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Cypen & Cypen
NEWSLETTER
for
June 28, 2012

Stephen H. Cypen, Esq., Editor

1.     FLORIDAAPPELLATE COURT REVERSES DECISION ON MIAMI BEACH REFERENDUM ISSUE:        The Third District Court of Appeal has reversed a Dade County Circuit Court ruling that required a referendum of electors to approve proposed changes to City Pension Fund for Firefighters and Police Officers in the City of Miami Beach (see C&C Special Supplement for August 4, 2011).  Rather than write its own opinion, the Third District adopted the 1999 opinion of a Circuit Judge in Daytona Beach.  The City of Miami Beach v. The Board of Trustees of the City Pension Fund for Firefighters and Police Officers in the City of Miami Beach, Case No. 3D11-2974, June 27, 2012. 

2.      STATE PENSION FUNDING LEVELS RECOVER:    U.S. states’ pension funded levels are gradually recovering from their fall in 2010, according to a Standard & Poor’s Ratings Services’ annual survey reported by plansponsor.com.  The survey report, “The Decline in U.S. States’ Pension Funding Decelerates, But Reform And Reporting Issues Loom Large,” says the rate of decline has decelerated, and in some cases, pension funded levels are gradually improving.  Still, municipal market participants are looking to improve pension plan reporting and disclosure.  The plans included in the survey receive at least some of their funding from the states, and generally are reported within the states’ financial disclosure.  Portions of the pension liabilities are funded by local governments and other governmental entities, and are not direct obligations of the states. 

3.      PUBLIC PENSION PLAN INVESTMENT RETURN ASSUMPTIONS:       As of the first quarter of 2012, state and local government retirement systems held assets of approximately $3 Trillion.  These assets are invested to defray cost of benefits within an acceptable level of risk.  The investment return on these assets matters, because over time, investment earnings account for a majority of public pension fund revenues.  A shortfall must be made up by higher contributions or reduced benefits.  Funding a pension benefit requires use of projections, known as actuarial assumptions, about future events.  Actuarial assumptions fall into one of two broad categories:  demographic and economic.  Demographic assumptions are those pertaining to a pension plan’s membership, such as changes in the number of working and retired plan participants; when participants will retire; and how long they will live after they retire. Economic assumptions pertain to factors such as rate of wage growth and investment return.  As with other actuarial assumptions, projecting public pension fund investment returns requires a focus on the long term.  A new issue brief from National Association of State Retirement Administrators discusses how investment return assumptions are established and evaluated, and compares these assumptions with public funds’ actual investment experience.  Public pension fund investment return assumptions have been the focus of growing attention in recent years.  With current low interest rates and volatile investment returns, some believe these assumptions are unrealistically high.  Because investment earnings account for a majority of revenue for a typical public pension fund, accuracy of the assumption has a major effect on the plan’s finances and actuarial funding level.  An investment return assumption that is set too low will overstate liabilities and costs, causing current taxpayers to be overcharged and future taxpayers to be undercharged.  A rate set too high will understate liabilities, undercharging current taxpayers, at the expense of future taxpayers.  An assumption that is significantly wrong in either direction will cause a misallocation of resources and unfairly distribute costs among generations of taxpayers.  Although public pension funds, like other investors, have experienced sub-par returns over the past decade, median public pension fund returns over longer periods meet or exceed the assumed rates used by most plans.  At 8.3 percent, the median annualized investment return for the 25-year period ended December 31, 2011, exceeds the most-used investment return assumption of 8.0 percent.  Public retirement systems employ a process for setting and reviewing their actuarial assumptions, including the expected rate of investment return.  Most systems review these assumptions regularly, pursuant to statute or system policy.  The process for establishing and reviewing the investment return assumption involves consideration of various financial, economic and market factors, and is based on a very long-term view, typically 30-50 years.  A primary objective for using a long-term approach in setting the return assumption is to promote stability and predictability of cost.  (Volatility in corporate plan contributions has been identified as a leading factor in the decision among corporations to abandon their pension plans.)  Since 1982, public pension funds have accrued an estimated $4.8 Trillion in revenue, of which $2.9 Trillion, or 61 percent, has come from investment earnings.  Employer/taxpayer contributions amount to $1.3 Trillion, or 26 percent of the total, and employee contributions total $623 Billion, or 13 percent.  For a typical career employee, more than one-half of investment income earned on assets accumulated to pay benefits is received after the employee retires.  Standards for setting an investment return assumption, established and maintained by professional actuaries, recommend that actuaries consider a range of specified factors, including current and projected interest rates and rates of inflation; historic and projected returns for individual asset classes; and historic returns of the fund itself.  The investment return assumption reflects a value within a projected range.  Many public pension funds have reduced their return assumption in recent years. Among the 126 plans measured in the Public Fund Survey, 42 have reduced their investment return assumption since fiscal year 2008. While 8.0 percent does remain the predominant rate assumption, the weighted average is 7.76 percent.  In conclusion, since 1985, a period that has included three economic recessions and four years when median public pension fund investment returns were negative (including the 2008 decline), public pension funds have exceeded their assumed rates of investment return.  Changes in economic and financial conditions are causing many public plans to reconsider their investment return assumption.  Such a consideration must remain consistent with long timeframe under which these plans operate. 

