as a percentage of all state and local government spending, by state, based on 2008 US Census Bureau statistics. Attendees were encouraged to add information specific to their own plan as part of the package.

US Senator Harkin Addresses NIRS Annual Policy Conference; Says Most Public Pension Plans are "Doing Just Fine"

United States Senator Tom Harkin (D-IA), Chairman of the Senate Health, Education, Labor and Pensions (HELP) Committee, was the keynote speaker at the second annual National Institute on Retirement Security (NIRS) retirement policy conference the day following the NCTR/NASRA Legislative Workshop. Harkin offered support for public pensions, criticizing “unfair scapegoating” by what he referred to as “a vocal group of activists and politicians who are trying to score political points. “ He also spoke of the need for “bold changes” to ensure that the nation’s retirement system works for everyone, with several essentials that mirror the success of public plans’ defined benefit model. Harkin stressed that “the conversation should be about how we can lift everyone up rather than knocking public sector workers down.” NIRS also used its conference to release new public opinion research that finds an overwhelming majority of Americans believe the nation’s retirement infrastructure is crumbling; that stock market volatility makes it impossible to predict retirement savings; and that government needs to do more when it comes to providing pensions for all Americans.

On March 8, NIRS held its second policy conference in Washington, DC, within walking distance of the NCTR/NASRA Legislative Workshop. This year’s NIRS conference was entitled “Policy at the Crossroads: Ensuring Economic Recovery Strengthens Retirement Security,” and focused on whether a rising economic tide will "lift Americans' retirement boats” or if policymakers, plan sponsors, and service providers will need to employ new strategies to restore America's retirement readiness.

Harkin Speech

Senator Harkin, the keynote speaker, referred to hearings he has been holding in the HELP Committee on retirement security, which made it “crystal clear” to him that the current national retirement system is failing many Americans. He said that 401(k) plans aren't doing enough to help families prepare for retirement, with low savings rates and “no simple way for people to convert their savings into a guaranteed stream of retirement income.” The Senator also pointed out that traditional defined benefit private sector pensions are disappearing.

This means that “the only people who really have pensions are public employees,” the Senator said, and the retirement security conversation “should be about how we can lift everyone up rather than knocking public sector workers down.” However, he noted that public plans are under attack, with opponents using “hyperbolic studies with pictures of burned out cities trying to make people think that pension plans are breaking state budgets.”

Harkin pointed out that “The truth is that not every public pension is in trouble.” “Most are doing just fine,” he said. While the Iowa Democrat recognized that a few public retirees are living “high-on-the-hog on the taxpayers’ dime,” he also underscored the fact that the average retirement benefit for a public employee is just $22,600. “And remember,” he reminded attendees, including members of the national press, “that lots of public employees aren’t in the Social Security system, so that’s all they get.”

Harkin said that any policy decisions regarding public pensions should be “based on facts, not unfair scapegoating.” “Let’s not forget who we’re really talking about,” the Senator stressed. “We’re talking about the police officers who put their lives on the line to keep our families safe and the elementary school teachers who make sure our kids know their ABCs.”

Senator Harkin has concluded that there are some “core principles” that he believes the nation’s retirement system needs to serve:
  1. The system needs to be universal and automatic. 
  2. It needs to provide certainty. People “need to know that they are going to get a check for a certain amount every month no matter how long they live, Harkin said.
  3. The retirement system needs to be one of shared responsibility. “Employees, employers and the government all have a role to play,” Harkin underscored, “and it’s patently unfair to make families shoulder the burden alone.”
  4. Retirement dollars need to be professionally managed.
Sounds like a traditional public sector defined benefit plan to me!

Harkin said that he will continue holding hearings on retirement security over the next year to highlight the need for comprehensive reform.

New NIRS Public Opinion Research

In addition to Senator Harkin’s address, another highlight of the conference was the release of a new NIRS report, “Pensions and Retirement Security 2011: A Roadmap for Policymakers,” based on opinion research conducted by Mathew Greenwald & Associates in a nationwide telephone interview of 800 Americans age 25 or older to assess their sentiment regarding retirement and actions Congress and the Administration could take. The data was balanced to reflect the demographics of the United States for age, gender, and income, and the poll has a margin of error of plus or minus 3.5%.

The report finds that nearly 80% of Americans believe leaders in Washington do not understand how hard it is to prepare for retirement in the current economy, with some 83% saying that government should make it easier for employers to offer pensions. Most Americans (81%) believe that Washington leaders need to give a higher priority to ensuring more Americans can have a secure retirement.

