July 16th 2024
LEOFF Plan 1 Restructuring – Q & A
By the Senate Ways and Means Committee: March 27, 2001
Summary
The proposed Senate 2001-03 operating budget uses a $250 million portion of surplus state assets in the Law Enforcement Officers and Fire Fighters Retirement System (LEOFF Plan 1). Under the proposal, the current LEOFF Plan I system is restructured. Current retirees and active members yet to retire continue to receive all benefits defined in state law. Surplus assets are divided between the LEOFF I members, local governments that are obligated to pay lifetime medical costs for LEOFF members, and the state. For example, employees in LEOFF paid nearly 12 percent of the plan 's contributions, so their share of surplus assets would be 12 percent. Without the LEOFF restructuring, the Legislature would be forced to cut state programs and services even further, reduce budget reserves to much lower levels, or both.
Why this proposal at this time?
How does the LEOFF Plan 1 work now?
How big is the LEOFF Plan 1 surplus?
Is the Senate budget taking money that belongs to LEOFF 1 beneficiaries?
Where do the courts stand on this kind of pension restructuring?
How does anyone know what it really will cost to pay the benefits guaranteed to LEOFF 1 retirees?
Does the phrase "plan termination" mean a reduction in the LEOFF Plan 1 benefits?
What changes will LEOFF Plan 1 retirees see in their pension plan?
Is the new LEOFF 1 retirement plan better?
Does the Senate budget plan use the entire reversion of surplus assets?
What other entities have restructured a pension system like this?
How does the recent drop in the stock market effect this proposal?
How does this change effect benefits for nonmember spouses?
Does taking these additional dollars out of the retirement surplus affect other retirement plans?
Do we have to sell at a loss or liquidate investments at the State Investment Board to do this?
Q: Why this proposal at this time?
Transferring a portion of the LEOFF surplus to the state budget benefits taxpayers because it avoids cuts to state services that otherwise would be necessary to balance the budget while keeping reasonable emergency reserves in place. Since the Governor's budget proposal was released in December, $350 million in new budget costs have been identified. Without additional LEOFF funds, some of the following programs would have to he cut in order to balance the 2001-03 budget:
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Eliminate Better Schools class size reduction funds ($80 million savings)
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Reduce medically indigent reimbursements to hospitals ($31 million savings)
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Eliminate dental and vision care for low income adults ($25 million)
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Reduce enrollments in the Basic Health Plan by 15,000 ($50 million savings)
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Eliminate funding for low-wage worker hourly pay increase ($20 million savings)
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Make across-the-board cuts in higher education ($23 million savings)
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Reduce cost-of-living adjustments for state employees and higher education employees by using a lower inflation percentage ($75 million savings)
- Further reduce General Fund budget reserves (up to $100 million)
LEOFF Plan 1 is the older of two statewide pension plans for law enforcement officers and fire fighters. The Legislature established the LEOFF Plan 1 in 1969 by consolidating various municipal police and fire fighter pension systems and transferring the members to the new state system. In 1977, the original LEOFF system (Plan 1) was closed to new members and subsequent employees became members of Plan 2. Plan 1 has 8,000 retirees and 1,400 members still working.
Q: How does the LEOFF Plan 1 work now?
The LEOFF Plan 1 retirement system is a defined benefit plan in which a member's retirement benefits are based on the member's salary and years of service. The benefits are guaranteed by the state and plan benefits are not dependent on the level of employer/employee contributions or market performance of the plan's investments. In addition to these pension benefits, LEOFF 1 members receive lifetime medical benefits, which their employers (local governments) are obligated to fund. To fund these benefits, the state has contributed about 77 percent of the amount, 11.5 percent is from employer contributions, and 11.5 percent is from employee contributions.
Q: How big is the LEOFF Plan 1 surplus?
