March 2, 2007

Benefits Policy Shifts
New Fiscal Environment
PPA Implementation
GETTING IT RIGHT!

District Court Finds Illinois Sudan Act Unconstitutional
Senators ask GAO to Study Pension Fund Investment in Hedge Funds

State News and Research (keithb@nasra.org)

S&P Report on Public Pension Funding Levels
Public funds register fourth consecutive year of strong investment returns
With colorful opposition from the media, Utah DC option dies in session’s waning hours
Terror divestment roundup

NASRA, NCTR Members Meet with Feds

In a format different from past years, the 2007 NASRA Winter Administrators’ Meeting, recently held in Washington, D.C., included a joint afternoon workshop where key officials and staff from Congress and the Administration were invited to sit down for a frank discussion of pressing issues. The response from interested federal policymakers was impressive. Congressman Earl Pomeroy (D-ND), U.S. Comptroller General David Walker, Treasury Benefits Tax Counsel Tom Reeder, Senior Policy Advisor to the House Majority Leader Scott DeFife, House Financial Services Committee Majority Counsel Lawranne Stewart, and House Education & Labor Committee Labor Policy Director Michelle Varnhagen all attended to converse with NASRA and NCTR members on the federal fiscal, legislative and regulatory landscape and how it might impact State and local retirement systems.

Benefits Policy Shifts
Most agreed the new leadership and make-up of the 110th Congress would change the direction of numerous federal policy discussions. In the benefits area, there seems to generally be a greater emphasis on the viability of the nation’s health care system than the pension system, and more interest in expanding the number of individuals covered by health and retirement savings arrangements than broadening the tax-preferred treatment of employer-provided benefits. Additionally, we are seeing far less concern with DB plan funding and greater attention to DC plan fees.

With regard to Social Security, the focus on individual accounts has moved away from carve-outs from the traditional Social Security DB benefit and toward add-ons. No one appeared to have high hopes for solvency reform to be tackled this Congress, but did believe all the elements for a “great compromise” were falling into place. Consensus is seemingly building around reforms to wage and eligibility calculations – such as progressive indexation, and increases in the eligibility age and the wage cap. In addition, some believed the right and left were coming together around ideas on how to increase individual retirement savings. Whether they are voluntary or mandatory, employer and/or employee financed, private or public, and if and how they include federal financial incentives remains unclear, but agreement on the need and importance is a starting point.

Within all this, it is hoped that it will not be lost that state and local governments have been “getting it right” (see below) for years by providing their employees with a modest guaranteed lifetime benefit and supplemental savings plans to bolster retirement security.

New Fiscal Environment
Topping everyone’s list of significant policy changes this Congress was the adoption of “PAYGO” rules in the House of Representatives, which will require all spending and tax expenditures to be fully offset. PAYGO will make it much more difficult to seek legislative changes that have a revenue impact and will also increase the desirability of “pay-fors.” This translates into increased attention to proposals that raise revenue by tightening pension and health care tax rules and a much tougher road for any attempts to expand existing benefits.

(In a recent report to Congress, the Congressional Research Service listed the net exclusion for pension contributions and earnings as the largest tax subsidy; the exclusion for employer contributions for health care was the third largest. A 2005 report by the Joint Committee on Taxation listed repeal of pick-up contributions, FICA taxation of fringe benefits, Mandatory Medicare for all state and local employees, and imposition of a 457 10% early distribution penalty as some of the many possible tax “loophole closers” Congress could consider. While these specific proposals have not moved in any legislation, other options outlined in the report have been added in the 11th hour of bill negotiations).

PPA Implementation
Public Safety Retiree Medical Exclusion. The most significant issue surrounding implementation of the public provisions in the Pension Protection Act of 2006 undoubtedly surrounded recent guidance issued by Treasury (Notice 2007-7) on Section 845 of the Act on qualified health insurance premiums of retired public safety officers. Of greatest concern was Q&A-23 of the guidance stating an accident or health plan receiving such payments may not be a self-insured plan. While Congressional staff has since voiced it was the clear intent of Congress to cover such arrangements, and Treasury has received numerous written comments by plans and their attorneys taking issue with their interpretation (see 1/23/2007 NASRA email alert), it remains uncertain whether Treasury will move from its position without a technical correction made by Congress. Thus far, congressional staffs indicate a technical corrections bill is very likely and, if needed, they would likely be amenable to including a provision making this clarification. Discussions with key committee staff are currently underway.

