H.F. 2449 (Rukavina); S.F. 2340 (Murphy) would make the full actuarial value military service credit purchase provisions enacted in 2000 permanent rather than expiring on May 16, 2004. Those provisions apply to the General State Employees Retirement Plan of the Minnesota State Retirement System (MSRS-General), the Correctional State Employees Retirement Plan of the Minnesota State Retirement System (MSRS-Correctional), the State Patrol Retirement Plan, the General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General), and the Public Employees Police and Fire Retirement Plan (PERA-P&F).

It is useful to begin by reviewing recent history, starting with the Commission’s service credit purchase policy statement as it appears in the Legislative Commission on Pensions and Retirement Principles of Pension Policy. That general policy statement, last revised in 1996, guided the Commission for a few decades. Recently, the Legislature has enacted several general law service credit purchase provisions, which are set to expire, which deviate from this policy document.

The Commission’s Principles of Pension Policy states in relevant part that any period of time proposed to be purchased should have a Minnesota connection. An individual providing out-of-state teaching service is not providing a service to Minnesota. Thus, there is no clear justification why Minnesota taxpayers should take on the risk involved in ensuring payment of the additional pension that would result from another year of teaching service in a Minnesota public plan.

1. Review of Service Credit Purchase Policy. Principle II.C.10. of the Commission’s Principles of Pension Policy covers purchases of service credit. It reads as follows:

10. Purchases of Prior Service Credit

Purchases of public pension plan credit for periods of prior service should be permitted only if, on a case-by-case basis, it is determined that the period to be purchased is public employment or substantially akin to public employment, that the prior service period must have a significant connection to Minnesota, that the purchase payment from the member or from a combination of the member and the employer must equal the actuarial liability to be incurred by the pension plan for the benefit associated with the purchase, appropriately calculated, without the provision of a subsidy from the pension plan, and that the purchase must not violate notions of equity.

This principle has the following elements:

1. Individual Review. The Commission considers each service credit purchase request separately, whether the request is proposed legislation for a single person or is proposed legislation relating to a group of similarly situated individuals.

2. Public Employment. The period requested for purchase should be a period of public employment or service that is substantially akin to public employment.

3. Minnesota Connection. The employment period to be purchased should have a significant Minnesota connection.

4. Presumption of Active Member Status at the Time of Purchase. The principle states that contributions should be made by the member or in combination by the member and by the employer. It is presumed that the individual covered by the service purchase request is an active employee, because retirees generally are not considered to be "members" of a plan and these individuals no longer have a public employer.

5. Presumption of Purchase in a Defined Benefit Plan. The prior service credit purchase contributions in total should match the associated actuarial liability. The specific procedures in Minnesota Statutes and law for computing service credit purchase amounts, Minnesota Statutes, Sections 356.55 and 356.551, presume that the purchase is in a defined benefit plan with a benefit based on the individual’s high-five average salary.

6. Full Actuarial Value Purchase. The pension fund should receive a payment from the employee, or from the employee and employer in combination, which equals the additional liability placed on the fund due to the purchase. This amount is referred to as the full actuarial value of the service credit purchase.

7. No Violation of Equity Considerations. Purchases of service credit should not violate equity considerations. Equity is a resort to general principles of fairness and justice whenever the existing law is inadequate.

2. Overview of Generalized Service Credit Purchase Provisions Enacted After 1998. The Commission followed this policy statement rather faithfully through 1998. In 1999, the Commission began to depart from these policy statements, at least in certain cases involving groups of individuals. The Commission was persuaded to support several proposed generalized service credit purchase provisions applicable to the Teachers Retirement Association and the first class city teacher retirement fund associations (the Duluth Teachers Retirement Fund Association, the Minneapolis Teachers Retirement Fund Association, and the St. Paul Teachers Retirement Fund Association). Under these provisions, classes of individuals (those with prior military service, out-of-state teaching service in a K-12 situation, individuals who taught in parochial schools, provided Peace Corps service and various other groups) were permitted to purchase service credit in the applicable Minnesota plan for the specified service. These provisions, which were strongly supported by teacher groups, conflicted with the Commission’s policy statement in several ways. All lacked any requirement of an individual review of the circumstance. Others were not related to public service or had no Minnesota connection.

