General Summary of the Proposed Legislation

H.F. 2460 (Simpson); S.F. 2341 (Larson) amends Minnesota Statutes, Section 353F.02, Subdivision 4, the privatized medical facility definition of the Public Employees Retirement Association General Employee Retirement Plan (PERA-General) Special Privatized Employee Benefit Coverage provisions, by including Fair Oaks Lodge, Wadena, employees under the special benefit coverage, retroactive to January 1, 2004, if the Todd and Wadena county boards both approve it and if the special privatization coverage does not cause a net actuarial loss for PERA-General when compared to the actuarial gain resulting from the privatization.

Public Pension Situation of the Fair Oaks Lodge Employees

The Fair Oaks Lodge, located in Wadena, Minnesota, is a Medicare-certified 115 bed (98 bed Medicare/Medicaid certified) nursing home with 113 employees (72 full-time, 41 part-time) which was acquired by TriCounty Hospital, Inc., of Wadena, Minnesota, as Internal Revenue Code Section 501(C)(3) nonprofit corporation on January 1, 2004.

The Fair Oaks Lodge was formerly owned jointly by Todd County and Wadena County and its full-time employees and eligible part-time employees (i.e., those meeting a $425 per month minimum salary threshold) have retirement coverage by the General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General), a defined benefit retirement plan.

Upon the acquisition of Fair Oaks Lodge by TriCounty Hospital, Inc., the nursing home employees lost future PERA-General retirement coverage and have future TriCounty Hospital, Inc. pension coverage, reportedly under a defined contribution retirement plan. For the privatized Fair Oaks Lodge employees, under PERA-General, employees with three years of public employment or more will have a right to a deferred retirement annuity, based on their pre-privatization final average salary, plus augmentation at three percent through age 55 and at five percent after age 55. Under the PERA-General privatization provisions, Minnesota Statutes, Chapter 353F, a privatized public employee would have a greater rate of augmentation (5.5 percent through age 55 and 7.5 percent thereafter), would qualify for the "Rule of 90" early normal retirement annuity by using their privatization service for vesting (but public service only for benefit calculation purposes), and would qualify for PERA-General disability or survivor benefits if a post-privatization casualty event occurs.

Background Information on Defined Contribution Pension Plans and Defined Benefit Pension Plans

Pension plans, whether in the public sector or in the private sector, are classified as being of one of two types, either a defined contribution plan or a defined benefit plan. The question is whether the pension plan is focused on the certainty of inputs or outputs. An Individual Retirement Account (IRA) or an Internal Revenue Code Section 403(b) tax-sheltered annuity is a defined contribution plan. The General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General) is a defined benefit plan.

A defined contribution plan is a pension plan where the funding for the pension plan is fixed as a dollar amount or as a percentage of payroll and the fixed element of funding leaves a variable element, which is the benefit amount that is ultimately payable. Under a defined contribution plan, the plan member bears the inflation and investment risks. If there is poor investment performance, the plan member’s pension assets will be depressed. If inflation impacts the immediate pre-retirement standard of living, the plan member’s benefit will be less adequate in meeting the person’s pre-retirement standard of living. The employer loses any turnover gain potential, where past plan funding becomes more concentrated on a subgroup of total plan membership. A defined contribution plan favors employees who are very employment mobile, where employment changes beyond a single employer or a multiple-employer group. It also favors short-term employees in comparison to defined benefit plans. It also favors employees with very stable and modestly increasing salary histories and employees who work considerably beyond the plan’s normal retirement age.

A defined benefit plan is a pension plan where the pension benefit amount that is ultimately payable is pre-determinable or fixed using a formula or comparable arrangement. The fixed element of the benefit amount leaves a variable element, which is the funding required to provide that benefit. As a defined benefit plan, PERA-General and the employing units covered by the plan have the inflation and investment risks. If the investment return on plan assets is poor or if inflation produces ever-increasing final salaries and benefit payouts, that risk is borne by the plan and its associated employers. The member has the turnover risks. If a plan member terminates with modest service having been rendered or at an early age, the member will receive either no benefit or an inadequate benefit. A defined benefit plan favors long-term or long-service employees. It also favors employees who receive regular promotions and sizable salary increases throughout their careers or who achieve substantial salary increases in their compensation at the end of their career. It also favors employees who retire at or before the plan’s normal retirement age.