Extended Reach of New ADEA Provisions. In Notice 2007-6, Treasury confirmed suspicions that the PPA’s new standards for benefit accruals in cash balance plans could reach to many other types of defined benefit designs and features. While the PPA provisions that amend ERISA and parts of the Internal Revenue Code do not apply to governmental plans, governmental plans are subject to Age Discrimination in Employment Act amendments – which, among other things, stipulate interest credit in a DB plan will not be age discriminatory if it does not exceed a “market rate of return” (to be defined by Treasury).

IRS specifically requests in Notice 2007-6 comments on applying the rules to a plan in which only a certain participants’ accrued benefits, or only a portion of a participant’s accrued benefit is determined by lump sum based accrual methods. Since then, Treasury officials have gone on to state publicly that they believe many governmental DB plan refunds of employee contributions that include interest credit, DROPs, hybrid plans, money purchase options and other features would likely be covered by these rules. Comments are due by April 16, 2007.

GAO Report, Continued Media Stories, Make Congressional Education and Outreach Critical. With continued media focus on retirement and OPEB liabilities, and with Government Accountability Office (GAO) staff (and the Comptroller General himself) stating they expect to report on the unfunded liabilities in public pension AND retiree medical plans by year’s end, it is critical that members of Congress receive information regarding the overall soundness of their state retirement systems and the security they provide to (hundreds of) thousands of constituents in their state/district.

GETTING IT RIGHT!
To this end, NASRA and NCTR joined forces this year to design pro-active materials to stress how state and local governments have been “Getting It Right” when it comes to building secure retirement plans. A folder of materials was developed to take plans off the defensive and instead provide clear, concise and positive messages on the public pension industry. Space is provided for state-specific information to be added so packets can be tailored by NASRA and NCTR members for their delegation.

The hope is that each member of Congress will receive a folder with information on their state system(s) and the industry. While many packets were delivered when NASRA and NCTR members made Hills Visits in conjunction with the Winter Meeting, a mailing will soon be going out urging systems to get theses materials to their delegation (if they have not already done so). This can be done either when members of Congress are home during a district work period or when NASRA and NCTR members are again in Washington, D.C. NASRA and NCTR legislative representatives are also willing and able to deliver packets that have been tailored for a delegation.

A PDF version of the “Getting it Right” materials, the Winter Meeting binder, and a list of each state’s Key Members in the 110th Congress can also be downloaded from the federal relations section of the NASRA web site.

District Court Finds Illinois Sudan Act Unconstitutional

The Federal District Court for the Northern District of Illinois ruled on February 23 that the Illinois Act to End Atrocities and Terrorism in the Sudan (Illinois Sudan Act) “violates federal constitutional provisions that preclude the states from taking actions that interfere with the federal government’s authority over foreign affairs and commerce with foreign countries.” The Court permanently enjoined the state from enforcing the Act. It remains unclear whether the decision will be repealed.

Application to Other State Divestment Laws Uncertain
The Illinois Sudan Act not only prohibits investment of public pension funds in Sudan-connected entities, it also imposes various restrictions on the deposit of state funds in financial institutions whose customers have certain types of connections with Sudan. The court found the Illinois Sudan Act’s amendment of the Deposit of State Moneys Act (restricting the deposit of state funds in financial institutions) violated both the Supremacy Clause and the Foreign Affairs Clause of the U.S. constitution. The court rejected the argument that the Act’s amendment to the Illinois Pension Code (requiring public pension divestment) violated the Supremacy Clause or the Foreign Affairs Clause, but did find it in violation of the of the Foreign Commerce Clause.

Under the Foreign Commerce Clause, Congress has the power to regulate commerce with foreign nations. The court held that the Illinois Sudan Act seeks to proscribe foreign commerce in conflict with the Foreign Commerce Clause by requiring divestment. The court acknowledged that neither the Supreme Court nor the Seventh Circuit has addressed whether a “market participant” exception applies to the Foreign Commerce Clause (the market participation doctrine protects states when they are acting as parties to a commercial transaction rather than as market regulators). However, the court proceeded to conclude that even if the “market participation” exception did apply, the State of Illinois was not acting exclusively as a market participant, as the Act also proscribed the investment choices of municipal pension funds that the State did not guarantee.

