The General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General), which provides pension coverage for most non-public-safety county and local government employees, and for school district employees other than teachers (school bus drivers, custodians, cafeteria workers, and similar employees), has a history of funding problems. PERA-General’s most recent funding concerns were studied by the Legislative Commission on Pensions and Retirement (LCPR) during the 2000-2001 interim, following the results of the July 1, 2000, PERA-General actuarial report which indicated a contribution deficiency of $70.4 million (1.96 percent of payroll), with an 86.3 percent funding ratio. PERA actuarial reports previously had indicated contribution deficiencies in two of the four previous years, although those deficiencies were not of the magnitude indicated in the 2000 actuarial report.

Senator Pogemiller introduced a bill during the 2001 Legislative Session (S.F. 810 (Pogemiller); H.F.___(    ): PERA General; Contribution Increases, Benefit Modifications, Coverage Changes, and Additional State Aid) sought to address PERA’s funding problems through combinations of benefit plan modifications, employee and employer contribution increases, and state aid. Representative Mares introduced a bill in the House (S.F.____(    ); H.F. 855 (Mares): PERA-General; Contribution Increases, Benefit Modifications, and Coverage Changes) which was similar to the Senate bill. The House bill differed from the Senate bill by a lack of an employer contribution increase and state aid provision.

No pension provisions were passed and enacted during the 2001 Regular Session. Public plan retirement provisions, including various provisions for PERA-General, were enacted during the 2001 First Special Session. The provisions that were enacted did include a somewhat scaled back employee and employer contribution rate increase compared to the initial proposal contained in the bills authored by Senator Pogemiller and Representative Mares, and no additional state aid. The new laws also included a provision (Laws 2001, First Special Session, Chapter 10, Article 11, Section 21), which requires the actuary retained by the Commission to include in the presentation of the PERA-General July 1, 2001, actuarial results a statement of the adequacy of inadequacy of the PERA-General support rates. This statement, along with other information regarding the condition of this pension fund and other Minnesota public pension funds, investment markets, the condition of the economy and the state budget situation, provides guidance to the Commission in its continuing review of the PERA-General funding issue.

Given the passage of several months since the Commission last considered the PERA funding situation, the addition of a new Commission member, and at least some preliminary PERA July 1, 2001, actuarial report results, the purpose of this memo is to provide background information to reacquaint Commission members with this funding issue. The memo begins with background sections on the history of PERA and its funding situation over time, and the impact of actuarial assumption changes adopted in recent years. This presentation updates information presented by staff to the Commission in June 2000, when the Commission reviewed PERA’s situation as an interim study, and materials provided for the Commission’s consideration during the last general legislative session of S.F. 810 (Pogemiller); H.F.___(    ), and S.F.____(    ); H.F. 855 (Mares). The memo then continues with a summary of the PERA provisions enacted during special legislative session. The memo concludes with a few observations and comments regarding additional information, not yet available as of this writing, which the Commission may need in its further consideration of this issue.

1. General Background Information on PERA. PERA was established in 1931. The legislation governing the plan was modeled heavily on the 1929 law governing the State Employees Retirement Association (SERA), renamed in 1969 as the Minnesota State Retirement System (MSRS). PERA was the third major statewide public pension plan established by the Legislature, following the creation of the predecessor to the Teachers Retirement Association (TRA) in 1915 and the creation of SERA in 1929. PERA was the second public pension plan that was established by the Legislature for local government general (not specifically police or fire) employees, after the Minneapolis Municipal Employees Retirement Plan (now the Minneapolis Employees Retirement Fund (MERF)) in 1919. The 1931 PERA plan was the predecessor to the current General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General).
   
   Because PERA preceded the creation of the Social Security system (the federal Old Age, Survivors, and Disability Insurance Program (OASDI)) and because Social Security initially did not extend to federal, state, or local government employees, PERA was a "basic" program. This means that the public employee’s entire retirement benefit comes from the public pension plan, without any Social Security benefit. PERA coordinated with Social Security for hospital employees in 1963 and for other local government employees in 1967.
   
2. Background Information on PERA Funding Developments. The funding of PERA has been a continuing concern for the LCPR since the Commission was created in 1955. The Commission’s creation reportedly was prompted by the predicted financial bankruptcy of PERA.
   
   Although PERA was established in 1931, actuarial valuations did not begin until 1943 and complete regular biennial or annual actuarial valuations did not begin until 1958. The 1955 special actuarial valuation indicated that PERA was 11.32 percent funded, with ongoing funding limited to member contributions only (four percent of pay), and with liabilities growing at a rate of 14 percent of pay. The following table (Table 1) lists the PERA funding ratio (actuarial assets divided by accrued liabilities) as indicated in these actuarial reports. Table 2 is a more complete presentation of PERA actuarial results from the 1986 actuarial valuation through the preliminary 2001 actuarial results.

