LCPR02-077, a blind amendment, would authorize a person or persons who are Minnesota Senate employees with Minnesota State Retirement System Unclassified (MSRS-Unclassified) Plan coverage for the current employment, and who previously was employed by the Minnesota Department of Finance with Minnesota State Retirement System General (MSRS-General) Plan coverage for that employment, to transfer all employee and employer contributions from MSRS-General to the eligible individual’s MSRS-Unclassified Plan account, notwithstanding general law which excludes transfer of any employer contribution intended to amortize MSRS-General unfunded liability, and to transfer these employee and employer contributions to the MSRS-Unclassified Plan with actual investment earnings, rather than with 8.5 percent interest.

A. Background on Defined Benefit Plans and Defined Contribution Plans

1.  General Distinction Between Plan Types

There are two major factors or elements in designing retirement plans. These are the level of the benefits and the level of contributions. When one factor is fixed or made predeterminable, the other factor is automatically made variable. If the level of benefits or computation of benefits is fixed or established by formula in law, the plan is a defined benefit plan, and the contribution rate is variable, adjusted as necessary to ensure that the liabilities of the plan are covered. If the level of contribution is fixed, the plan is a defined contribution plan. With a defined contribution plan, the benefit level is unspecified. The benefit level will ultimately be determined through the investment markets, which will determine the growth of the assets prior to distribution.

The MSRS-Unclassified Plan is one of several defined contribution plans found in Minnesota public pension law. The plan provides coverage for legislative employees (unless MSRS-General coverage is elected instead), many legislators, various individuals in the Executive Branch in unclassified positions, and some higher education managerial employees. In a defined contribution retirement plan, the level of contributions or the amount of member and/or employer funding is specified or fixed in some manner, making the level of eventual benefits and/or their duration the variable factor. Most commonly, in a defined contribution plan, the funding of the plan is specified as a percentage of the covered payroll of plan members. Those contributions, allocated to individual accounts and frequently invested based on individual selection, along with any investment return obtained, constitute the benefit available to the plan member upon termination of employment or retirement. Most commonly, the individual account balance is payable in a lump sum upon the termination of plan coverage or is available to be transferred to an insurance company for the purchase of a retirement annuity. Some retirement plans that generally are classified as defined contribution plans permit the individual account balance amount to be converted into a retirement annuity within the retirement plan at a specified rate, although the assumption of that retirement annuity mortality risk actually defines the post-retirement benefit amount and subjects the retirement plan to potential future mortality and investment return experience losses and a chance for an unfunded actuarial accrued liability, akin to a defined benefit plan.

The MSRS-General Plan is a defined benefit retirement plan. In a defined benefit plan, the level of benefits at the time of retirement or after retirement is specified or fixed in some manner, making the level of contributions or the amount of funding from period to period the variable factor. Most commonly, in a defined benefit plan, the retirement benefit is specified as a percentage of the final salary or of the final average salary per year of credited service rendered. Thus, the plan tracks and awards allowable service credit and salary credit and amasses a liability for the service and salary credit rendered to date that requires the periodic calculation and assessment by an actuary. The resulting actuarial valuation report both assesses the amount of actuarial accrued liability that the retirement plan has amassed to date and the amount of total contributions needed for the future plan year or plan years. Most commonly, in defined benefit plans, any lump sum amount is limited to a pre-retirement employment termination member contribution refund, with the regular retirement benefit only payable as a retirement annuity. Generally, a regular retirement annuity has optional equivalent value forms that open for election by the plan member. Retirement plans that are defined benefit plans can take on defined contribution retirement plan aspects, such as determining post-retirement adjustment amounts from the amount of investment gain in whole or in part generated by the plan.

In an actuarial report, the actuary determines the cost of the defined benefit plan being studied. This cost, usually specified as a percentage of covered payroll, is certainly strongly influenced by the specific benefits offered by the plan. But the cost of any given set of benefit provisions is dependent on many factors, such as the investment earnings rate assumptions, the average age and the age distribution of the covered membership, expected salary growth over the employee’s remaining employment prior to retirement, turnover (the probabilities that employees remain in covered employment to draw benefits), probabilities of disability, and mortality conditions before and after retirement.

In computing the plan costs, the actuary will divide the cost into three elements. The first element is the contribution amount necessary to cover the plan’s ongoing expenses, for staff salary, equipment, lease space, and all the other expenses related to operating a pension organization. The second element is the normal cost. The normal cost is the level contribution as a percentage of salary which will fund the current retirement plan benefits if made from first employment until retirement. Under general Commission policy, the normal cost contribution plus the contribution for expenses is shared equally between the employees and employer in non-public safety plans, while in public safety plans these costs are split on a 40 percent/60 percent basis between employees and employers.

