“Change is inevitable”…
After last weeks run-in with HB 303, we might review the overall challenge to FRS Participants. Judging from the amount of media coverage the Florida Retirement System is receiving, it is not a question of whether there will be changes made, but a question of what change and how much. Our newly inaugurated governor, Rick Scott, has made it very clear that he believes FRS is a “ticking time bomb”. Last year’s legislative session included over 35 bills introduced to make changes at FRS, and we can speculate that those proposals might simply be foreplay for this session’s action. Governor Scott has announced he will make his recommendations known by February 4th.
The Florida League of Cities has waged a full scale war against your Pension. Representatives and Senators from both parties, from Senate President Mike Haridopolis, a Republican, to Senator Jeremy Ring, a Democrat and chairman of the Senate panel that is considering the changes, are out to change the Florida Retirement System. Senator Mike Bennett announced his intention to introduce legislation to make sweeping changes months ago (See Is Florida Paying Former Employees too much). Florida Tax Watch has recommended far-reaching changes of the Florida Retirement System
Why is this such a major issue all of a sudden? As of the FRS Annual Report from June 30, 2008, the Pension Trust was slightly “overfunded”. When Lehman Brothers went bankrupt in September and created a financial panic, the assets in the plan dropped significantly, and the fund became “underfunded” for the first time in 11 years. As of the most recently published annual report, for the period ending June 30, 2009, the fund was only 87.5% “funded”, with some $96.5 billion. According to the MyFRS website, as of December 31, 2010, the FRS pension assets were up to almost $124 billion. That is putting the fund assets back on par with where they were in 2008 when it was fully funded, and is a gain of some $30 billion since the 87,5% funding report . According to the FRS and SBA Annual reports, the amounts are as follows:
2006 $116 billion overfunded
2007 $134 billion overfunded
2008 $124.8 billion overfunded
2009 $96.5 billion 87.5% funded.
2010 $123.9 billion ???
Obviously the financial markets rebound has had a positive impact on the fund. Lawmakers, particularly those claiming the fund is a ticking time bomb, should disclose what constitutes a fully funded FRS and be able to support the logic behind the number, because it is this number that will drive any change being considered. If the fund is close to being fully funded why not just let the markets continue to improve the fund without drastic cuts to those who relied on this benefit.
In order to influence decision making, it is essential FRS participants understand the various proposals, as well as the potential outcomes of those changes. The following is our best effort to outline the history, changes, and what it all might mean to you.
During the early 2000’s, the FRS Trust funds regularly had positive investment returns which exceeded the actuarial targets and the Pension Plan had surplus funding (over funded). During those years, the legislature kept contribution rates into the plan below the actuarially determined rates deemed necessary. Unfortunately, the decision to underfund the FRS Trust Fund by the legislature during better economic times has resulted in the need for more taxpayer dollars to be invested into the plan during this period of recession and hard economic times. In addition to a conscious decision by legislators to underfund the plan, they also expanded the eligibility in the “Special Risk” categories to job descriptions above and beyond the original jobs of Law Enforcement, Firefighters, and Correctional officers, further adding to the funding requirements (FRS Pension Summary Plan Description, pp 1-2).
In 2008, when the financial markets bordered on a meltdown, the assets in the FRS Trust funds took an extraordinary hit, losing almost 20% in one year. That downfall led to the plan being underfunded for the first time in many years. Now, two years later, much of that shortfall has been regained (See the SBA 2010 Investment Report), but it appears the legislature is using that underfunding as the catalyst to cut benefits to FRS participants.
Governor Scott has indicated in a recent interview that he believes the earnings assumptions the SBA uses are unrealistically high. FRS uses an expected return on its investments of 7.75%, which is down from 8%. We can track the returns FRS has achieved as far back as 1975 from the SBA Annual Investment Report. You will notice that in the 36 years shown, there have been 28 up years (a +14.25% avg.), of which 22 (or 79% of all up years, and 62% of ALL years) have exceeded the 7.75% target return (exceeded by an average of some 6.5%) , and only 8 years have had negative results (avg. -5.79%). 28 up years at 14.25% and only 6 down years at a -5.79% average. Thats batting .777, which looks pretty good to me! Is the newly elected Governor suggesting we change a long term, highly successful investment strategy because of one bad year.
FRS returns have averaged over 9% per year. That would seem to indicate the SBA is doing a darn good job of managing the assets for the FRS. It would also indicate that 7.75% is realistic, and contrary to Governor Scott’s opinion. The SBA reduced the actuarial return target to the current 7.75% last year from 8% to reflect the lackluster performance in the last decade. While the result of that move should make FRS investment returns achievable, it had the dubious effect of increasing the amount of underfunded liabilities in the short term.
The benefit to further reducing the actuarial target is difficult to understand. By reducing the actuarial target of expected returns FRS is able to achieve, as the Governor suggests, it would increase the amount of money that must be put into FRS, and the underfunding issue becomes more real. Funding of the Pension plan comes from employer contributions and investment returns. If actuarial targets for investment returns are reduced, the only way to keep funding inline would be to cut benefits, or increase contributions. In this environment, the legislature doesn’t want to increase contributions, so they are looking to benefit cuts. It is also important to consider that “funding” is a 30 year process. Perhaps the legislature should consider using longer term results for setting a realistic return rather than be arbitrary about setting a number too low and impacting the fund negatively. Decreasing the actuarial target will not solve anything. The chaos of the short term financial panic of 2008 doesn’t seem to be the best benchmark.
A bigger question that comes to mind is just why the legislators feel FRS is a ticking time bomb. Yes, after the financial crash of 2008, the previously overfunded plan became underfunded, at least for the time being. Much of that underfunding has been made up over the last 2 years. According to accepted criteria for a well funded pension plan, FRS is still in great shape, and is heralded as one of the best Pensions in the nation. Why is the legislature using short term issues to make long term remedies?
With that in mind, let’s take a look at some of the other proposals being tossed around:
Employees contributions of up to 5% of their paychecks into their FRS pensions. Contributing to your own retirement is not in and of itself a bad thing. Employee contributions may also have the added benefit of making your pension more of a contractual plan, a plan that might not be as easy to change from a unilateral position on the side of the legislators. Unfortunately an employee contribution is the same as a pay cut. Since there has been a lack of pay increases over the last several years, and the likelihood that there will be no pay raises in the foreseeable future, it is a change that will hurt. Furthermore, the contribution into FRS is by legal statute at 9% (regular 22% special risk). If the state reduces the amount of the employer contribution by an equal amount, it will provide some relief to the municipalities’ and state budget problems. It will not, however, despite the comments of some legislators, help any pension funding shortfalls at the state level. Employee contributions will simply transfer pension costs from the employer to the employee, and the net amount going to the FRS will remain the same.
“Smoothing” the calculation of Average Final Compensation (AFC). Currently, AFC is determined by the highest five years compensation, including overtime and sick pay. Last year a bill was proposed that would make the AFC calculation the average of all years of compensation instead of the high five years. Smoothing will reduce the average pension to every participant significantly, literally almost cutting your pension in half. Obviously this would have a significant impact on taxpayers and FRS participants. We have been unable to find any plans that use more than five years for AFC calculations, many use only three, so five years would appear to be a fair basis for the calculation. A change of this magnitude would be a direct conflict with the benefit package that you were promised when you went to work for the government.
Eliminating Overtime and Sick Pay from the AFC calculation. It allows an employee to boost their final compensation by concentrating OT in the last 5 years of employment. Eliminating the use of overtime and unused sick and overtime pay could have a dramatic impact on your Average Final Compensation. It might be a better practice if FRS were to “smooth” the overtime over a longer period of years. That way, credit would be given for overtime, but it would be calculated on a more realistic basis, by using the average overtime worked for every year, and then applied to the last five. It is confusing to me as to how compensation earned by working overtime should not be used in determining your Average Final Compensation, as it IS compensation. Again, this is a departure from the promises made upon employment.
