COVERAGE OF FEDERAL EMPLOYEES UNDER THE SOCIAL SECURITY SYSTEM

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP89-00066R000900110030-1
• Release Decision: RIFPUB
• Original Classification: K
• Document Page Count: 65
• Document Creation Date: December 22, 2016
• Document Release Date: January 11, 2011
• Sequence Number: 30
• Publication Date: October 24, 1979
• Content Type: MISC

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COVERAGE OF FEDERAL EMPLOYEES UNDER THE
SOCIAL SECURITY SYSTEM
The Compensation Group
Office of Personnel Management
October 24, 1979
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Page
Preface 1
Executive Summary of Major Findings 2
Part I: INTRODUCTION AND OVERVIEW . . . . . . . . . . . . . . . . . . . 4
Part II: ACCOMMODATING THE RETIREMENT PLAN
TO SOCIAL SECURITY. . . . . . . . . . . . . . . . . . . . . . 15
Part III: NON JOB-RELATED DISABILITY INCOME
REPLACEMENT SYSTEM . . . . . . . . . . . . . . . . . . . . . 3 7
Part IV: SURVIVOR BENEFITS . . . . . . . . . . . . . . . . . . . 52
Part V: HEALTH INSURANCE . . . . . . . . . . . . . . . . . . . . . . 57
Part VI: SUMMARY OF BENEFITS AND COSTS.........................,... 61
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PREFACE
Coverage of all American workers under the Social Security system, "universal
coverage," has been advocated since that system began. There now are 7,600,000
workers who are not covered by-Social Security, of whom approximately half are
excluded by law and half have chosen not to participate. The majority of those
excluded by law are the 2,700,000 employees covered by federal retirement systems.
Another 3,500,000 are employees of state and local governments, most of whom could
elect coverage. The rest are scattered throughout the private sector, primarily
in not for profit organizations.
A number of studies have been conducted in the last 43 years concerning the feasi-
bility and desirability of attaining universal coverage. The Social Security amend-
ments of 1977, P.L. 95-216, direct the Secretary of the Department of Health,
Education, and Welfare to report to Congress by the end of 1979 on the desirability
and feasibility of universal coverage. Secretary Califano appointed Joseph Bartlett
as the head of a Universal Social Security Study Group. This Group has held public
hearings, and is coordinating the overall study called for by the Social Security
amendments of 1977.
The Office of the Actuary of the Office of Personnel Management (OPM) has assist-
ed the Group by providing data on federal employees, and by furnishing analyses of
the impact of the extension of Social Security coverage to federal employees on
the associated federal employee benefit programs. This paper summarizes the
Actuarys' assessment of that impact. It takes no position on the pros and cons
of the basic issue. It does discuss means of accommodating the current federal
employee benefit package to the Social Security system of benefits, and provides
actuarial cost estimates on selected approaches.
A companion paper discusses options if Social Security coverage is not extended to
federal employees. A third paper presents detailed actuarial and economic projec-
tions of the costs of the various alternatives and their impact on individuals.
Coverage of federal employees by Social Security would necessitate extensive
changes to the federal retirement, leave and insurance benefit systems. There
are, literally, thousands of options which would only be touched in a much more
voluminous paper. This paper does not attempt to present all of the possible
major options and variables. Rather, it discusses the issues involved and
presents illustrative models of general approaches that might be taken. By
specifying exact parameters of the model we can answer the important questions
of impact on individuals and the economy. These parameters should not be read
as the only possible or even the most desirable approaches but simply as a
description of what could happen.
After an introduction the paper presents three alternative retirement systems
based on the different types of typical plans. Further sections deal with
methods of integrating disability, survivor and health insurance benefits.
Finally the four combined systems are presented along with the cost. The
major variation among the four systems is the level of retirement benefits. One
system makes the minimum possible changes to the existing benefits. The other
three systems differ primarily by the type of retirement formula.
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2
EXECUTIVE SUMMARY OF MAJOR FINDINGS
Extension of Social Security coverage to federal employees would necessitate
fundamental alteration of the existing federal employee benefit package. The
change would be significant whether the extension is limited to future employ-
ees, or includes some or all current employees. The principal changes would
occur in retirement, disability, survivor, sick leave, and health insurance
benefits.
These general approaches appear to be the most practical means of fitting the
federal employee benefit package and Social Security benefits together:
--Social Security retirement credits could be earned, and Federal Insurance
Contribution Act (FICA) contributions could be paid, by all new and by any
current employees Congress chooses to cover prospectively from the date of
enabling legislation. No current employees should be permitted to elect
Social Security retirement coverage, as windfall benefits could be obtained
by one fourth of the work force. If Congress mandates coverage for some of
the current work force, employees who are older than a given age, or age
and service combination, should not be covered as it would result in some
hardship and inequitable treatment.
--Social Security disability, survivor, and health insurance benefits could be
earned prospectively by new employees, and could be furnished to all current
employees retroactively. These benefits are not vested like retirement bene-
fits and event of receipt is not elective so the need to preserve current benefit
entitlements is not in the same category as retirement benefits.
Four basic pension formulae are analyzed in the paper to indicate the level of
income replacement that could be available through a combination of Social
Security retirement benefits and a restructured staff retirement plan. Because
of the inherent tilt of Social Security, the combined benefit favors lower in-
income, short service, and married employees vis a vis higher income, long ser-
vice, and single employees. Each produces lower benefits than the current
system for most employees who retire with 30 years of service at age 55. Each
produces basically equivalent or higher benefits for most employees who retire
with lower or median final incomes with 30 years of service at age 62. Each
produces lower levels of income replacement for employees who retire with high-
er final incomes at either age.
Any of the pension formulae could be combined with a thrift plan in which the
employer would match a portion of the savings set aside systematically by employ-
ees. This source of income replacement could be important in furnishing discret-
tionary income to annuitants.
Disability Benefits
Social Security disability benefits replace 'a higher percentage of final pay
for lower income, but a much lower percentage of final pay for higher income
employees than the staff retirement plan's current disability retirement benefit.
The definition of total and permanent disability is much more stringent under
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Social Security than under the civil service plan. And, there is a five month
waiting period under Social Security before employees may apply for benefits,
while there is no waiting period under the civil service plan.
If Social Security coverage is extended to federal employees, major changes
would be needed in the way in which disability benefits are structured,
including modification of the existing sick leave program.
Survivor Benefits
Benefits for surviving widows, widowers, and children are very different under
Social Security and the staff retirement system. As is the case with disability
benefits, major changes in survivor benefits will be needed if Social Security
coverage is extended to federal workers. Certain of the staff retirement
system's features could be retained and meshed with the basic Social Security
approach. Benefits for surviving children could be handled through Social
Security totally, as they are superior to the staff retirement system's bene-
fits in almost every instance.
Health Insurance
Medicare Part A coverage is prepaid for employees and annuitants who attain
age 65 or are totally and permanently disabled, if they are eligible for
Social Security benefits. When federal workers become eligible for Medicare
Part A, there will be a series of overlaps of coverage for them, and a series
of gaps in coverage for certain spouses and dependent children. Of the alter-
native means of dealing with the coverage overlaps and gaps, the possibility
of offering a Medicare supplement plan, hopefully at no cost to participants,
could be considered.
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4
PART I: INTRODUCTION AND OVERVIEW
Part I of this paper describes the differences and similarities between and among
the various Social Security benefits and related federal employee benefits. It
summarizes pertinent benefit practices of large companies, as their approaches
take into account the availability and value of Social Security. Federal tax
provisions and rules and regulations under the Employee Retirement Income Security
Act (ERISA) are referred to in order to clarify the implications of public policy
on benefits provided by employers. And, a discussion of general benefit and com-
pensation concepts, trends, and considerations is supplied at the outset to estab-
lish the context for benefit matters.
The Social Security system was enacted into law fifteen years after passage of the
Civil Service Retirement Plan. Federal employees initially were left out of
Social Security, primarily because they were covered under the staff retirement
plan. That retirement plan, at its time of enactment in 1920, was one of the
earliest pension plans to cover a large group of American workers. Private
pensions then were far less common than they are now. Over the forty plus years
since the enactment of Social Security, both, it and private pensions have under-
gone many changes. The net effect of the changes is that a combination of Social
Security and private pensions has become the basic income replacement system for
most American workers, while federal employees still get their income replacement
primarily from one source: the staff retirement plan.
Background on Benefits
During the initial stages of the industrial revolution, wages were the sole Com-
pensation for workers. People worked until death as no deferred compensation,
i.e., retirement benefits, were available. Workers were responsible for providing
the wherewithal to finance voluntary absences from work and periods of sickness and
disability.
Though benefits began emerging in the United States before the turn of the cen-
tury, events in the 1940s led to benefits becoming a more prominent part of com-
pensation. In 1942 it became a settled matter that employers could deduct their
contributions to qualified pension funds from gross income. The cost of provid-
ing this kind of benefit became an ordinary business expense under the tax code.
During the war years wage and price controls stimulated employers to offer bene-
fits in lieu of wages as a means of attracting and retaining workers. Once this
practice was set in motion, it carried over as a standard industrial relations
approach to recruiting and keeping a work force.
In 1948 the National Labor Relations Board ruled that employers had a legal
obligation to bargain in good faith over the terms of pension plans. After that
ruling was affirmed by the courts, it became clear that employee benefits were
proper subjects for collective bargaining. As. unions steadily increased the scope
of bargaining on benefits, employers tended to offer equivalent benefits to employ-
ees not covered by collective agreements.
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A definition of benefits is pay for time not worked, i.e., holidays and paid leave,
and such indirect compensation as may be provided through insurance and retirement
plans. Pay means wages or salaries paid to employees for time worked, as well as
shift premiums and overtime. Compensation is the sum of pay and benefits offered
by employers to employees as the economic reward for their work.
A 1977 Chamber of Commerce survey of 748 companies reported that the average employ-
er's payment for benefits, including Social Security, was 36.7 percent of payroll.
This survey primarily reflects benefits provided to employees in the private sect-
or who are subject to the provisions of the Fair Labor Standards Act, i.e., lower
paid, non supervisory office and plant employees. For 162 companies that have
been in the Chamber's survey since 1957, benefits have increased as a percentage
of payroll from 23.9 to 40.6. Another measure from the Chamber's study is the
percentage of payroll paid for benefits by the top quartile of companies. In
1975, 25 percent of the firms paid more than 40.4 percent of payroll for benefits.
In 1977 the top 25 percent paid more than 42.3, and the top ten percent paid more
than 48.7 percent of payroll. Leading corporations and the federal government,
as an employer, now routinely provide benefit packages worth more than 40 percent
of payroll.
Large employers offer six major benefits. They are: life insurance, health in-
surance, retirement, sick leave, annual leave, and paid holidays. Such employers
usually offer, or pay taxes to support, additional benefits for disability or for
termination. These benefits include: severance pay, unemployment compensation,
workers' compensation, and short and long term disability insurance. In addition
to such basic benefits, large private employers often provide a range of addition-
al benefits. Company lunchrooms and subsidized meals, tuition reimbursement, sub-
sidized parking, and discounts on the purchases of products, services, or stock
are representative e- of benefits that may be offered to rank and file employ-
ees.
Both employers and the government provide benefits to workers. In some situations
employers typically provide the benefits, in others the government provides them,
and in still other cases employers and the government provide related benefits.
For example, older, non working Americans need to replace part of their former
earnings in order to live. Employers meet part of that need by offering pensions
and capital accumulation plans. Government meets part of that need by providing
tax incentives to those persons who are not covered by pension plans such that they
are encouraged to establish their own annuities, as well as by blanketing the
general population under Social Security.
Benefits are inherently attractive to employees, as they promise financial security.
Most persons are more comfortable if they feel that their personal financial
situations will not be severely affected if they get sick, have an accident, face
expensive medical bills, become disabled, lose a job, become too old to work, or
die. Benefits cushion the financial effects of such problems.
Because of the tax situation, benefits often are more valuable to employees than
the employers' costs of providing them. A simplified example will illustrate
the point. Assume that two employees participate in a health insurance plan
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sponsored by an employer. One employee earns $10,000 and the other $50,000. The
employer pays $1,000 per year for each employee's health insurance coverage. The
employee earning $10,000 per annum, if informed of the amount of the employer's
contribution, can reason that the health insurance benefit alone is worth ten
percent of his or her pre-tax income. The employee earning $50,000, who may be
in the 50 percent tax bracket, reasons that although the employer's contribution
amounts to only two percent of pre-tax income, it is much more valuable than that
as he or she would have to earn at least $2,000 more (taxed at 50 percent) in
order to pay the full cost of the health insurance benefit from the last increment
of after-tax income.
Finally, the government's tax policy is an important factor affecting benefits. In
September 1978 the House joined the Senate and stopped the Internal Revenue Service
from pursuing the taxation of benefits to employees at the employer's cost or fair
market value. In hearings leading to the House's decision, employers strongly
opposed the Service's proposed action. Representatives of employees, college pro-
fessors and airline workers, for instance, also opposed the Service's approach as
regards free tuition for dependents and free airline travel respectively. The
actions of employers to broaden the scope of benefits incrementally year after year,
the actions of employees to fight for continued favorable tax treatment of bene-
fits and the encouragement of Congress for these positions, simply reflects how
sensitive benefits are to governmental policy, particularly on taxation.
Linkage of Social Security and
Employer-Provided Benefits
Social Security benefits are very important parts of most employers' benefit pro-
grams. The linkage is so strong that employers often integrate their benefit
packages with Social Security. There is a body of regulations issued by the In-
ternal Revenue Service, in fact, that specifies how employers may integrate their
retirement benefits with Social Security. One of the purposes of the Service's
rules and regulations is to assure that the interests of lower income employees
are not circumvented in favor of the interests of owners or officers of companies.
The rules on integration of retirement benefits do not directly affect how employ-
ers arrange and structure other parts of their benefit packages that parallel
Social Security benefits. But, employers take into account the value and avail-
ability of basic Social Security benefits explicitly or implicitly in connection
with disability benefits, survivor benefits, and health insurance for employees
and annuitants age 65 and older.
Retirement Benefits
Employees who are considering retirement often express concern about the degree
to which they will be able to maintain their respective standards of living
after they leave the work force. Most large employers have benefit plans that
conceptually take into account the income replacement needs of employees in three
stages. First, Social Security benefits are seen by employers as supplying
enough income replacement to provide the bare essentials of food, shelter, and
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clothing. Second, pensions provide additional income so that annuitants do not
experience substantial reductions in their standards of living. Employers view
employees' personal savings as the third component of total income replacement.
This component provides the basis for discretionary purchases and often allows
allows retirees to maintain their pre-retirement standard of living.
In the absence of Social Security, a "pure" staff retirement plan would provide the
same percentage of income replacement to employees at different levels of final pay,
assuming they had the same lengths of service. As an example, two employees with
35 years of service retire. One has final pay of $10,000, the other $50,000. Ac-
cording to a hypothetical annuity formula, each is due 60 percent of their respect-
ive final pay. Hence, one would receive an annuity of $6,000, and the second,
$30,000. The rationale for such a system rests on the premise that benefits, in-
cluding such deferred compensation as retirement annuities, should reinforce pay
pay distinctions.
Social Security redistributes income and provides a floor of protection for all
retired persons. Employees with families who had been earning $10,000, replace
$6,200, or 62 percent of their earnings. Employees with families who had earned
$19,000 replace $8,100, or 43 percent. High income employees with families who
had earned $50,000, replace $9,200, or 18 percent. Single employees who had earned
$10,000 replace $4,100, or 41 percent of former pay. Single employees who had earn-
ed $50,000 replace $6,100, or 12 percent of earnings. These, and all other Social
Security calculations in the paper, are based on the Social Security formula that
will prevail after 1983 rather than the higher levels provided by the transition
formulae. All benefits are a percentage of the Primary Insurance Amount (PIA) -
the unreduced benefit that a single employee can receive.