   In 2000, more service credit purchase provisions were added to law, this time for non-teacher plans, providing a full actuarial value service credit provision for individuals who had military service prior to becoming a public employee, or who failed to pay contribution requirements in a timely manner under other military leave service credit purchase provisions. These provisions enacted in 2000 were comparable to the military service credit provisions added to teacher plan law a year earlier. In 2000, teacher plan law was also revised to permit full actuarial value service credit purchases for nonprofit community-based teaching service.

   In 2001, several other service credit purchase provisions were enacted. An out-of-country teaching service credit purchase provision was created in teacher plan law, and also one for Development Achievement Center teaching. These new provisions included sections of law permitting purchase of service credit, not to exceed ten years, in the teacher plans for service while teaching at the University of Minnesota which was not covered by a pension plan at the University. These provisions stemmed from a legislative request for the executive director of the Minneapolis Employees Retirement Fund MERF), who many years earlier taught some accounting courses at the University while employed in a position that was excluded from pension plan coverage. The final generalized service credit provision enacted was a family leave provision permitting individuals who may be covered by a teacher plan, or any of several other general employee and public safety plans, to purchase service credit for the past family leaves or family-related breaks-in-service.

3. Justification of Legislative Support. There are a few reasons why the Commission and Legislature may have supported the above provisions. First, the provisions were intended to be temporary. Each was set to expire a few years after enactment. The departure from policy may have been viewed as a short-term departure from established policy to address short-term market conditions for teachers. Second, the Legislature was given assurances that the provisions created no financial harm to the pension funds because the purchases would be at full actuarial value. The methodology to compute full actuarial value purchase prices had been revised in 1998, and the teacher unions and the administrators of the teacher pension funds were confident the procedures would produce accurate price estimates, thereby shielding other fund contributors from subsidizing these purchases. When the revised methodology was enacted in 1998 as Section 356.55, the section included a provision requiring data to be retained and analyzed on every service credit purchase made using the procedure, and the section included an expiration date. If legislative review of these purchases suggested that the procedure was not accurate and was causing subsidies to occur, the section would be permitted to expire. If it expired, a previous procedure used to estimate full actuarial value, coded as Section 356.551, would again become effective. That prior procedure in Section 356.551 tended to produce higher cost estimates than the revised procedure. Teacher unions and other constituent groups favor continuing the revised procedure in Section 356.55, because it tends to produce lower prices. From a policy standpoint, the Section 356.55 procedure is better if it is more accurate than the prior procedure. If the lower prices are resulting in subsidies, its use harms the pension funds.

4. Current Situation. As the repeal date for the revised full actuarial methodology and each of these temporary generalized service credit provisions approached, the repeal dates were extended by the Legislature due to strong support for these provisions from the teacher unions and other constituent groups. Most of the provisions have now been extended more than once. All are currently set to expire in May or July 2004, depending upon the provision.

   The extension to May or July 2004 of the service credit purchase provisions and method for computing the prices was a result of action during the 2003 Session. The Commission heard a bill that as drafted would have made the purchase provisions and the pricing method permanent, rather than expiring during 2003. The Commission chose instead to recommend extending the purchase provisions and the methodology one more year, pending a thorough review of the pricing method and purchase provisions.

