Understanding Legislative Environment Critical for Managing Municipal Pensions
Investment management is only half the battle when it comes to effectively administering a municipal pension plan. Understanding recent legislation, State budget levels and funding priorities all play a significant role in helping Pennsylvania municipalities navigate the retirement planning processes for employees.
At FRS Capital Management’s recent municipal pension plan roundtable, township and borough managers, elected officials, uniformed officers, non-uniformed employees and citizen members of a municipal pension board discussed critical and timely issues related to municipal pension plan management including the recently enacted Act 44, the positives and negatives of offering Deferred Retirement Option Plans (DROP), and the new ROTH option for Code Section 457 Plans.
The roundtable addressed several topics related to Act 44, which lays out requirements for all retirement plans that receive State monies, including police and non-uniformed retirement plans (Note: Section 457 plans and GASB 45 trusts do not receive State aid). Act 44 requires an RFP process when municipalities seek professional service providers to manage retirement plans; defines Deferred Retirement Option Plan (DROP) parameters, providing municipalities with direction from Harrisburg when considering a DROP program; and outlines adjustments to asset smoothing guidelines, providing definitive guidance to actuaries.
Roundtable participants also discussed the pros and cons of DROP, as outlined in Act 44, and the new ROTH opportunity available for Section 457 plans effective 1/1/11. DROP plans allow municipal employees to retire for pension purposes, while still remaining as active employees for all purposes other than pension, and the new ROTH option for 457 plans offers municipal employees another option to consider when planning for retirement.
Randall Rhoades, Esquire, CPA
Rhoades and Wodarczyk, LLC
As usual, Harrisburg is long on mandates, but short on details according to Rhoades, who offered guidance on the yearly disclosure questionnaire to be completed by local government pension professionals. Rhoades also reviewed the RFP requirements under the new law to hire a pension professional including the requirement to advertise, select the most qualified proposing firm and notify the unsuccessful proposing firms. Rhoades entertained questions concerning RFPs issued before Act 44 passed and mentioned certain resources available to local governments to comply with the law. A sample Act 44 disclosure questionnaire can be found at here - Act 44 Disclosure Form.
Joseph Duda, President
Duda Actuarial Consulting, Inc.
Duda discussed the expanded asset smoothing range as authorized by Act 44, commenting that it only delays the point at which the municipality will be required to fund the plan at a greater level as a result of the reduced funding allowed by asset smoothing. Duda referred to asset smoothing as primarily a budget management technique that helps reduce the current Minimum Municipal Obligation (MMO). However, asset smoothing also leads to consequences with future pension funding requirements and should be used judiciously, Duda warned.
Jamie Bruton, Accredited Investment Fiduciary Auditor (AIFA)
Bruton Financial Partners
Fiduciaries need to be aware of the implications of asset smoothing, as to not be caught off guard by the results of decisions they’ve made in past, commented Bruton, who defined fiduciaries as municipal elected officials, managers and members of pension committees, as well as the plan’s investment advisor. Bruton stressed all fiduciaries must be aware of the overall process of managing a municipal pension plan and stressed ignorance is not a viable defense if fiduciaries are asked to explain current plan conditions
Bruton also explained that municipalities rely on money from Harrisburg to help fund their pension plans and that Harrisburg raises the money by levying a premium tax on insurance sold by companies not domiciled in the State. Consequently, Bruton questioned the security of this fund in the realm of high budget deficits at the state level.
Jonathan Tew, Legislative Director
Senator Daylin Leach’s Office, 17th Senatorial District
There is a $3B to $5B budget deficit at the State level for 2010. As a result, State aid unit values are not likely to increase in 2011. This ties into the comments made by Duda, who suggested that many municipalities that used asset smoothing in their 1/1/09 valuation may likely see either higher distressed levels or lower funding ratios at their 1/1/11 valuation. Minimum Municipal Obligations for 2012 and 2013 may be an unwanted surprise because of asset smoothing.
Philip J. Fogli, CFP®, ChFC, CLU
FRS Capital Management
With DROP, there are implications to both the municipality and the officer, Fogli said. It is not a foregone conclusion that DROP plans are financially beneficial to the officer. DROP money must earn a substantial and consistent rate of return to equate to the reduced pension and survivor benefits the officer and spouse would realize after several years in a DROP program.
Additionally, Fogli discussed Code Section 457 Plans, which are the municipal equivalent to corporate 401(k) plans. Effective 1/1/11, municipalities can amend their 457 plans to offer the ROTH option, allowing employees to make contributions while not taking an immediate tax deduction. As a result, the money grows forever tax free and, therefore, employees pay no income tax on the money when withdrawn in retirement. It’s a good deal, according to Fogli.
Overall, the roundtable sparked lively discussion around the management of municipal pension plans. It is clear that successful investment management is only one component to a well-run pension program. It is also critical to understand the legislative environment and coordinate the plan’s asset allocation model with the actuarial assumptions used in an effort to meet and exceed the assumed rate of return and optimize the State aid municipalities receive.