Pension Reform Primer Florida Government Finance

Officers AssociationJune 24, 2013

James W. Linn

Big Picture

• Florida cities are facing extreme challenges of :- declining revenues and - increasing costs

• One of the largest and fastest growing costs facing many cities is the cost of employee pension plans.

• This year pension contributions for many cities will be 30%, 40%, even 50% of payroll (or more).

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Some Numbers

• 492 Local Government Defined Benefit Pension Plans in Florida

• 111,267 Active Participants• 78,975 Inactive Participants (retirees and terminated

vested)• Approximately $24 billion in plan assets as of

9/30/2012 (but liabilities = nearly $30 billion)• 300 plans (61%) are funded at or below 80%• 187 plans (39%) are funded above 80%

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Defined Benefit Plan

Benefits are based on a formula:

Avg. Final Compensation X

Years of ServiceX

Multiplier

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Defined Benefit Plan

Typical benefit calculation:

$75,000 Avg. Final Comp. X

30 Years of ServiceX

3% Multiplier

= lifetime benefit of $67,500 per year

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Benefit Example # 1

Fire Driver Engineer – age 54 with 22 yrs 10 mos. service

Avg. Final Compensation = $71,500/yr. ($5,958/mo.)

Normal Pension Benefit = $65,294/yr. ($5,441/mo.)

Plus 3% Annual Cost of Living Adjustment

401K Value at Retirement: $ 1,587,712

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Benefit Example # 2

Fire Driver Engineer – age 49 with 25 years service

Avg. Final Compensation = $60,432/yr. ($5,036/mo.)

Normal Pension Benefit = $60,432/yr. ($5036/mo.)

Plus 3% Annual Cost of Living Adjustment

401K Value at Retirement: $ 1,669,010

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Benefit Example # 3

Police Officer – age 47 with 25 years service

Avg. Final Compensation = 126,690/yr * ($10,557/mo.)

Pension Benefit = $ 95,017 per year for life

Plus DROP Benefit = $239,946 lump sum

Plus “Share Plan” Benefit = $45,000

401K Plan Equivalent Value = $2,289,946

* Avg. Final Comp without overtime and other add-ons: $76,1668

Benefit Example # 3

Police Lieutenant – age 49 with 25 years service

Avg. Final Compensation = 134,141/yr*($11,177/mo.)

Pension Benefit = $ 100,606/year for life

Plus DROP Benefit = $544,468 lump sum

Plus “Share Plan” Benefit = $22,458

401K Plan Equivalent Value = $2,632,926* Avg. Final Comp without overtime and other add-ons: $76,669

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Pension Funding Law

• State law requires that defined benefit pension plans be funded on a “sound actuarial basis”

• This means the cost of current benefits cannot be shifted to future taxpayers.

• City is ultimately responsible for paying current pension costs (“normal cost”) plus amortizing unfunded liabilities over period of not more than 30 years.

• City bears the risk of pension fund investment losses.

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Pension Cost Components

1. Normal Cost – ongoing cost of benefits, with no UAAL (unfunded actuarial accrued liability)

2. UAAL Amortization Payment to cover past: Actuarial losses Plan improvementsChanges in actuarial assumptions &

methods 11

Pension Cost Components

• In many cities the UAAL amortization payment exceeds the normal cost of the plan:

Normal Cost UAAL Amort. Total Cost

16% 28.5%44.5%

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Pension Cost BreakdownExample• Normal Cost: $ 4.47 million (16.0% of payroll)• Amortization: $ 7.96 million (28.5% of payroll)

• Total Required: $12.4 million (44.5% of payroll)

• Members Pay: -$ 1.4 million ( 5% of payroll)

• Net City Cost: $11 million (39.5% of payroll)

[Annual City cost per employee = $ 25,166]

Pension Legacy Cost - The UAAL Issue

Why have unfunded liabilities grown even in years of good investment performance?• Because actuarial losses have exceeded investment gains.• Many plans have had consistent actuarial losses in recent

years.• Actuarial losses occur when actual experience does not meet

assumptions in areas such as: investment earnings salary increases / payroll growth mortality turnover retirement rates

