ACTUARIAL SERVICES SUBCOMMITTEE
of the
LEGISLATIVE COMMISSION ON PENSIONS AND RETIREMENT

Call to order:
Senator Don Betzold, Chair of the Subcommittee, called the meeting to order at 1:07 p.m.

Subcommittee Members Present:
Senator Don Betzold, Representative Mary Murphy, and Representative Steve Smith

Subcommittee Members Absent:
Senator Dan Stevens

Mr. Lawrence Martin, Executive Director, Legislative Commission on Pensions and Retirement, reviewed the information received since the last Subcommittee meeting:

• Written and telephone references for the two firms (copies of the written references were included in members’ packets);
• Two items related to the contract modifications proposed by Milliman USA – a joint memorandum from George McCormick (Senate Counsel) and Mark Shepard (House Research), and a Commission staff memorandum also related to the proposed modifications; and
• Correspondence from EFI Actuaries.

Mr. Mark Shepard, House Research, and Mr. George McCormick, Senate Counsel, testified that Mr. Martin had asked them to look over the proposed contract modifications submitted by Milliman USA and to provide comments. Mr. Shepard said that they responded to that request in the form of a joint memorandum and the memorandum was provided to Subcommittee members. Mr. Shepard said that their general conclusion was that this is a business decision for the Commission, that none of the proposed contract terms are favorable for the Commission, but that the Commission needs to weigh that undesirability against the need to obtain actuarial services. He then reviewed the specific comments contained in the memo.

Sen. Betzold asked if the Commission had right to terminate the contract in the event of a dispute. Mr. Martin responded that in the current contract there is a specific provision that the Commission may unilaterally terminate the contract if the Commission determines it is in the best interest of the State or the Commission, with a 30-day notice and the payment of just compensation to Milliman.

Mr. McCormick referred to the proposed language that the liability limitation would not apply in the event of intentional fraud or willful misconduct on the part of Milliman USA, and he questioned who would determine the existence of such fraud or misconduct.

Representative Murphy asked if these issues had been discussed at the time the last contract was negotiated. Mr. Martin said that this is a new issue for this contract.

Sen. Betzold asked Mr. Lance Burma, Milliman USA, to respond to issues raised during the discussion of Milliman’s proposal. Mr. Burma replied that both the limitation of liabilities and the request for arbitration started with Milliman’s errors and omission insurers. He clarified that their insurers asked the firm to pursue liability limitations and arbitration but did not impose a specific deadline and that this is Milliman’s effort to start discussing liability limitations and alternate dispute resolution with their clients.

Sen. Betzold then asked Mr. Burma about the confidentiality requirement. Mr. Burma responded that dropping the word confidential or the last sentence requiring the arbitration to be confidential would not be an issue for the firm, and that they could use a different arbitrator since the intent is simply to offer some alternative to a jury trial which could be lengthy and expensive for both parties. Regarding who determines fraud and willful misconduct, Mr. Burma believes that if the dispute is being arbitrated, the arbitrator would make the ruling on whether Milliman had committed fraud or willful misconduct, and if it were outside of arbitration and in a court of law, then the jury would decide. With respect to the technical correction on whether the funds are covered, Mr. Burma said it was Milliman’s would view this contract as a contract between Milliman USA and the Commission, therefore any work provided under this contract would be covered by this liability limitation. He said that in the past some of the funds have asked for Milliman USA to provide certain services through this contract and it would be their understanding that these provisions would apply in those cases, but if a fund says that they want to negotiate a separate contract with Milliman, that project would be subject to a separate contract and that the terms of that contract would have to be disclosed to the Commission. Mr. Burma confirmed that the LCPR could terminate the contract at any time for any reason with 30-days notice.

Sen. Betzold if Milliman would be open to an array of alternative dispute resolution options, and if the intent is to try something before going to litigation. Mr. Burma said that the technical points concerning the number of arbitrators or whether they have to come from a particular association are not as important as offering an alternative to going immediately to trial.

Sen. Betzold asked whether the language on alternative dispute resolution is in lieu of or prior to litigation, and if the language would preclude litigation. Mr. Burma stated that the proposed language points to arbitration only as opposed to arbitration prior to litigation. He said that the language is Milliman’s standard, board-approved language for all new contracts for existing clients. He recognized that the public sector has and that in many states it is illegal to have this particular provision. Mr. Burma stated that Milliman would not withdraw their proposal to the State of Minnesota because they could not get through the language. He did say that any modified language would have to be approved by an internal risk review committee, but that would be part of the negotiation process of working out the final terms of the contract.

In response to Sen. Betzold’s question about the specific liability limitation cap, Mr. Burma said that Milliman would be open to negotiating the specific figure provided there is some cap, and that the cap would be prospective and only work done after July 1, 2002, would be subject to the new contract. Regarding third party reliance, Mr. Burma said that in the public pension arena the language might have to be eliminated because the reports are public documents and that it would be difficult to limit the distribution of a public document.

Mr. Martin distributed a letter from EFI in response to a request from Subcommittee members for additional information, proposing a cost of $45,000 for the quadrennial experience study that not included in their original proposal. He then reviewed EFI’s condition in their proposal to replicate the July 2001 actuarial valuations, for which there would be a separate fee. Mr. Martin that would be beyond the Commission’s budget for actuarial services for the first year of the contract and would exhaust the special services budget and more. Mr. Martin referred members to the second page of the letter, where EFI has suggested some alternatives in an attempt to handle the financial problems related to their proposal to replicate the 2001 valuations.

Sen. Betzold reviewed the alternatives laid out by EFI regarding the redo of the valuations, pointing out that requesting additional funds is not a realistic option, and asked for comments from EFI Actuaries.

