Change in Methodology for Calculating and Crediting Interest to DROP Accounts

Background

The LAFPP Internal Audit Section (IAS) conducted an audit of the Member Benefit Payment Process to ensure pension benefits are being accurately communicated, calculated and disbursed in accordance with the Los Angeles City Charter and Administrative Code.   The result of this audit was the presentation of recommendations to the Audit Committee and full Board of Fire and Police Pension Commissioners in July 2011.  Retirement Services Section staff subsequently considered their findings in relation to the calculation and crediting of interest for DROP accounts and recommended policies for the Board’s consideration in August.  The Board approved the recommended policies at its meeting of August 4, 2011.

New Policies Related to the Calculation and Crediting of Interest to DROP Accounts

1. Interest will be earned at a rate of 5% compounded annually.  That is, after 12 DROP payments have been deposited in your account.
2. Interest will be calculated each month using a monthly factor of .004167 (1/12 of 5%), applied to the prior end of month inception-to–date balance.
3. Interest will be credited to member accounts on June 30 and December 31.
4. If a member exits DROP between the semi-annual interest-crediting dates, his/her account will be credited with the monthly interest earned as of the exit date (interest is not prorated for any period less than a full month).

Immediate Impact of These Changes in Policy

1. The prior methodology calculated interest on DROP pension payments prior to the payment actually being deposited to the DROP account.  To calculate interest in accordance with basic finance fundamentals, that interest will no longer be reflected in your account.
2. Your participation in DROP is limited to 5 years.   Interest will be compounded at the 13th, 25th, 37th, and 49th payment periods.
3. Your DROP statement will no longer provide monthly balances.  Instead, it will reflect the change in reporting from a monthly to semi-annual basis with cumulative balances as of 6/30 or 12/31.

Who is being affected by these changes?

The policy changes will be applied to all current DROP participants as of November 23.  Therefore, anyone in the process of entering DROP, or who is already a DROP participant is affected.  The December pension roll will be the first to issue DROP payments using the new methodology.

How do we know you are doing it right this time around?

The policy recommendations proposed to the Board by staff were the result of consultations with our Internal Audit Section and their insight into the methods used by other agencies and an understanding of standard financial practice.  The City Attorney also reviewed the staff recommendations. 

Who approved the change to the methodology used to calculate interest for DROP accounts?

On July 7, 2011 and July 21, 2011, the LAFPP Internal Audit Section presented its findings from an audit of the Member Benefit Payment Process to the Audit Committee and the Board of Fire and Police Pension Commissioners, respectively.  Staff reviewed the recommended changes, and shared them with labor representatives, prior to the Board’s adoption of the policy recommendations on August 4, 2011.

If the Board approved these changes in August, why are they just now being implemented?

Our pension administration system, OnPoint, has required re-programming for a number of calculations and processes that will use the new methodology.  The programming also demands a period of testing to ensure the results are accurate. 

The Board was aware that implementation would occur once these tasks were completed. Furthermore, when they approved these changes, the Board was informed that our system consultant was in the midst of programming for the retiree health subsidy contribution opt-in. 

Who do I contact with questions about this change?

Anyone in the process of entering DROP or who is already a DROP participant should have received correspondence from the General Manager, Michael A. Perez explaining the events surrounding this change.  That letter also provides contact names and phone numbers on the second page, which are also provided below: