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Cypen building

October, 2001

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001

1. BOND CREDIT QUALITY RATINGS AND WHAT THEY MEAN: There is a widespread misunderstanding about what bond credit ratings really mean and how they affect the returns and overall riskiness of a portfolio. Investors generally rely on bond ratings to evaluate the credit quality of specific bonds. Credit ratings indicate on a scale of high to low the probability of default; that is, the probability that debt will not be repaid on time in full. Failure to redeem principal at maturity constitutes a default. Failure to make interest payments on time also constitutes a default. Put another way, ratings answer two questions: how likely am I to get my money back at maturity and how likely am I to get my interest payments on time? All bonds, except securities issued directly by the U.S. government, are subject to default risk. Bonds other than those issued by the U.S. government are rated by a number of agencies that specialize in evaluating credit quality. The best-known rating agencies are Moody's, Standard & Poor's (S&P) and Fitch IBCA. The following table lists symbols used by each of the major credit rating agencies:

Moody's Standard & Poor's and Fitch IBCA  
Aaa AAA Gilt-edged. If everything that can go wrong does go wrong, debt can still be serviced.
Aa AA Very high quality by all standards.
A A Investment grade, good quality.
Baa BBB Lowest investment-grade rating; satisfactory, but needs to be monitored.
Ba BB Somewhat speculative, low grade.
B B Very speculative.
Caa CCC Even more speculative, substantial risk.
Ca CC Wildly speculative, may be in default.
C C In default, junk.

S&P may add a "plus sign" or a "minus sign" to its ratings: a plus signifies higher quality, a minus signifies a somewhat lower quality. Moody's may add a "1" to indicate slightly higher credit quality. When used in the ratings, the term "investment grade" stems from the requirement that certain fiduciary institutions, like banks, invest only in securities with such minimum rating.

2. TEN THINGS YOUR FINANCIAL PLANNER WON'T TELL YOU: From Smart Money magazine we get the usual top ten list, this time things your financial planner won't tell you. No. 1, "I got this gig on a whim;" anyone can hang out a shingle and call himself a financial planner because there is no required training or experience. No. 2, "I'm a jack of all trades and master of none;" a good financial planner should work alongside outside professionals like accountants, lawyers and insurance brokers. No. 3, "I have ghostwriters draw up your plan;" outsourcing plans to a secondary firm or freelancer is a growing trend, especially among big firms, enabling planners to spend more time wooing new clients. No. 4, "I'm a high-pressure shill in disguise;" the majority of financial planners work on commission, which can make for bad financial planning. No. 5, "I have a loose definition of 'fee-only';" to be sure your fee-only planner is true to his claim, ask for a written breakdown of fees and those associated with each investment product. No. 6, "Once I've done the plan, I'm outta here...;" financial planners like to give you the sense that they'll be with you every step of the way through important financial decisions, but most once-attentive planners become increasingly elusive as time wears on. No. 7, "...Especially if you're not well-to-do;" many planners have a minimum asset requirement, say, $100,000. No. 8, "Confused? That's the point;" unfortunately, confusion is often deliberate so that the planner can better manipulate you. No. 9, "In fact, I don't even understand your plan;" today's software designed to help planners with clients' asset allocation, cash flow, retirement planning and so on can make problems for planners who don't understand how the software works. No. 10, "Good luck busting me for malpractice;" since the financial planning industry is so loosely organized, it's not surprising that there are no firm regulations regarding consumer grievances.

3. BALTIMORE MAYOR WINS ON SUBJECT OF PENSION FUNDS: At the urging of Mayor Martin O'Malley, Baltimore's pension funds have agreed to make a concerted effort for the first time in years to invest locally, apparently ending what had been a bitter confrontation between the mayor and retirement system officials. Pension officials are considering investing significantly with local money managers, and possibly infusing some pension fund dollars, at least indirectly, into local companies and projects. The new enthusiasm for local investing represents a hard-won victory for the mayor, but experts warn that dangers exist: local politics might influence where the money goes, enriching political patrons and the funds might bypass better investment opportunities elsewhere. Local politics influence where money goes? Might? That's rich!

4. OVERTIME PAY FOR POLICE AND FIRE CHIEFS STIRS FEARS: The New York Times reports that New York City has agreed to pay hundreds of hours of overtime to high-ranking police and fire supervisors to reward them for the long hours that they worked after the terrorist attacks, even though they are normally not entitled to such pay. Nevertheless, union officials say the gesture would increase morale in a work force still reeling from the losses of September 11th. Some analysts, on the other hand, say the move threatens to worsen a problem the city has holding on to its most qualified and veteran police officers, who are retiring in exceptionally large numbers this year. The overtime payments, which could be as high as $15,000.00, may entice additional retirements because recipients would qualify for larger pensions based on the higher salaries. (Generally, after twenty years, members of the police and fire departments, receive 50% of salary received in their last year.) Police officers are already retiring at nearly double the pace they did last year, a total of 2,600 having left the force this year.

