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Federal E-NewsMay/June 2008
NCTR Urges Academy of Actuaries Not To Endorse MVL Disclosure NCTR, NASRA and seven other national organizations have filed a joint letter and statement with the American Academy of Actuaries opposing the reporting of the liabilities of public pension plans at so-called “market value,” often referred to as Market Value Liability (MVL). In a joint letter and statement sent to the Academy’s board of directors, the organizations also expressed concern with the manner in which the Academy has approached this issue to date, and asked that additional opportunities for public comment be provided. The Academy has referred the issue to its Public Interest Committee for further consideration. However, at the same time, the Academy’s Actuarial Standards Board (ASB) has begun a comprehensive review of the economic assumptions for measuring pension obligations, and has raised the possibility of including MVL in a revised actuarial standard of practice. A comment letter is being drafted to which NCTR member systems can add their names (see below). In the meantime, the issue of MVL is gaining increasing media attention that questions the validity of current funding numbers. NCTR joined19 other public sector groups in sending a letter to every member of Congress attempting to set the record straight, but, with the GASB review process of governmental accounting standards just getting under way, this is a fight that is far from over. For some time now, proponents of financial economics theory have argued that public pension plans should be required to calculate and disclose the purported “market value” of their liabilities, or MVL -- just as private sector plans are required to do. (“Financial economics” refers to a financial theory that essentially argues that traditional actuarial science, as it is applied to defined benefit (DB) plans, both public and private, is outdated and no longer appropriate. Proponents of financial economics (FE) believe that actuarial training and practices therefore need to be “modernized” to reflect the new tools and techniques of this theory, the main change being to require disclosure of MVL. That is, the calculation of liabilities would be based on a risk-free investment return assumption and not on that of a diversified portfolio. In other words, instead of the traditional actuarial approach of using the expected return of the assets being invested by the plan as the basis for the discount rate for liabilities, bonds would be used as matching assets for plan liabilities and their interest rate term structure would be the liability discount rate. According to a recent report by Gabriel Roeder Smith & Company (GRS), generally, this approach produces a measure of the pension liability that would be roughly 15% higher than the liability produced under the current conventional approach.) As part of their campaign, advocates of MVL disclosure have been pressing the American Academy of Actuaries (the Academy) to issue a statement supporting MVL. For example, the Academy and the Society of Actuaries (SOA) held a roundtable meeting in New York City in February to ostensibly examine public pension plan disclosure. However, the structure of the roundtable (“by-invitation-only”) and its focus on MVL led many in the governmental plan community to feel that the real purpose of the meeting was to advance the specific conclusion that MVL disclosure was necessary rather than to identify and discuss problems related to disclosure in general. Some were also concerned that the event was held to simply enable the Academy to say that stakeholders in the process has been consulted. Many governmental plan participants at the roundtable expressed these concerns and urged the Academy to provide additional opportunities for input on such an important issue. At the close of the roundtable, Academy officials promised that their process would be a deliberate one and that they would certainly take such requests into consideration. (See January/February 2008 NCTR Federal e-News) However, to date, no such additional opportunities have been provided. Therefore, when it was learned that the Academy’s board of directors was to have a statement dealing with MVL disclosure presented as part of its May 21, 2008 meeting, NCTR attempted to meet with Academy staff in Washington to discuss the matter. When there was no response, the Academy’s president, Mr. Bill Bluhm, was contacted and presented with a request that NCTR’s Federal governmental relations representative and other interested parties be permitted to attend, as observers, that portion of the board’s meeting at which the MVL topic was to be discussed. In response, Mr. Bluhm explained that the board would not be discussing the substance of the issue of MVL at the meeting, but would instead consider “how we will handle the management of this important topic.” He said that in 2007, the Academy board adopted a new strategic plan that included the creation of a Public Interest Committee (PIC) “to manage the process of reaching public policy positions for the Academy,” and that the motion being discussed “will be whether or not we will refer this matter to the PIC for its management of the issue.” Mr. Bluhm said he intended “to avoid any premature discussion of the substance of the issue itself by the board, until the PIC has followed its process.” NCTR was not invited to attend the meeting. NCTR responded that we welcomed the opportunity to work with the PIC on the development of relevant input into this issue. Furthermore, NCTR also requested a meeting with the Academy president and its executive director, Grace Hinchman, “to help ensure that this process of communication and involvement with the Academy is a productive and satisfying experience for all involved.” However, this request was refused. Mr. Bluhm wrote back that “I intend to let the Public Interest Committee do its work without interference from me or from Ms. Hinchman, and most certainly without lobbying by outside organizations.” Subsequently, the Academy board did indeed refer the matter to its PIC; we understand that the charge to the PIC is not to develop a statement on MVL, but rather to consider what the Academy should do about this issue. In the meantime, NCTR, working with NASRA and other public fund actuaries and economists, developed a statement addressing MVL disclosure and the Academy’s activities in connection with this issue, and on June 6, 2008, this statement, along with a transmittal letter, was delivered to each member of the Academy’s board of directors and also copied to its PIC members. In addition to NCTR and NASRA, other submitters included the National Conference on Public Employee Retirement Systems (NCPERS), the National Association of State Auditors, Comptrollers and Treasurers (NASACT), the National Education Association (NEA), the American Federation of Teachers (AFT), the National Association of Police Organizations, the American Federation of State, County and Municipal Employees (AFSCME), and the Service Employees International Union (SEIU). The transmittal letter expresses “serious concerns with mandating that governmental pension plans report their financial condition as if they were able to be immediately terminated” and notes that the organizations are also very disturbed by the apparent approach to this subject currently being pursued by the Academy. The letter argues 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. Specifically, the letter points out that MVL disclosure would be harmful because (1) It could lead to the disclosure of plan costs and liabilities that do not accurately represent the dynamics of governmental plans and are therefore unnecessarily high; (2) It could lead to the application of investment approaches that would unnecessarily limit the asset allocation and investments returns that can be earned by plans; and (3) It would create