Federal Pensions: Relationship Between Retiree Pensions and Final
Salaries (Letter Report, 08/11/97, GAO/GGD-97-156).

Pursuant to a congressional request, GAO responded to a series of
questions about federal pension costs and retirement policy, focusing
on: (1) the number of federal retirees, if any, whose pensions have come
to exceed the final salaries that they earned while working; (2) why
these retirees' pensions came to exceed their final salaries; (3) the
difference, if any, in these retirees' pension amounts if current
cost-of-living-adjustment (COLA) policy that is, the COLA policy enacted
in 1984, which established the formula and schedule used today by the
office of Personnel Management (OPM), had been in effect without
interruption since 1962; and (4) any difference in the number of
retirees whose pensions would have exceeded their final salaries.

GAO noted that: (1) an estimated 459,000 (or about 27 percent) of the
1.7 million retirees who were on the federal pension rolls as of October
1, 1995, were receiving pensions that had come to exceed their final
salaries when these salaries were not adjusted for inflation; (2)
however, when their salaries were adjusted for inflation --i.e.,
expressed in constant dollars, no retiree was receiving a pension that
was larger than his or her final salary; (3) as a general rule, using
constant dollars provides a more meaningful way to compare monetary
values across time, because the use of constant dollars corrects for the
effects of inflation or deflation; (4) although no retiree's pension
exceeded his or her final salary in constant dollar terms, GAO's
analysis confirmed that three factors played an important role in
explaining why the retirees' pensions came to exceed their unadjusted
final salaries: the number and size of COLAs that retirees received, the
number of years that they had been retired, and the number of years of
their federal service; (5) GAO's analysis of the effects that COLA
policies have had on retiree pensions suggests that the policies have
played an important role in maintaining the purchasing power of retiree
pensions since automatic COLAs began; (6) it also suggests that the
effects COLA policies actually have had on retiree pension amounts
cannot be summarized easily because of numerous changes that have been
made in COLA policies over the past 35 years; (7) COLA policy changes
have affected individual retirees differently, depending on when their
retirements began; (8) if current COLA policy, that is, the policy that
was enacted in 1984, had been in effect without interruption since
automatic COLAs began in 1962 the pensions of some of the sample
retirees would have been smaller than the pension that they actually
received, and the pensions of other retirees would have been larger; (9)
GAO's comparison of the effects of current and historical COLA policy on
pension amounts suggests that other factors being equal, a majority of
those who retired before 1970 would have received smaller pensions had
current COLA policy been continuously in effect during their retirement,
and about 90 percent of those who retired after 1970 would have received
larger pensions; and (10) the changes that would have occurred in the
sample retirees' pension amounts under current policy were enough to
cause about a 3 percentage point (3.0) increase in the number of
retirees whose pensions would have come to exceed their unadjusted final
salaries.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GGD-97-156
     TITLE:  Federal Pensions: Relationship Between Retiree Pensions and 
             Final Salaries
      DATE:  08/11/97
   SUBJECT:  Employee retirement plans
             Retirement pensions
             Cost of living
             Federal employee retirement programs
             Civilian employees
             Government retirement benefits
IDENTIFIER:  Civil Service Retirement System
             Federal Employees Retirement System
             Civil Service Retirement and Disability Fund
             Consumer Price Index
             
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Cover
================================================================ COVER


Report to the Chairman, Committee on Appropriations, U.S.  Senate

August 1997

FEDERAL PENSIONS - RELATIONSHIP
BETWEEN RETIREE PENSIONS AND FINAL
SALARIES

GAO/GGD-97-156

Relationship Between Retiree Pensions and Final Salary

(410004)


Abbreviations
=============================================================== ABBREV

  COLA - cost-of-living adjustment
  CPI - consumer price index
  CPI-W - wage earner index
  CRS - Congressional Research Service
  CSRS - Civil Service Retirement System
  FERS - Federal Employees Retirement System
  OPM - Office of Personnel Management

Letter
=============================================================== LETTER


B-270600

August 11, 1997

The Honorable Ted Stevens
Chairman, Committee on Appropriations
United States Senate

Dear Mr.  Chairman: 

Federal spending on pensions for retired civilian employees of the
federal government represents a significant share of the budget.  In
fiscal year 1996, excluding interest on the public debt, civilian
employee pension benefits (i.e., civil service retirement and
disability) was the seventh largest mandatory spending program, with
nearly $40 billion in payments to 2.3 million retirees and survivor
annuitants.  Although current employees finance a portion of these
benefits through the contributions they make, the federal government
pays most pension costs, as do states and localities and private
sector employers.  Thus, it is important for policymakers to
understand how key features of federal retirement policy--set in
statute--affect pension costs. 

At your request, we are responding to a series of questions about
federal and nonfederal retirement programs.  This report addresses
the part of your request that concerns pension costs and retirement
policy.  As agreed with your office, our objectives were to (1)
determine the number of federal retirees, if any, whose pensions have
come to exceed the final salaries that they earned while working; (2)
explain why these retirees' pensions came to exceed their final
salaries; and (3) determine the difference, if any, in these
retirees' pension amounts if current cost-of-living-adjustment (COLA)
policy--that is, the COLA policy enacted in 1984, which established
the formula and schedule used today by the Office of Personnel
Management (OPM)--had been in effect without interruption since 1962,
and also determine any difference in the number of retirees whose
pensions would have exceeded their final salaries.\1

We collected data for the Civil Service Retirement System (CSRS) and
the Federal Employees Retirement System (FERS) general employees, as
well as for all former Members of Congress who were retired and still
living as of October 1, 1995, using a computerized personnel database
and case file information maintained by OPM.  Although the
preliminary results for Members appear to be about the same as the
results for general employees, as agreed with your office, we are
reporting the results for general employees in this letter, and we
will report on Members separately.  We used a number of different
approaches to meet our objectives, including simulation and
statistical analyses of a randomly selected, projectable sample of
CSRS retirees.  The sample and techniques that we used are described
in greater detail in the Scope and Methodology section of this
report. 


--------------------
\1 The COLA policies we refer to in this report were set by various
federal statutes. 


