Cypen & Cypen
MARCH 25, 2010
Stephen H. Cypen, Esq., Editor
1. PUBLIC PENSION PLAN INVESTMENT RETURN ASSUMPTIONS DEMYSTIFIED: National Association of State Retirement Administrators has issued a brief on public pension plan investment return assumptions, indicating that the issue of investment return assumption used by public pension plans has been the focus recently of increasing attention. The brief explains the role this assumption plays in pension finance, how it is developed, and compares this assumption with public funds' actual experience. Some members of the media, academics and policymakers recently have questioned whether public pension fund investment return assumptions are unrealistically high. If so, it could encourage these funds to take too much risk in investing pension fund assets or it could understate cost of pension liabilities, reducing their current cost at the expense of future taxpayers. Alternatively, an investment return assumption that is set too low would result in overstating liabilities, which would overcharge current taxpayers. Public retirement systems employ a process for setting and reviewing their actuarial assumptions, including expected rate of investment return. Most systems review these assumptions regularly, pursuant to statute or system policy. Process for establishing and reviewing the investment return assumption involves consideration of various factors, including financial, economic and market data. The process is based on a very long-term view, typically 30 to 50 years. Although public pension funds, along with most other investors, have experienced sub-par returns over the past decade, median public pension fund returns over longer periods exceed the assumed rates used by most plans. Median investment returns for the 20- and 25-year periods ended December 31, 2009 exceed the most-used investment return assumption of 8.0 percent. (For example, for the 25-year period ended December 31, 2009, the median investment return was 9.25 percent.) Public pension actuaries calculate a public pension plan's funding level and cost using assumptions about many future events that have a direct effect on the pension plan, such as the age when participants will retire, their rate of salary growth, how long they will live after retirement and how much the plan's investments will earn. Of all the assumptions used to estimate cost of a public pension plan, none has a larger impact on the plan's costs than the investment return assumption, because earnings from investments account for a majority of revenues for most public pension plans. Since 1982 (when the U.S. Census Bureau began reporting public pension fund revenue data), public pension funds have accrued an estimated $4.4 Trillion in revenue, of which $2.64 Trillion, or 60 percent, is estimated to have come from investment earnings. Employer/taxpayer contributions account for $1.2 Trillion, or 27 percent of the total, and employee contributions total $578 Billion, or 13 percent. [Editorial comment: returns for the last ten years -- less than 4 percent -- have somewhat distorted the foregoing figures. We would guess that through December 31, 1999 that investment earnings accounted for 75% of pension revenue.] Public pension plans operate over long time frames and manage assets for many participants whose involvement with the plan can last more than half a century. Consider the case of a newly-hired public school teacher, 25 years old. If this pension plan participant elects to make a career out of teaching school, he may work for 35 years, to age 60, and live another 25 years, to age 85. This teacher's pension plan will receive contributions for the first 35 years, then pay out benefits for another 25 years. During the entire 60-year period, the plan is investing assets. To emphasize the long-term nature of the investment return assumption, for a typical career employee, more than one-half of the investment income earned on assets accumulated to pay benefits is received after the employee retires! The investment return assumption is established through a process that considers factors such as economic and financial criteria; the plan's liabilities; and the plan's asset allocation, which reflects the plan's capital market assumptions and its risk tolerance. A public pension plan's actuary typically has considerable influence in setting the investment return assumption. Actuarial Standards of Practice No. 27, "Selection of Economic Assumptions for Measuring Pension Obligations," which provides guidance for professional actuaries in setting the investment return assumption (among others), recommends that actuaries consider such criteria as current yields on government and corporate bonds; expected rates of inflation and returns for each asset class; historical investment data; and the plan's historical investment performance. Further, in developing the investment return assumption, the actuary may consider historical statistical data showing standard deviations, correlations and other statistical measures related to historical returns of each asset class and to inflation. The investment return assumption reflects a value within the projected range, and is considered to be the best predictor of future experience. With an investment return assumption of 8.0 percent, there is a projected 50 percent chance of actual experience being above that figure and an equal chance of falling below. A return assumption below the expected range would increase the plan's funding requirements, which would increase costs for current taxpayers (and, perhaps, plan participants), and would benefit future taxpayers and participants. Alternatively, an assumption that is too high would reduce the plan's costs in the near-term at the expense of future taxpayers (and, perhaps, plan participants). Although investment return assumptions used by public pensions are intended to reflect long-term considerations, they are not static, and they do change. Until the 1980s, most public pension assets were invested in bonds and other asset classes that yielded a lower projected return than a diversified portfolio of stocks, bonds, real estate, etc. Investment return assumptions were commensurately lower. First in response to high interest rates during the late 1970s and early 1980s, then as a result of pension funds' movement into diversified portfolios with higher expected returns, investment return assumptions rose to reflect the higher expected real rates of return. Empirical results show that since 1985, a period that has included three economic recessions and four years when median public pension fund investment returns were negative (including 2008), public pension funds have exceeded their assumed rates of investment return. Considering that public funds operate over very long timeframes, actuarial assumptions with a long-term focus should also be established and evaluated on similar timeframes. Viewed in this context, compared to actual results, public pension plan investment return assumptions have proved to be conservative. The purpose of the brief is not to argue for any particular investment return assumption; fiduciaries for each plan have a responsibility to consider the range of factors that are used to establish this key assumption. Rather, the brief is intended to clarify how this assumption is established, to compare public funds' actual investment experience with investment return assumptions and to describe how suitability of this assumption should be evaluated. NASRA is a non-profit association whose members are directors of the nation’s state, territorial and largest statewide public retirement systems. NASRA members oversee retirement systems that hold over two-thirds of the more than $2 Trillion in state and local government assets and that provide pension and other benefits to most state and local government employees.
