Model Legislation: Retirement Plan Financial Management

Stronger laws would optimize OPEB plans and benefits bonds.
February 12, 2009 AT 3:00 AM
Girard Miller
By Girard Miller  |  Finance Columnist
The finance columnist for Governing.

In the last month I've worked in several states with local officials who are seeking legislative changes to run their retirement plans better. As noted in my previous column on OPEB legislation, many states lack clear or proper authority to fund, finance and invest for retiree medical plans ("other post-employment benefits"). I've also discovered that in some states, well-intended legislation has inadvertently authorized inefficient issuance of OPEB bonds in deals seeking primarily to gain additional taxing authority by gaming the system. In a few cases, the resulting transactions are little more than a sham on the taxpayers.

And now that my thoughts on the new paradigm for benefits bonds have circulated via Governing's e-newsletters, readers have pointed out that several states' pension laws make it difficult or impractical for the new paradigm to work optimally because they are limited in their ability to invest in stocks by state law. In Michigan, for example, the maximum allowed for equities is 70 percent of assets. In Illinois, most police and fire pension funds have even less authority to invest in equities, which makes a pension obligation bond issue very impractical for them because they would be selling bonds mostly to buy bonds -- a gross inefficiency that makes them prey to disingenuous financial strategies. In New Jersey, there is virtually no enabling statutory authority, so new legislation is much needed.

To help guide local officials, retirement administrators and public finance professionals working to accomplish legislative changes, I drafted model legislation to strengthen local government retirement plan financial and investment authority. It covers both pension and OPEB plans, to provide for taxing authority (as allowed by law), bonding/borrowing authority, and improved investment authority. This model language represents my personal, lay (non-attorney) views based on practical professional experience. Like my other columns, this text does not represent the opinions, policies or work product of any organization with which I am associated. As model legislation, it should be reviewed and redrafted by competent counsel in each state where it is considered. Benefits and bond counsel with state-specific legal expertise and experience should be consulted when professional associations undertake to introduce specific legislation.

This model language provides for the following:

o Authority to establish defined-benefit, defined-contribution and hybrid plans, without abrogating any statewide pension systems.

o Authority to provide for trust funds that will meet GASB 45 requirements for OPEB, while giving employers the ability to collapse them if national health care or similar legislation changes the rules of the game.

o Authority to change benefits provisions going forward, subject to collective bargaining.

o Authority to sell bonds to fund pension and OPEB plans, but not more than necessary to fund 85 percent of the total accrued actuarial liability -- to avoid creating "overfunded" plans in the future by over-issuing debt. Such bonds would be exempt from statutory debt limitations to the extent they are re-characterizations or re-financings of pre-existing actuarial obligations.

o Authority to levy or impose taxes (subject to constitutional or charter constraints where they apply) to fund existing benefits obligations properly, whether by actuarial amortization or by benefits bond issues. This supplemental tax authority will empower some local governments not otherwise able to properly fund their current benefits promises, while also requiring a vote of the electorate for future tax increases under this section of the law.

o Authority to establish a pension obligation bond (POB) or OPEB obligation bond (OPEB-OB) trust separate from a pension or OPEB fund, with restricted powers to protect bondholders and taxpayers, and the authority to invest all or some of the bond proceeds entirely in equities if prudent in order to minimize the volume of benefit bond issuance. The master trustees or an independent investment adviser must determine if such action is prudent.

o Air cover for the actuaries to include benefits bonds trust assets in the valuation, so employers don't have to shuffle money from one trust unnecessarily or relinquish authority to deploy special-trust assets for debt repayment.

o Several other bondholder- and taxpayer-friendly provisions to prevent funding abuses that may not be politically feasible in some state legislatures. These ideas should be discussed when developing state-specific legislative proposals, especially when bonds or increased taxes are authorized: (a) limitations on benefits increases and over-extensive actuarial amortization of unfunded liabilities; (b) controls on retroactive benefits increases; (c) a special clause to guide arbitrators when they are considering benefits increases that greatly exceed the prevailing benefits in the local private-sector labor market just "because there is money available"; and (d) a requirement that excess assets be amortized to reduce taxpayer costs and not awarded for other purposes such as benefits increases, as long as such debt is outstanding or taxes are increased to pay for benefits.

