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Cypen & Cypen
November 1, 2012

Stephen H. Cypen, Esq., Editor

1.       STATE AND LOCAL PENSIONS ARE A FORCE IN OUR ECONOMY:  State and local governments, struggling to emerge from the aftermath of the financial crisis, face another looming funding gap: in their public pensions. In a piece written for, Peter Orzag, former director of the Office of Management and Budget, reminds us that these plans hold almost $3 trillion in assets, and cover more than 10 percent of U.S. workers.  The average state pension plan holds assets equal to only about three-quarters of projected liabilities, the difference amounts to about a half-trillion dollars.  Under a lower discount rate that has been approved by the Government Accounting Standards Board for use by mid-2014 by states that are not meeting their annual required contributions, the difference is greater.  Yet discussions about how to address the problem are based on flawed assumptions. The dominant view is that large state and local pension gaps are universal across the country, that they are caused largely by assuming too high a discount rate in assessing future liabilities and that intransigent unions are to blame for the biggest gaps.  Alicia Munnell, director of the Center for Retirement Research at Boston College, takes on each of these myths in her new book, State and Local Pensions: What Now?   First, she computes the funding ratio for each state plan. She finds substantial variation: five percent of public pension plans were fully funded in 2010, and 35 percent had a funding ratio of at least 80 percent. On the other hand, 12 percent of plans had severe problems; their assets were less than 60 percent of their projected liabilities.  Why were some plans so badly underfunded and others not? Munnell’s answer is the biggest surprise in her analysis. She argues that neither the high discount rate nor unions can explain the variation. She concludes that the poorly funded plans did not come close to surmounting the lower hurdle associated with a high discount rate; raising the hurdle is unlikely to have improved their behavior. And union strength simply did not show up as a statistically significant factor in any of the empirical analysis.  The worst-funded plans were not especially generous in their benefits, which is consistent with her argument that union strength is not what matters. These plans, though, did tend to share two characteristics: they were disproportionately teachers’ plans, and they used a funding method (called the projected unit credit cost method) that is less stringent than those used by other plans.  The states with huge funding gaps have either not made the required contributions or used inaccurate assumptions, so that their contribution requirements are not meaningful. Fiscal discipline simply appeared not to be part of the state’s culture.  In pensions, as in life, what goes around comes around. In states that have behaved well in the past, such as Delaware, the burden of pension plans will increase in future years only modestly, if at all.  In contrast, a state such as Illinois, which has perhaps the worst record of avoiding necessary funding even while expanding benefits, will have to increase its pension contributions sharply if it is to meet its obligations.  The revelation that problems exist mainly in states that have failed to adhere to a credible long-term funding policy contains a lesson for policy makers in Washington: it is essential to behave responsibly.  Simply hoping our long-term fiscal problems will magically disappear is not a credible strategy. As part of the negotiations over how to address the fiscal cliff scheduled to take effect in January, policy makers should combine more support for the economy in 2013 with a specific and credible deficit reduction plan that rolls out gradually over the next several decades.  We have ordered a copy of Dr. Munnell’s book, and suggest that no library will be complete without it.  Good job. 
According to a state news release, California Public Employees’ Retirement System, has filed an objection to the City of San Bernardino’s eligibility to seek bankruptcy protection. At this point, it is impossible to determine whether the City meets eligibility requirements of Chapter 9 (See C & C Newsletter for June 10, 2010, Item 1) because, despite its previous promises, the City has failed to provide CalPERS with reliable financial information..  The City has also not proposed a balanced budget, and has not filed a Pendency Plan to adjust its debts. Without these items, CalPERS cannot evaluate the City’s legitimate desire to effect a plan of adjustment. At the time of bankruptcy filing, the City alleged it had no unrestricted funds to pay for its operations. The City declared a fiscal emergency, without negotiations with its creditors regarding a potential plan of adjustment, and hastily sought the haven of bankruptcy.  Subsequent to the filing, the city filed its Pre-Pendency Plan, which indicated that the city would continue to make its required payments to CalPERS with respect to public employee benefits. The City has not complied with this plan, and has failed to make payments to CalPERS in accordance with the plan.  (These payments are required to be made under California law.)  The parties have been working together with respect to obligations to CalPERS and the missed payments, but if they do not come to a resolution, CalPERS will assert its legal rights to collect payments, within the framework of law outlined by the bankruptcy proceedings. Unlike most city creditors, CalPERS is an arm of the State.  Under federal law, the Bankruptcy Court may not interfere with the relationship between the State and a city. Thus, remedies available to CalPERS include not only seeking relief from the Bankruptcy Court, but also exercising its governmental powers.  Nevertheless, CalPERS at this time has no intention of terminating its relationship with San Bernardino. Similarly, San Bernardino cannot use the bankruptcy process to terminate its relationship with CalPERS.  CalPERS says it still “values” its partnership with San Bernardino.   (Perhaps, that value is now selling at a deep discount.)  
Speaking at the American Society of Pension Professionals & Actuaries Annual Conference, Dr. Bruce Weinstein, a/k/a the “Ethics Guy,” said there are five life principles to follow to behave ethically. As reported by, the first principle is “do no harm.”  A sponsor can harm participants by sharing confidential information or lying to a participant about a mistake made in his account. A financial adviser can also harm clients by consciously overcharging them or recommending an action that is not appropriate for their plans.  The second principle is “make things better.” A plan adviser helping a sponsor that is struggling with loan administration is making things better, as is a plan sponsor that admits it used the wrong compensation to calculate a participant’s benefit, and corrects the mistake.  The third principle Weinstein shared is “respect others.”  This one means keeping confidential information confidential, telling the truth and keeping promises made. “Be fair” is the fourth principle. Time management is ethical behavior, and can show how fair a plan sponsor or financial adviser is with participants or clients.  How one disciplines someone can also show fairness.  Weinstein suggests offering constructive criticism using a “praise sandwich” --begin with something complimentary, state the criticism in a gentle or even positive way, and end with an affirmation, like “you are always so diligent, I knew you would want to correct this problem.”  Finally, Weinstein’s fifth life principle that leads to ethical behavior is “care.” Treat others with care, kindness and even love.  One should show sincere appreciation for others; it takes little effort and causes both the giver and receiver to feel better.  Living by the five principles is not only the right thing to do, it is the smart thing to do.  So, that leads us to ask: if ethical behavior is so simple (as it seems to be), how come so many people are unethical? 
 Diversified, a leading retirement plan provider, has announced availability of Report on Retirement Plans 2012: Bridge to Your Retirement Success, a study on the trends influencing defined contribution and defined benefit plans of U.S. corporations with more than 1,000 employees. The report, says, is designed to provide plan sponsors and advisors with comprehensive benchmarking data, explores how the retirement savings environment is evolving as DB plans are increasingly displaced with DC plans.  Ninety-five percent of all large corporations offer a 401(k) plan and 80% offer a DB plan. However, evidence that many sponsors are likely to be terminating their defined benefit plans is widespread -- only 42% of DB plan sponsors state they are likely to continue to offer DB plans to all employees during the next five years. Historically, DC plans have been a replacement for DB plans -- nearly half (45%) of all DB plan sponsors have created a DC plan as a DB plan replacement.   Key DC plan trends highlighted in the report include:

  • Motivating employees is a challenge, as participation rates level and deferral rates drop.  The percentage of employees at large corporations participating in their employers' 401(k) plan remains unchanged since 2011 at 69%; and the average deferral rate dropped sharply from 8.8% in 2011 to 6.7% in 2012. 
  • How success is measured evolves. While having a high participation rate is still viewed as the best indicator of plan success, its significance is falling. 
  • Matching contributions prevail.  Nearly all large corporate plan sponsors (95%) offer a fixed or discretionary employer contribution. 
  • Plan features are expanding.  Over half of all large corporate 401(k) plans (53%) offer financial advice and an additional 33% are considering adding financial advice to their plan's offering.

Key DB plan trends highlighted in the report include: 

  • Future for DB plans is uncertain.  Forty-two percent of DB plan sponsors state they are likely to continue to offer DB plans to all employees during the next five years, 35% expect to continue to offer DB plans to existing employees but not to new employees, 13% are likely to freeze active DB plans, and 10% believe they will terminate active DB plans during this period of time.  
  • Financial implications are a top concern.  Thirty percent of all DB plan sponsors indicate the plan's impact on company financial statements is their primary concern, narrowly edging out the financial health of the DB plan, which was singled out by 26% of all sponsors.

Other highlights from the survey include:

  • Fifty-three percent of large corporate plan sponsors use an advisor and 19% of plans have plans to hire an advisor within the next 12 months.
  •  On average, large corporate 401(k) plans offer 13 investment options in 2012, up slightly from 12 options in 2011. 
  • Seventy-six percent of large DC plans offer investments that are proprietary to the service provider.   
  • Across all large corporate plans, the benefits budget allocation for all retirement plans is nearly equal to the healthcare budget, with 34% dedicated to retirement plans and 32% to healthcare.  
  • Just 20% of all plan sponsors believe that participants understand that their plan's fees "very well."  Forty-six percent state participants understand fees "somewhat well" and 34% report that participants do not understand the fees.

So what else is new?
U.S. Equal Employment Opportunity Commission brought suit under the Federal Age Discrimination in Employment Act against Baltimore County, challenging legality of certain provisions of its employee pension plan.  A United States District Court Judge granted partial summary judgment in favor of EEOC on the issue of liability.  Employees are required to contribute to the plan at different rates, based on the age at which they joined. Under a new system, employees hired after July 1, 2007 contributed at a flat rate, regardless of their age at the time of hiring.   EEOC brought the action on behalf of older Baltimore County workers hired prior to July 1, 2007.   The problem appears to be an unintended consequence, resulting from the interaction of two separate and independently lawful provisions of the County Code enacted decades apart. It is clear from the record that the age-based contribution rates, when put in place in 1945 until modified in 1977, were fully justified by the time value of money rationale.  Because all employees were eligible to retire at age 65, age served as a proxy for years until retirement. Thus, notwithstanding the fact that the plan nominally based an employee’s contribution rate on the age at which he or she was hired, years until retirement was the real determining factor.  In 1973 the County, at no additional cost to employees, added a generous early retirement option based on years of service.  Such benefit is explicitly authorized by ADEA.  A secondary effect of this provision, however, was to decouple an employee’s age from his years until retirement. Age of retirement is no longer yoked to chronological age, because some employees take early retirement while others do not.  A statute or policy that facially discriminates based on age suffices to show disparate treatment under the ADEA. Because the plan is facially discriminatory, the Court need not apply the six-factor test that the U.S. Supreme Court laid out in a 2008 case.  In that case, the Supreme Court concluded that pension status, not age, explained any differences in the way the plan treated different employees. In this case, however, after the County adopted the early retirement option, the different contribution rates charged to different employees are explained by age rather than pension status.  U.S. Equal Employment Opportunity Commission v. Baltimore County, Case No.1:07-cv-02500 (Dist. Md. October 16, 2012).
  I've always wanted to have someone to hold, someone to love.  After having met you…I've changed my mind.
Velcro -- what a rip off! 
8.      QUOTE OF THE WEEK:  
When I was a boy I was told that anybody could become President; I'm beginning to believe it.   Clarence Darrow
In 1932, Wernher von Braun named head of German liquid-fuel rocket program.
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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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