confusion among decisions-makers, taxpayers, and the media about the funded levels of public pension plans, potentially leading to their disuse or abandonment. In its only formal response to date to this joint letter and statement, the Academy’s director of public policy wrote that the Academy “recognizes this as a board-level issue that extends well beyond disclosures and speaks to overall standards of actuarial practice. As always, the Academy [through the Actuarial Standards Board (ASB)] promulgates standards by exposing them to the profession and other interested stakeholders.” It is interesting that this response does not reference the PIC referral, but instead focuses on the ASB, noting that “The Academy will continue to follow its process and expose for comment any new proposals for actuarial practice.” This is apparently a reference to the ASB’s March 27, 2008 Request for Comments concerning Actuarial Standard of Practice (ASOP) No. 27, Selection of Economic Assumptions for Measuring Pension Obligations. ASOPs identify what an actuary should consider, document, and disclose when performing an actuarial assignment. They provide standards for appropriate practice for U.S. actuaries, and serve as the basis for discipline in those instances in which these standards are not followed. According to the ASB, in the decade since ASOP No. 27 was first adopted, “pension actuarial practice has evolved and the pension actuarial landscape has been affected by such factors as deteriorations in the funded status and increases in the costs of many plans, an altered regulatory environment, changing expectations regarding actuarial assumptions, and the emergence of financial economics as an alternative to the traditional actuarial model.” (Emphasis added) The ASB therefore intends to “undertake a comprehensive review of ASOP No. 27 and, if warranted, to revise it to reflect actuarial practice as it has evolved since 1996.” As part of this review, it has solicited comments from actuaries and “others who are interested in the selection of economic assumptions for measuring pension obligations.” Included among its specific questions to which it is seeking input are several dealing with the issue of MVL, either directly or by implication. For example, one question asks “Should ASOP No. 27 provide specific guidance with respect to financial economics and, if so, what should that guidance be?” Another asks “Are the disclosure requirements of ASOP No. 27 appropriate? Are there any specific disclosures that should be added to or removed from the ASOP?” Yet another asks “Is there a need for guidance concerning the selection of economic assumptions for purposes other than measuring pension obligations (for example, for measuring pension risk)?” The deadline for comments is August 1, 2008. Given the significance of this issue, and the impact that modifying ASOP No. 27 to require the calculation and disclosure of MVL would have, Keith Brainard, NASRA’s Director of Research, is drafting a response to the ASB Request for Comments that will be made available for plans that wish to comment to sign onto. If you are interested in doing so, please contact Keith directly at keithb@nasra.org for further details. The issue of MVL and its potential impact on the future of governmental DB plans is becoming increasingly problematic. Press coverage over the last several months, including a front page item in The Washington Post and another item in The New York Times, continues to suggest that public pension plans are using phony numbers to disguise the “real” cost of governmental pensions. This is having an effect on Capitol Hill, as can be seen in the story on the pension technical corrections legislation elsewhere in this issue of e-News. In part to help set the record straight on this issue, NCTR, NASRA and 18 other national organizations representing the public sector recently sent a letter to every member of the House and Senate describing the important role that public pensions play. This letter contains a wealth of information on the status and impact of public plans, and also makes it clear that suggesting that governmental plans adopt the application of corporate finance measures -- which are aimed at companies that can be acquired or go out of business -- is “simply inappropriate, uninformed and irresponsible.” However, the real focus needs to remain on the Academy of Actuaries, the Actuarial Standards Board, and ultimately, the Governmental Accounting Standards Board (GASB). (See March/April 2008 NCTR Federal e-News) So stay involved. Learn where your actuary stands on this issue. Keep informed, because this issue could be one of the most important issues that governmental DB plans have ever confronted. Letter
and Joint Statement to the Academy The House of Representatives has finally included the long-sought “credited interest” amendment for public pensions as part of a new package of technical amendments to the Pension Protection Act of 2006 (PPA). The provision 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. This “must-do” amendment still managed to generate some controversy at the last minute, as it was confused by some with the issue of MVL. The focus now shifts to the Senate, which did not include the governmental plans provision in its previously-approved PPA technical amendments legislation. House action on the legislation containing the important fix for governmental plans occurred on Wednesday, July 9, 2008, when H.R. 6382, the Pension Protection Technical Corrections Act of 2008, was approved unanimously. Section 203 of the bill would amend the PPA to 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 a per se violation of ADEA, and the Equal Employment Opportunity Commission (EEOC) could pursue an enforcement action against the plan. Congressman Earl Pomeroy (D-ND), recipient of NCTR’s first “Award for Outstanding Service to Public Pensions” in 2006, specifically addressed the governmental plans provision during debate on the measure, explaining to his colleagues that “These public plans were caught in the provisions of a Pension Protection Act designed only to cover cash balance conversions. It was never intended to apply to public pension plans.” Congressman Pomeroy asked “Who in the world are we in Congress, without even thinking that this applied to public pension plans in the first place, to say what the credited rate of interest should be?” He underscored that “We have got to trust State and local political subdivisions with this call, and this bill fixes that problem.” Congressman Rob Andrews (D-NJ) also highlighted the public plan provision during debate, arguing that “the idea of Federal regulation imposing itself upon the decisions of [public pension] trustees is without any merit or justification.” Mr. Andrews said that the amendment “will mean that police officers and firefighters and teachers and other public employees will get the fair pension for which they bargained and to which they are entitled.” The technical amendments passed by the House earlier this year (and the Senate last December) did not contain this much-needed provision. The root of the problem was the failure of the earlier House bill to include an amendment providing adjustments to averaging, or “smoothing,” in the determination of the value of the assets of private sector single-employer defined benefit pension plans for minimum funding purposes. The absence of the smoothing provision was used as the basis for Republican objections that kept the governmental plans amendment out of the bill that cleared the House in March. (See March/April 2008 NCTR Federal e-News) However, despite the inclusion of smoothing in H.R. 6382, the bill still had some rough going in the days just prior to its consideration. In an indication of how politicized the Congressional agenda is becoming in this election year -- with neither side of the aisle wanting the other to be able to claim any credit for getting