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May 27, 1998

Federal Update on Mandatory Social Security Coverage and Securities Litigation Legislation

by Cindie Moore, NCTR Washington Counsel

Impact of Mandatory Coverage Discussed in Washington

Hearings Held and National Commission on Retirement

Policy Recommends Mandatory Coverage

According to the General Accounting Office (GAO), mandatory Social Security coverage of newly hired state and local government workers will benefit the Social Security system and cost money to the states and localities unless they reduce pension benefits. The GAO, Congress' investigatory arm, presented initial findings on a report it is conducting for Congress on the impact of mandatory coverage at a hearing before the House Social Security Subcommittee on May 21. Besides the GAO, public plan representatives also testified. Contact me for a copy of testimony by GAO or the plan representatives (see list below). Note, GAO's testimony does not represent its full report, which will be released in a few months (or maybe sooner). See story elsewhere in this report about the National Commission on Retirement Policy's report.

By way of background, the Social Security system did not cover state and local government employees when it was first authorized in the 1930's. By the 1950's, states and localities could voluntarily join the system if they wished. NCTR supports this principle of voluntary affiliation, but opposes mandatory coverage. Some retirement systems that belong to NCTR decided to participate in Social Security; some have foregone participation.

The GAO made the following points in its testimony:

1) mandatory coverage would benefit the Social Security program;

2) the impact of mandatory coverage on employers, employees, and their pension plans would vary depending on their response (GAO provides three scenarios, explained below);

3) mandatory coverage raises legal considerations, but any legal challenge would not likely succeed; and

4) states would require up to four years to implement mandatory coverage.

GAO's First Point: Mandatory coverage would benefit the Social Security program.

GAO cited three benefits. First, mandatory coverage would reduce Social Security's financial shortfall by about 10%, which translates into an extension of the program's solvency by two years. It pointed out that mandatory coverage alone would not shore up the program, but that other changes would also be required. Second, mandatory coverage would increase participation. It stated that 95% of non-covered state and local government employees receive a benefit through covered work or from a spouse. Despite the government pension offset (GPO) and the windfall elimination provision (WEP), which are designed to prevent such employees from getting an overly generous Social Security benefit, GAO said that the Social Security Administration (SSA) is unable to adequately determine to whom the GPO and WEP is applicable. Consequently, between $160 and $350 million in overpayments are made each year, according to a GAO review of the issue. Third, mandatory coverage simplifies the operation of Social Security. GAO cited as its source a 1996 SSA study in which the SSA believes that a significant risk of noncompliance with state and local coverage provisions exists. GAO implied that the risk would be gradually eliminated if mandatory coverage were enacted.

GAO's Second Point: Three scenarios about how states might adjust pension programs if mandatory coverage were enacted.

GAO proposed three scenarios. The first two would raise pension costs and the third would reduce them because it would lower benefits. GAO's discussion on each scenario follows.

Scenario I: Maintaining Level Benefits Would Likely Increase Costs

States and localities with non-covered workers could opt to provide newly hired employees with Social Security and pension benefits that, in total, approximate the pension benefits of current employees. Studies indicate that such an option could increase retirement costs of 7% of new-employee payroll. (In a conversation with a GAO official, I learned that GAO has no position about who would pay the additional cost, be it the employer, the employee, or some combination of the two.) GAO relied on a 1980 study by Social Security as well as more recent studies by Colorado, Illinois, and Ohio. If mandatory coverage were to begin January 1, 2000, this increase would cost states and localities (and their employees, too, depending on how the cost was allocated) about $9.1 billion over the first five years.

Scenario II: Matching Pension Benefits of Currently Covered Employees Would Likely Increase Costs

GAO did not make clear in its testimony (either oral or written) the difference between Scenarios I and II. According to a GAO official with whom I spoke after the hearing, Scenario I assumes that states would "integrate" Social Security benefits with pension plans under mandatory coverage. Integration takes into account the income-weighting feature of Social Security. Specifically, Social Security pays proportionately larger benefits to individuals with low earnings during their careers and proportionately smaller benefits to those with higher incomes. Under integration, pension benefits paid by a private or public plan are proportionately smaller for lower paid individuals and larger for higher paid individuals, thereby offsetting Social Security's income-weighting feature. Integration saves on pension costs because lower wage individuals get less. Private plans commonly integrate, but public plans rarely do. Under Scenario II, by contrast, GAO assumes that states would not integrate, but merely re-design a benefit for new hires incorporating Social Security that would yield a similar benefit to that of non-covered employees. The cost of Scenario II would be between 3% and 11% of payroll, based on the 1980 study referenced above. The 1995 Public Pension Coordinating Council data showed, for Social Security-covered plans, an average employee cost rate of 9% and an average employer cost rate (excluding the cost of unfunded liabilities) of 12%. For non-Social Security covered plans, the average cost for employees is 8% and for employers, the same percentage. GAO said that Social Security's cost is higher because it provides fully indexed COLAs, portability, and additional benefits for spouses and dependents. (This contention is debatable in the area of both portability and additional benefits. Public plans frequently provide portability through buy-back options and intrastate transfers. Public employees are eligible for a range of additional benefits for spouses and dependents that could very well exceed comparable Social Security benefits.)

Scenario III: Level Retirement Spending Could Mean Reduced Benefits

Scenario III assumes that the state or locality would maintain the current level of funding for the pension plan, which could result in reduced benefits for many employees. (GAO does not make clear in its written testimony whether it means both existing and new employees or just one or the other group.) GAO reached its conclusion based on an Ohio study. Note: the state laws that forbid the impairment or diminishment of pension benefits would likely prohibit the reduction of benefits.

GAO's Third Point: Mandatory coverage raises legal considerations, but any legal challenge would not likely succeed.

GAO acknowledged that mandatory coverage might trigger a lawsuit. In light of recent Supreme Court cases, it believes the challenges would fail. The cases fall into two categories: 1) affirming the authority of the federal government to enact taxes that affect states and 2) allowing the federal government to impose requirements regulating the states' relations with their employees. Despite GAO's contention, however, it is not clear whether these cases would be determinative in any case involving mandatory coverage.

GAO's Fourth Point: States would require up to four years to implement mandatory coverage.

GAO cited the 1980 study above for estimating a four year period to accomplish mandatory coverage. The study's authors took into account the need to redesign pension formulas, legislate changes, adjust budgets, and disseminate information to employers and employees. GAO additionally recognized that some state legislatures do not meet annually, which would also require more time. Finally, representatives of states, localities, and employees said that up to four years would likely be needed to implement the change.

Effective Testimony Presented by Public Plan Representatives

NCTR system directors Tom Lussier (Massachusetts), Bob Scott (Colorado), and George Pyne (Nevada) testified as did Richard Schumacher (Ohio PERS) and Martin Pfeifer, of the Washington D.C. Metropolitan Police Department. They pointed out the effectiveness of current plans and described the potential costs of mandatory coverage.

Government Pension Offset (GPO) and Windfall Elimination Provisions (WEP) Discussed

In addition to mandatory coverage, the hearing covered legislation to modify the unfair impact of the GPO and WEP to low income government retirees. Testifying were Bob Normandie and Bernadine Jernigan, representing the National Association of Retired Federal Employees and Joseph Rugola, representing the Ohio affiliate of the American Federation of State, County, and Municipal Employees. Contact me for copies of their testimony.

National Commission on Retirement Policy (NCRP) Recommendations Include Mandatory Coverage

The NCRP recently released a set of recommendations addressing both Social Security finance reform and retirement savings enhancements. As part of Social Security reform, the Commission advocates mandatory coverage of all state and local government employees hired after 1999 as a means to contribute to the system's actuarial stability and promote the goal of universal national participation in the program. Senator Breaux's office reported that the senator requested a separate vote on whether to include mandatory coverage as part of the recommendations. The vote was taken and the commissioners approved including it.

The Commission is made up of both Members of Congress and private sector members. Senators John Breaux (D-LA) and Judd Gregg (R-NH) and Congressmen Jim Kolbe (R-AZ) and Charles Stenholm (D-TX) represented Congress. The Commission is a subgroup of the Center for Strategic and International Studies (CSIS), a Washington think tank that is usually involved in international issues.

Highlights of the NCRP's Social Security reform recommendations include:

• raising the normal retirement age to 70 by 2029;
  
  
• reducing the percent of primary insurance amount payable to spouse beneficiaries from 50% to 33%;
  
  
• eliminating the earnings test; and
  
  
• establishing a mechanism to create individual savings accounts within Social Security that provides individuals with control over the investment of a portion of their FICA taxes.

In addition to the Social Security proposals, the NCRP also recommended changes to enhance retirement savings, including several portability provisions supported by NCTR. The report favors the use of 403(b) and 457 money for the purchase of service credit in governmental defined benefit plans. It also approves of rollovers into 403(b)s and 457s. It picks up a number of other provisions in H.R. 3503, the Retirement Account Portability (RAP) Act by Reps. Earl Pomeroy (D-ND) and Jim Kolbe (R-AZ). Other issues in the NCRP proposal include (but are not in RAP):

• simplification of IRAs;
  
  
• a universal 401(k), into which employers could (but would not be required to) transfer their existing 403(b)s and 457s; and
  
  
• simplification of defined benefit plans (similar to the SAFE and SMART plans currently proposed for small employers).

Legislation embodying the NCRP's proposals will be introduced shortly. A detailed summary of the recommendations is located on the Internet at www.csis.org. Contact me for a copy if you do not have Internet access.

Senate Passes Securities Litigation Legislation with Exception for Lawsuits by Public Pension Plans

Follow-on legislation to the 1995 congressional changes to securities litigation was approved by the Senate on May 13 (S. 1260 by Sen. Phil Gramm (R-TX)) by a vote of 79-21. The 1995 act placed stricter requirement on the filing of class action lawsuits involving publicly traded securities. While the act evidently reduced the number of such cases filed in federal court, cases are still being filed in state court. S. 1260 would require such lawsuits to be filed in federal court where the standards are stricter. The bill would also clarify what constitutes a class action lawsuit and makes clear that investors could still recover losses due to a company's reckless misconduct. The House bill, H.R. 1689, by Rep. Rick White (R-WA), was the subject of hearings on May 19. The legislation is generally supported by the White House.

Of particular interest to NCTR members is an amendment proposed by Senator Paul Sarbanes (D-MD). It would preserve the right of a state or political subdivision or a state pension plan to bring a class action suit in state court under securities laws. The Senate approved it unanimously. NCTR does not have a policy on securities litigation because its member retirement systems have a diversity of views on the issue.