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Purchase of Service Credits and How it Might Affect You

You have likely seen recent media coverage about the Fourth District Court of Appeal’s decision issued on June 7th affirming a trial court decision related to purchased service credits.

Here is the background on the case and an overview of what it means as well as when/how its consequences will likely be felt.

In October and November 2007, on the advice of its former outside fiduciary counsel Harvey Leiderman, SDCERS conducted two public meetings on the subject of purchased service credits and the alleged underfunding associated with them.  The “underfunding” arose because, as the benefit formula improved between 1997 and 2003, the price which SDCERS calculated and charged a plan participant for these purchases allegedly did not keep pace with the actual value of the service being purchased and the resulting cost to the City to fund these purchases when translated into a lifetime pension benefit.  SDCERS ultimately increased the pricing for these purchases effective November 1, 2003, such that it has been “cost neutral” since that time.  Mr. Leiderman informed the SDCERS Board that, among the alternatives available to it, were the following: “(1) void the purchase of service contracts;  (2) collect arrears payments; (3) offer rewritten contracts; (4) spread out additional payments; (5) reduce benefit levels; or (6) continue to collect the shortfall through the amortization of the system’s unfunded liability.

These meetings culminated in a SDCERS Board vote on November 16, 2007, to continue to include any underfunding of these “air time” service credits (as it had done since the inception of the program) in the unfunded actuarial accrued liability (UAAL) of the system for which the City remains responsible.   This was option # 6 on Mr. Leiderman’s list.

This vote prompted an immediate reaction from the City Attorney’s Office (then under City Attorney Mike Aguirre) in  filing a lawsuit against SDCERS challenging the legality of this vote.

During the course of the litigation which followed, the service credits under attack were narrowed to one discrete period: those service credits purchased during the period of August 15, 2003, through November 1, 2003or for which an application to purchase was submitted during the same period.  Because SDCERS was inundated with applications to purchase service credits at the lower rates during this “window period” from August 15, 2003, through November 1, 2003, hundreds of purchases were not actually completed until after November 1, 2003.  These purchases will nevertheless be affected by this ruling if the application for the “air time” service credit purchase was made to SDCERS from August 15, 2003, through November 1, 2003.  {Please note: The City also narrowed its attack to those plan participants who had purchased or applied to purchase “air time” service credits during this period and who had not yet retired as of the time the City filed its lawsuit on November 20, 2007.  Accordingly, those who retired before November 20, 2007, would not be impacted by this case even though they purchased or applied to purchase service credits between August 15, 2003, and November 1, 2003.}

This period of 8/15/03 through 11/1/03 became the focus of the City’s litigation because SDCERS’ actuary informed the Board in August 2003 that the rates being charged for service credit purchases were outdated as they had been set by the Board prior to certain benefit increases.  SDCERS’ actuary recommended an upward adjustment in the purchase-of-service-credit rate structure from 15 percent to 27 percent for general members and from 26 percent to 37 percent for safety members.  According to the system’s actuary, these adjustments were needed for “air time” service credit purchases to be cost neutral.  However, the Board felt that, in the exercise of its fiduciary duty to plan participants, it should provide notice of a new pricing structure and a window of opportunity for plan participants to purchase or apply to purchase service credits at the “old” lower rates.  This window period became August 15, 2003, through November 1, 2003, when employees either purchased or applied to purchase a significant number of service credits: 5,726 years of service by 1,609 general members and 828 years by 412 safety members.

Ultimately, the trial court concluded that SDCERS could not lawfully charge the City for this underfunding under the circumstances and directed the SDCERS Board to rescind its vote taken on November 16, 2007.  SDCERS appealed.

On June 7, 2010, the Fourth District Court of Appeal issued its decision affirming the trial court’s ruling.  The appellate court rejected SDCERS’ reasoning for the delay in implementing the new rate structure and concluded that the SDCERS Board action in August 2003 was contrary to law and exceeded the Board’s authority – i.e., the new higher rates should have been implemented immediately and no further purchases allowed at the old, lower rates because the benefit, as established by City ordinance, required the pricing to be cost neutral.


Unless SDCERS determines that there would be merit in seeking a discretionary review of this decision by the California Supreme Court, the decision of the 4th DCA will become final.  [Even if a petition for review is filed before the California Supreme Court, it would not likely be granted; thus, “finality” is likely right around the corner.]  This means that SDCERS will not be permitted to charge the City for the “underfunded” cost of the “air time” service credits at issue and SDCERS must look to another source for funding; if the City cannot be made to pay the underfunding, then the employees who purchased the “air time” service credits will become the only other viable payor.

However, it remains for the SDCERS Board to make a number of determinations before coming to this conclusion and acting upon it – for example:

(1) what are the IRS consequences of this situation (if any) in terms of the plan’s tax qualified status;

(2) what is the Board’s fiduciary duty to affected plan participants, all plan participants, and the City in light of this court decision;

(3) what is the input from affected plan participants (to be gathered in a public hearing); and,

(4) what is the Board’s decision and how will it affect you if you purchased or applied to purchase “air time” service credits during the targeted period.

I know this outcome will be disappointing news and will raise many questions and concerns.  However, only after SDCERS takes these additional steps and makes a concrete decision on what action to take and/or options to offer affected plan participants, will I be in a position to assist MEA’s Board of Directors in evaluating the situation in order to determine what steps are appropriate and available to protect your rights.