Federal E-News

July/August/September 2008

Massive Market Bailout Becomes Law -- What Does it Mean for Public Plans?
Congressional Roundtable on IRS Governmental Plans Initiative Held; Public Plans Call for Collaborative Process, More Guidance
Mixed News on NCTR “Must-Do” Issues for 2008
The Latest on MVL: Academy of Actuaries Ponders “Public Interest” Statement While State, Local Government Organizations and Plans Formally Oppose MVL-Related Changes to Actuarial Standards.
H ouse Passes New Commodities Legislation But Ban on Institutional Investors Not Included
PCAOB Constitutional, Appeals Court Rules
New GAO Report on Hedge Fund Investing by Pension Plans May Prove Helpful for Public Sector
DB Plans Much More Cost-Efficient Than DC, Report Finds
GAO Finds Millions Affected by Pension Freezes
New Reports on State, Local Governments’ Retiree Health Programs Paint Mixed Picture of “Fiscal Crisis”
SEC Finds Flaws at Credit Rating Agencies

NCTR's Federal e-News provides important information on the issues and events in Washington, D.C. that may impact NCTR members. For more information, contact Leigh Snell, NCTR's Director of Federal Relations, at (703) 684-5236 or Leigh Snell.

Massive Market Bailout Becomes Law -- What Does it Mean for Public Plans?

Following a roller coaster week, during which the Dow Jones industrial average lost 777.68 points -- the largest single-day point loss ever, wiping out approximately $1.2 trillion in market value -- Congress finally adopted a massive “Emergency Economic Stabilization” bill that President Bush promptly signed into law. Several provisions are of interest to public plans, including the possibility of participating in the new “Troubled Asset Relief Program” (TARP). The measure also contains provisions addressing executive compensation for participating companies. While earlier versions also included access to the proxy and “say on pay” voting, these provisions were stripped from the final measure. However, the focus on them during debate on the huge bailout bill may have set the table for their consideration in the next Congress.

Congressional Roundtable on IRS Governmental Plans Initiative Held; Public Plans Call for Collaborative Process, More Guidance

Key members of the House Ways and Means Committee hosted a Congressional Roundtable to discuss the new Governmental Plans Compliance Initiative announced earlier this year by the Internal Revenue Service (IRS). Representatives of State and local governments, public plans, and employee organizations were present, as were top pension officials from the IRS and the Treasury Department. The IRS announced that it was ready to move forward with its survey of selected governmental plans, while the public pension community called instead for an orderly, collaborative process that would focus on much-needed guidance before any enforcement-related efforts were initiated. In the end, a delay of the IRS survey was suggested by Congressman Earl Pomeroy (D-ND) in order for governmental plans to review and discuss the questionnaire to be used, and to hopefully develop a working relationship with the IRS on this new compliance effort. There were also hints of a possible extension of the current Cycle C determination letter process.

Mixed News on NCTR “Must-Do” Issues for 2008

While it appears that the Treasury Department is poised to provide relief from the impending application of its Normal Retirement Age regulations, otherwise set to take effect for governmental plans in 2009, Congress left town for the November elections without completing action on technical corrections to the Pension Protection Act of 2006 (PPA), including the public sector “credited interest” amendment. However, with plans to apparently return for a “lame duck” session the week of November 17, 2008, the 110th Congress may yet approve this much-needed provision before it adjourns for good.

The Latest on MVL: Academy of Actuaries Ponders “Public Interest” Statement While State, Local Government Organizations and Plans Formally Oppose MVL-Related Changes to Actuarial Standards.

The American Academy of Actuaries held a public forum to help them decide if it was in the public interest for the organization to take a position on MVL disclosure. Even though NCTR, NASRA and every governmental plan director who asked to present oral testimony were turned down, the public sector’s strong opposition to MVL was heard loud and clear nevertheless. In the meantime, a record number of governmental plans, as well as nineteen national public sector organizations, have submitted group letters to the Actuarial Standards Board (ASB) opposing any changes in ASB’s standards of practice for public pension plans that are based on financial economics. A decision by the Academy on taking a position concerning MVL could come at their next board meeting on October 7th; any ASB decision on this subject is expected to take much, much longer.

House Passes New Commodities Legislation But Ban on Institutional Investors Not Included

In late July, in the days just before Congress left for its August break, renewed efforts were made to prohibit institutional investors, including public pension funds, from making “speculative” investments in certain energy commodities. A House Agriculture Committee bill would have imposed such a ban, but the provision was removed in mark-up. When Congress returned from its summer recess in September, a Commodities bill subsequently passed the House. While the legislation would create new hurdles for pension funds investing in commodities, no outright ban was included. The Senate is not expected to act on the measure prior to adjournment, and even if it did, the White House has signaled that President Bush would veto the measure.

PCAOB Constitutional, Appeals Court Rules

A Federal appeals court ruled in August that the Public Company Accounting Oversight Board (PCAOB) is constitutional. At issue was whether Title I of the Sarbanes-Oxley Act (which created the PCAOB) provided adequate Presidential control of the Board. The D.C. Circuit Court, with one Judge dissenting, held that there was no violation of the Appointments Clause of the Constitution or separation of powers. However, it appears that the issue will probably end up before the U.S. Supreme Court, where it might not fare as well as it did in the lower courts.

New GAO Report on Hedge Fund Investing by Pension Plans May Prove Helpful for Public Sector

The Government Accountability Office (GAO) continues to provide solid support for public pension funds, concluding in Congressional testimony in July that the “funded status of state and local government pensions overall is reasonably sound.” A subsequent report examining pension fund investments in alternatives also reported favorably on the level of oversight and accountability exercised by State and local governments over their pension plans’ investments. However, the so-called “hedge fund” report also called for increased guidance from the Department of Labor to corporate pensions investing in hedge funds and private equity, saying plan sponsors may not understand all the risks involved in such strategies. Some in Congress have argued in the past that pension fund investments in hedge funds may be inappropriate and that perhaps there should be some restrictions placed on such activity by the Federal government. The new GAO report should be helpful in demonstrating that such actions are unnecessary for the public sector.

DB Plans Much More Cost-Efficient Than DC, Report Finds

According to a new study by the National Institute on Retirement Security (NIRS), a defined benefit pension plan can provide the same retirement income as a defined contribution plan at just over half the cost. Governing magazine calls the report a “401(k) eye-opener.” Beth Almeida, NIRS’ Executive Director, says that the analysis “is a myth buster of the conventional wisdom on the cost of retirement plans.”

GAO Finds Millions Affected by Pension Freezes

More than one fifth of participants in private sector defined benefit pension plans are affected by pension freezes, according to a Government Accountability Office (GAO) study released in July. Furthermore, the GAO says that “a freeze generally implies a reduction in anticipated future retirement benefits." Many blame the freezes on new private sector funding rules contained in the Pension Protection Act of 2006 (PPA) that are based on MVL standards. Volatility in funding, produced in large part by using MVL as the basis for measuring liabilities, was found to be a major reason for the freezes.

New Reports on State, Local Governments’ Retiree Health Programs Paint Mixed Picture of “Fiscal Crisis”

Three new reports from the Center for State and Local Government Excellence issued in July and September reveal that the picture with regard to retiree health care programs at the State and local level is not uniform. “Although there are wide-spread reports of a major fiscal crisis,” the first report notes, “the reality is that some states face a fiscal crisis while others do not.” The second report analyzes the key assumptions actuaries use to estimate a government’s retiree health costs, while the third presents a review of the differences and similarities among health plans on a state-by-state basis.

SEC Finds Flaws at Credit Rating Agencies

According to Securities and Exchange Commission (SEC) Chairman Chris Cox, the SEC’s investigation of the activities of the nation’s three major credit reporting agencies in rating subprime residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) linked to subprime RMBS has found “significant shortcomings.” However, the SEC said that it was providing its report “ solely to provide transparency to the ratings process and the activities of the rating agencies in connection with the recent subprime mortgage turmoil,” and that it was not making recommendations or seeking to “regulate the substance of the methodologies used.” Instead, the SEC has proposed new rules for credit rating agencies to “improve investor understanding of credit ratings through enhanced disclosure of credit rating agency methods and performance data, and to promote investor confidence in credit ratings by minimizing conflicts of interest." The SEC has also proposed changes in its own procedures to “ensure that the role we assign to ratings in our rules is consistent with the objective of having investors make an independent judgment of the risks associated with a particular security," Chairman Cox has explained.

Massive Market Bailout Becomes Law -- What Does it Mean for Public Plans?

After the House of Representatives refused to approve the initial bailout proposal on Monday, September 29th, the Senate made some modifications to the language – chief among them an increase in the FDIC and the National Credit Union Share Insurance Fund deposit insurance limits from $100,000 per account to $250,000 until December 31, 2009. The Senate then took the bailout provisions and bundled them with the so-called “tax extender” legislation as part of one big omnibus package in an effort to make it more attractive to House Republicans, who wanted to see a number of expired business and energy tax breaks extended. A fix to the Alternative Minimum Tax (AMT) was also included, and the legislation (H.R. 1424) was subsequently approved by the Senate by a vote of 74 to 25 on October 1st, and then by the House, 263 to 171, on October 3rd. President Bush signed it that same day.

While NCTR took no formal position on the legislation, it issued a joint statement with NASRA making it clear that “State and local retirement systems remain sound amid the current downturn in financial markets, and retirement benefits of the nation’s teachers, firefighters, police officers and other public workers remain safe and secure.” The statement was well-received on Capitol Hill, where it was found to be “very helpful.”

Under the new law, the Secretary of the Treasury is granted sweeping new powers to purchase up to $700 billion in troubled assets from financial institutions through a new entity, the “Troubled Asset Relief Program,” or TARP. The TARP will be administered by the Treasury Department in consultation with the Board of Governors of the Federal Reserve System, the FDIC, the Comptroller of the Currency, the Director of the Office of Thrift Supervision and the Secretary of Housing and Urban Development. In a nod to House GOP demands, the Treasury Secretary is also required to create a program to guarantee troubled assets of financial institutions, establishing risk-based premiums for such guarantees sufficient to cover anticipated claims.

Will governmental plans have access to the new TARP? And what, exactly, will qualify as “troubled assets” eligible for purchase?

First, there is language in the new law that certainly suggests that governmental plan participation in TARP is possible. For example, the definition of “financial institution” is very broad, and does not appear to expressly exclude governmental plans. But perhaps most significantly, in exercising his new powers, the Treasury Secretary is specifically directed to “take into consideration,” among other things, protecting the retirement security of Americans by purchasing troubled assets held by or on behalf of an eligible retirement plan, including governmental qualified plans, 457(b) plans and 403(b) plans.

Such assets are generally defined as “residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages” that were originated or issued on or before March 14, 2008. However, any other “financial instrument” could also be included if the Treasury Secretary, after consulting with the Federal Reserve, determines that its purchase “is necessary to promote financial market stability.” Congress would have to be notified in writing of any such decisions.

So it does appear possible that governmental plans could participate in the new program. However, before you get too excited, it is most important to recognize that this language falls far short of requiring that such purchases be instituted. Also, there is certainly no indication of the kind of situation a plan would have to be in to satisfy a finding that purchasing its troubled assets was necessary in order to “protect retirement security.” Nor is it clear whether any of the other provisions of the new law regarding such purchases from other financial institutions (such as the corporate governance provisions noted below, or others generally requiring the Secretary to obtain warrants or a long-term note from financial institutions, as part of the purchase transaction, to help minimize any potential long-term negative impact on the taxpayer) would apply in the case of purchases from governmental plans.

The new law requires that guidelines for the new program be promptly developed, and it is to be expected that TARP will initially focus on banks and other private sector institutions whose stability is at the heart of the current credit crunch. However, NCTR will be monitoring this new program and its potential impact on pension plans, so stay tuned.

With regard to corporate governance issues, the strict limits on executive compensation, especially so-called ‘golden parachutes,’ that were initially identified as an essential component in any bailout by many Democrats and Republicans alike, were significantly watered down in the final version of the bill. Under the new law, Treasury is to promulgate executive compensation rules governing financial institutions that sell their troubled assets as part of the new law. If assets are purchased directly, then such institutions must observe standards limiting incentives, allowing clawback and prohibiting golden parachutes. If instead Treasury buys assets at auction, an institution that has sold more than $300 million in assets will be subject to additional taxes, including a 20% excise tax on golden parachute payments triggered by events other than retirement, and to tax deduction limits for compensation above $500,000.

In earlier drafts of the legislation, companies that participated in the bailout would have been required to provide (1) access to the corporate proxy for the purpose of nominating and electing boards of directors to any shareholder or group of shareholders holding, in the aggregate, 3 percent or more of the equity securities of the company; and (2) an annual, non-binding “say-on-pay” vote on executive compensation.

However, both of these provisions did not make it into the final law. Nevertheless, the attention that they received, and the willingness of the Congressional leadership to include them in initial drafts of the legislation, certainly suggest that they will be on the table in 2009 as the massive job of restructuring the financial markets and their regulation begins in earnest in the new Congress.

· New Emergency Economic Stabilization Act (see pages 1-110

· Joint NCTR/NASRA Statement

Congressional Roundtable on IRS Governmental Plans Initiative Held; Public Plans Call for Collaborative Process, More Guidance

A Congressional Roundtable on the IRS Governmental Plans Compliance Initiative, originally scheduled for September 10th and subsequently rescheduled due to a conflict with memorial services for the late Congresswoman Stephanie Tubbs Jones (D-OH), finally took place on September 19th. Congressman Pomeroy, a long time supporter of public plans and a member of the Ways and Means Committee, chaired the two-hour meeting, while Ways and Means Committee Chairman Charles Rangel (D-NY) joined via conference call. Minority Committee staff, as well as representatives from numerous individual Ways and Means member offices on both sides of the aisle were also in attendance.

The primary goal of the Congressional Roundtable was to discuss the IRS’ initiative to gather information on, and significantly increase its audits of, governmental pension plans that was announced at an IRS Roundtable in April of this year. (See March/April 2008 NCTR Federal e-News.) A key component of the IRS’ plans has been a questionnaire to be used to survey selected governmental retirement systems (first about 24 plans, and then perhaps as many as 200 to 300 more), which raised a number of concerns when it was first shared with public plan representatives in draft form in May. (See May/June 2008 NCTR Federal e-News.)

NCTR and NASRA subsequently discussed these concerns with House Ways and Means Committee members, pointing out that the IRS does not have sufficient guidance in place for governmental plans in order to begin such audits, has not adequately involved State and local government officials in the process of establishing increased enforcement in this area, and may be getting into areas outside its jurisdiction. As a result, staff to Mr. Pomeroy and Chairman Rangel decided that a Congressional meeting/roundtable would provide a helpful venue to share these concerns and possibly break down misconceptions and distrust between the Service and the public plan community.

Steve Miller, IRS Commissioner of Tax Exempt and Government Entities (TE/GE), began the dialogue by describing the IRS’s interest in pursuing this new initiative. Gone were earlier references and justifications involving stories of funding problems in the media and “failed plans” in California. Instead, he explained that the IRS simply does not know if there are problems with what he estimated are roughly 2,600 governmental defined benefit (DB) plans serving more than 18 million people. He pointed out that few of these plans voluntarily come to the IRS for a check-up, and that given the size and importance of this community, it was his view that the IRS must ensure that government plans are complying with the rules for which the IRS has jurisdiction. He described the planned IRS survey/questionnaire as a form of “self-audit.”

