Public Pension Trustees and Bankruptcy

By now, you probably know that a U.S. District Court bankruptcy judge in Hawaii has ruled that the pension fund of the Commonwealth of the Northern Mariana Islands (CNMI), a U.S. territory, cannot file for bankruptcy under Chapter 11 of the Bankruptcy Code. However, you might not know that the judge had some pretty good things to say about the actions of the plan’s trustees.
On May 29th, Bankruptcy Judge Robert J. Faris tentatively found that the Northern Mariana Islands Retirement Fund is a "governmental unit" and not a “person.” Only a "person" may be a debtor in a Chapter 11 case, and since the term "person" does not include a governmental unit, Judge Faris said he was “inclined” to rule that the CNMI pension plan is therefore not eligible for relief under Chapter 11. He went on to say that "Congress did not intend that the Bankruptcy Code could solve all problems, least of all the financial problems of governmental units.” He noted that the dismissal of this case “will leave the Fund and its beneficiaries at the mercy of the commonwealth government, but Congress intended that the elected branches of the local government, rather than a federal court, should address such problems."

However, Judge Faris also said that the trustees of the CNMI plan “should be praised, not criticized, for commencing this case.” As he explained:

“The trustees find themselves in an intolerable position. The Fund for which they are responsible is caught between an irresistible force — obligations to retirees which it cannot pay — and an immovable object — the government, which has persistently failed to pay its debt to the Fund. The trustees' attempt to find a solution to this dilemma is creative and praiseworthy even though I am inclined to rule that it cannot succeed.”

On June 1st, Judge Faris formally dismissed the Chapter 11 petition. But he also once again expressed his serious concerns with the situation, saying that “The way the Fund is being treated is shameful! The way the beneficiaries are being treated is shameful!” according to press reports on the teleconference regarding the motions to dismiss.

Where do things go from here if this ruling stands? Reportedly, one option may be to dissolve the CNMI pension fund and give the CNMI Department of Finance the responsibility to pay benefits. However, as the pension plan’s administrator, Richard S. Villagomez, has been quoted as saying, "Having the fund's assets under the control of the entity that owes it the most money and is responsible for remitting contributions is analogous to the 'fox guarding the henhouse.’"

A recent post on National Public Radio’s blog, “Planet Money,” questions whether this option could “foreshadow what may happen to other struggling pension funds here in the continental U.S.”

Could it?

• Northern Mariana Island Pension Fund Chapter 11 Filing

• NPR “Planet Money” Blog Post

• Saipan Tribune Coverage of Dismissal Teleconference

• CNMI Retiree Blog Notes on Dismissal Hearing

More Biggs Bombast

Andrew Biggs, the economist and self-proclaimed expert on all things related to pensions, has been a busy boy in the merry, merry month of May. From his perch at the American Enterprise Institute (AEI) -- a Washington conservative think tank that is also home to Newt Gingrich, John Bolton, and Lynne Cheney -- Biggs has a long history of bashing public employees and their pension plans.

Teachers have a special place in his heart. He believes that education is a “less rigorous course of study” than other majors; that teachers “enter college with below-average SAT scores but receive much higher GPAs than other students;” and that a degree in education “simply does not reflect the same underlying skills and knowledge” as a degree in other areas. Indeed, he says that “When we compare salaries based on objective measures of cognitive ability — such as SAT, GRE, or IQ scores,” teachers are not only paid too much, but they earn more than they would likely receive in the private sector given their skill sets.

Now Biggs is focusing on what he refers to as the “pension industrial complex.”

No, I am not making this up.

First, in a May 3rd op-ed on the website “Real Clear Markets” entitled “Public Pension Stimulus Nonsense,” Biggs takes on the National Institute on Retirement Security (NIRS) and the pension administrators who belong to it. He labels as “nonsense” the NIRS “Pensionomics” research that shows how each dollar of pension benefits produces $2.37 in economic output, creating millions of new jobs and billions in additional labor income. According to Biggs, the NIRS research is “faulty” and, worse yet, pension administrators across the country are publishing their own localized versions of “the NIRS fallacy.” Instead, Biggs asserts that “the net economic impact of pension benefits is roughly zero.”

(He might want to point out similar “faulty’ reasoning to his friends at the U.S. Chamber of Commerce, who recently noted, in their White Paper entitled “Private Retirement Benefits in the 21st Century: A Path Forward,” that defined benefit plans are “an integral part of the national economy,” paying out over $167 billion in retirement benefits in 2009.)

Biggs concludes his May 3rd piece by explaining to his readers that pension administrators should be “apolitical public servants,” but that instead they are fighting “tooth and nail to preserve the existing pension systems, advancing dubious arguments along the way.” I presume that the last several years of major legislation in over 80% of the states making substantial reforms to pension systems -- in many cases accomplished at the behest of or in cooperation with pension plans and their administrators -- is to be ignored.