3. BEWARE OF IRS’S 2010 “DIRTY DOZEN” TAX SCAMS: Internal Revenue Service has issued its 2010 “dirty dozen” list of tax scams. Tax schemes are illegal and can lead to imprisonment and fines for both scam artists and taxpayers. Taxpayers pulled into these schemes must repay unpaid taxes plus interest and penalties. IRS pursues and shuts down promoters of these and numerous other scams. Readers can look at last year’s list (see C&C Newsletter for May 7, 2009, Item 6) for detailed descriptions of the following common schemes:
1. Return Preparer Fraud
2. Hiding Income Offshore
4. Filing False or Misleading Forms
5. Nontaxable Social Security Benefits with Exaggerated Withholding Credit
6. Abuse of Charitable Organizations and Deductions
7. Frivolous Arguments
8. Abusive Retirement Plans
9. Disguised Corporate Ownership
10. Zero Wages
11. Misuse of Trusts
12. Fuel Tax Credit Scams
Suspected tax fraud can be reported to IRS using Form 3949-A. Whistleblowers also may provide allegations of fraud to IRS and may be eligible for a reward by filing Form 211. IR-2010-032 (March 16, 2010).
4. IRS ISSUES HEART ACT GUIDANCE: Internal Revenue Service has issued Notice 2010-15, dealing with miscellaneous HEART Act changes. The notice provides guidance in the form of questions and answers with respect to certain provisions of the Heroes Earnings Assistance and Relief Tax Act of 2008, Pub. L. No. 110-245. The notice also requests comments regarding any additional issues relating to sections of the HEART Act that are addressed in the notice. Sections of the HEART Act addressed in the notice are section 104 (relating to survivor and disability payments with respect to qualified military service), section 105 (relating to treatment of differential military pay as wages), section 107 (relating to distributions from retirement plans to individuals called to active duty), section 109 (relating to contributions of military death gratuities to Roth IRAs and Coverdell education savings accounts) and section 111 (relating to an employer credit for differential wage payments to employees who are active duty members of the uniformed services). IRS is considering issuing additional guidance regarding the above sections of the HEART Act, and comments are requested regarding such possible guidance. Written comments are due April 9, 2010. The entire 27-page notice is available at http://www.irs.gov/pub/irs-drop/n-10-15.pdf.
5. FLSA DOES NOT REQUIRE NOTICE TO PUBLIC SAFETY OFFICERS BEFORE EXEMPTION FROM OVERTIME APPLIES: A case before the United States Court of Appeals for the First Circuit under the Fair Labor Standards Act raised an issue about whether a municipality must give notice to its public safety officers as a matter of federal law before the municipality may take advantage of a special statutory exemption for these officers from usual overtime requirements. The Court held no such notice was required. Police officers of the Town of Framingham, Massachusetts, brought a putative class action suit against the Town, alleging that the Town had failed to pay them sufficient overtime in violation of FLSA, and seeking damages. Anticipating the Town's defense, the officers sought a declaratory judgment that the Town was ineligible for FLSA's limited public safety exemption from overtime. That exemption eases FLSA's overtime pay requirements on public employers who establish work schedules that meet statutory requirements. The district court granted partial summary judgment, holding the Town met eligibility requirements for the public safety exemption. The appellate court affirmed the district court and rejected plaintiffs' argument that the Town was required to notify affected employees before establishing a valid work period under FLSA. Text of the statute and the Department of Labor's interpretive guidance, as well as circuit caselaw, confirm that a public employer need only establish an FLSA compliant work period to claim the exemption's benefits without explicitly giving notice to the affected employees. The Town had done so and was entitled to judgment. Calvao v. Town of Framingham, Case No. 09-1648 (U.S. 1st Cir., March 17, 2010).