Treasury Benefits Tax Counsel W. Thomas Reeder followed by stating Treasury hoped to provide State and local government stakeholders more opportunities for input in its current tri-agency effort with the Labor Department and the Pension Benefit Guaranty Corporation to provide guidance on the definition of a “governmental plan” under tax code Section 414(d). He made assurances that Treasury would be taking extra steps to allow comments to be received from State and local government stakeholders, including advance notice of proposed rulemaking to get initial comments, followed by proposed regulations, and then the opportunity for further comments before the final regulations were issued.

Representatives from the Governmental Accountability Office (GAO) also participated in the roundtable, sharing their findings in studying state and local government employee retirement system financing, benefit protections and investing. The GAO reports have generally found public plans in good condition in these areas.

Officials from State and local government who were invited as panelists with seats at the Roundtable included NCTR members Dana Bilyeu, director of the Public Employees' Retirement System of Nevada; Tom Lee, director of the New York State Teachers’ Retirement System; Mel Aaronson, treasurer of the United Federation of Teachers and a trustee of the Teachers Retirement System of New York City; and Gary Findlay, director of the Missouri State Employees' Retirement System. Other Roundtable panelists were Nancy Kopp, Treasurer of Maryland; Dan Ebersole, Treasurer of Georgia; Peter Mixon, general counsel for the California Public Employees’ Retirement System (CalPERS); and two private sector attorneys with many public pension clients, Bob Klausner and Bob Blum.

The public sector panelists relayed their appreciation for the roundtable and what they hoped would be the beginning of an ongoing, constructive dialogue with federal officials. They outlined key characteristics within the diverse public plan community, including State and local governance processes, benefit protections (even in extreme situations, such as municipal bankruptcy), public employee representation and transparency in public plans, and the fact that IRS regulation must accommodate both the inherent property rights with regard to public plan benefits as well as the legislative process required to make changes.

The consistent message was that the State and local government community hoped it could work cooperatively with Treasury and IRS in an orderly process to establish clear and appropriate guidelines for public plans prior to enforcement efforts being initiated. The goal was to convince the IRS to change its current questionnaire approach and replace it with a process that is based on more accurate information than would otherwise result from their survey, and which would serve as a sound basis for more detailed written guidance.

Specifically, a guide prepared by the IRS and state administrators of Social Security and Medicare was pointed to as a possible model for such a collaborative effort. This guidance, covering a large percent of the issues for public agencies in this area, is still used today (IRS Publication 963, “Federal-State Reference Guide, a Federal-State Cooperative Publication”).

Commissioner Miller nonetheless stated his strong desire to go forward with the IRS plans to distribute the questionnaire. He promised it had been significantly altered from the original draft shared with public plan representatives, which he admitted was “not ready for prime time.” Even when several roundtable participants as well as Congressman Pomeroy suggested that the Service should get feedback on the new draft before distributing it to plans, Miller stated that the IRS nevertheless strongly wished to get the questionnaire out to the pilot group, while simultaneously making the new draft public and available for comment.

Congressman Pomeroy strongly urged him to reconsider his approach and specifically suggested that a small working group be formed to work with the IRS to review the questionnaire. Congressman Rangel’s staff representative also indicated that she hoped she would be able to report back to the Chairman that some progress had been made instead of simply maintaining the status quo.

The IRS noted they already have advisory committees in place, but Mr. Pomeroy responded by saying these existing committees are apparently not working properly since, if they were, there would have been no need for the Ways and Means Committee to hold this Roundtable to clear the air. When Miller still indicated some reluctance, Congressman Pomeroy succinctly observed that the decision was Miller’s to make, but that he just wanted to remind the Commissioner that “I will be sitting on the dais” when the IRS comes before the Ways and Means Committee in the future.

Subsequent to the meeting, suggestions for a schedule for such consultations was developed and forwarded to Mr. Pomeroy’s office for their consideration and presentation to the IRS. While it focused on the questionnaire, it was designed to hopefully provide the basis for an ongoing working group/task force to engage the IRS and Treasury in a process of developing additional guidance and other compliance assistance as the predicate for any subsequent IRS enforcement efforts.

It was stressed to Mr. Pomeroy’s staff that State and local governments were not seeking special treatment, but rather attempting to model a review process on the collaborative effort that has been underway for many months now between the IRS and the college and university community in connection with a similar questionnaire initiative. According to press reports regarding that project, the IRS has been working to iron out an appropriate questionnaire with them. Lois Lerner, Director of the IRS Exempt Organization Division who works for Commissioner Miller, was quoted as saying that this consultative process helped reveal that the terminology the Service was using “meant something to us, but meant something completely different to the [college and university] community," a concern that NCTR has previously raised in connection with the proposed IRS questionnaire for governmental plans.

Unfortunately, the economic crisis and the involvement of the Ways and Means Committee in the efforts to come up with a legislative response have diverted attention from this effort, and a review process for the questionnaire, and hopefully the establishment of a working group approach, are currently on hold. On a more positive note, the IRS did indicate at the Congressional Roundtable that it was considering either delaying the current determination letter deadline for governmental plans under Cycle C (January 31, 2009), or opening up an additional cycle all together for governmental plan submissions. The IRS also said that it was aware of the need for additional guidance regarding the determination letter process, and pointed to its recently-published “Frequently Asked Questions” (FAQs) in connection with Cycle C as responding to this situation.

Other public sector attendees (but not panelists) at the Congressional Roundtable, in addition to NCTR’s Leigh Snell and Tom Lussier, NASRA’s Jeannine Markoe Raymond, and NCPERS’s Hank Kim, included Eric Stanchfield, director of the District of Columbia Retirement Board; Lance Kjeldgaard, Chief Counsel, San Bernardino County Employees Retirement Association; Patrick McElligott, President of NCPERS and head of the Tacoma, Washington Professional Fire Fighters Local #31; and representatives of the National Association of State Auditors Comptrollers and Treasurers (NASACT), the American Federation of Teachers (AFT), the National Conference of State Legislatures (NCSL), the National Public Pension Coalition (NPPC), the Government Finance Officers Association (GFOA, and the National Association of Government Defined Contribution Administrators (NAGDCA).

* FAQs on Governmental Plans Determination Letters

Mixed News on NCTR “Must-Do” Issues for 2008

Good news concerning the application of the Internal Revenue Service’s “Normal Retirement Age” regulations to governmental plans was announced at the recent Congressional Roundtable on the IRS Governmental Plans Initiative (see above story). In response to public sector concerns with the need for further guidance concerning these and other regulations, Thomas Reeder, Benefits Tax Counsel with the Treasury Department, said that there would definitely be relief provided in the very near future.

While Mr. Reeder did not say specifically what Treasury intended to do, a formal request for them to provide relief from the impending application of the regulations was submitted by NCTR and 18 other public sector organizations on April 30, 2008. This came in the form of a letter asking that the IRS delay the effective date indefinitely until the serious issues for governmental plans that the regulations present are adequately addressed. The IRS rules would require, for the first time, that governmental pension plans specifically define normal retirement age, or redefine normal retirement age, so that it is not based wholly or partly on years of service. (However, despite recent stories to the contrary, the regulations would not absolutely prohibit retirement before age 55, nor do they require that only persons age 62 and above may retire.)