something accomplished – the smoothing provision was suddenly being labeled as “non-technical” by the House GOP leadership. This maneuvering to slow down passage of the PPA technicals came as a surprise to those Republicans who had argued strenuously for the inclusion of the smoothing provision during consideration of the bill earlier in March, when Democrats were using the “non-technical” argument to keep the smoothing provision out of the measure! Furthermore, GOP aides also raised objections to the governmental plans credited interest amendment. According to press reports, an assistant to House Minority Leader John Boehner (R-OH) was quoted as calling the provision “a ruse that would allow unions to under-fund their pension plans on purpose, leaving workers more vulnerable and their benefits less secure.” It quickly became clear that the purpose of the amendment was being misrepresented, and that it was being confused with the issue of MVL. For example, some Republican staffers were suggesting that allowing local governments to use an above-market rate of return as its “interest credit” would make public pensions appear more thoroughly funded than they really are. CongressNow reported that these unnamed Republican aides claimed that if governmental plans “were limited to using the Pension Protection Act market interest rate — a lower interest rate in some cases — they would be forced to increase the amount of contributions to the pension plans and fully fund them.” Huh? While the issue was eventually clarified and the effort to stall the bill was unsuccessful, it does indicate how the issue of MVL disclosure and the arguments of its proponents are beginning to have an effect on the Congressional view of governmental plans and our funding status. As discussed above in the article on MVL, there is much work to be done in this critically important area. The PPA technicals bill as passed by the House also contains an amendment to clarify that the new $3,000 public safety retiree health benefit applies to self-insured health programs. This amendment (section 108(j) of H.R. 6382) would lay to rest an earlier problem that was raised when the IRS, in issuing guidance on the new PPA provisions in early 2007, said that any accident or health plan receiving the payments of qualified health insurance premiums eligible for the $3,000 exclusion cannot be a self-insured plan. While the IRS has subsequently reversed its views on that issue following complaints from the Congress, the amendment would seal the deal. Another amendment of interest to some governmental plans is intended to address IRS Revenue Rulings providing guidance on health reimbursement arrangements (HRAs). Specifically, Revenue Ruling 2006-36, which amplifies Revenue Ruling 2005-24 dealing with the income tax treatment under section 105 of the Internal Revenue Code (IRC) of amounts received by employees from employer-provided reimbursement plans, holds that amounts that may be paid as medical benefits to a designated beneficiary (other than an employee’s spouse or an employee’s dependent) are not excludable from the employee’s gross income under section 105(b). Thus, according to this ruling, HRAs are not allowed to reimburse eligible medical expenses to a non-spouse or non-dependent beneficiary of a participant, even if it is considered taxable income to the beneficiary. Thus, members that pass away without a spouse or legal dependent would have their account balance forfeited to their employer. For reimbursement plans containing such a provision on or before August 14, 2006, this ruling is to take effect for plan years beginning after December 31, 2008. The House-passed amendment (section 204 of H.R. 6382) creates a new special rule for governmental plans that are accident or health plans funded by a medical trust that is established in connection with a public retirement system and that has been authorized by a State legislature, or has received a favorable ruling from the Internal Revenue Service that the trust's income is not includible in gross income under section 115. In such instances, amounts paid (directly or indirectly) to the taxpayer from such an accident or health plan shall not fail to be excluded from gross income solely because such plan, on or before January 1, 2008, provides for reimbursements of health care expenses of a deceased plan participant's beneficiary, even if the beneficiary is a non-spouse or non-dependent. As far as Senate action is concerned, there are some indications that there was dissatisfaction with the inclusion of non-technical provisions in the House bill that were not mutually agreed upon by the Senate. While the governmental plans credited interest amendment has had support from all affected parties in both the House and Senate, it has also been seen by some – even some supporters -- as not a “purely technical” amendment and it could therefore be affected if this tension between the two bodies results in yet another version – perhaps stripped of non-technicals -- being approved by the Senate and sent back over to the House. Tennis, anyone? · H.R. 6382 (Be sure to scroll down) IRS Governmental Plans Initiative: the Plot Thickens The Internal Revenue Service (IRS) is preparing to survey a small group of randomly-selected governmental plans as part of its new “compliance” initiative, to then be followed by a much larger survey effort. NCTR has registered its strong objections to both the scope and methodology of this questionnaire/survey effort, and Congressional concern has been expressed to the IRS as well. The IRS initiative coincides with a push to encourage public plans to seek determination letters. While the overall effort is being characterized as focusing on guidance, this may simply be a self-targeting process for governmental plans to identify problem areas for the IRS to pursue through its focused examination initiative which relies on a process called “risk-based targeting.” It is a more cost-effective way for the IRS to pursue compliance checks and possible enforcement initiatives. On April 22, 2008, the IRS held a governmental plans roundtable in Washington, DC, as part of its new effort to assist governmental plans that the IRS felt had previously been “underserved” by the agency’s Tax Exempt and Government Entities Division (TE/GE Division). The roundtable’s purported goal was to raise awareness in the governmental plan sector of the need to comply with Federal tax qualification requirements, and to begin a dialogue on how to ensure that governmental plans succeed. At that time, a new survey was announced that would be used to produce a public report on the state of governmental plans. (See March/April 2008 NCTR Federal e-News) However, it soon became clear that this dialogue was apparently to be a rather one-sided affair. Even though a draft of the questionnaire to be used in the survey process – slated to begin in August with a preliminary test of the format using 20-25 plans – had been drafted prior to the April roundtable, it was not until the end of May that a copy was shared with NCTR, NASRA and NCPERS. The organizations were given 24 hours in which to provide comments. No other representatives of the public sector, such as employer or employee organizations, were asked for their input, and we were asked not to share the draft with them or anyone else. The draft survey, which was 15 pages long and consisted of thirteen parts, covered not only basic demographic and operational topics, as well as questions related to the plan “document,” but it also covered issues clearly outside the scope of the IRS’ jurisdiction over governmental plans, such as plan governance and the investment of plan assets. In addition, questions touching on subjects typically beyond a governmental plan’s authority were also included, such as plan funding decisions. In all, nine of the thirteen parts did not deal with plan compliance issues related to the Internal Revenue Code. For