Raising the retirement age from 60 to 63 (from 55 to 60 for special risk). In conjunction with this proposal, the years of service needed to retire could go from 30 years to 33, and 25 years to 30 for special risk. Obviously, this is not something FRS participants want to see happen, especially if you are on the waning part of your career. I suspect the legislative logic has to do with what has occurred with Social Security. When Social Security was started, you had to be 65 to collect, and the average life expectancy in the US was about 67. Now, it is still 65 (or 66), and the average life expectancy in the US is over 78. What was designed as a two year benefit has swelled to a 13 plus year benefit. Obviously the math won’t work. It is a similar situation for FRS. The average life expectancy is growing, but the number of years worked is not. If the legislators are going to raise the retirement age, it should be done on a long term, graduated scale, so that those of you who are looking forward to retiring in the near future, don’t have those plans crushed.
Drop the DROP (Deferred Retirement Option Program). This will not be a popular decision, but might be one of the few proposals that actually could make some sense. DROP was created to keep experienced employees from retiring when they hit their 30 years (25 for special risk). By offering the DROP, employees were incentivized to put in up to an additional five years. In the current environment, where downsizing is prevalent, it is an expensive option for FRS to offer. A sister proposal would be to reduce the interest rate paid on the DROP account. As you know, this proposal was snuck in at the last minute for last season’s legislative session. The proposal may have been fair, but the way it was slipped in wasn’t, and for that reason, and due to public (you) outcry, Governor Crist vetoed the bill. With interest rates substantially lower than they were when the DROP was started, it makes sense to make it better reflect current rates. For additional info please visit (FRSOptions discussion of a rate DROP). If you started you employment with the government after 1997, the DROP was an option you were promised, and if they eliminate it, it is just another broken promise by the state.
Indexing the COLA (Cost of Living Adjustment). This will hurt, but also might make sense. Since (at least by government measure) inflation hasn’t been averaging 3% for quite some time, it is logical to index COLA to an index reflective of inflation, like the Consumer Price Index (CPI). The automatic 3% is one of the nicest perq’s in FRS. A $30,000 per year pension grows to over $50,000 per year after 20 years. While indexing will (theoretically) allow you to keep up with inflation, it could have a real negative impact on your pension over time. Indexing COLA will also have a negative impact on how your actuarial Lump Sum Present Value would be calculated, as currently the 3% per year ads considerably to what is actuarially paid out over your life time.
Eliminate Double Dipping. Once again, it is hard to argue the legitimacy of being able to retire, collect a benefit and then go back to work at the same or similar job and get paid. While FRS has cut back on re-hire time periods, it may well be tightened up even more. It might be tough to eliminate double dipping altogether, as many people may well need to work, and legislating away one’s ability to make a living in the best manner possible would be hard. Eliminating the DROP would go a long way to doing away with this problem, so you might see that proposed this session.
Narrow the definitions of service classes, and the service credit given. As mentioned earlier, the special risk category has been expanded considerably over the years. Originally, it was specifically Cops, Fireman, and Corrections officers. It now comprises a myriad of additional job descriptions. While it is not my place to make a judgment of who does or doesn’t deserve the credit, it was designed for those who “put their lives in harm’s way” and had a real threat of death. You might well see it revert back to those definitions. There has also been proposals that would reduce the special risk credit to 2% from 3%. Since special risk still only comprises 10 or 12% of FRS participants, the saving here would not be great, and the moral issues it might create would be great. As a tax payer, I would prefer special risk positions to be given a priority in order to continue to attract good people. Senator Mike Fasano has already proposed bill SB 290 that would reduce the credit for judges and elected officers to 2%. While it will make for good sound bites to say he cut his own pension first, it would be a safe presumption that the average legislator is not counting on his FRS pension to the same extent as you are.
Raise vesting requirement back to 10 years. There is not much to say about this one. The original plan called for 10 years vesting (when you have earned a benefit), and it was reduced to 6% about 10 years ago. It is one of the less painful changes called for, but also will save a smaller amount of money.