Often, the accumulated contributions made to the plan are less than the current liabilities. This creates an additional cost element, an amortization contribution sufficient to pay off the uncovered liabilities by the plan’s full funding date. An amortization requirement can arise from many sources. Turnover which is less than expected, an increase in life expectancy, or investment earnings below the assumed rate can create a computed amortization requirement. Another common source is benefit improvements. Whenever benefits in a plan are improved, the contributions made in the past to cover normal costs, which were based on the plan cost prior to the benefit improvement, are inadequate to cover the liabilities imposed by the new, revised benefit plan. When an unfunded liability occurs, this added amortization cost may be covered by an employer additional contribution requirement.

2. Use of Defined Benefit Plans and Defined Contribution Plans In Minnesota

In Minnesota, public pension plans by both number and membership are predominantly defined benefit pension plans. The following sets forth a listing of defined benefit Minnesota public pension plans and of defined contribution Minnesota public pension plans:

B. MSRS-General to MSRS-Unclassified Plan Asset Transfer Provisions

The MSRS-Unclassified Plan includes a provision (Section 352D.02, Subdivision 1c) which permits an employee with prior MSRS-General Plan coverage who is subsequently employed as a full-time unclassified employee of the Legislature, legislative commission, or agency to transfer accumulated employee and matching employer contributions as further provided in Section 352D.03. By specifying that the contributions that transfer are limited to the employee contributions and matching employer contributions, Section 352D.02, Subdivision 1c, is indicating that any employer additional contributions, which is any additional employer contribution amount specifically intended to amortize unfunded liability, does not transfer. Section 352D.03 again specifies that the employee and matching employer contributions previously made to the MSRS-General Plan will transfer to the individual’s Unclassified Plan account with interest at the actuarially assumed interest rate, and includes an explicit statement that employer additional amounts do not transfer.

Section 352D.03 was included in the legislation that first created the MSRS-Unclassified Plan, which is coded as Chapter 352D. There have been minor revisions in Section 352D.03 over time, largely to accommodate changes in other law. However, there has been no changes in the policy reflected in this provision of law. Employee contributions plus a matching employer contribution amount may transfer, with interest at the actuarial assumed interest earnings assumption applicable at the time for MSRS-General, with a strict prohibition against any transfer of employer additional contributions. A copy of the 1980 version of Section 352D.03 is attached. That version was applicable during the mid-1980’s when the Minnesota Senate employee seeking coverage under LCPR02-077 was first employed by the Senate and was first eligible for Unclassified Plan coverage. The provision of law was next revised in 1992 for clarity and to revise the provision to also apply to certain Minnesota State Colleges and Universities System (MnSCU) managerial staff, but the basic policy reflected in the provision was not changed. That version as found in current statute is also attached.

The interest rate applied to the transfer amounts under this provision is the actuarial interest rate specified in law (Minnesota Statutes, Section 356.215) for MSRS-General. In 1970, when the individual seeking this legislation was first hired by the Department of Finance, the actuarial rate specified in statute for MSRS-General was 3.5 percent. The rate was increased to five percent in 1973, and to eight percent in 1984. In 1989, the rate was increased to 8.5 percent.

In 1985 (Laws 1985, First Special Session, Chapter 7, Section 9) a provision of law was enacted and coded as Section 352D.12, Transfer of Prior Service Contributions. This provision is similar but not identical to Sections 352D.02, Subdivision 1c, and 352D.03. One difference is that Section 352D.12 is more general in its coverage group. This section when first enacted permitted any employee covered by the Unclassified Plan with prior coverage by the Minnesota State Retirement System General (MSRS-General) Plan, Public Employees Retirement Association General (PERA-General), Public Employees Retirement Association Police and Fire (PERA-P&F) Plans, Teachers Retirement Association (TRA) first class city teacher plans, or Minneapolis Employees Retirement Fund (MERF), to transfer past employee contributions and matching employer contributions to the MSRS-Unclassified Plan. Similar to Sections 352D.02, Subdivision 1c, and Section 352D.03, any employer additional contributions are not eligible for transfer. The interest rate used in the transfer as stated in Section 352D.12 was specified as six percent, differing from that specified in Section 352D.03, which used the actuarial interest rate. In later years, Section 352D.12 was amended by including transfers from the Legislators Plan and the Elected State Officers Plan, and to permit 8.5 percent interest rather than six percent.

