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Donald M. Moe,
former State Senator, and
Larry Martin, executive director, Minnesota Legislative Commission
on Pensions and Retirement
Civic Caucus, 8301 Creekside Circle,
#920, Bloomington, MN 55437
Friday, June 25, 2010
Verne C. Johnson, chair; David
Broden, Janis Clay, Marianne Curry, Paul Gilje, Jim Hetland (phone), Jan
Hively (phone), Sallie Kemper, Dan Loritz, Wayne Popham (phone), Jim Olson
(phone), and Bob White
summary covers a Civic Caucus meeting
former State Sen. Donald M. Moe and Larry Martin, executive
director, Minnesota Legislative Commission on Pensions and Retirement. The
current system of public pensions in Minnesota offers too much incentive
for public employees and retirees to seek--and legislators to grant--
increases in retirement benefits, according to Donald Moe. Noting that
retirees also receive Social Security benefits, Moe suggests that for
non-public safety employees the state should gradually replace public
pensions that guarantee specific benefits with a plan where benefits are
based exclusively on amounts contributed and investments earned. He also
advocates centralizing policy proposals on pensions in the office of the
A. Context of the meeting--The
Civic Caucus is giving high priority to major issues facing the Minnesota
Governor and Legislature, along with spotlighting creative proposals for
rethinking and redesigning responses to these issues, in a time of severe
B. Welcome and
introductions--Verne and Paul
welcomed and introduced former State Sen.
Donald M. Moe and Larry Martin,
executive director, Minnesota Legislative Commission on Pensions and
Retirement (LCPR). Moe, a native of Crookston, MN, has a bachelor's
degree in business administration from the University of Minnesota. He
was a member of the LCPR during his service in the Minnesota Legislature
from 1971- 80 in the Minnesota House and from 1981-1990 in the Minnesota
Senate. He continues to follow pension issues closely. Martin is a
native of St. Paul and a graduate of the University of Minnesota and the
William Mitchell School of Law. He has worked in pension policy since
1974. After an initial period from 1974 to 1982 with the LCPR, he moved
to Pennsylvania for four years as director of that state's legislative
pension commission. Since 1986 he has been director of the LCPR.
pensions represent a large and growing segment of state and local
government expenses. Pension issues don't always emerge during general
discussions of government spending, because they are handled separately
from the more publicly-identified budgeting process. But they involve
major long term policy questions, nevertheless. Among questions discussed
in today's summary are (a) whether a change in the fundamental structure
of state local pensions should be considered, (b) whether enough money is
being set aside to pay promised pension benefits, and (c) whether the
Governor is in a position to exercise needed leadership on public
pensions. Before getting into policy questions, some background
1. Two kinds of approaches for retirement benefits--Retirement
benefits broadly fall into two categories, defined benefit (the
traditional fixed pension) and defined contribution (such as provided by
IRAs, individual retirement accounts). Overwhelmingly, Minnesota
state-local pension plans are defined benefit.
a. Defined benefit--A
pension plan under which an employee receives a set monthly amount upon
retirement, guaranteed for their life or the joint lives of the member and
their spouse. This benefit may also include a cost-of-living increase each
year during retirement. The monthly benefit amount is based upon the
participantís wages and length of service.
b. Defined contribution--A
retirement savings program under which an employer promises certain
contributions to a participantís account during employment, but with no
guaranteed retirement benefit. The ultimate benefit is based exclusively
upon the contributions to, and investment earnings of the plan. The
benefit ceases when the account balance is depleted, regardless of the
retireeís age or circumstances. Examples of such plans are 457, 401(k),
and 403(b) plans.
2. Number of persons covered--According
to the Legislative Commission on Pensions and Retirement about 295,000
current state and local public employees are covered by the several
defined benefit pension plans in Minnesota. Another 140,000 retirees are
receiving benefits. The largest plan, covering local government, is the
Public Employees Retirement Association (PERA) general employees plan,
with about 142,000 members. Next largest is the Teachers Retirement
Association (TRA), with about 77,000 members, followed by the Minnesota
State Retirement System general employees plan, with about 49,000
members. There are several other smaller plans covering various
categories of state and local employees.
3. Benefits received--While benefits are not uniform, a
typical pension for an employee with 30 years of service and an average of
$60,000 salary for the employee's five highest salary years is about
$30,600 annually. Retirees receive approximately a 2.5 percent increase
during each year of retirement, according to Minnesota House Research:
4. Payroll Contributions--Employers
and employees each contribute a percentage of payroll, about 5 percent to
7 percent, depending upon employer.
5. Retirement age--Most employees
hired before 1989 can retire and immediately receive full benefits if the
employee's age plus years of service equals 90. For most post-1989 hires,
the retirement age is indexed to the Social Security retirement age.
6. Amount set aside to pay future benefits--As
of June 30, 2009, about $41.3 billion in contributions by state and local
governments and their employees was available for paying future benefits,
according to the LCPR. In pension circles that amount is called "current
assets". The vast majority of this money is invested by the State Board of
Investment, composed of the state's constitutional officers.
7. Sufficiency of amount set aside--Experts
in projecting future pension obligations, known as actuaries, analyze a
host of data, including amounts being contributed, promised benefits, ages
of current employees and retirees, their likely life expectancy, and their
current and projected compensation. Using this and other data, actuaries
estimate what ultimately will be needed to pay benefits. As of June 30,
2009, the amount calculated was about $65.6 billion. In pension circles
that amount is called "accrued liability".
To pay all benefits as
promised a shortfall between "current assets" and "accrued liability"
represents additional dollars that ultimately will need to be raised in
state and local taxes and/from employee contributions. The shortfall is
called "unfunded accrued liability".
Conceivably a shortfall also
could be eliminated by reduction in pension benefits. Whether such
reductions might not stand up to court challenges, according to LCPR,
because state-local pension benefits, placed in state law, are regarded as
enforceable contracts between the unit of government and the employee.
As of June 30, 2009, the
unfunded accrued liability for all state-local pension funds in Minnesota
totaled $24.3 billion, according to LCPR, which is the difference between
an accrued liability of $65.6 billion and current assets of $41.3
billion. Expressed another way, Minnesota's funding ratio (assets as a
percentage of liabilities) was 63.0 percent.
8. Alternative approaches to estimating
pension shortfalls--LCPR actuaries also calculate unfunded
accrued liability using an alternative approach, which reflects ups and
downs in the investment markets. Adjusting for those ups and downs, an
actuarial value of assets in Minnesota pension plans was placed at $50.2
billion as of June 30, 2009, which would have the effect of shrinking the
unfunded accrued liability by about $9 billion. Using actuarial value of
assets increases Minnesota's funding ratio to 76.6 percent.
However, others contend that
the figure of $65.6 billion for "accrued liability" is understated. For
example, state law requires actuaries to estimate an 8.5 percent annual
return on pension investments. That number might sound high today, but
LCPR cites data that illustrate annual return exceeded 8.5 percent for
many years. According to one estimate, reported by the Minnesota
Taxpayers Association (MTA), accrued liability would increase by about $1
billion if an 8.0 percent annual return were used. If a rate of 5 percent
or 6 percent (a typical government bond rate) were chosen, unfunded
liabilities would rise by about 30 percent, according to the MTA.
In its most recent newsletter
the MTA said that a national organization that establishes accounting
standards, The Government Accounting Standards Board, is considering
changes that would have the effect of further increasing accrued
9. Decentralized organization--Minnesota
has the second most decentralized pension plan organization in the nation.
Some 10 percent of all public pension plans in the nation are located
within Minnesota. Each pension plan has its own legislatively-determined
structure and its own board of directors. Statewide there are 14 plans.
