Budget Watch Volume 6, Issue 2      April 2000

In March 1999, Florida TaxWatch, at the request of Senate President Toni Jennings, released a Research Report entitled "Florida's Public Employees' Pension Alternatives." The report discussed public employees' retirement plan options, including the existing Florida Retirement System (FRS) defined benefit (DB) plan and various proposals for an Optional Retirement defined contribution (DC) plan. The report compared each alternative under a series of guiding principals that considered the mutual interests of both the public employee and the public employer. The goal of the report was to provide a strategy to enhance Florida's public employers' competitive position to attract and retain a high quality workforce without adding billions of dollars in current and long-term taxpayer costs and liabilities.

While no final action was taken by the Legislature last session to offer public employees the option of choosing what type of retirement plan best suited their personal circumstance, the issue is now being considered by the 2000 Legislature. However, this year, unlike last year, there is a twist--one that would cost the next generation of Florida taxpayers billions of dollars, if implemented.

Setting the Stage

The FRS is the fifth largest public employee retirement system in the country, with more than $77.8 billion in actuarial valued assets. Formed from the combination of individual retirement systems (Teachers Retirement System, etc.), FRS now has more than 630,000 covered public employees and 190,000 retirees from almost 800 public employers (state agencies and the State University System, county governments, county School Boards, Community Colleges, special districts and city governments).

The FRS is a "defined benefit (DB)," employer-funded retirement plan. It provides a guaranteed, inflation-adjusted pension (with a survivors' benefit option) and disability income benefits. Benefits are based on an employee's "average final compensation" (highest 5-years earnings), years of service and benefit accrual rate. For "regular" class membership, the "normal" retirement age is 62, with reduced benefits at age 55, or retirement at any age (without benefit reduction) with 30 years of creditable service.

Over its lifetime, the FRS has been amortizing an "accrued unfunded liability" generated, in part, by the assumption of previous retirement systems and plans. The FRS accrued unfunded liability reached a high of $16.0 billion in 1992. Because of significant gains in the market value of FRS investments over recent years, the accrued unfunded liability in the plan was eliminated in 1998-99. Because public employer contributions were no longer required to fund the accrued unfunded liability, employer (taxpayer) contribution rates were reduced from an aggregate rate of 16.66 % to 10.55% (the "normal cost" contribution rate).

With the continued favorable stock market performance over the past year, the FRS investments have continued to increase in value to such an extent that the FRS now has an actuarial valued surplus of more than $9.2 billion (assets in excess of benefit costs).

Spend Today

A $9.2 billion surplus was just too tempting to leave alone, even though it could disappear just as fast as it appeared when the stock market declines. The Florida Senate has proposed to spend down the surplus by increasing benefits and reducing employer contribution rates. CS for SB 1026 (which passed the Senate on a 38-0 vote on April 4, 2000) is the tool that sets the raid on the FRS surplus in motion. The bill does the following:

The above enhancements come at an incredible cost to the state and local taxpayers of Florida. The first year cost alone would cost $3.4 billion, charged against the surplus. In addition, the annual 10% charged against the surplus would cost $643.0 million in each of the next twelve years until the surplus is eliminated. This assumes that the annual rate of investment return for the FRS is equal to the actuarial assumption of 8.0%. If the annual rate of investment return is less, the surplus would be eliminated sooner; if higher its elimination would be postponed.

Who benefits from this raid on the surplus? The beneficiaries are:

the 133,000 FRS member employees who are not currently vested but would become vested, either immediately, or after one additional year of employment; all FRS member employees by virtue of the high "three" verses high "five" years of service in the calculation of the average final compensation; selected FRS member employees whose service credit is increased or are moved to a higher service credit class; and employers whose contribution costs would be subsidized by using the surplus to cover a portion of the recurring cost. The latter include: the state $115 million school boards $209 million counties $98 million other $34 million

Taxpayers Pay Billions More Tomorrow

If the above enhancements were funded by employer contributions, the normal cost (as a percent of covered payroll) would be 12.06% (including an experience adjustment of 0.36% required of the FRS fund even before the enhancements). Because the surplus is being used to fund the enhancements, the effective aggregate employer contribution rate for 2000-01 is 8.63% (again, includes the required experience adjustment of 0.36%). This 3.43% reduction in the employer normal cost contribution rate is exclusively funded from the FRS surplus. By definition, when the surplus is exhausted, the recurring costs (benefit enhancements) remain, thus guaranteeing an immediate rate increase for all FRS employers, and, thus, potentially exposing state and local taxpayers to major reductions in other areas of government functions, tax increases, or a combination of these two. This will divert hundreds of millions of dollars in government revenues from existing programs annually, or worse, require tax increases.

Clearly, the Senate proposal to spend down the surplus violates many of the "Guiding Principals" for public employee retirement systems, as discussed in the March 1999 Florida TaxWatch research report. Displayed below, the highlighted principals are those in conflict with the Senate proposal.

Any retirement system must:

be market-driven (competitive)	be affordable
be funded in an actuarially sound manner	be independent of political manipulation
be portable	be easily understood (clarity)
be easily administered	be flexible
be equitable	be predictable (costs and benefits)

As a defined benefit plan (DB), the FRS entitles an employee to a certain level of retirement income based upon earnings and length of service, as determined by the employer in the plan provisions. A defined benefit system entitles an employee to a certain level of retirement income based upon earnings and length of service, as determined by the employer in the plan provisions. That income is isa variable cost, bourn entirely by the employer (and in this case, the state and local taxpayers of Florida). The variability in employer costs (contribution rates) is caused by such factors as: employee earnings, length of service and investment return. Through employer contributions and investment income and appreciation, at the end of a covered employee's employment, sufficient funds may be available to meet that obligation. In effect, the benefit amount controls the employer's cost (variable), with investment return (positive or negative), reducing or increasing that cost.

In contrast, in a defined contribution (DC) retirement plan, the employee retirement benefit amount is variable and unknown, with the employers's cost being known (a percentage of covered employees' earnings). While there are many variations of DC plans, in general, the employer assumes no "risk" since there is no stated benefit amount. The amount of an employee's retirement income is still a function of length of employment and earnings, but investment return assumes a larger importance in the total benefit. While investment return (positive or negative) can reduce or increase an employer's cost in a DC plan, the employee's retirement benefit remains "fixed." In a DB plan, the employee's retirement benefit is variable, dependent upon investment return, the individual employee's level of investment risk and reward and the asset is fully portable/transferable and can be passed to heirs and future generations.

The House is considering, and the Governor has proposed, the adoption of the DC retirement plan option this session. The following is a comparison of the major provisions as of April 11, 2000.

The Senate has not yet proposed a DC optional retirement bill as of this date this session, although knowledgeable sources have advised Florida TaxWatch that the Senate plans to do so.

TaxWatch believes that the consideration and adoption of the DC option is appropriate because it provides the potential for a higher level of competitive, market-driven, flexible and modern, retirement benefits to public employees and taxpayers, while at the same time providing employers with a better recruitment tool and potentially lower costs (both benefit and administrative).

The DC option accomplishes the following:

Providing public employees with an optional defined contribution retirement choice is the "right choice" for Florida taxpayers, public employers and public employees, especially when compared to the costly enhancement to the FRS proposed by the Senate. There is no compelling evidence that the Senate proposal will result in increased competition, productivity and performance from our workforce. Florida TaxWatch will provide updates as policy decisions are made and consequential events unfold.