If an employer wanted to furnish employees with combined Social Security and staff
retirement benefits that replaced, for example, 70 percent of former incomes, under
existing regulations the employer would be forced to choose to replace that percent-
age for lower, median, or higher income employees, but could not do so for all. In
the range of incomes between $10,000 and $50,000, which covers the range of income
of most federal employees, Social Security replaces approximately 41 percent for
the low income worker and 12 percent for the high income worker, a differential
of 29 percent. Regulations of the Internal Revenue Service do not permit employ-
ers to offset explicitly any part of the Social Security benefits attributable to
employees' contributions. By use of explicit retirement integration techniques,
an employer can reduce the impact of the tilt in the Social Security formula such
that the income replacement differential between lower and higher income workers
is around 15 percent in this income range.
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In practical terms, if the employer replaces 70 percent for lower income employees,
the highest percentage that could be replaced for higher income employees is 55
percent. If the employer replaces 70 percent for higher income employees, lower
income employees will have 85 or more percent of their former earnings replaced.
If the employer chooses to replace 70 percent for median income employees, the
lower income employees will be able to replace approximately 80 percent, and the
higher income employees will be able to replace 65 percent of their former earnings.
According to the Bankers Trust 1975 study of normal retirement benefits, the median
private sector plan benefits, plus Social Security, replaced the following combined
percentages of pay for persons who retired at age 65 with 30 years of service:
Combined Pension and Social Security
Final Year's Pay
As a Percentage of Final Year's Pay
$9,000
69%
$15,000
58%
$25,000
51%
$50,000
46%
Social Security influences retirement benefits in ways other than dollars and cents.
As Social Security pays full benefits at age 65, it is not surprising that most
private pension plans have 65 as the first age at which unreduced retirement benefits
are available. Social Security has an early retirement concept. Persons may apply
for reduced benefits at age 62. Private pension plans also often permit persons to
apply for reduced benefits at age 62 or even earlier.
Disability Benefits
A total and permanent disability, under Social Security, is one which prevents a
person from engaging in any substantial gainful work, and the condition is expected
to last, or has lasted 12 months, or is expected to result in death. Of course,
the total and permanent disability must be caused by a physical or mental condition.
Employers rely on the Social Security disability program to furnish basic income
replacement to employees who have total and permanent disabilities. Because Social
Security benefits are not payable for several months after a disability begins,
and because it does not cover temporary or partial disabilities, employers usually
provide short term income replacement to employees. When employees qualify for
Social Security disability benefits, many employers supplement the income replace-
ment furnished through that program by benefits payable from long term disability
programs. Employers often also continue paying benefits for temporary or partial
disabilities for a limited period.
Employers continue full pay for a limited period followed by reduced pay - typical-
ly 50% to 75% of pay for up to six months. The reduced pay continuation often
follows a three to seven day waiting period especially for blue-collar employees.
After six months, most large employers provide a long-term benefit of 50 to 60
percent of pay.
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Employers use a variety of formal and informal funding systems to provide these
benefits. Very short term full salary continuation is treated as salary. The
short term disability payments can be funded through an insurer or, for a large
employer, can be self insured. In the past, the long term disability benefits
were mainly funded through the retirement system but recently emphasis has been
shifted to separate long term disability insurance systems.
The typical plan is reduced by all or part of the Social Security benefits. An-
other common approach is to pay an unreduced but smaller amount from the plan with
Social Security added on. The long term disability benefits are for the duration
of the disability, until normal retirement age, or until death, subject to utiliza-
tion controls imposed by their respective definitions of disability. At normal re-
tirement age employees usually begin drawing retirement benefits under the employ-
er's retirement plans, and their disability coverage terminates.
Surviving Spouses and Children
Monthly cash benefits may be paid to widows, widowers, children and/or parents
of a deceased worker.
The survivor benefits under Social Security are substantial for widows who have
one or more children. A widow and child of a worker who had earned $10,000
would receive Social Security benefits of $6,200, or income replacement of 62
percent tax free. If the employee had earned $19,000, the survivors would re-
ceive $8,100, or income replacement of 43 percent. If the worker had earned
$50,000, the survivors would receive $9,200, or income replacement of 18 percent.
The maximum benefit payable to a family consisting of orphans, or one or more
children and a surviving spouse, generally is 175 percent of the PIA.
When the last dependent child reaches age 18, the widow loses eligibility for
Social Security benefits, unless she is disabled or has reached age 60. For
a widow who is disabled or age 65 or older, the Social Security benefit is
equal to the deceased worker's. Those who elect to receive benefits at age 60
will have a permanent reduction in the benefits of of up to 28.5 percent.
According to the 1975 Bankers Trust Study of corporate pension plans,
approximately 37 percent of private companies with pension plans do not
provide any preretirement survivor benefit. Approximately 63 percent of
private companies provide benefits from their retirement systems to surviving
spouses. The median benefit in such plans was approximately 50 percent of the
value of the accrued pension. Approximately one-third of the plans that pro-
vide benefits to surviving spouses permit surviving children to receive a bene-
fit but only if there is no surviving spouse. But many pension plans provide
no benefits to surviving spouses who are married to persons who die before
reaching a minimum qualifying age. The median qualifying age of plans includ-
ed in the study was 55. Thus, many surviving spouses of young workers who die
may not be eligible for a pension benefit. The median benefit in such plans was
approximately 50 percent of the value of the accrued pension.
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In short, Social Security benefits often are the sole source of income replace-
ment for surviving families of workers who die at young ages. And, the Social
Security benefits are payable in such cases only when the widows are disabled
or have one or more children. Social Security and private pension policy thus
encourages or necessitates that widows under age 60, who are not disabled, and
who do not have one or more dependent children, actively seek gainful employment.
The availability of post retirement death benefits in the form of survivor
annuities, are assured because of ERISA. ERISA requires that employers offer
a joint and survivor annuity to employees through their retirement plans, in
in which the surviving spouses would receive at least 50 percent of the actuarial
equivalent of the workers' annuities. The annuities would be payable in such
cases as supplements to the Social Security benefits that would be available
to surviving spouses who were age 60. Since, however, the reduced pension is
20 to 25 percent less than a life annuity, many annuitants chose the latter
leaving the Social Security system as the sole source of benefit for surviving
spouses.
Health Insurance
Medicare Parts A and B are available as benefits under Social Security. Part A
is hospital insurance. Part B is insurance for physician and other services.
Persons who receive benefits under Social Security are covered automatically
under Part A. Everyone who attains age 65 is eligible for Part B. Part A
coverage is free to persons receiving other Social Security benefits, and can
be purchased by other persons when they attain age 65. Part B is paid in part
by government subsidy, and in part by monthly premiums collected from benefi-
ciaries. Both Parts A and B are structured as typical indemnity insurance
plans in that coinsurance, deductibles, limitations, exclusions, and maximum
benefit levels are designed to discourage unnecessary utilization.
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Private employers structure their health insurance plans in a way that takes
into account the availability of Medicare. Such employers may offer a supple-
mentary health insurance benefit to employees and annuitants when they reach
reach age 65. This type of benefit is designed to cover the coinsurance and
deductibles built into the Medicare package in order to reduce out-of-pocket
health care costs of such persons. Or, employers may rely on Medicare alone
to meet the health insurance needs of older workers and annuitants.
Most employers who offer a supplementary health insurance benefit to complement
Medicare coverage usually do so on an employer-pay-all basis, according to the
Department of Labor's Digest of Selected Health and Insurance Plans. Employees
and annuitants who qualify for Medicare usually no longer are eligible to re-
main under the health insurance plan offered to employees who are under age 65.
The family members of persons who are age 65 still may be covered under the
employer's standard health insurance plan, usually until they too become eligible
for Medicare.
Federal benefits
The original retirement act in 1920, provided only for mandatory and disability
retirement after 15 years of service.
The present retirement law provides optional retirement on full annuity at age
55 with 30 years service, age 60 with 20 years service, or age 62 with 5 years
service; disability retirement is permitted at any age with 5 years service; in-
voluntary retirement at any age after 25 years service or at age 50 with 20 years
service. Deferred annuities are payable at age 62 with 5 years service. The
average salary is based on the highest three years of salary. The annuity formula
provides 1 1/2 percent of average salary for the first 5 years service, 1 3/4
percent for the next 5 years and 2 percent for any remaining service, up to a
maximum of 80 percent of average salary. Disability annuitants receive the
greater of the preceding computation or a guaranteed minumum of the lesser of
40 percent of average salary or regular formula using service projected to age
60. The law also contains special eligibility and computation requirements
for certain hazardous duty positions, Air Traffic Controllers, Congressional
employees, and Members of Congress.
Widows and widowers of those who die in service receive 55 percent of the dis-
ability formula as a-benefit. Generally this is 22 percent of average salary.
Widows and widowers of deceased annuitants receive 55 percent of the annuity
base on which the annuitant chose to take deductions. Since the deduction
(2 1/2 percent of annuity below $3600 a year and 10 percent above) is much less
than the actuarial equivalent of the widows' annuity, most married annuitants
elect the benefit. Children of deceased annuitants and employees receive a
flat monthly benefit.
Health insurance is provided through over 100 carriers, each of whom offer two
or four options. The coverage is very comprehensive and can be continued into
retirement. The government pays 60 percent of the cost for annuitants and
employees.
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Difference Between Social Security
and Federal Employees Benefits
The Social Security system of benefits differs in philosophy from comparable
federal employee benefit plans. A social insurance approach tilts income re-
placement benefits, whether at normal retirement or due to disability in favor
of lower income, short service, and married persons compared to higher income,
long service, or single persons. However, active employees pay for benefits to
current retirees through a common tax rate on all FICA wages. As a result, the
benefit tilt redistributes income from active employees to retirees with a dis-
proportionate share to lower income retirees. The concept of "the general wel-
fare" underlies these aspects of Social Security. In the income replacement
areas federal employee benefit programs tend to reinforce pay distinctions.
That is, employees at various salary levels, without regard to their marital
status, receive
the same percentage of income replacement if they have the same number of years
of service at normal retirement or at the time of disability.
There are a few points of coordination between the systems. In the income re-
placement area, there now is an offset provision that applies in cases where
federal employees or annuitants are married to persons who qualify for Social
Security benefits. It has the effect of reducing the Social Security benefits
payable to federal employees who get such benefits as spouses. In the health
insurance area, Medicare is primary and the federal employee health benefit plan
pays the balance of the medical bill after Medicare has paid its' share.
Social Security benefits are funded on a minimum reserve basis. There are four
trust funds from which benefits are paid. Current income is the source of cur-
rent benefits. A tax on employees and employers, alike, supports the Social
Security system of benefits. In 1979 the tax is 6.13 percent of wages and
salaries up to $22,900. After 1990, the tax will be 7.65 percent of salaries
up to $27,000 in 1979 dollars. Federal employee income replacement programs,
that is, retirement disability, and survivor benefits, are prefunded. Health
insurance is funded on a pay as you go basis.
Federal employees contribute seven percent of pay, as do their agencies, to cover
part of the cost of the income replacement programs. In addition, the Office of
Personnel Management requests appropriations from general revenue. And, the trust
fund is credited with investment income, based on the dollars in the retirement
trust fund that are placed at interest in federal debt instruments.
Social Security benefits are based on indexed career average salary, while feder-
al employee staff retirement benefits are based on the high-three years of salary.
Social Security gives more weight in its benefit computation formula to the early
years of service, while the federal employee staff retirement's approach is just
the opposite: it gives greater weight to later years of service. Social Security
treats all occcupations alike. The federal staff retirement system provides differ-
ent benefits for a number of occupational and special interest groups. Social
Security benefits are portable from employer to employer. Federal staff retirement
credits are not transferable to other employers. Finally, Social Security benefits
Are tax free and are indexed for inflation once a year, while comparable federal
employee benefits are taxable income and are indexed semiannually.
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There are two other key differences. Social Security provides reduced retirement
benefits only when persons reach age 62, and full benefits only at age 65. The
federal staff retirement plan allows full, unreduced benefits as early as age 55
for employees who have 30 or more years of service. Second, the Social Security
definition of disability is much more stringent than the staff retirement plan
definition. Many employees who now qualify as disabled under the staff retire-
ment definition of disability would be rejected for Social Security disability
benefits.
Guidelines for Analysis
In view of all of the factors that have been discussed, i. e., general benefit
trends, concepts, and considerations; the linkages that typically have been
established by private employers vis a vis Social Security benefits; and the
differences that now exist between Social Security benefits and related federal
employee benefits, we concluded that certain guidelines necessarily should apply
to any analysis of the method of accomodating the federal employee benefit pro-
grams to Social Security. The following six principles serve as guidelines for
the analysis.
Current annuitants should not be adversely affected by any benefit program change.
Once employees retire and are drawing benefits, their access to and enjoyment of
them should not be reduced as a result of Social Security. Similarly, those
eligible for immediate retirement should not be affected, or there could be a
mass retirement of 250,000 people who may retire voluntarily at any time.
Future hires should be fully covered by any modified system.
There should not be any substantial reduction or increase in expected benefits
for current employees, and there should be no reduction in benefits already
earned.
This comparison is of total projected benefits to be received from the combined
federal employee benefit programs and Social Security to currently expected bene-
fits from federal employee benefit programs alone. Any system should be able to
guarantee accrued benefits, in the case of the retirement program, but it may not
be possible to guarantee all projected benefits.
Any modified system should not cost taxpayers more than the current system.
The measure here is the total cost of modified federal employee benefit programs
and Social Security-coverage in the future to the total cost of such programs
and Social Security for federal employees under the current system.
The system should be as simple as possible.
Integrating two very complicated systems could lead to an extremely complicated
system. A simple approach is preferred where there is a choice between two
alternatives and nothing to strongly recommend the more complex method.
Federal employee benefit programs associated with income replacement should be
subject to ERISA/IRS rules.
The current retirement system does not conform to all ERISA/IRS rules. Though
there is no legal constraint that requires that a new income replacement system
for federal employees should do so, it is unlikely that the public would
tolerate a newly designed system that is not consistent with requirements
imposed on private employers.
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The funding requirements of ERISA are not however being imposed in this study.
It is doubtful that the federal government should be subject to the same fund-
ing requirements as the private sector. A quote from the Board of Actuaries
report as of September 30, 1977 makes the point:
"The stability of the federal government as the plan sponsor
and financier suggests that it is not imperative that the
funding system meet funding standards as tight as those which
might be imposed on private plans under an act like ERISA."
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PART II: ACCOMMODATING THE RETIREMENT PLAN
TO SOCIAL SECURITY
There are three basic concepts that relate to the replacement of income at re-
tirement. First, it is accepted that society has some responsibility for pro-
viding partial income replacement through a system of Social Security benefits.
Second, competitive forces in the labor market and concern for the living stand-
ards of career employees prompt employers to provide retirement plans. Third, to
achieve the individually desired level of income replacement, each worker is re-
sponsible for supplementing the combination of Social Security benefits and an
employer's pension through personal savings. It is this income replacement
triad that is the conceptual framework for this section of the paper.
The terms "income replacement" and "income replacement ratio" mean the portion
of the final year's salary or wages that is received in the first year of
retirement. If a worker who earned $20,000 in pay in 1978 retires on January 1,
1979, and receives $12,000 in 1979, then $12,000 of the $20,000 is replaced.
The replacement ratio is 60 percent.
This part of the paper presents information on possible measures of the adequacy
of income replacement at retirement, and the interrelationships among Social
Security benefits, pensions, and personal savings as components of an overall
income replacement approach. It then describes an income replacement system
that could be applicable to new employees that takes into account each component
of an overall income replacement approach, and analyzes the effects of pension
formulae and the presence or absence of employer-sponsored savings plans. Finally,
it describes options with respect to transitioning the current work force to a
benefit system in which the value and availability of Social Security retirement
benefits is a fact of life.
Adequacy of Income Replacement
The question of what is an acceptable level of income during the retirement
years has not been answered conclusively. It is one of the matters to be
addressed by the President's Commission on Pension Policy. There are at
least two points of reference. First, there is a limited body of theoretical
work directed to this issue. Second, there is substantial normative information
concerning the combined effect of the first two components of the income replace-
ment triad, and descriptive information about part of the third component.
The lowest level of income replacement that is acceptable is that furnished by
Social Security alone. The Social Security program represents a public policy
decision that the government should provide sufficient income replacement to
keep retiring workers and their family members from becoming welfare recipients.