those four parts that did seem applicable, many of the questions were unclear, confusing, or more appropriate for a private sector ERISA plan. NCTR and NASRA filed a joint e-mail response which noted that, given the very short review time allowed, our comments were cursory at best. However, it was made very clear to the IRS that NCTR believed that “the questionnaire reaches far beyond governmental plan qualification and attempts to mistakenly examine the retirement systems of State and local governments using an inapplicable and inappropriate ERISA plan lens. This is entirely outside the jurisdiction of the IRS, and will only result in misinterpretation and incomplete, inconsistent and inaccurate responses.” A copy of this response was shared with Capitol Hill. NCTR and NASRA also offered “to work with the public plan industry associations and government interest groups, who have more knowledge of these plans, in order to ensure the IRS is indeed able to glean a better understanding of this universe.” It was pointed out that these organizations have collected much of the information the IRS is attempting to gather on public plan benefit design, funding and governance, assembling detailed information, including specific citations to the appropriate statutes or policies in every state. In addition, it was noted that governmental plan Comprehensive Annual Financial Reports (CAFRs) also often contained much of the information the IRS was seeking in order to better understand public plans, and that the Public Fund Survey, sponsored by NASRA and NCTR, was yet another valuable resource for basic plan information. “Our organizations are willing and able to provide this and other information to IRS staff to ensure the Service better understands the unique structures of governmental plans,” the NCTR/NASRA joint comments stressed. Finally, the IRS was strongly urged to “allow for more thorough input on the questionnaire before moving forward.” It was pointed out that not only had public pension organizations not been given the time to appropriately review and discuss the contents within our membership, but that "additional organizations, particularly those whose members have governance authority over State and local government employee retirement system design, governance and funding, should be given plenty of opportunity to comment on a survey into these areas.” It was not until over three weeks later (June 24th) that a response was received from the IRS thanking NCTR for its input and advising us that the IRS is “continuing our work on developing the questionnaire and expect to test it in a limited setting after we have completed its initial development.” The Service advised that “Final decisions regarding scope and content will be made once we receive responses from our test group,” and reminded us again that “Ultimately, the questionnaire’s responses will be used to publish a report which can be used as a tool by the governmental plan sector and the IRS for future education and compliance efforts.” While the IRS also noted that “We expect to continue the dialogue with the governmental plans community that we started at the Roundtable,” there was no offer to meet again to discuss the questionnaire or the survey. Once again, a very one-sided “dialogue.” Accordingly, NCTR and NASRA responded on June 30th: Thank you for your response to our e-mail of June 5th asking for a sense of the current status of the IRS questionnaire that you are developing for governmental plans. We take it from your e-mail that the questionnaire process is still underway as initially planned. We want to therefore reiterate our previous concerns with its current scope and content, which we must assume to be essentially unchanged absent any communications to the contrary. We continue to question how a survey of a small sampling of our large and very diverse community of plans, often asking unclear and confusing questions concerning issues with which our plans, by their design and operations, have little or no involvement or input, can in any way be expected to either help the Service learn more about how the governmental plan community operates, or serve as the basis for ensuring that governmental plans have the tools we need to comply with applicable Federal law. We therefore also want to again express the desire of our two organizations (NCTR and NASRA) to help the Service better understand the unique structure and operations of governmental plans; we sincerely believe that we can substantially expedite the IRS's learning process. In this regard, we respectfully request a meeting with you at your earliest convenience to discuss the current questionnaire process in more detail, and to explore ways in which we can work together to assist the Service in its outreach and education efforts. There has been no response to date. In the meantime, Congressman Earl Pomeroy (D-ND), a member of the House Ways and Means Committee, which has jurisdiction over the IRS, and a strong supporter of public pension plans (see above story on PPA technical amendments), has raised the issue and his concerns with the questionnaire/survey process in a meeting with the new IRS Commissioner, Douglas Shulman. A representative of Ways and Means Committee Chairman Charles Rangel (D-NY) joined him in that meeting. Most recently, Congressman Pomeroy and Chairman Rangel’s staff have also met with Steve Miller, IRS Commissioner for Tax Exempt and Government Entities Division (TE/GE Division), who is directly in charge of the new governmental plans initiative. According to reports of that meeting, the IRS remains intent on pursuing the questionnaire/survey approach, but says that the questionnaire has been substantially modified. Nevertheless, it does not appear that they plan to share their updated version with representatives of the public sector before it is sent out. The next step from Capitol Hill appears be for the Ways and Means Committee to convene a meeting (not a formal hearing) with members of Congress, the IRS, and public sector representatives to discuss this matter further; hopefully, the IRS survey process can be suspended until such a meeting can occur. Why is the IRS so intent on pursuing this process? They argue that they have a legitimate interest in seeing if the retirement security of public employees, who make up 20% of the workforce, is sound. As Commissioner Miller explained at the IRS roundtable for governmental plans, the IRS is concerned with media reports that, due to economic stress affecting state and local government policy, adequate funding is an issue and the IRS wants to “ensure people get the pension benefits they are entitled to." The IRS governmental plans initiative also fits neatly with their “focused examination initiative,” which is a process that hones in on key issues based on plan type and industry. According to Monika Templeman, Director of the IRS’ Exempt Plans Examinations Division, this focused examination approach provides the IRS agent with two to three issues to examine based on historical analysis, initial review, and industry type. After the initial interview and analysis of the records, the agent can expand the audit scope, if so warranted, allowing agents to perform examinations more effectively and efficiently, and reducing time (and therefore IRS costs) on an examination. A critical component of this focused examination initiative is a process called “risk-based targeting.” “In fulfilling our mission of protecting retirement plan assets and the benefits of plan participants, it is important that we foster and promote plan sponsors’ compliance with the applicable Internal Revenue Code provisions,” Templeman argues, echoing Miller’s comments. “We cannot maximize our compliance impact if agents routinely audit compliant plans,” Templeman explains. “Utilizing data-driven case selection methods allow us to focus on market segments with the highest potential for noncompliance” she states in a recent interview in the IRS “Employee Plans News.” This is where the questionnaire/survey and the push for governmental plans’ determination letter requests come into play. The IRS “Risk-Based Targeted” case selection process is premised on a risk assessment analysis to determine compliance levels and problems. This permits the IRS to identify a high level of noncompliance through the baseline examinations, allowing the Service to improve the use of their resources by focusing on less compliant market segments. In short, through the questionnaire process, and to a lesser extent, the determination letter process, governmental plans will self-target themselves for the purpose of efficient IRS compliance checks and enforcement actions. How kind of us. NCTR, working with NASRA and other public sector organizations, will continue to work to get the focus of this effort shifted to guidance – often much-lacking and much-needed in several areas. Without such guidance, what basis can there be for any reasonable compliance assessment? While ignorance of the law may be no excuse, this old adage should certainly not be a rationale for compliance audits and enforcement actions when the lack of knowledge on which any mistakes are based is the result of a lack of guidance from the IRS on how to be in compliance with the law in the first place. Senators Drop Ban on Pension Investments in Commodities Futures, But Fight May Not be Over Yet
For months now, Congress has been struggling to do something to prove to voters that it is working to bring down record prices for gasoline. Hours and hours of hearings have been held on both sides of Capitol Hill, with one House Committee hearing running over seven hours. Multiple committees, both with and without the jurisdiction to do anything about the problem, have become involved. At the center of this whirlwind of activity is the allegation that speculation by institutional investors, including pension funds, is artificially driving up oil prices. For example, a recent Washington Post article, read by many members of Congress and their staff, led with the assertion that soaring fuel prices that are “burning a hole in the wallets of consumers” are not only “benefiting oil companies and Middle Eastern producers” but they are also “lighting up the investment returns of pension funds.” The article focused directly on governmental plans, noting that the California Public Employees Retirement System (CalPERS) made its first investment of $1.1 billion into oil and other commodities early last year, and since then, “has seen it soar 68 percent.” The story also claimed that in Fairfax County, Virginia, “pension managers have enjoyed a 61 percent return from a similar move over the past 12 months, far outpacing any other segment of the fund's portfolio.” According to the Post, “Other pension funds are rushing to get in on the action as the prices of oil, precious metals, corn, uranium and other vital goods continue to reach record highs.” It characterized this activity as part of a “tidal wave of investment dollars that has flooded commodity markets in recent years” and contributed to the run-up in gas prices. According to at least one outspoken critic of pension fund “speculation,” (Michael Masters, a long/short equity hedge fund manager who has testified before several of the above-referenced hearings), legislation addressing this speculation could produce a 50% cut in gas prices within 30 days of enactment. It should come as no surprise, then, that there have been about two dozen pieces of legislation introduced in both the House and Senate aimed at either addressing the possibility of outright manipulation occurring in under-regulated or unregulated commodity futures markets, or providing ways in which “excessive” speculation can be driven out of the energy markets. In fact, in late June the House passed one bill, H.R 6377, introduced by Congressman Collin Peterson (D-MN), Chairman of the House Agriculture Committee, by a vote of 402-19. The measure does not specifically blame speculators for all of the problems; instead, it simply refers in its Congressional findings to a May 2008 report by the International Monetary Fund which “raised the possibility” that speculation has played a significant role in the run-up of oil prices. The legislation does not give the CFTC any new powers, but simply directs it to use all its current authority – including its emergency powers, which could allow it to impose temporary limits on traders or halt trading altogether when oil prices become too volatile – to address the current situation. When an effort was made to bring up the House-passed bill for consideration in the Senate, Republican Leaders objected and attempted to attach an amendment to increase oil drilling and exploration in the outer continental shelf. It is widely believed that they acted to prevent Democratic members from claiming any success concerning gas prices during the July Fourth recess. As for Senate legislation on the subject, the Senate Majority Whip, Richard Durbin (D-IL), has introduced S. 3130, which is cosponsored by 19 Senators including Senator Harry Reid (D-NV), the Senate Majority Leader, Senator Jeff Bingaman (D-NM), Chairman of the Senate Energy Committee, and Senator Barack Obama (D-IL). While Senator Durbin has said that “Increasing evidence shows that the run-up in crude oil prices and gasoline is being driven by larger trader banks, pension and hedge funds,” and that “Speculation may have as much, if not more, to do with high gas prices than any Saudi Sheik," his bill does not contain any ban on institutional investor access to the commodity futures market for oil. Instead, his measure would authorize new resources for the CFTC by providing 100 new employees and additional monies for technology. It would also improve transparency in the commodity futures market by closing the so-called “London Loophole,” requiring all traders on oil futures markets to report transactions in a detailed manner to the CFTC. Finally, the bill also directs the CFTC to investigate the impact of these trades on the price of oil. Although the Durbin legislation states the sense of the Senate that the CFTC should be given the power to “potentially” impose limits on excessive speculation that is increasing the price of oil and other energy commodities, it has been legislation discussed by Senator Joseph Lieberman (I-CT), Chairman of the Senate Committee on Homeland Security and Governmental Affairs, that has come the closest to imposing such a ban. In June, following the second hearing on the subject by his Committee, Senator Lieberman said that he was considering offering legislation that would, among other things, prohibit pension funds and governmental entities from investing in commodities and prohibit other large institutional investors from investing in commodities index funds. However, investor organizations responded with a vigorous campaign to set the record straight. For example, William F. Quinn, Chairman of the Committee on the Investment of Employee Benefit Assets (CIEBA) testified before Senator Lieberman on June 24th. CIEBA members are the chief investment officers of most of the major private sector retirement plans in the United States, representing 110 of the country’s largest pension funds. He told Lieberman’s Committee “It is critical that pension plans have the ability to invest in accordance with modern portfolio theory and pursue the best investment strategy available.” As he reminded the Committee, “The investment marketplace is constantly changing and pension plans need to be able to adapt and evolve accordingly without having to comply with lists of permitted and impermissible investments.” The CIEBA testimony stressed concerns not only with specific restrictions on pension plan investments in commodities, but also “with the precedent that action will set for allowing the government to intrude on pension investment