RETIREMENT SYSTEMS FORPUBLIC EMPWYEES

PENSION RESEARCH COUNCIL PUBLICATIONS

Concepts ojActuarial Soundness in Pension Plans. Dorrance C. Bronson. 1957.Continuing Care Retirement Communities: An Empirieal, Financial and Legal

Analysis. Howard E. Winklevoss and Alwyn V Powell, in collaborationwith David L. Cohen and Ann Trueblood-Raper. 1983.

Corporate Book Reserving Jor Postretirement Healtheare Benefits. Edited byDwight K. Bartlett. 1990.

An Economic Appraisal oj Pension Tax Policy in the United States. Richard A.1ppolito. 1990.

The Economics oj Pension Insurance. Richard A. Ippolito. 1989.Employer Accounting Jor Pensions: Analysis oj the Financial Accounting

Standards BOal·d's Preliminary Views and Expom"e DraJt. E. L. Hicks andC. L. Trowbridge. 1985.

Fundamentals ojPrivate Pensions, Sixth Edition. Dan M. McGill and DonaldS. Grubbs. 1988.

Inflation and Pensions. Susan M. Wachter. 1987.It's My Retirement Money, Take Good Care ojIt: The TIAA-CREF Story. William

C. Greenough. 1990.Joint nust Pension Plans: Undentanding and Administaing Collectively

Bargained Multiemployer Plans under ERISA. Daniel F. McGinn. 1977.Pension Asset Management: An International Perspective. Edited by Leslie

Hannah. 1988.Pension Mathematics with Numerical Illustrations. Howard E. Winklevoss.

1977.Pensions, Economics and Public Policy. Richard A. Ippolito. 1985.Proxy Voting oJPension Plan Eqllit\· Secw-;ties. Planned and edited by Dan M.

McGill. 1989.Retirement Systems Jor Public Employees. Thomas P. Bleakney. 1972.Retirement S~stems in Japan. Roben L. Clark. 1990.Search Jor a National Reti"ement Income Policy. Edited by Jack L. VanDerhei.

1987.Social Investing. Edited by Dan M. McGill. 1984.Social Sewrity and Private Pensions: Competitive or Complementary. Planned

and edited by Dan M. McGill. 1977.

Retirement Systems forPublic Employees

THOMAS P. BLEAKNEY, F. S.A.Consulting Actuary, Milliman and Robertson, Inc.

Published by the

Pension Research Council

Wharton School of the University of Pennsylvania

Distributed by the

University of Pennsylvania Press

Philadelphia

© Cop.yright 19721ry the Pension Research Council of the Wharton School ofthe University of Pennsylvania

Fifth printing 1991 by the University of Pennsylvania Press

All Rights Reserved

Library of Congress Cataloging-in-PubJication Information

Bleakney, Thomas P.Retirement systems for public employees, by Thomas P. Bleakney(Pension Research Council Publications)Published for the Pension Research Council, Wharton School of the University

of Pennsylvaniaxvii, 205 pp. 23 emIncludes bibliographical references and indexI. Local officials and employees- United States-Pensions. 2. Local officials

and employees-Canada-Pensions. 3. Civil service pensions- United States­States. 4. Civil service pensions-Canada-Provinces. I. Title. II. Series.JS361.B53 72-90774ISBN 0-256-01407-8 CIP

ISBN 0-256-01407-8

Printed in the United Stales of America

CIP

PENSION RESEARCH COUNCIL

DirectorJERRY S. ROSENBLOOM, Chairman and Professor of Insurance, Wharton

School, University of Pennsylvania

Associate DirectorDWIGHT K. BARTLETT, III, F.S.A., VisiIing Executive Professor of

Insurance, WharIon School, University of Pennsylvania

Founding DirectorDAN M. MCGILL, Chairman Emeritus and Frederick H. Ecker Professor of

Life Insurance, DeparIment of Insurance and Risk Management,WharIon School, University of Pennsylvania

Vincent Amoroso, F.S.A., Principal, KPMG Peat Marwick, Washington, DCZvi Bodie, Professor of Finance and Economics, School of Management,

Boston UniversityGeorge W. Cowles, Senior Vice President, Bankers Trust, New York CityGary I. Gates, Secretary, DeparIment of Employee Trust Funds, State of

Wisconsin, MadisonMichael S. Gordon, Esq., The Law Offices of Michael S. Gordon,

Washington, DCDonald S. Grubbs, Jr., F.S.A., Consulting Actuary, Grubbs and Co., Inc.,

Silver Spring, MDRonald S. Keller, Senior Vice President, The Principal Financial Group, Des

Moines,IARaymond S. Lauver, Member of the Board, Financial Accounting Standards

Board, Norwalk, CTJudith F Mazo, Senior Vice President and Director of Research, Martin E.