Other key findings include:

  • Some 84% of Americans are concerned that current economic conditions are impacting their ability to achieve a secure retirement, with more than half (54%) very concerned. 
  • Americans have low retirement expectations, with only 11% expecting retirement to include leisure, travel, restaurants, and/or hobbies. 
  • Nearly 9 out of 10 Americans believe the retirement system is under stress and needs to be reformed, with more than 80% of Americans believing that the recent economic downturn exposed the risks of America’s retirement system.
  • Some 83% of Americans indicated that those with pensions are more likely to have a secure retirement, and 75% believe the disappearance of pensions has made it harder to achieve the “American Dream.”
In addition to Senator Harkin, conference speakers included Ted C. Fishman, author of China, Inc. and Shock of Gray ; Mark Iwry, Senior Advisor to the Secretary and Deputy Assistant Treasury Secretary for Retirement and Health Policy; former Governor Dick Kempthorne, President & CEO of the American Council of Life Insurers; Maya MacGuineas, President of the Committee for a Responsible Federal Budget at the New America Foundation; Scott Pattison, Executive Director of the National Association of State Budget Officers (NASBO); Brian Perlman, Partner, Greenwald & Associates; former Congressman Earl Pomeroy; and Paul Van de Water, Senior Fellow at the Center on Budget and Policy Priorities.

The conference also provided an opportunity to introduce Diane Oakley, the new NIRS Executive Director, who succeeded NIRS’ first leader, Beth Almeida, effective January 18, 2011. Diane was formerly a senior policy advisor on retirement and tax policy issues to Congressman Earl Pomeroy. She also has 28 years of service at TIAA-CREF, where she held several leadership positions including Vice President for Special Consulting Services and Vice President for Associations and Government Relations.

Final Normal Retirement Age Regs for Governmental Plans Still Appear to be in Limbo

It has been almost four years since the Internal Revenue Service (IRS) first asked the question whether normal retirement age under a public plan may be based, in whole or in part, on years of service. The issue was raised in connection with so-called “Normal Retirement Age” regulations that were released in final form in 2007, but whose application to governmental plans has been repeatedly delayed. Progress has been slow in resolving the matter, despite repeated meetings between governmental plan organizations, including NCTR, and the Treasury Department. Now, however, hundreds of determination letter requests are reportedly being held up by uncertainty regarding pending guidance in this area, and pressure is growing to provide a final ruling. Some believe that another extension may be in order, while others think that the matter may ultimately need to be dealt with legislatively.


The so-called Normal Retirement Age(NRA) regulations that the IRS issued in May of 2007 in final form actually deal with the ability of individuals (both public sector and private sector) to receive “in-service” distributions. Generally speaking, the Internal Revenue Code (IRC) permits pension distributions only after a participant terminates employment, or reaches “normal retirement age.” The 2007 regulations, which currently apply to the private sector only, now additionally permit a pension plan to pay benefits to an employee who has not terminated if the employee has attained age 62 – a provision which was contained in the “Distributions During Working Retirement” language of the Pension Protection Act of 2006 (PPA).

With regard to what qualifies as “normal retirement age,” the regulations require that the normal retirement age under a plan be an age that is “not earlier than the earliest age that is reasonably representative of the typical retirement age for the industry in which the covered workforce is employed.”

Several safe harbors are provided. For example, a normal retirement age of at least age 62 is deemed to meet this new “typical retirement age” standard; for plans with normal retirement ages between ages 55 and 62, there will be a presumption that they are acceptable based on a “good faith determination of the typical retirement age for the industry in which the covered workforce is employed that is made by the employer.” (However, private sector employers have indicated this presumption is being interpreted as still requiring proof regarding the typical retirement age for the industry of the covered workforce.) For a normal retirement age that is lower than age 55, there is a presumption that it does not meet the new standard “absent facts and circumstances that demonstrate otherwise.” (For plans where substantially all of the participants in the plan are qualified public safety employees, a normal retirement age of age 50 or later is deemed to meet the new standard.)

In 2007, the IRS also issued Notice 2007-69, underscoring that the new regulations do not provide a safe harbor with respect to a retirement age that is conditioned (directly or indirectly) on the completion of a stated number of years of service. The IRS also requested comments from sponsors of governmental plans on whether “normal retirement age” under such a plan may be based on years of service.

Governmental Plan Issues

There are several problems with the final regulations, whose application to governmental plans has been extended several times and which are now set to apply to public plans in the first plan year beginning on or after January 1, 2013.

  1. All governmental pension plans would be required to specifically define a normal retirement age as an actual age. However, many governmental plans define normal retirement age or normal retirement date as the time or times when participants qualify for unreduced retirement benefits under the plan, which is set forth in State and/or local statutes and may not state a specific age.
  2. Many governmental plans define normal retirement age or normal retirement date often based wholly or partly on years of service. Furthermore, under many governmental pension plans, a participant can reach normal retirement age by satisfying one of several age and service combinations. Sponsors of such plans would find it very difficult to select a single age to be the plan’s normal retirement age. Selecting an age that is higher than the lowest age would likely impair the constitutionally protected rights of the participants to any benefit conditioned on normal retirement. Selecting an age that is lower than the highest age could impact the actuarial cost of the plan.
  3. Governmental pension plans often provide multiple benefit structures and cover multiple employee groups. The use of the term “plan” under the Final Regulations makes it unclear whether such governmental plans will be required to engage in the enormous undertaking of going through state and local governing bodies to unnecessarily fracture governmental pension systems into several smaller “plans” in order to have multiple normal retirement ages or take advantage of the safe harbor relief provided under the final regulations. It is also unclear how “the typical retirement age for the industry in which the covered workforce is employed” would be applied in the diverse public sector setting.
Accordingly, NCTR and NASRA have proposed that governmental plans should not be required to define normal retirement age. For those, however, that do define a normal retirement age or date, such normal retirement age or date should be permitted to be based on age, service, or a combination of age and service. Finally, whether or not normal retirement age or date is specifically defined for a governmental plan, in-service distributions should be permitted when made on or after the earlier of age 62 or the date on which the participant is permitted to receive unreduced benefits under the plan.

