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Cypen & Cypen
February 21, 2013

Stephen H. Cypen, Esq., Editor

1.     MILLIMAN STUDY REFLECTS IMPACT OF CLOSING THE FLORIDA RETIREMENT SYSTEM DEFINED BENEFIT PLAN TO NEW MEMBERS EFFECTIVE JANUARY 1, 2014, INCLUDING PROJECTED BLENDED RATES FOR THE NEXT 30 FISCAL YEARS:  The Florida Division of Retirement requested Milliman to project the impact on the Florida Retirement System of a proposal that would close the defined benefit plan to new members and provide mandatory participation in the defined contribution plan for all new members, effective January 1, 2014. By letter-report dated February 15, 2013, Milliman has projected the uniform or "blended" rates for the next 30 fiscal years based on the required contributions for the DC and DB plans under the proposal. The study does not include cost comparisons of keeping the DB plan open.  Originally, FRS was created to provide defined benefit retirement, disability and survivor benefits for participating public employees. Beginning in 2002, the FRS became one system with two primary programs, the existing DB Program and a DC plan alternative to the DB plan, now known as the Investment Plan. The earliest that any member could participate in the IP was July 1, 2002.  When the IP was implemented, members of the DB program were provided an educational period about their plan choice options prior to a 90-day election period to elect between the DB and the DC plans. Currently, new employees are provided five months after their month of hire to file an election between the two primary programs. Members who do not make an election, default into the DB plan.  After the initial election, members are allowed a second election to transfer into the DB or DC plan. If transferring into the DB plan, the members who were not previously DB members must make a contribution equal to their actuarial accrued liability calculated as if they had participated in the DB plan their entire FRS career. Prior DB members who transferred their membership and present value of accrued service must transfer the current value of their prior accrued DB benefit, calculated as if they had participated in the DB plan their entire FRS career. If transferring into the DC plan, members are allowed to transfer the present value of their accrued benefits.  The proposal would require all newly enrolled members of the FRS to enter the DC plan, effective January 1, 2014. Such newly enrolled members would not have a second election or an option to transfer into the DB plan for any reason. Existing members of the FRS would retain their second elections, if still available. Current IP employer contribution rates to the members' accounts vary by class: 11.00% for special risk class members, 3.30% for regular class members and other classes are in between these rates. Employees contribute 3.00% on a mandatory basis. The proposal would not change the level of employer contribution to the IP. DB plan accrual rates would remain the same as they are in current law for members enrolled before January 1, 2014.  The following are from Milliman’s commentary, which says closing the defined benefit plan to new members, commonly referred to as a "soft freeze,” would have several results: 

  • A soft freeze does not impact the current amount of the unfunded actuarial liability.  It reduces the normal cost component of defined benefit funding in future years.
  • If future members cannot join the DB plan, the result is a declining DB payroll base on which contributions to fund the DB plan are traditionally made. This situation would produce increasing contribution rates as a percentage of payroll, as the payroll over which the cost of the UAL is spread declines. This is mitigated based on Florida law continuing to require that UAL contributions also be made by employers of IP members and other DC plan participants.
  • The UAL component when developing the Annual Required Contribution for financial reporting purposes will increase because, GASB would require a different amortization technique. GASB 25 may require that the UAL be amortized using either level dollar amounts, or the amortization must reflect the decrease in DB plan payroll for financial reporting purposes. 
  • Over time, the DB plan cost per DB participant would increase as the less expensive shorter service and younger participants are eliminated from participation in the DB plan. 
  • Over time, the State Board of Administration may lose the ability to invest with a long-term perspective, as annual cash flow becomes more and more negative. Under a closed plan, as the active population shrinks and the retired population continues to grow, benefit payments will exceed the contributions made to the plan by continually increasing amounts. This situation will possibly necessitate future changes in asset allocation in order to provide sufficient sources of cash for benefit payments, which in turn, could impact the rates of return earned by the fund's assets. This impact could jeopardize the ability of FRS's assets to earn the assumed valuation rate of return of 7.75% per annum, thereby putting upward pressure on costs. (The study does not consider the impact of potential asset allocation changes or the impact of the soft freeze on the assumed asset rate of return.)  