Segal Co., New York CityAlicia H. Munnell, Senior Vice President and Director of Research, Federal

Reserve Bank of BostonRobert] Myers, F.S.A., International Consultant on Social Security, Silver

Spring, MDGeorge] Pantos, Esq., Partner, Vedder, Price, Kaufman, Kammholz & Day,

Washington, DCjames E. Pesando, Professor of Economics, Institute for Policy Analysis,

University of TorontoSamuel H. Preston, Chairman and Professor of Sociology, University of

Pennsylvania

vi Pension Research Council

Anna M. Rappaport, F.S.A., Managing Director, William M. Mercer, Inc.,Chicago

Sylvester j. Schieber, Director of the Research and Information Center, TheWyatt Company, Washington, DC

Ray Schmitt, Specialist in Social Legislation, Congressional ResearchService, Library of Congress, Washington, DC

Richal'd B. Stanger, National Director, Employee Benefits Services, PriceWaterhouse, Washington, DC

Marc M. Twinney, fl:, F.S.A., Manager, Pension Department, Ford MotorCompany, Dearborn, MI

jack L. VanDahei, Associate Professor of Risk and Insurance, TempleUniversity

L. Edwin Wang, Past President, Board of Pensions of the Lutheran Churchin America, Minneapolis, MN

Howard E. Winklevoss, President, Winklevoss Consultants, Inc., Greenwich,CT

Howard l0nng, F.S.A., Adjunct Professor of Mathematics, University ofMichigan, Ann Arbor

PURPOSE OF THE COUNCIL

THE PENSION RESEARCH COUNCIL of the Wharton School ofthe University of Pennsylvania was created in 1952 for thepurpose of sponsoring objective research in the area of privatepensions. It was formed in response to the urgent need for abetter understanding of the private pension movement. Pri­vate pensions have experienced a phenomenal growth dur­ing the last three decades, but their economic, political, andsocial implications are yet to be explored. They seem destinedto playa major role in the quest for old-age economic se­curity, but the nature of that role can be ascertained onlyon the basis of more enlightened evaluation of the capabili­ties and limitations of the private pension mechanism. Itwas to conduct an impartial study into the facts and basicissues surrounding private pensions, under the auspices of anacademic and professional group representing leadership inevery phase of the field, that the Council was organized.

Projects undertaken by the Council are broad in scope andpredominantly interpretive rather than technical in nature.In general, attention is concentrated on areas which are notthe object of special investigation by other research groups.Its research studies are conducted by mature scholars drawnfrom both the academic and business spheres. Research re­sults are published from time to time in a series of books andmonographs.

vii

FOREWORD

THIS IS the fifteenth publication of the Pension ResearchCouncil. It represents the culmination of an effort initiatedalmost ten years ago. Recognizing the importance of publicemployee retirement systems in the total economic securitystructure and keenly aware of some major deficiencies in theirdesign and operation, the Council commissioned a study ofthis sector of the pension field in 1959. Several abortive at­tempts were made to get the study under way, but it was notuntil Thomas Bleakney was persuaded, three years ago, toundertake the task that the study began to move forward.Mr. Bleakney carried out the study in the face of formidableobstacles, with little respite from the heavy professional andadministrative burdens associated with his full-time positionwith a nationally active employee benefit consulting firm.

This study was essentially conceptual in nature, not de­signed to present a detailed quantitative profile of public em­ployee retirement systems as they exist today in the UnitedStates and Canada. Mr. Bleakney examined with a criticaleye the environment in which public employee retirementsystems operate and called attention to the prevailing con­cepts, practices, and influences that will have a material bear­ing on how these plans will fulfill their assigned mission andat what cost to the taxpayers. He points to many inadequaciesand anomalies that will have to be corrected before these re­tirement systems can be considered sound from the stand­point of either the participants or general public policy. Hecalls especial attention to the urgency of recognizing the ac­cruing cost of pension and other benefits under public em­ployee plans and the adoption of realistic fiscal policies tomeet the obligations created by these plans. The book waswritten at a level and with a focus designed to further the un­derstanding of public employee retirement systems by legis­lators and others responsible for their proper functioning.