But Biggs has not gone unchallenged. NIRS quickly responded with a post entitled “Perfect Sense” on their website that reiterates that using U.S. Census Bureau data and an economic analysis modeling software widely used by industry and governments analysts, their “Pensionomics 2012” demonstrates that public and private sector pension benefit expenditures supported more than $1 trillion in total economic output in 2009. Moreover, these defined benefit pension expenditures supported some 6.5 million American jobs that paid nearly $315 billion in income to other Americans.

NIRS executive director, Diane Oakley, argues that “What doesn't make sense is the nation's broken retirement infrastructure.“ She underscores that when older Americans are unable to support themselves, it is inevitable that they will need financial assistance from families or turn to public assistance to meet their basic needs. “It makes perfect sense that the lack of pensions and retirement insecurity are the issues we should be attacking,” she concludes.

Dean Baker, an economist and the co-founder of the Center for Economic and Policy Research (CEPR), also responded to Biggs’ piece on the CEPR blog, noting that NIRS’ claim that the economy gets $2.37 of additional output for each dollar of pension spending due to the multiplier effect of spending is not unreasonable. Baker points out that the Congressional Budget Office's estimates of multipliers for the category that includes pensions has a top range of $2.10 per dollar of spending, suggesting that “NIRS was in the ballpark.” Baker said that Biggs’ criticism fails to take into account that during a recession, the lack of demand is the real culprit facing the economy, and anything that creates demand – including pension spending -- would in fact increase growth and jobs.

Finally, Monique Morrissey, an economist with the Economic Policy Institute (EPI), joined in the criticism of Biggs. In a post on the EPI blog entitled “Andrew Biggs is at it again,” Ms. Morrissey notes that Biggs’ real goal is to increase savings in private accounts. However, when promoting President George W. Bush’s plan to partially privatize Social Security, Morrissey points out that Biggs did not take into account the cost in the form of reduced guaranteed benefits, which is similar to the “sin” which he accuses NIRS of committing.

Despite these critiques, Biggs was at it again later in the month, this time in AEI’s online magazine, “The American,” with an article entitled “Public-Sector Pensions: The Transition Costs Myth” on May 21st. In this piece, Biggs begins by stating that public-sector employees and “the pension industrial complex” – which he describes as plan managers, pension actuaries, and investment advisors -- do not like DC plans and are using “deceptive and self-serving arguments despite having an obligation to provide the public with solid facts.” In effect, we are all liars.

This time around, Biggs is complaining about the “novel” argument that “DB pensions’ massive unfunded liabilities create ‘transition costs’ that make shifting to DC plans unfeasibly expensive.” In other words, according to Biggs, “the more broke DB plans become, the more we have to stick with them.”

Biggs refers to a new report by University of Arkansas economist Bob Costrell for the Laura and John Arnold Foundation that argues that these transition costs are largely a myth. Costrell says that the assertions by plans and others that the Governmental Accounting Standards Board (GASB) rules allow an open plan to amortize unfunded liabilities over a period of 30 years, but require a closed plan to amortize its unfunded liabilities more quickly – thus creating a temporary period of higher pension amortization costs, termed the “transition cost” – are simply not true.

On the contrary, Costrell says that if a government wishes to follow their current amortization schedule even as they shift to a DC plan, there is “nothing whatsoever preventing them from doing so,” and that some states that have moved to DC pensions have done exactly that. In short, GASB rules don’t govern funding, just accounting and disclosure. Thus, Biggs claims that having new employees participate in a new DC pension makes no difference to what the old DB plan owes.

As usual, Biggs also takes some time in this op-ed to argue the desirability of DC plans over DB plans, underscoring that an “essential difference between traditional defined-benefit (DB) pensions and newer 401(k)-style defined-contribution (DC) plans is that DC plans can’t generate unfunded liabilities.” Under a DB plan, Biggs explains, the employer promises employees a fixed retirement benefit regardless of how the plan’s investments fare. “In a DC plan, by contrast, employers promise employees a fixed contribution, say, 5 percent of salary.” As Biggs stresses, “Once that contribution is made, the employer’s obligation is fulfilled.” In other words, that’s that, and let the chips fall where they may.

Once again, Biggs – and the Arnold Foundation report it references -- did not go unanswered. NIRS issued a “Members’ Alert” on May 18th that referred to their ”Look Before You Leap” research and said that Costrell's paper fails to appropriately address the full context of this NIRS research, as well as the subsequent NIRS research on the effectiveness of sound actuarial practices in assuring well-funded DB plans.

According to NIRS, to suggest, as Costrell and Biggs do, that government officials simply ignore appropriate actuarial analysis of benefit and design changes “can result in ill-informed policy decisions that increase costs and undermine the efficient delivery of public services.” Making sure that the appropriate amortization is attached to pension reform options “provides clarity not confusion,” says NIRS’ Diane Oakley. “Moreover, the pension reform decisions must also address other important factors, such as economies of scale, transition costs, and the eventual investment returns,” she reminds her members.