5. PENNSYLVANIA PENSION COSTS GREATLY EXCEED EXPECTATIONS: A hefty pension increase for Pennsylvania public school employees approved in May (see C&C Newsletter for June, 2001, Item 9) will cost the state and school districts $465 Million next year, partly because of poorly-performing retirement fund investments. Public School Employees' Retirement System officials have just approved a new employer contribution rate of 5.64% for 2002-03, up from 1.09% this year. Half the hike is paid by the state and half by over 500 school districts, the largest of which will be hit with unanticipated costs in excess of $1 million. Just six months ago, the governor and legislative leaders had assured local school officials that the total cost to them would be less than $40 Million.

6. THANK GOODNESS FOR "SMOOTHING": The fifty largest U.S. corporate pension funds lost 25% of their funding "cushions" in 2000, thanks to a combined $38 Billion decline in assets, according to a report in the Detroit News. Nevertheless, the same funds were able to report profits of $8.7 Billion through techniques designed to "smooth" returns over multiyear periods. If the companies had reported actual returns last year, they would have had to recognize losses of about $27 Billion. These corporate pension funds, which include Exxon Mobil, GM and Ford, had an average funded ratio of 125% at the close of 2000, down from an average 135% at the close of 1999. Recognizing that pension funds invest for the long term -- as much as thirty years -- they generally use smoothing techniques to spread out gains and losses, usually over a five-year period. In 2001, despite another expected decline in pension assets, many funds will still be able to report "profits" through smoothing.

7. CONFLICT OF INTEREST WHERE FIRE COMMISSIONER SERVES AS FIREFIGHTER: In CEO 00-23, the Florida Commission on Ethics found that a commissioner of a fire district who serves for compensation (however small in amount) as a "volunteer" firefighter of the district's fire department does so in violation of Sections 112.313(10) and 112.313(7)(a), Florida Statutes. Those sections prohibit, respectively, an employee of a political subdivision from holding office as a member of its governing board and the member from holding employment with an agency that is subject to regulation of his agency. However, were the district to eliminate the $2 per run payment or substitute a true reimbursement procedure, or if the member were to refuse in writing in advance the payments, the resulting situation would not be conflicting under either of said statutes because the element of "employment" would fail for want of "compensation," notwithstanding the provision of workers' compensation coverage, life insurance, uniforms and firefighting equipment to the firefighters (including the member). Although the opinion was written over a year ago, we just came it across it at http://www.ethics.state.fl.us/opinions/00/CEO%2000-023.htm.

8. SOCIAL SECURITY BENEFITS WILL INCREASE BY 2.6%: The Social Security Administration announced that Social Security and Supplemental Security Income benefits will increase 2.6%in 2002. The average monthly check will rise to $874.00. The maximum amount of earnings subject to the Social Security payroll tax will increase from $80,400.00 to $84,900.00. The payroll tax rate will remain at 6.20% for Old Age Survivors and Disability Insurance. The Senior Citizens Freedom to Work Act of 2000 eliminated the retirement earnings test for individuals between 65 and 69 (see C&C Newsletter for April, 2000, Item 24). However, for those under the Social Security normal retirement age in 2002, the annual exempt amount will be $11,280.00. And for recipients who attain the Social Security normal retirement age in 2002, the annual exempt amount for taxable years ending in 2002 will be $30,000.00.

9. A LITTLE LESSON ON SOCIAL SECURITY COST-OF-LIVING ADJUSTMENTS: As long as we are on the subject, perhaps a little lesson on Social Security cost-of-living adjustments is in order. Legislation enacted in 1973 provides for automatic COLAs to prevent inflation from eroding Social Security and Supplemental Security Income benefits. The Social Security Act specifies a formula for determining the COLA. In general, the COLA is equal to the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of one year to the third quarter of the next. For the 2002 COLA, the average CPI-W from the third calendar quarter of 2000 is measured against the third quarter of 2001. These averages are 169.7 and 174.1, respectively. Thus, the 2002 COLA is calculated as follows (rounded to the nearest one-tenth of one percent): 174.1 - 169.7 / 169.7 x 100 = 2.6. Legislation enacted in 1983 may limit the COLA for Social Security (but not Supplemental Security Income) if combined assets of the Social Security trust funds are below 20 percent of annual expenditures. Not to worry: the combined trust fund assets are estimated to be almost 240% of 2001 expenditures.