Current Status

There have been several meetings with the Treasury Department over the last three years to discuss these regulations and the serious problems they would present for governmental plans. However, there has been little progress to date.

One reason for the delay is that the IRS views the definition of normal retirement age for purposes of governmental plans as “not just [an] issue of application of final regulations” to governmental plans, but also as implicating what they view as pre-ERISA vesting standards (that do apply to governmental plans) that require full vesting upon attainment of normal retirement age.

Therefore, they appear to believe that governmental plans have always been required to specify a definitive age – despite the fact that many governmental pension plans (including those whose sponsors have relied for decades on favorable determination letters) have never defined normal retirement age. As George Bostick , Treasury’s Benefits Tax Counsel, explained to the NCTR/NASRA workshop attendees, there is therefore much research being done currently to better understand how such governmental pension plans, or those with a normal retirement age conditioned on the completion of a stated number of years of service , were initially seen as satisfying the pre-ERISA vesting rules.

Finally, the decision with regard to the NRA also affects the current processing of determination letters from Cycles C and E, which is why some plans that have applied have yet to receive a response. Therefore, the resolution of this issue is highly complex and has implications in a number of areas. It is still unclear at this stage whether an answer will be forthcoming soon, or if there will be yet another extension of the application of the regulations. It may well be that a legislative clarification will ultimately be necessary.

Guidance on Pick-Up Arrangements Under 414(H)(2) May Be in the Works

A number of private letter ruling (PLR) requests reportedly pending before the Internal Revenue Service (IRS) have helped to spur the IRS and the Treasury Department to consider issuing additional guidance on Internal Revenue Code Section 414(h)(2) employer pick-ups under IRS Revenue Ruling 2006-43. The specific issue involves the ability of a governmental defined benefit plan to offer current participants a choice between two benefit formulas, and whether this gives rise to a cash-or-deferred arrangement (CODA) which could result in plan disqualification. There is growing pressure from Capitol Hill and elsewhere for a response to these PLR requests. However, depending on how this question is answered, issues could be raised with the ability to use pick-ups in connection with not just elective tiers but other employee elections/options as well, such as the purchase of service credit and DROP arrangements.

Perhaps the most discussed PLR request related to this issue involves Orange County, California. There, as part of pension reform, a plan was devised whereby newly-hired workers were given the option of choosing a lower defined benefit pension with a government-matched 401(k)-type component. Orange County is seeking permission from the IRS to allow current workers to opt into this hybrid retirement plan as well, which requires lower employee contributions resulting in approximately a 7 percent increase in their take-home pay.

Revenue Ruling 2006-43

IRS Revenue Ruling 2006-43 deals with what actions are required in order for a State or local government employer to "pick up" employee contributions to a qualified plan so that the contributions are treated as employer contributions pursuant to § 414(h)(2) and therefore tax-deferred. It clarifies that in order for employee contributions to be considered made, or picked up, by the employer:
  1. Contributions, although designated as employee contributions, are to be paid by the employer pursuant to formal action taken by the employing unit to provide that the contributions on behalf of a specific class of employees of the employing unit, although designated as employee contributions, will be paid by the employing unit in lieu of employee contributions; and
  2. A participating employee, from and after the date of the “pick-up”, cannot be permitted to have a cash or deferred election right with respect to designated employee contributions. That is, participating employees must not be permitted to opt out of the “pick-up”, or to receive the contributed amounts directly instead of having them paid by the employing unit to the plan.
Based on one reading of this Revenue Ruling, Orange County’s optional defined benefit plan tier for current employees -- because it changes the level of the “picked-up” employee contribution – could be viewed as a prohibited cash or deferred arrangement (CODA) under the plan. The Orange County PLR seeks to determine if the second part of this Revenue Ruling requirement would indeed prevent it from offering its new tier as an individual option to its current employees. That is, would the Revenue Ruling not only prohibit any employee from opting out of the pick-up, but also from making any election that would changes the amount of the employee’s picked-up contribution since it would result in the employee “electing” to have more current or deferred compensation?