6. INSURANCE CARRIER SHOULD HAVE ADDRESSED SOCIAL SECURITY AWARD IN DENYING DISABILITY BENEFITS: In an action under the Employee Retirement Income Security Act of 1974 claiming that defendant insurer wrongly denied plaintiff disability benefits, summary judgment on the merits for plaintiff was affirmed where defendant’s decision was procedurally unreasonable because the Social Security Administration had determined plaintiff was fully disabled and unable to perform any work. Nevertheless, defendant did not address the SSA award in any of its denial letters, according to a summary from findlaw.com. On the other hand, the district court’s order granting plaintiff attorneys' fees was reversed where the legal questions in the case were much closer than the district court credited, and the district court therefore abused its discretion in assessing attorneys' fees against defendant. Schexnayder v. Hartford Life and Accident Insurance Company, Case No. 08-30538 (U.S. 5th Cir., March 12, 2010).
7. IN PSOBA CASE, BJA SHOULD NOT HAVE APPLIED AMENDED REGULATION THAT CHANGED BURDEN OF PROOF: Petitioner, widow of Woodward, a volunteer firefighter with the Blackman, Florida Volunteer Fire Department who died shortly after fighting a fire, submitted a claim to the Bureau of Justice Assistance seeking death benefits under the Public Safety Officers' Benefits Act. BJA denied Petitioner’s claim on the conclusion that smoke inhalation was not a "substantial factor" in Woodward's death. The United States Court of Appeals for the federal circuit reversed. BJA had applied a regulation implemented after the claim was filed, which provided a more burdensome standard of proof for certain aspects of claims made under PSOBA. When Woodward first filed her claim, the regulation provided that BJA shall resolve any reasonable doubt arising from circumstances of the officer's death in favor of the death benefit. The new regulation provided that a claimant has the burden of persuasion as to all material issues of fact and by the standard of proof of “more likely than not." (Ironically, another part of the amended regulation, which is intended to implement the Hometown Heroes Act of 2003, creates a presumption that the benefit must be paid to the family of any public safety officer who dies within twenty-four hours of engaging in non-routine activity in line of duty, without regard to whether there was a traumatic personal injury. However the presumption is specifically not retroactive.) In any event, BJA incorrectly applied the amended regulation during the appeal, changing Petitioner’s burden of proof midstream through the agency proceedings. Application of the amended regulation is strongly disfavored because it represents a significant change in the burden of proof. Woodward v. Department of Justice, Case No. 2009-8004 (U.S. Fed. Cir., March 15, 2010).
8. DEMOCRATIC INDECISION BLOCKS DB RELIEF ACTION: Funding relief legislation for defined benefit plan sponsors has stalled, and is not expected to see the light of day in the House at least until April -- because Democrats have been unable to agree on what provisions to include. According to pionline.com, House Democrats were so at odds over DB relief that they decided not to include it at all in a jobs creation bill approved by the House Ways and Means Committee earlier this month. The key dispute has been over whether to beef up, relax or delete a provision included in the Senate tax bill that would require plan sponsors that opt for relief to make additional contributions to their pension plans if they pay out extraordinary dividends to shareholders or redeem more than 10% of the market capitalization of their stock in a year. Some lawmakers argued the provision represents an unnecessary incursion into business practices. Other lawmakers favor keeping the provision in place. A Senate bill -- the American Workers, State and Business Relief Act of 2010 -- includes a provision that would allow DB plan sponsors to stretch out amortization periods for investment losses for two of the years between 2008 and 2011, either over a period of up to 15 years or over a nine-year period, at the option of the plan sponsor. Current law requires plans to amortize their investment losses over seven years.
9. DELAY IN PAYMENT OF LUMP SUM PENSION NOT UNREASONABLE; INTEREST THEREON NOT PAYABLE: Stephens, a retired pilot for US Airways, sued the Pension Benefit Guaranty Corporation as successor-in-interest to Retirement Income Plan for Pilots of U.S. Air, Inc. He alleged that US Airways violated the Plan by not paying lump sum benefits on their commencement dates, and that US Airways violated the "actuarial equivalent" provision of the Employee Retirement Income Security Act of 1974, by not paying interest for the period between their benefit commencement dates and dates the lump sum benefits were actually paid. The United States District Court for the District of Columbia granted PBGC's motion for summary judgment. On retirement, Stephens elected to receive his accrued retirement benefits under the Plan as a single lump sum payment, rather than as an annuity paid monthly. He received a lump sum payment in the amount of almost $500,000 on January 14, 1997, 45 days after his December 1, 2006 benefit commencement date. Upon learning that this 45-day delay was being applied to all lump sum payments under the Plan, Stephens initiated administrative proceedings to challenge the actions of US Airways and the Plan. The administrative proceedings culminated in a decision by the US Airways Retirement Board denying Stephens's administrative challenge. The Plan defines "Benefit Commencement Date" as the date as of which payment of a Participant's retirement income is to commence, determined in accordance with further terms of the Plan. "Further terms of the Plan" provide that each Participant who retires from employ on his Normal Retirement Date will receive a normal retirement income commencing on the first day of the month coinciding with or next following his Normal Retirement Date. Stephens construed the date as of which payment of a Participant's retirement income is to commence as the date on which lump sum payments must be made. The Internal Revenue Service distinguishes between commencement or starting date of an annuity and the date on which benefits actually are paid. The annuity starting date -- that is, the benefits commencement date -- is not the actual date of payment. Having failed to show that the Plan required US Airways to pay lump sum benefits to Stephens on his Benefit Commencement Date, his claim was reduced to a challenge to reasonableness of the carrier's policy to pay lump sum benefits 45 days after the Benefit Commencement Date. US Airways explained that because of the definition of Final Average Earnings in the Plan, which is required in order to determine the final benefit, coupled with pay periods specified in the collective bargaining agreement and multiple calculations required under terms of the Plan, it is administratively impossible to make a lump sum payment on a pilot's actual Benefit Commencement Date. Finally, Stephens complained that US Airways had a duty to ensure that the defined benefit, when distributed as a lump-sum, was the actuarial equivalent to the annual benefit under the Plan commencing at normal retirement age. Because the lump-sum benefits were distributed 45 days after actual retirement date, Stephens claimed the lump-sum payment was not the true present value of the annuity. ERISA provides that in case of any defined benefit plan, if an employee's accrued benefit is to be determined as an amount other than an annual benefit commencing at normal retirement age, the employee's accrued benefit shall be the actuarial equivalent of such benefit or amount. ERISA's actuarial equivalence rule requires only that the value of the lump sum benefit be the actuarial equivalent of the individual's accrued benefit. Stephens cited no legal authority supporting his argument that ERISA's actuarial equivalence rule requires payment of interest to account for the time value of money resulting from reasonable delay to allow for payment calculation. In fact, the argument is contrary to Internal Revenue Service’s regulations, which provide that a payment shall not be considered to occur after the annuity starting date merely because actual payment is reasonably delayed for calculation of benefits amount if all payments are actually made. Stephens v. US Airways Group, Case No. 07-1264 (U.S. D.D.C., March 17, 2010).
10. HIRE ACT PROVIDES HIRING INCENTIVES: On March 18, 2010, President Obama signed into law the HIRE (Hiring Incentives Restore Employment) Act, which provides $17.5 Billion in tax cuts and business credits, as well as increases in funding to the highway trust and transit programs. A key piece to the legislation includes tax benefits for employers who hire unemployed workers. Employers who hire unemployed workers after February 3, 2010 and before January 1, 2011 may qualify for a 6.2% payroll tax holiday exempting their share of Social Security taxes on wages paid to these newly hired employees. The maximum savings per employee can be as much as $6,621. The employee portion of the Social Security will still be withheld from income; the employee payroll tax savings provision does not apply to Medicare tax. A qualified employee is one who worked fewer than 40 hours during the 60 days prior to beginning work and provides a qualifying signed statement. Internal Revenue Service is currently developing the form to be used as the required statement. Other restrictions and limitations apply. The exemption relates to salaries paid for work performed after March 18, 2010. The reduced withholding will have no effect on a worker's future Social Security benefits. In addition, for each qualifying worker retained for at least one year, the business may claim a tax credit of up to $1,000 on its 2011 tax return. The credit will constitute a general business credit, but carrybacks are not allowed.
11. OXYMORON: Why do we say something is out of whack? What is a whack?
12. FABULOUS RANDOM THOUGHTS: I have a hard time deciphering the fine line between boredom and hunger.
13. SIMPLE BUT BRILLIANT...QUOTES FROM WILL ROGERS, PROBABLY THE GREATEST POLITICAL SAGE THIS COUNTRY HAS EVER KNOWN: Never miss a good chance to shut up.
14. QUOTE OF THE WEEK: “All marriages are happy. It’s the living together afterward that causes all the trouble.” Raymond Hull
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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.