The court did not address whether or not the provisions of the Act that apply to state pension funds violated the Foreign Commerce Clause. Instead, it held the entire Act unconstitutional on the grounds that it could not bring the Act into compliance with the Foreign Commerce Clause once it struck down the portion of the Act affecting municipal pension funds. Left unanswered is whether or not state legislation requiring only state-funded pensions to divest would violate the Foreign Commerce Clause.

(Also See Terror Divestment Roundup Below)

Senators ask GAO to Study Pension Fund Investment in Hedge Funds

On March 1, 2007 Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Member Chuck Grassley (R-IA) sent a formal request to Comptroller General David Walker to have the Government Accountability Office (GAO) investigate the scope of public and private pension plan investments in hedge funds. The Senators stated in their letter that little is known about the extent to which public and private sector pension systems are investing in these vehicles or the role of regulators in overseeing such investments. They added that “of particular concern to the committee is the extent to which under-funded plans sponsored by financially weak employers may be investing in hedge funds in an attempt to quickly build plan assets.”

In a press release surrounding the letter to GAO, the Senators stated they wished to know more about American pension plans' investments in hedge funds, and whether those investments pose risks for workers' retirement security. "If the folks running retirement plans don't have the facts about hedge funds, we could end up with the blind leading the broke," said Baucus. "Now is the time for a careful, impartial assessment of just how many retirement dollars are going into hedge funds, and whether retirees can expect decent dollars to come back out. We need to know whether hedge funds are risky business or real asset builders for retirement."

The text of the Senators' press release and letter can be found at: http://finance.senate.gov/press/Bpress/2007press/prb030107c.pdf

S&P Report on Public Pension Funding Levels

Bond ratings agency Standard & Poor’s on February 28 released a report, “Improved U.S. State Pension Funding Levels Could be on the Horizon.” The report points out that FY 2005 state pension funding levels declined from the previous year, but that a turnaround appears likely.

A Wall Street Journal story on the report was titled, “States’ Pension Shortfalls Widen Amid An Increase in Tax Receipts.” The tone of Journal story’s matched its gloomy headline and never referred to the report’s upbeat title.

The S&P report touched briefly on GASB OPEB liabilities, stating, “Standard & Poor’s believes that, with or without the prefunding of OPEB liabilities, most employers will be able to continue to meet their ongoing OPEB cost requirements without any near-term effect on credit quality.”

The report is accessible via the NASRA website:
http://www.nasra.org/resources/S&Pstatefundinglevels0702.pdf

Thanks to NASRA Associate Member Standard & Poor’s for permitting us to post this resource.

Public funds register fourth consecutive year of strong investment returns

According to both the Trust Universe Comparison Service (TUCS) and Callan Associates, public pension funds registered another year of strong investment gains in 2006.

The table below shows median annualized public pension fund investment returns for periods ended 12/31/06:

Based on Callan single-year returns, the median public pension fund has returned more than 65 percent compounded during the four-year, 2003-2006 period. Evidence of this performance is supported by public pension asset values reported by the Federal Reserve: from $1.93 trillion at year-end 2002; aggregate public pension fund assets are estimated to top $3 trillion as of 12/31/06. While adding more than $1 trillion in assets, during this four-year period these funds also have distributed more than $550 billion in benefits.

With colorful opposition from the media, Utah DC option dies in session’s waning hours

Utah, where Republican legislators outnumber Democrats in both houses by more than two to one, was the unlikely focus of legislation to establish an optional DC plan, but the proposal died in the Senate after being narrowly approved by the House. HB 377 would have enabled new hires of one state agency to choose between the URS DB plan and a DC plan.

The URS Non-Contributory Plan is the system’s predominant plan, covering state employees and most employees of school districts and political subdivisions. At the end of 2005, the plan was funded at 92.3 percent.