Keith Brainard, the Director of Research for the National Association of Retirement Administrators (NASRA) also prepared a memorandum to NASRA members offering his perspectives on the Arnold report and the Biggs assertions related to it. In this memo, Mr. Brainard explains that even though policymakers may determine the period and basis with which to amortize unfunded pension liabilities, without regard to GASB standards, there are nevertheless “sensible reasons… to consider pension reforms in terms that comply with the sound actuarial principles on which these GASB standards are based.” He also notes that constitutional and statutory provisions in many states require policymakers to apply amortization periods that are consistent with the actuarial principles contained in the current GASB standards.

Keith concludes by stating that the impact of a change in amortization policy is only one of many factors policymakers must consider when evaluating pension reform. “Although GASB standards do not directly tie the hands of governmental plan sponsors,” Keith acknowledges, “the principles on which these standards are based are primary considerations and should, with cost and other analyses, be calculated for policy makers to determine the full impact of retirement plan changes.”

Finally, Gary Findlay, the Executive Director of the Missouri State Employees’ Retirement System (MOSERS), responded to Biggs’ article with a post on “PensionDialog.” In it, Mr. Findlay argues that the so-called “myth” to which Biggs refers is not whether transition costs exist, but how governments must finance them. “I agree that governments can mortgage added costs in any number of ways,” Gary states, “What seems to be completely lost is the fact that closing a defined benefit pension plan and setting up a 401(k)-style plan doesn’t change the unfunded liability, and often increases other costs,” he warns.

Gary also comments on Biggs’ statement that DC plans can’t generate unfunded liabilities. He points out that participants in such plans have nowhere near the amount that will be needed to provide anything close to a subsistence level of retirement income, and that the difference between what participants accumulate and what they need to survive is an unfunded liability that is going to fall on someone. Employers, Gary notes, will ultimately be on the hook for the financing of entitlement programs needed to fill the gap. “By any reasonable assessment, that is an unfunded liability,” he concludes.

Biggs responds, and then Gary responds to the response. Needless to say, neither ends up agreeing with the other. Biggs does offer up a few of what I refer to as “Huh?” moments. For example, he thinks it inappropriate to talk about DC plans generating “unfunded liabilities,” saying it is not “a plausible use of the term,” and would prefer instead to talk about “savings shortfalls.” Call it what you will, the consequences are still going to ultimately fall on the employer, aren’t they?

But why quibble over terminology? After all, Biggs argues that “a lot of talk about a retirement savings crisis is far overblown.”

Most recently, Biggs has appeared in a May 28th article in “Pensions and Investments” entitled “Cash Balance Plans Gain Favor As Option Among Public Pension Funds.” Biggs acknowledges the advantages of cash balance plans, but is still pushing for a DC approach. “The idea that it is more expensive because of transition costs (is) really just a BS excuse to not reform your pension,” he once again asserts.

Biggs also says that a big issue is that DC plans can't match “the generosity in contributions to DB plans.” “DB plans are scary generous,” he warns. A technical, economic term, I suppose.

Responses are in the works.

All in all, a busy month for our Mr. Biggs. However, it is encouraging to see the rapid responses to his diatribes. Also, the fact that they are beginning to come from a number of sources other than just the “pension industrial complex” is also encouraging. Finally, to the extent that opponents of DB plans are reaching out for new reasons to support their “conversion” arguments could suggest that perhaps some of their older ones are not gaining much traction? One can only hope.

•  Andrew Biggs, American Enterprise Institute: “Public Pension Stimulus Nonsense,” May 3, 2012

• Response by NIRS
• Response by Dean Baker, Center for Economic and Policy Research
• Response by Monique Morrissey, Economic Policy institute

•  Laura and John Arnold Foundation: "GASB Won't Let Me - A False Objection to Public Pension Reform"
    by Professor Robert Costrell, May 2012

• Response by Keith Brainard, NASRA
• Response by NIRS

•  Andrew Biggs, American Enterprise institute: “Public-Sector Pensions: The Transition Costs Myth,”
    May 21, 2012

• Response by Gary Findlay, MOSERS, in PensionDialog.com

•  Pensions and Investments: “Cash Balance Plans Gain Favor As Option Among Public Pension Funds,”
    May 28, 2012

A Mixed Bag: New Issue Brief on Public Plan Funding

What’s wrong with this picture? The stock market is up; state and local government revenues are on the rise; and governmental pension plans have made record numbers of changes, raising employee contributions for all workers and/or reducing benefits for new workers. However, the funded status of public pension plans has once again slipped.