Basic Social Security benefits are tilted to favor lower income workers and their
families over higher income workers precisely for this reason.
The highest level of income replacement that may be needed by workers is that
percentage of their gross income in the year before retirement that was spend-
able. Spendable income is that amount of income that remains after adjustments
are made that take into account the reduced expenses retired persons would have
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in connection with getting to and from work; reduced federal, state, and local in-
come taxes, and FICA taxes; and reduced needs for personal savings. The presump-
tion in this analysis, based on work by Messrs. Givens and Miller, is that the per-
sons who retire no longer need to save for the future. The Bankers Trust 1975 study
of normal retirement benefits furnishes an indication of the extent to which the com-
bination of Social Security benefits and employers' pensions, together, meet the
theoretical upper limit of income replacement described by Messrs. Givens and Miller.
Both studies assume that persons retire at age 65 and receive a benefit equal to the
full Social Security PIA. The average age of persons retiring has been dropping
steadily, however, over the last several years. Social Security statistics show that
the percentage of persons who elect reduced awards, as a percentage of the total num-
ber of immediately payable awards, has increased from 59 to 76 percent from 1965 to
1977. Three of four persons who retire today and claim a Social Security benefit
are doing so at ages under 65. In the case of persons under the civil service staff
retirement plan, the average age for optional retirement has dropped from 64.1 to
60.9 during the same interval
Updating the analytical approach used by Givens and Miller, the actuary calcula-
ted the amounts of spendable income available to persons in the year before their
retirement. Within the range of incomes spanned by the federal pay system, where
$10,000 final gross income represents low income, where $19,000 is the median final
gross income, and where $50,000 represents high final gross income, these are the
amounts of spendable income available to employees:
Single
Married
Gross Income
Spendable Income
Gross Income
Spendable Income
$10,000
$ 7,800
(78%)
$10,000
$ 8,400
(84%)
$19,000
$11,800
(62%)
$19,000
$12,800
(67%)
$50,000
$22,900
(46%)
$50,000
$25,700
(51%)
Information in the Givens and Miller and Bankers' Trust studies was adjusted to re-
flect age 62 as normal retirement by reducing the Social Security benefit available
at age 65 by 20 percent, as that is the actual reduction that is experienced by per-
sons claiming such a retirement benefit at that age. Pension benefits were not re-
duced. The next two tables show how much pre tax income from which sources would
be needed by single and married persons, if they retire at age 62 and accept reduced
Social Security benefits, assuming there is to be no reduction in their spendable
income. Since income is reduced after retirement, and a major part of the income,
Social Security, is tax free, taxes are greatly reduced. There is, however, still
significant taxation of higher income annuitants.
The following table shows the amount and sources of income needed to produce post-
retirement spendable income equal to the above levels of pre-retirement spendable in-
come. For example, single employees earning $50,000 in the year before retirement
had spendable incomes of $22,900. Allowing for the greatly reduced post-retirement
income to generate the same $22,900 spendable incomes. Social Security tables show
this income will produce $4,900 in Social Security benefits and the Bankers Trust
study shows that these people can expect average pensions of $19,000. This leaves
$2,700 to be made up from personal savings.
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Sources of Income for
Single Retired Persons
Income
Needed
SSA
Benefits Pensions Savings
$ 7,800 $3,100 $3,200 $1,500
$12,400 $4,300 $6,300 $1,800
$26,600 $4,900 $9,009 $2,700
-0 1gv
Sources of Income for
Married Retired Persons
Income
Needed
SSA
Benefits, Pensions Savings
$ 8,400 $ 8,400 $ 3,000 $ 500
$12,800 $12,800 $ 6,300 $ 100
$25,700 $28,200 $19,000 $1,800
The tables suggest the relative importance of pensions, savings, taxes, and
Social Security benefits as they affect on single and married persons based
on their final gross incpmes at retirement. The importance of these sources
can be shown more clearly as percentages of final gross income for single
and married persons.
Gross
Pre Tax Percent of Income
SSA Benefits
Income
Replaced by
Pensions
Savings
.
S/M
S/M
S/M
S/M
$10,000
30/30%
15/5%
33/49%
78/84%
$19,000
33/33%
9/2%
23/34%
65/67%
$50,000
38/38%
5/4%
10/15%
53/56%
Because Social Security benefits replace a lesser percentage of final income
for single than for married persons, savings become a more important source
of income replacement for single persons. The lower the final income, the
more important Social Security would be as an income replacement source, and
the less important the pension. The higher the final income, the less
important is Social Security, and the more important is the pension, again,
assuming the goal is to skiffer no reduction of spendable income.
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The above tables illustrate the relative benefits for a family with one working
spouse. Current trends suggest that most families may someday have two working
spouses. In these cases, the relative Social Security benefits are much smaller
as a percent of total family income than for the one worker family. The rest of
this paper will deal with the income needs of a single person to avoid the compli-
cation of presenting data on various marital situations.
Retirement Before Age 62
The concept of early retirement is changing rapidly. Many pattern retirement
plans, the type covering blue collar and plant employees, have reduced age and
service requirements for early retirement, and many have shifted to service only
requirements. For instance, in 1970 The Bankers Trust study showed that 37 per-
cent of these plans listed age as the earliest retirement age while in 1975 only
18 percent still considered this combination as the earliest retirement. While
the number of plans with conservative requirements diminished, the number with
liberal, service only requirements increased. In 1970 one-fifth of the pattern
plans permitted early retirement at any age with 30 years of service. In 1975
one-third of the plans did so.
Conventional retirement plans, the type covering white collar employees, have
had similar but less dramatic changes with respect to early retirement require-
ments. While 11 percent of the conventional plans considered age 60 and some
years of service as early retirement in 1975, only three percent permitted early
retirement with 30 or fewer years of service at any age. Instead of changes at
these extremes, the trend from 1970 to 1975 was toward an increasing number of
plans that defined age 55 and some service as early retirement. Fully 58 percent
of the conventional plans permitted early retirement at that age in 1975, as
long as employees met a stipulated service requirement.
Along with the trend to liberalized early retirement requirements, benefits pay-
able to workers who retire early similarly have been improved. One of the key
indicators of the benefit liberalization trend is the marked change in the amount
of the reduction applied to pensions payable to those who retire early.
An actuarially equivalent pension may be paid to employees who retire before attain-
ing normal retirement age. The value of such a benefit is the same as the value of
the accrued benefit commencing at normal retirement age. However, the actual amount
of such a benefit is reduced to reflect the loss of interest earnings and the longer
period of expected benefit payments. Were the normal retirement age 65, employees
who took actuarially reduced pensions at age 55 would receive only about half of
the amount they could have expected to receive at age 65. Actuarially reduced
benefits thus result in substantially lower levels of income replacement.
In 1970, 48 percent of the pattern plans provided only actuarially equivalent pen-
sions to workers who retired early, while in 1975 the percentage of plans offering
fully discounted benefits dropped to ten percent. Instead of paying only actuarial-
ly equivalent pensions, 64 percent of the pattern plans now pay a benefit greater
than the actuarial equivalent but less than the full accrued benefit, while 26
percent paid it in the 1975. In addition, 56 pecent of these plans pay a supple-
mental benefit until age 62 or 65, or the start of Social Security, to a majority
of persons who retire early.
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The supplements provided to blue collar employees range from nominal to very
large amounts of income replacement. The supplements may be flat dollar
amounts, e.g., $150 monthly, or a certain number of dollars per month,
$7.50-$8.00, for instance,'times years of service.
In the 1970 study 53 percent of the conventional plans paid only actuarially
equivalent benefits to persons who retired early. In 1975 only 15 percent of
these plans paid the actuarially equivalent benefit. A full 83 percent, in
fact, provided a benefit that is larger than the actuarial equivalent but
less than the full accrued benefit, and two percent paid the full benefit.
The typical reduction was four percent per year under normal retirement age,
or only about half of the actuarial full reduction. The Bankers Trust study
also shows the levels of early retirement benefits, except for any supple-
mental benefits, that are payable to employees who retire at age 55 or age
60 with 25 or 30 years of service respectively. Generally speaking, median
pattern and conventional plans provide a benefit at age 55 that is 60 percent
of the benefit payable at normal retirement age, and 90 percent of the full
benefit. Because of the supplements and the "30 years of service and out"
provision, a higher percentage of blue collar employees may retire earlier
with higher levels of income replacement than white collar employees.
Based on The Bankers Trust 1975 study, the actuary estimated effective income
replacement for employees covered by conventional plans who retire early at
age 55 with 30 years of service, and included the impact of the Social Security
benefit when it becomes available at age 62.
Gross Income
% of Gross Income
% of Gross Income Re-
Pre-retirement
Replaced by
placed by Pensions &
Spendable
Pensions at age 55
SSA Benefits at age 62
Income
$10,000
18%
51%
78%
$19,000
20%
43%
65%
$50,000
23%
33%
53%
We have interpreted information on which the above table is based in such a
way as to reflect the highest level of income replacement from private pensions,
rather than the lowest. Hence, the estimate may be less than fully accurate,
and if it is, the error lies in the direction of overestimating the percentage
of income replaced by typical private retirement plans. In any event, personal
savings, a job with a different employer, or acceptance of a lower standard of
living certainly are possible ameliorations of the impact of early retirement
on the income replacement available to most white collar employees who leave
a private employer at age 55.
Capital Accumulation and
Savings Systems
If the civil service staff retirement plan is integrated with Social Security,
two of the three basic components of an income replacement system will be in
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place. The third element of the income replacement triad is capital accumula-
tion-personal savings. Federal employees now may contribute up to ten percent
of pay to the pension plan in order to buy additional annuities as supplements
to their basic pensions. The amounts deposited to employees' accounts earn
interest at the rate of three percent, compounded annually. As less than one
percent of the federal work force participate in the annuity purchase plan, it
clearly is not an effective benefit subsystem for purposes of helping any sub-
stantial percentage of employees accumulate capital for their retirement years.
Prevailing Practice in the Private Sector
Employers utilize such benefit mechanisms as profit sharing plans, and thrift
plans, as primary means of helping employees to take actions systematically
during their working lives to meet future income replacement needs. Such
benefit approaches encourage employees to save or invest a portion of their
current incomes. Trust funds that are created to manage the monies associated
with such plans assure for employees the deferral of current taxes, advantageous
future tax treatment, or both.. Finally, employees may elect to receive a
distribution of any proceeds in these types of plans on a monthly basis as
supplements to their Social Security benefits and pensions.
Approximately 30 percent of the companies included in the Conference Board's
profile of employee benefit plans offer profit sharing. Of these, nearly
two-thirds provide profit sharing plans in addition to pension plans. The
other one-third use their profit sharing plans in lieu of pension plans. Most
profit sharing plans provide for the deferral of payments of employees' shares
until retirement or termination for other reasons. The shares typically are
deposited in qualified trust funds that invest the money in equities, debt
instruments, or combinations thereof. Among the companies that the Board
considers the leaders in benefits, generally speaking, it is the smaller firms
that provide profit sharing plans. Two-thirds of the profit sharing plans
permit blue collar, as well as white collar employees to participate.
Thrift, or savings plans, are offered by 18 percent of the companies that
participate in the Board's survey. But, almost half of the companies that
employ 25,000 or more persons have such plans. In fact, a Bankers Trust study
found that 61 of the Fortune 100 companies offer thrift plans, and that over
60 percent of their employees participate. Two-thirds of the thrift plans in the
Board's survey permit blue collar as well as white collar employees to partici-
pate. The plans typically permit employees to save up to six percent of their
pay. The prevalent practice is that employers then contribute 50 cents to the
plans for each dollar saved by employees. Nearly one-fifth of the compamies
that offer thrift plans match employee's savings dollar for dollar. Some
employers vary their contribution rates by the employees' lengths of service,
or, with regard to the respective levels of profit of their firms. Employees
must save after tax dollars in order to.participate in thrift plans. The
incentive for systematic saving in employer's thrift plans, rather than local
financial institutions, clearly are the employers' contributions.
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Employees' contributions to thrift plans or profit-sharing plans are not con-
sidered taxable income to employees at the time they are deposited to their
accounts in the trust funds. Earnings on equities or debt instruments are
not taxed until retirement, termination, or at such other times as distribu-
tions are provided for by the plans. Finally, if part of the proceeds at the
time of distribution consists of capital gains, that portion may qualify for
favorable tax treatment.
Federal Plans
None of the federal agencies offer profit sharing plans. But, at least two
federal agencies provide thrift, or savings plans to their employees, the
Tennessee Valley Authority and the Federal Reserve Board. The Authority
permits employees to buy shares in mutual funds that are invested either in
common stocks or in debt instruments. The latter type of fund is referred
to as an "interest fund." The Authority does not match employees' contribu-
tions. Slightly more than 11 percent of the work force participates.
The Board offers a plan to its employees, and to employees of the regional
banks within its system. Employees are given a choice with respect to common
stocks or interest income funds. They may contribute up to 16 percent of
pay. The Board matches employees' savings at the rate of 25 cents on each
dollar up to the first six percent of pay. Employees' contributions that are
greater than six percent of pay are not matched. The Board's employees are
covered by a retirement system which requires them to contribute seven percent
of their pay. Approximately 70 percent of the employees who are eligible,
those having one or more years of employment, participate in the plan. The
Board's employees who work in the banks are covered under a separate, non
contributory retirement plan. Nearly 80 percent of this work force are
actively involved in the thrift plan.
A Federal Employee Savings Plan
A thrift plan, if offered on a basis comparable to that of prevailing
practice, should attract 60+ percent federal employee participation. Such a
plan can be designed so that employees have choices among equities, interest
funds, or combinations of such investments. Such plans also can be designed
so that employees'have options regarding the percentage of pay they choose
to save. As not all employees would participate, and as some would participate
at less than the comparable maximum rate, six percent, the government's
probable cost could range from one percent to two percent of payroll, should
it decide to offer such a plan.
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From the standpoint of the employer, a thrift plan has known powers of attraction
to employees. If such a plan is offered, a sufficient percentage of the work
force is likely to participate to make it a major benefit program at a reasonable
cost. For employees, the employer's matching contribution is an incentive to
save current, after tax income for the long term.
The data below indicate the income replacement furnished at retirement, assuming
three different periods of participation in the plan at the prevailing maximum
savings rate, six percent, and a three percent match by employing agencies. There
are several additional assumptions. Income replacement means the percentage of
final pay that is replaced by the savings plan at the time of retirement for ten
years certain or life. The employees' pay increases from the initial level at an
annually compounded rate of seven percent per year, and interest or investment in-
come is earned at seven percent per year, compounded. Employees leave their
savings, and the employer's matching amounts, in the plan until retirement at age
55 or 62.
Years of Plan Partici-.
% of Final Pay Replaced
pation Before Retirement
at Retirement for Ten
and at 6% Savings Rate
Years Certain or Life
Age 55
Age 62
10 years
7%
8%
20 years
14%
17%
30 years
22%
26%
Savings plans produce the same percentage of income replacement for lower and
higher income employees, as well as median income employees. As can be seen
from the table, the number of years of plan participation and the age at retire-
ment influence the level of the income replacement. Finally, there is no cost of
living adjustment in payments made from a savings plan. As a result, the purchas-
ing power represented by the payments from such a plan will diminish in line with
the rate of inflation.
New Employees: Possible Retirement Formulae
There are a number of possible retirement formulae that could be considered in the
event that new federal employees were covered under a retirement system that was de-
signed to take into account the value and availability of Social Security. After
providing background information and stating the underlying assumptions, information
is provided on the income replacement characteristics of four possible formulae,
three of which are discussed in this part of the paper. The fourth, a minumum
change formula, is analyzed in part VI.
Background
A complete description of pension formulae often consists of an accrual rate that is
expressed as a dollar amount for each year of service in pattern plans, and a per
cent of pay for each year of service in the case of conventional plans; a specific
.pay base; a period of service; a decision not to integrate explicitly with Social
w"' Goodea Security, or a method of integration; and minimum and maximum benefit
limitations.
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The first choice is whether or not federal employees are to be covered under
a single plan or multiple plans. At this time federal blue collar, white
collar, and postal employees are covered under one plan, under a single
retirement formula. Private employers typically provide a pattern plan with
a flat dollar accrual per year of service to blue collar employees, and a
percent of pay accrual rate for white collar employees in conventional plans.