Table 1 PERA-General Funding Ratio
Year	Funding Ratio		Year	Funding Ratio		Year	Funding Ratio
2001*	86.97%		1987	77.08%		1973	57.17%
2000	86.31%		1986	73.44%		1972	73.44%
1999	89.89%		1985	70.50%		1971	71.45%
1998	87.08%		1984	71.79%		1970	68.45%
1997	82.72%		1983	78.59%		1969	64.54%
1996	79.59%		1982	77.62%		1968	56.50%
1995	77.60%		1981	77.19%		1967	53.04%
1994	76.28%		1980	73.12%		1966	51.61%
1993	75.63%		1979	71.44%		1965	46.06%
1992	73.13%		1978	68.66%		1963	50.92%
1991	71.57%		1977	65.98%		1958	23.38%
1990	72.30%		1976	62.63%		1955	11.32%
1989	71.67%		1975	61.94%		1947	**
1988	70.75%		1974	59.47%		1943	**

In 1931, when PERA was established, the retirement plan was designed to be funded on a non-actuarial or "pay-as-you-go" basis. Local government employees in 1931-1932 were required to pay an initial application fee ($1 in 1931, $10 in 1932), were obligated to make member contributions of 3.5 percent of regular salary, and post-January 1, 1932, members were required to pay back member contributions to July 1, 1931, plus five percent compound interest. There was no employer contribution required.

In 1941, governmental subdivisions that impose a mandatory retirement age limitation on employment were required to pay one-half of the cost of all retirement annuities granted to public employees affected by mandatory retirement provisions, based on a PERA determination and certification.

In 1943, the member contribution was increased to four percent.

(Click here for Table 2)

In 1956, governmental subdivisions that had elected to participate in PERA were required to make an employer contribution, with the employer contribution set at an amount equal to one-half of the member contributions of its employees (i.e., two percent of pay). Covered salary was also limited to $4,800 in 1949.

In 1956, the employer contribution was increased to four percent of salary, subject to a salary maximum of $4,800. In 1957, the member contribution was increased to six percent of salary, up to a salary maximum of $4,800. The employer contribution was increased to five percent of covered salary for fiscal year 1958. For fiscal year 1959, the employer contribution was increased to six percent of covered salary and a 2.5 percent of covered salary additional employer contribution was imposed.

With the creation of a coordinated program for some hospital employees in 1963, the hospital coordinated member contribution was set at three percent of covered salary, while the hospital coordinated employer contribution was also set at three percent of covered salary and the hospital coordinated additional employer contribution was set at two percent of covered salary for fiscal years 1964 and 1965 and at 1.5 percent of covered salary for fiscal years after 1965.

In 1965, the covered salary amount for both contributions and retirement annuity calculations increased from $4,800 to $6,000. In 1967, covered salary was increased to total salary. Also, in 1967, following a generally-applicable "split basis" Social Security referendum, the PERA coordinated program contribution rates were revised, at three percent of covered salary for the member contribution rate and for the employer contribution rate, and at 1.5 percent of covered salary for the additional employer contribution. In 1971, the PERA Hospital Employee Coordinated Program was transferred into the regular PERA Coordinated Program.

In 1973, contribution rates were increased. The member contribution rates were increased to eight percent of covered salary for the PERA Basic Program and to four percent of covered salary for the PERA Coordinated Program. The employer contribution rates were increased to equal the member contribution rates, while the additional employer contribution remained at 2.5 percent of covered salary for the PERA Basic Program and at 1.5 percent of covered salary for the PERA Coordinated Program.

In 1984, the PERA Coordinated Program additional employer contribution was decreased from 1.5 percent of covered salary to 0.25 percent of covered salary.

In 1989, contribution rates again were increased. The member contribution rates were increased to 8.23 percent of covered salary for the PERA Basic Program and to 4.23 percent of covered salary for the PERA Coordinated Program, with the employer contribution rates increasing by the identical amounts.

In 1997, contribution rates were again increased. The member contribution rates were increased to 8.75 percent of covered salary for the PERA Basic Program and to 4.75 percent of covered salary for the PERA Coordinated Program. The employer contribution rates increased identically, while the additional employer contribution rates increased from 2.5 percent to 2.68 percent for the PERA Basic Program and from 0.25 percent to 0.43 percent for the PERA Coordinated Program. A special state aid program was created for fiscal year 1998 and thereafter to cover the 1997 employer contribution increases.

On January 1, 2002, due to legislation passed in the recent special legislative session, the employee and employer PERA Basic contribution rates will increase from 8.75 percent of pay to 9.1 percent of pay. The corresponding PERA Coordinated contribution rates are increased from 4.75 percent to 5.1 percent of pay.