The latest issue brief from the Center for State and Local Government Excellence, entitled The Funding of State and Local Pensions: 2011–2015, takes a look at 126 state and local pension plans and attempts to answer this question.

The result is somewhat of a mixed bag. As the Center’s President and CEO, Beth Kellar, puts it, “Readers can find reason to feel encouraged or worried as they read the analysis from the research team at the Center for Retirement Research (CRR) at Boston College.” Indeed.

On the positive side, CRR finds that during 2011, the funded status of public plans slipped only slightly -- from 76 percent to 75 percent. This result reflects only a modest gain in the value of actuarial assets, reflecting the smoothing of gains and losses over several years. However, even when that is factored in, 36 percent of the plans in the brief’s sample have a funded ratio of over 80 percent.

There was also an unexpected reduction in liability identified, dropping to 3.4 percent from 4.6 percent in 2010, and about 6 percent in earlier years.

Going forward, CRR projects that the funded ratio will remain steady next year and then gradually improve as the weak stock market experienced in 2009 is fully phased out of the calculation and replaced by years of positive market performance.

But…..

The issue brief also notes that the 75 percent funded ration in 2011 is based on liabilities discounted by the expected long-term yield on plan assets (roughly 8 percent), and revalues liabilities using the riskless rate, “as advocated by most economists for reporting purposes,” showing an aggregate funded ratio in 2011 of only 50 percent. Unfortunately, the brief does not directly acknowledge the vigorous debate surrounding this topic or the arguments against discounting liabilities by a risk-free interest rate.

Furthermore, the issue brief finds that the Annual Required Contribution (ARC) rose to 15.7 percent of payrolls in 2011. And the percent of ARC paid dipped to 79 percent.

Next, the issue brief projects funding for 2012–2015 and shows that, under the most likely of three stock market scenarios, the aggregate funded ratio will remain steady next year, and then gradually rise by 2015, but only to 82 percent – far short of the 103 percent average in 2000, or even the 88 percent level in 2007.

Finally, CRR points out that the reason that the growth in liabilities has slowed is that states and localities have laid off some workers, frozen salaries, and reduced or suspended COLAs. “Because many of these changes are one-shot, liability growth is likely to pick up somewhat in coming years,” CRR concludes.

The issue brief contains an appendix showing the ratio of assets to liabilities for 136 state and local plans for 2001–2010, along with projections for 2011.

• The Funding of State and Local Pensions: 2011–2015

Update on IRS Governmental Plans Definition Effort

As you know, on November 8, 2011, the Internal Revenue Service (IRS) and the Treasury Department published their long-awaited Advance Notice of Proposed Rulemaking (ANPRM) relating to the definition of the term “governmental plan” under section 414(d) of the Internal Revenue Code (IRC) as well as additional rules regarding the definition of an Indian Tribal Government (ITG) governmental plan. Each notice contains an appendix setting forth a draft of possible proposed regulations. (These regulations have not actually been proposed yet, and are provided as an example of what a proposal in this area might look like.)

Section 414(d) of the IRC generally defines a governmental plan as "a plan established and maintained for its employees by the Government of the United States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing." If a public plan fails to meet this definition, then ERISA titles I (Federal protection of employee benefit rights, administered by the DOL’s Employee Benefits Security Administration) and IV (plan termination insurance, enforced by the PBGC) would technically apply to it. In addition, the nondiscrimination and minimum participation rules of the Federal tax code would also apply, as would the minimum funding standards. In short, this is a big deal! The ultimate outcome of this process will have major implications for governmental plans, their sponsors, and participating employers and employees.

This ANPRM is the first step in what will be a multi-year process. The IRS is holding meetings across the country on their proposal, and there will be additional opportunities to formally comment on the regulations as they continue to be developed. The first of these meetings occurred on March 15, 2012, in Oakland, CA, and one attendee has provided a brief summary that he has agreed to share.

The next “town hall” meeting will be in Cleveland, OH, on May 3, 2012, which I plan to attend. The IRS will also hold a “phone forum” on May 15. With regard to formal comments, these are due by June 18, 2012, and there will be a public hearing in Washington, DC on July 9, 2012. Requests to testify, as well as an outline of comments, are also required to be filed by the June 18th deadline.

NCTR and NASRA will be developing joint comments that will focus primarily on administrative issues involved with the proposal, including transition rules, grandfathering and de minimus rules, and safe harbors. However, individual systems are strongly encouraged to consider filing comments where it appears that specific issues will arise, providing examples and explaining the impact on the individual plan. It will be during this current comment period that there will be the greatest chance to make an impact on the drafting of these regulations, so please do not wait until actual proposed regulation are issued before you comment.

Comments can be viewed on the new “regulations.gov” website which is now used for submitting and viewing electronic submissions. There have already been 1,869 comments filed, most from individuals related to the treatment of charter schools. (I find this site very difficult to use; be sure to select “public submissions” as the “Document Type,” and then click on “organization,” which will sort the submissions alphabetically by organization, with submissions from individuals listed at the end. But be forewarned: it is slow going.)