Defined contribution pension plans predominate in the private sector, while defined benefit pension plans predominate in the public sector. The U.S. Department of Labor, in a study by the Bureau of Labor Statistics entitled National Compensation Survey: Employee Benefits in Private Industry in the United States, 2002, indicates that 36 percent of all private sector employees are covered by a defined contribution plan and that only 18 percent of private sector employees are covered by a defined benefit plan. In a study entitled Employee Benefits In State and Local Governments, 1998, the Bureau of Labor Statistics reports that 90 percent of public employees are covered by a defined benefit plan and only 14 percent of public employees are covered by a defined contribution plan. In both studies, the total of the percentages for the two types of plans exceeds the total number of employees covered by pension plans because some employees are covered by more than one plan.

Background Information on Minnesota Statutes, Chapter 353F, PERA Privatized Hospital Employee Pension Coverage

When a privatization of a PERA-covered employing unit occurs, the employees, who up to the date of privatization were public employees and therefore covered by the General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General), no longer qualify as public employees. At the time of privatization, PERA-General coverage terminates. However, the provisions of Minnesota Statutes, Chapter 353F, extend certain rights to the privatized employees that differ from the typical treatment of terminated employees. One justification for this different treatment is that the privatized employees did not choose to be privatized. Their status changed from public to private or quasi-public employment due to a transfer of ownership of the employing hospital. In contrast, termination is assumed to be initiated by the employee exercising his or her free will, with full understanding of the consequences of that action.

Under a privatization, Chapter 353F provides the following special coverage provisions to the privatized employees:

1. Vested Benefit With Any Service Length. The normal three-year PERA vesting period is waived, so a privatized employee with less than three years of PERA-covered service would be entitled to receive a PERA retirement annuity, notwithstanding general law.

2. Increased Deferred Annuity Augmentation Rate. For the period between the date of privatization and the date of eventual retirement, the privatized employee’s deferred PERA retirement annuity will increase at the rate of 5.5 percent rather than three percent until age 55 and at the rate of 7.5 percent rather than five percent after age 54.

3. "Rule of 90" Eligibility With Post-Privatization Service. For privatized employees with actual or potential long service who could have retired early with an unreduced retirement annuity from PERA under the "Rule of 90" (combination of age and total service credit totals "90"), the employee will be able to count future privatized service with the hospital for eligibility purposes, but not benefit computation purposes.

Background Information on Health Care Facility Privatizations

1. Privatization Trend. There has been a trend among health care facilities to convert from public sector ownership to private sector or quasi-public sector ownership. These conversions have involved selling, leasing, or transferring the facility, and transferring the existing employees to that reorganized health care facility. The privatization of health care facilities is occurring among both large and small hospitals, clinics, and related healthcare providers. The privatizations typically increase organizational flexibility and reduce various costs to remain financially competitive. One area of potential savings is that of the employer cost of retirement coverage by the General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General), or other public pension plan, which may be eliminated by the privatization.

2. Privatization Impact on Retirement Coverage. When a privatization occurs, the employees may no longer qualify as public employees for PERA-General pension purposes. When this occurs, membership in PERA-General terminates, and retirement benefit coverage problems may emerge.

Under current PERA-General law, three years of PERA-General coverage is required for vesting. For employees who terminate PERA-General membership without vesting, no deferred retirement annuity right typically is available. The member may elect a refund of accumulated member contributions with six percent interest, or the individual may leave the contributions at PERA-General, perhaps in the expectation that the individual will change employment in the future and again become a covered public employee. For a vested employee who terminates PERA-General membership with at least three years of service, there is a choice between a deferred retirement annuity right or a refund. The deferred retirement annuity is augmented by three percent per year under age 55 and five percent per year thereafter until retirement.

When a privatization occurs and employees lose the right to continue coverage by the public plan, all the employees are impacted. The employee may be terminated from employment at the time of the sale, transfer, or reorganization. Those employees will lose both continued employment and continued retirement coverage. For employees who remain employed after transfer to the newly organized healthcare facility, the privatization interrupts their benefit coverage. If there is no pension plan established by the privatized health care facility, the employees will suffer a loss of overall benefit coverage beyond Social Security. If a plan is provided by the new employer, portability problems between the old and new plan are likely.

3. Prior Precedent on Hospital Privatization. The Legislature has dealt with health care privatizations numerous times and has used several different treatments to address pension coverage issues. At times, in addition to any benefit that the employee may have been eligible for under a public pension plan, the individual was offered the alternative of an enhanced refund (employee plus employer contributions) plus interest. On at least one occasion, the individuals were permitted to remain in PERA-General, although that practice has not been favored in more recent years.