There are also other problems with the Normal Retirement Age regulations for public plans that were extensively outlined in a joint comment letter to the IRS submitted by NCTR and NASRA in December of 2007. Obtaining a delay in these regulations and, ultimately, either major modifications for governmental plans or the complete withdrawal of the regulation’s application to public plans, has therefore been one of NCTR’s top priorities for 2008. (See March/April 2008 NCTR Federal e-News)

On the PPA technical corrections front, however, the news is not nearly so good. The issue here is the need to pass an amendment that would protect governmental plans from per se violations of the Age Discrimination in Employment Act (ADEA) if they have interest crediting features that provide above-market rates of return. The amendment would permit interest rates on refunds of employee contributions, interest-bearing deferred retirement option plans (DROPs), survivor benefits and other optional ancillary forms of benefits to continue to be set under applicable State or local laws rather than be capped by inappropriate Federal restrictions aimed at ERISA plans.

Currently, without this much-needed amendment, the Treasury Department's proposed regulations limit the rate of interest that can be paid to no greater than the so-called “market rate,” i.e. an index, a bond rate, or a fixed rate of 3% or 4%. If a governmental plan paid interest that exceeded this market rate, it would constitute an automatic violation of ADEA, and the Equal Employment Opportunity Commission (EEOC) could pursue an enforcement action against the plan.

Although the House passed a package of technical amendments to the PPA in early July that contained this much-needed fix for public pensions, the Senate has yet to take up the measure for reasons unrelated to the governmental plans issue. (See May/June 2008 NCTR Federal e-News) Therefore, as the days dwindled down to a precious few in September, efforts were made to try to reach some compromise on a way to break the apparent deadlock. At one point, there was even an attempt to include some or all of the PPA technicals (including our governmental plans credited interest fix) as part of the market bailout package when it was being initially negotiated. However, these efforts fell apart, and no PPA technicals were included in the first version of the bailout legislation that the House initially voted down or the final package that is now law.

Subsequently, an effort was made on the House side to split the PPA technical amendments into two packages, with the governmental plans amendment and other “quasi-technical” amendments (including the changes to the smoothing rules for the private sector that have been so important to many GOP members) in one package, and the purely technical fixes in another. The hope was that the smaller “non-technical” technical amendments package could be passed now with a firm commitment to take up purely technical amendments later.

However, House staff reportedly was told that the Senate was not interested in taking up any technical corrections (or anything at all that is pension related) before they left for the elections, and so this effort also fell apart – for now. The one good piece of news on this front is that Senate Finance Committee Chairman Max Baucus (D-MT) has indicted that he intends to deal with pension technical amendments in a lame duck session in November.

Therefore, we may have yet lived to fight another day on this other “must-do” issue for 2008.

The Latest on MVL: Academy of Actuaries Ponders “Public Interest” Statement While State, Local Government Organizations and Plans Formally Oppose MVL-Related Changes to Actuarial Standards.

The interest of the American Academy of Actuaries in the subject of MVL disclosure may be coming to head very soon, when the Academy board’s next scheduled meeting takes place in October. At that time, it is anticipated that the Academy’s “Public Interest Committee” (PIC) will report on its public forum on MVL disclosure held in early September in Washington, DC, and a decision may be made as to whether or not the Academy will take a public position on this controversial subject.

The Academy’s interest in making a statement on MVL became very public earlier this year when the actuaries’ organization and the Society of Actuaries held a roundtable on the subject in New York City. (See January/February 2008 NCTR Federal e-News) Even though the issue had been under intense debate within the Academy, the NYC February event was the public sector’s first real exposure to the strong effort underway at the Academy to come out in support of MVL disclosure. The manner in which this gathering was held, and the lack of any follow-up, convinced many that the Academy had prejudged the issue and was intent on taking a position in support of MVL advocates.

Subsequently, NCTR, NASRA and 7 other state and local government organizations wrote a letter to the Academy Board, accompanied by a joint statement, opposing the reporting of the liabilities of public pension plans at so-called “market value.” The organizations also expressed concern with the manner in which the Academy has approached this issue, and asked that additional opportunities for public comment be provided. (See May/June 2008 NCTR Federal e-News) In May, the Academy’s board voted to refer the “management” of the MVL issue to the PIC.

The PIC in turn decided to hold a “public forum” to hear views on the disclosure of market value of assets and liabilities for public pension plans. According to the Academy, “The committee will use information obtained through this forum to determine whether a statement from the Academy's board of directors on the issue is in the public interest.”

However, actual participation in this “public forum” was by invitation only and interested parties were given approximately one week to submit names to the PIC, and then another week to submit outlines of their intended comments. The PIC made the final decisions as to who would be allowed to speak for no more than 5 minutes.

NCTR and NASRA both submitted requests to appear, as did a number of directors of public pension systems. As Dave Stella, chair of the NCTR Legislative Committee and Secretary of the Wisconsin Department of Employee Trust Funds (ETF), said in the outline of his proposed comments, governmental pension plans, unlike their private sector counterparts, are long-term (essentially permanent), stand-alone, independent organizations and not merely “pass-through” entities. He stressed that public pension plans, and the boards of trustees who are responsible for their governance, are clearly stakeholders in the outcome of the debate over the use of MVL disclosure.

Nevertheless, the PIC apparently took the view of proponents of financial economics, who argue that pension plans are not considered to be a self-standing entity, but merely a pass-through entity, and that analyses that focus on the pension plan alone are unable to reflect the shareholder value perspective. Neither NCTR nor NASRA, nor any plan administrator was invited to testify.

Fortunately, however, there were a number of representatives of State and local government concerns present, as well as others who share the public sector’s views on MVL disclosure. These included Nancy Kopp, Maryland State Treasurer; Ron Mulvihill, Employee Benefits Specialist, American Federation of State, County, and Municipal Employees (AFSCME); Karen Steffen, Principal and Consulting Actuary, Milliman; Paul Angelo, Senior Vice President and Actuary, The Segal Co.; Norm Jones, Chief Actuary, Gabriel, Roeder, Smith and Co.; Beth Almeida, Executive Director, National Institute on Retirement Security (NIRS); and Christian Weller, Senior Fellow, Center for American Progress .

Proponents of MVL disclosure were also well-represented. Their representatives included, among others, David Wilcox, Deputy Director, Division of Research and Statistics, Federal Reserve Board; Robert North, Chief Actuary, New York City Office of the Actuary; Michael Peskin, Managing Director, Morgan Stanley Investment Management; and Mark Ruloff, Director, Asset Allocation, Watson Wyatt Investment Consulting.

Interestingly, two other speakers -- R. Evan Inglis, Chief Actuary, Vanguard, Institutional Strategic Consulting, and John Moore, Chief Actuary, JP Morgan Compensation and Benefit Strategies -- who were to appear on the same panel with other pro-MVL speakers, withdrew at the last minute. It is not know if their decision not to appear had anything to do with several contacts made by NCTR members with their representatives of these two firms, inquiring if they knew of these planned appearances at the PIC forum; providing them with the NCTR resolution on the subject of MVL disclosure; and asking them to please explain their firm’s specific interest in the subject of MVL as applied to governmental plans.

In addition to the oral presentations, written submissions (of no more than 1,000 words) were also accepted. These included submissions opposing MVL from 14 State and local government plans; several plan trustees and actuaries; the treasurers of Georgia, South Carolina and California, as well as the California Controller; the Governor of Idaho; and U.S. Congressman Earl Pomeroy (D-ND). NCTR and NASRA also filed a joint statement, and several other national organizations and labor unions submitted strong statements as well. Finally, a petition signed by over 170 actuaries, mostly public plan valuation specialists, was also submitted separately to the PIC saying that they believe “it is not in the public interest for the Academy to advocate for disclosure of ‘market value liability’ measures by public pension plans.”