decisions.” This is particularly true since the case for limiting pension investments in commodities has simply not been made, CIEBA argued. “As others, including the Commodity Futures Trading Commission (“CFTC”), have testified, it is far from clear that institutional investors in the commodities market are driving the surging prices,” CIEBA stressed. “The allegations that institutional investors engage in harmful speculation in the commodities markets have been almost entirely anecdotal and we are not aware of any substantial analysis that supports the allegations,” Mr. Quinn concluded. While representatives of governmental plans declined requests to testify in an effort to shift the media focus from this subset of all institutional investors, the Council of Institutional Investors (CII) issued a press release on the day of the hearing. The statement echoed the concerns of CIEBA, pointing out “legislative proposals to limit the ability of sophisticated institutional investors to make commodity-based investments could harm millions of Americans, including U.S. workers and retirees who are the beneficiaries of pension funds, without impacting the issue of escalating commodity prices.” CII urged Congress not to take any precipitous action until all the facts have been ascertained. While the Council agreed that Congress and the CFTC should investigate potentially abusive market practices, it also stressed that “absent data suggesting the need for market reforms, we oppose legislation that would unnecessarily limit or prohibit sophisticated investors from investing in commodity-based securities.” Subsequently, when Senator Lieberman, joined by his Committee’s Ranking Republican, Senator Susan Collins (R-ME) and Senator Maria Cantwell (D-WA), finally introduced his legislative proposal, S. 3248, it did not contain any outright ban on institutional investor access to commodity futures. According to press reports, an aide to Lieberman said the Senator decided after hearing from experts, lobbyists, the public and his colleagues that restricting investments in food and energy futures by pension funds, hedge funds and financial firms would simply not be able to pass the Senate. Instead, the legislation would require the CFTC to consider the overall effect of speculation when it sets the position limits that restrict the amount that any one investor can invest in a commodity. As with the Durbin legislation, it would also add 100 new CFTC staff to improve its market oversight and enforcement capabilities. The bill would extend the existing rules that apply to the regulated exchanges to currently unregulated over-the-counter and foreign markets; eliminate the swaps loophole that allows pension funds and other large investors to invest in index funds without following restrictions on how much can be invested in a commodity; and direct the CFTC to set speculative position limits, rather than have them set by the for-profit futures exchanges. So, is the threat of restrictions on pension fund investments in this area over? Certainly it is a major accomplishment not to have such a ban included in the Lieberman bill. However, it is by no means certain that the issue will now disappear. For example, during three days of hearings the week Congress returned from the July 4th break, the House Agriculture Committee was told by the Petroleum Marketers Association of America (PMAA) that “Excessive speculation on energy trading facilities is the fuel that is driving this runaway train in crude oil prices,” and that institutional investors’ “buy and hold” strategy has further inflated crude oil price because index speculators do not trade based on the underlying supply and demand fundamentals of the individual physical commodities. “When institutional investors buy an initial futures contract, that demand drives up the price,” according to the PMAA testimony. This has the same effect as the additional demand for contracts for delivery of a physical barrel of oil, thus driving up prices for oil on the spot market. The PMAA, an association of 8,000 independent fuel marketers that collectively account for approximately half of the gasoline and nearly all of the distillate fuel consumed by motor vehicles and heating equipment in the United States, urged Congress to ban from the market any participant that does not have the ability to take direct physical possession of a commodity, is not trading in order to manage risk associated with the commodity, or is not a risk management or hedging service. Despite the vigorous educational campaign of the investor community, this message may be falling on the sympathetic ears of powerful players in the ultimate legislative outcome of this overall debate. The Agriculture Committee Chairman, Congressman Collin Peterson -- despite having passed a bill a month ago that, as noted above, was not aimed at banning speculators -- nevertheless said at these recent hearings that he had a “real problem” with pension funds investing money in commodities. In response to CIEBA’s testimony before his Committee that their pension fund members reported having less than 1% of assets invested directly in commodities and natural resources in 2007, Congressman Peterson responded that “I think personally that’s 1% too much.” Reports are that the Senate hopes to take action soon on a legislative proposal that will probably use the Durbin bill as its base, and then package that with the House-passed bill – perhaps as part of a larger energy bill. In any case, Democrats hope to have a final deal completed and before the President before leaving town for their August recess. While it currently looks like this legislation will not contain a ban on institutional investors’ access to commodity futures, a lot can happen between now and then – particularly if gasoline prices suddenly spike again. Supreme Court Sides with Kentucky; Disability Plan Found Not to be Age Discriminatory
The saga began in 1995 when a deputy sheriff’s application for disability retirement at age 61, with 17 years service as a public employee, was denied because he had already become eligible for regular retirement benefits at age 55. Since employees who qualified for disability retirement before becoming eligible for normal retirement were credited with additional years for purposes of calculating the disability retirement benefits – specifically, the number of years until the employee would have reached normal retirement age, not to exceed 20 years of service – but the Plan did not impute any additional years for purposes of the calculation of his benefit, the deputy claimed that he was being denied additional benefits because of his age. The EEOC agreed and brought an age discrimination lawsuit against the Commonwealth of Kentucky, Kentucky’s Plan administrator, and other state entities. The EEOC argued that if the deputy sheriff had become disabled before he reached the age of 55, the Plan, in calculating his benefits, would have imputed a number of additional years. However, since the Plan failed to impute any additional years solely because he became disabled after he reached age 55, Kentucky’s actions violated the Age Discrimination in Employment Act (ADEA). The U.S. District Court held that the EEOC could not establish age discrimination; and it granted summary judgment in Kentucky’s favor. When the EEOC appealed, a panel of the U.S. Sixth Circuit Court of Appeals affirmed the lower court’s judgment. However, the Sixth Circuit then granted a rehearing before the entire court (an en banc hearing), and changed its mind, holding that Kentucky’s Plan did violate ADEA after all, and reversed the District Court’s ruling and sent it back so the EEOC lawsuit could continue. (See November 2006 NCTR Federal e-News) Kentucky then sought certiorari before the Supreme Court, which decided to hear the case “in light of the potentially serious impact of the Circuit’s decision upon pension benefits provided under plans in effect in