During the November 4, 2003, meeting of the Legislative Commission on Pensions and Retirement, the Commission staff raised the issue of the need for the Commission to resolve the contractual issues with its consulting actuary, Milliman USA, and to renew the 2002-2004 contract for the next two years or to resolve the actuarial services issue in some other fashion.

To further Commission deliberations on this topic, the Commission staff requested the Commission Chair, Representative Steve Smith, to add the topic to the January 13, 2004, meeting agenda and prepared this memorandum.

This memorandum summarizes the current contract dispute with Milliman USA, summarizes Milliman USA’s proposal for resolving the dispute and some alternative approaches to reaching a new contract agreement with Milliman USA, and summarizes alternative approaches to the provision of actuarial services to the Legislature and to the retirement plans.

In June 2002, the Legislative Commission on Pensions and Retirement entered into a contract for the provision of actuarial services for the Commission with Milliman USA, following a competitive bid process. Milliman USA, the successor to the prior firm of Milliman & Robertson, Inc., was first retained by the Commission to provide actuarial services in 1991.

The 2002 actuarial services contract between the Commission and Milliman USA was for two years, with an option for the Commission to extend the contract for two additional years, through June 30, 2006, if Milliman USA and the Commission can resolve, in a mutually agreeable manner, three remaining issues. The issues remaining for resolution are:

1. Liability Limitation. Milliman USA is seeking a limit on its liability for errors and omissions. In any fiscal year, Milliman USA would be limited in liability in tort, contract, or otherwise, except for intentional fraud or willful misconduct by Milliman USA, to a specific dollar amount.

2. Mandatory Dispute Arbitration Rather than Litigation. Milliman USA is seeking the use of mandatory dispute arbitration rather than litigation in resolving disputes with the Commission. All actuarial services contract disputes would be resolved by final and binding confidential arbitration without any authority for the arbitrator or arbitrators to award punitive damages.

3. No Third-Party Reliance. Milliman USA is seeking a restriction on the reliance on actuarial results by third parties.

If an agreement is not reached before June 1, 2004, which is the deadline for the Commission to notify Milliman USA in writing of its exercise of the extension option, the actuarial services contract with Milliman USA would conclude on June 30, 2004, rather than June 30, 2006.

The Commission’s Actuarial Services Subcommittee (Senator Don Betzold, Chair, Senator Dan Stevens, Representative Mary Murphy, and Representative Steve Smith), in 2002, was generally uninterested in resolving the issues raised by Milliman USA in the manner then suggested by Milliman USA. In 2002, Milliman USA was willing to enter into an actuarial services contract with the Commission that did not address these issues only through the length of its then-current insurance coverage, which was through June 30, 2004.

Thomas K. Custis, on behalf of Milliman USA, has refined Milliman USA’s proposals to resolve the three actuarial services contractual issues at the request of the Commission staff. Mr. Custis has presented proposed contractual language to resolve the three liability limitation issues that Milliman USA has. To assist a potential Commission discussion of Mr. Custis’ proposed language by utilizing a document with numbered pages and lines, the Commission staff has replicated the Custis proposal in Document LM103003-1.

The Custis proposal, contained in his August 14, 2003, letter and replicated in Document LM103003-1, includes the following substantive changes in the actuarial services contract between Milliman USA and the Commission:

1. Defines Interested Parties. (Document LM103003-1, Page 1, lines 1 through 7.) In addition to the Legislative Commission on Pensions and Retirement, the following persons or entities have the ability to rely on actuarial work and are covered by a liability limitation and a mandatory dispute mediation and arbitration process:

1. all legislators;
2. Finance Commissioner;
3. State Auditor;
4. staff of the Legislative Commission on Pensions and Retirement;
5. trustees of each retirement fund; and
6. any State agency or organization that contracts with Milliman for actuarial services under the contract.

2. Limitation on Milliman USA Liability. (Document LM103003-1, Page 1, lines 8 through 15.) The total aggregate liability of Milliman USA to interested parties, in tort, under contract, or otherwise, is limited to $10 million. The limit does not apply to intentional fraud, willful misconduct, or gross negligence by Milliman.