   During the 2003 Interim, the Commission reviewed these matters over the course of three meetings, hearing testimony from fund directors, teacher union representatives and other interested parties, and considered the three Commission staff memos provided for those meetings. The first meeting was on September 9, 2003, and the staff memo provided a general overview. The second meeting was on October 7, 2003, and the staff memo reviewed each generalized service credit purchase provision enacted after 1998, noted conflicts with the Commission’s policy document and other policy concerns, and reviewed the accuracy of the service credit purchase methodology. To review that methodology, Commission staff examined the purchase price produced by the procedure and paid by the individual to the pension plan, and compared that to the additional liability created in the next actuarial valuation due to the specific purchase. The plans and the actuary were required by law to retain and report that information to permit study of the procedure. In reviewing several hundred purchases, in no case did the purchase price match the liability due to that purchase as reflected in the plan actuarial valuation following the purchase. Differences tended to be large, generally several thousands of dollars, and in many cases tens of thousands of dollars. This raised concerns that the pricing method was not accurately estimating the full actuarial value of the service credit purchases, resulting in considerable subsidies in many cases, and possible overcharges in others.

   The data suggested that individuals who purchase service credit very shortly before retirement tend to be considerably undercharged relative to the full additional liability the purchase adds to the plan. Those purchases by individuals further from retirement may be less likely to be subsidized, and might be overcharged. However, a broader view of the situation suggests that even those who appear to be overcharged may eventually impose additional liability on the fund. Estimating the proper price to charge involves a few actuarial assumptions, including estimating when the individual will retire, projecting the individual’s salary until retirement, and assumptions about life spans. To the extent that future events do not match these estimates, errors are created, exposing the fund to risk. Perhaps the biggest concern is that the computed purchase price is keyed to the benefits offered by the current pension plan. If benefit improvements are enacted after the purchase occurs, and the improved benefit applies to all years of service (including those that were purchased), then the individual receives a windfall. That service credit was more valuable than was recognized at the time it was purchased. If a benefit improvement were expected in the future, it would be economically wise for teachers or other public employees to purchase service credit now. Despite efforts to accurately price the service credit, the price is actually discounted. Thus, viewing the results in a fuller context, the data suggests that under the current procedures, individuals purchasing service credit very close to retirement are likely to be subsidized. The pension fund also is exposed to risk for those further from retirement, because the individuals may live longer than currently estimated due to medical advances over time, and because of benefit improvements enacted after the purchase but prior to retirement which may increase the value of the purchased service.

   The review of results from the full actuarial pricing methodology concerned Commission members. Commission members were aware that the various full actuarial value service credit purchase provisions enacted in 1999 and later conflicted with the Commission’s policy statement, by including purchases for periods of private or nonprofit employment rather than public employment, and in other cases by lack of any Minnesota connection. But these policy departures were believed to create no burden on the pension funds. The Commission’s review of results of those purchases raises considerable doubt about the accuracy of the current pricing method, and also whether any system could be devised that can be consistently accurate, because any method must use assumptions about future events. If the Commission cannot be confident in the pricing mechanism, it cannot be confident that the pension funds are not being harmed. Departures from policy, which were assumed to cause no financial harm, may have monetary consequences.

   The various general law service credit provisions added to law since 1998 have greatly increased the number of purchases than would have otherwise occurred. While the Commission will need a full actuarial value methodology in place for those situations where it must be used, the Commission may decide to take the position of limiting its use by allowing the various full actuarial value service credit provisions to expire. The Commission reviewed this option and various others at the third meeting on this topic, on November 4, 2003.

Under the general law military service credit purchase provisions enacted in 2000 for various MSRS and PERA plans, a vested MSRS-General, MSRS-Correctional, State Patrol Retirement Plan, PERA, or PERA-P&F member who performed service in the armed forces before becoming a member of the applicable plan or who failed to make contributions to obtain service credit while on a military leave of absence is entitled to purchase service credit for the initial period of enlistment, induction, or call to active duty not including any voluntary extension. To receive the service credit, the member must pay the full actuarial value. (Laws 2000, Chapter 461, Article 4, Sections 1 to 4. Coded as Minnesota Statutes, Section 352.275 for MSRS-General and MSRS-Correctional, Section 352B.01, Subdivision 3a, for the State Patrol Plan, and Section 353.01, Subdivision 16a, for PERA and PERA-P&F.)