many States.” The high court’s ruling was a 5-4 split decision, and was issued on June 19, 2008. It certainly presents a case of “interesting bedfellows.” For example, Chief Justice Roberts and Justice Alito, the two recent Bush nominees, are on opposite sides, as are the two Clinton appointees, Justices Breyer and Ginsburg. The decision even divided the most dependable duo on the court, Justices Scalia and Thomas. And for good measure, the Court’s two most liberal Justices, Souter and Stevens, were also on opposing sides. Writing for the majority, Justice Breyer explained that the differences in treatment were not actually motivated by age. “First, as a matter of pure logic, age and pension status remain ‘analytically distinct’ concepts,” he writes. Furthermore, the issue is not an individual employment decision, but a set of complex systemwide rules involving pensions, not wages. The majority also points out that there is a clear non-age-related rationale for the disparity at issue: the disability rules clearly track Kentucky’s normal retirement rules. “It is obvious, then, that the whole purpose of the disability rules is, as Kentucky claims, to treat a disabled worker as though he had become disabled after, rather than before, he had become eligible for normal retirement benefits,” Justice Breyer explains. “Age factors into the disability calculation only because the normal retirement rules themselves permissibly include age as a consideration,” he notes. The point is that Kentucky’s disability plan simply seeks to treat disabled employees as if they had worked until the point at which they would be eligible for a normal pension. “The disparity turns upon pension eligibility and nothing more,” Breyer concludes. With regard to the EEOC’s argument that the Older Workers Benefit Protection Act, (OWBPA) passed by Congress in response to the Supreme Court’s ruling in Public Employees Retirement System of Ohio v. Betts, was controlling, the Court noted that it did not dispute that ADEA prohibitions apply to Kentucky’s disability plan under the OWBPA, but that “our basis for finding the Plan lawful does not rest upon amendment-related justifications”, but instead their finding that the discrimination is not “actually motivated” by age. In a dissent written by Justice Kennedy for himself and Justices Scalia, Ginsburg, and Alito, the majority’s ruling is characterized as ignoring established rules for interpreting and enforcing “one of the most important statutes Congress has enacted to protect the Nation’s work force from age discrimination, the Age Discrimination in Employment Act of 1967.” The ruling undercuts the basic framework of ADEA, according to the dissenters. Even the potential impact of an adverse ruling on Kentucky’s disability program does not sway the dissenters. According to them, the majority’s desire to avoid construing the ADEA in a way that encourages the Commonwealth to eliminate its early retirement program or to reduce benefits to the policemen and firefighters who are covered under the disability plan may be understandable. However, under the Court’s precedents, a benefit that is part and parcel of the employment relationship may not be doled out in a discriminatory fashion, even if the employer would be free not to provide the benefit at all, the dissent reminds the majority. “If Kentucky’s facially discriminatory plan is good public policy,’ Justice Kennedy writes, “the answer is not for this Court to ignore its precedents and the plain text of the statute.” Will this be seen as a veiled invitation for Congress to address the issue? Does the holding set a dangerous precedent for age discrimination in the provision of pensions, or does it offer a green light for provisions implicating age as long as age isn’t an “actual motivation” for discrimination? With a 5-4 split, it is difficult to give too broad a reading to the decision. However, it is interesting to note that the Court, in its ruling, acknowledged that should the EEOC's position have been permitted to prevail, the likely result would not have been to increase benefits for disabled older workers, but to have reduced benefits for disabled younger workers. Perhaps there is hope after all for looking at the practical consequences of government action? · Supreme Court’s Kentucky Majority Opinion President Signs New “HEART” Act; Requires Changes to Retirement, Survivor and Disability Benefits for U.S Servicemembers and their families.
The HEART Act (PL 110-245) deals with a number of issues related to military personnel, including making permanent the election to treat combat zone compensation as earned income for purposes of the earned income tax credit. The exemption from the first-time homebuyer rule for veterans using mortgage revenue bonds to purchase a residence is also made permanent. In addition, the new law addresses a problem highlighted in hearings last year dealing with the treatment of public employees who die while performing National Guard duty (or any other USERRA-qualified military service). In some cases, such individuals were being treated as terminated employees for benefit purposes, and their survivors were thus only eligible for a survivor benefit equal to a refund of contributions. (See October 2007 NCTR Federal e-News) Under the new law (see Section 104(a)), tax-qualified pension plans are required, as a new qualification standard under Internal Revenue Code Section 401(a), to provide that, in the case of a participant who dies while performing qualified military service, the survivors of the participant are entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) provided under the plan had the participant resumed and then terminated employment on account of death. This therefore applies to not only DB plans, but also 403(b) plans and 457(b) plans, and is retroactive to deaths occurring on and after January 1, 2007. For a governmental plan, amendments to provide for such must be made on or before the end of the 2012 plan year. As far as benefit accruals in such cases are concerned, the new law (Section 104(b)) makes it optional for a plan to treat an individual who dies or becomes disabled (under the terms of the plan) while performing qualified military service as if the individual had resumed employment in accordance with USERRA on the day preceding death or disability and terminated employment on the actual date of death or disability. However, in order to do so, the plan must provide service and benefits on reasonably equivalent terms to all individuals performing USERRA service. This is also retroactive to deaths and disability occurring on and after January 1, 2007, and, if a plan chooses to adopt such provisions, it must do so on or before the end of the 2012 plan year. Some governmental plan attorneys have already raised the question whether Section 104(a) requires a plan to pay service-connected death benefits to the survivors of the plan participant or just ordinary death benefits. The answer to this question can be significant, as service-connected death benefits are often better than the ordinary death benefits payable without regard to the cause of death. In addition, since the tax-qualified status of the plan is dependent upon compliance with this issue, it is essential that the requirement be clearly understood. However, it appears that the language of the Act provides no real guidance. Furthermore, regardless of the answer to this question, is the benefit paid under this provision excludable from income under Section 104 of the Internal Revenue Code (IRC)? That is, even if the benefit is permitted to be treated as non-service connected by the plan, since it is mandated in connection with military service, does this make the death benefit nevertheless excludable? The answer to this question is also very important, since there is a liability issue should a pension plan fail to withhold if, in fact, the benefit is taxable. On the other hand, plan participants