New PEW Report Relies on FY 2010 Data, Presents Flawed Picture of Current State of Public Pensions

New PEW Report Relies on FY 2010 Data, Presents Flawed Picture of Current State of Public Pensions
On June 18, 2012, the Pew Center on the States released an update to their report, "The Widening Gap," which addresses state liabilities and costs for pensions and retiree health care benefits. The report asserts that States “continue to lose ground in their efforts to cover the long-term costs of their employees’ pensions and retiree health care,” and that in fiscal year 2010, states were $1.38 trillion short of having saved enough to pay their “retirement bills,” a nine percent increase from the year before, according to Pew.

However, the Pew report’s analysis uses old data that fails to reflect recent market gains.  As Keith Brainard, NASRA’s Director of Research, points out, by relying on FY 2010 data, “the dates the Pew study is using to measure the condition of many public pension plans are near the low point of the recent investment market decline.” Nearly one-half of plans in the NCTR/NASRA Public Fund Survey have an actuarial valuation date that pre-dates their fiscal year-end date, usually by one year, Keith notes.

Also, in order to arrive at the $1.38 trillion figure, Pew once again combines pensions with retiree healthcare.  As NCTR and NASRA have noted in the past, retiree healthcare cost containment options, financing structures and benefit protections are entirely different from those of pensions.  Pew’s decision to couple retiree healthcare with pension liabilities distracts from the issues States face with these very different benefits.

Finally, as Pew itself notes, its report does not reflect the many actions that States have taken in 2010 and 2011 to address plan sustainability, including benefit cuts.  The condition of some states “may have improved because of those reforms,” Pew concedes.

PensionDialog was quick to point out these flaws.  In a June 20^th post, Ady Dewey stresses that the Pew report is nothing more than a snapshot in time, “a single frame out of a feature film that runs for decades.”  Is it any wonder that, using data from the bottom of the market decline, public pension funding levels were lower, she asks?  “It’s also no surprise that states had difficulty making their full pension contributions as revenues declined sharply in 2009 and 2010,” she notes.

PensionDialog suggests that another snapshot should be considered:  according to the Federal Reserve, in the first quarter of 2012, public pension plan assets rose to $3.1 trillion, which is up from $2.8 trillion in the fourth quarter of 2011, taking assets above $3 trillion for the first time since 2008.  Ms. Dewey suggests that a report can be helpful as long as it is recognized for what it reflects: a static moment in time.  “When it comes to public pensions, a series of multiple snapshots, taken with a long-range lens, is going to provide a more accurate perspective of their condition and sustainability,” she concludes.

The National Institute on Retirement Security (NIRS) picked up on the PensionDialog “snapshot” analogy a few days later.  In a “Commentary” posted by Diane Oakley, NIRS’ Executive Director, on June 22^nd, she observes that “Flipping through old photo album provides a view of where we have traveled, but it certainly doesn’t tell us where we are today.”  “The same can be said of the recent Pew Center on the States ‘new’ report on public pension plans,” she asserts.

Ms. Oakley also notes the use of 2009 data and the failure to reflect the changes that have been made in 41 states since then.  In contrast to the Pew study, she references a May, 2012, Boston College Center for Retirement Research (CRR) report that finds, using moderate economic assumptions, that aggregate pension funding is projected to cross over the 80 percent level in 2015, without taking into account the pension reforms passed by the 41 states.   “Fine tuning may still be needed, but we are making progress,” Ms. Oakley points out.  “This is not reflected in the limited snapshot provided by the Pew study,” she concludes. 

The Pew report also garnered some attention from the media.  However, not all coverage was negative with regard to public pensions.  For example, an article by Mark Miller with Reuters notes the Pew report findings, but argues that while pensions are consuming a larger share of some state and local budgets -- and many plans also took major hits in the 2008 crash, with returns since then hurt by low interest rates -- there are five things to keep in mind about public sector pensions “before we continue swinging the axe.”  According to Miller, these are:

1.       Pensions aren't simply a gift from taxpayers.

2.       Many workers don't get Social Security.

3.       Pension underfunding isn't as bad as you think.

4.       Pensions are more efficient than 401(k)s.

5.       The retirement crisis is real.

The Pew report also assesses each state’s management of its pension and retiree health care obligations as of fiscal year 2010 based on funding levels and contribution policies.  States were rated as "solid performer," "needs improvement," or "serious concerns."  Pew rated 11 states as “solid performers” in managing their pension obligations in fiscal year 2010; 8 needed improvement; and the 32 remaining states, all of which were less than 80 percent funded according to Pew, were judged to be in the “serious concerns” group.