3. Impact on PERA of Recent Actuarial Assumption Changes.

1. In General. Under Minnesota Statutes, Section 356.215, Subdivision 5, every four years an experience study is required to be performed by the consulting actuary retained by the Commission for PERA-General, the General State Employees Retirement Plan of the Minnesota State Retirement System (MSRS-General), and the Teachers Retirement Association (TRA).
   
   The quadrennial experience study compares the actual experience of the pension plan for that five-year period with the expected experience for the same period under the actuarial assumptions then applicable for the pension plan. The quadrennial experience study is intended, along with the actuarial gain and loss assessment portion of the annual actuarial valuation, to identify the need for actuarial assumption revisions.
   
   Once a series of the actuarial gain and loss assessments of the annual actuarial valuations and one or more quadrennial experience studies indicate that an actuarial assumption has become an unreliable predictor of future occurrences, the process of developing a more reliable actuarial assumption and implementing a new actuarial assumption is initiated.
   
   Because the actuarial services rendered to the Commission and the various public pension plans are provided by a combination of sources, chiefly the consulting actuary retained by the Legislative Commission on Pensions and Retirement and the consulting actuary retained as actuarial advisor by the applicable public pension plan, the task of the development of new actuarial assumptions can be performed by either consulting actuary or in combination. If there is a difference of opinion between these actuaries, professionally or personally, the development of new actuarial assumptions can be delayed or totally derailed.
   
   Once revised actuarial assumptions are developed by an actuary, the revisions must be implemented. Minnesota Statutes, Section 356.215, Subdivision 4d, specifies the major economic actuarial assumptions, namely the interest (future investment performance) assumption, the salary growth (individual member) assumption, and the total payroll growth (total plan membership) assumption. Minnesota Statutes, Section 356.215, Subdivision 4e, requires the use of demographic and other economic actuarial assumptions that are consistent with the most recent quadrennial experience study (or the best estimate of future occurrences if no experience study for the applicable pension plan is required) and Minnesota Statutes, Section 356.215, Subdivision 7, requires the approval of non-statutory actuarial assumptions by the Legislative Commission on Pensions and Retirement.
   
2. Annual PERA Experience Gain and Loss Assessments 1985-2001. The annual actuarial valuations are required to contain an exhibit that attempts to allocate the sources of increases and decreases in the unfunded actuarial accrued liability of the pension plan. Four experience gain or loss items (five before 1986) are required to be assessed in the actuarial valuation, which are salary increase, investment return, retiree (Minnesota Post Retirement Investment Fund) mortality, and other benefit recipient (non-MPRIF) mortality. Other gains or losses are not required to be separately identified, although the Standards For Actuarial Work prescribed by the Commission require that additional analysis should be performed if the undesignated "other" items of unfunded actuarial accrued liability change is greater than two percent of the actuarial accrued liability or exceeds $50 million.
   
   The following sets forth the annual actuarial gain and loss identification for PERA for the past 17 years (since the actuary retained by the Commission has performed the regular annual actuarial valuation):

3. 1996 PERA Experience Study Results and 2000 Assumption Changes. The 1996 PERA experience study covered the period June 30, 1992 to June 30, 1996, and was reported to the Commission on May 29, 1997.
   
   The following summarizes the results of the 1996 PERA-General experience study and the recommendations of the actuary retained by the Commission:

Assumption	Analysis Observation/Conclusion	Recommendation
Interest	Investment experience was favorable, averaging 12.9 percent, compared to the pre-retirement assumption of 8.5 percent.	Recommended retention of both the pre-retirement interest rate assumption and the post-retirement interest rate assumption.
Salary Increase	Salary increases averaged 5.5 percent, with increases both age and service related and with the strongest correlation to service.	Recommended breaking the assumption into two components, a base increase assumption and a merit and longevity increase assumption. Recommended base increase rate of 4.5 percent and development of an assumption based on an age, service, or both by the plan and Commission actuaries.
Payroll Growth	Flat 6.5 percent assumption ignores the potential for increases/decreases in the number of active members and the impact of replacement active members.	Recommended breaking the assumption into two components, a base salary increase assumption and a total active membership growth assumption.
Retirement	Single age retirement assumption does not reflect the actual experience of retiring members, especially related to the utilization of the "Rule of 90" early normal retirement age. Period results also reflect the impact of early retirement incentives.	Recommended the development of an age-related retirement decrement table to more closely reflect future expected retirement patterns.
Optional Annuity Selection	Number of married retiring active members probably greater in the Basic Program than the Coordinated Program, based on the utilization of the subsidized joint and survivor optional annuity form.	Recommended no change.
Active Member Disablement	Actual disability rates are well below expected, especially for females.	Recommended that the disablement rates should be reduced, especially for females.
Active Terminations	Total active terminations are close to the assumption, but withdrawal rates are strongly correlated with both service and age. Potential data inconsistencies also exist.	Recommended that specific select and ultimate withdrawal tables be developed.
Annuitant Mortality	Annuitant mortality has been considerable below expected, especially ages 65-84.	Strongly recommended strengthening of the mortality assumption.
Disabled Mortality	Assumption is favorable, but relatively close to reality.	Recommended retention of assumption.
Active Mortality	Assumption experience is unfavorable.	Recommended consideration of a separate table with strengthened assumption.