4.      FIVE THINGS TO KEEP IN MIND ABOUT PUBLIC-SECTOR PENSIONS:     In a Reuters article about cutting public-sector pensions, the author says that before doing so, five things should be kept in mind: 

  1. Pensions are not simply a gift from taxpayers.  They are an integral part of total compensation, along with salary, health benefits and vacation.  Unlike private-sector defined benefit pension plans, most state and municipal workers contribute hefty amounts from their salaries.  Investment earnings account for more than 60 percent of all public pension revenue; employee contributions account for 12 percent and employer contributions cover around 28 percent. 
  2. Many workers do not get Social Security.  Thirty percent of state and municipal workers work for states that have not opted into Social Security. 
  3. Pension underfunding is not as bad as one might think.  A few states have dropped to frightening levels, especially those that failed to make necessary plan contributions for years.  Nationally, aggregate asset/liability ratios have been rising.  The funding level for all state plans combined was 77 percent last year, up from 69 percent in 2010.  Although most public sector pension plans have a target funding ratio of 100 percent, ratings agencies consider a ratio of 80 percent to be adequate. By comparison, private-sector pension plans are considered at risk of default if their funded ratios fall below 80 percent.  However, it is worth noting that public sector funding ratios rely on long-term rate assumptions of around 8 percent.  Actuaries support that projection, since it is upheld by actual long-term investment history.  
  4. Pensions are more efficient than 401(k)s.  Despite the underfunding of some plans, defined benefit pensions provide retirement benefits more efficiently than defined contribution plans.  The efficiencies stem from pooling of longevity risk, maintenance of portfolio diversification and professional investment by pension fund managers.  For example, a recent study found cost to New York City taxpayers 57 percent to 61 percent more to provide workers in the city’s five defined benefit plans with equivalent benefits via a defined contribution plan. 
  5. The retirement crisis is real.  The Federal Reserve’s recently issued Survey of Consumer Finances contains these stunning figures:  the median American family’s net worth fell nearly 40 percent in the three years ending in 2010, and the asset accumulation of most was set back almost two decades.  Real income fell 7.7 percent.  Sixty percent of households say the total value of their savings and investments -- excluding their homes -- is less than $25,000!  Against that backdrop, pensions are the only safety net available to public sector workers, especially in states where they are not enrolled in Social Security.  Thus there is a real risk that pension reforms could push public-sector retirees into poverty. 

