A02-1322: Blind Amendment Revision of S.F. 3066 (Hottinger): Early Retirement Incentives, Temporary Increased Accrual Rates in Public Plans in Which Teachers Have Service Credit; Employer-Paid Healthcare is an author’s amendment containing the provisions of S.F. 3066 (Hottinger), with revision in the employer-paid healthcare portion of the bill to provide some targeting by Minnesota State Colleges and Universities System (MnSCU).

A02-1322 mandates that school boards and intermediate school districts must offer two early retirement incentives to teachers who are eligible to draw annuities from the Teachers Retirement Association (TRA), a first class city teacher plan, or the Higher Education Individual Retirement Account Plan (IRAP). K-12 teachers who are eligible for both incentives would receive both incentives.

The first added benefit is an increase in the accrual rates used to compute the retirement annuity. The accrual rate or rates must be increased by .1 percentage point for each year of service. To be eligible, the teacher must have at least 25 years of service in one or more plans included under the combined service annuity provision, or be at least age 65 with one year of service; be immediately eligible to draw a retirement annuity from TRA, a first class city teacher plan, or IRAP; be at least age 55; and retire between May 1, 2002, and June 30, 2003.

The second incentive that must be offered to teachers is employer-paid healthcare to age 65. Eligible individuals would receive employer-paid health insurance for single and dependent coverage and employer payments to which the person was entitled immediately before retirement. To be eligible, the teacher must have at least 25 years of service in one or more combined service annuity plans; have at least as many months of service with the current employer as the number of months younger than age 65 the person is at the time of retirement; be immediately eligible to draw a retirement annuity; be at least age 55 and younger than age 65; and retire on or after May 1, 2002, and before June 30, 2003, if the teacher is employed by a school district or MnSCU, and between July 1, 2002, and July 1, 2003, if employed by another eligible employer.

MnSCU must offer the annuity enhancement to MnSCU teachers who are covered by TRA or a first class city teacher plan. MnSCU may offer the healthcare provisions and may choose to target the healthcare incentive to employees in specific departments or programs.

Minnesota has utilized numerous early retirement incentives in connection with its public employee workforce over the last few decades. Most of the early retirement incentives presumably were intended to assist with state and local budget difficulties by encouraging retirements instead of layoffs. The incentives would induce some higher-paid and longer-service employees to terminate active public employment at an earlier age than they otherwise would. The savings that potentially will accrue to the public employer in this circumstance is dependent on the employer not filling the employment position with another employee or on the employer filing the employment position with another employee at a much smaller salary.

Public pension plans exist primarily to assist in recruiting new public employees, the retention of existing trained and productive public employees, and the predictable systematic out-transitioning of employees who have reached the end of their regularly expected productive working career. This is done through a retirement plan that provides a sufficient post-retirement income (adequate based on pre-retirement earnings). In providing an early retirement incentive, the pension plan is emphasizing the out-transitioning function and is attempting to speed up the timing of this out-transitioning. Other employment benefit coverage, such as severance pay or employer-paid early retirement health care premiums, can also assist in this out-transitioning function.

A02-1322, in offering an increase in annuity accrual rates to eligible teachers who retire during a specific period, and in providing employer-paid healthcare coverage to these terminating members, raises numerous pension and other policy issues. A partial list follows:

Unclear Purpose or Impact. As the provisions are currently stated, there is no clear indication of purpose other than to benefit certain public employees. The provisions provide a temporary increase in accrual rates which individuals can access by terminating within a window of opportunity, and employer-paid healthcare is also provided, both of which may set the stage for permanent provisions providing these added benefits. There is no clear indication that these provisions are intended to assist in dealing with employer budget problems, or that the provisions are capable of being an effective tool for dealing with the current budget situation.

Lack of Targeting. The increased annuity provisions are not targeted. The healthcare provisions are not targeted in the K-12 system, and MnSCU may choose to target the healthcare provisions but is not required to do so. The lack of targeting creates inefficiencies.

When early retirement incentives during the late 1980’s and early 1990’s were criticized by certain legislators, by employee groups, and in studies by the Department of Finance and the Program Evaluation Division of the Legislative Auditor’s Office, the Legislature began to build into proposed early retirement incentives some suggestions to better target the incentives. These targeting provisions are lacking in this proposal. A Legislative Auditor’s report studying 1993 incentives concluded that the cost of that program averaged between $25,000 and $33,500 per retiree. Given inflation since 1993, the cost of the 1993 incentives if offered currently might be in the $30,000 to $40,000 per retiree range. The auditor staff concluded that the cost was considerably higher than the salary savings gained by the incentive program except in cases where the specific governmental employer had to achieve considerable payroll reductions by leaving positions vacant, and could not gain those vacancies without a sizable number of layoffs. A02-1322 lacks any requirement that these incentives be restricted to situations that cannot be sufficiently addressed by normal staff retirements and turnover, and there is no requirement that the positions remain unfilled, even for periods of a few months or few years. It is possible that many of these positions must be filled, due to the number of students in the district. While that may be the case, the need to refill these positions considerable lessens the likelihood that net savings will result.

Some recent temporary incentives included a prohibition against rehiring the specific individuals who terminated. A prohibition of this type avoids favoritism and can help ensure budget savings. With a rehiring prohibition, an employee could not terminate service and begin drawing an annuity, only to then reenter teaching employment at or near full employment, earning a considerable salary plus a full or even enhanced retirement benefit.

Reemployment could undermine any budget savings and create a considerable windfall for the individual, by considerably increasing the individual’s total income due to the combination of salary and the pension. The language of the original bill and of A02-1322 does not prohibit rehiring. This may have been intended, given arguments made in recent years that there is an advantage in creating a flexible workforce of teachers, including a group of retirees who can return to teaching on a part-time substitute teaching basis, or on a near full-time or full-time basis. As an alternative to the current proposal, the Legislature may conclude that it would be more efficient to not offer the incentives, which would act to retain these capable teachers, and avoids creating situations where retirement benefits are paid to active employees. The general intention of the retirement systems is to replace income for those who are beyond their productive years, not to provide total income prior to true retirement that may be in excess of full salary.

Issues Relating to New Reemployed Annuitant Policy. In 2000, the Legislature adopted laws which revised reemployed annuitant policies for most, if not all, Minnesota public plans which have provisions restricting the amount of salary which a reemployed annuitant could earn without forfeiting a portion of the annuity that would otherwise have been received. Under the revised policy, there is no forfeiture. Any amounts that would previously have been forfeited are deferred and placed in an account for the reemployed employee. The value of that account with six percent interest is paid at age 65, or early if the reemployment ceases.

Because of that new policy, it is now possible that a fair portion of the individuals who terminate under these incentives (paid healthcare and enhanced annuities) will be reemployed with considerable salary by the school district or college while also receiving an enhanced pension, although receipt of a portion of the pension payment payable for the year may be deferred until a later date, with interest during the deferral period. The total compensation, which could also include severance pay packages offered by many districts, could easily exceed full salary as a continuing employee without termination. If this combination does create savings for the employer, it may be because part of the cost is shifted from the employer to the pension plan.

Even if it can be demonstrated that there are budget savings for the employing school district, the Legislature may wish to consider the perception that these incentive programs may create with other public employee groups. These other employee groups are not offered enhanced annuities or paid healthcare if they terminate, and these employees may have no reemployment opportunities with a public employer. An arrangement for teachers which creates windfalls and can lead to total compensation in excess of prior full salary may be viewed as unfair, given the plight of other public employees, who may face layoffs due to the budget situation and do not have reemployment opportunities.