Over time, I will post updates and revisions as readers provide suggestions for improvement. This way, the model will become a living document that grows with experience and application. State professional associations seeking technical help in drafting or advancing similar legislation are welcome to ask me for assistance. As noted above, I strongly encourage that state-specific drafting sessions include experienced bond counsel and perhaps a benefits attorney as well.

Model Legislation for Public Retirement Plan Financing

This bill shall be known as the

Local Government Retirement Plan Sustainability and Financial Powers Act

Findings: The legislature determines that supplemental powers are needed by local governments throughout the state to:

(a) properly fund, operate and manage their pension and other post-employment or retirement benefits plans including retiree health care arrangements previously promised to employees and retirees, and

(b) protect and balance the rights and interests of employees, retirees and taxpayers in the future by assuring the systematic financing of retirement and benefits plans.


Except where expressly prohibited by constitution or charter, a local government or political subdivision including any city, county (or township, town, borough, etc.), school district, community college, special district or authority may undertake and perform any of the following activities in addition to any powers otherwise authorized by law:

Section 1. (General retirement plan authority) Create, join, fund and operate a defined benefit or defined contribution retirement plan or combination thereof for the benefit of its employees, with functional and investment powers determined in writing by the local government as otherwise permitted by law or this act. Such plans may include pension plans, retirement savings plans, retiree medical benefits plans and other post-employment benefits plans and may be referred to hereafter as retirement benefits plans. This section shall not, however, supersede or abrogate the obligations of a local government to continue its participation in any state-operated retirement system.

Section 2. (General trust authority and investment powers) Establish or join a trust for the funding and payment of retirement benefits, retiree medical benefits and other post employment benefits with the same investment powers as public pension funds, endowment funds or other retirement trust funds allowed by law. (If necessary, cite statutes; alternatively, the ERISA prudent person language could be authorized as the general investment law, if the sponsor believes that attainable.)

Section 3. (Broad taxing authority to properly fund pre-existing obligations) (Subject to constitutional or charter limitations established by vote of the people.) Raise sufficient taxes without limitation as to amount, to pay for retirement benefits obligations earned by its employees and retirees prior to (the date of the introduction of this bill). This taxing authority includes the power to raise sufficient funds to (a) properly finance the repayment of debt obligations issued hereby to reduce a retirement benefits plan's accrued actuarial liabilities and (b) to make employer contributions for the actuarially determined amortization of any remaining unfunded liabilities incurred heretofore. Such supplemental taxing authority shall not apply to benefits earned by employees or increased after (the date of the introduction of this bill -- to discourage subsequent retroactive benefits increases).

Section 4. (Bonding authority) Issue bonds, notes, certificates of other evidences of indebtedness, without limitation in amount, to fund investments held in trust for the eventual payment of unfunded retirement obligations incurred at the time of issue. No more than 85 percent of a retirement benefits plan's most recently determined total accrued actuarial liabilities at the time of issuance may be funded hereby through the issuance of new debt obligations without a vote of the electorate, except for a refunding debt issue which reduces total debt service costs on a present-value basis. Retirement benefits increases awarded or approved after (the date this bill is introduced) may not be funded with new debt obligations without a vote of the electorate. Debt obligations issued pursuant to this section to finance actuarial obligations outstanding at (the date of introduction) shall be excluded from all statutory debt limitations because they are recharacterizations of existing obligations.

Section 5. (Special-purpose trusts for debt proceeds) (a) (i) Establish separate trusts for monies raised through the issuance of debt for the purposes of improving the funding of any retirement benefits plan and protecting the interests of taxpayers and bond investors Such trusts may provide independently for the investment and disposition of such debt proceeds.