 5.      GASB APPROVES NEW PENSION ACCOUNTING AND FINANACIAL REPORTING STANDARDS:     The Governmental Accounting Standards Board has voted to approve two new standards that will substantially “improve” the accounting and financial reporting of public employee pensions by state and local governments.  Statement No. 67, Financial Reporting for Pension Plans, revises existing guidance for the financial reports of most pension plans.  Statement No. 68, Accounting and Financial Reporting for Pensions, revises and establishes new financial reporting requirements for most governments that provide their employees with pension benefits.  The new standards are supposed to improve the way state and local governments report their pension liabilities and expenses, resulting in a more faithful representation of the full impact of these obligations.  Among other improvements, net pension liabilities will be reported on the balance sheet, providing citizens and other users of these financial reports with a clearer picture of the size and nature of the financial obligations to current and former employees for past services rendered.  Pension plans are distinguished for financial reporting purposes in two ways.  First, plans are classified by whether the income or other benefits that the employee will receive at or after separation from employment are defined by the benefit terms (a defined benefit plan) or whether the pensions an employee will receive depend only on the contributions to the employee’s account, actual earnings on investments of those contributions and other factors (a defined contribution plan).  Statement 67 (Plans) replaces the requirements of Statement No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans and Statement 50 as they relate to pension plans that are administered through trusts or similar arrangements meeting certain criteria.  The Statement builds upon the existing framework for financial reports of defined benefit pension plans, which includes a statement of fiduciary net position (the amount held in a trust for paying retirement benefits) and a statement of changes in fiduciary net position.  Statement 67 enhances note disclosures and Required Supplementary Information for both defined benefit and defined contribution pension plans.  Statement 67 also requires presentation of new information about annual money-weighted rates of return in the notes to financial statements and in 10-year RSI schedules.  The provisions in Statement 67 are effective for financial statements for periods beginning after June 15, 2013.  However, earlier application is encouraged.  Statement 68 (Employers) replaces the requirements of Statement No. 27, Accounting for Pensions by State and Local Governmental Employers and Statement No. 50, Pension Disclosures, as they relate to governments that provide pensions through pension plans administered as trusts or similar arrangements that meet certain criteria.  Statement 68 requires governments providing defined benefit pensions to recognize their long-term obligation for pension benefits as a liability for the first time, and more comprehensively and comparably measure the annual costs of pension benefits.  The Statement also enhances accountability and transparency through revised and new note disclosures and RSI.  The provisions in Statement 68 are effective for fiscal years beginning after June 15, 2014.  However, earlier application is also encouraged.  Both Statements will be available for download at no cost from http://www.gasb.orgin early August.  A plain-language description of new requirements will also be available there.  News Release 06/25/12. 

6.      UNDER FIRST AMENDMENT, UNION IMPOSING SPECIAL ASSESSMENT OR DUES INCREASE LEVIED TO MEET EXPENSE NOT DISCLOSED WHEN ORIGINAL ASSESSMENT WAS SET, MUST PROVIDE NEW NOTICE AND OBTAIN CONSENT FROM NONMEMBERS:        California law permits public-sector employees in a bargaining unit to decide by majority vote to create an agency shop arrangement under which all employees are represented by a union.  Even employees who do not join the union must pay an annual fee for chargeable expenses, that is, the cost of nonpolitical union services related to collective bargaining.  A public-sector union can bill nonmembers for chargeable expenses but may not require them to fund its political or ideological projects.  Service Employees International Union sent to California employees its annual notice, setting and capping monthly dues, and estimating that 56.35% of its total expenditures in the coming year would be chargeable expenses.  A nonmember had 30 days to object to full payment of dues, but would still have to pay the chargeable portion.  The notice stated that the fee was subject to increase without further notice.  That same month, the Governor called for a special election on two ballot propositions opposed by SEIU.  After the 30-day objection period ended, SEIU sent a letter to unit employees announcing a temporary 25% increase in dues and a temporary elimination of the monthly dues cap, billing the move as an “Emergency Temporary Assessment to Build a Political Fight-Back Fund.”  The fund’s purpose was to help achieve the union’s political objectives.  Nonunion employees were not given any choice as to whether they would pay into the fund.  Nonunion employees who paid into the fund brought a class action against SEIU, alleging violation of their First Amendment rights.  The Federal District Court granted petitioners summary judgment.  Ruling that the special assessment was for entirely political purposes and ordering SEIU to send a new notice giving class members 45 days to object and to provide those who object a full refund of contributions to the fund.  The Ninth U.S. Circuit Court of Appeals reversed, concluding that prior case law prescribed a balancing test under which the proper inquiry is whether SEIU’s procedures reasonably accommodated the interests of the union, employer and the nonmember employees.  On review, the United States Supreme Court reversed.  The Court held that although SEIU offered a full refund to all class members after certiorari was granted by the U.S. Supreme Court, the case was not moot.  Under the First Amendment, when a union imposes a special assessment or dues increase levied to meet expenses that were not disclosed when the regular assessment was set, it must provide a fresh notice and may not exact any funds from nonmembers without their affirmative consent.  Knox v. Service Employees International Union, Local 1000, Case No. 10-1121 (U.S. June 21, 2012). 