   BACKGROUND
------------------------------------------------------------ Letter :1

CSRS and FERS are the two largest retirement programs for federal
civilian employees.  At the beginning of fiscal year 1995, these
programs covered about 2.8 million federal employees, or 90 percent
of the current civilian workforce.  OPM administers CSRS and FERS. 
CSRS and FERS pension benefits are financed partly by federal agency
and employee contributions and partly by other government payments to
the Civil Service Retirement and Disability Fund.\2

Although CSRS and FERS both provide pensions, the programs are
designed differently.  CSRS was established in 1920 and predates the
Social Security system by 15 years.  When the Social Security system
was established, Congress decided that employees in CSRS would not be
covered by Social Security through their federal employment.  CSRS is
a stand-alone pension program that provides an annuity determined by
a formula as well as disability and survivor benefits.\3 The program
was closed to new entrants after December 31, 1983, and, according to
OPM actuaries, is estimated to end in about 2070, when all covered
employees and survivor annuitants are expected to have died.  FERS
was implemented in 1987 and generally covers those employees who
first entered federal service after 1983 as well as those who
transferred from CSRS to FERS.  The primary impetus for the new
program was the Social Security Amendments of 1983, which required
that all federal employees hired after December 1983 be covered by
Social Security.\4 FERS is a three-tiered retirement program that
includes Social Security and a Thrift Savings Plan---in addition to a
basic pension.  Like CSRS, FERS provides disability and survivor
benefits. 

A distinctive feature of CSRS and FERS pensions is the annual COLAs
they are to provide.  COLAs are post-retirement increases in pension
amounts that generally are given on either an ad hoc or automatic
basis to offset increases in living costs due to inflation.  Congress
enacted the first automatic COLA for CSRS annuitants in 1962
(effective January 1963).  At that time, the automatic adjustment was
viewed as a way of controlling pension costs, because prior ad hoc
adjustments had been criticized as being unrelated to price increases
and subject to political manipulation. 

Although COLAs generally have been provided on an automatic basis
since 1962, COLA policies have been modified numerous times over the
years.  As shown in table 1, the changes made during the 1960s and
1970s were intended to enhance pension purchasing power with respect
to inflation as measured by the consumer price index (CPI), but some
of the changes made during the 1980s had the effect of reducing
purchasing power.\5

Table 1 is based on information in the Congressional Research Service
(CRS) Report for Congress, 94-834 EPW, updated March 13, 1996. 



                                Table 1
                
                Major Changes Made to COLA Policy Since
                      Automatic Adjustments Began

Year    Public law  Description
------  ----------  --------------------------------------------------
1962    P.L. 87-    Provided the first automatic adjustments whenever
        793         the CPI in a given year exceeded the CPI for the
                    year of the last adjustment by 3 percent or more.
                    This was later modified to provide for adjustments
                    whenever the CPI rose 3 percentage points or more
                    above the CPI in the month of the last adjustment
                    and remained at or above this level for 3
                    consecutive months.

1969    P.L. 91-    Added an extra 1 percent to the adjustment--known
        93          as a kicker--to offset the erosion in pension
                    benefits due to the time lag between increases in
                    living costs and benefit adjustments.

1976    P.L. 94-    Repealed the kicker because it had been found to
        440         overcompensate for inflation. However, Congress
                    replaced the kicker with semiannual COLAs as
                    another way to address the time lag.

1981    P.L. 97-    Replaced semiannual COLAs with annual COLAs based
        35          on the change in the CPI from December to December
                    and payable in March of the following year,
                    thereby saving money by having benefits held
                    constant for longer periods.

1982    P.L. 97-    Added a restriction in certain cases to ensure
        253         that pensions would not exceed the current maximum
                    pay for a General Schedule (GS) 15 federal
                    employee.

1983    P.L. 98-    Established the formula upon which COLAs currently
        270         are based and made COLAs effective in December of
        (enacted    the current year and payable in January of the
        in 1984)    following year.\a

1984    P.L. 98-    Specified that COLAs were to be payable in checks
        369         issued the first business day of the month
                    following the month for which they are scheduled
                    or effective.

1985    P.L. 99-    Suspended COLAs for fiscal year 1986 and for all
        177         subsequent years in which specified deficit
                    reduction targets would not otherwise be met.

1986    P.L. 99-    Reinstated COLAs for programs that had been
        509         subject to the suspension under P.L. 99-177 for
                    calendar years 1987-1991.\b

1993    P.L. 103-   Changed the effective dates for COLAs from
        66          December to March for fiscal years 1994 through
                    1996.\c
----------------------------------------------------------------------
\a This formula and schedule are the same as those used for Social
Security COLAs, which were established for that program in P.L. 
98-21.  This law also eliminated the COLAs scheduled for May 1984 and
June 1985.  Instead, COLAs were scheduled for December 1984, payable
in January 1, 1985, checks. 

\b The Balanced Budget and Emergency Deficit Control Reaffirmation
Act of 1987 (P.L.  100-119) permanently exempted federal pension
COLAs from suspension under P.L.  99-177. 

\c The COLAs were in checks payable the first business day of April
rather than January.  This law did not change the CPI measuring
period. 

Source:  CRS. 