Comment letters to date from public plans include filings from the Illinois Municipal Retirement Fund; the Kentucky Retirement Systems; the Orange County Retirement System; the Oklahoma Municipal Retirement Fund; the Public Employee System of Idaho; and the San Bernardino County Employees’ Retirement System. The law firm of Ice Miller has also prepared a suggested format for such comments that you may wish to consider.

Summary of Oakland IRS Town Hall Meeting


Outline of Oakland Comments of Terry Mumford, Ice Miller

Possible Letter Format

What's Happening with Normal Retirement Age Regs? An Update

As things currently stand, in just over 10 months, governmental pension plans will be required to comply with regulations issued in final form by the Internal Revenue Service (IRS) in 2007 dealing with distributions from a pension plan upon attainment of normal retirement age.   The IRS and Treasury have stated for the last several years that they would address serious public plan concerns with these regulations as they relate to the use of service as a component in determining the earliest age or date when a participant can retire with an unreduced benefit.  However, despite very recent assurances that this long-awaited “fix” was imminent, there still has yet to be a formal release issued.  Many state legislatures are already meeting, and if changes are required to be made, time is running out.  While it is still hoped this issue can be resolved through the regulatory channel at Treasury and the IRS -- thus obviating the need for state changes -- Federal legislation has now been introduced in the House of Representatives to resolve the problem.  But there is no guarantee that Congress will act on such legislation before the end of this year.

Background

These so-called Normal Retirement Age (NRA) regulations were made applicable to private plans immediately upon their issuance in May of 2007, but public plans were given two years to make any necessary amendments to their laws and regulations.  Thus, the NRA regulations were originally to have been effective for plan years beginning on or after January 1, 2009, for governmental pension systems.   This effective date has been extended twice, and is now set to take effect for plan years beginning on or after January 1, 2013.

The IRS regulations reflect a change made by the Pension Protection Act (PPA) of 2006 that provides an exception to the general plan qualification rule that pension benefits can be paid only after retirement.  This PPA exception permits a pension plan to commence payment of retirement benefits to an employee who is not separated from employment at the time of such distribution (known as an “in-service distribution”) as long as the employee has attained age 62.

However, the IRS also used this opportunity to (1) “clarify” that a pension plan is also permitted to make such in-service distributions after the participant has attained “normal retirement age;” and (2) provide rules on how low a plan’s normal retirement age is permitted to be.  

Specifically, the new regulations require a pension plan’s normal retirement age to 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.”  This is an effort by the IRS to prevent a normal retirement age from being set so low as to be a subterfuge to avoid the qualification requirements that, essentially, the benefit be truly related to retirement.

Several safe harbors are also provided in the regulations:

·    a normal retirement age of 62 or later (or age 50 or later, in the case of a plan in which substantially all of the participants are qualified public safety employees) is deemed to pass muster;

·    a normal retirement age lower than 55 (or 50 in the case of public employees) is presumed not to satisfy the requirement unless shown otherwise on the basis of facts and circumstances;

·    a normal retirement age that is at least 55 but below 62 is presumed to be 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.”     

Significantly, the 2007 regulations do not provide a safe harbor (or other guidance) with respect to a normal retirement age that is conditioned (directly or indirectly) on the completion of a stated number of years of service, as is the case with many if not most public plans.   In a notice (IRS Notice 2007-69) issued in August of 2007, the IRS and Treasury explained that the reason for this is because they expect that a private sector plan under which a participant’s normal retirement age changes to an earlier date upon completion of a stated number of years of service typically will not satisfy the ERISA vesting rules (found in Section 411 of the Internal Revenue Code). 

But what about public plans?  While the IRS noted at the time that sponsors of governmental plans were not subject to these Section 411 vesting rules, they nevertheless asked governmental plans to submit comments on whether normal retirement age under such a governmental plan may be based on years of service.  

Specifically, they asked for comments on:

·    whether and how a pension plan with a normal retirement age conditioned on the completion of a stated number of years of service satisfies the requirement , in order to be a qualified plan under IRC Section 401(a), that a pension plan be maintained primarily to provide for the payment of definitely determinable benefits after retirement or attainment of normal retirement age; and

·     how such a plan satisfies the pre-ERISA vesting rules.

Public Plan Issues

Many governmental plans define normal retirement “age” as more a normal retirement “date.”  That is, the plan formula provides the time or times when participants qualify for unreduced retirement benefits under the plan, often based wholly or partly on years of service.  

If the IRS decides that the use of a normal retirement age conditioned (directly or indirectly) on the completion of a stated number of years of service does not meet the plan qualification standards described in IRC Section 401(a) and/or does not meet the pre-ERISA vesting rules, then all governmental pension plans will be required to specifically define a normal retirement age as a single “age.”   This could prove to be very difficult to do, particularly when a participant can reach normal retirement age by satisfying one of several age and service combinations.   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.