We assume that federal employees will continue to be covered under a single
conventional plan, hence, no pattern plan is presented.
The Bankers Trust 1978 update study of private conventional plans shows that
a sample of 19 plans have accrual rates per year of service that range from
0.9 to 2.25 percent. The median rate of accrual, used by five of the 19 plans,
is 1.5 percent. The rate of accrual, by itself, does not indicate the level
of benefit produced by formula. A formula with a low rate of accrual may
produce a higher benefit than one with a higher accrual rate, if the Social
Security offset of the plan is lower, for instance, in the first than in the
second plan. Of the 19 plans, 14 use the offset method. Of'these, 11 use
a 50 percent offset.
The pay base could be career average or final pay. Our analysis is based
on final pay formulae, as they are much more common now in the private sector
than career average approaches. Within the final pay approach, the benefit
could be calculated on the high three or high five years of earnings. Both
are reasonably common. We selected the high three years, which is the
approach used in the current civil service plan.
Another common approach to integration with Social Security is the use of a
sliding rate, not an offset. In such plans one accrual rate is used below a
break point, and a higher accrual rate is used for earnings above the break
point; for example, 1.0 percent times pay up to $10,000, and 1.5 percent
times pay above $10,000. This type of formula provides a lesser percentage
of income replacement from pensions to lower income employees, who enjoy a
substantial level of income replacement from Social Security. Conversely,
the pension replaces a higher percentage of income for higher income employees,
who obtain a lesser percentage of income replacement from Social Security.
Of plans described by The Bankers Trust, 16 use a single break point, while
18 use two break points.. The range of differences in accrual rates above
and below the break point is from .2 to 1.25 percent, with .5 percent being
the most common difference.
Other final pay plans have accrual rates that are tied to years of service.
Some plans have accrual rates which are higher during the first several
years of service and then decrease gradually with additional service. Such
plans are referred to as "front loaded". The current civil service staff
retirement plan also has accrual rates that are tied to years of service,
however, they are "back loaded". The earlier years of service have lesser
accrual rates than later increments of service.
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There are three global criteria that are relevant to an evaluation of the en-
titlement to and level of retirement income replacement. They are: the cur-
rent benefits available to civil service employees; comparable income replace-
ment benefits furnished by large private employers; and the theoretical percent-
age of income replacement needed by individuals at normal retirement age to main-
tain their standards of living without reduction.
Of these three, we believe that the provisions of the current civil service staff
retirement plan should be weighted most heavily, the prevailing practices should
be considered next, and the theoretical approach should be weighted the least.
The rationale is that the current staff retirement system antedated most of the
large private plans in this country and has developed independently of them for
nearly 60 years. During that time there have been years of careful scrutiny of
it by Congress after public testimony and debate. Consequently, it is fitting
that any proposed plan be matched against the existing plan in the first stage
of evaluation.
Given the commitment to total compensation comparability, a concept the Ad-
ministration supports and the Congress is considering, certainly the practices
of the other large employers have to be considered carefully. This paper refers
exclusively to the private sector, as it is known that the Universal Social
Security Study Group is conducting research and gathering information concerning
practices of large state and local government employers.
Finally, the theoretical approach yields essential measures of the adequacy of
benefits in terms of maintaining standards of living. As a result, potential
outputs of a theoretically sound income replacement program also should be con-
sidered in any evaluation process.
Common Provisions
The major choice in developing a new retirement system will be among the benefit
formulae. The other characteristics of the current retirement plan were reviewed
but, to concentrate the analysis on the important variable, only one set of these
other characteristics was used. Unless there was a very good reason to change a
characteristic, the current one was retained.
This section focuses on the retirement benefits and formulae. Disability and
survivor benefits are presented in Parts III and IV of this paper. Disability
benefits have needed substantial revision for some time and the rationale for.
much of the survivor benefit program collapses if Social Security is extended
to federal employees. Therefore, each of these subjects deserve a whole section
with a unique treatment.
Two of the characteristics of the current Federal retirement system deserve close
examination if they are to be retained since they are much more liberal than
provisions of typical private sector plans and contribute greatly to the cost of
the current Federal system.
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The first of these is full retirement benefits at the age 55 with 30 full years
service. This provision was introduced, in its current form, in 1966 when few
pattern plans and almost no convential plans had liberal early retirement con-
ditions. Although the pre-1966 reduction below age 60 was relatively small, only
1 percent for each year under age 60, the change to full retirement benefit de-
creased the average age at optional retirement from 64.1 in 1965 to 60.8 today.
Since 1966, many of the private sector plans have moved toward or even beyond the
55 and 30 conditions but a majority still have less liberal benefits. Well over
half of the conventional plans and over three-fifths of patterns plans allow re-
tirement at or below age 55 often with less than 30 years of service. In fact,
more than a third of private plans in the Bankers Trust study have more liberal
early retirement conditions than those found in the federal plan. Payment of an
unreduced benefit, however, is not as common. Only one- fourth of the pattern
plans and two percent of the conventional plans provide full benefits. A large
!a majority, however, do apply a reduction that is much lower than the full
actuarial reduction.
Thus, while full retirement at age 55 with 30 years of service is a very costly
aspect of the federal retirement program it is no longer the most liberal bene-
fit compared to the private sector. When compared to pattern plans, in fact,
the provision is around the norm. When compared to conventional plans the
eligibility is a little better than the norm but the level of benefit is still
very liberal. Since this provision is very popular among federal employees,
and is no longer atypical, it was retained in this study. This is one area
that policymakers would want to look at for offsetting cost gains if the bene-
fit formulae are viewed as being too low.
The new retirement systems include a new reduced benefit for those who retire
between ages 55 and 62 with more than 5 years service but less than the 20 or
30 years needed for full retirement. This benefit is reduced 4 percent for
years under age 62. One reason for adding the benefit is that it has become
very common in the private sector. Currently there are many employees who hang
on to age 60 or 62 or seek disability to receive immediate benefits. Often it
is not in the best interest of the government or the employees to keep these
people on the employment rolls. Also, tightening up of the disability conditions
would add to this pattern. The reduced benefit will allow these employees to
retire when they are ready and receive a good but not full retirement benefit.
The other relatively liberal and costly provision of the current federal retire-
ment system is the application of full cost-of-living increases to benefits after
retirement. A recent study by the Wyatt company of 39 large employers showed
that while most of these had made a recent adjustment to annuities to reflect
inflation, none had given full increases and even the most liberal were less
than 10% in total for the last three years. Federal annuities, which are fully
indexed, have increased 30% in the last three years.
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The federal annuity adjustment is similar to that used by Social Security. But,
the federal system is more liberal in that benefits are adjusted twice a year
rather than once a year as under Social Security. Over the long run both systems
keep benefit increases at the same relative level but federal employees get higher
benefit for six months of every year.
Full inflation adjustment, especially in times of high inflation, is necessary for
annuitants to avoid a substantial loss in standard of living. If, for instance,
annuity adjustments are at one-third of the level of inflation, and double digit
inflation continues, typical annuitants will receive benefits in their final years
of life that is worth less than one third of their annuities in the year after
retirement. If the annuitants receive a fully indexed Social Security benefit
with a supplemental retirement benefit the loss in income diminishes but is still
large especially for higher-paid annuitants. We decided to retain full indexing
but with the Social Security adjustment rather than the current federal adjust-
ment. This keeps the federal system more liberal in this area than the typical
private system but it is a very desirable provision of the current federal
system that should be retained if possible. Again, policymakers may want to look
here for a place to cut costs if it is decided to improve other parts of the
package.
Several changes were introduced as part of these packages. First, service con-
tinues to be all military and civilian service but credit is only given for act-
ual time worked. This change removes the ability of employees to work partial
careers for, say, 27 years and then go,full time for three years thereby receiving
the same benefit as employees who worked full time for 30 years. Integration will
eliminate the need for adjusting the benefit at 62 to remove military service
earned since 1956. The current adjustment leads to some cases where total income
is actually reduced at 62.
These systems are non-contributory. Just as benefits should be adjusted to reflect
Social Security, contributions should be adjusted. The current federal retirement
contribution is 7 percent of covered salary. The Social Security/Medicare tax is
6.13 percent of pay up to $22,900 and will eventually be 7.65 percent up to an in-
dexed equivalent of $26,000 in todays' dollars. It was decided to eliminate the
federal retirement contribution since it would eventually be fully offset for most
employees by the new Social Security contribution. This is a relative liberaliza-
tion for high paid employees since Social Security contributions stop at about half
of the highest earnings. This is more than offset, however, by the relative
reduction in combined benefit for high paid employees.
The change in contribution leads directly to correction of a problem with vested
employees. Employees now can divest themselves of valuable benefits by electing
to take their contributions when they leave before retirement. This current
provision is far below the minimum required by ERISA. With no contribution the
employees cannot divest themselves of benefits and the ERISA conditions are met.
Five years vesting is retained. This is more liberal than found in most private
sector plans but it is much closer to the goal of full portability devised by
Congress. Going to a norm of, say, ten years would be a step backward.
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The pay base of three years was retained - this was once relatively liberal but
is becoming more common. The other involuntary and voluntary retirement condit-
ions were also retained. These include; in addition to 55 and 30; age 62 and
five years or age 60 and 20 years voluntary; 25 years service or age 50 and 20
years service involuntary. The involuntary benefit is reduced 2 percent for each
year below age 55 as it is currently.
The Formulae
The three formulae described in this section are a broadly representative
sample of possible approaches used by large private employers. They are: Offset,
Step Rate, and Add-on. In Part VI of the paper a fourth formula is presented,
Minimum Change. This latter formula represents the least possible departure
conceptually from the present civil service retirement plan, given extension
of Social Security coverage to federal employees.
--Offset. The formula is 1.65 percent times service up to 40 years, and times
the high three years' earnings average. The pension would be reduced by 1.25
percent times the employees' estimated Social Security benefit at age 62 for each
year of service up to 40 years.
--Add-on. The formula is 1.35 percent times service up to 40 years, and times
the high three years earnings average.
--Step Rate - The pension payable at or after age 62 is 1.5 percent times that
part of the high three years' average earnings below $10,000 and 1.65 percent
times that part of the high three earnings above $10,000, all times service up to
40 years. For employees retiring before age 62 a supplement will be payable to
age 62. The supplement will be equal to .5 percent times that part of the high
three year earnings below $10,000 times year of service up to 40 years. The
break point of $10,000 would be increased each year at the maximum level permitted
by regulations of the Internal Revenue Service.
The step-rate method as described above does not meet the current IRS integration
rules in cases of retirement before age 62. To meet such rules, the .5 different-
tial between pay above and below $10,000 would have to be reduced or, alternative-
ly, actuarially equivalent benefit would have to be provided. Since it is like-
ly that the integration rules would be changed by 1982, we are including this
formula because it fits in well with the overall benefit ratio and plan design
objectives.
Analysis
The Offset formula is very typical of prevailing practice in the private sector.
The Step Rate formula calculates benefits at age 62 in a manner consistent with
an approach that is also common in private sector plans. However, use of an
add-on rate to calculate the benefit for those who retire before age 62 is unusual
with respect to conventional plans covering white collar employees. But, it is
common in other governmental plans.
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The choice between formulae is subjective, there are advantages and disadvantages
to each method. Some of these are:
Offset Method -
Advantages
1. Simple in concept.
2. Can be easily explained to participants.
3. Adapts automatically to changes in Social Security and the wage base.
4. Can be articulated in an overall income objective including Social Security.
5. Clear that only a portion of Social Security will be offset.
Disadvantages
1. It is not possible to calculate the exact plan benefit till Social Security
benefit is known.
2. Presently the employer cannot obtain an employee's Social Security benefit
directly and must depend on an approximate computation.
3. Method leads to unequal treatment of participants who retire immediately before
or immediately after a Social Security increase.
4. Plan benefits are affected by the timing of a Social Security change.
5. Employees may object to a direct reduction of their plan benefits by benefits
provided under a national old-age insurance program to which they have contri-
buted.
Step Rate Method -
Advantages
1. Plan benefit can theoretically be calculated without knowing amount of Social
Security benefit.
2. Gives recognition to existence of Social Security benefit but such is not
actually used in plan benefit computation.
3. The timing of a Social Security change does not immediately impact on earned
benefit.
4. It is a more subtle integration approach which is often more acceptable to
employees.
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Disadvantages
1. Although the computation of the plan benefit is theoretically independent of
the Social Security benefit the supplement payable before 62, cannot exceed
the Social Security benefit which will be payable. Practically, then, the
actual Social Security benefit does enter the calculation.
2. The break point of $10,000 would be changed each year as permitted by IRS.
This means that the plan benefits will change each year and this may be hard fe
communicate to employees.
3. Since ERISA provides that accrued benefits cannot decrease by plan amendment,
a comparative benefit calculation will have to be done each time the break
point is changed.
4. Benefit formula needs to be constantly reviewed to make sure that initial
goals are met. Formula must be revised if it goes out of phase.
Add-On
Advantages
1. Simple to calculate
2. Completely independent of Social Security benefit.
3. Simple to communicate.
4. Employees can view it as a separate system with no reduction in benefits because
of Social Security.
Disadvantages
1. Does not directly recognize Social Security
2. Overall retirement income retains complete impact of Social Security weighting
in favor of short term low paid employees. The benefit ratio for low paid
employees will be as much as 30 percent higher than for higher paid employees.
The table below shows the income replacement characteristics of these formulae for
employees who retire at age 62 after 30 years of service, compared with (1) the
current civil service plan, (2) the income typically replaced by Social Security
and pensions for employees of private firms as reported by Bankers Trust, and
(3) the income needed, according to the theoretical Givens and Miller approach
to assure no reduction in spendable income.
Typical
Theoretical
Current civil
Private
Spendable
Offset
Step
Add-on
Service Formula
Sector
Income
Rate
$10,000
53%
63%
78%
67%
65%
71%
$19,000
53
55
65
61
61
61
$50,000
53
48
53
53
53
48
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Lower and median income employees, in each case, have greater income replacement than
is available under the civil service plan. Higher income employees obtain yields
from the formulae that are not significantly different from the current plan. From
the standpoint of comparability with private plans, lower, median, and high income
employees would do better by a few percentage points than their counterparts in
industry. Against the theoretically necessary yields, lower income employees would
would receive substantially less than what is needed under the Offset and the Step
Rate formula. Median income employees would obtain approximately what is theoretic-
ally necessary. Higher income employees would obtain income replacement very close
to the theoretically desirable level.
When compared to net take-home-pay the tilt of the various retirement formulae change.
In this case, most of the replacement ratios are close to 100 percent and the ratios
for the different salary levels close to each other:
Offset
Step Rate
Add-on
$10,000
86%
83%
91%
$19,000
94
94
94
$50,000
99
100
91
The following table shows the income replacement characteristics of these formulae
for employees who retire at age 55 after 30 years of service. After age 62 the
percentage of income replacement would be the same as those in the previous table,
reflecting the Social Security benefits.
Typical Theoretical
Current Civil Private Spendable Offset Step Add-on
Service Formula Sector Income Rate
$10,000
53
18%
78%
47%
47%
38%
$19,000
53
20
65
47
47
38
$50,000
53
23
53
47
47
38
Each of the formulae, at all income levels, result in lower levels of income replace-
ment ranging.from seven to eleven percentage points, compared with the civil service
plan. In terms of the private sector, each of these formulae yield twice as much in-
income replacement as is the norm for white collar employees. Each of the formulae
furnishes far less than the level of income replacement that is theoretically necess-
ary to avoid lowering a standard of living.
Again the comparison to take-home-pay shows a different story. The new formulae
still produce less than a full take-home pay but the ratios are much higher than
for gross pay and there is a decided tilt toward high paid employees.
Offset
Step rate
Add-on
$10,000
57%
57%
48%
$10,000
67
67
56
$50,000
82
82
83
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The government could establish a thrift plan for federal employees by reducing the
benefit provided by the pension formulae sufficiently to match contributions to
employees' savings. In these. circumstances, there would be two groups of employees
who would each have substantially different levels of income replacement; those not
participating in a thrift plan, and those participating in it.