The LEOFF Plan 1 Fund includes about $1 billion more than is needed to fund benefits for current and future LEOFF Plan 1 retirees. The Plan 1 Fund currently has assets of approximately $5.2 billion based on the most recent market valuation estimate for December 2000. (The State Actuary will complete a new valuation study this summer.) Actuaries estimate that the total cost of paying benefits to current and future retirees will be about $4.2 billion.
Q: How did we get this surplus?
LEOFF 1 was created in 1970 when the state assumed responsibility for more than $100 million of unfunded liability from local government police and fire pension plans. Since then, funding LEOFF 1 primarily has been a state responsibility. Over time, the state has contributed about 77 percent of its funding. Contributions earned higher than expected investment returns so that by 1999, surplus assets totaled $1 billion. Because assets exceeded liabilities of the system, all further contributions to the plan were terminated in June 2000.
Q: Is the Senate budget taking money that belongs to LEOFF 1 beneficiaries?
No. Nothing changes for LEOFF members. In fact, they get additional pension benefits - on top of guaranteed pension benefits defined by state law - and there are no more employee contributions to the system. In addition, lifetime medical benefits paid by employers - cities, counties and fire districts - are backed up by new assistance to employers that help these jurisdictions meet their obligations to LEOFF members.
LEOFF members would get every pension benefit they now receive or are owed. But they don't own surplus assets not needed to fund their guaranteed benefits. The state made by far the largest contribution to the program over the years, so the state owns a sizable share of the surplus.
Q: How much of the surplus will the state get, and how much will LEOFF members and local governments get?
In the next biennium, about $250 million would go to the state budget. LEOFF members would see a new investment of between $90 million to $ 120 million in additional benefits - as much as $12,000 each for self-directed individual retirement accounts. And $90 million to $120 million would go to a fund to help local governments provide medical and long-term care to retirees.
Q: Where do the courts stand on this kind of pension restructuring?
The courts have supported principles that guide the Senate proposal. State and federal courts have held that members of a defined benefit plan like LEOFF 1 have a right only to the promised pension benefits, and have no claim to any surplus assets. Court rulings in the past have dealt with private pension funds, however, and the Senate proposal marks the first time a state pension fund has been restructured in a way that allows the surplus to be used to benefit taxpayers. The state Supreme Court never has ruled on ownership of surplus assets in a state pension fund, although a 1956 ruling suggested that LEOFF members' claim to pension funds does not go beyond their defined pension benefits.
Q: How does anyone know what it really will cost to pay the benefits guaranteed to LEOFF 1 retirees?
LEOFF 1 members receive the most generous benefits of any pension fund in the state retirement system. Through 2040 they will have received $14 billion in benefits after contributing $267 million in total member contributions. Actuaries who determine what amount of pension funds needs to be available to pay the guaranteed benefits take into consideration expected fluctuations in the economy. The LEOFF 1 Plan currently has $5 billion in assets. Actuaries estimate the costs of paying benefits to current and future retirees will be $4 billion.
The rising costs of medical care are addressed by the Senate proposal. It provides local governments a share of the surplus to help them meet their obligation to pay the costs of LEOFF retiree's medical care.
Q: Does the phrase "plan termination" mean a reduction in the LEOFF Plan 1 benefits?
No. LEOFF Plan 1 is being restructured and improved, not abolished. Under federal tax laws, the surplus can only revert to the state if the existing plan structure is ended. The proposed legislation creates a new Restated LEOFF Plan with identical defined benefits and a substantial new defined contribution benefit, with design being placed in the hands of the affected LEOFF Plan 1 participants. The legislation expressly prohibits any action that would jeopardize the defined benefits and the state remains constitutionally bound to insure the integrity of the new LEOFF plan. No future employee or city employer contributions can ever be required. The reduction from the state's reversion cannot be made unless adequate funds remain in the reserve to address any actuarial cost fluctuations in the restructured LEOFF plan.
Q: What changes will LEOFF Plan 1 retirees see in their pension plan?
All members of the LEOFF Plan 1 pension system will be transferred to a new Restated LEOFF Retirement System, which includes a defined benefit plan that exactly duplicates the provisions and benefits of the original LEOFF Plan l system, plus a new defined contribution plan that provides additional benefits. The defined benefit component is fully funded by a transfer of sufficient assets from the old Plan l fund to guarantee the actuarial soundness of the new plan, with no further contributions required from employers or employees.
Q: Is the new LEOFF 1 retirement plan better?
Yes. In addition to the defined benefit plan that continues the existing benefits of LEOFF Plan l, the new defined contribution plan will distribute 12 percent of the plan's surplus assets (between $90 and $ l 20 million) among the individual members of the plan, through a self-directed retirement plan that will be designed by a council consisting of LEOFF Plan l members. Within the distributed funds, the council can design a customized plan based on the preferences of the members. This new benefit is in addition to the existing Plan l benefits.
Q: Does the Senate budget plan use the entire reversion of surplus assets?
No, even though it would be entitled to do so from a legal point of view. While the historical contribution levels to LEOFF Plan l Fund reflect the substantial financial obligation undertaken by the state to eliminate large, previously unfunded liabilities, only 77 percent of the fund is attributable to state taxpayers. Of the remaining 23 percent of contributions, l 1.5 percent is from employer (local governments) contributions and l 1.5 percent is from employee (police, sheriffs, and fire fighters) contributions. The Senate restructuring proposal respects these historical contribution percentages. Assets of the Plan l Retirement Fund that are surplus to the actuarial needs of the defined benefit plan of the Restated LEOFF system, are distributed to three new funds as follows:
- LEOFF Defined Contribution Plan (12 percent of surplus assets or
between $90 and $120 million) that will fund self-directed individual
retirement accounts for each active member and retiree of the former
LEOFF Plan l system.
- LEOFF Medical Benefits Risk Pool (12 percent of surplus assets or
between $90 and $120 million) assists local governments in providing
medical benefits and long-term care for LEOFF l retirees.
- State Surplus Assets Reserve Fund (76 percent of surplus assets or between $600 and $750 million) consists of the remainder of the LEOFF Plan l assets, to be used to guarantee the actuarial soundness of the Restated LEOFF defined benefit plan (in case of any adverse actuarial experience) and to provide a budget reserve for state government.
Q: What other entities have restructured a pension system like this?
Several local government pension plans, including the Anchorage, Alaska Police and Fire System, and the West Palm Beach Fire Fighters Plan, have terminated plans that had surplus assets and arranged for the sharing of the surplus between the plan sponsors and the plan members. It is our understanding that several other states have begun to review this option, and that some large nonprofit organizations, including the American Red Cross, have terminated over-funded defined benefit pension Plans.
Q: How does the recent drop in the stock market effect this proposal?
While recent volatility in the stock market will affect the total value of the existing Plan I fund, it will not reduce the amount of money required to be deposited in the new fund to guarantee the existing benefits. Any drop in the stock market may affect the amount of surplus remaining after the new plan is fully funded.
Q: How does this change effect benefits for nonmember spouses?
The new restated LEOFF system does not eliminate any benefits to be received by members' spouses or children. In addition, they will be eligible to participate in the new benefits of the defined contribution plan to the same extent they participate in the current plan. The net result is increased benefits for all members and beneficiaries.
Q: Does taking these additional dollars out of the retirement surplus affect other retirement plans?
Other retirement systems are not affected. This proposal does not affect the state's retirement systems for teachers, state employees, or Plan 2 of LEOFF. LEOFF Plan 1 is the only state retirement plan that is closed to new members and has a substantial surplus.
Q: Do we have to sell at a loss or liquidate investments at the State Investment Board to do this?
No. The assets necessary to fund the new LEOFF system will be transferred from the old system, without liquidating the investments. A portion of the reverted assets may be sold during the next several years, however, to meet the state's cash needs or to make distributions to the beneficiaries of the new defined contribution plan.