Furthermore, even where there may be a true normal retirement “age,” if it is less than age 62, then the safe harbors that the IRS provides will be inadequate in many ways.  For example, it is very 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.

NCTR and NASRA filed lengthy formal comments with the IRS in December of 2007 in response to these issues, underscoring that governmental pension plan sponsors have, for many decades, conditioned eligibility for normal retirement benefits on the completion of a stated number of years of service and many have defined normal retirement age as the time the participant becomes eligible for normal retirement.   Indeed, prior to these new regulations, there was no reason to believe that such a practice was prohibited, at least for governmental plans, and in the past, the IRS has routinely approved service-based normal retirement ages through the determination letter process.

NCTR, NASRA and other public sector organizations have also held numerous meetings with the Treasury Department and the IRS over the last several years to discuss the issues with the regulations as currently drafted, the most recent of which was on January 26, 2012.

Current Status

Treasury and the IRS continue to say that a resolution of the issues involving the NRA regulations is “imminent.”  Furthermore, in our last meeting with them, they suggested that they thought the public sector would be generally pleased with the outcome, although no details were shared as to what that outcome might look like.

Here is a somewhat educated guess.  First, in response to increased pressure to complete the processing of determination letters from Cycles C and E, some of which are apparently being held up over this matter, a statement could be forthcoming that will allow the issuance of such letters with the understanding that, based on a final resolution of the regulations,  results could be different going forward.   For example, the log-jam might be broken for all but plans with NRAs based wholly on service, (perhaps with an exception for public safety plans)? 

Then, revised regulations applicable to governmental plans would be issued for comment, with an extension of the effective date of 1/1/2013 in order to accommodate this process.  The reason for this prediction is that in answer to repeated inquiries, we have been told that whatever is proposed will not be in final form, as were the regulations for the public sector in 2007, and that comments would be sought.

In the meantime, there is now legislation introduced in Congress that would address this issue as well.  The legislation is HR 3561, the Small Business Pension Promotion Act of 2011, introduced by Congressmen Ron Kind (D-WI), Jim Gerlach (R-PA), and Richard Neal (D-MA) on December 5, 2011.  All three are members of the House Ways and Means Committee, to which the bill has been referred. 

The legislation is primarily designed to adjust regulations for required distributions from employee pensions, allowing certain deductions for contributions to individual retirement accounts (IRAs), and permitting companies to contribute more to pension plans without penalties.   Congressman Kind describes it as helping to “put our small businesses on a level playing field with larger corporations by providing small business employees access to retirement and pension accounts as well as tax deductions related to those accounts, in the same sense as those available to larger, corporate employees.”

In addition, the legislation contains a provision to address problems with the 2007 NRA regulations as applied to rural electric cooperatives.  While NCTR and other public sector organizations continue to hope that our discussions with Treasury and the IRS will lead to a productive regulatory resolution to our concerns in this area, we felt that we could not permit a bipartisan piece of legislation sponsored by three members of the Ways and Means Committee to advance with provisions related to the workings of the normal retirement age regulations that did not also address our specific concerns. 

We therefore worked with the three Congressmen’s offices to include language dealing with this problem in Section 7(a)(2), “SERVICE-BASED RETIREMENTS IN GOVERNMENTAL PLANS”.  We also made sure that Treasury and the IRS were aware of our efforts and that we in no way were indicating that we believed that discussions with them should not proceed.   In a letter from NCTR and 18 other national organizations to Congressman Kind offering support for his bill, this point was stressed:  “Our representatives have been working with the IRS and other Treasury Department officials for the last several years in an effort to favorably resolve this matter, and understand they may soon be modifying the regulation.  While we hope the full extent of our concerns will be addressed, nevertheless, with the pending application of the IRS regulations now less than one year away, we greatly appreciate your readying legislation to properly remedy the harmful effects of the pending regulation.”     

The goal of the governmental plan provision in HR 3561 is to ensure the following:

1.         State and local retirement plans may have service-based normal retirement ages, either implied or implicit.  Service-based normal retirement ages include, but are not limited to, a specified length of service (i.e., 30 years), combinations of years of service and age (such as the rules of 80 or 90), and requirements that participants reach a specific age and meet a years of service requirement (i.e., reach age 60 with 10 years of service or 65 with five years of service).