One of these changes provides especially relevant background for
considering the relationship between current pensions and final
salaries and requires a more complete discussion.  As noted in table
1, P.L.  97-253 (the Omnibus Budget Reconciliation Act of 1982)
restricted COLAs in relation to final salaries in certain cases. 
Under this restriction, a pension may not be increased by a COLA to
an amount that exceeds the greater of the current maximum pay for a
GS-15 federal employee or the final pay of the employee (or high-3
average pay, if greater), increased by the overall annual average
percentage adjustments (compounded) in rates of pay of the general
schedule for the period beginning on the retiree's annuity starting
date and ending on the effective date of the adjustment.  In effect,
the statute requires that a retiree's pension is to be capped at an
amount not to exceed the maximum pay of a general schedule employee
(i.e., GS-15) or an amount that represents the value of the retiree's
final or average pay, adjusted for the general schedule pay
adjustments that had been provided since the annuitant retired. 
According to OPM's policy handbook, because the cap applies to COLA
increases to pensions, in no instance would a pension already
exceeding the cap be reduced.\6

As noted earlier, under current policy--enacted in 1984--COLAs for
CSRS and FERS retirees are based on increases in living costs as
measured by the CPI-W between the third quarter (July through
September) of the current calendar year and the third quarter of the
previous year.  Although the COLA formula and schedule are the same
for FERS and CSRS, FERS COLAs are limited if inflation is over 2
percent.  If inflation is between 2.0 and 3.0 percent, the FERS COLA
is 2.0 percent; if inflation is 3.0 percent or more, the COLA is the
CPI minus 1 percent.  If, however, inflation is less than 2 percent,
FERS COLAs are to be fully adjusted for inflation.  Also, CSRS
benefits are to be fully indexed from the time of retirement, and
FERS pensions are to be indexed beginning at age 62 for regular
retirees.\7


--------------------
\2 The Department of the Treasury also makes annual payments that are
to cover interest on unfunded liabilities, payments for spouse
equity, as well as amortization payments to finance supplemental
liabilities for FERS. 

\3 If a survivor annuity benefit is chosen, pensions may be reduced
by as much as 10 percent.  Pensions are reduced to provide for
spousal benefits or insurable interest benefits (i.e., a person
designated by the retiree as expecting to receive some financial
benefit from the continuance of the life of the retiree), but not for
children's benefits.  Children's benefits are provided by law and do
not need to be elected by an employee or retiree.  If a spousal
survivor annuity is chosen and the spouse predeceases the retiree,
the annuity reduction is eliminated upon notification to OPM.  At the
time of retirement, CSRS pensions may also be reduced for other
reasons, including reductions for age and unpaid deposits.  FERS
pensions may be reduced for age. 

\4 After December 31, 1983, certain rehires participating in CSRS
before 1984 could elect to either stay in that plan under special
rules that integrate CSRS and Social Security or transfer to FERS. 
For a more detailed discussion of the transition from CSRS to FERS,
see Federal Retirement:  Federal and Private Sector Retirement
Program Benefits Vary (GAO/GGD-97-40, Apr.  7, 1997). 

\5 The CPI is compiled by the Bureau of Labor Statistics and is
intended to measure the average change in the prices paid by urban
consumers for a fixed market basket of goods and services.  It is
calculated monthly for two population groups, one consisting only of
wage earners and clerical workers and the other consisting of all
urban families.  The wage earner index--CPI-W--is the index used for
federal COLA purposes.  Because it is a national average, it affects
retirees differently, depending on whether they live in areas where
the CPI-W differs from the national average.  Also, because the CPI
is a statistical average, it may not reflect an individual's
experience, particularly an individual whose expenditures differ
greatly from the "average" consumer's.  Moreover, whether the CPI
accurately estimates inflation is currently being debated.  In a 1996
report, the Advisory Commission to Study the Consumer Price Index
concluded that the CPI overstates inflation.  The Commission
recommended that the market basket on which the CPI depends be
updated more frequently than is currently done and that adjustments
be made to correct any bias in the estimates. 

\6 Under CSRS, initial annuities are also capped.  As described in
greater detail later in this report, with certain exceptions, the
maximum initial annuity that a retiree can receive under CSRS is 80
percent of his or her high-3 average salary. 

\7 The first FERS COLA was effective in December 1988 and payable in
January 1989.  FERS participants of any age who retired on disability
are to receive COLAs after their first year of disability. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

An estimated 459,000 (or about 27 percent) of the 1.7 million
retirees who were on the federal pension rolls as of October 1, 1995,
were receiving pensions that had come to exceed their final salaries
when these salaries were not adjusted for inflation.  However, when
their salaries were adjusted for inflation--i.e., expressed in
constant dollars--no retiree was receiving a pension that was larger
than his or her final salary.  As a general rule, using constant
dollars provides a more meaningful way to compare monetary values
across time, because the use of constant dollars corrects for the
effects of inflation or deflation. 

Although no retiree's pension exceeded his or her final salary in
constant dollar terms, our analysis confirmed that three factors
played an important role in explaining why the retirees' pensions
came to exceed their unadjusted final salaries--the number and size
of COLAs that retirees received, the number of years that they had
been retired, and the number of years of their federal service.  The
first two factors in combination reflect retirement policies that are
intended to maintain most or all of a pension's purchasing power. 
Although the COLAs that the sample retirees received caused their
pensions to increase at rates that generally were to equal inflation
during retirement, their unadjusted final salaries remained the same. 
Thus, the longer the annuitants had been retired, the more COLAs they
would have received and the more likely their pensions would have
come to exceed their unadjusted final salaries.  Also, because COLAs
were to be automatic and inflation continued throughout the period we
reviewed, the number of COLAs that the sample retirees would have
received was highly correlated with the number of years that they had
been retired.  The third factor--a retiree's years of federal
service--also contributed, because years of service is a major
component in determining the amount of a retiree's initial pension. 
Specifically, the sample retirees with many years of service would
have received initial pensions that came closer to the amounts of
their final salaries than the retirees with fewer years of service,
other factors being equal.  Smaller beginning differences between
initial pensions and final salaries, in turn, would have caused the
pensions of the first group of retirees to have exceeded their
unadjusted salaries sooner than the second group's pensions. 

Our analysis of the effects that COLA policies have had on retiree
pensions suggests that the policies have played an important role in
maintaining the purchasing power of retiree pensions since automatic
COLAs began.  It also suggests that the effects COLA policies
actually have had on retiree pension amounts cannot be summarized
easily because of the numerous changes that have been made in COLA
policies over the past 35 years.  COLA policy changes have affected
individual retirees differently, depending on when their retirements
began.  For example, because the effects of COLAs and COLA policy
changes compound over time, the COLA policies of the late 1960s and
1970s, which overcompensated for inflation, will continue to affect
the pensions of those retirees who receive them as long as they are
alive, just as the suspensions of some COLAs in the 1980s will
continue to be reflected in the pensions of anyone who retired before
the suspensions occurred. 