The assumption changes recommended by the actuary retained by the Commission were approved by the Commission in February 2000. The July 1, 2000, PERA-General actuarial valuation, in addition to the $207.2 million net experience gain, also reflected a $736.5 million increase in the unfunded actuarial accrued liability on account of actuarial assumption changes and a $44.9 increase in the unfunded actuarial accrued liability on account of actuarial method changes (i.e., the redefinition of the actuarial value of assets).

4. Current PERA-General Financing Insufficiency. The July 1, 2000, PERA actuarial valuation, which is the last final actuarial report we have, indicted a 1.96 percent of covered payroll ($70.4 million) annual deficiency when the financial support (required member, employer, and employer additional contributions) of the pension plan is compared to the actuarial requirements of the pension plan. The July 1, 2001, actuarial report, which is currently a draft rather than a final document, indicated a more modest contribution deficit of 1.28 percent of payroll. The results of the draft July 1, 2001, actuarial valuation and other recent actuarial valuations are summarized below.
   

	2001 (prelim.)		2000		1999		1998		1997
Membership
Active Members		151,413		135,560		137,528		136,166		130,865
Service Retirees		41,797		39,940		38,077		36,187		34,168
Disabilitants		1,468		1,397		1,301		1,223		1,115
Survivors		6,149		6,010		5,881		5,732		5,531
Deferred Retirees		22,352		21,495		16,340		10,817		10,817
Nonvested Former Members		74,666		79,362		18,491		15,162		15,162
Total Membership		297,845		283,764		217,618		205,287		197,658
Funded Status
Accrued Liability		$12,104,543,000		$11,133,682,000		$9,443,678,000		$8,769,303,000		$8,049,666,000
Current Assets		$10,527,249,000		$9,609,367,000		$8,489,177,000		$7,636,668,000		$6,658,410,000
Unf. Accrued Liability		$1,577,294,000		$1,524,315,000		$954,501,000		$1,132,635,000		$1,391,256,000
Funding Ratio	86.97%		86.31%		89.89%		87.08%		82.72%
Financing Requirements
Covered Payroll		$3,820,084,000		$3,602,750,000		$3,544,488,000		$3,385,720,000		$3,214,578,000
Benefits Payable		$592,209,000		$527,119,000		$467,602,000		$412,746,000		$342,154,000
Normal Cost	9.40%	$359,404,000	9.33%	$336,088,000	7.49%	$265,778,000	7.61%	$257,628,000	7.11%	$228,459,000
Admin. Expenses	0.23%	$8,786,000	0.23%	$8,286,000	0.28%	$9,925,000	0.22%	$7,449,000	0.18%	$5,786,000
Normal Cost & Exp.	9.63%	$368,190,000	9.56%	$344,374,000	7.77%	$275,703,000	7.83%	$265,077,000	7.29%	$234,245,000
Normal Cost & Expense	9.63%	$368,190,000	9.56%	$344,374,000	7.77%	$275,703,000	7.83%	$265,077,000	7.29%	$234,245,000
Amortization	1.98%	$75,638,000	2.38%	$85,745,000	1.67%	$59,193,000	2.01%	$68,053,000	2.51%	$80,686,000
Total Requirements	11.61%	$443,828,000	11.94%	$430,119,000	9.44%	$334,896,000	9.84%	$333,130,000	9.80%	$314,931,000
Employee Contributions	4.94%	$188,856,000	4.77%	$171,898,000	4.78%	$169,398,000	4.79%	$162,179,000	4.55%	$146,127,000
Employer Contributions	5.38%	$205,577,000	5.21%	$187,823,000	5.23%	$185,221,000	5.24%	$177,504,000	4.92%	$158,067,000
Employer Add'l Cont.	0.00%		0.00%	$0	0.00%	$0	0.00%	$0	0.00%	$0
Direct State Funding	0.00%		0.00%	$0	0.00%	$0	0.00%	$0	0.00%	$0
Other Govt. Funding	0.00%		0.00%	$0	0.00%	$0	0.00%	$0	0.00%	$0
Admin. Assessment	0.00%		0.00%	$0	0.00%	$0	0.00%	$0	0.00%	$0
Total Contributions	10.33%	$394,433,000	9.98%	$359,721,000	10.01%	$354,619,000	10.03%	$339,683,000	9.47%	$304,194,000
Total Requirements	11.61%	$443,828,000	11.94%	$430,119,000	9.44%	$334,896,000	9.84%	$333,130,000	9.80%	$314,931,000
Total Contributions	10.33%	$394,433,000	9.98%	$359,721,000	10.01%	$354,619,000	10.03%	$339,683,000	9.47%	$304,194,000
Deficiency (Surplus)	1.28%	$49,395,000	1.96%	$70,398,000	(0.57%)	($19,723,000)	(0.19%)	($6,553,000)	0.33%	$10,737,000
Amortization Target Date	2031		2024		2020		2020		2020
Actuary	Milliman USA		Milliman & Robertson		Milliman & Robertson		Milliman & Robertson		Milliman & Robertson