Did the strong display of opposition make a difference? According to those present at the forum -- both panelists as well as observers -- it was difficult to tell from the PIC’s questioning where they stood on the issue. This could be a consequence of the PIC’s membership, which includes only one pension actuary (and not a public pension practitioner). However, from the statements presented and the comments filed, it will be difficult for the PIC to point to any stakeholders with an interest in the disclosure process who think MVL will be helpful.

So where might the PIC go with this “hot potato” that the Academy board handed to them? The answer might lie in a submission from a number of actuaries who recommended that “issues regarding appropriate disclosures by actuaries should not be addressed by the Public Interest Committee or the Academy Board, but should be referred to the Actuarial Standards Board.” This would seem to be the safest course for the PIC to follow at this juncture, and there are those who believe that this is exactly what the PIC will recommend to the Academy board at their October 7th meeting.

And speaking of the ASB, as reported earlier, it has already initiated a comprehensive review of the economic assumptions for measuring pension obligations, and has raised the possibility of including MVL in a revised version of its Actuarial Standard of Practice (ASOP) No. 27, which would be binding on actuaries. In response, NCTR, NASRA and seventeen other national organizations, including employer organizations such as the National Conference of State Legislatures (NCSL), the National Association of Counties (NACo), the United States Conference of Mayors (USCM), and the National League of Cities (NLC), filed a joint comment letter with the ASB.

In that letter, NCTR and the other organizations expressed their concerns with several references in the ASB Request for Comments related to the concepts of financial economics and their use as “an alternative to the traditional actuarial model.” The letter stated that suggesting the application to the public sector of corporate finance measures -- which are aimed at companies that can be acquired or go out of business -- is “simply inappropriate, uninformed and irresponsible.”

The letter also raised questions regarding the appropriateness of the ASB’s review of this particular standard given the current activities of the Governmental Accounting Standards Board (GASB). Since the independent standard setting authority responsible for financial reporting and disclosure requirements of state and local governments was already looking at this issue, the nineteen national groups said that they believed “it would be premature for the ASB to begin the process of potentially amending actuarial standards of practice in the public plans area prior to the completion of this examination.”

In addition to the letter from the national organizations, 72 public plans also signed onto a joint letter to the ASB which also expressed the view that financial reporting models applicable to terminable private sector corporations and their pension plans that require the reporting of MVL are “inappropriate” for governments and are “inconsistent with the nature and purpose of public retirement systems.” The 72 plans urged the ASB to “reject standards for public pension plans that are based on financial economics, particularly standards that require calculation or disclosure of an MVL.”

The joint letter from the systems also noted that the requirement that corporate pensions calculate and disclose their MVL has “resulted in significantly greater volatility in their funding levels and required contributions,” and pointed out that many corporate pension plans have been frozen or terminated in the years since this requirement was established. “Although other factors may have played a role in the decline in corporate pension coverage, we believe that the MVL requirement also was a factor,” the letter argued.

The comment period on this initial stage of the ASB process is now closed. According to those who are familiar with the ASB’s workings, the time line for considering changes to an ASOP is very long, and an Exposure Draft may take a year or more before it is released for comment. If, as is possible, the Academy board decides to refer the MVL issue to the ASB, it therefore may well be years before they arrive at any definite decisions.

What does this mean as far as the overall MVL issue is concerned? The GASB process of reviewing Statements 25 and 27 has already formally begun, but they are reportedly just now reviewing initial drafts of the formal “Invitation to Comment.” This is not likely to be finalized and actually issued until March or April of next year. There will then likely be a three month comment period, to be followed by public hearings and user forums. It will probably not be until the end of 2009 before the next stage in the GASB multiyear process will then commence.

Who will end up deciding whether MVL disclosure is to be required in some form or another? Some believe that the ASB process may actually take longer than GASB’s, and that it is unlikely that the ASB would act to effectively reverse any decision on MVL disclosure made by GASB.

Are we, then, about to enter a long quiet period during which the wheels of the ASB and GASB mills grind exceedingly slow and we can therefore afford to catch our collective breath and drop our guard a little? The answer is a definite “no.” NCTR and the public sector cannot allow ourselves to be lulled into any false sense of security on this critically important issue. It is true that much hard work has been performed to address the Academy’s initiatives, and these efforts will surely prove to have been helpful in educating our community to the challenge and developing a solid array of arguments to be presented to GASB opposing MVL disclosure.

However, the next stage of the fight will be even more difficult, as it is likely to involve efforts at the State and local level, orchestrated by MVL proponents, to begin building a grassroots base of support for their cause. They will focus on governors and legislatures, and will use the fallout from the current economic crisis to their advantage when it comes to estimates of funding needs and rates of return, and will offer MVL as the last best hope to save taxpayers from the evils of DB plans.

We, as a community, cannot afford to take our eyes off the GASB/ASB endgame when it comes to MVL, but neither can we afford to develop a strategy that is only directed at the long-term. In the short-term, it may well be that a good offense, i.e. developing a solution we can live with to some of the real, underlying problems that are implicated in this debate, will prove ultimately to be the best defense.

· NCTR/NASRA Joint Statement To PIC on MVL

· PIC Hearing Statements and Comment Letters

· Letter from NCTR, Other National Organizations to ASB

· Letter to ASB from 72 Public Plans

House Passes New Commodities Legislation But Ban on Institutional Investors Not Included

In late July, in the days just before Congress left for its August break, renewed efforts were made to prohibit institutional investors, including public pension funds, from “speculative” investments in certain energy commodities. A House Agriculture Committee bill would have imposed such a ban, but the provision was removed in mark-up. When Congress returned from its summer recess in September, a Commodities bill subsequently passed the House. While the legislation would create new hurdles for pension funds investing in commodities, no outright ban was included. The Senate is not expected to act on the measure prior to adjournment, and even if it did, the White House has signaled that President Bush would veto the measure.

Some Members of Congress continue to believe that excessive speculation in the oil futures market has been to blame for high gasoline prices throughout most of the summer. Nevertheless, it appeared that a push to impose an absolute ban on institutional investor participation in the commodities futures markets was losing its initial appeal earlier in July, when Senator Joseph Lieberman (I-CT) decided not to include the approach in his legislative proposals (see May/June 2008 NCTR Federal e-News). However, as the August recess neared, the House leadership began pressing again for something that members could point to that evidenced their concern for consumer difficulties at the gas pump.

Consequently, in the last days of July, a prohibition on institutional investor “speculation” in the commodities markets was proposed as part of a comprehensive bill dealing with the Commodity Futures Trading Commission (CFTC). In effect, it would have amounted to a ban on pension fund investments in commodities. However, due in part to concerns raised by public funds, this provision was successfully stripped from the bill during the Agriculture Committee’s mark-up of the legislation. Nevertheless, significant restrictions on institutional investor trading involving interest rate swaps, equity derivatives, and other derivative transactions were included that many viewed as potentially amounting to a “de facto” ban. But the House failed to pass the legislation on July 30th under an expedited suspension process requiring a two-thirds vote, and when it became clear that no legislation in this area would be capable of being passed in the Senate, the House left for its summer break without further action on the measure.

After Congress returned in September, the fall in the price of oil and the looming credit crunch appeared to distract attention from the legislation. Nevertheless, Congress eventually returned to the issue when, in mid September, the House decided to take up energy legislation. Initially, it appeared that provisions dealing with commodities trading would be included in the energy bill, but a deal was reached where the commodity legislation would be dealt with separately.

Thus, on September 18, the House passed the “Commodity Markets Transparency and Accountability Act,” H.R. 6604, by a substantial margin of 283 to 133. Under the legislation, the CFTC would be prohibited from allowing a foreign board of trade to provide its members or participants located in the U.S. with access to the electronic trading and order matching system for energy and agricultural commodities, unless the board of the foreign board sets transparency requirements similar to those on U.S. exchanges.

