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Hanson Pension

Hanson Pension

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Published by: Jbrownie Heimes on Feb 22, 2012
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02/22/2012

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FEBRUARY 7, 2012
PENSION REFORM
ALERT
On February 2, 2012 Governor Brown releasedthe text of a bill and proposed constitutionalamendment for his pension reform proposals.The proposals follow his prior announced policy.They include a number of important limits andraise questions about operation. This memois a rst cut analysis of the proposals, limitsand questions. As we learn more, and as theLegislature takes action, we will provide moreinformation.
SUMMARY OF PROPOSALS
The Governor’s pension reform bill generallywould do the following:
•
For new hires on and after July 1, 2013,require a mix of dened benet (“DB”) anddened contribution (“DC”) plans that targeta benet after a full career of 75% of nalcompensation, with a cap generally equalto the Social Security wage base. The fullbenet would not be payable for a safetymember who retires before 57 and a general(miscellaneous) member who retires before67.
•
Eliminate the purchase of airtime for currentemployees and new hires.
•
Require annual DB plan contributions equalto normal cost with the cost split 50/50between employers and employees.
•
Limit return to work by retirees who keepreceiving their pensions.
•
Prohibit retroactive benet enhancements.
•
Change the composition of the PERS Board,giving the Governor more appointments.These proposals are discussed below.
DISCUSSION OF PARTICULAR PROVISIONS
1.
Hybrid Pension Plan With CappedBenets
A new mandatory benet structure will berequired for new employees hired on and after July 1, 2013, called a “hybrid plan.” It would bethe only plan that a public employer could offer to its employees.
Governor’s Pension ReformBill and ConstitutionalAmendment ProposedFebruary 2, 2012
Published by the Hanson Bridgett Employee Benefits Group
HANSONBRIDGETT.COM
 
a. New EmployeesThe only retirement plan that may be offered by a public employer to its employees who are rsthired on and after July 1, 2013
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is a hybrid plan as determined under the proposed new constitutionalprovisions.
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The hybrid must be a combination of a DB and a DC plan.
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Another “alternative plan” maybe offered, but this has major hurdles.
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b. DB & DCThe hybrid plan must have both a DB and a DC “component.” The bill does not provide what percentageof benets must be provided through DB or DC. Theoretically, 99% could be from the DB, but this isunlikely. We expect that the State Director of Finance will determine the mix of DB and DC.
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c. 75% Replacement RatioThe hybrid plan must “be designed with the goal” of providing an annual retirement “replacementincome” of 75% of the employee’s nal compensation “based on a full career in public service.”
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Fullcareer is dened as 30 years for safety and 35 years for general (also called miscellaneous) members.
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This provides an accrual of about 2% per year of service for general members and about 2.5% per year accrual for safety.
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d. Target Retirement Age
 
The target age for the 75% replacement income is 57 for safety members with 30 years of service and67 for general members with 35 years of service. This suggests that there will be an actuarial reductionfrom the 75% replacement for members who retire at younger ages.e. Additional Dollar Cap On BenetsThere are additional caps in the proposal. Perhaps the most important is that the target benet is notonly capped at 75%, but it is also capped at the Social Security wage base.
9
The wage base for 2012is $110,100. If the employee is not “eligible” for Social Security, the target is 120% of the wage base,or $132,120 for 2012.
1 The bill and constitutional amendment also provide that if the IRS allows an election, current employees “shall” be given theoption to participate in the hybrid plan. Prop. Art. VII, Sec. 12(a)(5). Prop. Code Sec. 7514.70(b)(3)(A). References to Art. VII, Sec.12 are references to the proposed constitutional amendment. References to code sections are to proposed or current sections of theGovernment Code unless otherwise stated.2
 
Prop. Art. VII, Sec. 12(a)(3). It takes a bit of digging to nd the “mandatory” part of the proposal. The proposed bill only
requires employers to “offer” a hybrid plan. Prop. Code Sec. 7514.70(b)(1).3 Prop. Code Sec 7514.70(a)(2).4 To offer an “alternative plan,” the governing board of the agency and the system’s “chief actuary” must certify that has less risk
and lower costs than “any available hybrid plans” that satises the rules. Prop. Code Sec. 7514.70(b)(1). The bill also opens the wayfor taxpayer lawsuit against the actuary and board and the employer to challenge any such certication, the authorization to offer the
alternative plan, or the actual offer of the alternative plan. Prop. Art. VII, Sec. 12(a)(4). Prop. Code Sec. 7514.70(b)(2).5 Prop. Art. VII, Sec. 12(a)(2).6 Prop. Code Sec. 7514.70(a)(2). Prop. Art. VII, Sec. 12(a)(1). Meeting this target can be complex; we discuss some examplesbelow.
7 Prop. Code Sec 7514.70(a)(2). Prop. Art. VII, Sec. 12(a)(1). Also, “safety” is narrowly dened as essentially police and re.Probation ofcers, for example, would not be “safety”.8 Note that it does not appear that an employer could offer a lower benet than 75% replacement benet because the hybriddescribed appears to be mandatory. Question -- will the proposal provide for benets higher than the 75% target for employees who
work to an older age or have more than the 30/35 years of service? If so, this may encourage older employees to stay longer.9 Prop. Code Sec. 7514.70(a)(2). Prop. Art VII, sec 12(a)(1).
pg
 