In 1984, relating to the privatization of the Owatonna City Hospital, legislation allowed the affected employees to receive a deferred retirement annuity with at least five years of service or to receive a refund of employee and employer contributions, plus interest at six percent, compounded annually. In 1986, relating to the St. Paul Ramsey Medical Center reorganization, legislation allowed only a delayed right to withdraw from PERA-General and receipt of a refund of only member contributions plus interest at five percent, compounded annually. In 1987, relating to the Albany Community Hospital and the Canby Community Hospital, legislation allowed the affected employees to receive a deferred retirement annuity with a five year vesting period or to receive a refund of both employee and employer contributions, plus compound annual interest at six percent. In 1988, relating to the Gillette Children’s Hospital employees, legislation continued the membership of the affected employees in the General State Employees Retirement Plan of the Minnesota State Retirement System (MSRS-General), but excluded new employees from public pension plan coverage. In 1994, relating to the St. Paul Ramsey Medical Center again, legislation continued the PERA-General membership of existing employees who were PERA members unless the employee elected to terminate PERA-General membership before July 1, 1995.

In the most recent years, 1995 through 1997, two approaches have been used:

1. Public Pension Plan Membership Discontinuation With Local Employer Option. In the first model, continuing PERA coverage ends for all employees at the time of the transfer of the healthcare facility to the new ownership. The new healthcare entity may provide a "PERA-like" plan for individuals who are transferred with the facility and remain as employees of the new entity. For individuals who are terminated at the time of the transfer, and who were not vested in PERA-General, the city may match any refund with interest that the individual receives from PERA-General. This model was used with the Olmsted County Medical Center privatization (1995), the Itasca County Medical Center (1995 and 1996), and Jackson Medical Center, Melrose Hospital, Pine Villa Nursing Home, and the Tracy Municipal Hospital and Clinic (1997), and the initial Luverne Community Hospital legislation (1998).

2. Special Continuing Public Pension Plan Rights After Membership Discontinuation. In the second model, termination of coverage by the public plan occurs at the time of the privatization, but the employees who terminated coverage were permitted deferred annuities (even those who were not vested) from the public plan with an augmentation rate that exceeded that used under general law, and the employees were allowed to use service with the new organization to meet age/service requirements for qualifying for the Rule of 90 under the public plan. This approach was used in 1996 for the University of Minnesota Hospital-Fairview merger and the plan that had previously provided coverage to the transferred employees was the General Employees Retirement Plan of the Minnesota State Retirement System (MSRS-General).

Since 1999, the Legislature has passed legislation for PERA-General privatizations based on the model used in the 1996 University of Minnesota Hospital-Fairview merger. That process is coded as Minnesota Statutes, Chapter 353F, and provides the type of benefit extension provisions, the waiver of vesting requirements, enhanced deferred annuity augmentation, and "Rule of 90" eligibility provisions previously described.

Discussion

H.F. 2460 (Simpson); S.F. 2341 (Larson) would provide the privatized public employees of the Fair Oaks Lodge in Wadena, Minnesota, with additional retirement benefit coverage beyond the retirement rights to a General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General) benefit provided terminated employees under the PERA-General Privatized Employee coverage provisions, Minnesota Statutes, Chapter 353F, if the actuarial cost of the special coverage does not exceed the actuarial gain from the privatization.

The proposed legislation raises several pension and related public policy issues, as follows:

1. Appropriate Model. The policy issue is whether the Commission and the Legislature should conclude that the model used in the last few years remains an appropriate model, or whether some other approach or other action should be considered. Other possibilities include returning to an enhanced refund approach, retaining the privatized employees in future PERA-General coverage, or simply taking no action. If no action is taken and a privatization occurred, the individual would be treated under PERA-General law, with the same options as any other public employee who terminates employment. The individual would have a right to a refund of employee contributions plus interest. If the individual had at least three years of covered service but cannot or chooses not to retire, the individual can have a deferred annuity in lieu of a refund. The deferred annuity would augment at three percent per year up to age 55 and five percent per year thereafter, which is less favorable augmentation than is extended under the provisions of Chapter 353F.

2. Actuarial Cost of the Special Benefit Provisions and Actuarial Gain/Loss Issues. In the Fairview/University hospital merger, and in the PERA privatizations where employees have been extended the treatment under Minnesota Statutes, Chapter 353F, the Commission and the Legislature approved the proposed treatment if the pension plan from which the employees were terminating (MSRS-General in the case of the Fairview/University Hospital merger and PERA-General in the case of the PERA privatizations) was not expected to suffer net actuarial losses as a result of the proposed treatment. The actuary retained by the Legislative Commission on Pensions and Retirement was able to provide an analysis for the Commission’s consideration. The actuarial work from Milliman USA indicates the following about the proposed inclusion of the Fair Oaks Lodge in Minnesota Statutes, Chapter 353F:

(a)	(b) Privatization Calculations Using the PERA-General Inactive Member Combined Service Annuity Load	(c) Privatization Calculations Using the PERA-General Active Member Combined Service Annuity Load
(1) Number of Fair Oaks Lodge Employees	93	93
(2) 7/1/03 Accrued Liability As Ongoing Active Members	$3,521,855	$3,521,855
(3) 7/1/03 Accrued Liability As Terminated Members Without Chapter 353F	$3,042,155	$3,042,155
(4) PERA-General Termination Gain ( (2) – (3) )	$479,700	$479,700
(5) 7/1/03 Accrued Liability Under Chapter 353F	$5,195,165	$3,272,954
(6) Net Privatization Benefit (Chapter 353F), if positive, or Cost, if negative ( (2) – (5) )	($1,673,310)	$248,901

Column (c) replicates the calculations that were performed for the prior privatization under Minnesota Statutes, Chapter 353F, before 2004. The difference between the Column (b) and Column (c) calculations relates to a difference in an actuarial cost loading to account for the Combined Service Annuity, which was increased for PERA-General by the Commission in actuarial assumption changes approved in late 2002. Milliman USA indicates its opinion that the Column (b) calculation significantly overstates the likely true cost of the inclusion of Fair Oaks Lodge employees in Minnesota Statutes, Chapter 353F, and indicates its opinion that the Column (c) calculation slightly understates the likely true cost of the inclusion of Fair Oaks Lodge employees in Minnesota Statutes, Chapter 353F. If the Commission determines that the actuarial cost of the Minnesota Statutes, Chapter 353F, privatization benefits does not exceed the actuarial gain accruing to PERA-General from the privatization and that the inclusion should occur, Amendment LCPR04-112 replaces the current effective date provision with a more straightforward January 1, 2004, retroactive effective date.

3. Fair Oaks Lodge Employee Count Discrepancy. The policy issue is the reliability of the actuarial calculations given a discrepancy in the Fair Oaks Lodge employee count between the number of employees reported by the employer and the number of employees in the PERA-General database. Of 135 Fair Oaks Lodge employees submitted to Milliman USA for evaluation, Milliman USA matched 93 with its PERA-General membership database. If the 42 unmatched Fair Oaks Lodge employees were either very new employees, or were part-time employees excluded from PERA-General coverage, or were data errors, the numbers are reliable. If the unmatched Fair Oaks Lodge employees are characterized otherwise, the calculations may not be reliable. Testimony should be requested about the differences in the total Fair Oaks Lodge employee group reported to Milliman USA and the matched employees in the PERA-General database.

4. Special Consideration Due to PERA-General Actuarial Condition. The issue is whether the proposed legislation should be recommended by the Commission given PERA-General’s current funding problems. PERA-General has had a contribution deficiency. The results from PERA-General’s most recent actuarial valuation (July 1, 2003), summarized below, indicate a current contribution deficiency of 1.24 percent of payroll, or a $52.8 million actuarial shortfall annually.

PERA-General
July 1, 2003, Actuarial Valuation Results

The proposed legislation would provide the treatment indicated under Minnesota Statutes, Chapter 353F, to privatized Fair Oaks Lodge employees. With privatization, PERA will be in a better financial condition without this proposed legislation, although the positive effect will be quite marginal, given the relatively small number of employees involved compared to PERA’s total membership.

5. Replacement Pension Plan. The policy issue is the total retirement coverage ultimately provided to Fair Oaks Lodge employees following privatization and how much of the total benefit coverage will be provided by PERA-General under Minnesota Statutes, Chapter 353F. The Commission may be interested in the pension plan coverage that the private employer will provide for these privatized employees for the service provided after privatization. In the not too distant past, it was hoped by the Commission that the new employer would establish a "PERA-like" plan for the privatized employees. If the pension plan coverage provided by the employer following privatization is deemed by the Commission to be inadequate, that may be a reason for the Commission, at some future date, to reconsider its current policy used in privatizations.

6. Retroactive Legislation. The policy issue is the appropriateness of the proposed legislation having a retroactive application to a medical facility privatization that occurred before the enactment of the legislation. The Fair Oaks Lodge privatization occurs on January 1, 2004. Any legislative enactment covering the Fair Oaks Lodge by Minnesota Statutes, Chapter 353F, likely will not occur until April or May 2004. Prior privatizations were prospective, allowing for public employees on the verge of privatization to do better planning. Making the privatization benefit package applicable to the Fair Oaks Lodge employees should not cause any policy or practical problems unless some of the Fair Oaks Lodge privatized employees take a PERA refund during the January 1, 2004 – April or May 2004 interval and then desire the benefits under Minnesota Statutes, Chapter 353F, for which additional special legislation would become necessary.