The bill would also require the CFTC to establish limits on the positions that may be held by a single person with respect to the future sale of agriculture and energy commodities contracts traded on the open market, either through contract market, a derivatives transaction facility, or an electronic trading facility.

Within 150 days of enactment, the CFTC would also be directed to assemble and convene a ‘Position Limit Agricultural Advisory Group’ and a ‘Position Limit Energy Group.’ These groups would consist of members from commercial short hedgers, commercial long-hedgers, non-commercial participants in futures and designated contract markets, and would submit advisory recommendations regarding position limits, and whether the limits should be administered by the CFTC or by the registered entity on which the commodity is listed.

The strong support for the bill reflects how sensitive Members of Congress continue to be to the need to respond to the high cost of energy. However, the Senate has yet to take up the measure, and the White House has indicated that were the bill to be sent to the President, he would veto it, saying that it “offers poorly targeted short-term measures that do nothing to address the fundamentals of supply and demand that bear the primary responsibility for current high energy prices” and that it would “hurt the competitiveness of American futures markets.”

Therefore, for the present, it appears that Federal efforts to place investment restrictions on pension plans in the area of commodities have been successfully avoided. However, the effort to do so in the House Agriculture Committee came very close to succeeding. Given the current economic unrest, the likelihood of major changes to the financial regulatory structure in the next Congress, and a new occupant in the White House in 2009, institutional investors will need to pay close attention to ensure that “reform” in this area does not result in unnecessary limits or prohibitions on large investors.

· Section-by-Section Analysis of H.R. 6604

PCAOB Constitutional, Appeals Court Rules

On August 22nd, the United States Court of Appeals for the District of Columbia Circuit denied a Constitutional challenge of a major component of the landmark Sarbanes-Oxley Act (SOX) establishing the PCAOB. The ruling is expected to be appealed.

The plaintiffs in the case (Free Enterprise Fund v. PCAOB) had challenged the constitutionality of the board, arguing that since the hiring and firing of board members is done by the Securities and Exchange Commission (SEC) and not the President, the agency is outside the reach of the Executive Branch. However, the DC Circuit Court found that SOX “does not encroach upon the Appointment power because, in view of the Commission’s comprehensive control of the Board, Board members are subject to direction and supervision of the Commission and thus are inferior officers not required to be appointed by the President.”

While two members of the three-judge panel supported PCAOB’s design, the third wrote a strong minority opinion that some observers say will likely set the stage for a Supreme Court ruling on what the dissenting judge, Brett Kavanaugh, called “the most important separation-of-powers case regarding the president’s appointment and removal powers to reach the courts in the last 20 years.”

“By restricting the president’s authority over the board, the act renders this executive branch agency unaccountable and divorced from presidential control to a degree not previously countenanced in our constitutional structure,” Kavanaugh wrote. Kavanaugh, notably, once worked in Kenneth Starr’s Office of Independent Counsel, and Starr helped to represent the Free Enterprise Fund in the case. He also clerked for Supreme Court Justice Anthony Kennedy, a possible swing vote in the case.

· DC Circuit Court Ruling and Kavanaugh Dissent

New GAO Report on Hedge Fund Investing by Pension Plans May Prove Helpful for Public Sector

In testimony earlier this year before the Joint Economic Committee, the GAO reported that, based on its earlier studies, the “funded status of state and local government pensions overall is reasonably sound.” (See May/June 2008 NCTR Federal e-News) Noting that while many public pensions have a funded ratio below 80 percent, the GAO report said that this is not necessarily cause for alarm.

“By themselves, lower funded ratios and unfunded liabilities do not necessarily indicate that benefits for current plan members are at risk, according to experts we interviewed,” the GAO testified. “Unfunded liabilities are generally not paid off in a single year, so it can be misleading to review total unfunded liabilities without knowing the length of the period over which the government plans to pay them off.” The GAO also pointed out that “Current funds and new contributions may be sufficient to pay benefits for several years, even when funded [ratios] are relatively low.”

However, as the credit crisis deepens, and the unprecedented market turmoil continues to have a major impact on investment returns, the GAO’s outlook may not remain as rosy. Therefore, a new GAO report issued in late August on defined benefit plan investments in hedge funds and private equity may prove to be somewhat helpful down the road. This is true particularly if Congress believes that one consequence of lower equity returns for pension funds will be increased pressure for plans to turn to alternative investments and other “riskier” investment vehicles to make up their losses.

First, the new GAO report documents that while a considerable and growing number of private and public pension plans have investments in hedge funds and private equity funds, such investments generally comprise “a small share of total plan assets.” Furthermore, the GAO found that investments in hedge funds and private equity are more common among large pension plans, measured by assets under management, compared to mid-size plans. For example, about 16 percent of plans with $250 to $500 million were invested in hedge funds, while 29 percent of plans with $1 billion or more had such investments, according to a 2006 survey. The GAO also reports, however, that survey data on plans with less than $200 million in assets are unavailable and, in their absence, “the extent to which these plans invest in hedge funds or private equity is unknown.”

It is these smaller pans with which the GAO is most concerned. For example, while the new GAO report does express concerns with the “special challenges” pensions plans face investing in hedge funds, they single out smaller funds that “may not have the expertise or financial resources to be fully aware of these challenges, or have the ability to address them through negotiations, due diligence, and monitoring.”

However, despite these potential shortcomings, the GAO observes that neither Federal law nor regulation specifically limits private sector pension investment in hedge funds or private equity. Instead, ERISA simply requires that corporate plan fiduciaries apply a prudent man standard, which does not explicitly prohibit investment in any specific category of investment, but rather focuses on diversifying assets and minimizing the risk of large losses. Nor does the U.S. Department of Labor specifically monitor private sector pension investment in hedge funds or private equity.

On the other hand, the GAO report documents that even though State regulation of public pension plan investments has become generally more flexible in recent years, it is not unusual for applicable State law to impose restrictions on the ability of public pension plans to invest in hedge funds and/or private equity. Furthermore, the GAO also notes that individual public plans may have their own restrictions adopted by plan boards or staff.

For example, some States have established explicit limitations on the amount that pension plans can invest in hedge funds or private equity, while others may establish detailed limitations and guidance. As an example, the GAO report discusses the Massachusetts Public Employee Retirement Administration Commission (PERAC), which has created such an approach, with particular limitations on smaller public plans. The GAO report notes that according to a PERAC official, such limitation exists “because hedge funds are relatively new investments for pension plans and because they require high levels of due diligence and expertise that may be excessive for smaller plans.”

The GAO goes on to discuss State “legal lists” of authorized investments for pension plans that in some cases do not specifically include investments in hedge funds or private equity funds as authorized assets. Also, the report notes that “public pension plan investments in hedge funds are prohibited or limited in some states by laws restricting pension plan investment in certain investment vehicles or trading strategies.”

In addition to such specific restrictions/limitations on hedge fund investments that States may impose, the GAO report also discusses the variety of approaches to overseeing and monitoring public pension plan investments in general that States and their retirement systems have instituted. For example, the report points out that in Massachusetts, before conducting a hedge fund manager search, public plans must first obtain PERAC approval and provide the agency with a summary of the plan’s objectives, strategies, and goals in hedge fund investing. PERAC also requires pension plans to document the major due diligence steps taken in the hedge fund manager selection process, and prospective hedge fund managers must submit detailed information to PERAC regarding their key personnel, assets under management, investment strategy and process, risk controls, past performance, and organizational structure. Finally, hedge fund managers must also submit quarterly performance and strategy review reports directly to PERAC.