3. Application of Laws to Liability Limitation. (Document LM103003-1, Page 1, lines 16 through 21.) The construction, interpretation, and enforcement of the liability limitation provision is required to be governed by Minnesota substantive contract law, without regard to Minnesota conflict of laws provisions. If, contrary to the belief of the parties, a liability limitation provision is not enforceable under Minnesota law, New York law rather than Minnesota law applies.

4. Severability. (Document LM103003-1, Page 1, lines 21 through 23.) If any provision of the contract is found unenforceable as a matter of law, the remaining provisions are to stay in full force and effect.

5. Mandatory Dispute Mediation Process. (Document LM103003-1, Page 1, lines 24 through 31.) The parties agree to initially attempt a good faith settlement to any dispute arising out of or relating to the engagement of Milliman USA by the Commission or any interested party. The settlement attempt must be with the aid of an impartial mediator to facilitate negotiations. The mediation process begins with a written notice of a dispute by a party to the other party or parties. The mediator must be jointly selected by the parties, but if the parties cannot agree on a mediator, the American Arbitration Association will designate a mediator at the request of a party.

6. Confidential Mediation Settlement. (Document LM103003-1, Page 2, line 1.) Mediation must be treated as a confidential settlement discussion.

7. Tolled Statute of Limitation. (Document LM103003-1, Page 2, line 2.) The applicable statute of limitation tolls during the pendency of the mediation.

8. Mediation Costs. (Document LM103003-1, Page 2, lines 3 and 4.) Each party is obligated to pay its own mediation costs and the mediator’s fees and expenses must be split equally by the parties.

9. Mandatory Dispute Arbitration Process. (Document LM103003-1, Page 2, lines 5 through 14.) In a dispute involving a potential claim against Milliman USA that is not resolved through mediation within 60 days of the beginning of the mediation process, the dispute will be resolved by final and binding arbitration under the Commercial Arbitration Rules of the American Arbitration Association. If the parties cannot agree to a single arbitrator within 30 days of the commencement of arbitration, each party must designate, in writing, a single neutral and independent arbitrator, with the arbitrators designated by the parties selecting a third arbitrator. An arbitrator is required to have sufficient background in employment benefits, actuarial science, or law to reasonably prepare the person to decide a dispute.

10. Arbitration Discovery. (Document LM103003-1, Page 2, lines 14 through 16.) The arbitrator or arbitrators may permit limited discovery, including depositions, prior to an arbitration hearing, with the discovery conducted consistent with the Federal Rules of Civil Procedure.

11. Limits on Arbitration Awards. (Document LM103003-1, Page 2, lines 16 through 19.) The arbitrator is not permitted to award punitive damages or exemplary damages, but may award the prevailing party with the cost of the arbitration, including reasonable attorney fees. An arbitration award may be confirmed in any court with jurisdiction over the dispute.

12. Confidential Arbitration Award. (Document LM103003-1, Page 2, lines 19 to 22.) An arbitration award must be confidential and, unless required by law, a party to the arbitration is not permitted to disclose the contract or results of an arbitration without the prior written consent of the other parties beyond disclosure to the auditors and legal advisors of the party.

13. Restricted Third Party Reliance. (Document LM103003-1, Page 2, lines 23 through 31.) Milliman USA’s work is designated as having been prepared solely for the legislative or operational use of interested parties and, although it may be distributed as required under the Minnesota Open Meeting Law, the work is not intended to create a legal duty from Milliman USA to anyone other than an interested party. Milliman USA and the Legislative Commission on Pensions and Retirement agree that Milliman USA may include in its reports clear language to restrict any reliance on the work product by parties other than interested parties. An additional release of Milliman USA work product by the Legislative Commission on Pensions and Retirement or by any interested party would be prohibited without the prior written consent of Milliman USA.

On behalf of the Commission, Mark Shepard of House Research, has looked at the liability limitation concerns raised by Milliman USA and has discussed the issues with Christie Eller, an Assistant Attorney General managing the Public Finance and Opinions Division of the Attorney General’s Office. While the Commission should consider consulting with Mr. Shepard and Ms. Eller further as it deliberates on the actuarial services contract extension issue, some general advice on arbitration for contractual disputes was provided by Mr. Shepard and Ms. Eller to the Commission staff on the topic, summarized from various e-mails as follows:

1. No Minnesota Constitution Prohibition on Arbitration by the State. No provision of the Minnesota Constitution prohibits the State from including arbitration in a contract for the settlement of a dispute. Article XI, Section 1, of the Minnesota Constitution, however, prohibits payments from the State treasury without a legislative appropriation. If arbitration is to be utilized, any contractual provision should recognize the constitutional limit as a curb on the arbitrator’s authority to make an award against the State. Specifically, any arbitration award against the State or the Commission should be limited to the availability of an appropriation. Presumably, the damages would be payable only from the remaining balance of the Commission’s appropriation.

