Background Information on Prior Service Credit Purchases
Principle II.C.10 of the Commission’s Principles of Pension Policy suggests that the purchase of service credit in a defined benefit plan for prior periods of time should only be permitted if the period is either public employment or is substantially akin to public employment, if the service period for purchase has a significant connection to Minnesota, if the purchase is funded either from member payments or a combination of member and employer payments, if the purchase payment is the full actuarial value without a pension plan subsidy, and if the purchase does not offend equity notions.
Prior service credit purchases are a phenomenon of defined benefit pension plans, which are pension plans that fix the variable of the pension benefit amount, typically through the use of a formula based on the amount of compensation and on the length of service, and that leave the variable of the pension funding cost to be determined through the actuarial valuation process.
Prior service credit purchases are opportunities for pension plan members to obtain allowable service credit, and, if applicable, covered salary credit, in a pension plan for a period that was not otherwise credited through normal pension plan membership. There is typically a process to be followed in obtaining credit for a prior service credit purchase period, usually involving the payment of some amount to defray all or a portion of the actuarial cost attributable to the purchase and the provision of documentation relating to the service period.
Prior service credit purchases are sought by pension plan members for a variety of reasons, including a desire to gain defined benefit pension plan portability, a desire to obtain a larger pension benefit, or a desire to qualify for a special retirement provision. Public pension service credit purchases also are permitted by pension plan sponsors for a variety of reasons, including a desire to allow some otherwise unobtainable portability, a desire to correct for some service crediting deficiency, or a desire to cover service rendered prior to the creation of the pension plan.
The 1995-1996 principle on service credit purchases has the following elements:
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.
Public Employment. The period requested for purchase should be a period of public employment, or service that is substantially akin to public employment. This is consistent with the notion that public pension plans should be providing coverage for public employees for periods of time where they were serving the public through public employment or through quasi-public employment. Coverage for a period where an individual provided private sector employment is not consistent with this statement.
Minnesota Connection. The employment period to be purchased should have a significant Minnesota connection. This is consistent with the notion that Minnesota taxpayers support these public pension plans and bear the investment risk in amassing plan assets. Given the support that taxpayers provide, it is appropriate that the service have a Minnesota connection, reflecting services provided to the people in the state.
Presumption of Active Member Status at the Time of Purchase. There should be contributions from the member, or in combination from the member and employer. There is a consequent presumption that the individual covered by the service purchase request is an active employee. Active plan members contribute to the plan, and certainly once an employee terminates service or retires from public employment, the former public employee no longer has a public employer. If there are unresolved issues of whether an individual should have service credit for a given period, those issues should be resolved before the individual terminates from public service, and certainly before the individual retires. The act of retiring undermines a claim that there is sufficient need for the Legislature to consider the coverage issue. If there were considerable hardship caused by the lack of service credit, presumably the individual would not have retired. Entering retirement suggests that the associated pension benefit is adequate without any further increase in the benefit level due to a purchase. Only on very rare occasions has the Commission and the Legislature authorized service credit purchases by retirees.
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. There is no process in law specifying a procedure for computing a "full actuarial value" purchase in a defined contribution plan, or even defining what that concept means in the context of a service purchase or service credit purchase in a defined contribution plan.
Full Actuarial Value Purchase. Within the context of a defined benefit plan, the pension fund should receive a payment from the employee or from the employee and employer in combination, an amount which equals the additional liability placed on the fund due to the purchase. This is referred to as the full actuarial value of the service credit purchase. The procedure used to compute this full actuarial value should be a methodology that accurately estimates the proper amounts. The Commission has purposely departed from the full actuarial value requirement when there is evidence that the pension plan administration created the lack of service credit coverage do to pension plan administration error. In situations of pension plan error, the employee may be required to pay the contributions that would have been required for the relevant time period, plus 8.5 percent interest to adjust for the time value of money and any difference between the payment and the full actuarial value would be absorbed by the pension fund. Where there is clear evidence that the employing unit committed an error which caused the individual to not receive pension plan coverage, the Commission has permitted the employee to make the employee contribution for the relevant time period, plus 8.5 percent interest, and the employer has been mandated to cover the remainder of the computed full actuarial value payment rather than simply permitted to pay it. If the employer does not directly make the payment following notification that the employee has made his or her portion of the full payment, the Commission has required that a sufficient amount to cover the remainder of the full actuarial value be deducted from any state aids that would otherwise be transmitted to the employer.
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. Requests by existing retirees to purchase additional service credit and have their annuities recomputed could be viewed as being a situation that violated equity considerations. New requests on behalf of individuals who were covered by purchase of service credit authorizations passed by earlier Legislatures but who are dissatisfied with the purchase of service credit terms that were provided can be considered as violating equity considerations. Individuals requesting service credit purchases for periods specifically excluded from plan coverage under the applicable law could also be considered as violating equity considerations, among other policy concerns relating to those considerations. Long delays in seeking remedial action can also be considered a violation of equity considerations. Individuals tend to wait until late in their career before seeking any remedial action for lost service credit. Prompt action, closer to the time period when the service credit problem occurred, would often result in a solution at lower cost and would avoid efforts by the Commission to try to determine the factual situation many years, or even decades, after the event occurred. In general, any issue or factor associated with a service credit purchase request which can be viewed as lacking fairness or being less than impartial can be a basis for rejecting a request.
The general purchase of service credit legislation enacted in 1999, 2000, and 2001 conflicted with the Commission policy as stated in the 1995-1996 Commission Statement of Pension Principles. Perhaps the 1999-2001 service credit purchase legislation should be viewed as reflecting evolution and permanent change in Commission policy. The 1999-2001 legislation also may be viewed as temporary provisions to address a short-term labor shortage situation, warranting a temporary waiver of the standard Commission purchase of service credit policy.