and beneficiaries will not be thrilled if the plan withholds on what is later determined to be a non-taxable benefit! It appears that guidance form the IRS may be in order, but before NCTR and others approach the Service on this issue, what are your thoughts? Do you think the benefit should be treated by the plan as a service-connected death benefit? Do you think that plans should take a position on taxability, or simply treat the benefit as taxable and leave it up to beneficiaries to seek a refund? Other sections of the new HEART Act that should also be of interest to public plans are: · Section 105, dealing with the treatment of differential military pay as wages, including a new rule that a person receiving differential pay must be treated as an employee of the employer making the payment and the payment shall be treated as compensation for purposes of calculation of contributions and benefits, as well as a special rule for distributions that says, regardless of this latter new rule, an individual shall be treated as having severed employment while in USERRA covered service for the purpose of taking a distribution from the plan; · Section 107, making the exemption from the 10% premature distribution tax for "qualified reservist distributions" permanent; and · Section 109, allowing a military death benefit payment to be rolled over to a survivor's Roth IRS or to an education savings account without regard to annual limits on rollovers. For answers to your questions on the HEART Act or other new rules and regulations from our friends at the IRS, be sure to attend the afternoon workshop, “Update on Legal Issues Affecting Public Plans,” Monday, October 13, 2008, at the 86th Annual NCTR Convention. Public Pensions “Getting it Right”
According to Congressional Hearing by Joint Economic Committee The JEC hearing on July 10th was entitled “Your Money, Your Future: Public Pension Plans and the Need to Strengthen Retirement Security and Economic Growth.” The JEC is a House-Senate bicameral Congressional Committee whose main purpose is to make a continuing study of matters relating to the U.S. economy. It is composed of ten members from each body, with twelve Democrats and eight Republicans. The JEC holds hearings, performs research and advises Members of Congress, but has no legislative jurisdiction. That is, it does not have power to develop bills. Senator Casey, who envisioned the hearing and was its chair, is former Auditor General and State Treasurer of Pennsylvania. He is therefore very familiar with public sector funds; he audited both the Pennsylvania Public School Employees Retirement System as well as the Pennsylvania State Employees' Retirement System, and as State Treasurer, served as a trustee for both funds. As he explained in his opening statement, “It gave me an insight into the benefits of well-run defined benefit plans, both to retirees and to our economy as a whole.” Senator Chick Schumer (D-NY) the Chairman of the JEC, said that “it is critical that we in Congress do all we can to ensure that public defined benefit pension plans are protected.” He noted that “Public sector defined benefit pension plans provide workers with 34 percent higher earnings over a 25 year period than defined contribution plans and save taxpayers hundreds of millions of dollars in reduced state and local government contributions.” Turning to their role as economic engines, Senator Schumer reminded the Committee that “At the same time, these plans help fuel the economy by driving investment to venture capital funds that play a critical role in nurturing American innovation and breakthroughs across the technological spectrum – including life saving advances in health care.” Congresswoman Carolyn Maloney (D-NY), the Vice-Chair of the Committee, also said in her statement for the record that public pensions were “a model for providing retirement security to workers.” The Congresswoman, who is also chair of the House Financial Services Committee’s Subcommittee on Financial Institutions and Consumer Credit, also pointed out that “In the current credit crisis, pension plans have played an important role in providing liquidity to the markets.” Other Committee members in attendance were Congressman Kevin Brady (R-TX) and Elijah Cummings (D-MD), as well as Senator Amy Klobuchar (D-MN). Congressman Earl Pomeroy (D-ND), a great supporter of governmental DB plans, also attended to commend Senator Casey for convening this hearing to examine the economic and retirement security benefits of pensions. Testifying at the hearing were: Mr. Sherrill Neff, Partner, Quaker BioVenture; Dr. Christian Weller, Associate Professor at the University of Massachusetts and Senior Fellow at the Center for American Progress; Mr. Will Pryor, a firefighter and Chair of the Los Angeles County Employees Retirement Association; and Barbara Bovjberg, Director, Education Workforce, and Income Security with the Government Accountability Office. NCTR, NASRA and 18 other national public sector organizations also wrote a letter to Senator Casey in support of his hearings. The letter, which Senator Casey submitted for the record along with his opening remarks, closed by saying that “We share your interest in providing a secure retirement for American workers and future economic growth for our country. Indeed, we believe many public sector retirement systems are innovative models. Their independence and flexibility has enabled them to achieve important objectives related to the recruitment and retention of quality workers, while also promoting participants’ ability to attain financial security in retirement, reduce reliance on public assistance programs, and provide significant economic benefits to communities and the financial markets.” Senator Casey also used the opportunity of the hearing to note his concern that “some here in Washington and across America want ordinary people to assume sole liability for decisions regarding their health care, their pensions and their Social Security.” However, he cautioned that “If we want people to take 21st-century, global economy-type risks, like changing jobs, stopping-out for more education and training or starting their own businesses, we cannot also dump all the risk of health care and retirement on them.” “I am concerned that moving billions of dollars of retirement assets from defined benefit plans to defined contribution plans ads substantially to the risk we are asking ordinary Americans to take,” Casey warned. At the end of the hearing, Senator Casey asked each of the witnesses for specific recommendations on what to do about the future of defined benefit plans. Professor Weller, echoing the NCTR/NASRA “Getting it Right” educational campaign for public DB plans, told him that “Public sector plans are getting it right,” and should be used as a model for the private sector to improve income security. While he questioned whether there was any appropriate role for the Federal government in public sector plans, Dr. Weller did suggest that Congress might want to examine why single-employer defined benefit plans have disappeared while multiemployer plans have remained stable. The GAO witness, Barbara Bovjberg, noting the stability of public plans, told Senator Casey that she did not think that there was much to done by the government. Finally, Mr. Neff, testifying for the venture capital community, warned the Federal government not to do anything that would cause governmental plans to move from the defined benefit model to a defined contribution system. Senator Casey apparently agrees. In his opening statement, he answered his own question by asserting that “At a minimum, we should ensure that the circumstances that led to the decline of defined benefit plans in the corporate world are not repeated in the public or Taft-Hartley sectors.” It was enough to make a grown man cry – tears of joy! · JEC
Hearing on Public Pension Funds
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