2. No State Law Prohibition on State Contractual Arbitration. No provision of Minnesota Statutes prohibits the use of arbitration by a State agency.

3. Current MSRS, PERA, and TRA Actuarial Services Contracts Lack Arbitration Provisions. The current actuarial services contracts between Mercer, an actuarial consulting company, and the Minnesota State Retirement System (MSRS) and the between Mercer and the Public Employees Retirement Association (PERA), and the current actuarial services contract between Buck, an actuarial consulting company, and the Teachers Retirement Association (TRA) do not include dispute arbitration provisions.

4. Arbitration Process Should Be Limited to the Primary Concern. Any arbitration process should be specifically targeted to the primary concern that gave rise to the issue. The primary concern raised by Milliman USA relates to potential damage claims by the State of Minnesota or other entities against it relating to its work for the Legislative Commission on Pensions and Retirement that may be resolved in a forum that lacks an understanding of actuarial science and actuarial services. Mandatory arbitration could be narrowed, then, to apply solely to claims by the State of Minnesota or by related parties against Milliman USA arising under the Commission’s actuarial services contract. Arbitration could be permissive, but would need not be mandatory, in instances where Milliman USA is seeking damages from the Commission or the State of Minnesota.

While the actuarial services contract extension issue does not have to be resolved by the Commission in the short run, an extension of the current Milliman USA contract or the commencement of a competitive bidding process for a new actuarial services contract will need to occur by February or March, 2004, in order to ensure that the Commission can provide the actuarial valuations required under Minnesota Statutes, Section 3.85, as of July 1, 2004.

The Commission has four readily identifiable alternatives for addressing the actuarial services contract extension/actuarial services contract competitive bidding issue, which are:

1. Full Commission Deliberation. The Commission could meet in January 2004 or early February 2004 with Milliman USA and attempt to resolve the liability limitation/mandatory arbitration/third party reliance restriction issues raised by Milliman USA and negotiate a contract extension or authorize the competitive bidding process for a new actuarial services contract.

2. Commission Executive Committee Resolution. The Executive Committee of the Commission (i.e. Representative Steve Smith, Senator Don Betzold, and Senator Cal Larson) could be assigned the task of negotiating a contract extension with Milliman USA or of implementing the competitive bidding for a new actuarial services contract.

3. Resurrection of the 2002 Commission Actuarial Services Subcommittee. The remaining three members of the 2002 Actuarial Services Subcommittee (i.e. Senator Don Betzold, Chair, Representative Mary Murphy, and Representative Steve Smith) could be assigned the task of negotiating a contract extension with Milliman USA or of implementing the competitive bidding process for a new actuarial services contract. The Actuarial Services Subcommittee initially heard Milliman USA’s concerns about contractual liabilities in Spring, 2002, and declined to specifically address the concerns in the 2002-2004 two-year portion of the contract.

4. Creation of New Commission Actuarial Services Subcommittee. A new Actuarial Services Subcommittee could be appointed from interested Commission members and could attempt to resolve the Milliman USA issues or to commence with the competitive bidding of a new actuarial services contract.

The contract dispute with Milliman USA raises the broader potential issue of the manner in which the State of Minnesota obtains annual actuarial valuations and related services with respect to its statewide and major local public retirement plans because, without an actuarial services contract with a consulting actuarial firm after June 30, 2004, future actuarial services are in doubt.

There are seven readily identifiable alternatives available to the Commission for obtaining actuarial services beyond June 30, 2004. The alternatives are:

1. Accede to the Milliman USA Liability Limitations and Mandatory Arbitration Proposal. The Commission could ensure that actuarial consulting services are provided to the Legislature after June 30, 2004, by accepting the Milliman USA proposal assembled by Thomas K. Custis in August 2003, and then act to extend the Milliman USA actuarial services contract until June 30, 2006.