·         Pew’s “The Widening Gap Update”

·         PensionDialog:  “Capturing a Snapshot in Time”

·         NIRS Commentary:  “The Pew Pension Report: A Snapshot Leads to a Flawed Rating System”

·         CRR Report:  “The Funding of State and Local Pensions: 2011-2015”

·         “Five Things to Consider Before Cutting Pension Benefits”

 DELAY CLAIMING SOCIAL SECURITY BENEFITS -- A SMART IDEA? 

Is waiting to claim your Social Security benefit in order to obtain a higher monthly benefit at an older age -- using your savings in the interim to pay current expenses – a good strategy?  According to a new Issue brief from the Center for Retirement Research (CRR) at Boston College, the answer is essentially yes.  Effectively “buying an annuity” from Social Security -- the savings used is the “price” and the increase in monthly benefits is the annuity it “buys” -- is especially attractive in today’s low interest rate environment, according to the brief, which finds that this Social Security option “presents an effective, and often overlooked, drawdown strategy that households should seriously consider.”

Indeed, CRR says that it is “the best deal in town.”

Why?  CRR gives several reasons:

1.       When interest rates are low, as they are now, living on interest income is “essentially impossible,” particularly when these rates are less than the rate of inflation;  

2.       Basing an income on a portfolio of stocks and bonds is also not very practical since bond interest rates are low and “any increase would reduce the value of the bonds retirees hold;” and

3.       Commercial annuities funded by bonds “also provide much less income than they would in ‘nor-mal’ times.”

By contrast, the additional income available by delaying claiming Social Security is not affected by current interest rates, CRR notes.  Furthermore, the “annuity rates” for using savings to delay claiming Social Security benefits are much higher than drawdown rates from stock and bond portfolios, and uniformly higher than current rates on commercial inflation-protected annuities.  

Thus, CRR claims, the ability to “buy an annuity” from Social Security at these rates “provides a critical safety net against the risk of retiring when interest rates are low.”  It should also be noted, however, that a key limitation on the use of Social Security as a source of retirement income is the inability to delay claiming past age 70.   

·         CRR Issuebrief:  “Should you buy an annuity fromSocial Security?”

PUBLIC EMPLOYEES:  IN THE NEWS AND UNDER THE GUN

As public employees continue to be the focus of political maneuverings in many State capitols as well as in Washington, DC, a new updated report from the Center on Budget and Policy Priorities (CBPP) and a blog post by its author, Elizabeth McNichol – who spoke at the 2011 NCTR Annual Convention – remind readers of “Five Important Facts about Public Employees.” 

1.     Elementary and secondary education comprises — by far — the largest share of state and local government employees.

2.     The public workforce has grown only modestly as a share of the population over the last three decades.

3.       Public-sector workers earn less in wages than their private-sector counterparts.

4.     Counting both wages and benefits, public-sector workers on average still earn less than their private-sector counterparts, though the gap is smaller.

5.       Labor costs make up a significant share of state and local spending.

The CBPP is a well-respected Washington think-tank founded in 1981 to analyze federal budget priorities, with particular emphasis on the impact of various budget choices on low-income Americans.  It has been referred to by Congressional Quarterly Today as being “socially liberal, fiscally conservative, and academically rigorous.”

The CBPP report, “Some Basic Facts on State and Local Government Workers,” was updated on June 15, 2012.  It contains key statistics about state and local employees which are always good to have at hand.

Ms. McNichol is a Senior Fellow at the CBPP.  She is also the co-author, along with Iris Lav, of a paper entitled “A Common-Sense Strategy for Fixing State Pension Problems in Tough Economic Times,” issued by the CBPP in May of 2011, which argued that it would be “extremely difficult, as well as unnecessary, for states to immediately begin fully funding their pension shortfalls.  State economies and budgets continue to struggle because of shrunken revenues and rising needs. The long-term pension shortfalls are not the cause of the current state fiscal problems, and addressing them need not overwhelm state and local budgets now or reduce states’ ability to recruit and retain a high-quality workforce.”

·         “Five Important Facts about Public Employees”

·          “Some Basic Facts on State andLocal Government Workers”

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.