If current COLA policy--that is, the policy that was enacted in
1984--had been in effect without interruption since automatic COLAs
began in 1962, the pensions of some of the sample retirees would have
been smaller than the pensions that they actually received, and the
pensions of other retirees would have been larger.  Our comparison of
the effects of current and historical COLA policy (as shown in table
1) on pension amounts suggests that, other factors being equal, a
majority of those who retired before 1970 would have received smaller
pensions had current COLA policy been continuously in effect during
their retirement, and about 90 percent of those who retired after
1970 would have received larger pensions.  The changes that would
have occurred in the sample retirees' pension amounts under current
policy were enough to cause about a three percentage point (3.0)
increase in the number of retirees whose pensions would have come to
exceed their unadjusted final salaries. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3

To respond to your request, we used a computerized personnel database
of CSRS and FERS retirees and case file information maintained by
OPM.  At the time of our analysis, the latest available data were for
living CSRS and FERS annuitants who were retired as of October 1,
1995.  The database and case files provided much of the information
that we needed for our analysis, including the retirees' initial and
1995 pensions, retirement dates, high-3 average salaries, service
histories, survivor benefits, and other retirement-related
information.  However, the database did not have information on
retirees' final salaries, which we needed in order to compare their
final salaries to their 1995 annuities.  The database did have
information on "high-3" average salaries, which are used in
calculating initial pensions.  Thus, we compared the retirees' high-3
average salaries to their 1995 pensions to identify a set of retirees
whose pensions were most likely to have exceeded their final
salaries.  From this group, we selected a random sample of 400 from
among the 524,435 CSRS retired general employees whose annuities
exceeded their high-3 average salaries and all 105 FERS retired
general employees for whom the database reported annuities exceeding
their high-3 average salaries.\8 We reviewed the selected retirees'
case files to verify that those we had selected had 1995 pensions
that, in fact, exceeded their unadjusted final salaries. 

From our review of the sample of 400 CSRS annuitants, we identified
348 whose 1995 pensions exceeded their final salaries.  We identified
and removed from our sample 50 with pensions below their final
salaries, 1 whose case file did not have the data we needed for our
analysis, and another whose case file was not available for our
review.  From our case file review of the 105 FERS annuitants, we
identified and removed 104 that did not match our criterion (i.e.,
did not have a 1995 annuity that exceeded the retiree's final
salary).  The remaining case had a pension that exceeded the final
salary.  However, the pension combined both FERS and CSRS benefits. 
This retiree had transferred from CSRS to FERS and thus was receiving
benefits that were neither wholly FERS nor wholly CSRS. 
Consequently, we included this individual in our estimates of the
number of retirees who had annuities that exceed their final
salaries, but excluded this individual from our regression analysis. 

We weighted the CSRS sample results to estimate the number of retired
general employees in the population whose pensions had come to exceed
both their final salaries and high-3 average salaries.  In making
these estimates, we assumed that the small number of FERS and CSRS
cases for which data were not available were similar to the cases
that we had reviewed.  The sample results thus estimate the total
number of general employees whose pensions exceed both their final
salaries and their high-3 average salaries.  As the final salary is
generally included in the three highest salaries that are averaged,
these employees are described as having pensions that exceed their
"final salaries" in the remainder of the report.  We also adjusted
the retirees' final salaries for inflation, using the 1995 CPI-W, and
made a second estimate of the number of retirees whose 1995 pensions
exceeded their final salaries, expressed in constant dollar terms. 

To understand why retiree pensions could come to exceed unadjusted
final salaries as much as they did, we used regression analysis to
model the relationship between key retirement policy variables and
the extent to which the pensions of the sample retirees exceeded
their unadjusted final salaries.  Regression is a statistical
technique that can be used to measure the relationship between a
dependent variable and a set of independent (i.e., explanatory)
variables and isolate their independent effects.  This analysis was
based on the subsample of 348 CSRS employees whose 1995 pensions
exceeded their final salaries.  This subsample did not include the
single FERS annuitant whose pension exceeded the final salary, the
two sampled cases with missing information, nor the 50 sampled cases
whose 1995 pensions did not exceed their final salaries.\9 We used
the percentage by which the retirees' pensions exceeded final
salaries as the dependent variable in the model, because our sample
did not include retirees whose pensions were below their high-3
average salaries.\10 We selected retirement variables to use as
independent variables because they were (1) required to be used for
computing pension benefits (e.g., years of service); or (2) known to
affect pension amounts for some or all retirees (e.g., COLAs and the
selection of spousal survivor benefits).\11 Although variables
representing changes in a retiree's personal circumstances (e.g.,
marriage, death of a spouse, or divorce) that would have changed his
or her pension over the period of retirement were not included in the
final regression model, we reviewed the retirees' case files to
determine what effects these changes may have had on individual
sample retirees.  We found that these changes in personal
circumstances could cause an individual retiree's pension to
fluctuate (e.g., increase and/or decrease) during his or her
retirement depending on whether survivor's benefits were being
deducted. 

To compare the effects of current and historical COLA policy on
retirees' pensions, we reviewed federal retirement-related documents
and identified the historical changes in COLA policy since the
inception of automatic COLAs in 1962.\12 Using this information, we
calculated the pensions that the sample of 398 retirees would have
received each year from 1962 through 1995 had current COLA policy
been in effect without interruption.  We compared these results to
the pensions that they would have received under actual COLA policy,
absent other changes that might have affected their pensions (e.g.,
adjustments due to death of a spouse when survivor benefits had been
chosen).  We then compared the resulting numbers to assess the
probability that the change, if any, in the number of retirees whose
1995 pensions had exceeded their unadjusted final salaries was
statistically significant, that is, unlikely to be due to sampling
error. 