5. Comparison of Selected PERA-General Funding Information with Other Plans. Earlier LCPR staff memos to the Commission for recent consideration of PERA-General issues included bar graphs comparing PERA, MSRS, and TRA funding ratios over time, and administrative expenses. We currently do not have data to update that information. The information provided in past memos is included as an attachment.

Given the recent study of PERA-General funding problems, during the 2001 Legislative Session the Commission considered two bills, one introduced in the Senate by Senator Pogemiller, and a bill having many similar provisions in the House, introduced by Representative Mares. Neither bill was enacted during the session, but many provisions with modifications and additional inclusions were included in provisions passed during the subsequent special session. Below we summarize the Senate version of the PERA funding bill considered during the regular session, and note how it differed from the House bill. We then summarize the applicable PERA provisions enacted during the special session.

1. 2001 Regular Legislative Session: General Summary of Senate and House PERA Funding Bills.

S.F. 810 (Pogemiller): H.F.___( ): PERA General; Contribution Increases, Benefit Modifications, Coverage Changes, and Additional State Aid, sought to amend various provisions of Minnesota Statutes, Chapter 273, relating to local property taxes and state aid to local governments; Chapter 353, relating to PERA; and Chapter 356, relating to public retirement generally; by making the following changes with respect to PERA-General and PERA-P&F:

1. Broadened Membership Eligibility. With the exception of newly excluded seasonal (under 185 days of employment per year) employees and work-study employees, all local government and non-teaching school district employees on and after July 1, 2002, are required to become members of PERA-General;

2. Proration of Benefit Calculation Service Credit for Part-time Employees. For PERA-General and PERA-P&F members employed less than half-time (under 80 hours per month), after July 1, 2002, service credit for benefit calculation purposes would be prorated;

3. Increased Coordinated Member and Employer Contribution. Beginning in January, 2002, PERA-Coordinated Program member and employer contribution rates each would be increased by 0.375 percent of covered payroll, and, if the PERA-General financing deficiency continues, beginning in January, 2004, PERA-Coordinated Program member and employer contribution rates would again each be increased by 0.25 percent of covered payroll;

4. Extended Amortization Target Date. The current 2024 amortization target date for eliminating the PERA-General unfunded actuarial accrued liability is extended seven years, to 2031;

5. Five Year Vesting Requirement. For new entrants after June 30, 2002, the service requirement for obtaining a vested PERA-General retirement annuity or benefit is increased from three years to five years;

6. Refund of a Portion of Employer Contributions. After June 30, 2001, vested PERA-General members who terminate active service receive an enhanced refund, including 25 percent of the employer contribution plus interest below age 55 and 50 percent of the employer contribution plus interest after age 54;

7. Reduced Deferred Annuities Augmentation Rate. The deferred annuity augmentation rate for vested PERA-General or PERA-P&F members who terminate active service for a period before applying for a retirement annuity would be reduced from five percent (after age 55) to three percent for all ages;

8. Increased State Aid to PERA Employing Units. The 1997 state aid program for local government units and school districts is increased, with an additional annual $27 million in State revenue allocated to employing units in proportion to their total covered payroll to offset increased employer contribution rates; and

9. Increased PERA-General Employer Additional Contribution Rate. Effective August 1, 2001, the PERA-General employer additional contribution increases by 0.75 percent (to 1.18 percent of covered payroll).

The House bill (H.F. 855 (Mares): PERA General; Contribution Increases, Benefit Modifications, and Coverage Changes) was identical to Senator Pogemiller’s bill except that the House bill did not include the increased state aid to PERA employing units (point 8, above) or an increased PERA-General employer additional contribution rate (point 9, above).

2. 2001 First Special Session, PERA Provisions.

