News From Washington: An Update on Federal Issues

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1 News From Washington: An Update on Federal Issues NCSL Spring Forum Labor and Economic Development Committee April 24, 2008 Hyatt Regency on Capitol Hill Washington, D.C. Jeannine Markoe Raymond Director of Federal Relations National Association of State Retirement Administrators Legislative Landscape Surrounding Public Pensions More Congressional Interest in Pension Issues (Tax, Labor and Investment Committees) Greater Concern with Coverage Levels than Benefit Levels Less Focus on Strengthening DB System, More Focus on DC Plan Fees/Conflicts of Interest/Liability Tight Budget Environment = Need to Keep a Close Watch on Increasing Search for Revenue: 3% Withholding on Government Purchases of Property and Services Included in Reconciliation Bill Passed in May 2006 (Effective 2011) Proposed Changes to Taxation of Alternatives Suggested repeal of pick-ups, application of FICA to cafeteria plans Roth 457 (~$1B pay-for) in Farm Bill Reevaluation of Pension Policy With the Limited Percentage of Covered Individuals Can the Largest Tax Expenditure (According to JCT) be Justified?

2 Social Security Issues Coordination of Social Security and Worker s Comp Social Security disability benefits are reduced if, when added to workers compensation benefits, the total amount exceeds 80 percent of average earnings before disability This amount is not indexed and thus the real value of injured worker s benefits are steadily reduced each year

3 GPO/WEP Reform Government Pension Offset (GPO) affects the spousal benefit of non-ss-covered workers Windfall Elimination Provision (WEP) affects the SS benefits of individuals that have had both covered and non-covered employment during their working career Federal legislation to repeal GPO and WEP offsets (HR 82, S 206) Reform Will Be Difficult to Move Separate from Social Security Solvency and Will Likely Need an Offset Concern Mandatory Coverage is the Most Likely Pay-for Social Security Solvency Social Security Solvency coupled with add-on universal savings proposal could be the Great Compromise Currently, the most popular changes appear to be progressive indexing increasing eligibility age (no longer affects private pensions) increase in the taxable wage

4 Expanding Coverage Universal 401(k) Automatic IRAs New Benefit Platforms State-K Initiatives Continuing to Make the Case for Public Sector Defined Benefit Plans as National Pension Policy is Reexamined Guaranteed Lifetime Benefits Sound Income Replacement Employee-Employee Partnership Professionally-Managed and Pooled Assets Survivor and Disability Protections Low Costs and Fees Flexibility and Portability

5 Other Federal Legislative & Regulatory Issues Affecting State Pensions Sudan Accountability and Divestment Act of 2007 (P.L ) Signed into law December 31, 2007 Among other things, authorizes targeted divestment by State and local governments: Limited to four sectors (military, mineral extraction, oil and power) Exempts investment in Southern Sudan Requires engagement of companies before divestment occurs Requires notification of divestment and/or contract prohibition to the Department of Justice Not a mandate Arguably the exclusive means by which States can divest Sense of Congress that the Federal Government should support the decision of any State or local government to divest from a person that the State or local government determines poses a financial or reputational risk (not defined)

6 President Bush s Signing Statement Noted: This Act purports to authorize State and local governments to divest from companies doing business in named sectors in Sudan and thus risks being interpreted as insulating from Federal oversight State and local divestment actions that could interfere with implementation of national foreign policy. However, as the Constitution vests the exclusive authority to conduct foreign relations with the Federal Government, the executive branch shall construe and enforce this legislation in a manner that does not conflict with that authority. Further State Divestment Initiatives Terrorism Iran Sovereign Wealth Funds Could be argued that the presence of federal authorization for targeted Sudan divestment and the absence of similar authorization for any other type of divestment seriously calls into question the constitutionality of other divestment movements

7 Technical Corrections for Pension Protection Act of 2006 Modifying Application of Federal Cap on Interest Crediting Rates to Governmental Plans: State statutes and/or Local Ordinances Provide (and Often Guarantee) Numerous Types of Interest Credit, Including Fixed, Underlying or Minimum Rates of Return on: o refunds of contributions o deferred retirement option plans (DROPs) o survivor benefits o money purchase or other greater than or optional forms of benefit Various Policy Objectives: o protect public plan participants from the ravages of inflation or downside investment risk o to allow members to share in the investment gains of the plan o provide flexibility or accommodate the needs of short-service employees while safeguarding the traditional pension as the primary plan benefit Allowing Premiums for Self-insured Plans to be Included in $3000 Healthcare Enhancement for Local Public Safety (HELPS) Retirees Deduction Concerns with Final Treasury Regulations on Normal Retirement Age Would require plans to adopt a specific age for normal retirement and not condition normal retirement on the completion of service or a combination of age and service Unclear terms may not accommodate governmental plans that have differing benefit calculations for various employee groups and tiers within the same plan Public sector organizations are asking for IRS to extend effective date so these issues may be considered, changes can be made, and governments have sufficient time to act