To illustrate the effects that the different COLA policies could have
had on pensions during the sample annuitants' retirements, we
simulated the effects of current and actual policy on pension amounts
for three different retirement periods.  To simplify the analysis,
our simulation of the impacts of current COLA policy implemented
without interruption since 1984 was not adjusted to reflect the
actual effective dates of COLAs, the actual pay dates, "lookback"
payments or adjustments, or prorated to reflect the month an employee
retired.\13 We selected 1961 to 1995, 1968 to 1995, and 1981 to 1995
to show the cumulative effects that the COLAs of the 1960s and 1970s,
which overcompensated for inflation, and the suspensions of COLAs in
the 1980s could have had for different periods of retirement.  We
used the average initial pension for the sample annuitants who had
retired in the first year of each of the three periods for our
starting pension amounts (e.g., the average initial pension of those
annuitants who retired in 1961). 

Our analysis had several limitations.  As agreed with your office, we
did not independently verify the accuracy of OPM's database. 
However, we did verify the accuracy of the data for the cases used in
our analysis.  Also, the number of retirees whose pensions had come
to exceed their final unadjusted salaries could be somewhat higher
than we estimated for two reasons.  As noted, we used high-3 average
salary to identify a population that we believed would be most likely
to have pensions that had come to exceed final salaries, because
OPM's computerized database did not include final salary information. 
Thus, our estimates do not include those retirees whose pensions were
lower than their high-3 salaries but whose pensions were higher than
their final salaries.  Also, the annuity amounts contained in the
case files already had survivor benefit reductions, if any, taken. 
Thus, retirees who selected survivor benefits would have had higher
initial pensions than the pensions reported in OPM's files.  However,
we could not take this reduction into account, because the automated
data file did not identify those retirees who had selected this
benefit.  On the basis of our examination of the data and our
knowledge of the key retirement policy variables used in our
analysis, we believe that any such underestimate would have been
small. 

We requested comments on a draft of this report from the Director of
OPM, and those comments are discussed at the end of this letter.  We
did our review from December 1995 to July 1997 in Washington, D.C.,
according to generally accepted government auditing standards. 


--------------------
\8 We did not sample from the 66 CSRS annuitants whose high-3 average
salaries were listed as zero in the database. 

\9 Our regression estimates are not applicable to the larger
population of all retirees, because no FERS participants and no
retirees with 1995 pensions lower than their high-3 average salaries
were included in the analysis. 

\10 More than two-thirds of all annuitants retired in 1995 received
pensions that were below their high-3 average salaries. 

\11 It is important to note that the model's parameter estimates of
the effects of the retirement policy variables are for those retirees
whose 1995 pensions had come to exceed their final salaries.  Had all
retirees been used, the parameter estimates could have been different
because the analysis would have examined instances in which retirees'
1995 pensions had not come to exceed their final salaries. 

\12 Payment of COLAs specified by the current COLA policy enacted in
1984 has been interrupted several times since then, as shown in table
1.  Our simulations of current COLA policy did not include these
interruptions. 

\13 The lookback adjustment, or comparative annuity computation, was
established by P.L.  93-136 and applied to retirees whose immediate
annuities commenced on or after July 2, 1973, and before January 20,
1981.  Under this COLA provision, a retiree was assured that his or
her annuity would be no less than it would have been if the annuity
had commenced on the effective date of the COLA and had included the
increase payable on that date.  P.L.  96-499 eliminated the lookback
adjustment and, instead, provided for the proration of a retiree's
initial COLA increase. 


   SOME RETIREES' PENSIONS
   EXCEEDED THEIR UNADJUSTED FINAL
   SALARIES
------------------------------------------------------------ Letter :4

As of 1995, 1.7 million retirees who were covered by the CSRS and/or
FERS pension plans were on the federal retirement rolls.\14 Our
estimate of the number of these retirees whose 1995 pensions exceeded
their final salaries differed, depending on whether we adjusted the
retirees' final salaries for inflation.  When we did not adjust the
salaries for inflation, about 459,000, or 27 percent, of the total
general employee retirees received pensions that in nominal dollars
exceeded their final salaries.  However, when we adjusted the final
salaries for inflation, no retiree received a pension that exceeded
his or her final salary. 

As a general rule, using constant--rather than nominal--dollars is
more meaningful for examining dollar values across time, because
constant dollars correct for the effects of inflation or deflation. 
Constant dollars are especially appropriate for comparing current
pensions and final salaries, because the number of years that the
annuitants in our sample had been retired averaged 22 years and
ranged from 8 to 42 years.  Table 2 compares the 1995 pensions and
the nominal and inflation-adjusted final salaries for three
illustrative retirees in our sample.  The illustrative pensions shown
in the table are the average amounts received by those sample
annuitants who had retired in the years 1961, 1968, or 1981. 



                                Table 2
                
                 A Comparison of the 1995 Pensions and
                Final Salaries Presented in Nominal and
                 Constant Dollar Terms for the Average
                  Annuitants Who Retired in 3 Selected
                                 Years.

                                  Nominal dollar     Constant dollar
                                      terms               terms
                                ------------------  ------------------
                                              1995                1995
                                        pension as          pension as
                          1995           a percent           a percent
                        pensio   Final    of final   Final    of final
Retirement year              n  salary      salary  salary      salary
----------------------  ------  ------  ----------  ------  ----------
1961                    $21,10       $         289  $36,29          58
                             2   7,290                   1
1968                    $22,21  $10,17         218  $43,58          51
                             1       5                   0
1981                    $24,06  $21,59         111  $35,37          68
                             4       4                   2
----------------------------------------------------------------------
Source:  GAO analysis of OPM data. 


--------------------
\14 About 97 percent were CSRS retirees.  Of the approximately 12,000
FERS annuitants added to the retirement rolls in fiscal year 1995,
about 30 percent had prior CSRS service. 


   THREE FACTORS HELP EXPLAIN WHY
   PENSIONS CAN COME TO EXCEED
   UNADJUSTED FINAL SALARIES
------------------------------------------------------------ Letter :5

Three factors help to explain why some retirees' pensions came to
exceed their final salaries when their salaries were not adjusted for
the effects of inflation--the number and size of COLAs that retirees
received, the number of years that they had been retired, and their
number of years of federal service.  Two factors--the number and size
of the COLAs that the retirees had received and the number of years
that they had been retired--contributed because they helped to cause
the retirees' pension amounts to increase over time.  The third
factor--years of federal service--contributed because years of
service was used in computing the retirees' initial pensions.  Our
regression model showed that the value of the COLAs that the sample
retirees received, as determined by the number and size of COLAs and
the length of employees' retirement, together with their years of
federal service, explained about 82 percent of the variation in the
percentage by which the retirees' pensions exceeded their unadjusted
final salaries.  The important role that COLAs and length of service
played is a predictable consequence of pension policies that are
designed to reward employee service and maintain the purchasing power
of pensions. 