Use of a voluntary thrift plan as part of the federal retirement package reduces
benefits for those who do not participate by three to four percent of final salary.
The resulting income would be close to the total provided by a typical private
sector plan but five to fifteen percent less than the amount needed to replace all
spendable income.
Employees who did participate would do much better. The next table shows the effect
of adding income replacement from a thrift plan to the reduced pension plus Social
Security. The premise underlying the thrift plan yields is that the employees
contribute six percent of gross pay, and the employer matches half of the employees'
earnings during each
year of employment.
Retirement at Age 62
Step Rate
Add-On
$10,000
90%
88%
98%
$19,000
84%
84%
88%
$50,000
75%
75%
74%
Retirement at Age 55
Offset
Step Rate
Add-On
$10,000
65%
65%
61%
$19,000
65%
65%
61%
$50,000
65%
65%
61%
The table indicates the high potential of systematic savings as a mechanism for
assisting employees to replace income at age 62. Against the theoretical measure,
savings plus Social Security and reduced pensions replace from 12 to 22 percent
more than employees' former spendable income, assuming that they save at the
maximum rate throughout a full career. In fact, even at age 55 savings plus
a reduced pension replace more than the theoretically necessary level for median
income employees, but 13 percent below that level for lower income employees.
In short, a thrift plan is a powerful income replacement mechanism for those who
use it. Published data shows that a large majority of employees will participate
but the participation rate is probably skeyed by salary with a larger portion
of high paid employees than of low paid employees contributing. Thus, the relative
advantage to the low paid employee of going to Social Security could be offset for
many employees by the natural tendency of low paid employees not to participate in
a thrift plan.
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. -00066R0. 009001'10030.~
Current Work Force
There are several approaches to transitioning from a staff retirement plan,
as the principal income replacement mechanism, to a staff retirement plan as
a supplement to Social Security. The basic choices are whether or not some
or all current employees are allowed to elect coverage under Social Security
and/or a new staff retirement plan; are mandatorily included in either or
both; or are required to stay under the existing staff retirement plan with
no Social Security coverage.
Approximately 250,000 employees now are eligible to retire voluntarily for
age and service. Nearly 450,000 are eligible to retire involuntarily but not
voluntarily. These employees have 20 or more years of service and are age 50
or older, or they have 25 or more years of service. Slightly more than 1.5
million additional employees have five or more years of civilian service, and
are fully vested to a retirement benefit. Finally, there is a group of
500,000 employees who have less than five years of service, and are not
vested.
Social Security Retirement Coverage
There are two ways of providing Social Security coverage, retroactively and
prospectively. There are three basic benefits that could be provided in one
of these ways: retirement benefits, disability benefits, and survivor
benefits. The provision of retirement benefits retroactively would seriously
disrupt the existing plan financially and administratively as well as the
vested rights of employees affected. Retroactive coverage involves payment
to the Social Security Trust Fund of an amount equivalent to the FICA taxes
plus accrued interest, on.both the employees' and the employer's share over
each year of career federal service for each employee. Doing this could be a
problem under ERISA/IRS rules. Social Security retirement benefits must be
provided prospectively to avoid undue disruption of the staff retirement plan.
The possibility of providing disability and survivor benefits either retroact-
ively or prospectively is discussed in Parts III and IV of the paper.
At this time three of four federal employees who retire become eligible
eventually for a Social Security retirement benefit. Their eligibility is
based on covered employment in non federal jobs. This group of employees
would have little incentive to voluntarily seek coverage under Social Security
in connection with their federal employment, as the benefit is weighted
toward the short service worker and they would not gain as much from addi-
tional service.
The group of one in four employees who had little or no Social Security
retirement credits would have a substantial incentive to voluntarily elect to
pay FICA taxes and earn Social Security retirement credits, as the benefits
they would gain at age 62, in terms of income replacement, would far outweigh
their out-of-pocket costs. As examples, the table below shows the extent to
which ten years of Social Security coverage would serve to replace income for
low, median, and high final income employees, and the costs to them of such a
benefit. All values are. expressed as a percent of final salary.
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Gross
Income
Annual Income
Replacement
Total lifetime
Benefit
Total
Contributions
$10,000
19%
340%
50%
19,000
13
234
49
50,000
6
108
26
For one-fourth of the current work force there would be a substantial windfall, as
shown in the table, if they were permitted to elect to be covered under Social
Security. As permitting election of Social Security coverage could lead to a wind-
fall benefit for many employees, the taxpayer interest would be better served with
u44k a mandatory cutoff.
The immediate purpose of considering the extension of Social Security to federal
employees is to put everyone in the same boat. The advantage seen is that this
provides a basic fully insured benefit for all working people and helps reduce
the ultimate cost of the Social Security system. The primary argument against
this is that 8,000,000 employees have built up equities and look forward to a
certain level of retirement under current systems and these would, at best, be
disrupted by universal coverage and, at worst, result in loss of potential in-
come. If Social Security is extended, the secondary question is whether or not
to extend it to current employees. A deciding factor here may be the cost. If
it developes that the Social Security system will be hurt, not helped, by cover-
ing current employees there is little chance that this will happen. Since this
question is not yet determined it is necessary to illustrate the potential impact
of extending Social Security coverage to some or all current federal employees.
To qualify for a retired worker Social Security benefit at age 62, most current
federal employees with no prior covered employment would have to work for a
minimum of ten years, 40 quarters. Under these conditions it would be inequit-
able to mandate Social Security coverage for anyone within ten years of normal
the earliest Social Security retirement age (age 62-1052), as the chances are
high that some persons would pay FICA taxes for a number of years but not obtain
sufficient retirement credits to qualify for a benefit. Or, many employees might
be forced to delay their planned retirements in order to assure that they did not
lose a Social Security benefit after paying into that system for a number of years.
On the other hand, the earliest age for retirement of federal employees in
certain occupations is age 50. Hence, it might be argued that all employees
under age 40 should be covered under Social Security, as each would have
sufficient time to earn 40 quarters of coverage and thereby earn a benefit
payable at age 62.
Between these extremes is a large group of employees, ages 41-51. Some work in
occupations where their first opportunity to retire is at age 50 and where they
must retire by age 55; some are eligible initially at age 55, some at older ages.
Assuming that the same age and service combinations are kept for employees in such
occupations as criminal investigations and air traffic control, and that the same
age and service combinations are kept for involuntary retirement, it is clear that
employees in special occupations and those who retire involuntarily could have
expected to continue working until age 55.
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Given these factors, we feel that there are several possible age, or age and service
cutoffs, that could be used. The approach used to illustrate the impact of retro-
active coverage is to put only employees now under age 44 in the Social Security
system while thay are federal employees. Alternate approaches would be use of the
involuntary retirement criteria; age 50 and 20 years of service; 25 years of service
at any age; another age such as 40, 50, or 52; or service such as five or ten years.
The table below illustrates some of the possible criteria and their relative impact
with respect to the percentage of the 2,700,000 federal employees in the retirement
system who would be covered initially under Social Security. The proportion shown
as covered is somewhat higher than it would be because a split between military
and civilian service was not available.
If those excluded
are employees
Number not
covered
Number covered
Percentage
covered
Meeting involuntary
retirement conditions
675,000
2,025,000
75%
Over age 52
755,000
1,945,000
72
Over age 50
890,000
1,810,000
67
Over age 45
1,240,000
1,460,000
54
Over age 40
1,600,000
1,100,000
41
With more than ten years' service
1,600,000
1,100,000
41
With more than five years' service
2,200,000
500,000
19
Coverage Under the New
Retirement Plan
Whichever age, and or age and/or service conditions are selected for the Social
Security coverage cutoff, is likely to also be an attractive cutoff for coverage
of current employees under the new retirement plan. The new plan will integrate
with Social Security so the obvious choice would be to have the new plan and
Social Security cover the same people for the same period of time.
Few employees who would be eligible to retire on a voluntary basis would have
any reason to prefer being under a new retirement plan. As a result, it is
predictable that many, if not all, would choose to retire before being placed
under the new system, assuming they were given a choice.
It is reasonable to assume that employees with long service, especially those
with median and higher final incomes, would feel that it generally would be
contrary to their financial best interest to be forced into any of the proposed
retirement plans, as each produces a lesser benefit at age 55 with 30 years
of service than the current system. As this group has been under an established
set of rules for many years, there is a line of rationale that suggests that
they too should be exempt from a new retirement plan on the basis that it is
ie too late for many of them to end their involvement in federal employment
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and start new with another employer, even though their federal benefits would
be, in some cases, substantially diminished.
Another major question concerning transitioning current employees to a new
retirement plan is how should service under the old and new plans be treated
in calculating the benefit? We believe that the most practical and the
fairest way would be to determine the accrual rate earned under the old rules
for service before the effective date of the new plan and the accrual rates
under the new rules for service after the effective date, and multiply each
of them against the high three years average earnings to produce the amount
of the benefit.
Benefits between ages 55 and 62, for those retiring before age 62, also must
vary by salary level. The current plan provides a 53 percent replacement for
thirty years service at age 55. The offset and step rate plans will eventually
provide 47 percent. For an employee with twenty years under the current system
and ten under the new system the rate will be 50 percent and for ten old and
twenty new the rate will be 48 percent. Under the add-on approach the ultimate
level will be 38 percent; the level with twenty old and ten new will be 47 per-
cent; and the level for ten old and twenty new will be 40 percent. Thus there
would be a smooth progression in the decrease in benefits as service under the
new plan is added to service under the old.
After age 62 the progression to new levels is more rapid because employees
quickly become eligible for a large share of the Social Security benefits.
Current federal benefits for 30 years service remains at the 53 percent level
after age 62. For new employees the benefits will disperse to slightly lower
levels for high paid and much higher levels for low paid employees. Reference
to the earlier table for new employees will show that the new levels have al-
most been reached with only ten years under the new combined system:
Twenty years old and Ten years old and
Final pay ten years new twenty years new
$10,000 $19,000 $50,000 $10,000 $19,000 $50,000
Replacement rates for:
Offset 67% 61% 53% 67% 61% 53%
Step-rate 65 60 55 65 60 53
Add-on 67 60 53 68 59 49
For all but high paid employees the new benefit levels after age 62 are higher
than under the current system. If, however, an employee under the current
system had managed to obtain minimum Social Security coverage his or her benefit
under the new system will probably be lower at all pay levels. With thirty
years federal service and ten years Social Security service an employee now
could expect to receive combined benefits ranging from 72 percent for low paid
paid to 59 percent for high paid employees.
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Summary of Findings
There are three possible criteria for determining the adequacy of the income
replacement provided by the government to employees. Any new plan may be
compared to the existing civil service plan, to the prevailing practices of
private sector employers, and to theoretical measures of income replacement
adequacy.
We have developed three retirement plans which vary by the benefit formulae
used. The other parts of the benefit design are the same for each of the
three plans and are consistent with current federal retirement benefits,
except where there were strong reasons to vary them.
Generally speaking, if employees retire on or after age 62, the formulae
yield income replacement that is equal to or greater than the current civil
service plan for lower and median income employees, and slightly below the
current plan for higher income employees. For employees who retire at age
55, the income replacement is lower for employees at all income levels.
Never the less, the benefit at age 55 would be much greater than what is
provided to private sector white collar workers, but roughly equal to that
provided to blue collar workers.
The government could improve the pattern yield of its income replacement
approach by offering a thrift plan to employees. The income replacement
available to employees who chose to participate could be enhanced considerably
at reasonable cost.
E.
These approaches could be considered almost in the abstract, except for the
fact that there is an existing federal work force. Some of the decisions that
have to be made center on whether or not current employees are mandatorilly
included or excluded from Social Security retirement coverage, and from any
new pension system. There are various age, or age and service combinations,
that could be considered possible cutoffs for inclusion under Social Security
and under any new retirement plan.
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PART III: NON JOB-RELATED DISABILITY INCOME
REPLACEMENT SYSTEM
Non job related sicknesses and accidents often result in temporary or permanent
disabilities. Such disabilities may be partial or total. Or, a temporary dis-
ability may lead to a partial disability and, in turn, to a total and permanent
disability. The possibility of experiencing a disabling illness lasting more
than six months is much higher than that of premature death. One person in every
five will be disabled for six months or longer before age 65, and the average
disability period for these persons will exceed 18 months. Disability is a threat
to the financial security of employees and their families.
Employers who pay FICA taxes rely on the Social Security disability program to
furnish basic income replacement to employees who have total and permanent
disabilities. Because Social Security benefits are not payable for several
months after a disability begins, employers usually provide short term income
replacement to employees through such benefit mechanisms as accident and sickness
insurance, sick leave, and informal salary continuation programs. When employees
qualify for Social Security disability benefits, many employers supplement the
income replacement furnished through that program by benefits payable from long
term disability insurance, or disability retirement. One advantage of long term
disability insurance benefits to employers is that such benefits may be offset by
100 percent of the Social Security disability benefit. That level of offset is
not possible if the disability benefit is payable from a qualified retirement
plan, because of integration rules of the Internal Revenue Service.
The retirement benefits were measured against three criteria - the current plan,
private sector benefits and theoretical income replacement. This triad is not
being used to evaluate disability benefits. The current federal disability plan
has come under a lot of criticism. First, conditions for coming on and leaving
the disability rolls are far more liberal than those provided by Social Security
alone and are very much lower than the total benefit for typical private sector
employees who become disabled. Finally, there is a need to integrate sick leave
and disability benefits into a continuous adequate benefit system. Since the
disability system needs revision and since OPM is in fact working on proposals
in this area, it would not be appropriate to measure new integrated benefits
against the current system.
The theoretical income replacement measures also have less relevance for dis-
ability than for retirement. If employees work full careers, the employer can
be considered to have a duty to maintain the employees' standard of living. By
the same token, if careers are spread over several employers it is appropriate
for each employer to each contribute retirement benefits that add up to a
desired total. Disability, however, affects both short and long term employees
and the level of benefits should be measured in social as well as service-related
terms.
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Since the current federal system needs changes and since the theoretical income
is not as relevant the important measure is private sector practice. The bene-
fit system in this part is developed in these terms. In some instances, private
practice is modified to achieve what we believe is a more logical flow and level
of benefits.
Definitions of Disability
The Social Security definition of disability is: A person must have a physical
or mental condition which prevents him or her from doing any substantial gainful
work, and the condition must be expected to last, or has lasted, for at least 12
months, or is expected to result in death. Under such a definition, even if the
person is unable to continue his or her regular work, if it is possible to do
any other kind of work, he or she is not disabled for purposes of securing
Social Security disability benefits.
A less stringent but very common insurance definition of disability is: Unable
to perform the duties of occupations for which qualified on the basis of education
and experience. This definition indicates that the person is disabled for his or
her current job and for all other jobs in occupations in which his or her back-
ground would be considered qualifying. It is unstated but understood that during
the first phase of a period of disability the measure is occupations which pay
reasonably comparable wages and salaries. After the duration of the disability
has been lengthy, it is understood that the measure is any occupation for which
qualified, whether or not the pay amounts to reasonably comparable rates.
The least stringent definition of disability is one associated with the Office of
Personnel Management's disability retirement function: The employee is unable to
provide useful and efficient service in the grade or class of position last occupied
because of disease or injury. In practice, the definition amounts to inability to
perform one or more of the principal duties of the current job because of a physical
or mental impairment.
Administrative Mechanisms
Short term disability coverage typically consists of accident and sickness in-
surance for blue collar employees, and sick leave and informal salary continuation
for white collar workers. The prevalent practice is to replace 50-75 percent of
pay for six months or less. Informal salary continuation on a case by case basis,
however, is a reasonably common benefit practice for white collar workers. The
amount of sick leave available to white collar employees often increases with
their length of service and may be full pay or some percentage of it. Some white
collar workers first use sick leave at full pay for some interval and then are
eligible for accident and sickness insurance thereafter during the first six
months of a period of disability. Typical waiting periods for accident and sick-
ness insurance coverage are three to seven days.