Windfall to Those Who Would Retire Without the Incentives. The policy issue is the appropriateness of providing these proposed early retirement incentives when it is likely to grant a windfall to numerous retirees who would have retired during the early retirement window without any incentive. In a report by the Program Evaluation Division which studied a 1993 incentive program, the staff estimated that roughly one-half of the public employees who receive the 1993 incentives would have retired during that same year without the incentive program. For public employees who were induced to retire early, the acceleration of retirement was between one year and 1.7 years on average. The large number of individuals who will receive windfalls represent a cost without any real salary savings that would not have occurred without the program.

Cost Implications if Incentives Offered with Relative Frequency. The LCPR may wish to consider the implications of offering these incentives on a fairly consistent basis. If plan members come to expect that these incentives will be offered every few years, members may time their retirement to coincide with the offering of these incentives. This change in retirement behavior has the potential to increase the cost of Minnesota retirement plans.

Need for Both Provisions. The LCPR may wish to consider whether there is sufficient justification to provide either incentive (enhanced annuities or paid healthcare following termination). If the LCPR concludes there is a need for some action, the LCPR may wish to consider whether both incentives are needed to achieve the policy goals of the Legislature, or whether one will be sufficient.

Pension Fund Cost Issues. There are several pension fund cost-related issues. The employer-paid healthcare, if that were the only incentive offered, may have a pension fund cost impact. The direction of the cost change due to this incentive is uncertain. This incentive presumably would cause some individuals to terminate service sooner that would otherwise be the case. That could increase pension cost, but it might also reduce the liabilities that were expected, leading to a cost reduction. However, the other incentive, which will add .1 percentage points to the accrual rate used to compute the annuity of any individual retiring under the incentive, is very likely to increase liabilities.

One cost issue for the proposed package is the financial impact on the pension funds, and whether the LCPR should consider any action on this proposal given the lack of information from the LCPR-retained actuary. Teachers Retirement Association (TRA) and all first class city teacher plans will be impacted. TRA has a contribution sufficiency and assets in excess of its liabilities. However, the LCPR may wish to consider whether it is fiscally prudent to offer these proposed incentives in StPTRFA and the MTRFA. The St. Paul Teachers Retirement Fund Association (StPTRFA) has a considerable unfunded liability. The Minneapolis Teachers Retirement Fund Association (MTRFA) has a considerable contribution deficiency, and its funding level is so low that its assets are approximately $200 million less than the amount needed to fully fund the annuities of its existing retirees. Due to problems in the design of the MTRFA post-retirement adjustment, the increases paid to its retirees require more assets than the association is generating through its investments. In the case of MTRFA in particular, extending this incentive to the members of that plan is adding more liabilities to a sinking ship.

A second cost-related issue is whether it is good policy to create liabilities in pension plans through an action which presumably is intended to address a short-term budget situation. Under this proposal, a short-term employment and budget situation is being addressed through an approach which creates long-term liabilities, with amortization which can extend for decades. A current budget situation would be paid for by the next generation of taxpayers. Also, the cost is shifted from the immediate employing unit to, in many cases, statewide plans. This can lead to decisions that would not be made if the full cost was born by the employing units, and creates cross subsidy effects between employing units. The incentives in this proposal may not impact pension plan normal cost, but seem likely to create liabilities. In TRA, which is more than fully funded, these liabilities can be covered by some of the current surplus assets in excess of liabilities. This does, however, shift the cost of the incentive from the specific public employer to the statewide plan. The LCPR may wish to consider whether that is appropriate. Because the public employer does not confront the full cost of providing the incentive, the employing units may be far more supportive of this proposal than would be the case if the employer had to bear the costs. In the case of StPTRFA and MTRFA, which currently have unfunded liabilities, the same cost-shifting issues are relevant. In addition, because there are no surplus retirement fund assets to utilize to cover the cost of the program, the cost will be added to the pension plan’s amortization requirements. A short-term budget problem will be addressed by amortizing the cost for decades. The LCPR may conclude that is not an appropriate solution.