(ii) Notwithstanding any other limitations on investments under law, the authority under this section (5) shall include the necessary powers to invest all such monies held in such separate trusts in part or entirely in common stocks managed professionally, registered stock index funds, and any other securities or investment vehicles otherwise authorized by law for the investment of trust funds or pension plans.

(iii) Trust funds authorized under this section (5) may be invested in any assets permitted herein without limitation as to proportions or percentages, subject to provisions in the trust agreement or written investment policies. The issuer of the debt obligations, or a professional financial adviser, shall determine in writing the trust's investment allocation guidelines or limits as appropriate to minimize the volume of debt required to achieve its objectives and may specify the maximum or minimum allocations for specific asset classes within the trust, taking into account the associated plan's total asset allocations and other appropriate investment considerations including the use of debt proceeds.

(iv) Trust investments shall be made in accordance with written policies which require prudent oversight by the trustees or their agents upon the recommendation, or at the discretion, of a registered investment adviser.

(v) The special trust investment powers authorized by this section (5) shall not extend to other retirement plan trust funds unless otherwise provided by law.

(b) At the direction of the local government plan sponsor, the actuarial valuation of a pension or retirement plan shall include such separate debt-financed trust funds as a valuation asset for the entire plan, subject to the actuarial reduction for any reserves for debt repayment that the trust agreement or the trustees may establish. The actuarial valuation shall not be diminished by the source or location of trust assets or whether the trust is governed by independent trustees.

(c) To assure prudent oversight of such a trust, the majority of its trustees shall be qualified on the basis of financial or investment training and experience, and may not be beneficiaries of the plan. No trustee may vote on a proposal that affects his or her benefits personally and directly, including a plan design or benefits change or a discretionary decision to transfer assets to a benefits plan which would thereafter increase his or her benefits, and such trustees shall be barred by law from receiving any resultant increase in benefits approved while serving as a trustee on an approving body.

(d) Such trusts may provide for reserves in anticipation of possible future market fluctuations.

(e) Such trusts may permit, authorize or provide for (i) transfers of trust assets, including securities in kind, to a pension or retirement benefits plan, (ii) payments to a pension or retirement benefits plan in lieu of, or in addition to, the employer's actuarially required contributions, and (iii) the direct or indirect repayment of the associated debt obligations including advance repayment or defeasance of such obligations.

Section 6. (Clear authority to tier and change benefits prospectively) Establish different benefit levels and types of benefits for employees based on their date of hire or their age, and change the benefit formulas or provisions of incumbent employees for services performed after the date of the plan modification, subject to collective bargaining where required by law.


To assure the equitable allocation of costs of public employee benefits between generations of taxpayers and employees, the legislature further requires that for any local government that levies supplemental taxes pursuant to this act or has outstanding debt obligations authorized hereby:

a. Retroactive and prospective pension benefits increases: cost recognition. Before awarding retirement benefits increases, prospectively or retroactively, the governing body shall be presented in public with a full actuarial analysis of the accrued and future annual expenses, including the present value thereof and the annual projected costs for the entire amortization period. Any retirement benefit increase awarded retroactively shall be accounted for and funded in the year awarded and not amortized, unless active employees bear at least one-half of the incremental amortized actuarial cost, or the benefits increase or a deferred amortization plan is approved by the electorate.

b. Amortization of unfunded benefits. The actuarial amortization period for unfunded employee benefits shall not exceed the expected service lives of active employees or the expected lives of retirees, respectively.

c. Arbitration considerations. In making arbitration decisions, an arbitrator shall consider the extent to which nongovernmental employers in the employer's immediate labor market provide comparable pension and other retirement benefits to employees in similar or comparable occupations.

d. Reserves and use of surplus. As long as plan-associated debt principal remains outstanding or increased taxes are levied hereby, any surplus of benefits plan assets in excess of accrued actuarial liabilities shall be (i) held as a reserve for capital market fluctuations or (ii) amortized as a reduction of employer contributions over such period as the actuary shall determine appropriate under those circumstances, or (iii) used for repayment of the associated debt obligations; and such assets may not be used for any other purpose.

Girard Miller
Girard Miller | Finance Columnist |