During retirement, the retirees' pensions increased because the COLAs
that the retirees were to receive increased in number.  The amount of
the increase each year fluctuated according to changes in the CPI-W. 
In contrast, unadjusted final salaries remained unchanged.  Thus, the
longer the annuitants had been retired, the more COLAs they received
and the more likely it was that their pensions exceeded their
unadjusted final salaries.  In fact, the average annuitant in our
sample had been retired about 22 years and had received 26 COLAs. 
The 4 percent who had retired before 1963 had received 36 COLAs. 

Generally, the likelihood that a retiree's pension exceeded his or
her unadjusted final salary increased when the annuitant had been
retired during periods of high inflation, because larger COLAs were
given during these periods.\15 Our model showed that, on average, a 1
percentage point increase in the total value of the COLAs that a
retiree had received would result in a 0.5 percentage point increase
in the amount by which the retiree's pension exceeded his or her
final salary, other factors being equal.\16 In particular, more than
90 percent of the retirees in our sample had been retired during all
or part of the 1969 through 1980 period when the most frequent and
largest COLAs were given.  Over this 12-year period, pensions
increased by 166 percent in nominal terms.  Appendix I provides a
summary of COLA history since automatic COLAs were enacted in 1962. 

The number of years of federal service also contributed to the
explanation of why some retirees' pensions exceeded their unadjusted
final salaries, because years of service is included in determining
the percentage of high-3 average salary that a retiree ultimately
will receive as his or her initial pension.  For example, under CSRS,
an employee who had 41 years, 11 months of service at retirement
would have been entitled to receive 80 percent of his or her high-3
average salary--the maximum percentage allowed--while an employee who
had worked 30 years would have been entitled to receive 56.25
percent.\17

As a result, the longer a retiree had worked for the federal
government, the closer the retiree's initial pension would have been
to his or her unadjusted final salary.  Nineteen (5 percent) of the
retirees in our sample had worked 40 years or more for the federal
government, and another 288 (83 percent) had worked 20 to 39 years. 
The remaining 41 (12 percent) worked 5 to 19 years.\18 Our model
showed that on average, a 1-year increase in a retiree's federal
service time would result in about a 3.7 percentage point increase in
the percentage by which the retiree's pension had exceeded his or her
final salary, other factors being equal. 

A final factor--whether a retiree had chosen a survivor's annuity
benefit--helped to explain why some retirees' pensions had come to
exceed their unadjusted final salaries as much as they did.  As noted
in the background section of this report, an employee who chooses a
survivor annuity benefit can have his or her basic annuity reduced by
as much as 10 percent.  As a consequence, if two retirees retired in
the same year and had the same final salaries and years of service,
but only one had chosen a survivor annuity benefit, the retiree who
elected not to take the benefit would have had a pension that
exceeded his or her unadjusted final salary sooner than the retiree
who had chosen the survivor benefit.\19

An employee who chose a survivor annuity benefit would have reduced
the initial pension and thus increased the gap between the initial
annuity and the final salary.  Of the CSRS retirees in our sample, 48
percent were not having survivor benefits deducted from their
pensions. 


--------------------
\15 As noted, although CSRS and FERS COLA policies differ from each
other and from COLA policies of the past, these differences do not
affect whether a pension would come to exceed an unadjusted final
salary, but rather, when. 

\16 In considering these and the other regression results in this
report, it is important to recognize that the results can be applied
only to those retirees whose 1995 pensions had come to exceed their
unadjusted final salaries. 

\17 CSRS retirees may receive additional service credit for unused
sick leave, which would allow them to exceed the 80-percent rule.  In
contrast, FERS does not have a maximum percentage base.  The formula
used to calculate initial annuities under FERS provides a lower
annuity than the one used under CSRS.  Thus, it is unlikely that
someone who has government service solely under the FERS pension plan
would receive as much as the maximum percentage base allowed under
CSRS. 

\18 The vast majority (76 percent) of these annuitants retired under
disability. 

\19 Also, retirees who had chosen a survivor's annuity benefit and
who became divorced or whose spouses died during their retirement
would have exceeded their final salaries sooner than they otherwise
would have because their pensions were increased due to a change of
marital status. 


   SOME RETIREES' PENSIONS WOULD
   HAVE BEEN SMALLER, OTHERS
   LARGER, HAD CURRENT POLICY BEEN
   IN EFFECT WITHOUT INTERRUPTION
------------------------------------------------------------ Letter :6

Had current COLA policy--that is, the COLA policy enacted in 1984,
which established the formula and schedule used today by OPM--been in
effect without interruption since 1962, some sample retirees'
pensions would have been smaller than the pensions that they actually
received, and other retirees' pensions would have been larger.  Our
simulations suggest that other factors being equal, the majority of
those who retired before 1970 would have received smaller pensions,
while about 90 percent of those who retired after 1970 would have
received larger ones.\20 If current policy had been in effect for all
retirees in the sample, the number of retirees whose pensions would
have exceeded their unadjusted final salaries would have increased by
about 3 percentage points. 


--------------------
\20 The margin of error is plus or minus 5 percent with a 95-percent
confidence interval. 


      THE EFFECTS OF COLA POLICIES
      WOULD HAVE DIFFERED,
      DEPENDING ON WHEN ANNUITANTS
      RETIRED
---------------------------------------------------------- Letter :6.1

The following examples compare the pensions that retirees would have
received under current versus actual COLA policy by simulating the
effects that changes in COLA policy would have had on pension
amounts, other factors being equal.  The examples cover three
different periods--1961 to 1995, 1968 to 1995, and 1981 to 1995--and
show how the impacts would have varied, depending on the period of
retirement.\21 In considering the meaning of the figures, it is
important to recognize that the trend lines refer to current versus
historical CSRS COLA policy.  FERS lines were not presented because,
as stated earlier in this report, none of the FERS retirees received
an annuity that was based solely on his or her FERS participation. 