7.      LONGEVITY RISK AND RETIREMENT:     Over the last 25 years, we have witnessed the shift from defined benefit plans to defined contribution plans in the private sector.  From a historical standpoint, it is quite remarkable that DC plans, initially devised as a supplementary retirement savings vehicle, have essentially replaced the DB plan, and gone on to be the primary retirement plan sponsored by employers.  Writing in The Actuarial Digest, Actuary Zorast Wadia acknowledges the extreme reversal in retirement landscape, but questions its stability in the long run because of longevity risk.  Longevity risk is defined as the risk of running out of money during retirement.  Having benefits from a DC plan as a primary retirement source subjects plan participants to longevity risk. Based on average life expectancy statistics, half of the population will survive beyond its life expectancy and half of the population will not. This situation creates challenging circumstances for people to manage withdrawals from their retirement accounts.  In addition, there is the added challenge of managing investments.  The article is meant to promote a new retirement paradigm, where both types of plans can coexist and complement one another.  This new retirement paradigm will recognize the existing DC plan as the primary retirement vehicle, and view the DB plan as a secondary plan sponsored by private sector employers.  The paper offers this retirement model as a solution to the longevity risk problem.  The author introduces the “longevity plan,” the key features of which include: 

  1. Unit accrual pattern such as in a career average plan or a plan based on flat dollar per years of service
  2. Simplistic retirement options:  no ancillary death, disability or early retirement benefits would be offered
  3. Life annuity options only:  a single-life option for single participants and 75% joint and survivor option for married participants
  4. Participants would not begin plan participation before age 45
  5. Participants would not commence benefits earlier than age 75

At this time, the proposed longevity plan cannot come into existence because of minimum eligibility rules, normal retirement date definitions and minimum distribution rules. 

The paper outlines the concept, and demonstrates its value relative to cost.  If retirees cannot adequately support themselves, they will need to turn to forms of social welfare funded by the federal government.  It should be recognized that if some type of longevity plan solution is not made available, then social welfare programs will eventually take the place of the “lost” DB plan.  The foregoing sentence is exactly the point we have been making for years:  when people run out of money, they don’t disappear, they look for public assistance, which means that the government pays in the end.  

8.      U.S. SUPREME COURT STRIKES DOWN PORTIONS OF ARIZONA IMMIGRATION LAW:     An Arizona statute known as S. B. 1070 was enacted in 2010 to address pressing issues related to the large number of unlawful aliens in the state.  The United States sought to enjoin the law, as preempted.  The District Court issued a preliminary injunction preventing four of its provisions from taking effect.  Section 3 makes failure to comply with federal alien-registration requirements a state misdemeanor; Section 5(C) makes it a misdemeanor for an unauthorized alien to seek or engage in work in the state; Section 6 authorizes state and local officers to arrest without a warrant a person the officer has probable cause to believe has committed any public offense that makes the person removable from the United States; and Section 2(B) requires officers conducting a stop, detention or arrest to make efforts, in some circumstances, to verify the person’s immigration status with the Federal Government. The Ninth Circuit affirmed, agreeing the United States had established a likelihood of success on its preemption claims.  On review by the United States Supreme Court, the Court affirmed in part, reversed in part and remanded.  The Federal Government’s broad, undoubted power over immigration and alien status rests, in part, on its constitutional power to establish a uniform Rule of Naturalization and on its inherent sovereign power to control and conduct foreign relations.  The Supremacy Clause gives Congress the power to preempt state law.  Sections 3, 5(C) and 6 of S. B. 1070 are preempted by federal law.  On the other hand, it was improper to enjoin Section 2(B) before the state courts had an opportunity to construe it and without some showing that Section 2(B)’s enforcement in fact conflicts with federal immigration law and its objectives.  Arizonav. United States, Case No. 11-182 (U.S. June 25, 2012). 