Avoiding Harm to Pension Funds. To avoid harm to the pension funds, the LCPR may wish to consider language which would require the employing unit from which the terminating employee retires to compensate the pension fund or funds for the added cost of the enhanced annuity or annuities. This was required in an early retirement incentive provided to Metropolitan Council employees a few years ago. The legislation required the employer to pay to MSRS the difference between the accrual reserves needed to support the annuity with and without the enhancement. Through that procedure, the employer covered the cost of the enhancement. The employer was permitted to stretch payment to MSRS over three years providing payment was made with interest.

Combined Service Annuity Issues. Although the enhanced annuities will only be offered to individuals who are teachers who agree to terminate and commence drawing an annuity, some of the cost repercussions are felt within the Minnesota State Retirement System (MSRS) plans, the Public Employees Retirement Association (PERA) plan, the Minneapolis Employees Retirement Fund (MERF), and possibly other non-teacher plans. The reason is that one of the eligibility requirements is at least 25 years of service covered by combined service annuity plans. There will be individuals who have prior service in MSRS, PERA, or MERF who move to teaching, ending up with teaching service covered by one of the teacher plans, with total service from all plans of 25 years or more. These teachers, if they meet other eligibility requirements and terminate from their current employer, qualify for the benefits provided by the incentives. The enhanced annuity incentive (language found on page 2, lines 1 to 5) can be interpreted as indicating that the combined service annuity computed by all the plans that provided service to the applicable individual must be increased by .1 percentage point. Even if the LCPR concludes that an amendment is needed to clearly limit the accrual increases to one or more teacher plans, there will be some impact filtering through to the non-teacher plans.

Age Discrimination, Related Issues. The question is whether all or portions of A02-1322 could be included in law without creating age discrimination and related conflicts with federal law. Attached are copies of a few documents LCPR staff received today which discuss that concern.

Amendments to A02-1322 for Commission Consideration. Given issues raised by this proposed legislation (A02-1322) it is not possible for staff to cover, through amendments attached to this document, all the possible changes or redirection, including all possible expansions or contractions in scope that the LCPR may wish to consider. Several amendments are attached and are described below. However, it may be necessary for the LCPR to direct staff to draw other amendments that could be considered at a later date or at another stage in the processing of the Commission’s omnibus bill.

1. LCPR02-090. This amendment would restrict any increased annuity percentage to an increase in the TRA or first class city annuity, and not permit the annuity from any other combined service annuity plan in which the individual has service credit to use the increased annuity percentage for computing the benefit.

2. LCPR02-091. The amendment could be used if the LCPR concluded it was appropriate to remove MnSCU employees from this incentive package. The LCPR might conclude that exclusion is appropriate if it concluded that higher education employees with TRA coverage should not be permitted to add additional liabilities to TRA, given the lack of any mechanism specified in A02-1322 for MnSCU to reimburse TRA for that added liability. If the LCPR chose to permit MnSCU to offer the healthcare incentive but not the TRA annuity enhancement, that could be accomplished by striking the last three lines of LCPR02-091.

3. LCPR02-092. This amendment would remove the first class city teacher plans from the package of offered incentives. The LCPR may conclude that is appropriate given the unfunded liability in StPTRFA and the very weak funding condition and large contribution deficiency in MTRFA.

4. LCPR02-093. This amendment is an alternative to LCPR02-092. LCPR02-093 would remove the first class city teacher plans other than the Duluth Teachers Retirement Fund Association (DTRFA), which is well funded.

5. LCPR02-094. This amendment permits employing units to choose whether to offer either incentive. If an employing unit decided to offer an incentive, it cannot offer both. The employing unit must reimburse the applicable retirement fund for the added cost to the plan of enhanced annuities, if offered. The employing unit may offer an incentive if the employer determines that layoffs will occur if the incentive is not offered. The employer may designate specific positions, departments, or programs, as applicable, where employees will be eligible for an incentive, and may exclude otherwise eligible employees.