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Until the middle of the 1960s private employers commonly offered disability re-
tirement to employees who became totally and permanently disabled. This is
still the prevailing practice for blue collar employees. Approximately two-
thirds of large companies now offer long term disability insurance programs--in
place of disability retirement--to their white collar work forces, while slightly
more than one-fourth of such companies offer the same type of coverage to their
blue collar work forces. The long term disability insurance coverage typically
has a waiting period of six months, and dovetails with the ending of coverage
under the employers' short term disability programs. Most long term disability
insurance programs replace 50-60 percent of pay. Almost 90 percent of these
plans pay benefits for the duration of the disability, until normal retirement
age, or until death. At normal retirement age employees begin drawing retire-
ment benefits under the employers' staff retirement plans, and their coverage
under long term disability insurance terminates. The long term disability
insurance coverage is integrated with Social Security disability benefits.
That is, large employers may provide benefits that supplement the income
replacement furnished by Social Security up to some target level that usually
is expressed as a percentage of former earnings.
The Social Security definition of disability and system of benefits will apply
to federal workers, as it now does to more than 90 percent of the Nation's work
force, if and when the Civil Service Retirement System is integrated with Social
Security. The major issue associated with the integration in the area of non
job-related disabilities is:
--What changes are needed in the existing federal benefit structure to accomo-
date to the Social Security disability system?
--What level of disability benefits should be paid by which organization for
how long through which benefit mechanisms to employees who are temporarily,
partially, or totally and permanently disabled?
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Classes of Non Job-Related Disabilities
There are three distinct classes of non job-related disabilities that are
described in this part of the paper, temporary, partial, and total and permanent.
For purposes of this paper, a temporary disability is a medically determinable
condition preventing employees from performing one or more of the principal duties
of their current jobs. With temporary disabilities there is an expectation that
employees will recover and return to work within a reasonable period of time,
e.g., nine months. A partial disability may be defined as a medically determined
condition preventing employees from performing one or more of the principal duties
of their jobs for an indefinite interval that is likely to exceed one year. Em-
ployees with partial disabilities still are capable of performing some substantial
gainful work. A total and permanent disability, as defined under Social Security,
is one which prevents persons from performing any substantial gainful work, and
the condition is expected to last, or has lasted 12 months, or is expected to
result in death. Of course, the total and permanent disability must be caused by
a medically determined physical or mental condition.
Background
Most temporary disabilities end within one month, though there are many indivi-
dual cases where employees have illnesses or suffer accidents where the treatment
requires lengthy periods of convalescence. Partial disabilities may result from
incidents with sudden onsets, i.e., accidents, strokes, etc., but most are the
results of incremental changes that occur because of physical, or nervous and
mental disorders. Some diseases have known courses of short duration. Others
are chronic and of indefinite duration. Still others are characterized by periods
of active disease, periods of remission or limited damage, or varying intervals
of more or less intense activity. In effect, a small percentage of absences ini-
tially presumed to be due to temporary disabilities eventually are found to be
caused by partial disabilities, and an even smaller percentage stem from condi-
tions brought about by total and permanent disabilities.
In the current federal employee benefit system, the sick leave program deals with
temporary disability, and the disability retirement program covers both partial,
and total and permanent disability, as they have been defined.
--Temporary Disability
Federal employees accrue 13 days of sick leave annually, and may accumulate and
carry it over from year to year without limit. Sick leave plans of private
employers typically provide lesser amounts of- sick leave, especially to employees
who have only a few years of service, and do not permit carryover of sick leave
from year to year. Federal workers now use 9.5 days of sick leave each year,
which represents 3.5 percent of the government's payroll. Private employees use
an estimated five-six days of sick leave annually. The difference between federal
and private employee' use of sick leave is overstated. The numbers for private
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employees do not reflect use of sickness and accident insurance benefits, use of
personal rather than sick leave, and variations in the administrative practices
of some companies that may not charge sick leave for doctors' or dentists'
appointments.
The current sick leave program provides full income replacement for the period
an employee has accrued sick leave. The accrual can range from zero for new
employees or employees who have previously used all of their sick leave to
more than a year for long service employees who have made little use of sick
leave. When their sick leave balance is exhausted, employees may request an
advance of sick leave. Agencies may advance such leave within limits. Employees
also may use their annual leave. When the combination of sick and annual leave
is exhausted, agencies may place employees who cannot return to work on leave
without pay. While in this status, employees and their families have no income
replacement.
As federal employees would be subject to a waiting period of five full months
before they may apply for disability benefits under Social Security, only those
with eight or more years of service, who never had used sick leave, would have
enough accrued to provide income replacement throughout the Social Security
waiting period. In short, there will be an income replacement gap, unless the
government changes the sick leave program's plan design.
--Partial Disability
The Social Security disability system rejects persons with partial disabilities.
Yet some federal employees who are on sick leave will not recover sufficiently
to perform the full range of duties of their jobs. -These persons will eventually
be capable of performing some gainful work. Under the current staff retirement
plan, those employees with five years of service have a right to elect to retire
on disability rather than accept another position which they are qualified to
perform on the basis of experience, education, and medical fitness, even if they
are only partially disabled.
The experience of large insurance organizations that administer long term dis-
ability programs for private companies has been that temporarily and partially
disabled employees either return to the work force in their first year or two of
their disabilities, or they do not return at all. The number of those who are
going to return is greatest during the first year, smaller during the second
year, and rapidly declining thereafter. Their experience suggests that an
employer should assure that partially disabled employees are given every oppor-
tunity to return to the work force as early in their periods of disability as
possible.
There is not a great amount of reported experience with respect tc the rehabili-
tation and subsequent reemployment of partially disabled employees in industry,
according to the Metropolitan Insurance Company. The federal government has
substantial experience, however, with the hiring of the partially disabled, the
handicapped. That process involves cooperation with state vocational rehabili-
tation specialists, agency personnel staffs, and federal medical officers. If
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the government chooses to help disabled employees to pursue a suitable employment,
an effort parallel to what is done for handicapped new hires seems reasonable.
Current practice under the retirement plan does not envisage the restructuring
of jobs, or the involvement of rehabilitation specialists in assisting partially
disabled employees to return to active employment. In fact, the sole requirement
is that the agency consider the possible reassignment of employees to other jobs.
Often, the jobs which such employees can perform are at lower pay rates. There
now is no method of cushioning the financial effects of employees voluntarily
moving to a lower paid position.
Most private sector employers cover partial disability under their long term
disability insurance benefit, for one or two years. Thereafter, most only pay
the benefit if employees are unable to engage in any gainful work. The prevailing
practice of such employers is to provide a benefit in the range of 50-60 percent
of earnings to white collar employees.
--Total and Permanent Disability
The retirement plan for civil service employees draws no distinction between
employees who are partially disabled and those who are totally and permanently
disabled, in terms of income replacement. Both classes of disability retirement
recipients receive identical levels of income replacement. Employees who hired
into federal service before attaining age 38 replace a guaranteed minimum of
37 percent of current earnings (40 percent of the high three years of earnings).
Employees with 22 or more years of service at the time of their disabilities
receive an accrued benefit that is greater than the guaranteed minimum.
From the standpoint of income replacement, Social Security disability benefits
are more sufficient for some and less so for others. Lower income employees
with families replace 60 percent of earnings, median income employees with
families replace 45 percent, and high income employees with families replace
18 percent. Single lower income employees replace 40 percent of earnings,
while single high income employees replace only 12 percent of earnings through
Social Security disability benefits. In the case of totally and permanently
disabled white collar employees, employers provide a supplement to the Social
Security disability benefit, usually sufficient so that the combined benefit
replaces 50-60 percent of former earnings.
As many blue collar employees replace the full target income level through
Social Security, or may not meet the age or the age and service requirements
of their respective disability retirement plans at the time of disability,
Social Security benefits often are the sole source of income replacement for
them.
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Fitting Federal Benefits to Social
Security Disability Benefits
Temporary Disability
There are two alternatives with respect to dealing with temporary disability
in the context of Social Security disability benefits. The first involves
the installation of an accident and sickness insurance type of program. The
second involves changing the existing sick leave program.
If an adjustment of the sick leave program were selected as the means of bridging
the Social Security waiting period, and to provide help to convalescing employees,
the employing agencies would be the logical administrators of the plan. Assuming
that the benefits levels are to be reasonably comparable to those furnished to
employees of private companies, the kinds of questions that arise include: How
long should sick leave at full pay be provided? How long should a benefit at
less than full pay be provided? And, when does the presumption that the employees
will recover and return to work status get tested?
Partial Disability
There are also two fundamental alternatives with respect to partial disability.
First, the government could choose to continue paying a lifetime benefit of 37
percent of final. pay under the retirement plan to those employees who do not
qualify for Social Security disability benefits, but who cannot perform one
or more of the principal duties of their jobs.
Or, the government could elect to pay a higher benefit for a shorter interval,
for example, two years, and assist employees who are partially disabled to find
gainful employment that is consistent with their medical conditions.
The primary advantage of continuing to pay a lifetime benefit of 37 percent
of final pay to employees who become partially disabled is that of avoiding
change. But, there are many problems that would arise in the event that
some federal employees could retire on disability benefits of 37 percent of
final pay, while others who qualify for Social Security disability benefits
would receive a higher percentage of final pay. There has been criticism of
the current civil service definition of disability as too loose, and that
opinion would persist as long as two levels of lifetime benefits were provided
under substantially different definitions of disability.
One of the problems of a benefit payable at 37 percent of final pay is that
the employees and their families experience a very drastic reduction in their
purchasing power and standard of living. Hence, the second alternative, pay-
ing a higher level of benefit for a shorter interval, has some appeal, especial-
ly if it is linked with a positive effort to place those employees who are fit
to work in other jobs.
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In the event employees are given fitness for duty examinations after some months
on extended sick leave, e.g., nine months, and are found to be partially disabled,
decisions could be made by federal medical officers, in concert with the private
attending physicians, concerning the feasibility and desirability of employees'
returning to work in other jobs. If the decisions are that the employees cannot
return to work at that time, the extended sick leave benefits would continue being
payable for up to two years from the date of the initial absence. On the other
hand, if employees are medically ready to resume some active employment, agency
management could assist employees in finding suitable placements.
The process of placement of partially disabled employees would involve, as a
minimum, agency personnel staffs and medical officers. It might necessitate
the services of vocational rehabilitation specialists, or others with expertise
often unavailable in agency work forces. Certainly the agencies would be
expected first to identify any jobs at the same pay level, and with the same
opportunity for advancement, for which the employees are qualified on the
basis of medical as well as experience and education factors. In the event no
such fit was possible, the agencies could identify the next best available
offers that could be made. The positions in question might be jobs which were
restructured to take advantage of the employees' strengths and minimize those
skills, knowledges, and abilities in which there might be limited capacity.
To overcome the financial difficulties of moving to lower paying positions,
were that the only realistic alternative, consideration should be given to
cushioning the effects through use of saved pay provisions.
Total and Permanent Disability
Social Security disability benefits provide adequate income replacement to
lower income married employees and their families. But, such benefits are too
low to permit single and median or higher income employees and family members
to have a standard of living close to their former ones. Comparable practice
of large private companies is a reasonable guide to the level of income replace-
ment that the government should provide to its employees through a combination
of Social Security benefits and long term disability benefits. As private
employers typically replace 50-60 percent of final income through these sources,
that seems to be a reasonable goal for the government.
There seems to be little reason to continue paying a long term disability
benefit under the retirement plan, as it complicates the process of integrating
general retirement benefits under the rules of the Internal Revenue Service
without a corresponding advantage. Thus, it would be possible for the government
to set up a separate fund for purposes of paying long term disability benefits
centrally, or agencies simply could pay the benefits themselves to any of their
employees who qualify for Social Security disability payments.
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One Possible Benefit Design
There are many ways of adjusting the federal employee benefit package so that it
accommodates to the value and availability of Social Security disability benefits.
What follows is a description and a rationale for one way of making the adjust-
ment. We recognize that there are many alternative means of making the changes,
and are simply showing one such system as an illustration and basis for pricing.
Temporary Disability
The government could continue to provide sick leave at full pay to cover short
term absences due to temporary disabilities. For example, six days for new m-
ployees and ten days maximum at full pay for employees with more than one466
service. The carryover of sick leave from year to year is unnecessary, however,
if the government provides an extended sick leave benefit. That benefit might
be payable at 75 percent of pay for the balance of the first five months of ab-
sence and 60 percent thereafter for up to two years from the first day of absence.
Sick leave balances of current employees would be carried foward so that they
would lose nothing already earned.
Employees could accrue extended sick leave on the basis of one hour for each
four hours in a pay status. For full time employees, the accrual would be 13
weeks of benefits for each year of service. Accumulation would be limited to
104 weeks of benefits. This limit would be reached after eight years if the
employee had not used extended sick leave in that time. Employees who use
some or all of the extended sick leave balance would restore that balance after
returning to work by again adding 13 weeks to the balance each year.
With such a combined program of sick leave at full pay and sick leave at 75 or
60 percent of pay, the government would be providing a liberal but comparable
benefit that would assure adequate income replacement throughout the Social
Security waiting period and during lengthy convalescences. This is the primary
goal of the proposal with respect to temporary disabilities.
There would be a waiting period of five work days from the first day of absence
due to illness before employees could apply for the extended sick leave benefit.
During this interval employees could use sick leave at full pay, annual leave,
or ask for leave without pay. The waiting period is a common method of con-
trolling utilization of such a benefit.
To qualify for the extended sick leave benefit, employees would present medical
certificates signed by their physicians indicating that they were unable to
work due to illnesses. The employees would provide such medical certificates
through their supervisors to the payroll offices. Submission of such certifi-
cates by employees would be sufficient documentation for agencies to pay the
benefit for up to four work weeks. As most temporary disabilities end within
the first month, this procedure would not be cumbersome administratively in
terms of handling most temporary disabilities.
When employees recognize that their disabilities may last longer than four
weeks they would be responsible for getting their attending physicians
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to submit clinical reports that. specify which duty or duties in their current
position descriptions could not,be performed, as well as a diagnosis and prognosis,
directly to the employing agencies' medical officers or contract physicians.
The employing agencies' medical officers would evaluate such reports on the
employees' health status to assure that they were temporarily disabled for
their current positions. They would advise supervisors that sufficient medical
evidence existed to justify the use of extended sick leave benefits. Further,
they would be authorized to request updated medical reports from attending
physicians at intervals that reflect their best professional judgments given
the diagnosis and prognosis. If they questioned the acceptability of the
medical evidence, they could recommend that supervisors request that employees
be given fitness for duty examinations.
Partial Disability
There appears to be little to recommend paying a lifetime benefit to employees
who become partially disabled. If employees are capable of participating in
gainful employment, it seems more fitting for the government to have a policy
and a program for helping them return to work as quickly as possible. If an
employee takes a job outside government he or she will have to report it. The
disability benefit will be reduced in proportion to the employees' salary or
dropped altogether if the salary is large enough. The reduction will be less
than dollar for dollar to allow some incentive to return to work. In any event,
the benefit will be fully restored if the employee loses the job before the end
of the extended sick leave period.
The concept of active agency involvement in working out satisfactory placements
of employees who become partially disabled should be explored. The combined
efforts of agency medical officers, personnel staffs, and vocational rehabilita-
tion specialists should be sufficient to work out placements in existing or re-
tructured positions for many of the partially disabled. If the government per-
mits partially disabled employees who accept positions at lower rates of pay
to receive saved pay, it should ease their financial transition over a reason-
able interval.
As there is little or no justification for paying lifetime benefits to such
employees, at some point persons who are capable of working either should
work or terminate employment. Two years on sick leave at partial pay seems to
be a sufficiently long interval for partially disabled persons to recover and
to accept jobs for which they qualify. If they elect not to work, then they
will be eligible for deferred annuities if they had more than five years of
civilian service including the disability period.
Total and Permanent Disability
Social Security disability benefits form the core of the income replacement
approach covering most American workers. If such benefits become available to
federal employees, they will be more adequate for some and less so for others,
due to the inherent tilt of Social Security. Most employers provide some
supplement to Social Security disability benefits so payment of a long term
disability benefit by government is appropriate.