In Laws 2001, First Special Session, Chapter 10, Article 11, several changes were made in the PERA-General Plan including changes in service crediting procedures for new members, changes in eligibility and coverage groups, and contribution rates. These are summarized below.

1. Reorganization, Revision, and Clarification of PERA Public Employee, Included Employee, and Excluded Employee Provisions. PERA’s public employee definition is revised by clarifying that a public employee is a governmental employee performing services for a governmental subdivision. The term includes, where applicable, employees of governmental subdivisions where PERA law authorizes a government unit or the employee of that government unit to elect PERA coverage and the election is exercised. Language excluding independent contractors and their employees and reemployed annuitants from coverage is retained although moved to another provision. A new optional membership provision is created, largely containing coverage groups moved from other provisions.
   
   The PERA coverage group is revised for new hires after June 30, 2002. The earnings threshold criteria for PERA membership ($425 per month or $5,100 per year) is removed from law, which extends PERA membership to those earning less than those amounts. Local governing body elected officials (other than elected county sheriffs) and individuals appointed to fill one of these elected positions are excluded from PERA-General coverage. The PERA exclusion of all full-time students who are part-time employees is made more limited, revised to apply to full-time students in high school, undergraduate, graduate, and professional-technical students, only if the individual is in that status on the hire date and the employment is predicated on the student status of the individual. A coverage exclusion is created for seasonal employees, hired for periods not longer than six months in length.
   
   Any individual who is a PERA-General active member before July 1, 2002, and who is in any category that will be excluded after that date retains PERA coverage for the full period of employment. (Laws 2001, First Special Session, Chapter 10, Article 11, Sections 1 to 6, and 22.)

2. Termination of Membership Provision Revised. PERA’s termination of membership provision is revised by eliminating reference to the exclusion of full-time students, by eliminating salary threshold references, and by specifying that any termination of membership must be reported to PERA. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 7.)

3. Temporary Position Provision Revised. PERA’s temporary position definition is revised to include any employment position filled by an employee hired for a predetermined period of six months or less, and by clarifying probationary period language. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 8.)

4. Seasonal Position Defined. A new subdivision is created to define seasonal position, which is a position where the nature of the work or its duration are related to a specific season of seasons, regardless of whether the same individual fills the position in each season in which the position becomes available. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 9.)

5. Allowable Service Revisions: Proration of Service Credit for Less than Half-Time Employment. PERA’s allowable service credit provision is revised by specifying that in PERA-General, PERA-Correctional, and PERA-P&F, for new members (including terminated/rehired members) after January 1, 2002, the member will receive one month of service credit for each month with 80 or more compensated hours. If there are less than 80 compensated hours in a given month, the individual will receive a fraction of one month of allowable service equal to the percentage relationship that the number of compensated hours bear to 80 hours. Prorated service will be used for benefit computation purposes. For purposes of vesting, individuals will receive a month of service credit for vesting purposes for any month in which any salary was received.
   
   Prorating does not apply to elected officials and or to any other public employees who are compensated solely on an annual basis. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 10.)

6. Allowable Service Revisions; Revisions of Leave Provision to Incorporate Prorating; Other Revisions. PERA’s allowable service provision is revised by specifying that for all PERA leaves for which service credit is obtainable (personal, parental, family, medical, and military) service credit due to the leave will be full months if the salary or compensated hours used in computing the leave payment amounts were from a non-prorated period, or will be prorated if the salary or compensated hours used in computing the leave payment amounts were from a prorated period. In addition, for military leaves, the time period for purchasing service credit is revised. Rather than within five years of the date of discharge, payment must be made within three times the length of the military leave period, if that is less than five years. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 10.)

7. Allowable Service Revisions; Service Credit for Temporary Layoff Periods. After January 1, 2002, for members who earned a month of service credit in each of the nine calendar months immediately preceding the temporary layoff, the member will receive a month of service credit for each month of the temporary leave, not to exceed three months per year. If any of the prior nine months was prorated, the individual will receive prorated service credit for each month of the leave, determined by divided the total number of months of service credit earned for the compensated employment by nine and multiplying the resulting number by the total number of months in the layoff period. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 10.)

8. Business Year Definition. A definition of business year is added to PERA’s definition section, defining a business year as the period from the first day of the first full pay period in the fiscal year through the last day of the last full pay period in the fiscal year. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 11.)

9. Compensated Hours Definition. A definition of compensated hours is added to PERA’s definition section, defining compensated hours as hours during which the employee performs services in one or more positions for the single government subdivision and for which the employee receives compensation. The term also includes paid holidays, used sick leave hours, paid personal leave hours and vacation hours, and paid hours drawn from accrued compensatory time. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 12.)