The answer to this question, depending upon what it is, or on what circumstances it might be conditioned, could also significantly affect other employee elections in addition to opting into a new benefit tier that has a different employee contribution rate, such as electing to purchase service credit through a salary reduction, or electing a deferred retirement option plan whereby the employee contributions to the plan cease.

A reading unfavorable to Orange County would also appear to overturn past favorable IRS rulings that specifically allowed use of pickups where individual employees make an irrevocable election to have contributions made to a plan on their behalf by payroll deduction. It would also contradict Congressional intent. For example, under the Tax Reform Act of 1997, Congress stated that nothing in the new purchase of service credit provisions were meant to interfere with pickups to purchase service credits. Also, under the Pension Protection Act of 2006, Congress specifically reaffirmed the ability of public employees to purchase service under a plan whereby “a lower level benefit is converted to a higher benefit level otherwise offered under the same plan.”

Current Status

Discussions have been underway with Treasury to address the potential unintended impact of such a reading. For example, any action by Treasury that officially affirms this reading of Revenue Ruling 2006-43, even in part, could raise serious issues for many plans. It could also impact a number of changes being considered by some to enhance sustainability. There is also concern that a proscriptive outline by Treasury of the timing, circumstances, financial condition, etc. under which a new tier or plan can receive picked-up contributions could be interpreted as a one-size-fits-all Federal model that employers are encouraged to follow.

Public plan organizations, representatives and attorneys are currently urging the Service to consider a ruling position with regard to Revenue Ruling 2006-43 that clarifies that a CODA does not include an irrevocable election to prospectively modify contributions or accruals under an existing broad-based qualified governmental defined benefit plan (available to all similarly situated individuals in a reasonably equivalent manner), if made pursuant to any provision of federal, state, or local law (including any administrative rule or policy and any collectively bargained provision adopted in accordance with such law).

However, certain public employee unions – but not all -- are concerned with the implications of the Orange County plan and the temptation it presents to current employees to waive their constitutional guarantees to their current benefits. These unions have urged Treasury and the IRS to follow a strict interpretation of Revenue Ruling 2006-43 and find that individually elected contributions should continue to be excluded from treatment as employer “pick-up” contributions.

There is clearly a feeling at the IRS and Treasury that this is becoming a major political problem. The fact that there is not unanimity as to a resolution of the issue among the various public sector organizations is also viewed as a problem and has likely been a factor in the delayed response. There are also reports that the IRS is considering a very narrowly-drawn, fact-specific PLR that simply recites the facts of the Orange County situation and states that this does not present a CODA.

In any case, it appears that pressure from Capitol Hill for a response to the pending PLR requests means that something is likely to happen sooner rather than later.

SEC Proposes to Treat Certain Public Pension Trustees as Municipal Advisors

The Securities and Exchange Commission (SEC) has released for comment new rules to clarify what constitutes a “municipal advisor” and to provide a permanent registration process for them. If adopted as proposed, elected and ex officio members of governmental pension plan boards of trustees would be excluded from the definition, but appointed board members would be covered. The SEC thinks that elected members are accountable to the municipal entity as opposed to appointed members, who are not directly accountable “for their performance to the citizens of the municipal entity.” NCTR and NASRA have filed joint comments with the SEC objecting to this approach, arguing that all trustees of state and local government retirement systems (whether elected or appointed), are part and parcel of the plan that they govern, and not advisers to it. Comments were due by February 22nd, and a final rule is expected from the SEC sometime later this year.


A provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act makes it unlawful for municipal advisors to provide advice to, or solicit, municipal entities without registering with the SEC. The new law also imposes an express fiduciary duty on municipal advisors in their dealings with municipal entities.

(“Municipal entities” are defined to include any state or state political subdivision or municipal corporate instrumentality; any agency, authority or instrumentality thereof; any plan, program or pool of assets sponsored or established by a state or state political subdivision or municipal corporate instrumentality (or an agency, authority or instrumentality thereof); or any other issuer of municipal securities. Furthermore, the SEC specifically notes that this definition includes public pension funds, local government investment pools and other state and local governmental entities or funds, along with participant-directed investment programs or plans such as 529, 403(b), and 457 plans. )

Accordingly, on December 20, 2010, the SEC proposed new rules to clarify what constitutes a “municipal advisor” and to provide a permanent registration process for them. However, since Dodd-Frank only excluded “employees of a municipal entity” from the definition of “municipal advisor” and did not explicitly refer to the board members of a municipal entity, the SEC decided that it had to address this issue in its regulations. Specifically, the SEC has proposed that elected and ex officio board members would be excluded from the definition of “municipal advisors,” but not appointed board members. The SEC’s rationale is that elected members are accountable to the municipal entity as opposed to appointed members, who are not directly accountable “for their performance to the citizens of the municipal entity.”

NCTR/NASRA Joint Comment Letter

NASRA and NCTR have filed joint comments with the SEC objecting to this approach. The letter argues that all trustees of state and local government retirement systems (whether elected or appointed), as members of a governing body of a governmental pension fund, are, per se, a part of that municipal entity, and, as such, are therefore expressly excluded from the definition of a “municipal advisor.”

