EXPLANATION OF SB 6166 LEGISLATION

Senate Ways & Means Comrnittee March 26, 2001

Summary

Plan 1 of the Law Enforcement Officers' and Fire Fighters' (LEOFF) Retirement System, which was closed to new members in 1977, is a ''defined benefit" plan that guarantees the retirement benefits of its members. Of the approximately $5 billion in the LEOFF Plan I fund, approximately $1 billion is surplus to the amount needed to actuarially guarantee the benefits to be paid to the members

The draft legislation restructures the LEOFF Plan 1 system and creates a new Restated LEOFF retirement system. After establishing a new fund to guarantee the LEOFF retirement benefits under the new system, the remaining assets are used to create three new funds: (1) a "defined contribution" fund to establish individual accounts providing additional retirement benefits for each LEOFF member; (2) a fund to assist local governments to meet their obligation to provide medical and long^term care to LEOFF retirees; and (3) a state budget reserve account. The distribution of the surplus assets among these three funds reflects the historical share of LEOFF retirement contributions made by the employees, the employers, and the state.

Members of a defined benefit plan such as LEOFF Plan 1 have a contractual right to receive their promised retirement benefits. The members and employers do not have a legal right to any excess assets. Under federal law, the state (as the sponsor of the retirement plan) cannot have access to the retirement fund, but upon restructuring the plan, the excess assets revert to the state.

Background

The Legislature established the Law Enforcement Officers' and Fire Fighters' (LEOFF) Retirement System 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; subsequent employees became members of Plan 2.

The LEOFF retirement system is a defined benefit plan, whereby the plan benefits are guaranteed by statute and are not dependent on the level of employer/employee contributions or the market performancc of the plan's investments. LEOFF Plan 1 has been funded by a combination of contributions from three parties: the employers (local government), the employees, and the state (as the creator and sponsor of the plan). Because the assets of the Plan I retirement fund significantly exceed the total actuarial liabilities of the system, all further contributions to the plan were suspended in June 2000.

The LEOFF Plan I Retirement Fund has current assets of approximately $5 billion dollars, of which approximately $1 billion is surplus to the actuarial liabilities of the fund. The historical contribution levels to the Plan I fund reflect the financial obligation undertaken by the state to eliminate large, previously unfunded liabilities: 77 percent of the fund is attributable to contributions from the state, 11.5 percent from employer contributions, and 11.5 percent from employee contributions.

Several legal principles govern the use of these surplus assets. Under federal law, the assets of a tax qualified retirement system may be used only for the exclusive benefit of members of the system. No reversion of assets is permitted while the plan is in existence. However, once a plan is terminated, the members of the retirement system do not have an ownership interest in those assets that are surplus to the actuarial needs of the system. State and federal courts (including the U.S. Supreme Court in the 1999 Hughes Aircraft decision), have held that members of a defined benefit plan have a right only to the promised pension benefits and have no claim to the members' contributions or to any surplus assets.

These decisions are consistent with retirement law in Washington state. In the 1956 Bakenhus case, the state Supreme Court held that members of the state's retirement systems have a constitutionally protected contractual right to a secure retirement benefit, funded on a sound actuarial basis. While Washington courts have not ruled on the ownership of surplus assets, the Bakenhus decision is consistent with cases in other jurisdictions holding that the members' legal rights do not extend beyond the defined pension benefits. For example, the federal Court of Appeals (Koster v. Davenport, 8th Circuit, 1999) held that the sponsors of several fire fighter pension plans, who bore the risk of market fluctuations in the plan's investments, were entitled to enjoy the benefits of excess funding.

Summary of Legislation

The legislation restructures the LEOFF Plan 1 retirement system. All members of the system are transferred to the new Restated LEOFF Retirement System, which includes a defined benefit plan that exactly duplicates the provisions and benefits of the old system, and a new defined contribution plan. The defined benefit component is fully funded by a transfer of sufficient assets from the old Plan 1 fund to guarantee the actuarial soundness of the new plan, with no further contributions required from employers or employees.

The remaining assets of the Plan I Retirement Fund, which are surplus to the actuarial needs of the defined benefit plan of the Restated LEOFF system, are distributed to three new funds:

(1) LEOFF Defined Contribution Retirement Plan will fund self-directed individual retirement accounts for each member of the former LEOFF Plan 1 system. The details and investment options for this defined contribution plan will be determined by a Council of Advisors consisting of LEOFF members, both active and retired. This plan receives 12 percent of the Plan 1 surplus assets, representing the members' proportionate share of contributions to LEOFF Plan 1.

(2) LEOFF Medical Benefits Risk Pool assists local governments in providing medical benef1ts and long-term care for LEOFF 1 retirees (similar to SB 5191). lt receives 12 percent of the surplus assets, reflecting the contribution level of local government LEOFF employers.

(3) State Surplus Assets Reserve Fund consists ofthe reminder ofthe LEOFF Plan 1 assets, to be used to guarantee the actuarial soundness of the Restated LEOFF defined benefit plan (in case of any future adverse actuarial experience) and to provide a budget reserve fund for state govermnent.

Contents of Legislation

Secs. I - 8: Restructuring of LEOFF Plan 1. LEOFF Plan I is terminated, the Restated LEOFF Defined Benefit Plan is established, the LEOFF Defined Contribution Plan is authorized, and the State Surplus Assets Reserve Fund is created.

Secs.101 - 104: Amendments to Chapter 41.26 RCW. All provisions relating to the old Plan I are deleted from chapter 41.26 RCW, which will now apply exclusively to Plan 2 members.

Secs.210-243: Enactment of Chapter 41.26A (Restated LEOFF). New chapter41.26A is enacted, governing the Restated LEOFF Defined Benefit Plan, with no change in benefits from the old plan.

Secs. 301 - 311: LEOFF Medical Benefits Risk Pool. The LEOFF Medical Benefits Risk Pool is established, to be administered by the Office of Community Development (similar to Senate Bill 5191).

Secs. 401 - 449: Miscellaneous Amendatory Sections. Technical amendments are made to various sections of the RCW to insert correct references to the LEOFF retirement systems.

Secs. 501 - 505: Repealer and Miscellaneous Sections. LEOFF Plan I sections are repealed from chapter 41.26 RCW. (These sections are re-enacted in chapter 41.26A RCW.