GAO reports that officials in other states they contacted may review hedge fund and private equity investments as part of a broader oversight approach. For example, they cite the Ohio Retirement Study Council, which reviews the five large statewide public retirement funds semiannually to evaluate a plan’s investment policies and objectives, asset allocations decisions, and risk and return assumptions.

In summary, the GAO report spends pages documenting how States and their pension investment processes are much more regulated and subject to oversight and control than are their private sector counterparts. Not a bad thing!

It is no surprise, then, that the GAO report’s recommendations focus solely on private sector pension plans. Specifically, the GAO recommends that the Secretary of Labor provide guidance specifically designed for qualified plans under ERISA “to ensure that all plan fiduciaries can better assess their ability to invest in hedge funds and private equity, and to ensure that those that choose to make such investments are better prepared to meet these challenges.” This guidance would include such things as (1) an outline of the unique challenges of investing in hedge funds and private equity; (2) a description of steps that plans should take to address these challenges and help meet ERISA requirements; and (3) an explanation of the implications of these challenges and steps for smaller plans.

However, not all is sweetness and light. The GAO also states that, based on its study and its concerns with regard to smaller pension plans, hedge fund investments “may not be appropriate for some pension plans.” This conclusion will fit quite nicely with the views of some on Capitol Hill who have been worried for some time that these types of investments may simply be too risky for some pension funds.

The increasing growth in such investments by pension funds, coupled with reports that hedge funds are in deep trouble as a result of the recent market turmoil, which has been exacerbated by restrictions on such hedge fund strategies as short selling, may only serve to fan such flames. Although it is unlikely that any action in this area will occur during the remainder of this year, the reform of the financial markets and their regulatory structure that will be a guaranteed focus for the new Congress and Administration in 2009 is where the danger lies.

Some Congressional leaders already think that there may need to be Federal laws to either (1) protect pension plans from their own ignorance and gullibility when it comes to hedge funds, or (2) protect their participants from the plans’ reckless desire to chase returns. This new GAO report and its discussion of the safeguards in place in the public sector may serve as an important tool in keeping any such Federal legislation from affecting governmental plans.

· GAO Hedge Fund Report

· SEC Guidance on Short Selling

DB Plans Much More Cost-Efficient Than DC, Report Finds

A defined benefit pension can provide the same retirement income as a defined contribution plan at just over half the cost, according to a new NIRS study released in August entitled “Better Bang for the Buck.” According to the study, in order to fund a retirement benefit that replaces 53 percent of final salary, a DC plan would require 22.9 percent of payroll, whereas a DB pension would need just 12.5 percent. This means that the total cost of providing a monthly benefit of $2,200 to a worker who retires at 62 would be $355,000 for a DB pension and $550,000 for a DC plan.

The savings, according to the report, come from the ability of DB plans to do three things: 1) pool longevity risks; 2) maintain a consistent investment approach and ride out bear markets; and 3) get better returns because of lower fees and professional management.

Ms. Almeida, an author of the report, said “The analysis clearly indicates that the qualities inherent in DB plans – particularly, the pooling of risks and assets – fuel their fiscal efficiency. Importantly, the report provides a new lens for policymakers, employers and employees, who are struggling to ensure adequate retirement income with the fewest dollars possible.”

NIRS is a not-for-profit organization whose purpose is to conduct research and education programs regarding the traditional pension system in the United States. It was formed by NCTR, NASRA and the Council of Institutional Investors (CII) in 2007 to help offset the "research" and other reports prepared by opponents of DB pensions in support of their efforts to convert public systems to a defined contribution model.

During this time of economic turmoil, millions of Americans are fearful for their retirement security as they have watched their 401(k) balances decline. The new NIRS study shows that not only can DB plans help assure a reliable, dependable retirement for their participants that they will not outlive, but DB plans can do so at a lower cost to employers as well. Not a bad model to emulate, I’d say.

· Bigger Bang for the Buck

GAO Finds Millions Affected by Pension Freezes

According to the GAO, from 1990 to 2006, private sector plan sponsors have voluntarily terminated over 61,000 sufficiently funded single-employer DB plans. In some cases, a so-called plan “freeze” (that is, an amendment to the plan to limit some or all future pension accruals for some or all plan participants) preceded these terminations. The GAO found that such freezes are a common phenomenon, affect a large number of participants, and have important implications for plan sponsors, participants, and the Pension Benefit Guarantee Corporation (PBGC). “While plan freezes are not as irrevocable as plan terminations,” the GAO found, “they are indicative of the system’s continued erosion.”

The GAO study, entitled “Plan Freezes Affect Millions of Participants and May Pose Retirement Income Challenges,” was based on a sample of 471 DB plan sponsors. It found that about 3.3 million active participants in DB plans were affected, at the time of the study, by employer decisions to freeze plans, and nearly a third of the sponsors ultimately expect to terminate their largest frozen plan. Furthermore, the GAO found that about half of all frozen plans were “hard frozen” (future benefit accruals had ceased), and that sponsors of hard frozen plans appear more likely to anticipate termination as an eventual outcome.

For active plan participants, the GAO said that plan freezes “imply a possible reduction in anticipated retirement income,” with hard freezes especially likely to produce such reductions. Furthermore, for those participants with traditional pension plan formulas that are hard frozen and replaced with a typical DC, or 401(k)-type plan, the GAO found that, all else being equal, “longer-tenured, mid-career workers are most likely to see the greatest reductions in anticipated retirement income.” This effect occurs, according to the GAO study, because older, longer-tenured employees generally have less time remaining in their careers to offset anticipated accrual losses through typical 401(k)-type plan contributions compared to younger workers.

Why do plan sponsors freeze their plans? The GAO found that the reason sponsors of frozen plans cited most often for why they froze their largest plan was “Annual contributions needed to satisfy funding requirements and their impact on cash flows,” with 72 percent of sponsors responding that this was a reason. The next most oft-cited reason was “Unpredictability/volatility of plan funding requirements,” with 69 percent giving this as a cause of their actions.

About half of the freezes of sponsors’ largest frozen plans have occurred since 2005. Some observers have therefore pinned part of the blame for freezes on provisions of the Pension Protection Act (PPA) of 2006 that tightened pension funding requirements. Congressman Earl Pomeroy (D-ND), a strong supporter of DB pensions in general and public plans in particular, noted that these two situations -- impact on cash flow and funding volatility -- both have increased under the PPA. “Unfortunately, faced with greater uncertainty employers may decide that offering a pension no longer makes good business sense,” he observed when the GAO report was released. “More frozen pensions would mean a big loss for workers who already are increasingly less confident about their retirement security,” he warned.

Not long after the GAO report was released, the Treasury Department and the Internal Revenue Service issued a revenue ruling on August 25th that limits the ability of employers to transfer frozen pension plans to investment firms or other entities not related to the company that would assume the plan sponsors' fiduciary responsibility.

Congressman Pomeroy, a member of the House Ways and Means Committee which has jurisdiction over the Treasury Department and the IRS, and the Committee’s Chairman, Charles Rangel (D-NY), had expressed concern with the possibility of transferring frozen defined benefit plans to independent investment firms. Saying that "Democratic majorities are highly skeptical of pension buyouts," Mr. Pomeroy praised the IRS action as “slamming the door” on efforts to dilute employer responsibilities to employees covered under their pension plans. He said that the Revenue Ruling was “good news” for workers who have seen their retirement benefits under defined benefit pensions plans frozen.

For supporters of DB pension plans such as Mr. Pomeroy, the link between the decline in private sector DB plans and the MVL influence on the PPA are directly related. This correlation will be an important element in fighting the application of MVL to public pensions.