Specifically, the letter underscores that the role of public pension trustees is to oversee the assets and administration of their retirement systems, and not to provide advice concerning investment strategies to other municipal entities, to their fellow trustees, or to participants in self-directed accounts. “Therefore, as a threshold matter, public pension trustees, in their capacity as members of the governing body of a public pension plan, are not, by definition, ‘municipal advisors,’” the letter stresses.

Also, NCTR and NASRA point out that, as members of the governing body of a state or local retirement system, public pension trustees are part and parcel of the plan that they govern, and not advisers to it. “To hold otherwise,” we point out, “would mean that any third party who provides advice within the meaning of the Dodd-Frank Act to the governing body of a municipal entity with respect to bonds, swaps, or any other specified municipal financial products, would NOT be required to register as a municipal advisor with the SEC. Such third party would also NOT be subject to the other municipal advisor provisions of the Dodd-Frank Act, such as the imposition of a fiduciary duty to the municipal entity, since the Dodd-Frank Act ‘s prohibitions refer to soliciting or providing advice to a “municipal entity.”

Finally, the comment letter notes that all public pension trustees (however selected) are already subject to strict accountability standards. Comments were due by February 22nd, and a final rule is expected from the SEC sometime later this year.

Chances for Repeal of 3% Non-Wage Withholding Requirement Impove

House Ways and Means Chairman Dave Camp (R-MI) has said that he wants to explore repeal of the requirement that Federal, state, and local governments and their instrumentalities – including pension plans -- withhold 3% from payments for most goods and services which is currently set to take effect on January 1, 2012. Although the withholding requirement does not apply to retirement benefits, other pension plan payments could be affected. Legislation to repeal the provision has also now been introduced in both the House and Senate, and NCTR has recently joined a dozen other State and local government organizations in urging Chairman Camp to immediately address the issue, We thank you for recognizing the problematic nature of this provision and ask that you address this issue immediately, as State and local governments must start spending scarce resources now in order to accommodate the impending January 1st deadline.

Section 511 of “Tax Increase Prevention and Reconciliation Act” (P.L. 109-222) was a last-minute provision added to raise revenue during the 11th hour of conference negotiations on the 2006 legislation. It requires withholding at a rate of 3% on all government payments for products and services made by the Federal government, state governments, and local governments with expenditures of $100 million or more. The withheld amounts will be a credit against the tax liability of the recipient, and will be shown on an information return after the end of the tax year, similar to backup withholding or withholding on wages. Originally set to apply beginning in 2011, a one year delay was included in the 2009 American Recovery and Reinvestment Act.

While the 3% withholding requirements would not apply to the payment of pension benefits, they would appear to apply to a number of pension plan activities, such as consultant contracts, fees paid to money managers, and payments to healthcare providers where the plan administers health benefits.

Legislation to repeal Section 511 has now been introduced in both houses of Congress. Congressmen Wally Herger (R-CA) and Earl Blumenauer (D-OR) introduced H.R. 674 on February 11th, and the measure currently has 41 other bipartisan cosponsors. In the Senate, there are two bills: S. 89, introduced by Senators Vitter (R-LA), Burr (R-NC), Inhofe (R-OK) Isakson (R-GA) and Wicker (R-MS), and cosponsored by Senators Cochran (R-MS) and Johanns (R-NB); and S. 164, introduced by Senators Brown (R-MA) and Snowe (R-ME) and cosponsored by Senators Klobuchar (D-MN), Thune (R-SD) and Collins (R-ME).

NCTR, along with other State and local groups, continues to push for repeal of the withholding requirement. Following a recent speech by House Ways and Means Chairman Dave Camp (R-MI), in which he said that he wants to explore repeal as well, and that it could possibly be included as part of a larger tax bill that could be moving later this year, NCTR and NASRA have joined with other governmental organizations, spearheaded by the National Association of State Auditors, Comptrollers and Treasurers (NASACT), in sending a letter to Chairman Camp urging prompt action.

“State and local governments face unique challenges in preparing to implement Section 511, as the sophistication of systems necessary to capture and report the required data vary greatly between governments and most entities do not have the resources, capacity or staff to undertake the required withholding and remittance,” the letter notes. It also underscores that the costs to purchase or retrofit existing payment and procurement systems “are particularly concerning in light of the current state and local government fiscal situation.”

Repeal of the legislation has always been problematic due to the loss in Federal revenues that the measure purportedly is expected to raise. However, while it was estimated to “increase” revenue by $7 billion from 2011 to 2015 when originally adopted, $6 billion of this total was projected to occur in the first year solely due to accelerated tax receipts and not from new revenue as the result of “improved tax compliance.” Furthermore, the Department of Defense -- the withholding would apply to all Federal agencies – has estimated its compliance costs alone to be $17 billion over the first 5 years of enforcement. Finally, final regulations have not been issued from the Department of Treasury yet.