At the local level are two teachersí plans (Duluth and St. Paul) and
firefightersí relief associations in cities across the state.
No comprehensive proposal
covering all public pension plans is ever presented to the Legislature by
the Governor, in contrast, for example, to the Governor's biennial budget
proposal and biennial capital improvements budget. Thus, the Legislature
makes adjustments in each pension plan, one-by-one.
The LCPR, made up of five
members from the House and five from the Senate, was established at least
partially to give the Legislature some potential to establish overall
policy. The LCPR reviews bills that are introduced affecting the various
pension plans. The LCPR has adopted a set of principles to guide its
review of proposed legislation.
10. Changes enacted in 2010--A
law was passed in the 2010 Legislature that would required higher
contributions by workers and state and local governments and also curtail
benefits. There is controversy over whether the new legislation adds to
the long-term unfunded liability of the state's pension plans. The law
includes an eventual 2 percent increase in school district and teacher
contributions to reduce future liabilities in the statewide teachers plan.
The law includes significant help for the
Minneapolis Employees Retirement Fund, with almost 5,000 retirees and only
about 100 employees still paying into the fund. In addition to $9 million
a year in state appropriations the new law adds up to $15 million a year
to keep the fund from insolvency.
11. Legality of reduction in benefits being
challenged--A lawsuit is challenging the legality of reduction
in employee benefits that was part of the 2010 legislation. The challenge
is based on certain past court decisions that have regarded pension
benefits as legally-binding contracts between employer and employee that
can't be later reduced by legislation.
D. Comments and
discussion--During Moe's and
Martin's comments and in discussion with the Civic Caucus the following
points were raised:
1. History of pension plans in Minnesota--Fire
department relief associations in St. Paul (1868), Minneapolis (1874), and
Fergus Falls (1874) were the earliest public pension plans in the state,
according to the LCPR. Teacher retirement plans were introduced in
Duluth, Minneapolis, and St. Paul in 1910. Statewide plans were
introduced for teachers in 1915, for state employees in 1929, and local
government employees in 1931.
2. Demand for increased benefits is
insatiable--Pension plans attract very little public or
legislative interest. They are immensely complicated. But they are of
great significance to employees and retirees, both of whom are always
seeking improvements in benefits, Moe said. A very small change in law
might not seem very significant on the surface but can have immense
long-term expense consequences, he said.
3. Effective lobbying--Some 15 to
20 political campaign funding organizations along with employee
organizations are very effective in raising money to support candidates
for the Legislature as well as to lobby for changes in pension law, Moe
said. Their effectiveness is enhanced because the pension system is so
decentralized and complicated, he said.
4. Overstating solvency--It has
been possible for pension advocates to take advantage of the complexity of
pensions and the difficulty in creating interest and understanding in the
Legislature as a whole and in the general public, Moe said. For example,
state law requires that, in calculating how much money will be needed to
pay future pension claims, actuaries must assume pension investments will
yield an average of 8.5 percent return every year, Moe said. While higher
returns have been recorded in some years, such a figure has the effect of
overstating the solvency of pension plans, he said. Moreover, retirees
have successfully lobbied for a bump in benefits in years when the 8.5
percent has been exceeded, he said.
5. Moe's proposal for a change in the
structure of public pensions--Moe would gradually phase out
Minnesota's existing defined benefit approach. Current employees would
continue to be covered under the current system, now and when they
retire. New employees would be covered by the defined contribution
approach. Thus, the defined benefit approach wouldn't be totally phased
out--and the defined contribution approach totally phased in--until the
death of the last current employee or survivor. The State Board of
Investment would continue to manage investments from defined
contributions, just as it currently manages pension investments.
Employees would be given a limited number of investment choices.
Retirees would continue to
receive Social Security, which is a defined benefit program, Moe noted.