It would appear that individuals covered by LCPR02-077 (Minnesota Senate employees with prior Department of Finance employment) could be covered by either set of provisions (Sections 352D.02, Subdivision 1c, and 352D.03, or the more general coverage transfer provision, Section 352D.12). In 1985, when the individual who requested the language in LCPR02-077 began Senate employment, treatment under Section 352D.03 would be the more beneficial approach, since the actuarial interest rate was eight percent at that time, while Section 352D.12 specified six percent interest. More recently, either section of law would provide the same interest rate treatment, since the actuarial interest rate is currently 8.5 percent. All these laws, however, prohibit any transfer of employer additional contributions.

It may be useful for the LCPR to hear testimony from Mr. Bergstrom, Executive Director of MSRS, to obtain a better understanding of the factual circumstances and how MSRS interpreted and applied applicable laws. The LCPR may also wish to hear testimony from the individual seeking this amendment.

LCPR02-077, a blind amendment, would authorize a person or persons who are Minnesota Senate employees with Minnesota State Retirement System Unclassified (MSRS-Unclassified) Plan coverage for current employment, and who previously were employed by the Minnesota Department of Finance with Minnesota State Retirement System General (MSRS-General) Plan coverage for that employment, to transfer all employee and employer contributions from MSRS-General to the eligible individual’s MSRS-Unclassified Plan account, notwithstanding general law which excludes transfer of any employer contribution intended to amortize MSRS-General unfunded liability, and to transfer these employee and employer contributions to the MSRS-Unclassified Plan with actual investment earnings, rather than with interest at the actuarial rate of return.

An eligible individual seeking this legislation was hired by the Department of Finance in 1970 and was covered by MSRS-General for that service. In a letter, this individual indicates that he was hired by Senate in 1985, and he refers to an agreement which would permit all the prior employer contributions to be credited to his MSRS-Unclassified Plan account. He elected MSRS-Unclassifed Plan coverage, but he indicates in the letter that the transfer of all employer contributions "did not occur because of a law passed in special session 1985 which limited the transfer [of employer contributions] to an amount equal to the employee share with interest at 6 percent. Also, the laws of 1992 which changed the 6 percent assumed market rate compounded annually to 8.5 percent, does not apply to all my contributions."

The dates indicated (1985 and 1992) are the years that Section 352D.12 was enacted (1985) and the year that legislation passed revising the interest rate used in Section 352D.12 from six percent to 8.5 percent. That interest rate change was enacted in 1992 but did not become effective until May 1, 1994. However, it is unclear whether Section 352D.12 has any application to the individual. Given the employment by the legislature, the applicable provision may have been Sections 352D.02, Subdivision 1c, and Section 353D.03. Neither approach permitted transfer of employer additional contributions, although at the time Section 353D.03 permitted more interest than Section 352D.12.

Whichever set of law MSRS concluded was applicable, LCPR02-077 would create a benefit improvement for a single individual or a small group of individuals who are current Minnesota Senate employees or who in the future become Minnesota Senate employees, who select MSRS-Unclassified coverage for that employment period, and who had prior service in the Department of Finance. The benefit improvement is composed of the MSRS-General employer additional contribution amounts that would transfer to the individual’s Unclassified Plan account, plus the added increment, if any, that the actual investment return on MSRS-General Plan assets exceeds the actuarial assumed return during the applicable period.

The following chart indicates from 1969 forward all years in which an MSRS-General Plan employer additional contribution was required by law. The rate was revised several times between 1969 and 1992, and was terminated in 1997. The next column, to the right, indicates the actuarial interest rate for each year. This is followed by the actual rate of return earned on MSRS-General assets, those in the State Board of Investment (SBI) Basic Fund. The final column indicates the difference by year between the actuarial rate of return and the applicable SBI rate of return. We do not know how many individuals might be covered by the draft, or when they may have started employment with the Department of Finance and were subsequently hired by the Senate. The chart indicates that if the Department of Finance employment occurred prior to 1996, there were years where an employer additional contribution to MSRS-General was made, and use of the actual MSRS return rather than the actuarial return will create a sizable additional advantage.