ix

x Foreword

A native of the state of Washington, Mr. Bleakney attendedthe University of Washington, where he received his Bachelorof Science degree with a major in mathematics and statistics.Following graduation he was employed briefly in the groupdepartment of California-Western States Life Insurance Com­pany while awaiting induction into the military service. Uponrelease from the service, he joined the group department ofNew York Life Insurance Company. In 1955 he returned toSeattle to join the consulting actuarial staff of Stuart Robert­son. Shortly thereafter, when Wendell Milliman left NewYork Life to form the Milliman and Robertson actuarialconsulting firm, Mr. Bleakney accepted an invitation to casthis lot with the new organization. He has been a principal inthe firm from its inception. While he serves a wide variety ofclients, his activities in recent years have been predominantlyin the area of public employee retirement systems. He is aFellow of the Society of Actuaries, the Canadian Instituteof Actuaries, and the Conference of Actuaries in PublicPractice, and a member of the American Academy of Ac­tuaries.

The Council is very much indebted to Mr. Bleakney forhaving taken on this burdensome assignment and seeing itthrough to a successful completion. He did so at substantialfinancial and personal sacrifice. The Council is also gratefulto Milliman and Robertson, Inc. for having made Mr. Bleak­ney's services available and to the various members of the firmwho lent technical assistance and moral support to Mr. Bleak­ney. Special acknowledgment is due Wendell Milliman for hisunique contribution.

As with any other Council publication, the views andopinions expressed in the book are those of the author andare not necessarily shared by all members of the Council.

October 1972DAN M. McGILLResearch Director

PREFACE

IT WOULD BE unrealistic to expect an author to urge anythingbut the complete devouring of his creation by its readers. Itwould be equally unrealistic for any author of a work of thissort to expect any but the most devout students of the subjectto do this. As a guide for the vast majority, therefore, par­ticularly those who have legislative or administrative respon­sibilities for public employee retirement systems, I wouldurge the reading of the prologue, Chapters I and 9, and theintroductory remarks in each of the other chapters. In thecourse of this reading, points of particular interest may comeup which can then be pursued in the balance of the text.

At the end of Chapter I is a guide to the plan of the book.In brief, the plan is as follows:

Prologue and Chapter I IntroductionChapters 2, 3, and 4 System structure and benefitsChapters 5 and 6 FinancingChapter 7 InvestmentsChapter 8 AdministrationChapter 9 Summation of matters at issue

The debt lowe to my colleague, Wendell Milliman, forhis assistance in this work can never be repaid. In the firstplace, it was through him that the Pension Research Councilprovided me with the opportunity (for which, in the morediscouraging moments of this work's birth, I have read "in­flicted the burden") of discoursing on a subject I find sofascinating. Wendell Milliman reviewed and red-penciledevery page of the original draft, and his discussions of many ofthe more obscure concepts helped immeasurably. His aid wasespecially valuable for the chapters about financing, in reduc­ing to manageable size and logical order the complex mattersdiscussed.

I am also most grateful for the extensive and detailed sug­gestions given me by members of the Pension Research Coun-

xi

xii Preface

cil in their review of drafts of the text. Dr. Dan M. McGill,the Council's research director, had the least enviable taskwith respect to that review-that of directing my efforts to­ward a new organization of the material of an earlier draft.He did this with the utmost tact and patience. His guidanceand encouragement will always be appreciated.

In distributing my thanks for support in this book's pre­paration, I certainly must include my staff associates, who dida great deal of the legwork and gathered voluminous statistics,many of which were edited out in the final revisions. Amongthis group of individuals, particular thanks are due toCharles E. Dean, Jr., who reviewed the entire text and sug­gested many changes to improve the presentation.

A special place in my acknowledgments is reserved for mysecretaries, Tamara Tanner and Leah Woodruff, who, I amsure, despaired of ever seeing the end of the countless redraftsinflicted upon them in my inimitable scrawl.

Finally, a general note of thanks should be extended to allof the others who reviewed the text and gave their suggestions.Space does not permit listing them for individual remarksand appreciation, but it should be noted that I am gratefulfor their help.

October 1972 THOMAS P. BLEAKNEY

CONTENTS

Foreword

Preface

List of Tables

Prologue: The Legislative Process

I. An Overview .

The Scope of the Systems' CoverageControl of Public Systems .The Need to Know CostsThe Funding QuestionPlan of the Book .

2. The Systems and Their Membership.

Retirement Systems .Advantages of Conglomeration .Disadvantages of ConglomerationPolitical Conclusions.

Qualifying for Membership .Employment StatusAge or Service RequirementsReemployment .