Under defined contribution
the state has no long-term liability. The employee's future pension is
exclusively dependent upon the amounts contributed by the employee and the
employer and the investment earnings on those contributions. All
employees would have their own investment accounts. Individuals would
decide how much to withdraw in each year of retirement.
The Legislature would never
be called on to bail out a defined contribution plan, as is the case with
the Minneapolis Employees Retirement Fund, he said.
The defined contribution
approach is widely used in the private sector and in a few cases in
Minnesota's public sector, such as retirement plans for higher education
faculty and as supplemental to some defined benefit plans.
The 2010 Legislature called
for the LCPR to conduct a study of defined contribution plans.
6. More portability claimed for defined
contribution plans--Moe contended that new employees are likely
to welcome the defined contribution approach because an employee's pension
fund is easily portable back and forth between private sector and public
sector jobs. Moe contended that new employees would favor defined
contribution if given a choice.
7. Defined contribution is in effect some
other states' public systems--Since 1997 new public employees
in Michigan have been covered by defined contribution. A few other states
provide a combination of defined contribution and defined benefit. Moe
said he opposes a combination because he believes employee groups would
successfully apply pressure to ever increase pensions under the defined
benefit. He also noted that public employees in Minnesota already are
covered by social security, so they are receiving a defined benefit from
8. Arguments against defined contribution--Because
public employees would be given a greater role in determining how their
pension funds are invested, some risk exists that they could make
ill-advised choices. Also employees could opt to spend their defined
contribution investments earlier in life, thereby leaving them without
9. Treat public safety employees differently--If
defined contribution were more widely used in the public sector, special
arrangements would need to be made for public safety employees, Martin
said. He pointed out a public safety employee could be killed while on
duty and a survivor could be left with nothing were it not for the defined
10. Long-term impact of public pensions on
the state's general fund--Pension decisions--such as those
enacted by the 2010 Legislature--require additional contributions from
state and local governments, as well as by employees, Martin said in
response to a question. However, those additional governmental
contributions don't show up as appropriations in this session, but will
have an automatic claim on the general fund in coming years.
11. Question of the extent to which unfunded
liabilities represent a serious problem for the state--Martin
said that having been associated with Minnesota pension plans for 30-plus
years, he's not panicky about gaps between what ultimately will be
required to pay pensions and amounts likely to be available given current
employer and employee contributions. Anything as serious as bankruptcy is
not in foreseeable future, he said. There's always been significant lead
time available to increase contributions in advance of a crisis, he said.
In the discussion, it was agreed, however, that an increased amount of tax
revenue will be needed in coming years to pay defined benefits.
12. Urgent need for statewide leadership on
pension policy--With the absence of the Governor in any
structured responsibility for public pensions, overall leadership on
behalf of the state's electorate is absent, Moe said. The LCPR was
created to help fill this vacuum, but top legislative leaders must assure
that the LCPR members they select are independent and objective, he said.
The LCPR doesn't advocate comprehensive changes; rather it evaluates
proposals made by individual legislators and pension plans.
The conversation moved to
whether Minnesota should consider a framework whereby the Governor would
be required to propose comprehensive pension legislation, giving the
Legislature a chance to review overall policy changes, not just changes
advocated by the individual plans. Such a change would not necessarily
require placing all pension funds under the Governor, as is the case in
Wisconsin, which has centralized its pension plans in one body, the
Department of Employee Trust Funds
In 1988 Moe tried
unsuccessfully (S. F. 958) to create a pension bureau within the Minnesota
Department of Employee Relations.
13. Opposition to using pension funds to
help balance the state's budget--During the meeting it was
noted that the state of New York will borrow from invested pension funds
to pay pension contributions for current employees. It also was noted
that that someone who follows the Minnesota State Legislature very closely
has said that proposals might be advanced to use invested pension funds in
Minnesota to help balance the 2011 budget. Moe said he strongly opposes
any such use of pension funds.
14. Thanks--On behalf of the
Civic Caucus, Verne thanked Moe and Martin for meeting with us today.