Year	MSRS-General Employer Additional Contribution Rate1	Actuarial Interest Rate Assumption2	Actual State Board of Investment Basic Retirement Fund Investment Performance3	Differential Between Assumption and Actual Investment Performance4
1969	1.00%	3.50%	4.37%	+0.87%
1970	1.00	3.50	4.46	+0.96
1971	1.00	3.50	4.61	+1.11
1972	1.00	3.50	5.11	+1.61
1973	2.00	5.00	5.46	+0.46
1974	2.00	5.00	5.67	+0.67
1975	2.00	5.00	4.85	-0.15
1976	2.00	5.00	10.9	+5.9
1977	2.00	5.00	7.9	+2.9
1978	2.00	5.00	0.9	-4.1
1979	2.00	5.00	10.4	+5.4
1980	2.00	5.00	7.5	+2.5
1981	2.00	5.00	7.1	+2.1
1982	1.58	5.00	2.0	-3.00
1983	1.87	5.00	40.5	+35.5
1984	0.17	8.00	-5.5	-13.5
1985	0.17	8.00	26.9	+18.9
1986	0.17	8.00	26.2	+18.2
1987	0.17	8.00	14.5	+6.5
1988	0.17	8.00	-0.3	-8.3
1989	0.17	8.5	15.5	+7.0
1990	0.14	8.5	10.8	+2.3
1991	0.14	8.5	6.7	-1.8
1992	0.13	8.5	14.5	+6.0
1993	0.13	8.5	14.4	+5.9
1994	0.13	8.5	2.1	-6.4
1995	0.13	8.5	15.8	+7.3
1996	0.13	8.5	18.8	+10.3
1997	0	8.5	21.8	+13.3
1998	0	8.5	22.2	+13.7
1999	0	8.5	11.3	+2.8

1 Percentage of covered salary.

2 Percentage of actuarial value of assets (book value until 1984; book value plus one-third of the difference between book value and market value since 1984).

3 Percentage of market value of assets (total rate of return, time-weighted). Combined Basic Retirement Fund 1980-1999; MSRS-General 1969-1979.

4 Percentage of asset value.

Sources: Annual Actuarial Valuations; MSRS-General
Annual Report, State Board of Investment

Pension policy issues raised by LCPR02-077 are as follows:

1. Need Or Justification For Benefit Improvement For Selected Group Of Individuals. The issue is whether there is any need or justification to provide a benefit improvement for a group of Senate employees with prior Department of Finance employment. There may have been some confusion regarding which law or set of laws applies in the case of the specific employee or employees seeking this legislation. However, unless the individuals or MSRS identifies some applicable law that LCPR staff did not find in its review, it would appear that the individuals seeking this legislation were not harmed, unless it is now determined that an incorrect interest rate was used.

If the LCPR determines based on testimony that harm did occur, the LCPR may wish to consider whether the solution proposed in LCPR02-077 bears any relationship to that harm. The draft would authorize for the coverage group treatment that does not appear to have been used for any group (permission to transfer employer additional contributions and to receive actual investment return earnings, rather than six or 8.5 percent interest).

The justification for that benefit improvement is at best unclear. Limiting this treatment to a small group (current and future Senate employees with prior Department of Finance service) reduces total harm to MSRS-General, but it raises the equity issue of why other Unclassified Plan-covered employees are not also extended this proposed treatment.

2. Precedent For Additional Transfers. The policy issue is the precedent that the proposed legislation would set for additional increased transfers. Under Minnesota Statutes, Section 352D.12, MSRS-Unclassified Plan participants can transfer prior member contributions and an equal amount of employer contributions from other statewide or major local Minnesota pension plans, plus 8.5 percent interest. If the proposed legislation was enacted, it would set a precedent for comparable treatment for those with past coverage by Public Employees Retirement Association (PERA), Public Employees Retirement Association Police & Fire (PERA P&F), Legislators’ Plan, Elected State Officers Plan, Teachers Retirement Association (TRA) first class city teacher plan, or Minneapolis Employees Retirement Fund (MERF). Since several of these plans are relatively poorly funded and consequently have large additional employer contribution rates, this will produce additional funding pressure on those plans. It will also lead to inconsistencies for the employees transferring contributions. If the employers contributing to a given plan were not required to make employer additional contributions to a given plan, the employee transferring contributions from that plan would not have an employer additional contribution to transfer. Those in a prior plan with a modest employer additional contribution requirement would transfer a modest amount. Those employees with prior coverage by a plan with a poor funding ratio and a larger employer additional requirement would transfer the largest amounts.

3. Appropriateness Of Including Employer Additional Contribution In Transfer Amount. The policy issue is the appropriateness of including the MSRS-General additional employer contributions in the transfer amount that current MSRS-Unclassified participants can access. The MSRS-General additional employer contribution, when it existed until 1997, was intended to amortize the unfunded actuarial accrued liability of the retirement plan. The additional contribution was not a benefit attributable to an MSRS-General participant, but was catch-up funding to correct past funding deficiencies and the impact of past benefit improvements. In transferring an identical amount to the member contribution, under current law, the current MSRS-Unclassified member with past MSRS-General covered service already receives more in transferred contributions than their actual benefit value in MSRS-General. To demonstrate this, the following compares the current transfer amount (member contribution rate plus equal matching employer contribution amount) with the MSRS-General actuarial normal cost and administrative expenses (the actuarial measure of the average value of MSRS-General benefit coverage):

Source: Annual Actuarial Valuations, MSRS-General

If the goal is to provide equal benefit value to a transferring employee, that goal is already achieved because the amount transferred exceeds the actuarial value of the benefit coverage being forfeited by virtue of the transfer. If the goal is to gain the advantage of the total state contribution, including the amount to correct for decades of state underfunding that preceded 1957, then the proposed legislation could be argued to be appropriate.