Last we heard, proponents were labeling the study as “incomplete,” and temporarily putting the whole matter on hold.  Note to Florida Legislature: be careful what you wish for.  See the entire 49-page study at
2.      PROTECTING SOCIAL SECURITY FROM AN ONSLAUGHT OF MISINFORMATION: Young people need to make sure that Social Security will be there to help them, says Professor of Law at George Washington University Neil Buchanan, writing in On March 27, 2013, current laws that allow the federal government to operate will expire. Unless Congress approves spending and taxing policies to take effect beyond that date, the government will shut down.  One major sticking point in ongoing negotiations between House Republicans and the White House is so-called entitlement programs.  The Tea Party-dominated Republican Party’s official position is that spending is the problem, and that Medicare, Medicaid and Social Security are growing monsters whose rising budgets must be severely cut. The White House and Congressional Democrats have tried (successfully) to find ways to cut health care costs, only to be attacked by Republicans, in the 2012 elections, for taking money away from Medicare.  Social Security is not in crisis, and it is not facing an unsustainable future.  We should celebrate that fact, but a large number of Republican politicians have committed themselves to the idea that Social Security must be cut or even eliminated.  To bolster that false contention, they use a series of misleading arguments and half-truths, which are mostly designed to scare younger people into believing that Social Security is a scam that will be bankrupt before most current workers are even able to collect their promised benefits. Professor Buchanan’s column explains the basic financial workings of the Social Security program, and makes clear why aging of the Baby Boom generation will not inexorably harm younger citizens.  Many people think Social Security maintains a series of deposit accounts, similar to savings accounts in a bank or credit union, from which retirees “withdraw” their money.  When they find out that the situation does not work that way, many people become enraged, thinking that the money, since it is not being kept in deposit accounts, is being wrongly diverted by politicians to pay for something illegitimate. The reality, however, is that, although Social Security does not put deposits into a vault, to be withdrawn later, banks do not work that way, either.  When a person deposits money into a bank account, only a tiny fraction of that money is kept in the bank’s vault.  For that matter, almost none of the deposit is held even in an electronic form of cash.  Instead, the bank will (in order to earn profits, which allow it to pay interest to depositors) loan out the money to businesses and families, to be used to build factories, buy houses and so on.  When Social Security was founded, President Franklin Roosevelt decided to describe the system as if it were a series of private accounts.  In some ways, that description was not quite right.  Rather than collecting deposits and crediting them to a bank-like account that earns interest on every dollar deposited, Social Security collects deposits and uses a formula to determine the benefits to which a person will later be entitled. Because that formula is designed to be economically progressive (that is, it is more beneficial to lower-income workers than it is to upper-income workers), there is no set interest rate applied to every account.  Even so, Social Security really does work like a bank, in that it accepts funds and later pays people according to legal rules that it must follow.  Because bank accounts themselves are not what many people think they are, it is true but meaningless to say that Social Security is not what many people think it is.  Both banks and Social Security are legal institutions that take money in and send money out, holding little or nothing in-house on a daily basis.  There is, therefore, nothing sinister about the fact that current Social Security taxes are used to pay benefits for current retirees, rather than being saved for current workers.  Even if we saved the money in a bank, the bank would use the money to make loans that people would immediately spend.  Asking “where our money is” makes no sense, in either case.  Moreover, Social Security and banks each carry risks -- risks that things will not work as planned.  Just as a bank would not be able to pay depositors when there is a run, it is possible that Social Security could someday not be able to pay what people currently expect.  Possible, but definitely not inevitable. What makes Social Security risky, today, is that too many politicians are telling us that it is risky.  A political panic threatens to create a run on Social Security, not because the system is fundamentally unsound, but only because panics can be self-fulfilling.  The good news is that our financial system’s legal underpinnings were changed in a way that has made bank runs a thing of the past (because the federal government legally guarantees deposits, allowing depositors to remain calm about repayment).  The better news is that we do not even need to change the law governing Social Security.  There is no basis for panic, notwithstanding the high volume of political rhetoric.  