Figure 1 shows the relative effects of current and actual policy for
a CSRS participant who retired in 1961.  As the figure shows, if the
current policy had been in effect without interruption, the retiree's
pension would have been smaller over the period.  Our analysis showed
that by 1995 the retiree's pension would have been 6.3 percent
smaller than it was under the actual COLA policy.  However, as the
gap shown between the 1995 pension and the unadjusted final salary
amount makes clear, such a reduction would not have been nearly
enough to have caused the retiree's pension to fall below his or her
final unadjusted salary. 

   Figure 1:  Comparison of the
   Effects of Actual COLA Policy
   and Current COLA Policy, Had It
   Been in Effect for the Average
   Sampled CSRS Employee Who
   Retired in 1961

   (See figure in printed
   edition.)

Source:  GAO analysis of OPM data. 

Figure 2 shows similar results for an annuitant who retired in 1968. 
In this example, our analysis showed that the retiree's pension would
have been 3.5 percent smaller if current policy had been in effect
without interruption.  The reduction in this annuitant's pension is
less proportionally than the reduction in the pension of the
annuitant who had been retired since 1961 (shown in fig.  1),
primarily because of the difference in the number of the COLAs that
were received and, to a lesser extent, the shorter period of
compounding.  Again, the reduction would not have been large enough
to cause the retiree's 1995 pension to fall below his or her
unadjusted final salary. 

   Figure 2:  Comparison of the
   Effects of Actual COLA Policy
   and Current COLA Policy, Had It
   Been in Effect for the Average
   Sampled CSRS Employee Who
   Retired in 1968

   (See figure in printed
   edition.)

Source:  GAO analysis of OPM data. 

The third example (fig.  3) shows the results for an annuitant who
retired in 1981.  The retiree's pension would have been larger if
current policy had been in effect without interruption.  As the
figure shows, under actual policy, the retiree did not receive a COLA
in 1984 or 1986, which caused this retiree's pension to fall somewhat
short of the pension that he or she would have received had current
policy been in effect.  Because the effects of these suspensions
continued to be reflected in the pension amounts that the retiree
received in subsequent years, by 1995 the retiree's pension would
have been 1.4 percent larger under current, compared to historical,
COLA policy. 

   Figure 3:  Comparison of the
   Effects of Actual COLA Policy
   and Current COLA Policy, Had It
   Been in Effect for the Average
   Sampled CSRS Employee Who
   Retired in 1981

   (See figure in printed
   edition.)

Source:  GAO analysis of OPM data. 


--------------------
\21 As stated in the scope and methodology section of this report, we
used the average initial pension for the sample annuitants who
retired in the first year of each period as the starting pension
amount for all three figures.  However, the amount that we used for
the beginning pension did not matter because, in percentage terms,
the impacts would have been the same for any beginning annuity that
we selected. 


      THE PERCENTAGE OF RETIREES
      WHOSE PENSIONS EXCEEDED
      THEIR UNADJUSTED SALARIES
      WOULD HAVE BEEN HIGHER IF
      CURRENT POLICY HAD BEEN IN
      EFFECT
---------------------------------------------------------- Letter :6.2

The increases in the pensions of some sample retirees, if current
policy had been in effect the entire time, would have been enough to
cause an increase of 3.0 percentage points in the number of retirees
whose pensions exceeded their unadjusted final salaries.  When we
estimated what the sample retirees' pensions would have been if
current policy had been in effect without interruption, we found that
about 29 percent of retirees would have had annuities that exceeded
their unadjusted final salaries, compared to about 26 percent under
the actual policy simulation.\22 Although the difference was quite
small, it was statistically significant.\23

The two estimates differed by about 3 percentage points in part
because the effects of COLAs on pension amounts are cumulative and
compound.  In particular, the suspensions of COLAs during 1980s
tended to offset the COLA policies of the 1960s and 1970s that
overcompensated for inflation. 


--------------------
\22 Since legislative changes made after 1984 did not permanently
affect the COLA formula or schedule, we did not include them in our
analysis of current COLA policy.  However, these changes were
included in our actual COLA policy analysis.  Thus, because our
simulation of COLA policies used the initial annuity as the starting
point for adding COLAs, our simulation did not include any
adjustments (e.g., loss of survivor's annuity benefit due to spouse's
death) to annuities subsequent to the calculation of the initial
annuity.  When these adjustments are considered by using the annuity
received in 1995, the percentage of those retirees exceeding their
final salaries is 27 percent. 

\23 Of the 398 sample cases for which data were available, 38 had
pensions that were below their final salaries under actual COLA
policy but above their final salaries under current COLA policy. 
None of the sample retirees whose pensions were above their final
salaries under actual COLA policy had pensions below their final
salaries under current COLA policy.  The estimate that about 3
percent more of the pensions would have exceeded final salaries under
current COLA policy compared to actual COLA policy is surrounded by a
95-percent confidence interval that extends from about 2 to 4
percent. 


   OBSERVATIONS
------------------------------------------------------------ Letter :7

Our analysis of the effects that COLA policies have had on retiree
pensions shows that the policies have played an important role in
maintaining the purchasing power of retiree pensions since automatic
COLAs began.  Although COLA policies of the 1960s and 1970s
overcompensated for the effects of inflation as measured by the CPI,
COLA policies of the 1980s sometimes under-compensated.  And,
although current COLA policy would have tracked the CPI more closely
had it been applied over the period we reviewed compared with some
past COLA policies, the numerous changes that have been made in COLA
policies over the past 35 years did not cause any retiree's pension
to exceed his or her final salary when the salaries were adjusted for
inflation. 