2. Negotiate with Milliman USA about its Liability Limitation and Mandatory Arbitration Proposal. The Commission could negotiate directly or indirectly with Milliman USA about its liability limitation and mandatory arbitration concerns, and if the negotiations can be successfully concluded, elect to extend the current Milliman USA contract for an additional two years. The outcome of any negotiations is unclear because the Commission gains nothing beyond future actuarial services in attempting to accommodate Milliman USA in the negotiations.

3. Negotiate an Actuarial Services Contract with Edward Friend, Inc. The Commission could elect to offer to enter into an actuarial services contract for the remainder of the four-year period with the unsuccessful 2002 bidder, Edward Friend, Inc. (EFI). Although the Commission staff has not approached EFI about its interest in becoming the actuarial consultant to the Commission, Mr. Friend has periodically sent correspondence to the Commission office and that may indicate continued interest in the job.

4. Rebid the 2004-2006 Actuarial Services Contract. The Commission could appoint an Actuarial Services Subcommittee and direct the Commission staff to issue a Request for Proposal to begin the rebidding process for an actuarial services contract with another consulting actuarial firm. If liability limitation concerns are widespread among consulting actuarial firms and with the severe limitations on the Commission’s budget for actuarial services, the success of a rebidding of the Commission’s actuarial services contract is unclear.

5. Retain a Pension Actuary on the Commission Staff. With the retention of a pension actuary and the upgrading of the Commission staff computer capabilities, the actuarial services function could be shifted from a consulting actuarial firm to a professional staff position. Taking the actuarial services function internal would require an amendment to Minnesota Statutes, Section 3.85, Subdivision 11, Paragraph (a), and would require identifying a pool of competent candidates. Potentially, there may be a pool of relatively recent Fellows of the Society of Actuaries or of experienced pension actuaries seeking to reduce or eliminate consulting-related travel and related activities. Budgetary concerns would constrain attempts to take the function internal.

6. Make the Commission Actuary the Reviewing Actuary and Reinstate the Retirement Fund Actuaries as the Production Actuaries. Post-June 30, 2004, actuarial services for the Legislature and the various retirement plans could be secured by reversing the decision of the 1984 Legislature, by making the actuary retained by the Commission the reviewing actuary for future actuarial work, and by redesignating the retirement plan actuaries as the primary production actuaries for actuarial valuations, experience studies, and benefit costing. It is unclear if Milliman USA would be willing to serve in this capacity. A number of the statewide and major local retirement plans either do not retain consulting actuaries or do not receive regular actuarial valuation services from their consulting actuaries. The quality of future actuarial services, which prompted the 1984 legislation creating the current actuarial services arrangement, would not be guaranteed. Draft Proposed Legislation LCPR04-007 would implement this option.

7. Replace the Commission Actuary with a Consulting Actuary Jointly Retained by MSRS, PERA, and TRA. The Commission could provide for actuarial services for the Legislature and for the various statewide and major local retirement plans by replacing the current Commission actuary with a single consulting actuary who would be selected jointly by the three largest retirement systems, the Minnesota State Retirement System (MSRS), the Public Employees Retirement Association (PERA), and the Teachers Retirement Association (TRA). The jointly retained consulting actuary would function essentially in the same manner as the current arrangement with an actuary retained by the Commission, except that the selection of the consulting actuary, the negotiation of the actuarial services contract, and the establishment of a budget for actuarial services would become the responsibility of the three major retirement plan administrations. The shift of the responsibility for the joint consulting actuary from the Legislative Commission on Pensions and Retirement to the joint retirement plans should eliminate the need or desire of the various retirement plans to retain an additional actuary, thereby saving the total public pension operations some administrative expenses, and would delegate the responsibility to negotiate actuarial services contract terms to plan administrators, who perform that function currently. The shift, however, would make the joint plan consulting actuary the agent of the various retirement plans rather than the agent of the Commission and the Legislature. The manner in which legislative initiatives would be costed out by the joint plan consulting actuary and how those services would be funded also would need to be resolved. Draft Proposed Legislation LCPR04-006 would implement this option.

The future of the Commission’s contract with a consulting actuarial firm for the provision of actuarial services is a major administrative issue facing the Commission in the next five months. The Commission staff hopes that this review of Commission options in attempting to resolve the consulting actuarial services issue is of assistance to Commission members as deliberations on the issue continue.