Many misinformed pundits and politicians claim that Social Security is financially unsustainable.  At least one former Republican presidential candidate even refers to Social Security as a “Ponzi scheme,” absurdly suggesting that there is no way for the system to balance revenues and benefits. This is dangerous and wrong. Concerns about whether Social Security deposits are sitting in a vault are simply based on a naive misunderstanding about how basic finance works. The more sophisticated question is whether Social Security’s long-term commitments can be matched by its long-term revenues.  People’s understanding of even that question, however, is often based on similarly naive misconceptions about demographics and economics.  Perhaps the most common misconception is that there are now too many old people compared to the number of young workers.  And it is true that the ratio of workers to retirees has shrunk over the decades, as the working-age population has been reduced by the decline in birth rates in the decades after the Baby Boom ended.  If we go from, say, four workers per retiree in one time period, to two workers per retiree in a later time period, it might seem that the later workers will have to pay twice as much in taxes to support the people who are retired at that point, or else those retirees will have to live on only one-half of the benefits that current retirees receive. (Some combination of benefit cuts and tax increases, of course, is also possible.)  Doing nothing, then, we are led to believe, would bankrupt the system.  What this logic ignores is that workers’ productivity has risen over time. If each worker who is employed in the later time period is able to produce twice as many goods and services as his earlier counterpart did, then neither the workers nor the retirees in the later period need to reduce their living standards.  The Social Security system also maintains trust funds. These funds, like bank accounts, represent the system’s net savings.  A 1983 law mandated that the system collect more in revenues than it paid out in benefits, for several decades, and then mandated that the system pay out more in benefits than in revenues, for several subsequent decades. During the time when benefits exceed revenues, the system will be repaid money that it loaned to the U.S. Treasury during the earlier decades.  Politicians and pundits gleefully exploit misunderstandings about Social Security’s trust funds. They point to annual projections by the Social Security trustees and the Congressional Budget Office, who provide an estimate of the date on which the trust funds’ net savings will reach a zero balance. The most recent estimate is that the depletion date could be in 2033. One recent headline referred to this date as a Social Security “shocker.”  Is that a reason to panic, or at least calmly to cut benefits or increase taxes? Actually, the answers to both of those questions is no. The first thing to remember is that these are forecasts, with ranges of error.  Under one plausible set of assumptions that Social Security’s trustees have published, the main trust fund is never depleted.  Even if it did reach a balance of zero, however, the trustees estimate that the system could still cover three-fourths of the benefits that would be due under the formula that it uses. That formula, moreover, would set payment levels for most future retirees that are actually higher, even after a 25% cut, and adjusted for inflation -- than benefits are today. 
3.      JEFFERSON COUNTY MAKES DEAL WITH CREDITOR:Officials in Alabama's bankrupt Jefferson County, approved a deal with a European bank to cut interest charges on about $162 million of the county's school debt.  Although the agreement saves only about $1 million a year for the county, the deal would bolster the county in talks to hammer out a broader adjustment plan with its Wall Street creditors.  According to Reuters, Jefferson County was primarily driven into what-is-the-biggest-bankruptcy-ever by a U.S. local government by massive sewer system debt now estimated at $3.2 billion. Some creditors and county officials are meeting privately to work out a possible plan to require reductions in interest rates and other concessions by creditors such as JPMorgan Chase & Co. The plan is needed for Jefferson County to exit bankruptcy protection, for which the county filed in November 2011. 
4.      REVISED 60’s HITS FOR BABY BOOMERS:  Tony Orlando  -- Knock 3 Times On The Ceiling If You Hear Me Fall.
5.      PROFOUNDITIES: A government big enough to give you everything you want, is strong enough to take everything you have.  Thomas Jefferson
6.      ON THIS DAY IN HISTORY: In 968, Baseball announces a minimum annual salary of $10,000.
7.      KEEP THOSE CARDS AND LETTERS COMING: Several readers regularly supply us with suggestions or tips for newsletter items.  Please feel free to send us or point us to matters you think would be of interest to our readers.  Subject to editorial discretion, we may print them.  Rest assured that we will not publish any names as referring sources. 
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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.

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