9.      PHARMACEUTICAL REPS ARE OUTSIDE SALESMEN UNDER FLSA:      Fair Labor Standards Act requires employers to pay employees overtime wages, but this requirement does not apply with respect to workers employed in the capacity of outside salesmen.  Congress did not elaborate on the meaning of “outside salesmen,” but delegated authority to the Department of Labor to issue regulations to define the term.  DOL’s regulations define outside salesman to mean any employee whose primary duty is making sales, which includes any sale, exchange, contract to sell or other disposition of tangible property.  Promotion work that is performed incidental to and in conjunction with an employee’s own outside sales or solicitations is exempt work.  The prescription drug industry is subject to extensive federal regulation, including the requirement that prescription drugs be dispensed only upon a physician’s prescription. In light of this requirement, pharmaceutical companies have long focused their direct marketing efforts on physicians.  Pharmaceutical companies promote their products to physicians through a process called “detailing,” whereby employees known as detailers or pharmaceutical sales representatives try to persuade physicians to write prescriptions for the products in appropriate cases.  Christopher was employed by Smithkline Beecham as a pharmaceutical sales representative for four years, and during which time his primary objective was to obtain a nonbinding commitment from physicians to prescribe Smithkline‘s products in appropriate cases.  Each week, he spent about 40 hours in the field calling on physicians during normal business hours and an additional 10 to 20 hours attending events and performing other miscellaneous tasks.  He was not required to punch a clock or report his hours, and he was subject only to minimal supervision.  He was well compensated for his efforts, and his gross pay included both a base salary and incentive pay.  The amount of incentive pay was determined based on the performance of his assigned portfolio of drugs in his assigned sales territory.  It is undisputed that he was not paid time-and-a-half wages when he worked more than 40 hours per week.  Christopher filed suit, alleging that Smithkline violated FLSA by failing to compensate him for overtime.  Smithkline moved for summary judgment, arguing that Christopher was employed in the capacity of outside salesman, and therefore is exempt from FLSA’s overtime compensation requirement. The District Court agreed, and granted summary judgment to Smithkline.  Christopher moved to alter or amend the judgment, contending that the District Court had erred in failing to accord controlling deference to DOL’s interpretation of the pertinent regulations.  The District Court rejected this argument and denied the motion.  The Ninth Circuit, agreeing that DOL’s interpretation was not entitled to controlling deference, affirmed (see C&C Newsletter for July 15, 2010, Item 6and C&C Newsletter for March 3, 2011, Item 9).  On review, the United States Supreme Court held that Christopher qualified as an outside salesman under the most reasonable interpretation of DOL’s regulations.  DOL’s current interpretation -- that a sale demands a transfer of title -- is quite unpersuasive.  It plainly lacks the hallmarks of thorough consideration.  Because DOL’s interpretation is neither entitled to deference nor persuasive in its own right, traditional tools of interpretation must be employed to determine whether Christopher is an exempt outside salesman.  Christopher v. Smithkline Beecham Corp., Case No. 11-204 (U.S. June 18, 2012). 

10.    GUAM SEEKS TO AVOID THE WAY OF THE NORTHERN MARIANAS:    Guam Memorial Hospital and Department of Education employees whose retirements have been placed on hold while their agencies owed contributions to the Government of Guam Retirement Fund may soon be able to retire and receive pensions.  A report from guamdn.com indicates that of the $108 Million bond that GovGuam borrowed recently, $24.8 Million went to pay DOE’s and GMH’s years-old obligations to the Retirement Fund.  Receipt of the $24.8 Million ends more than a decade of litigation and frustration on the part of employees of Guam Memorial Hospital Authority and Guam Department of Education who were held hostage from retiring and receiving their benefits in a timely manner.  GMH and DOE withheld retirement contributions when budgets became tight.  Failure to make timely retirement contributions led to the near-collapse of the Northern Marianas government retirement fund, and GovGuam Retirement Fund board looked to that situation as a lesson fully to commit to preserving the GovGuam Retirement Fund’s assets.  The Northern Marianas government’s failure fully to pay its share of retirement contributions put its retirement fund in a hole by more than $325 Million, according to its recent attempted bankruptcy filing (see C&C Newsletter for May 10, 2012, Item 3and C&C Newsletter for June 21, 2012, Item 1). 

11.    GOLF WISDOMS:   It's not a gimme if you're still away. 

12.    PUNOGRAPHICS:    I did a theatrical performance about puns.  It was a play on words.   

13.    QUOTE OF THE WEEK:   “Procrastination is opportunity’s natural assassin.”  Victor Kiam

14.    ON THIS DAY IN HISTORY:  In 1982, Prince Charles and Lady Diana name their baby “William.” 

15.    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. 

16.    PLEASE SHARE OUR NEWSLETTER:  Our newsletter readership is not limited to the number of people who choose to enter a free subscription.  Many pension board administrators provide hard copies in their meeting agenda.  Other administrators forward the newsletter electronically to trustees.  In any event, please tell those you feel may be interested that they can subscribe to their own free copy of the newsletter at http://www.cypen.com/subscribe.htm.  Thank you.

 

Copyright, 1996-2012, all rights reserved.

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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