Our analysis also shows that the effects that COLA policies actually
have on retiree pension amounts cannot be summarized easily. 
Generalization is difficult, in part because no one COLA policy has
ever been implemented for a sustained period.  For example, although
the current underlying policy has been in effect since 1984, Congress
has modified this policy several times for limited periods to help
reduce the deficit.  Also, the effects of many individual COLAs and
COLA policy changes are cumulative and compound over time.  As a
consequence, COLA policy changes have affected individual retirees
differently, depending on when they retired.  In particular, the
effects of the COLA policies of the 1960s and 1970s that
overcompensated for inflation will continue to have an effect on
retiree pensions for as long as those who received them are alive,
just as not receiving scheduled COLAs in 1984 and the suspension of
COLAs in 1986 will continue to be reflected in the pensions of anyone
who retired before these years. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :8

We received oral comments on a draft of this report from OPM on July
16, 1997.  OPM officials who provided comments included Federal
Retirement Benefits Specialists from the Retirement Policy Division
and a Program Analyst from the Retirement and Insurance Service. 
These officials generally concurred with the information and
conclusions presented in our report.  In particular, they agreed that
using constant dollars, rather than nominal dollars, is a more
meaningful way to compare retiree pensions to final salaries and that
the statutory factors that are designed to maintain pension
purchasing power and reward employees with longer service play a
major role in determining whether pensions come to exceed nominal
final salaries.  These officials also provided a number of technical
and clarifying comments, which we incorporated into this report where
appropriate. 


---------------------------------------------------------- Letter :8.1

We are sending copies of this report to the Ranking Minority Member
of your Committee and the Chairmen and Ranking Minority Members of
the Subcommittee on International Security, Proliferation, and
Federal Services, Senate Committee on Governmental Affairs; and to
the Subcommittee on Civil Service, House Committee on Government
Reform and Oversight.  Copies of this report are also being sent to
the Director of OPM and other parties interested in federal
retirement matters and will be made available to others upon request. 

Major contributors to this report are listed in appendix II.  If you
have any questions, please call me at (202) 512-9039. 

Sincerely yours,

Michael Brostek
Associate Director, Federal Management
  and Workforce Issues


SUMMARY OF COLA HISTORY SINCE
AUTOMATIC COLAS WERE ENACTED IN
1962
=========================================================== Appendix I

                                    Effect
                                       ive    Date    CSRS      FERS
Measuring period                    date\a  paid\b    COLA      COLA\c
----------------------------------  ------  ------  ------  --  ------
*                                     1/63    2/63     5.0      -
**                                   12/65    1/66     6.1      -
**                                    1/67    2/67     3.9      -
**                                    5/68    6/68     3.9      -
**                                    3/69    4/69     3.9      -
**                                   11/69   12/69     5.0      -
**                                    8/70    9/70     5.6      -
**                                    6/71    7/71     4.5      -
**                                    7/72    8/72     4.8      -
**                                    7/73    8/73     6.1      -
**                                    1/74    2/74     5.5      -
**                                    7/74    8/74     6.3      -
**                                    1/75    2/75     7.3      -
**                                    8/75    9/75     5.1      -
**                                    3/76    4/76     5.4      -
June-December 1976                    3/77    4/77     4.8      -
December-June 1976/77                 9/77   10/77     4.3      -
June-December 1977                    3/78    4/78     2.4      -
December-June 1977/78                 9/78   10/78     4.9      -
June-December 1978                    3/79    4/79     3.9      -
December-June 1978/79                 9/79   10/79     6.9      -
June-December 1979                    3/80    4/80     6.0      -
December-June 1979/80                 9/80   10/80     7.7      -
June-December 1980                    3/81    4/81     4.4      -
Dec. 1980-Dec. 1981                   3/82    4/82     8.7      -
Dec. 1981-Dec. 1982                   4/83    5/83   3.9\d      -
3rd qtr. 1984-3rd qtr. 1983\e        12/84    1/85     3.5      -
3rd qtr. 1985-3rd qtr. 1984          12/85    1/86     0.0      -
3rd qtr. 1986-3rd qtr. 1985          12/86    1/87     1.3      -
3rd qtr. 1987-3rd qtr. 1986          12/87    1/88     4.2      -
3rd qtr. 1988-3rd qtr. 1987          12/88    1/89     4.0      3.0
3rd qtr. 1989-3rd qtr. 1988          12/89    1/90     4.7      3.7
3rd qtr. 1990-3rd qtr. 1989          12/90    1/91     5.4      4.4
3rd qtr. 1991-3rd qtr. 1990          12/91    1/92     3.7      2.7
3rd qtr. 1992-3rd qtr. 1991          12/92    1/93     3.0      2.0
3rd qtr. 1993-3rd qtr. 1992           3/94    4/94     2.6      2.0
3rd qtr. 1994-3rd qtr. 1993           3/95    4/95     2.8      2.0
3rd qtr. 1995-3rd qtr. 1994           3/96    4/96     2.6      2.0
----------------------------------------------------------------------
Legend

* = Adjustments made whenever the CPI in a year exceeded the CPI in
the base year by 3 percent or more. 

** = Adjustments made whenever the CPI in a month rose by at least 3
percent over the month of the last adjustment and remained at or
above that level for 3 consecutive months. 

\a The "effective date" column indicates the month the COLA went into
effect. 

\b The "date paid" column indicates the month the retiree received
the COLA. 

\c All disability retirees (and survivors) and nondisability retirees
age 62 or over.  (The first FERS COLA was effective in December 1988
and payable in January 1989.)

\d The COLA rate was 3.3 percent for nondisabled retirees under age
62. 

\e Due to a change in the adjustment period, no COLA paid in 1984. 

Sources:  OPM and CRS. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II

GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C. 

Margaret T.  Wrightson, Assistant Director
Gregory H.  Wilmoth, Senior Social Science Analyst

DALLAS FIELD OFFICE

Tyra J.  DiPalma, Senior Evaluator
Enemencio S.  Sanchez, Evaluator

ACKNOWLEDGEMENT

In addition to those named above, Jerry T.  Sandau, Social Science
Analyst, GGD, contributed through his development of the regression
analysis results presented in this report. 


*** End of document. ***