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FEBRUARY 7, 2012
PENSION REFORM
ALERT
 
Under a strict reading of the bill, it appears that this cap is imposed system-by-system.
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This will probablyencourage higher income employees to move jobs from, e.g., a PERS employer to a 37 Act employer when they hit the dollar cap in their current system.f. Will There Be COLAs?
 
Another cap in the proposal exists by implication only, so we are not sure that it exists. The 75% capis “retirement replacement income of 75 percent of a public employee’s nal compensation.”
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Finalcompensation does not have an ination adjustment. By implication, the hybrid would not have anyCOLA adjustment after retirement. If this is correct (and perhaps the Director of Finance who sets thecriteria for hybrid plans, would have a different interpretation), elimination of COLAs will signicantlyreduce the cost of pensions. From our actuary friends, we understand that COLAs can cost as much as30% of total pension cost.g. Early RetirementEmployees may retire with 5 years of service at age 52 (safety) or age 57 (general). If the SocialSecurity minimum age for retirement is increased, these ages will be increased by an equal number of years.
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As noted above, the implication of the proposal is that retirement benets that start before age57 (safety) and 67 (general) will be reduced actuarially to be equivalent to the benet payable at 57 or 67, as applicable.h. Working With the DC Component
 
There are no statutory guidelines for the DC component of the hybrid, so there are no guidelines as tohow their portion of the 75% is to be determined. Under the constitutional amendment, the State Director of Finance will establish the criteria and requirements.
13
DC plan investment returns are notoriouslyvolatile; perhaps the Director of Finance will take that into account in setting the criteria.
14
Additionally, akey deciency of a DC component is that it is very difcult for members to obtain a lifetime income fromthe DC account balance – the risk of outliving the DC account balance (some call this the “mortality risk”)is shifted to the individual. The IRS has just last week formally recognized this problem and is trying toencourage a market for longevity insurance. It is unknown whether this market will develop or not, andif so what it will cost to buy this insurance.
15
 
i. Final CompensationFor the dened benet part of the hybrid, “nal compensation” is the member’s highest average payratefor a 36 consecutive month period
16
. (This denition applies only to employees hired on and after July 1,
10
“System” is not dened in a meaningful way. It is not clear if this means any “plan” including a stand-alone plan or if it only
includes multiple employer plans as PERS and 37 Act plans. It is more likely to include a stand-alone plan however. Otherwise some verylarge retirement plans would be exempt, such as those for San Francisco, Los Angeles, San Diego, etc.11 Prop. Code Sec. 7514.70(a)(2).12 Prop. Code Sec. 7514.81(c). Prop. Art. VII, Sec. 12(b)(2).13 Prop. Art. VII, Sec. 12(a)(2).14
There are a number of ways to set up a hybrid plan with a 75% replacement ratio target. It could be as easy as providing alower than 2% (or 2.5%) accrual rate with a “make up” DC contribution. Or it could be as complex as providing that the DB accrual is 2%(or 2.5%) with an offset at retirement for the value of the DC plan account balance. In the pension world, this is called a “oor-offset” plan;usually the investments in the DC component of a oor-offset are professionally managed without employee investment choice.
15
An alternative would be to allow retirees to transfer their DC balances to the DB component of the plan to essentially buy addi
-
tional lifetime pensions. If the pricing is right, this can be at low or no cost to the DB plan (or even at a slight gain to the DB plan), and yet
at a substantially more favorable cost to the retiree than can be obtained from the insurance market. If this were to occur, the State could
be a leader in solving a difcult retirement issue for DC plan members. Of course this does mean that the DB plan is assuming risk andwill need to be priced accordingly, but would not need to “prot” as is the case for commercial products.
16 Prop. Code Sec. 7514.60(b); Prop. Art. VII, Sec. 12(d).
pg
 
3
FEBRUARY 7, 2012
PENSION REFORM
ALERT

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