Mr. Edward Friend, EFI Actuaries, reviewed the reasons for their proposal to re-do the valuations, which concern the gain and loss between the last valuation and the first done by EFI, the financial impact of recent assumption changes, the different techniques used by different actuaries, and that it helps them to understand how the plan has been designed.

Mr. Norman Crowder, EFI Actuaries, said that they would recommend spreading the cost of the developmental over the four-year contract, and EFI would accept the risk that the contract would not be extended after the initial two years.

Rep. Murphy asked if they have ever agreed to their alternative to not be compensated for the developmental work. Mr. Friend responded that they have, on occasion, done work without compensation, and although they would hope the Commission would recognize the cost they offer it as an alternative.

Mr. Crowder expressed EFI’s willingness to work with the Commission toward the potential objective of brining the actuarial work in-house and that they are prepared to assist in the building an infrastructure, to turn over the required software, and assist in training and developing a staff. Mr. Crowder said that EFI has done so in the past for the New York City Retirement System and the California Employees Pension System, continuing in an oversight or auditing function.

Sen. Betzold said that the Commission would have to consider over the next few years.

Rep. Murphy asked whether EFI’s insurance carriers have indicated any increased costs in the future for liabilities or dispute resolution. Mr. Friend responded that they have no requirements for liability limitations and no procedural limitations on mandatory arbitration.

Sen. Betzold invited representatives from the pension funds to comment on the options presented by EFI regarding the replication of the 2001 valuations.

Mr. J. Michael Stoffel, Executive Secretary, DTRFA, testified that being the smallest of the large seven funds they are least able to absorb a cost for which they haven’t budget. Mr. Stoffel remarked that their actuarial firm, Hewitt and Associates, indicated that they would ask for reimbursement of the development cost because of the short-term nature of the contract, but if it were a longer contract they would not ask for any developmental costs because they would have more time to recoup their upfront costs. In reference to the possibility of bringing the actuarial work in-house, Mr. Stoffel also asked the Commission to consider returning to the pre-1985 structure of having the actuarial contracts at the level of each pension fund rather than a legislative body.

Rep. Murphy asked Mr. Martin how many firms were present at the potential bidders’ meeting. Mr. Martin said that he was not sure exactly how many firms were represented, but he thought there were about six or seven, and that he received questions from five of the firms. Rep. Murphy expressed her concern that only two firms responded to the Request for Proposal.

Ms. Mary Vanek, Executive Director, PERA, testified to her concern regarding the additional costs. She said that she understands the professional need to redo the valuation and to establish a base as a new actuary, but at a time when budgets are limited she has concerns as to how those costs would be allocated back to the funds since they are not included in their current budget.

Mr. Eugene Waschbusch, Secretary/Treasurer, StPTRFA, testified that StPTRFA must always support the lowest cost bid because they are required to pass on the cost to their members and therefore would prefer to not pay any additional startup costs.

Ms. Judith Johnson, Executive Director, MERF, testified that MERF is required to direct bill the employers for the cost. She said that the additional cost in the current proposal from EFI is about $25,000 for MERF that they would have to bill through to the schools and the city in this tight budget time. Ms. Johnson recommended that the Commission look at a five-year contract so the upfront fees could be better absorbed in the cost.

Sen. Betzold responded that because the Request for Proposal went out the Commission is not able to change the terms of the contract without reissuing the RFP and asked for input from Mr. McCormick or Mr. Shepard. Mr. McCormick agreed that were the Commission to lengthen the term of the contract it would be necessary to put out a new Request For Proposals, and since the current contract expires at the end of June he doesn’t see how that could be done.

Sen. Betzold reviewed the options for the terms of the contract, stating that at its last meeting the Subcommittee recommended a two-year contract with the option of two one-year extensions. He also reviewed various provisions in the two proposals and indicated some of the issues raised by each proposal.

Mr. Friend withdrew the request to have consideration of adding one-quarter for four years and that EFI is prepared to take on the additional work without compensation.

Rep. Murphy asked Mr. Burma if Milliman would withdraw their application if the contract did not contain the liability limitation. Mr. Burma confirmed that Milliman would not withdraw their proposal if there were no limitation on liability. He pointed out that any firm would have an inherent liability limitation equal to the liquidation value of the firm.

Rep. Smith asked what Milliman’s total annual receipts are from all sources, and Mr. Burma responded that Milliman’s total revenue for 2001 was just over $300 million. Mr. Burma said that total fees for the State of Minnesota were in the neighborhood of $300,000.

Rep. Smith asked Mr. Burma whether Milliman would continue with the contract if the terms and conditions as proposed were not acceptable to the State. Mr. Burma confirmed that Milliman would definitely accept the contract without the proposed language for the first two years, but that the two one-year extensions would have to be approved by the board of directors.

Rep. Murphy assumed the chair.

Sen. Betzold moved to recommend to the full Commission a two-year contract with Milliman USA, without any of the proposed conditions, for the provision of actuarial services.

Rep. Smith asked if it was Sen. Betzold’s intent that there be an evaluation of the transition from Mr. Custis to the new partner and that there be a report back to the Commission by April or May of 2003. Sen. Betzold responded that yes, the Commission needs to look at this issue over the next two years.

Rep. Murphy suggested that the Subcommittee should continue to meet to continue to explore other related issues and options. Sen. Betzold and Rep. Smith agreed with Rep. Murphy’s recommendation.

Sen. Betzold renewed his motion. MOTION PREVAILED.

Sen. Betzold assumed the chair and announced that the Commission will meet on June 11, 2002, to act on the Subcommittee’s recommendation.

Adjournment
The meeting adjourned at 2:30 p.m.