Employee ContributionsAdvantages of Contributory SystemsDisadvantages of Contributory SystemsLevel of Contributions .Interest Credited on Employee Contributions .

3. Normal Retirement Benefits.

Types of Benefit Formulas.Defined Contribution versus Defined Benefit.Career Average versus Final Salary .Annuity Conversion Rates.

Benefit Entitlement . .Age Requirements.Service Requirements.Compulsory Retirement .

xiii

ix

xi

xvii

1

10

11

13I41517

18

1820212223232425262628293\

33

3437404\43444546

xiv Contents

Form of PaymentPayment for Period Certain and LifeContinuation to Surviving Beneficiary.Standard Form .Suspension During Reemployment .

Postretirement AdjustmentsNeed for Adjustments .Scope of Adjustment .Mechanisms of Adjustment .

4. The Total Benefit Structure.

Employee Rights prior to Normal Retirement.Disability BenefitsDeath Benefits .Early RetirementVested Benefi ts .

Termination of Employment without Vesting.Benefit Comparisons.

Retirement BenefitsDisability Benefits .Survivors' Benefits.Vested Benefits .

464748484950515355

61

61626467687272n767677

5. Financing-Measuring the Cost. 79

Three Ways to Measure Pension Costs 80Current Disbursements 81Projections 82Actuarial COSt Method 83

Two Actuarial Cost Methods. 84Accrued Benefit Method (Unit Credit) 85Projected Benefit Method with Supplemental Cost (EntryAge Normal) 86

Supplemental Cost. 89Actuarial Assumptions 92Analysis of Techniques of Measuring Costs. 94

Current Disbursement Method . 94Projections 95Actuarial Cost Methods in General. 95Differences in Actuarial Cost Methods. 96

Cost Comparisons . 96Cost Method . 97Actuarial Assumptions 98Employment Characteristics 99

Requirements for Employee ParticipationEmployee Contributions.Normal Retirement Date .Postretirement AdjustmentsVested Benefi ts .

Contents xv

100101102103104

6. Financing-Paying the Cost

To Fund or Not to Fund.Arguments against Funding .

Financial HardshipInadequate Investment ReturnExport of Money .InflationHazards of a Large FundGovernment's Guarantee of Benefit.Administrative Simplicity .

Arguments in Favor of Funding.Current Payment for Current Services.Protection of Employee Rights .Investment Earnings .Use of the Best Cost Measurement MethodFlexibility. '

Financing Federal Old.Age Insurance.Unfunded Actuarial Liability .Actuarial Gains and Losses. .

Effects of Actuarial Gains and Losses on Funding.Failure to Fund .Valuation of AssetsActuarial Revaluation Gains and Losses.

Employer Contribution Rates.

7. Investments

The Significance of Investment Yield .Types of Investment and Yields.

Investments of United States SystemsInvestments of Canadian Systems.Comparative Yields of Insurance Companies.

Investment Strategy and Legal Restrictions.Examples of Investment PolicyLegal Restrictions .Solvency

Political Considerations.Professional Investment Management .

106

108110110IIIIII112112112112113113114115116117118120121122123125127127

131

132134134138139140141141142143145

xvi Contents

8. Administration

Retirement Board .Administrative StaffTechnical Staff .

Actuarial .AccountingLegalMedicalInvestmentOutside Professional Help

Administrative ExpensesBenefits to Participants and their Beneficiaries.Other Administrative Responsibilities.

9. Summation.

148

148150151151152153154154154155156158

160Benefits 160

Collective Bargaining 160Ratchet Effect . 161Special Benefits. 162Employee Contributions. 163Younger Normal Retirement 164Postretirement Adjustment. 164

Vesting 165Financing and Investment. 167

The Need to Know Retirement Costs. 167Funding 168Rate of Employer Contributions. 169Economic Implications 169

General 171Social Security 172Conglomerates 175Public Pension Commissions 176

Appendix A-Glossary 179

Appendix B-Excerpts from Booklet Describing the Cali­fornia Public Employees' Retirement System. 188

Index . 201

LIST OF TABLES

I. Employee Contribution Rates, New Jersey Public Employees'Retirement System. 30

2. 1970 Consumer Price Index as Percentage of Index in SelectedYears 51

3. Employees Eligible for Full Vesting, Mid-1960s . 78

4. Assets of State and Local Retirement Systems in the UnitedStates (in billions) 1115

5. Assets of Provincial and Local Retirement Systems in Canada(in millions) . 1118

6. Composite Financial Summaries of State and Local Retire-ment Systems in the United States (in billions) . 170

xvii