No hearings have yet to be scheduled on the repeal legislation, however, in either the House or Senate.

Public Plans Respond to CFTC on Suitability Regulations for SWAPS

Under provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, special requirements and business conduct rules are to be imposed on swap dealers advising or engaging in trades with pension funds or state and local government “special entities.” The Commodity Futures Trading Commission (CFTC) has now proposed such rules, which would provide that when swaps dealers interact with such special entities, including governmental pension plans, they must act in the “best interests” of the plan and have a reasonable basis to believe that it has a qualified representative meeting certain sophistication and independence criteria. Some public pension plans have concerns with the proposed regulations, and have filed comments stressing that there is an “inherent conflict of interest for one of the parties to a transaction also to be responsible for determining who might represent the other side of a transaction.” The plans urge an alternative whereby the CFTC would permit swap transactions with a special entity so long as the special entity had a representative, either internally or at a third-party, certified as able to evaluate swap transactions.

Initially, the Senate version of what ultimately became the Dodd-Frank law would have imposed a strict fiduciary duty on swap dealers advising or engaging in trades with pension funds or state and local government “special entities.” However, many protested that since swap dealer would be the “opposing” party to the transaction, as such they would therefore have a conflict of interest that would preclude them from fulfilling their fiduciary duty under the law. Thus, it was feared that the provision could have had the unintended result of discouraging swap dealers from agreeing to do business with pension plans at all.

Although unions and consumer groups just as strongly opposed any weakening of the original Senate language, claiming that there was “overwhelming evidence that most pensions and government entities lack the financial sophistication to protect their own interests in these transactions," the final bill was modified, and the law now requires that a swap dealer that acts as an advisor to a public plan regarding a swap has a duty to act "in the best interests" of the plan and to make a reasonable determination that any swap it recommends is in the best interests of the plan.

However, a swap dealer that simply enters into or offers to enter into swap, but does not offer advice, must only have a reasonable basis to believe that the plan has a representative that, among other things, is independent of the swap dealer and has a duty to act in the best interests of the plan.

In December of 2010, the Commodity Futures Trading Commission (CFTC) proposed business conduct rules to govern swap dealers and major swap participants in their dealings with counterparties. The proposed regulations would prohibit certain fraudulent and abusive practices and impose significant disclosure, diligence, suitability and transaction execution obligations on swap dealers. In particular, when a “special entity” is involved as a counterparty, including certain governmental entities, municipalities, employee and governmental benefit plans and endowments, swap dealers must act in the “best interests” of the special entity and have a reasonable basis to believe that the special entity has a qualified representative meeting certain sophistication and independence criteria.

Some public pension plans have concerns with the proposed regulations, and have filed a joint comment letter. These plans include the California Public Employees’ Retirement System (CalPERS), the Public School & Education Employees’ Retirement System of Missouri, the Missouri State Employees’ Retirement System (MOSERS), South Carolina Retirement System Investment Commission, the Pennsylvania Public School Employees’ Retirement System, the State of Wisconsin Investment Board, Colorado PERA, the Utah Retirement Systems, the New Jersey Division of Investments, and the Virginia Retirement System.

Specifically, their letter raises issues with the proposed regulation’s requirement that a swap dealer that offers to enter into, or enters into, a swap with a special entity have a reasonable basis to believe that the special entity has a representative who is independent of the swap dealer and who meets certain other requirements. According to the CIO’s of these plans, there is an “inherent conflict of interest for one of the parties to a transaction also to be responsible for determining who might represent the other side of a transaction.” They are concerned that this “would give undue influence” to a swap dealer to determine who qualifies to fill that role.

The letter also expresses concern with the vagueness of the meaning of certain terms, and concludes that the regulations pertaining to dealings with a special entity “could be wholly unworkable and adversely affect pension fund members.”

The CIOs propose an alternative that would permit off exchange swap transactions with a special entity so long as the special entity had a representative, either internally or at a third-party, certified as able to evaluate swap transactions. The certification process would include a proficiency exam to be developed by the CFTC (or by an appropriate self-regulatory organization) and periodic ethics training. This would permit persons employed by a special entity that have extensive experience in the swaps and other financial markets to qualify for the certification and thus not be blocked from serving as an independent representative by a swap dealer.


New FBAR Rules Finalized
Following much confusion as to whether public pension plans and plan employees with signature authority over foreign investments would be required to file Foreign Bank and Financial Accounts (FBAR) reports, NCTR, NASRA and NCPERS wrote the Treasury Department in October, 2009, arguing that such a requirement would not further the aims of Federal law in this area, but would instead create an unproductive and unnecessary administrative burden for governmental plans.

Subsequently, in 2010, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) proposed revisions of the regulations stating their intent to exempt public plans from the filing requirements. However, there were some perceived ambiguities between the filing instructions and the regulation’s language that left some unclear as to whether there would be an obligation for governmental plans to file FBAR reports that may fall due before June 30, 2011. NASRA, NCTR and NCPERS therefore once again filed comments suggesting a clarification.