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Federal employees would get whatever Social Security disability benefits were
due to them, and in the event that the employees' direct benefits replaced
less than 60 percent of their final pay, they would receive a long term dis-
ability benefit up to that level. There is little reason to centrally fund a
long term disability benefit, as it simply involves an additional layer of
administration.
The administration of the benefit, instead, could work as follows. Once em-
ployees are notified by the Social Security Administration that they qualify
for disability benefits, and know the amount of the benefit, they could pre-
sent the notification to their agency employers. Agency payroll offices would
carry out the calculations and pay a long term disability benefit until the
disabilities end, the employees reach age 62, or die. At age 62 the long term
disability benefit would end, and a retirement benefit would be payable from
the staff retirement system that, together with Social Security benefits,
would replace at least 60 percent of former earnings.
If, as is often the case, the Social Security determination did not occur
before five months the agency would continue the employee at 60 percent of
pay, the same as for a partial or temporary disability. After the Social
Security determination is made the retroactive Social Security payments would
be made to the federal agency. Since there is no financial incentive for an
employee to apply for Social Security in the first two years, the agency
should first encourage the employee to apply and, if that fails, insist on
a determination.
Summary of Findings
This paper outlines the kinds of problems that have to be faced regarding
the management of non job-related disabilities, if the federal employee
benefit package is integrated with the Social Security System. These are
the basic findings:
--The Social Security definition of disability is acceptable for use in
regard to determining whether or not employees are totally and permanently
disabled. A modification of the current civil service definition of disability
is acceptable for use in connection with both temporary and partial disabilities.
--Social Security disability benefits, as supplemented by long term disability
payments, together provide the optimum method of replacing the appropriate
amount of income fQr employees who become totally and permanently disabled.
--Current federal benefit mechanisms are not adequate for replacing income for
seriously disabled employees during the five full months it takes to complete a
mandatory waiting period for Social Security disability benefits, or for providing
financial support to employees who need lengthy intervals of convalescence.
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These general approaches appear to be the most practical means of fitting the
federal employee benefit package and Social Security disability benefits
together:
--The amount of sick leave at full pay that is provided to employees could be
reduced, and carryover of such leave should end.
--A new benefit, extended sick leave, is needed to bridge the income replace-
ment gap that occurs because of the Social Security disability waiting period,
and to assist employees who have temporary disabilities that require lengthy
periods of convalescence or partial disabilities that do not qualify the
employee for Social Security. Extended sick leave should be payable, for example,
at 75 percent of pay during the first five months of absence and 60 percent
thereafter until two years of absence have elapsed.
--Emphasis is needed on placing employees who cannot perform their current jobs,
but still are capable of useful service, in other jobs. The combined efforts of
agency medical officers, personnel staffs, and rehabilitation specialists are
needed to help partially disabled employees return to the work force. The focus
initially should be on placement in jobs with comparable pay rates and opportun-
ities for advancement. If that is not feasible, saved pay for two years should
be available to ease the transition to placement in lower paying jobs.
--A new benefit, long term disability, is needed for employees who qualify as
totally and permanently disabled under the Social Security disability system.
Social Security disability benefits and long term disability benefits, together,
should replace, for instance, 60 percent of employees' former pay. This benefit
should be payable until the disability ends, employees reach age 62, or die.
--Federal employing agencies should administer and pay sick leave, extended
sick leave, and long term disability benefits.
--Employees who have not accepted job offers from their agencies and who have
not qualified for Social Security disability benefits after two years of absence
would terminate their employment status, but retain any vested rights they may
have earned to deferred annuities.
--The Office of Personnel Management should continue to be responsible for
governmentwide policy making, program evaluation, and medical standards, but
should have no operational functions in connection with the administration of
the system of replacing income for employees who become disabled for non job-
related reasons. Time on the disability rolls will be credited as service
for retirement benefits. When persons who are receiving Social Security disability
benefits and long term disability benefits reach age 62, the Office of Personnel
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Management should pay a retirement benefit to take the place of the long term
disability benefit. Social Security benefits and retirement benefits, together,
should replace at least 60 percent of employees' former pay.
--The Merit System Protection Board should be responsible for dealing with
appeals from employees that arise from agencies' administration of the system.
The results of implementing such approaches are:
--A system of managing non job-related disabilities that yields comparable
income replacement to federal employees with temporary, or permanent and total
disabilities, as are provided to their counterparts in the private sector.
--A higher benefit to employees with total and permanent disabilities than is
currently provided, better protection for most employees with temporary dis-
abilities and a reasonable benefit for federal employees with partial disabili-
ties.
--A reduction in the number and the cost of employees who leave federal service
because of total and permanent disabilities.
--An emphasis on returning employees with partial disabilities to work status
as soon as posible.
--A system which places the full range of program administration responsibili-
ties with employing agencies so that they can better manage the federal work
force.
One basic design of a disability income replacement system thus is:
(1) Sick leave at full pay during the initial phase of a disability;
(2) Extended sick leave payable at 75 percent of basic pay during
the balance of the first five months of absence, and 60
percent thereafter until two years have elapsed;
(3) Social Security disability benefits plus a long term disability
supplement for totally and permanently disabled employees that
is payable at 60 percent of basic pay until termination of dis-
ability, age 62, or death; and
(4) Termination of employment rights, except for any vested entitle-
ments to deferred annuities, for any employees who have not
accepted offers of employment or qualified for Social Security
disability benefits within two years.
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The design features are summarized below:
New employees are
credited with six
days of sick leave
at full pay during
their first year
of employment, and
ten days each year
thereafter. There
is no carryover of
sick leave at full
pay from year to
year. Employees
could accrue ex-
tended sick leave,
however, at the
rate of one hour
for each four hours
in a pay status, to
a maximum of two
years of extended
sick leave.
After employees exhaust sick
leave at full pay, they are
eligible for an extended sick
leave benefit. The benefit is
initially payable after five
days of absence, in the event
employees have less than that
amount of sick leave at full
pay credited to them. Initial
and periodic medical certifi-
cates are needed to support
claims for benefits. The
benefit is payable at 75 per-
cent of basic pay during the
balance of the first five
months of absence, and 60 per-
cent thereafter until two years
have elapsed.
Employees may apply for
Social Security disabil-
ity benefits after five
months of absence, or any
time thereafter. If quali-
fied, employees would
receive Social Security
benefits and long term
disability benefits payable
by their agencies which, in
combination, would replace
60 percent of their former
pay.
Employees who have
been on sick leave
for nine months
and have not quali-
fied for Social
Security disability
receive fitness for
duty medical exam-
inations. If they
are fit for their
former jobs, they
would return to
them.
If employees are not medically
fit to return to their former
jobs, but are capable of per-
forming useful service in other
jobs, the agency medical officers,
personnel staffs, and rehabilita-
tion specialists would identify
existing or restructure new posi-
itions, whenever possible, with
comparable rates of pay that the
employees can perform. Any va-
cant positions of this type must
be offered to the employees. Em-
ployees may apply for any positions
with rates of pay that are lower
than those of their former positions
and if qualified and selected are
eligible for saved pay for two years.
If employees have not
accepted employment with
their agencies after 24
months of absence, their
extended sick leave bene-
fit terminates, as do
their employment rights,
with the exception of
any vested rights to a
deferred annuity.
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Illustration of Benefits
Assume employees in mid-career have used little sick leave so that they would
have accrued five months sick leave under the current system and the full two
years extended sick leave under the new system. If they become disabled the
percent of pay continued under the current and new systems, including Social
Security, would be as follows.
two months.
The temporary disability is assumed to last
Permanent
Partial
Temporary
Current
New
Current New
Current New
First two weeks
100%
100%
100%
100%
100% 100%
Third week through
second month
100
75
100
75
100 75
Third through
fifth month
100
75
100
75
Recovered
Sixth month through
second year
37
60
37
60
After second year
37
60
37
0
Another employee early in his or her career has accumulated one month of sick
leave under the current system and would have accumulated twelve months
extended sick leave under the new system. If he or she becomes disabled as
above the replacement ratio under each of these systems would be as follows:
Permanent
Partial
Temporary
Current
New
Current New
Current New
First two weeks
100%
100%
100%
100%
100% 100%
Third and fourth weeks
100
75
100
75
100 75
Second month
37*
75
37*
75
0 75
Third through fifth
month
37*
75
37*
75
Recovered
Sixth month through
first year
37*
60
37*
60
Second year
37*
60
37*
0
After second year
37*
60
37*
0
*Zero if less than five years civilian service.
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Previous sections have described the benefits available for employees who
work a full career and then retire or suffer a disability that temporarily
or permanently stops a career. Another event to be insured against is the
possibility of death before or after retirement leaving dependents who have
relied on the employees for support. There is a strong trend toward families
with two workers but even in these cases there is a sharp reduction in income
if one of the two earners dies.
Social Security recognizes the needs of survivors by paying substantial bene-
fits if the employees or annuitants die. In the typical case of retired work-
ers with spouses, Social Security benefits are continued at 67 percent of the
predeath annuity if either person dies. If employees die, typical survivor
families wIll3( receive 50 percent to to 100 percent of the annuity that would
have been paid to the workers and spouses after the worker retired. Substantial
benefits are also
paid if there are children or if there are dependent parents. An important
exception is that widows without children will not receive a benefit until after
age 60.
Historically, private sector plans were geared to providing benefits for em-
ployees leaving to the employees the responsibility of providing survivor bene-
fits through insurance. Employees often could elect actuarially equivalent
survivor benefits to continue benefits to widow(er)s in the event of death
after retirement but the reduction in initial benefit was usually so large
(20 percent or more to continue half of the benefit) that few em-
ployees elected it. Most large employers also provided life insurance bene-
fits. The employers apparently believed that life insurance plus Social
Security benefits met their responsibility to families of young employees.
Since 1974, ERISA has required that the survivor benefit be the primary
benefit even though employees can elect single life annuities. There has
also been a trend among large employers to subsidize survivor benefits with
the reduction set at 10 percent or less as it is for federal survivors bene-
fits. We assume that the ERISA requirement and the trend to subsidies will
greatly increase the prevalence of survivor benefits from private sector
retirement systems. These benefits continue to be limited to survivor of
employees' who die with retirement eligibility.
Another common benefit has been a bridge between the zero benefit payable
to survivors of young employees and the full survivor benefit available to
retirees. Without some sort of bridge an undesirable anomaly would occur. If
employees age 60 die, for instance, their families would not receive any benefit.
But if they had retired the day before,;under early retirement,the spouse would
have received a lifetime benefit. The bridge built into many private plans
assumes that if deceased employees had been eligible for early retirement,
and could have predicted their death, they would have retired the day before
death and elected a survivor benefit. These plans, therefore, provide such
survivor benefits to anyone who dies in service after becoming eligible for
an immediate retirement benefit.
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Federal Employee Benefits
Since federal employees have not been covered by Social Security their benefits
have been improved periodically to replicate the survivor benefits available
under Social Security.
Children will generally receive a flat dollar benefit which is pegged to the
cost-of-living. Currently each child with a surviving parent will receive
$1,900 a year and a child without a surviving parent will receive $2,300 a
year. The total children's benefit for a family is limited to three times
the single child amounts. Children are paid through age 18 unless they
(1) continue in school or (2) become disabled in which case they are paid as
long as they live.
The precedent and subsequent marital conditions are similar under Social
Security and the federal employee system. CSR requires that a widow must have
been married to the decedent for a year and Social Security requires nine
months of marriage. Both systems will continue benefits if the widow remarries
after age 60. One significant difference is that Social Security will pay full
benefits to former divorced wives (but not husbands) who have been married to
the decedent at least 10 years. A similar provision has been proposed for
federal employees but with the benefit split between the current and former
wives.
Benefits are available under the federal life insurance program which, if elected,
combine with retirement benefits to provide substantial benefits to the family
of a deceased employee or annuitant. Regular insurance will provide a one time
benefit equal to one years' pay plus $2,500 and additional optional insurance
of $10,000 can be purchased.
Accomomodating Survivor Benefits to Social Security
Many of the survivor benefits under the federal retirement system were developed
to mirror Social Security. For instance, there is probably not another retirement
system in the United States with a children's benefit or a substantial benefit
for young widows. One obvious way to integrate, therefore, is to eliminate these
benefits if Social Security coverage is extended to federal employees. This
solution is particularly attractive for children since Social Security provides
higher benefits. It would, however, cut benefits substantially for many future
widows and. widowers.
To emulate typical private sector benefits, and current post-retirement coverage,
the new package should continue survivor benefits to annuitants. It would also
be good practice to use the common private sector practise of bridging into this
benefit from an earlier age to avoid a sharp increase in benefits at the time the
employee first becomes eligible for early retirement.
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The level of benefits is another important consideration. Typical private
practice is to offer a 50 percent survivor benefit as the primary option.
When combined with the 67 percent continuation of benefit under Social
Security, the widow or widower can expect to receive 55 percent to 65 percent
of the annuitants' income. The federal program now continues about 60 percent
of the annuitants' income to the widow.
Therefore, using a 50 percent continuation for the new integrated federal bene-
fit would be consistent with private sector practice and current federal bene-
fits.
A final consideration is who should pay for the benefit. Social Security has
no reduction in benefit to the annuitant since the full cost of survivor
benefits is included in the overall tax rate. Consequently, there is no need for
an election of a survivor benefit under Social Security. The federal system
has a nominal reduction of 2 1/2 percent below $3600 and a more significant re-
duction of 10 percent above $3600 annuity. Neither reduction is close to the
full actuarial reduction of 20 percent to 25 percent that would be required
in most cases if the primary annuitants were really paying for the survivor
benefits.
At the other end of the spectrum, for younger employees, it would be consistent
with the private sector to rely exclusively on Social Security benefits. There
are, however, two strong arguments against this. First, this would be a
substantial cut in benefits over current levels for young widows and widowers
who do not have a family. Secondly, the federal life insurance benefits are
far below comparability with the private sector, both in the level of benefits
and the proportion of the cost paid by the employer. The model benefits in
this paper continue 20 percent of the employees' pay, but only for two
years.
Eligibility for Benefits
When federal survivor benefits were first introduced in 1939 they were only
payable as long as the widow did not remarry. In 1966, the remarriage condition
was limited to those under age 60 to allow older annuitants to marry without
.losing benefits since there was evidence that many older annuitants were living
together without marrying because of the annuity situation. Changing marital
patterns in the last decade have introduced even more complications. Among
these are the increasing trends toward both spouses working, avoidance of
marrying for tax reasons and serial monogamy. The latter occurence has led to
changes in the Social Security system to pay benefits to certain divorced women,
and many similar proposals for changes to federal annuities. We anticipate
that these trends will be recognized in federal benefit modifications eventually
and do not attempt to address these issues here. The proposed benefit will,
however, be provided to spouses only on condition that they would have been
married to the annuitant at least a year at the time of death. The benefits
will be continued irrespective of future marital conditions of the survivors
since ERISA requires that the benefit be independent of subsequent marital
status.
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As with retirement and disability, we are presenting possible integrated models
for illustration and as a basis for pricing. The model relies more heavily on
typical private sector practice than on current federal survivor benefits since
the latter were developed largely to replicate Social Security coverage and the
logic behind much of the survivor benefit structure, viz. children's benefits,
will collapse if federal employees become covered by Social Security.
Possible Benefit Design
A separate survivor benefits system will be constructed and old-age survivor
benefits will be added to the retirement system presented in Part II of this
paper. There will be no benefits payable to children since Social Security
benefits are always higher. Widows and widowers will receive benefits
irrespective of subsequent marital status to conform to ERISA requirements.
The separate survivor system will pay benefits to widows and widowers of de-
ceased annuitants or deceased employees who had worked at least 18 months im-
mediately preceeding death. This benefit will pay 20 percent of the employ-
ees' final salary to the widow or widower for two years.
If the decedent had been between ages 55 and 62, the widow or widower will re-
ceive the greater of the above amount or 50 percent of the retirement benefit
that would have been paid if the employee had retired the day before death. If
employees die between ages 51 and 55, survivors will receive an increasing per-
cent of the retirement benefits starting with 10 percent at 51, and increasing
10 percent a year to 40 percent at age 54._
At the time annuitants become age 62, they will be able to elect a survivor bene-
fit of 50 percent of their annuity in return for a reduction in annuity based on
the current 2 1/2 and 10 percent formula. If the employees or annuitants die be-
tween ages 50 and 62, the benefits will be moved to the retirement system when
the employee would have been eligible for early retirement. In any event, the
20 percent benefit will be paid from the survivor system for two years to sur-
vivors of eligible employees or annuitants but the total benefit in that two
years period will be no more than the larger of the two formulae.