10. MEDICARE VALUES FOR 2002 ANNOUNCED: The Medicare Part A inpatient hospital deductible will rise to $812.00 from $792.00. Part A daily coinsurance amounts will be $203.00 (up from $198.00) for the 61st through 90th days of hospitalization, $406.00 (up from $396.00) for lifetime reserve days and $101.50 (up from $99.00) for the 21st through the 100th day of extended care services in a skilled nursing facility. Because the Omnibus Budget Reconciliation Act of 1993 removed the limit on wages subject to the Medicare Part A tax, employers and employees will continue to pay the 1.45% payroll tax on all wages in 2002. The Medicare Part B deductible will remain at $100.00, but the monthly premium for 2002 will rise to $54.00 from $50.00.

11. WASHINGTON LAW HELPS TEACHERS SHIFT FROM "RETIRED TO REHIRED": Under a Washington State law (see C&C Newsletter for July, 2001, Item 6), over 500 teachers and administrators are taking advantage of a new law that allows retired educators to return to full-time teaching while still keeping their pensions and health benefits. The law, which went into effect in July, helps solve the teacher shortage, holds on to experienced educators at a critical time of reform and allows retirees to stay connected to education while gradually retiring. Educators can return part-time or full-time with a year-to-year contract once they have been retired at least thirty days. Previously, retirees could work no more than 840 hours per year without jeopardizing their pensions. Although supporting the legislation, the Washington Education Association stresses it is not a long-term solution to the teacher shortage: "It's a temporary stop-gap measure, and we were disappointed that the Legislature didn't look at the larger issue of fair and competitive compensation. That's ultimately what it will take to ensure enough teachers for our students," said a WEA spokesman quoted in the Seattle Times.

12. WISCONSIN RELEASES STUDY OF MAJOR PUBLIC EMPLOYEE RETIREMENT SYSTEMS: The State of Wisconsin Retirement Research Committee has issued a staff report entitled "2000 Comparative Study of Major Public Employee Retirement Systems." Since 1982, the Wisconsin Retirement Research Committee staff has compared major statewide public employee retirement systems across the country with public pension plans in Wisconsin. These studies have emphasized retirement programs for general employees and teachers. The 2000 Comparative Study includes 85 public pension plans, which are the same systems that are found in previous studies since 1982. Although the study does not include all major public pension plans, it does include one or more statewide plans from each state. Also, because the same pension plans are always included, the biennial studies may reflect trends in the public pension sector as they occur over time. The plans surveyed provide pension coverage for almost 11 million active employees and 4.3 million retirees. Since 1996, the number of active participants has grown by 8.1% while the number of retirees has grown by 15%. For 74 (87%) of the systems, the ratio of actives to retired declined over the four year period. The systems in the 2000 study range from 6,000 active participants to more than 750,000. Coverage under the Federal Social Security Program was once elective for public employers, but is now mandatory for those employers who had elected such coverage. Of the 85 plans included in the current study, Social Security coverage is also provided for participants of 68 of the systems. The 17 plans without Social Security coverage include 2.7 million active employees, or 25% of the total active employees in the survey. There is continued growth in the total number of participants in the plans surveyed. All plans, except one, had a growth in the number of retirees, and 78% had a growth in active participants. However, the number of retirees is growing at a faster rate than active employees, as reflected in declining ratios of active to retired participants.

13. MIAMI F&P BOARD WINS FEDERAL DISCRIMINATION CASE: A Latin-American police officer sued the Board of Trustees of the City of Miami Fire Fighters and Police Officers Retirement Trust pursuant to 42 U.S.C. §§1981 and 1983. He alleged racially discriminatory practices in granting disability benefits to injured employees. He claimed that his application for disability benefits was wrongfully denied because of his race. In granting summary judgment in favor of the board (and the City of Miami, which was also joined as a defendant), the United States District Judge reached the following conclusions:

  1. The Board operates as a quasi-judicial body rendering disability decisions. Procedures employed by the Board are the functional equivalent of a judicial proceeding, whereby the Board hears the parties' evidence and makes findings based on that evidence and established rules. In addition, the employee is protected by appropriate due process safeguards, including the right to counsel, multi-level review hearings and the right to appeal the Board's decision to Florida courts. In view of the quasi-judicial nature of the Board's proceedings, the Board has immunity from suit.
  2. 42 U.S.C. §1981 prohibits racial discrimination in the making and enforcement of contracts, including those in the employment setting. However, under well-settled Florida law, a city employee has no contract with the Board or the city.
  3. 42 U.S.C. §1983 prohibits a person from depriving another of a constitutionally protected liberty or property interest with deliberate indifference to constitutional rights. Following other federal court decisions, the court found that the Board is not a "person" within the meaning of §1983 and thus may not be sued for any alleged violation of said section.

Of course, that the Board prevailed in a federal discrimination case is important. However, more significant is the breadth of the ruling, which virtually insulates any pension board from discrimination claims arising out of disability proceedings, at least in the Southern District of Florida. We served as co-counsel to the Board, one of our regular pension clients. Gorordo v. City of Miami, Case No. 99-0582 (S.D. Fla., October 10, 2001).

Copyright, 1996-2004, 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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