On February 24, 2011, FinCEN issued final regulations regarding FBAR reporting. These are effective March 28, 2011, and apply to FBARs required to be filed by June 30, 2011(including any deferred filings that were originally due in June of 2010). According to the release accompanying the final rules, FBAR instructions are revised to reflect the language adopted in the final regulations. Specifically, the rules and instructions will now clearly provide a filing exemption for the accounts of governmental pension plans for both the plan itself and the plan's employees with signature authority over foreign investments.

Private Sector Pensions Regulated to Death, according to New NIRS Issue Brief
The National Institute on Retirement Security (NIRS) has issued a new report finding that private sector employers have been closing and freezing their pensions due to onerous laws and regulations enacted since the 1970s, including the Pension Protection Act of 2006. According to NIRS, these regulations created complicated funding rules, and increased contribution volatility.

According to Ilana Boivie, author of the research brief and director of programs for NIRS , “What’s particularly interesting is that the research shows that the trend away from pensions is not driven by the costs of pensions.” Instead, she said that the “heart of the issue is the volatility and unpredictability of plan funding, which impacts cash flow and income statements.” For example, NIRS found that among some 26% of plan sponsors who would consider forming a new pension plan, the vast majority said they would do so if there were more predictability and less volatility.

GAO Issues Several New Reports of Interest to Governmental Plans
The Governmental Accounting Office (GAO) has issued three new reports in the last several months that should be of interest to many public plans.

  1. 401(k) Conflicts of Interest. Perhaps the most significant report found that improved regulation could better protect 401(k) plan participants from conflicts of interest. In this report, GAO said that “The presence of conflicts of interest and the potential for financial harm hinder participants’ retirement security and call into question the integrity of the 401(k) system.”

    GAO found that the sponsors of 401(k) plans face conflicts of interest from service providers assisting in the selection of investment options because of third-party payments and other business arrangements. They also found that in certain situations, participants face conflicts of interest from providers that have a financial interest when providing investment assistance.

    GAO recommended that the Department of Labor amend pending regulations to require that service providers disclose compensation and fiduciary status in a consistent, summary format and revise current standards, which permit a service provider to highlight investment options in which it has a financial interest. GAO also recommended that the Department of the Treasury amend proposed regulations to require disclosure that investment products outside a plan typically have higher fees than products available within a plan.
  2. GASB’s Role and Importance in the Municipal Securities Markets; GASB Funding . The Dodd-Frank financial reform law directed the GAO to study the role and importance of the Governmental Accounting Standards Board (GASB) in the municipal securities markets as well as the manner and level at which GASB has been funded. GASB is recognized by the American Institute of Certified Public Accountants as the body that sets generally accepted accounting principles (GAAP) for state and local governments.

    The GAO reported a number of interesting findings, including: all state governments use GAAP for state-level financial reporting; State requirements regarding the use of GAAP by local governments vary, but institutional investors and rating agencies generally agreed that most municipal issuers use GAAP; stakeholders viewed GAAP-basis financial statements as highly useful for assessing the quality of municipal securities; and stakeholders generally agreed that governments are not always timely in issuing audited financial statements, making them less useful to analysts and other users, although a few stakeholders maintained that other publicly available information compensates for the lack of timeliness.

    One finding of particular significance with regard to calls from some politicians and academics for better comparability among plans was that stakeholders generally agreed that use of GAAP’s reporting framework provides consistency and facilitates comparability of financial information across different municipal issuers and securities.

    With regard to funding, GAO found that the Financial Accounting Foundation (FAF), which is responsible for the oversight, administration, and finances for GASB and FASB and currently receives its funding from subscription and publications revenues, accounting support fees for FASB pursuant to the Sarbanes-Oxley Act of 2002, and voluntary contributions in support of GASB, has had to use FAF funds from its reserve to compensate for annual shortfalls in GASB’s funding. Furthermore, GAO found that officials from most issuer organizations agreed that GASB needed a steady, sustainable stream of funding.

    However, the GAO made no recommendations with regard to whether or not the Securities and Exchange Commission (SEC) should use its authority, granted under Dodd-Frank, to require a registered national securities association to establish a reasonable annual support fee to adequately fund GASB, and rules and procedures to provide for the equitable assessment and collection of the support fee from the members of the national securities association.
  3. Prescription Drugs Pricing Trends. The GAO was asked to examine recent trends in drug prices for brand-name and generic pharmaceuticals. In this report, they (1) looked at usual and customary price trends for commonly used prescription drugs from 2006 through the first quarter of 2010, the latest available data at the time of our analysis, and compared these trends to those of other medical consumer goods and services, and (2) examined price trends using drug prices other than usual and customary.