2.         The Treasury Department must amend its regulations on normal retirement age to:

a.  Recognize that the definition of normal retirement age for state and local 
     retirement plans  is found in state and local law;

b.  Provide that a governmental plan with a normal retirement age conditioned on the completion of a stated number of years of service (i) satisfies the requirements of Internal Revenue Service Regulation §1.401(a)-1(b)(1)(i) that a pension plan be maintained primarily to provide for the payment of definitely determinable benefits after retirement or attainment of normal retirement age, and (ii) satisfies the pre-ERISA vesting rules; and

c.  Provide that the safe harbor provisions found in the May 2007regulations solely relate to in-service distributions, so as to not supersede the state and local-based definitions of normal retirement age, and must additionally recognize the unique nature of state and local retirement plans and their workforces.

In summary, although time is running short, it does appear that the Treasury Department and the IRS are aware of the legislative pressures facing public plans, and will soon release for comment proposed new regulations dealing with the meaning of “normal retirement age” as applied to governmental plans.  It may well be that this release will be accompanied by another extension of the application of the regulations in order to accommodate this process.  While it is still unclear as to what the new regulations will contain, Treasury has been provided with the language of the Kind bill, and has also been provided with the above “plain English” description of what the public sector intends to accomplish with this language.  While they did not state agreement with it, they did not react negatively.

Difficult tea leaves to read, but it does appear that there could soon be movement on this front, and if there is not, or if it falls far short of what has been discussed over the last several years, legislation is now in the hopper that would address the problem.  While it will be difficult for such a bill to advance this year as a free-standing bill due to the impact of the fall elections on the legislative process, it should be reintroduced in the 113^th Congress, when tax reform legislation is likely to advance, regardless of the outcome in November.

·         NCTR/NASRA 2007 Comment letter on NRA Regulations

·         HR 3651

·         Letter to Congressman Kind Supporting HR 3561

GASB Update: Report by the Center for Retirement Research at Boston College, entitled “How Would GASB Proposals Affect State and Local Pension Reporting"

The recent report by the Center for Retirement Research (CRR) at Boston College, entitled “How Would GASB Proposals Affect State and Local Pension Reporting,” contains an appendix that has been creating some confusion and concern.  Specifically, Appendix B shows a column listing the year in which each of the 126 plans covered in the report will run out of money.   As I noted in my posting, these dates are not actual projections by CRR of when a plan will become insolvent.  

In an effort to further clarify the situation, PensionDialog discussed these dates with CRR and has posted its interview, which notes that: 

• These dates are not reflective of an ongoing plan, and are intended only for use in implementing GASB’s particular liability concept; 
• The methodology used to calculate the “run-out” dates was GASB’s, based on an accounting method that does not accurately portray all aspects of an ongoing plan; and
• Purported exhaustion dates previously developed by CRR in March of 2011 (and also found in Appendix B) present a “worst-case” scenario.

 The full interview can be found here.

Happy Holidays? 3% Withholding Law Repealed and State Legislature Opposes PEPTA, but New JEC Report Suggests Stormy Weather Ahead

PRESIDENT SIGNS REPEAL OF 3% NON-WAGE WITHHOLDING LAW

As expected, on November 16, 2011, the House of Representatives agreed to the Senate’s changes to H.R. 674, legislation to repeal the imposition of a 3 percent withholding on each payment of $10,000 or more for property and services made to vendors by governmental entities, including public pension plans.  Five days later, on November 21^st, President Obama signed the bill into law (PL 112-056).

Adopted at the last minute in 2006 in conference committee, and delayed on several occasions thereafter, the withholding requirement was to have begun applying in 2013 to all payments made by most governmental pension plans for goods or services, but not benefits.  The withheld amounts were to be a credit against the tax liability of the recipient of the payment, and were to be shown on an information return after the end of the tax year, similar to backup withholding or withholding on wages.

Repeal of the withholding requirement was one of NCTR’s major legislative goals, as it would impose administrative burdens, increased technology costs, and could also result in higher prices as vendors attempted to deal with its impact.  Efforts to do away with the mandate therefore began almost as soon as it became law.  These were led by the National Association of State Auditors, Comptrollers and Treasurers (NASACT).  

However, despite significant advances toward repeal, it was not until the Chamber of Commerce made it a priority and flooded Congressional offices with letters from businesses large and small calling for terminating the requirement that interest in repeal began to increase substantially. 

And when doctors realized that the definition of government contractors would include physicians who bill Medicare for health services, things really began to pick up.  (While most individual payments for physicians would not reach the $10,000 per payment threshold imposed by regulation, some health practices aggregate claims, and could therefore exceed that threshold.)  The American Medical Association and several other healthcare organizations warned Congress that the withholding requirement would cause cash-flow problems at practices and facilities if it were to be implemented.

In addition to repeal of the withholding mandate, the new law provides:

•  tax credits for veterans hiring; 
•  a Treasury study of tax delinquency among Federal contractors; 
• a technical clarification about the application of the existing federal levy program to reflect Congressional intent that payments for property can be levied along with payments for goods and services.