8 Reservists Benefits (HR 3997) House: Heroes Earnings And Relief Tax (HEART) Act of 2007 Senate: Defenders of Freedom Tax Relief Act of 2007 Would create new qualification requirements for treatment of survivor benefits of those killed while performing qualified military service: Must be treated as though the individual resumed employment and subsequently terminated employment on account of death For benefit accrual purposes, plans may treat an individual as if they had resumed employment under USERRA and terminated employment on the actual date of death or disability. Enables employers to include differential wages in the calculation retirement benefits Makes permanent the Internal Revenue Code provision that permits active duty reservists to make penalty-free withdrawals from retirement plans. GAO Investigations State and Local Government Retiree Benefits: Current Status of Benefit Structures, Protections, and Fiscal Outlook for Funding Future Costs released on September 24, 2007 generally reported that the largest state and local public pension plans are: well funded and on track to manage future pension obligations had mechanisms in place to protect pension benefits and comply with fiduciary responsibilities Not the same for retiree health benefits and fiscal challenges lie ahead--driven primarily by the growth in health-related costs for Medicaid, and for active employees as well as retirees.

9 GAO Investigations, cont. STATE AND LOCAL GOVERNMENTS: Growing Fiscal Challenges Will Emerge during the Next 10 Years, was released January 22, 2008: Included simulations of the state and local government sector s long-term fiscal outlook and an analysis of the underlying causes of potential fiscal difficulties for the sector Pensions and health care are specifically cited as fiscal challenges GAO Investigations, cont. State and Local Government Retiree Benefits: Current Funded Status of Pension and Health Benefits was released on February 28, 2008: The funded status of state and local government pensions overall is reasonably sound, though recent deterioration underscores the importance of keeping up with contributions, especially in light of anticipated fiscal and economic challenges. Noted a number of governments reported not contributing enough to keep up with yearly costs In the case of retiree health benefits, pay-as-you-go financing has been the norm up to the present day. State and local governments need to find strategies for dealing with daunting unfunded liabilities, and such strategies will take time, will require difficult choices, and could be affected by changes in national health policy.

10 GAO Investigations, cont. GAO asked to investigate public and private pension plan investments in hedge funds--scope expanded to cover all alternative investments of pension plans Public plans have been heavily implicated in a number of heated Congressional debates on hedge funds, private equity and alternatives Perception that plans are chasing returns although surveys/studies document participation in alternative investments are relatively modest, and, although there is a trend toward increased use of such investment options, the survey does not suggest a rush to this asset class SEC Takes Aim at Government Accounting SEC Chairman Cox Forwards White Paper to Congress on Need for Improvements in Governmental Accounting and Disclosure, Suggesting: Regulation of Municipal Securities Mandatory Governmental Accounting Standards SEC Oversight of GASB First among the various examples used by the SEC to justify the need for improved governmental disclosure and accounting practices is the City of San Diego s failure to disclose the gravity of its enormous pension and retiree health liabilities. SEC Investigation Underway of New Jersey s Pension Funding & Disclosures

11 Government Accounting, cont. International Accounting Standards Recent debates about international convergence of accounting standards are driving explorations into the future role of the FAF and the FASB in relation to the quality and consistency of international accounting standards GASB Research Project on Pension Accounting and Reporting Reviewing the effectiveness of Statements No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, and No. 27, Accounting for Pensions by State and Local Governmental Employers A decision is expected by GASB at its April 2008 meeting in regard to whether to formally add a project to the GASB s current agenda Push for Disclosure of Termination Liabilities While the multiplicity of methods and assumptions used by public plans makes them difficult to compare, the purpose of such information is not intended to help compare plans, but rather to determine contributions that will achieve full funding over time [GAO, State and Local Government Retiree Benefits: Current Funded Status of Pension and Health Benefits] Requiring all public plans to calculate and publish a termination liability ignores that this scenario is virtually impossible in the public sector: states and cities are essentially perpetual entities and will not go out of business or be acquired participants in public pension plans generally are entitled to continue accruing benefits once those benefits have been established and they are protected under State constitutional, statutory, contractual and/or case laws the observable past and reasonable future return expectations for capital markets and common public fund portfolio construction does not correspond to those used in calculating termination liability The cost of calculating termination liability and the risk of misinterpretation likely far outweigh any value added