4. Appropriateness Of The Transfer Of The Additional Investment Performance. The policy issue is the appropriateness of the proposed transfer of interest greater than the actuarial interest rate assumption. Currently, the transferring employee receives the value of the interest that amassed contributions are assumed to earn for the actuarial valuation of the MSRS-General. Similar to the proposed additional contribution transfer, it becomes a question of the transferring employee receiving the value of the retirement coverage they had, which would be the actuarial interest rate assumption, or receiving the additional benefit of any investment-related actuarial gain that the pension plan accrued. Clearly, the proponents of the proposed legislation want to obtain the greatest value that they can, but equitable considerations do not require that these employees receive more than the value they had at the time, which the current law provides. If these employees think that the current transfer provision undercuts the value that they had at the time, they should not have transferred past contributions to MSRS-Unclassified and should have retained their MSRS-General benefit coverage.

5. Misconception About The Nature Of Defined Benefit Plans And Defined Contribution Plans Underlying The Proposed Legislation. The policy issue is the nature of past defined benefit plan coverage, the appropriate manner of converting that defined benefit plan coverage to defined contribution coverage, and the extent that misconceptions about the nature of those pension plan types is driving the proposed legislation. Defined benefit plans provide a benefit derived from a mathematical formula (i.e. highest five successive years average salary multiplied by an annual benefit accrual rate multiplied by years of service credit) which is independent from the contributions assessed, because the pension plan averages the benefit liability risk, and because the annual funding requirements are set based in part on amortizing any unfunded actuarial accrued liability that the pension plan has. In contrast, defined contribution plans provide a benefit derived solely from the funding and investment earnings amassed on behalf of a particular employee. The contribution rates for one type of plan are not necessarily identical for the other. In converting from one to the other, which is what the current transfer authority permits, it is necessary to look to the value the employee receives under the defined benefit plan rather than the financial support that the plan receives. The proponents of the proposed legislation equate the funding received by the pension plan with the benefit value earned by the transferring employee under that plan, which is a misconception.

6. Impact on MSRS-General. The policy issue is the impact on MSRS-General that would be caused by the proposed legislation. The proponents of the proposed legislation suggest that there is no additional cost to the state or to MSRS-General, but ignores the fact that this will have an actuarial impact on MSRS-General. Already, under current law, transferees receive a greater amount of assets from MSRS-General than the MSRS-General liability released as a result of the transfer. This negative actuarial impact (actuarial loss) on MSRS-General will be enlarged if the proposed legislation is enacted.

7. Drafting Issues. LCPR02-077 is closely based on language suggested by the an eligible Senate employee in a letter (applicable portion is attached). LCPR02-077 differs from the drafting proposed in the letter only in format, by separating the language identifying the eligible employee or employees into a separate paragraph, following a drafting approach often used by LCPR staff.

There are several issues with the drafting. The individual clearly indicates in the letter that he is concerned that all employer contributions did not transfer. Presumably, the amounts that did not transfer are the employer additional contribution amounts. However, the proposed draft language does not specifically indicate that these are to be transferred. For consistency with the wishes of the eligible individual, the LCPR may wish to consider language specifying the transfer of those amounts. A second problem is the language on page 2 of LCPR02-077, in paragraph (c). The language is confusing regarding transfers before and after the effective date. Similarly, the purpose of meaning of paragraph (d) on page 2 of LCPR02-077 is unclear. It is not clear how including an expiration date would force an unplanned retirement, and failure to include an expiration date causes problems. In addition to certain current employees, the provision would also apply to individuals who in the future become Senate employees and have Department of Finance prior service.

The LCPR may wish to consider alternative amendments. The first of these is LCPR02-085. This amendment limits the eligible class to a Senate employee with prior service with the Finance Department who was first hired by the Finance Department in 1970. This version provides the enhanced interest treatment the individual requests and allows employer additional contributions to transfer, providing that the eligible individual demonstrates to the satisfaction of the MSRS Executive Director that applicable law in effect within the six-month period prior to the start of Senate employment permitted that treatment. The provision expires on July 1, 2002.

LCPR02-086 is identical to LCPR02-85 except that it does not provide the enhanced interest treatment.