The repeal is expected to “cost” the Federal government about $11 billion in lost revenues that would have been gained by the withholding provision.  This loss was offset by closing what was considered to be a coverage loophole in the “Patient Protection and Affordable Care Act,” the Obama healthcare reform law passed in 2010.  Under that law, some people with annual incomes up to about $60,000 might have become eligible for Medicaid when the program expands in 2014 because the healthcare reform law did not count Social Security benefits toward Medicaid income eligibility.  The withholding repeal fixes this and the revenue that will be saved by this Medicaid modification will then be used to offset the loss from the withholding repeal.

PEPTA UPDATE:  STATE INSURANCE LEGISLATORS ADOPT RESOLUTION OPPOSING PEPTA, BUT JOINT ECONOMIC COMMITTEE STAFF REPORT HINTS AT POSSIBLY MORE CONGRESSIONAL REVIEW

At their annual meeting in November of 2011,  the National Conference of Insurance Legislators (NCOIL) approved a resolution in opposition to the “Public Employee Pension Transparency Act" (PEPTA), introduced as H.R. 567 in the House of Representatives by Congressman Devin Nunes (R-CA) and in the Senate as S. 347 by Senator Richard Burr (R-NC).  (NCOIL is an organization of state legislators whose main area of public policy concern is insurance legislation and regulation. Many legislators active in NCOIL either chair or are members of the committees responsible for insurance legislation in their respective state houses across the country.)

New NCOIL President Senator Carroll Leavell (R-NM), the sponsor of the resolution along with NCOIL Past President Representative Kathie Keenan (D-VT), said that the bill had “big brother undertones” that are “too much for those of us that have worked hard in the states to protect the retirement security of our constituents and to make sure hard-earned taxpayer dollars are used wisely.”  Senator Leavell said that “We do not need the distant Federal government to insert itself into state and local pension plan decisions.”

The action by NCOIL’s executive committee came three days after their Financial Services & Investment Products Committee voted fifteen to one in support of the resolution following a presentation by NCTR’s Director of Federal Relations encouraging them to oppose PEPTA and answering legislators’ questions concerning the Federal legislation.  The Financial Services Committee also approved a 2012 charge to monitor state and federal pension reform initiatives, so the issue will remain on their radar.

In addition to opposing PEPTA, the NCOIL resolution calls on Congress to let state and local officials manage their own unique pension systems.  Among other things, the resolution argues that PEPTA would unnecessarily inject the Federal government into the administration of state and local pension plans and would threaten funding for state and local government projects by conditioning continued tax benefits for government bonds on plan compliance with new federally directed reporting requirements.

As far as PEPTA’s current status is concerned, there have been no further hearings dealing with the subject in the House of Representatives since the May 5, 2011, hearing on “Transparency and Funding of State and Local Pension Plans” by the House Committee on Ways and Means’ Oversight Subcommittee.  That was the fifth hearing in the House in 2011 that examined the PEPTA legislative proposal either directly or indirectly.  There were no Senate hearings on the subject in 2011.

H.R. 567 has a total of 51 cosponsors; none have signed onto the bill since May 10, 2011.   In the Senate, S. 347 has 8 cosponsors, with the latest, Senator Kirk (R-IL) having signed up on July 27, 2011.   As 2012 will be the second session of the 112^th Congress, the two bills are still pending and do not need to be reintroduced. 

While no further action has yet to be scheduled, the Republican staff of the Joint Economic Committee (JEC) issued a staff commentary in December of 2011 entitled "States of Bankruptcy Part I: The Coming State Pensions Crisis."   Relying almost exclusively on work by Professors Joshua Rauh and Robert Novy-Marx, this report claims that " a number of plans are projected to run out of money in just over five years based on private sector accounting standards" and that the combination of massive unfunded pension liabilities and poor economic policies "are setting many states up for a Greek-style fiscal death spiral."  The report concludes by stating that "the state pension crisis is virtually unavoidable" but that the federal government's role in "bearing the burden of irresponsible states" can be mitigated through "preemptive actions that will help prevent a taxpayer bailout of state pension systems," no doubt a lightly-veiled reference to the “PEPTA" legislation.

Senator Jim DeMint (R-SC), a member of the JEC, also was quoted in the press in connection with the GOP staff report, saying that “The deeper we get into this research, the clearer it becomes that federal legislation may be necessary to force states to use honest accounting, fix their pension debt and protect taxpayers from the mother of all bailouts."  In addition, the JEC commentary also notes that there will be “future reports” that will examine “the prospects for pension reform (including promising measures to confront existing unfunded liabilities and to establish fully sustainable pension plans).”  This suggests that another round of Congressional hearings on state and local governmental pensions could be in the works, perhaps in connection with these subsequent JEC Republican staff reports.

·         NCOIL Press Release on Opposition to PEPTA

·         NCOIL Resolution Opposing PEPTA

·         JEC GOP Staff Commentary on State Pensions