Purchases are not authorized under these full actuarial value military service credit purchase provisions if the individual is eligible for a military pension or if the individual has service credit in another plan due to this military service. During the most recent interim, the Commission discussed the various full actuarial value military service credit purchase provisions within the context of compliance with federal laws and regulations, or based on court decisions. Some of the pension fund administrations contend that language found in these provisions which prohibits service credit purchases if the individual is eligible for a military pension or otherwise has coverage for the military service should be stricken from the law, because of federal law which overrides any provision of law which interferes with the federal government’s national defense needs. Commission staff records do not indicate that any action was taken to remove the prohibition against double coverage. The Commission may wish to hear testimony on this issue. The Commission could recommend by amendment that the prohibition should be removed. That, however, will create a double coverage concern. An alternative is to let the provisions expire by not taking action on these bills.

These full actuarial value service credit purchase provisions conflict in a few ways with Commission’s policy statement. First, while individuals providing military service in the armed forces of the United States are unquestionably providing a value service to all Americans, one can question whether there is a sufficient Minnesota connection to justify allowing service credit to be purchased in a Minnesota public pension plan. Second, the scope of the provisions raises several equity concerns. Individuals who are eligible to purchase service credit under these provisions include Minnesota public employees who failed to take advantage in a timely manner of a more generous treatment under other military leave of absence provisions under these pension plans, provisions which permit the individuals to receive service credit by making the employee contributions that the individual would have made if the military leave had not occurred. Among others covered by these full actuarial value provisions are individuals who were not public employees before or immediately after the leaving the military.

The staff memo for H.F. 2422 (Smith); S.F. 2507 (Pogemiller), which is also on this agenda, includes an extensive discussion of the impact of service credit purchases to date, based on a Commission review over the 2003 interim of full actuarial value service credit purchases. That discussion, which covered all full actuarial value service credit purchases of all types made in 2000, 2001, and 2002, is not repeated here, but a brief summary of the findings is provided.

The study analyzed to outcome of the methodology used to compute the purchase price for full actuarial value service credit purchases. Commission staff observed that in no case did the service credit purchase amount exactly match the additional liability due to the purchase noted in the next actuarial report, and the differences tended to be large rather than small. Most active purchases (purchases by individuals who remained active members at the next actuarial valuation) resulted in a gain to the plan (the added liability due to the purchase as recognized in the next actuarial valuation was less than the purchase price). The opposite result is seen for those individuals who purchase service credit and then retired by the next actuarial valuation (the "retired purchases"). When the purchase price is compared to the change in liability reflected in the next actuarial valuation due to the purchase, most retired purchases resulted in losses to the fund. These findings raise the possibility that individuals who purchase service credit using the full actuarial methodology may rarely be charged an amount approximating the liability created in the fund by the purchase. Some individuals may be charged too little, while others may be charged too much.

The actuary, in discussing the service credit purchase tables in the Summary of Valuations, has not directly addressed the issue of accuracy. Rather, the actuary has commented indirectly on this issue by focusing on the impact purchases had on the funding status of the plans as indicated in the actuarial valuations. The 2000 Summary of Valuations included a statement that service credit purchases reviewed in the 2000 actuarial valuations harmed the funding status of the plans because service credit purchases in total were less than the resulting liability recorded in the actuarial valuations for the plans. In the last two years the situation reversed, and the total amounts received through service credit purchases were greater than the added liability recognized in the actuarial valuations. Thus, in the last two years, these purchases moved the plans marginally ahead in their reported funding condition, given the methodology used in actuarial valuations.

While these funding ratio effects may be occurring, it was never the intention of the Legislature to influence plan funding ratios through service credit purchases. The purpose was to have a purchase procedure that was fair to each purchaser and to the fund.