10. Employee and Employer Contribution Rate Increases. On January 1, 2002, the employee and employer regular contribution rate increases from 8.75 percent of pay to 9.10 percent of pay for basic members, and from 4.75 percent of pay to 5.1 percent of pay for coordinated members. (Laws 2001, First Special Session, Chapter 10, Article 11, Sections 13 and 14.)

11. Revised Employer Reporting Provisions, Reporting of Compensated Hours. Given the new service credit prorating provisions, PERA employing unit reporting requirements are revised to include reporting of actual or estimated compensated hours for PERA-covered employees. (Laws 2001, First Special Session, Chapter 10, Article 11, Sections 15 and 16.)

12. Volunteer Ambulance Service, PERA or PERA-P&F Participation Provision Revised to Exclude Post-June 30, 2002, Hirees. A PERA provision which permits volunteer ambulance personnel who are members of PERA or PERA-P&F due to other service to also include contributions based on the volunteer ambulance service, provided no coverage for that volunteer service is provided by any other fund or plan, is revised to limit application to pre-July 1, 2002, hirees. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 17.)

13. Amortization Date Extended to 2031. PERA-General’s full funding date is extended from June 30, 2024, to June 30, 2031. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 18.)

14. PERA-General Study of Financial Needs. The actuary retained by the Legislative Commission on Pensions and Retirement (LCPR), as part of the PERA July 1, 2001, actuarial report, must include a finding on the adequacy of the PERA-General support rates. (Laws 2001, First Special Session, Chapter 10, Article 11, Section 21.)

Earlier sections in this memo provided a history of PERA, concentrating on recent history, and summarized recent Legislative actions regarding PERA’s funding situation. In this final section we comment on questions about the reliability of the contribution deficiency estimate appearing in the draft PERA actuarial report. For various reasons indicated in this section, the estimated contribution deficiency may be revised. Rather than considering any further action at this time to address PERA’s apparent contribution deficiency, it is reasonable for the Commission to wait for additional information. The draft report’s results may be influenced by errors in the data set used, and Commission members may wish to wait to review the results that follow from corrected information. The Commission may also wish to reflect on some current methodology used in the valuations. It is also reasonable to review the actuarial results, currently unavailable, from other Minnesota public pension funds before considering where the state’s limited resources might be best used.

1. Data Quality Issues. PERA’s Executive Director, Ms. Mary Vanek, indicated that the salary data used in the draft valuation report contains errors. PERA did not have any salary data for several thousand individuals who were included as PERA active members. PERA’s actuary and the actuary retained by the Commission have been discussing this issue and have reached a mutual agreement about revisions to appear in the final actuarial valuation. Commission staff is uncertain as of this writing to what extent the data changes reflect the results of actual verification and correction of the member data in question, rather than the actuaries making a simplifying assumption in lieu of the data problem. According to Ms. Vanek, many of these "zero salary" cases reflect individuals who terminated service, but the termination was not reported to PERA. This lead to an overstatement of active employees and presumably to an understatement of terminations and deferred annuitants. Perhaps some of the cases do involve individuals who are active, but for some reason salary information is was not reported by the employer. Another question is whether some of these cases will lead to newly identified delinquent or deficient contribution cases.
   
   Ms. Vanek indicated that a revised actuarial report is currently being produced as of this writing. She indicated that the report will indicate several thousand fewer PERA active members than the draft report, but that the adjustments had no discernable impact on the computed contribution deficiency. At some point, Commission members may wish to received comments from Ms. Vanek and the actuary to better understand the situation, and to permit Commission members to form a judgement about the confidence to place on the valuation’s results.

2. Complications Caused by the Timing of the Employee/Employer Contribution Rate Increase. The employee and employer contribution increase is set to occur on January 1, 2002, which is in the middle of the fiscal year. In computing the results of the July 1, 2001, actuarial valuation, the actuary mirrored this situation by assuming that the current rates remain in effect for the first half of fiscal year 2002 (July 1, 2001, through December 31, 2001), and that the higher rates are charged starting in the second half of the fiscal, beginning January 1, 2002. While this accurately reflects the effective date of the contribution increase, the computed contribution deficiency that follows from that treatment may give a misleading estimate of the contribution deficiency looking into the future, after the date of the rate change. In a footnote to a table in the draft report (Table 11), the actuary notes that if the post July 1, 2002, rates were assumed to be in effect for the whole year, the computed contribution deficiency would be about 0.95 percent of payroll, rather than 1.28 percent of payroll.

3. Impact of Actuarial Assumption Changes; Adopted and Potentially Recommended. Earlier in the memo we noted actuarial assumption changes proposed by the actuaries in the late 1990s. When the actuaries studied PERA data for the experience studies and other follow-up work, they concluded that the separation assumptions (terminations from PERA-covered employment) that had been used previously were not acceptably accurate. PERA liabilities were being understated because the gain to the fund from terminations was overestimated. Changes in the actuarial turnover assumptions and several other actuarial assumption changes were recommended by the actuary and were adopted by the Commission in February 2000.
   