· GAO Report on Pension Freezes

· Revenue Ruling 2008-45

New Reports on State, Local Governments’ Retiree Health Programs Paint Mixed Picture of “Fiscal Crisis”

The Center for State and Local Government Excellence and researchers from North Carolina State University’s School of Public and International Affairs and College of Management have established a partnership to focus on state and local government retiree health care. Their first publication was issued in July and examines whether there is really a funding crisis in this area. This issue brief identifies “some of the most important perceptions concerning retiree health plans in the public sector” and shows some to be fact while others are merely myths based on a lack of data or understanding of key aspects of these plans.

Based on an analysis of actuarial reports, the issue brief explains that there is a substantial variation in unfunded liabilities depending on the size of the work force, the generosity of the retiree health plan, the portion of the plan paid for by the state, and the type of employees in the plan. For example, some states and localities require retirees to pay the full cost of participating in the health plan, while others offer health insurance that does not require any premium payment by the retiree.

As a result of these differences, the issue brief notes that the annual cost of providing retiree health insurance can vary substantially among public employers, with the annual cost per retiree ranging from a modest subsidy associated with allowing retirees to buy into the health plan for current employees to the full cost of medical insurance for retirees, which can exceed $10,000. For example, based on the actuarial reports from selected states, a wide range in unfunded liabilities related to future health care benefits was identified, ranging from less than $1 billion in North Dakota, Wyoming, Iowa, Oregon, Rhode Island and Oklahoma to $48 billion in California, $50 billion in New York and $69 billion in New Jersey.

The second report looks at the key assumptions that actuaries examine to estimate a government’s unfunded retiree health costs under GASB 45 and analyzes how health care plan design, demographic factors, and financing methods affect the estimate of future costs. This issue brief examines some of the broad questions that will affect these future costs, and discusses how many states and localities have begun to shift from a pay-as-you-go basis to other strategies to finance their future health care costs.

The third report, issued in September, looks at differences and similarities in state health plans in what it calls “a quick reference format,” including eligibility requirements for coverage and the cost to employees and to state governments for the benefit. As this issue brief notes, while virtually all states provide some type of retiree health benefit to their employees, these plans differ substantially in their generosity and coverage and hence their cost. Each state’s retiree health plan is included, and plans are organized by their key characteristics.

According to the Government Accountability Office (GAO), “in 2006 the annual cost to state and local governments for retiree health plans averaged about 2 percent of employee salaries.” The GAO estimates that if public sector employers continue to pay for these benefits on a pay-as-you-go basis, “the cost of retiree health plans is projected to rise to 5 percent of payroll in 2050.” Accordingly, many state and local governments have begun to make changes in their health care plans to manage rapidly growing costs, and these three issue briefs provide an important overview of the issues involved in such an undertaking.

Founded “to explore issues that are important to attract and retain the talent needed for public service,” the Center for State and Local Government Excellence is “committed to identifying best practices that can ensure the economic security of future retirees.”

· The Crisis in State and Local Government Retiree Health Benefit Plans: Myths and Realities

· Financing Retiree Health Care: Assessing GASB 45 Estimates of Liabilities

· Retiree Health Plans: A National Assessment

SEC Finds Flaws at Credit Rating Agencies

In August 2007, the Securities and Exchange Commission’s Staff initiated examinations of three credit rating agencies -- (Fitch Ratings, Ltd. (Fitch), Moody’s Investor Services, Inc. (Moody’s) and Standard & Poor’s Ratings Services (S&P) -- to review their role in the recent turmoil in the subprime mortgage-related securities markets. (See September 2007 NCTR Federal e-News) The results of this review, released in July, 2008, found that the three agencies struggled to handle the large number of the complex instruments related to subprime mortgages with none of the three agencies having written procedures in place for rating them. In addition, the SEC found that the companies failed to disclose or document significant parts of the ratings process and that they did not manage conflicts of interest properly.

Specifically with regard to conflicts, the report found that “the combination of the arrangers’ influence in determining the choice of rating agencies and the high concentration of arrangers with this influence appear to have heightened the inherent conflicts of interest that exist in the ‘issuer pays’ compensation model.” (“Arrangers” are generally investment banks that package mortgage loans into a pool and then transfer them to a trust that will issue securities collateralized by the pool.) The SEC staff also found that “high profit margins from rating RMBS and CDOs may have provided an incentive for a rating agency to encourage the arrangers to route future business its way.”

Pursuant to regulatory authority that the SEC received from Congress to register and oversee nationally recognized statistical rating organizations (NRSROs), the SEC has proposed a package of rules that are intended to regulate the conflicts of interests, disclosures, internal policies, and business practices of credit rating agencies. These proposed rules would:

Prohibit a credit rating agency from issuing a rating on a structured product unless information on assets underlying the product was available.
Prohibit credit rating agencies from structuring the same products that they rate.
Require credit rating agencies to make all of their ratings and subsequent rating actions publicly available. This data would be required to be provided in a way that will “facilitate comparisons of each credit rating agency's performance.” The SEC believes that this will provide “a powerful check against providing ratings that are persistently overly optimistic.”
Prohibit anyone who participates in determining a credit rating from negotiating the fee that the issuer pays for it.
Prohibit gifts from those who receive ratings to those who rate them, in any amount over $25.
Require credit rating agencies to publish performance statistics for 1, 3, and 10 years within each rating category, in a way that facilitates comparison with their competitors in the industry.
Require disclosure by the rating agencies of the way they rely on the due diligence of others to verify the assets underlying a structured product.
Require disclosure of how frequently credit ratings are reviewed; whether different models are used for ratings surveillance than for initial ratings; and whether changes made to models are applied retroactively to existing ratings.
Require credit rating agencies to make an annual report of the number of ratings actions they took in each ratings class, and require the maintenance of an XBRL database of all rating actions on the rating agency's Web site.
Require the public disclosure of the information a credit rating agency uses to determine a rating on a structured product, including information on the underlying assets.
Require documentation of the rationale for any significant out-of-model adjustments.

The Council of Institutional Investors (CII) has said that it “generally supports” provisions in the proposed rules that would enhance investors’ and the SEC’s understanding of NRSRO ratings on structured finance products. CII also likes the provisions that would curb or manage conflicts of interest between rating agencies and entities that purchase ratings from them. “Credit rating agencies have long maintained that their ratings are merely opinions,” the CII said in comments filed with the SEC, but “in practice, the agencies wield considerable influence over market participants.”

The Securities Industry and Financial Markets Association (SIFMA) has expressed its concerns, however, as to “possible serious adverse and unintended consequences for our markets if the existing credit rating scales are changed.” SIFMA wrote that “We anticipate that such a change could further damage our already unsettled capital markets, impair capital raising (for student loans, auto loans, credit cards, mortgages, and the like), and lead to the sudden sale of structured finance securities, at fire-sale prices, into an already highly illiquid market at a time when our financial markets can ill afford such an unnecessary shock to their system.”

The Commission has also reviewed the requirements in its rules and forms that rely on credit ratings and has concluded that, in many cases, such references can be removed or revised. According to the SEC, it is concerned that the inclusion of requirements related to ratings in its rules and forms has, in effect, placed an "official seal of approval" on ratings that “could adversely affect the quality of due diligence and investment analysis.”

House Financial Services Committee Chairman Barney Frank (D-MA) agreed with this SEC action, saying that “For too long we have, in effect, encouraged investors to outsource their judgment to the rating agencies, with negative consequences.” According to Chairman Frank, “Investors should obviously be free to pay attention to the ratings if they wish to, but the rigid effect that they have had has been harmful in a number of ways, and I am pleased that the Commission has recognized this and acted on it.”

· SEC Report on Credit Rating Agencies

· CII Comment Letter on New Credit Reporting Rule Proposals