And the biggie, Eliminate the Pension (Defined Benefit, or DB) and replace it with a Defined Contribution Plan (DC) similar to a 401-K plan. This would be huge. It might not immediately save municipalities on the cost aspect up front, but it would totally eliminate any “under-funded” issues forever. Actuarial calculations would go away. Your retirement would be based on how much money was contributed over your career, and the investment returns that money earned over the years. It places all of the risk on you, and takes all of it away from FRS. In my experience working with FRS participants, it is fair to say that many of you took the job in large part because of the generous pension. The private sector has already embraced this change. 15 years ago, 78% of corporations offered a pension; that number is down to 21% today. After seeing the pension issues of large and old companies like GM, it is an easy change for a private company to make. Pensions in the private sector are a benefit, while most public employees view it more as an entitlement they earn in exchange for lower pay. Less pay, better benefits has been a public service mantra forever. Eliminate the benefits, and one can guess the quality of employee will suffer. Another Con is a defined contribution plan is primarily funded by the employee (read that as a smaller paycheck), with a partial matching contribution from the employer. Again, this shifts the primary costs and the responsibility for your retirement to you.
In summary, are all of the proposed changes being driven by fact or political pandering. I believe it is safe to say changes will be made, and your input and views will help shape how the change is legislated. It is questionable whether there is a need for any changes, but that might not matter. The legislators have some very tough budget issues to solve, and the Florida Retirement System is the low hanging fruit for their easy picking of money to fund other areas. Many of our readers question how these changes can be legal, and hint at lawsuits if the state changes their benefits. Florida statutes 121.011, paragraph 3, part a states
PRESERVATION OF RIGHTS.—(a) the rights of members of the retirement systems established by chapters 122, 238, and 321 shall not be impaired, nor shall their benefits be reduced by virtue of any part of this chapter,
I am not an attorney, so I can’t say for sure what that means, but it looks to me like the benefits were meant to be secure. A problem I foresee; the statutes are created, deleted, and changed by the Florida Legislature, so I suspect if the language prevents change, they will simply change the language. ERISA, established by Congress to protect pension plan participants, does not cover the Florida Retirement System.
Nationally, many states have significant problems – Florida is not one of those. Unfortunately, the media propaganda has worked overtime to paint a picture of public pensions leading to those financial problems. Public employees, particularly special risk, have been stamped public enemies for their high salaries, and “exorbitant” pension plans. The “millionaire Cop next door” is on everybody’s lips. Accuracy has never been the strong point of our media, nor our legislators (see FRSOptions posts “Is Florida paying former employees too much”, and “Fact or Fiction?”), but the reality is, if people hear it enough, they will believe it. The reality is, had the various state legislatures appropriately legislated and funded their spending, as well as funding pensions as needed, these actions would not be necessary. Governor Scott plans to run the state like a business (corporate raider??), which could be good for all of us as citizens and taxpayers. It may not be easy, as he will not have the autonomy he enjoyed as a corporate CEO. It most likely will not be good for FRS participants.
Last year you demonstrated, if you join together and bury the legislators with calls, letters, and emails, you will make a difference. You are 650,000 plus strong, and can be heard. Educate yourself, and don’t fall victim to rhetoric. Let your legislators know what you know and that you know, and TELL them how you want them to act to best represent you, after all, that is their job.
- Question if the fund is really “underfunded”
- Reducing the employer contribution and shifting it to the employee does nothing to make the fund more fiscally strong.
- Changing benefits for those already in the system is wrong, unfair and unnecessary.
- Whether you are willing to accept reasonable changes to such things as guaranteed rates of return when the market doesn’t support those conditions.
- And most important of all, you want your legislator to address real problems not ones made up to support a political agenda. There is plenty of pork in the budget that could/should be eliminated before you start cutting earned pensions!
The information and opinions in this post are presumed to be accurate. FRSOptions is not affiliated with the Florida Retirement System, and our opinions are not endorsed nor supported by FRS. FRSOptions does not provide tax , legal, nor investment advice. Please check with a financial advisor in regard to your personal situation before taking action based on information contained herein.