   The revised actuarial assumptions were used in the July 1, 2000, PERA actuarial valuation. Use of the new actuarial assumptions increased the plan’s computed unfunded liability by $736.5 million. A revised method for computing the actuarial value of assets was also used in the July 1, 2000, actuarial valuation, following a change in the law specifying how the actuarial value is to be determined. The revised actuarial asset value methodology was recommended to the LCPR by its retained actuary. That new methodology added an additional $44.9 million increase to PERA’s unfunded liability. These changes heavily influenced the computed contribution adequacy in the July 1, 2000, report compared to the report for one year earlier. The July 1, 1999, actuarial valuation indicated a PERA-General contribution sufficiency of 0.57 percent of payroll. In dollar terms, that valuation suggested that total contributions to PERA-General were $19.7 million more than needed. The July 1, 2000, actuarial valuation indicated a contribution deficiency of 1.96 percent of payroll, which is a contribution shortfall of $70.4 million.
   
   In May 2001, Commission staff received a copy of the latest experience study conducted by Milliman and Robertson, based on an analysis of PERA experience from 1996 to 2000. Based on that experience study, the actuary is now indicating that the previous change in the rate of separation may have been an overadjustment. For many age groups there is considerably more turnover than predicted by the newly adopted assumptions, often twice the predicted turnover, or more. The actuary may recommend another change in that assumption, which may lead to a lower estimate of the contribution deficiency.

4. Actuarial Value Issues. Many public pension systems throughout the country do not use market value in actuarial studies. The frequent contention is that the changes in the market value of assets over time are too volatile due to the swings that occur in investment returns from year-to-year. Instead of market value, a smoothed measure of asset value is used, referred to as the actuarial value of assets. There is no universal agreement on how to compute actuarial value. Many different methods are used.

For the larger Minnesota public pension plans, until recently the actuarial value of assets (or "current assets" as it is referred to in statute), was defined as the cost of the assets of the applicable pension fund plus one-third of the difference between cost and market (one-third of the unrealized gains or losses in the portfolio). This was revised during the 2000 Legislative Session. There are some phase-in procedures, but in essence the revised methodology uses market value on the actuarial date adjusted for deviations between the actual asset value on current and prior valuation dates and the asset value predicted by matching the 8.5 percent assumed rate of return. The calculation of the actuarial value of assets (current assets) for the PERA July 1, 2001 draft report is shown below. The actuary started with the market value of assets and then determined the "unrecognized asset returns" on June 30, 2001, 2000, and 1999 (the deviations between the actual market value and predicted market value on those dates). Those unrecognized asset returns are used in a weighted adjustment, as indicated on line (3), and that adjustment is subtracted from the market value to arrive at the actuarial asset value of current asset value. Since the adjustment is negative and is subtracted, the actuarial value of assets is greater than the market value of assets, by more than $436 million.

Source: Table 1, PERA July 1, 2001, Draft Actuarial Valuation

An actuarial value methodology is a smoothing methodology, intended to remove annual deviations and lend more consistency to the actuarial report results over time, so that funding decisions can be based on longer term tendencies rather than results that are due to a short-term shock to the investment markets, or any other situation of a temporary nature. It is possible, however, in creating a smoothing method to go too far in masking the impact of recent shocks. At some point, the Commission may wish to consider whether the current actuarial value method goes too far in obscuring recent events. We noted earlier that SBI’s investment return in the last fiscal year was the lowest in decades, negative seven percent. The effect of that return is barely discernable in this actuarial valuation. According to this valuation report, PERA’s funding ratio actually increased from the prior valuation, from 86.3 percent to 86.97 percent, rather than declined. Because of the weighting from various prior years used to compute the actuarial value, we have an actuarial value that is $436 million greater than the actual market value of applicable PERA assets. If we computed the July 1, 2001, funding ratio using the market value of assets rather than the actuarial value, the funding ratio would be 83.4 percent, rather than 86.97. The apparent improvement in PERA’s funding ratio compared to the prior valuation and the computed contribution deficiency in this valuation are validity only if we assume that PERA has $436 million more in assets than it actually had on the valuation date. The actuarial valuation is not conservative; it suggests a healthier funding situation than actually exists.

If there is a quick recovery in the markets, this overstatement of the actual PERA assets on the valuation date will do no harm. If the economic recession and weak investment markets persist for some time, this valuation may have masked the onset of a worsening PERA funding situation. At some point the Commission may wish to further analyze the actuarial value methodology and determine whether the method needs further revision.