Introduction

This memorandum and Amendment LCPR04-126, attached, were prepared in response to your recent request.

Summary of Amendment LCPR04-126

Amendment LCPR04-126 amends Minnesota Statutes, Sections 354.05, Subdivision 35; 354A.011, Subdivision 24; and 356.611, the Teachers Retirement Association (TRA), first class city teacher retirement fund associations, and general law provisions governing or limiting covered salary, by limiting the annual salary covered for retirement purposes to an amount equal to 85 percent of the salary of the Governor.

Problem of Potential Covered Salary Manipulation by School Administrators

In response to a request from a Commission member about the potential for manipulation in covered salary by recently retired school administrators, the Commission staff obtained information from the Teachers Retirement Association (TRA) on school administrators who retired between July 1, 1999, and June 30, 2003.

TRA provided information on 202 school administrators from 126 school districts who retired during the 1999-2003 period. Of the 126 TRA employing units, covering 202 retired school administrators, there were potential end-of-career salary increase problems in 28 school districts relating to 33 retired school administrators that were determined by the Commission staff to merit follow-up analysis. The criteria for the follow-up analysis was either a set of high percentage increases during the highest five successive years averaging period, or a high degree of difference between the highest five years average salary figure and the salary for the middle year of the highest five years average salary period, or both. The 33 retired school administrators identified as having potentially problematic salary increase histories, with some pertinent salary numbers, were as follows:

In August-September 2003, the Commission staff corresponded with the 28 affected school districts, requesting that they review the salary data supplied by the Teachers Retirement Association (TRA) and that they explain the rationale for any salary increases received by the applicable administrator or administrators that exceeded the general increases provided to school district teachers and other employees. Eventually, all 28 school districts responded to the Commission staff request and provided the requested additional analysis.

In analyzing the responses from the 27 school districts, the reason or reasons for the salary increases during the highest five successive years average salary period and the period immediately before the final five years can be reduced to eight different types.

The compensation increase types and the school districts involved are as follows:

Retroactive Salary Settlements

Promotions

Additional Payments

Performance Increases

Increased Duty Time

Extracurricular Activities and Pay

Pay Period Change

Longevity Pay

The likely improper salary included a superintendent search stipend, a mileage payment, wellness payments, miscellaneous compensation, an unidentified additional work stipend, a conversion of deferred compensation plan employer contributions, severance payments, and unused vacation time payments.

Where additional employment duties are actually associated with the additional payment or stipend, the payment could meet statutory requirements for covered salary, but it is unclear whether or not the assignment of additional duties or the payment of additional compensation to a school administrator is done on an arms-length, actual-need basis or is a potential manipulation. The redirection of deferred compensation employer contributions into salary, the doubling up of two months of income in a year, the conversion of a mileage reimbursement into salary, the conversion of wellness payments into salary, the inclusion of severance pay in covered salary, the inclusion of unused vacation time in salary, and the receipt of elective discretionary stipends all appear to be at variance with the current requirements and limitations of Minnesota Statutes, Section 354.05, Subdivisions 35 and 35a.

The salary inclusions open to manipulation included contract settlement delays, retroactive contract settlements, retroactive pay increases, performance increases, extracurricular pay, and longevity pay.

Since retroactive pay following delayed contract settlements arise in the context of employment contracts that are bargained individually or bargained involving very small groups, the situation involves the potential for salary manipulation during the immediate period before retirement. It is clear from some of the responses from school districts, the school administrator controls the timing of the contract negotiations. Since the highest five successive years average salary on which a TRA retirement annuity is calculated is based on the salary actually paid and received rather than the salary accrued, retroactive salary increase payments related to the employment period before the highest five successive years average salary period that can be shifted into the final average salary period through retroactive pay will work to increase the person’s retirement annuity. Performance-related salary increases also are open to manipulation by the school administrator based on the personal relationship between the school administrator and the school board, especially if the performance increases are wholly discretionary with the school board and if the employment contract with the school administrator lacks any clear standards, criteria, or measurement basis. While the Commission staff does not have extensive knowledge of school district employment practices, it is our understanding that performance pay provisions in school employee contracts are generally restricted to a small number of upper-level school employees. Longevity pay, if the actual school district practice is clearly reflected in the name, should be applicable only to long-service school employees and should be based on a formula. It is unclear whether the nomenclature and the practice necessarily converge and whether or not this form of compensation is a potential area for final average salary manipulation. The addition of pay for additional or extracurricular activities, when it occurs during the final average salary period and is not part of the pre-final average salary period, is actually or potentially manipulation, but the manipulation would be generally available to teachers at large and would not be restricted to school administrators.

Discussion

Amendment LCPR04-126 would establish a covered salary limitation for teacher and other pension plans set at 85 percent of the salary paid to the Governor, or $102,258 currently.

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

1. Appropriateness of Setting Any Pension Covered Salary Limitation. The policy issue is the appropriateness of setting a limitation on the salary of teachers and other public employees covered by public pension plans. There is currently a limit in Minnesota Statutes, Section 356.611, set at 95 percent of the salary of the Governor, or $114,288. The amendment resets the limitation to 85 percent, or $102,258 in Fiscal Year 2004. The limitation has the advantages of its simplicity and its focus on preventing or limiting the most potentially egregious problem cases.

2. Precedent. The policy issue is the question of the existence of precedents for limitations on salaries covered for pension purposes. Minnesota Statutes, Section 356.611, enacted in 1994, following the problems of excessive salaries used in calculating the retirement annuity from the General Employee Retirement Plan of the Public Employees Retirement Association (PERA-General) for John Allers, a former Service Employees International Union local official covered by PERA-General, is the most recent precedent. De facto caps on covered salary existed from the creation of the General State Employees Retirement Plan of the Minnesota State Retirement System (MSRS-General) in 1929 and of PERA-General in 1931 until 1955. Explicit limits were imposed in 1957 (set at $4,800, the salary cap for Social Security purposes then in force), and revised in 1965 (set at $6,500 for MSRS-General and PERA-General and at $7,200 for TRA). The 1957 salary caps were eliminated in 1967.

3. Appropriateness of Highly Generalized Solution to Covered Salary Manipulation Problem. The policy issue is the appropriateness of utilizing a highly generalized solution to the problem of the potential manipulation of covered salary figures by recently retired TRA-covered school administrators evident in the special Commission staff interim project. The limit, set at 85 percent of the Governor’s salary, will reduce the opportunity for any salary manipulation by the highest paid teachers and other public employees, but would still allow for potential manipulation by teachers and public employees who are compensated at somewhat lower salary levels. Thus, a school administrator with a $90,000 or $95,000 salary would still have a retirement-related incentive to attempt to shift compensation items into the final five years of employment.

4. Appropriate Manner of Implementing a Decrease in the Covered Salary Cap. The policy issue is the appropriate manner in which a decrease in the maximum salary applicable to retirement coverage will be implemented. The amendment would immediately implement the change on July 1, 2004. For any teachers or other public employees with salaries between $102,258 and $114,288, the new salary cap would constitute a reduction in benefit coverage, although pre-July 1, 2004, salary levels will continue to be available to be used in calculating the person’s highest five successive years salary for a future retirement.