Compliance January 17, 2014

State Not Bound by Informational Pension Materials

January 17, 2014 (PLANSPONSOR.com) – An appeals court has ruled that the state of Michigan is not obligated to follow pension contribution formulas mentioned in informational materials.
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The State of Michigan Court of Appeals recently reviewed the case of AFT Michigan v. State of Michigan and denied the plaintiffs’ appeal to a Court of Claims ruling. The plaintiffs, representative organizations of public school employees, had challenged amendments made to Michigan’s Public School Employees Retirement Act (PSERA) in 2012, which altered future health care and retirement benefit plans available to public school employees for service performed after December 1, 2012.

These amendments include the requirement that public school employees who had historically contributed nothing to their pensions would now be required to contribute a portion of their income to their pensions. In addition, these employees were asked to opt in or out of retiree health care benefits.

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The plaintiffs sued the state, alleging that the amendments were a breach and diminishment of contract, unconstitutional diminishment of accrued financial benefits and a denial of substantive due process. The Court of Claims ruled in favor of the state, saying, “We have informed consent and there are a number of choices [for employees].” In regard to the plaintiffs’ claim that pension-related pamphlets published by the state constituted a contract, the Court of Claims ruled that the pamphlets were advisory in nature and included disclaimers, adding that they did not believe that “a pamphlet can be part of a contract.”

In their appeal of the Court of Claims ruling, the plaintiffs argued that the PSERA amendments impair “existing contractual obligations to pension and retiree health care benefits in violation of both the federal and state constitutions.” The appeals court disagreed with the plaintiffs, upholding the Court of Claims contention that the state was not bound by previously published materials, especially since these materials contained disclaimers such as “The law may change at any time altering the information in this booklet.”

According to the appeals court’s ruling, “The Court of Claims did not err in concluding that the documents did not form an enforceable contract. The pamphlets and brochures were simply an informational explanation of the then-existing formula. The state was not bound in perpetuity by its contents.”

The full text of the court’s decision can be found here.

Opinions January 17, 2014

New Funding Method for Certain Public Sector Plans

January 17, 2014 (PLANSPONSOR.com) - Buck Consultants, LLC, has developed a new funding method for public sector plans that has two advantages over traditional methods:
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1.     It produces contribution rates that are more stable than those of traditional methods, and

2.     It provides an immediate and significant financial reward to plan sponsors that adopt a new tier of reduced benefits or increased employee contributions for future hires.

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The Governmental Accounting Standards Board is replacing current pension accounting statements 25 and 27 (which have been used as a funding standard) with new statements 67 and 68 (which do not address funding).  Thus, subject to state and local laws, public plan sponsors will be free to adopt new funding methods if they so desire.

The method Buck has developed is an open-group forecasting method—it recognizes that new employees will come into the plan in future years. The method begins with a 75-year forecast of traditional actuarial valuations using the same methods and assumptions that plans currently use. The actuary must also make assumptions about future hires: their number, ages at hire and pay levels. The method calculates the present value of employer contributions over the 75-year period and then determines the level contribution rate that will produce the same present value. That rate, subject to one modification, is the contribution rate under the open-group method.

The one adjustment is an amortization of the differences in open-group and traditional contribution amounts. The adjustment increases open-group contribution rates gradually when they are lower than those of the traditional method, and reduces them when they exceed those of traditional methods. As a result, contribution rates under the open-group method increase slowly in the early years and decline slowly in the later years of the projection. On the whole, they are much more stable than those of traditional methods.

The below graph shows a 30-year deterministic forecast of anticipated contributions and contribution rates under the open-group method and under the current traditional method.

Buck Consultants Chittenden byline graph

The open-group method offers immediate relief to the plan sponsor when it commences in 2014—the contribution rate falls from 31% in 2013 to 17.9% in 2014. It stays in the range of 16% to 22% during the entire 30-year period, while the traditional method contribution rates fall from 31% to 9%.

Buck has tested the plan design in an environment of varying investment returns. The new method holds contribution rates more stable than traditional methods, but funded status declines more under the new method when the plan experiences periods of poor investment performance. Buck has also explored variations in the method that seek to prop up funded status percentages when necessary. These variations improve funded status, but also increase contribution rate volatility.

This open-group forecasting method may be of interest to public plan sponsors that have been struggling to make the contributions required under traditional methods and to those that have been reluctant to introduce a new tier of less costly benefits because the savings that traditional methods produce for such a change take too long to materialize.

A copy of the paper is here.

 

Charlie Chittenden, principal and consulting actuary with Buck Consultants in Pheonix  

Joseph Son, senior consultant with Buck Consultants in Los Angeles  

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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