Illustrative benefits
The federal children's benefit will be dropped since the Social Security benefits
are almost always greater. Sample replacement ratios are:
Income level
$10,000
$19,000
$50,000
Current federal benefits
One child
19%
10%
4%
Three or more orphans
without parent
69%
36%
14%
New Social Security benefit
One child
h
31%
22%
9%
T
ree or more children
72%
50%
21%
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Young widow(er)s with children will usually get more under Social Security than
they would with current federal benefits but young widow(er)s without children
will get nothing. Therefore an additional benefit close to current federal
levels is included but only for two years as the combined replacement rates will
a3 be very high. Following are illustrative benefits for survivor families
of widows and two children.
Income level
$10,000
$19,000
$50,000
Current federal benefits
While children receive benefits
59%
41%
29%
Widow(er) alone
21
21
21
First two years after death
99%
80%
46%
After two years while
children receive benefits
72
50
21
After children grow up
0
0
0
After widow(er) reaches
age 60
29
20
9
Benefits to widow(er) of annuitants will generally be higher than under the
current system because of the 67% continuation of benefit under Social Security.
The relative improvement in benefit will-decrease as salary and service increase
because of the income redistribution feature of Social Security. A widow(er)
of an annuitant with 30 years service will receive the following benefits:
Income level
$10,000
$19,000
$50,000
Current federal benefits
29%
29%
29%
New combined benefits
- First two years
60%
47%
31%
- After two years
55%
44%
31%
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Federal employees who retire on immediate annuities with at least five years of
creditable service and enrollment under the Federal Employees Health Benefits (FEHB)
Program for the five years of service immediately preceding retirement, or for all
service since their first opportunity to enroll, may carry health benefits coverage
into retirement, provided the annuities are sufficient to cover the required with-
holding. Annuitants may elect coverage for eligible family members. Elements of
the FEHB Program, including benefits, premium rates, and choices among plans, are
the same for annuitants as for active employees.
The Medicare portion of the Social Security Act establishes Health Insurance for
the Aged and Disabled, consisting of Medicare Part A (hospital insurance), and
Medicare Part B (supplementary medical insurance). Any individual over age 65 who
is eligible to receive Social Security benefits is automatically covered under Part
A at no current cost to the protected person. Dependents, age 65 and over, are
eligible as well as disabled persons who have been receiving Social Security
disability benefits for at least 24 consecutive months. Part B is open to any
individual covered under Part A, and anyone over age 65 who opts to purchase coverage
through a monthly premium shared by the government and enrollees.
If FEHB enrollees are eligible for Medicare coverage, double coverage limitations
in FEHB contracts require co-ordination of benefits. The double coverage provision
is intended to prevent payment of benefits which exceed expenses. Therefore, one
plan will pay its benefits in full and one plan will pay a reduced amount which,
when added to the benefits from both plans for the same covered expenses, will not
exceed 100 percent of reasonable and customary expenses. Medicare, designated by
law as the primary carrier, provides #ts benefits in full at all times. In most
circumstances, enrollment in a FEHB plan complements services covered by Medicare
so that enrollees with dual coverage have 100 percent reimbursement of most
health care costs.
If universal Social Security coverage is mandated, federal annuitants will be
eligible for both portions of Medicare. Our goal should be to assure a comprehen-
sive health care package for both enrollees and their dependents at a financially
feasible premium level. The new system should have benefits similar to those in
the current federal system and in typical private sector plans.
Major Considerations
There are two major areas of structural difference, eligibility and dependents'
coverage, between the FEHB Program and Medicare. Federal civilian employees may
continue their health benefits coverage into retirement. Survivor annuitants may
continue enrollment if the deceased enrollee were covered under a Self and Family
enrollment at time of death, if at least one family member is entitled to an annuity
as a survivor of the deceased, and if the annuity is sufficient to meet the required
withholding.
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An individual is eligible for Medicare participation (Part A), regardless of working
status, at age 65 if the individual has been covered under Social Security long
enough to qualify for cash benefits, or if entitlement exists for railroad retirement
benefits. Dependents, age 65, also are eligible. Those persons who have been
receiving disability benefits under the Social Security system for two years are
also eligible, as are those covered under the chronic kidney disease program. The
latter two benefit categories do not include dependent coverage. All persons
entitled to Part A benefits are enrolled automatically in Part B. Anyone 65 or
over, regardless of entitlement rights under Social Security, may elect Part B.
Under the FEHB Program, enrollees may opt to cover eligible family members by
electing Self and Family coverage. Eligible family members include the enrollee's
spouse, unmarried children under age 22, or over age 22 but incapable of self support.
Under Medicare, only a dependent spouse of an eligible Medicare participant may be
covered upon attainment of age 65.
Coverage Gaps
If the FEHB Program is designed to interact with Medicare to achieve full health
benefits coverage, protection gaps will arise under the following circumstances:
for spouses, under age 65, of enrollees eligible for both FEHB and Medicare; for
dependent children, eligible for FEHB, but not Medicare; and for all dependents of
those eligible for Medicare by virtue of two years on the Social Security disability
rolls.
A factor for consideration in choosing a health benefits alternative is the effect
on the overall premium structure. First, the equity of charging enrollees for
two systems that, to a large extent duplicate benefits, is questionable. Under the
current system, although FEHB benefits are not paid to the extent that Medicare
benefits are paid for the same services, FEHB annuitants and employees who are
covered by Medicare pay the same FEHB premium as those who do not have Medicare
coverage. Thus, although such employees and annuitants pay the full premium that
is charged for comprehensive FEHB coverage, these employees and annuitants receive
only complementary benefits.
Second, since the payments for health care services covered under the FEHB program
are reduced by the amount of Medicare benefits that are also payable, there is a
substantial savings to the FEHB Program. Because of the nature of the experience
rating, the savings effected by a FEHB plan because of its nonduplication of Medicare
benefits result in a somewhat lower standard premium for all employees and annuitants
enrolled in that plan and for the Government.
Alternatives
If universal Social Security coverage is achieved, three alternative approaches to
health care protection suggest themselves: discontinue all FEHB program coverage
at age 65, relying totally on Medicare protection; retain the present method of
annuitants participating in the FEHB Program with benefit payment co-ordinated with
Medicare; or establish a Medicare supplement plan under the FEHB Program available
to those over age 65. The proposals should be evaluated for their impact on eligi-
bility, dependents' coverage, effect on premium rate structure, level of benefits
available, and ease of administration.
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There are two basic arguments favoring discontinuing FEHB coverage at age 65.
First, claims administration would be easier because of the elimination of benefit
co-ordination between FEHB plans and Medicare. Second, there would be a reduction
in the total government cost, as there would be fewer participants.
The arguments against this approach involve four concerns. First, there would be a
loss of comprehensive health coverage now available by participation in both programs.
Second, it would be a significant break with practices of the current system, which
allows continuation of coverage in retirement. Third, there could be a possible
increase in premium level for remaining FEHB participants. And, fourth, there
probably would be negative psychological and political impact overall. If this
approach were adopted, it would be necessary to amend the law to establish a special
enrollment category for otherwise covered dependents under age 65, and to remove
Medicare recipients from eligibility.
The second approach is to retain the present method of annuitants participating in
the FEHB Program with benefit payments co-ordinated with Medicare. The four
advantages of this approach are: dependents' coverage would not be affected; there
would be a decrease in premium level for all FEHB participants; a good benefit
level would be available by co-ordination of the two programs; and administration
of the double coverage limitation by FEHB plans would be facilitated, as anyone 65
or over would have Medicare coverage. But, the disadvantage is that enrollees
would pay both the FEHB premium and the Medicare B premium, which would not be
received favorably by them. If this approach were adopted, it would be necesary to
negotiate benefit provisions with FEHB plans that would more adequately supplement
Medicare benefits than do the current benefit packages.
The third basic approach is to establish a mandatory Medicare supplement plan under
the FEHB Program for those over age 65 and other eligible Medicare recipients.
Principal advantages of this approach are that: the benefit level could be designed
to supplement major gaps in Medicare coverage, and thereby offer fuller protection
for those over age 65; Medicare supplement plans in the private sector show premium
rates as low as Medicare Part B, and together they pay a majority of annuitants'
health care costs; the premium for a Medicare supplement plan would provide benefits
in excess of Medicare coverage; and there would be ease of administration for
participating carriers, as all enrollees in the Medicare supplement plan would be
known Medicare enrollees.
There are three disadvantages. There possibly could be an increase in premium
level for the remaining FEHB participants and for the government. There would be
increased agency administrative responsibility in maintaining sole enrollment files
for the majority of annuitants. And, there would be a loss of plan identification
and connection for those who would have no alternative but to join the Medicare
supplement plan.
If the third approach were adopted, it would be necessary to amend the law to establish
a special enrollment category for otherwise covered dependents under age 65, since
supplemental coverage would not be adequate without Medicare coverage. And, of
course, the law would have to be amended to permit inclusion of a Medicare supplement
plan.
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Summary of Findings
Of the three approaches, our model includes establishment of a Medicare supplement
plan that would be available to all enrollees and dependents eligible for Medicare.
coverage. The benefits would be structured, as much as is economically feasible,
specifically to fill Medicare coverage gaps. Medicare supplement plans, usually
provided at no cost to the insured, are the norm for large employers in the private
sector.
The Medicare supplement plan could be established on an indemnification basis,
similar to the current government-wide and employee organization sponsored plans.
Additionally, many HMO-type plans now participating under the FEHB Program-offer
special Medicare supplement plans to their Medicare population. FEHB enrollees in
HMO plans could be given the option upon attaining Medicare coverage of entering
the HMO's supplement plan. Therefore, 65 year old FEHB enrollees could retain the
option of choosing between pre-paid health care, or indemnification for medical
expenses.
The medicare supplement plan could be offered free of charge to the enrollee. De-
pendents under age 65, who would otherwise be eligible to receive health benefits
under the FEHB Program by virtue of the relationship between the enrollees, could
enroll in any FEHB plan for which the enrollees had been eligible. For eligible
family members under age 65, the enrollees would pay the Self Only rate for one
dependent, the more common occurrence, and the Self and Family rate for two or more
dependents.
The most advantageous arrangement for instituting a FEHB Medicare supplement plan
would be for the Government to self underwrite it and contract out claims adminis-
tration. Claims processing service to enrollees, timely under the current system,
could be-guaranteed through contract specification. The result for those covered
by Medicare who opt for a supplemental plan would be comprehensive health coverage
for the price of the Medicare B premium, currently $8.20 per month, per enrollee.
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61
Part VI: SUMMARY OF BENEFITS AND COSTS
So far this paper has presented possible integration approaches for separate parts
of the benefit package. This section brings the various elements of the fringe
benefit program together in order to present a cost analysis. A companion paper
presents detailed cost and projection tables. Summary data from that paper is
presented here to show the relative cost of the benefit systems.
One of the desideratum presented at the end of part I was that the modified
system should not cost the taxpayers more than the current system. The taxpayer's
cost is the difference between the total cost of benefits and the employees'
contributions.
A full analysis would include the cost of benefits and contributions under Social
Security which will be done by the Social Security Administration. In the mean-
time, it is assumed that there will be some savings to the taxpayer through in-
cluding federal employees under Social Security. The result of this assumption
is that it is valid to develope modified federal benefit systems that cost slight-
ly more than the current system using the expected savings from Social Security to
meet the increased direct cost. If it turns out that the Social Security savings
are less than the increased cost of the new federal benefits the formulae can be
modified to reduce the direct federal cost.
Cost Measure
There are many economic and actuarial methods for measuring the comparative cost
of different income replacement systems. The comparison paper presents full
analysis of the change in normal cost, the change in actuarial liabiality, total
annual projections and individual benefit comparisons. The measure chosen to
summarize costs herein is the normal cost.
The "normal cost" in this case is the entry-age normal cost as used by the Board
dimwd of Actuaries of the Civil Service Retirement system.. This is the percentage
of pay that must be contributed for a typical group of new employees to provide
their own and their survivors' benefits.
The retirement, disability and survivor benefits involve projections of costs over
the next fifty to seventy-five years. To do this, assumptions as to future act-
uarial and economic conditions had to be made. The assumptions are those used by
the Board of Actuaries in their 1977 valuation of the retirement system modified AS
needed to measure the particular benefits. The most critical assumptions are the
long term interest rate of 7 percent a year, the inflation rate of 6 percent and
the general salary increase factor of 6.5 percent a year.
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The long term retirement, disability and survivor benefit costs were combined
with the employers' contribution under Social Security and Medicare; the change
in health benefit costs; and the change in sick leave costs to present the
total picture.
Options
Three of the options are based on the retirement formula variations from Part I.
The offset variation is the offset formula with related benefits and conditions
as defined in Part II coupled with the integrated disability system from Part
III, the survivor benefit system from Part IV, and the health insurance system
from Part V. The step-rate variation is the step-rate formula from Part I
combined with the other systems. The add-on variation is the add-on formula
from Part I combined with the other systems.
Finally, we have analyzed the cost of a minimum change variation. As the name
suggests this is the current system changed as little as needed to integrate
with Social Security. The retirement formula is back-loaded as now but at a
lower level to allow for the new Social Security benefits. Specifically the
retirement formula is 1.4 percent a year for the first five years service; 1.5
percent for the next five years, and'1.75 percent for years over ten with a
maximum of 80 percent of high three pay. The benefit is offset by the same
amount as the offset formula - 1.25 percent times service times the PIA after
age 62 with an equal supplement before age 62. Contributions are 7 percent
over the FICA base but nothing below that base since the Social Security/Medicare
contribution will eventually exceed 7 percent. Since the contributions are small
there is no forfeiture for refund of contributions but only a reduction in the
benefit value. As with the other formulae, the eligibility conditions are un-
changed but there is no new reduced benefit for employees retiring between 55
and 62 with five to twenty-nine years service.
The minimum change formula has a separate disability benefit but the conditions
and amount are the same as in the current system. The benefit is fully offset
by Social Security before age 62 and by 1.25 percent times the Social Security
benefit times service after age 62. There is no change in the sick leave system.
The survivor benefits are the current levels and conditions fully offset by any
Social Security benefit before age 62 and by the regular formula offset after
age 62. There are no children's benefits. Health benefits are the same as
those in the other new systems since there would be little objection to and no
loss of equity in integrating g &t4t:g health benefits and Medicare.
Cost Analysis
The total normal cost of the current system is 36.0 percent of payroll. Allowing
for the 7 percent employee contribution the employer cost is 29.0 percent of pay-
roll. This is the benchmark against which changes must be measured.
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The total cost of the retirement, survivor and disability benefits of the minimum
change system is 24.9 percent of payroll. When offset by employee contributions
equivalent to .5 percent the net cost to the employer is 24.4 percent of payroll.
This cost must be increased by the employers' contribution to Social Security and
Medicare and offset by the health benefits savings due to full coverage by Medicare.
With these adjustments the total employer cost is 30.8 percent or 1.8 percent of
payroll more than the current system.
The total cost of retirement, disability and survivors benefits for the offset
formula is 26.3 percent of payroll with no employee contribution to offset the
cost. The other cost items are those included with minimum change with a further
reduction for the change in the sick leave program. This leads to a total cost of
32.1 percent of payroll or 3.1 percent more than the current program.
Analysis of the step rate and add-on formulae is the same as for the offset formulae.
This leads to a total cost for the step rate formulae of 30.1 percent or 1.1 per-
cent more than the current program and a total cost for the add-on of 31.0 percent
or 2.0 percent more than currently.
The cost of the income replacement systems described in this paper range from
1.1 percent to 3.1 percent higher than the current system. We assume that this
income will be less than the equivalent savings the Social Security system would
experience through coverage of federal employees. If the Social Security savings
turns out to be less than these differences the benefits can be modified to
result in no total increased cost to the taxpayer.
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