H.F. 2449 (Rukavina); S.F. 2340 (Murphy) would make the full actuarial value military service credit purchase provisions enacted in 2000 permanent rather than expiring on May 16, 2004. Those provisions apply to the General State Employees Retirement Plan of the Minnesota State Retirement System (MSRS-General), the Correctional State Employees Retirement Plan of the Minnesota State Retirement System (MSRS-Correctional), the State Patrol Retirement Plan, the General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General) and the Public Employees Police and Fire Retirement Plan (PERA-P&F). Pension policy issues are:

1. Conflict with Commission’s Policy Statement. The policy statement indicates that the period being purchased should have a Minnesota connection, and should be a period of public employment or quasi-public employment. The Commission may wish to decide if there is a sufficient Minnesota connection. In cases where the individual was a Minnesota public employee before and after the military service, the Commission may wish to also consider the equity issue of allowing individuals who failed to take advantage of far more generous purchase terms, under other provisions of these plans applying to military leave situations, to allow a second chance. The Commission may feel this is not a concern, because of the far less generous terms offered under full actuarial value service credit purchase provisions.

2. Question of Removing Double Coverage Prohibition. The issue is whether the Commission should consider an amendment to remove the prohibition against purchasing service credit if the individual is already covered for that service in a military plan or other retirement plan. The Commission may wish to hear testimony on this issue. If the language is removed by amendment, or if the pension funds contend that even under current law they must permit these purchases because of federal law that overrides the language of these Minnesota statutes, there will be double coverage in some instances. If the Commission is not overly concerned about the double coverage, the Commission could remove the prohibition by an amendment. If the Commission is concerned about the double coverage, the Commission may choose to let these service credit purchase provisions expire.

3. Concern About Accuracy of the Full Actuarial Value Procedure. The Commission may be concerned about the problems with the full actuarial value methodology. The approach used may not be sufficiently accurate to avoid either harm to the purchaser or harm to the fund. Another set of bills, H.F. 2422 (Smith); S.F. 2507 (Pogemiller), Various Plans; Service Credit Purchase Deadlines Extension, includes language which would extend the use of current procedure to estimate these prices for several more years. If that method is extended, the Commission may have concerns about making permanent the military service purchase provisions that use that methodology. The Commission may wish to consider that all of Minnesota’s public pension funds have had decreases in their funding levels in recent years due to three years of bad markets (2000 through 2002). The Commission may also wish to be concerned that when service credit is purchased just before retiring, a loss to the fund (a gain to the individual) is likely to occur. The best information available to the Commission indicates that the pension fund is harmed in those situations.

4. Early Retirement Issues. Service credit purchases are being used by those nearing retirement to retire earlier than they otherwise would. The purchase permits the individual to qualify under the Rule-of-90 or other early retirement provision. Therefore, these service credit purchase provisions are an early retirement tool, but without any specific targeting to the employer’s workforce needs.

5. Scope. The issue is the proper scope of the legislation. The MSRS and PERA full actuarial value military service credit provisions would be made permanent under these bills, but TRA and the first class city teacher plans have similar provisions. The Commission may wish to decide whether to address the full actuarial value military service credit provisions in all of these plans rather than only a few of the plans.

6. Permanent versus an Extension. The Commission may wish to decide whether to make these provisions permanent or whether to continue them as temporary provisions by extending the expiration date, which is currently May 16, 2004.

LCPR04-142 would make the provisions expire on a date to be set by the Commission, rather than being made permanent.

LCPR04-143 would add the teacher plans (TRA and first class city teacher plans) full actuarial value military service credit purchase provisions to the bills. All the full actuarial value military service credit purchase provisions would be permanent.

LCPR04-144 would add the teacher plans (TRA and first class city teacher plans) full actuarial value military service credit purchase provisions to the bills. All the full actuarial value military service credit purchase provisions would be temporary, expiring on a date to be set by the Commission.

LCPR04-153 would remove the prohibition against a military service credit purchase if the service is covered by a military or other pension plan. This language is removed from the various MSRS, PERA, and Teacher Retirement Association (TRA) and first class city teacher plans.