HB 377 was introduced as a DC option available to all new hires after June 30, 2007. The bill subsequently was amended to apply only to employees of two state agencies, and further amended to include new hires of just one agency—the Department of Technology Services. It was in this form that the bill narrowly passed a House committee and the full House.

Utah’s primary newspaper editorialized strongly in opposition. With colorful imagery, the Salt Lake Tribune editorial used some familiar arguments in favor of traditional pension benefits for public employees. Below are excerpts:

Utah's public employee pension plan is a thoroughbred; a rock-solid, high-performing $17 billion fund that will carry retirees through the homestretch of their lives. But the state Legislature is treating it like the old gray mare.

Utah's public employees have a pension system that rewards longevity, commitment and dedication by requiring employees to contribute for four years before they become vested. If a 401(k) plan becomes an option, it will attract short-timers and transients, people who are looking to take the money and run instead of paying their dues and acquiring the institutional knowledge necessary to make public agencies work, and work efficiently.

Do you want a revolving door at the police department, and the fire department, and the teacher's lounge? We don't.

We also worry that some public employees will reach for the stars and fall on their faces. If they forsake the safe, traditional guaranteed pension and their investments backfire, they could one day become wards of the state, instead of retired state employees.

And we wonder if the bill's supporters are sincere about their reasons for putting a 401(k) plan into the mix. Is anyone clamoring for a choice of plans? Not a single public employee testified in favor of the bill.

What's really at work here is an attack by a conservative Legislature on a long-standing employee benefit. It's an attempt to follow the lead of private industry and reap a long-term savings in employee benefits instead of making a long-term investment in a stable of competent public employees.

Dougall's bill should be put out to pasture.

Terror divestment roundup

Notwithstanding the federal court ruling last week that found Illinois’ Sudan divestment statute unconstitutional, terrorism divestment legislation remains an issue in a number of states. Below is a sampling of this activity.

After announcing its intention in January to divest from companies doing business in the Sudan, the Vermont Pension Investment Committee announced this week that the divestment process is complete. State Treasurer Jeb Spaulding is quoted in a Reuters news story saying, “"We have now completely divested from those companies that have been identified by the Sudan Divestment Task Force as engaging in activities that substantially support the Sudanese government's genocidal activities."

Divestment legislation in Colorado has been approved by the Centennial State House and awaits action in the Senate. According to the bill’s fiscal note, this bill requires the Colorado PERA board (among other state entities) “to develop a list of "scrutinized" companies that have business operations in Sudan; notify those companies by mail; and sell, redeem, divest, or withdraw all publicly traded securities of any company that does not stop its active Sudan-related business operations within 90 days of receiving notification.”

Texas Senate Bill 247, which is expected to include the ERS, TRS, and the $21 billion University of Texas Investment Management Company (UTIMCO), would require those entities to divest their Sudan investments. The bill is scheduled for an initial hearing March 12.

Brian Goodman with the Virginia Retirement System neatly summarizes the Sudan divestment experience in the Old Dominion:

The Virginia General Assembly adjourned on Saturday, February 24 without a Sudan divestment bill to present to the Governor, although each legislative body passed some form of Sudan divestment legislation. There were 3 identical bills introduced, one in the Senate and two in the House of Delegates, that mirrored the model legislation developed by the Sudan Divestment Task Force.

The two House bills died in committee, and the full Senate passed its version with a few modifications. Once the Senate bill crossed over to the House for consideration, the House passed a sweeping amendment that reduced the Senate version to one sentence in the VRS investment standard that read, "As part of its considerations of investments, the Board should take into consideration the official position of the United States government towards any foreign country in which the investment in any entity may be made."

The Senate rejected this amendment, and the bill went to a conference committee (at the insistence of the House) on February 22. Nothing more happened, and it is no longer an issue for Virginia, at least in 2007.

According to one news report, Indiana legislators are reviewing their Sudan divestment bill in the wake of the Illinois federal court ruling. The Indiana bill has been approved by the House and is awaiting Senate action.

Additional resources on the terrorism divestment issue are available on the NASRA website Resources on Investments With Ties to Sanctioned Nations page, accessible here:

http://www.nasra.org/resources/sanctions.htm

NASRA is always interested in legislative proposals and developments around the country. Feel free to send news to keithb@nasra.org. Thanks.