    GAO found that the price index for their sample of commonly used prescription drugs increased at an average annual rate of 6.6 percent from 2006 through the first quarter of 2010 compared with a 3.8 percent average annual increase in the medical CPI. The increase in the price index from the first quarter of 2009 through the first quarter of 2010—prior to passage of health reform in March 2010—was 5.9 percent, less than the increase for the 2 years prior but higher than in 2006.

    GAO also found that the price index for their sample of 55 brand-name drugs increased at an average annual rate of 8.3 percent during our time period. In contrast, the price index for their sample of generic drugs decreased at an average annual rate of 2.6 percent.

    Finally, when shifts in consumer utilization between brand-name and generic versions of the same drug were included in the analysis using drugs selected by active ingredient, the price index increased about 2.6 percent per year, a much lower rate than the 6.6 percent annual increase observed when shifts in utilization were not included.
SEC Adopts Say-on-Pay Rules
On January 25th, the Securities and Exchange Commission (SEC) finalized so-called “Say-on-Pay” rules implementing the provisions of the Dodd-Frank financial reform law relating to shareholder approval of executive compensation and “golden parachute” compensation arrangements.

Under the new rule, effective for annual meetings taking place on or after Jan. 21, 2011, not less frequently than once every 3 years, a proxy or consent or authorization for an annual or other meeting of the shareholders shall include a separate resolution, subject to shareholder vote, to approve the compensation of executives. However, the shareholder vote to approve executive compensation “shall not be binding on the issuer or the board of directors of an issuer,” according to the rule. At least once every six years, the rule requires that there also be advisory votes on the frequency (every one, two or three years) with which shareholders want “say-on-pay” votes.

In addition, the new rules require additional disclosures related to “golden parachute” arrangements in merger transactions, and give shareholders an advisory, non-binding vote on such arrangements, effective for filings on or after April 25, 2011.

However, companies with market capitalizations of less than $75 million will not be required to follow the new “say-on-pay” requirements until January of 2013.
New Boston College Paper Finds Little Link Between Pension Funding, Bond Ratings
A paper released in February from the Center for Retirement Research at Boston College looked at the impact of pensions on state borrowing costs. The research was done in response to concerns that governmental pension plan underfunding could be having an impact on bond ratings similar to that found in the private sector, where numerous studies have shown that pension underfunding affects corporate bond ratings.

However, the results of the study indicate that, while the rating agencies say they consider pensions, in fact “pension funding does not have a statistically significant effect on bond ratings.” However, it was found that pension funding does have an effect on the spread of from 3 to 7 basis points.

The report states that this result is “not surprising given that pension expense accounted for only 3.8 percent of state budgets in 2008.” However, the report also cautions that this could increase to the extent that pensions become an increasingly important component of state budgets.

New Paper Looks at Collective Bargaining, Pensions
The Employment Policy Researcher Network (EPRN) researchers have recently written a white paper, "Getting it Right: Empirical Evidence and Policy Implications from Research on Public-Sector Unionism and Collective Bargaining," in response to the events in Wisconsin. Authors of the paper were UCLA Professor David Lewin and MIT Sloan School of Management Professor Thomas Kochan, with help from several others, including New School for Social Research's Teresa Ghilarducci and University of Massachusetts, Boston's Christian Weller.

The paper finds that the principal cause of public pension underfunding is the investment loss that occurred during the Great Recession. It also finds that a “secondary cause is the failure of some governments to make annual payments to cover the ‘normal costs’ of pensions,: and that this can be addressed by requiring governments to make promised annual pension-fund payments.

The paper also finds that public employers and employee unions also “need to address and, where appropriate, reform certain pension-design and administrative features, such as those that increase pension benefits based on an employee’s final years or year of service. “ However, the researchers also caution that “putative short-term savings in pension costs achieved by shifting to 401K and other defined-contribution plans covering public employees risk imposing additional, hidden costs on the public, and are based on faulty assessment of the reasons for the public- sector pension shortfall.”

The paper calls for (1) getting the facts right about the real costs of public-sector pay and benefits and future funding liabilities and communicating these findings to the public; (2) using these findings as inputs into state-level “public-sector summit meetings” that clarify and better define the problems and challenges requiring immediate attention and can be used to “negotiate a new state wide ‘Grand Bargain’ that addresses the most critical budget challenges, while also being fair to public employees;” and (3) using the lessons learned from this experience to “carry out an evidence-based analysis of what else should be done to modernize public-sector bargaining practices to fit the needs of today’s more transparent and financially strapped environment, while remaining true to core values.”

New Pension Funding Case Studies Look at Four Plans
The Center for State and Local Government Excellence has produced a series of case studies that focus on a sample of states and what they have done to maintain a funding ratio of over 80 percent in their defined benefit plans, even after the economic downturn of 2008. Included are Delaware, Illinois Municipal, Iowa, and North Carolina

The studies examine pension funding; employer and employee contributions; and what is referred to as “Strategies for Success,” which include such things as “Ad-hoc cost-of-living increases (COLA) that are not imbedded in the pension statute, are considered annually by the legislature based on fund performance, and are funded over five years when granted.