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$2,300,000

$4,700,000

$6,500,000

$8,100,000

$11,732,050

$15,126,269

$17,989,780 $17,107,414

$19,767,031

$21,758,951

$2,000,000

$4,000,000

$6,000,000

$8,000,000

$10,000,000

$12,000,000

$14,000,000

$16,000,000

$18,000,000

$20,000,000

$22,000,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

UA

AL

+ 944%

Unfunded Actuarial Accrued Liability

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5 Year Smoothing - Example

• Assumed rate of return = 7.5%• Actual return = minus 12.47%• Actuarial loss = minus 19.97%

[(minus 7.5%) + (minus 12.47%)] = minus 19.97%• 19.97/5 = 3.99• Minus 3.99% will be recognized each year for the next

5 years • Result: Employer contributions will likely increase

unless actual return exceeds 11.49% (7.5% + 3.99%)

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Pension Reform Legal Guidelines

• Changes in retirement benefits and employee contributions are mandatory subjects of collective bargaining.

• Accrued pension benefits (benefits earned in the past) cannot be reduced or taken away.

• Future benefits can be reduced for current employees who have not reached retirement status.

• City is ultimately responsible for unfunded pension liabilities, even if current plan is terminated or frozen, or all employees are laid off or transferred to another employer. 17

Ch. 175/185 Premium Taxes • Chapters 175 & 185, F.S. provide for a rebate of the

state excise tax on property and casualty insurance premiums to cities that have firefighter and police pension plans.

• Premium taxes are paid by City taxpayers.• The premium tax monies must be used exclusively for

fire and police pensions, and the local pension plan must comply with the requirements of Chapters 175 & 185.

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Ch. 175 Premium Taxes Old Interpretation

• “Excess” premium tax monies can only be used for new “extra benefits.”

• If benefits are reduced below 1999 level, City loses eligibility for future premium taxes.

• Premium tax money that can be used for extra benefits is first year dollar cost. As payroll grows, cost of extra benefits shifts to City.

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Ch. 175 Premium Taxes New “Naples” Interpretation

• City eligible for future premium tax revenues as long as Ch. 175 minimum benefits are met (can be less than 1999 benefits).

• If cost of Ch. 175 minimum benefits is more than “additional” premium taxes (i.e., taxes above the 1998 amount), all premium tax revenues may be used to reduce the City’s required contributions.

• City and union can negotiate use of “excess” premium tax monies.

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2013 Retirement Legislation

Passed:• SB 534 – Public Pension Plan Disclosure• HB 1810 – FRS Contribution RatesDid Not Pass:• SB 458 / HB 1399 – Police & Firefighter

Pension Plans• HB 7011 – Florida Retirement System

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2013 Legislation

SB 534 – Public Retirement Plan Disclosure – passed. Creates new reporting requirements for local government defined benefit pension plans.

• Long-term funded ratio of the plan calculated in compliance with GASB 67 and 68, including the market value of plan assets, the value of the plan’s actuarial liabilities, and the amount of any unfunded accrued liability;

• Dollar value of any unfunded accrued liability; • Number of months or years for which the current market

value of assets are adequate to sustain the payment of expected retirement benefits; and

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2013 LegislationSB 534 (cont.)• Recommended contributions to the plan stated as an annual dollar

value and a percentage of valuation payroll, using actuarial assumptions and cost methods specified in the legislation:– Entry Age Normal actuarial cost method. – Assumed rate of return two percent less than the plan’s assumed

rate of return. – RP-2000 Mortality Tables – Asset valuation method -- market value less the value of DROP

accounts; – Actuarial accrued liabilities, excluding the value of DROP accounts;

and – All other assumptions and methods used by the local plan in its

latest valuation. 23

2013 LegislationSB 534 (cont.)• Plan sponsor must publish the required information,

on any website that contains budget or actuarial information relating to the plan. Local government plans also must provide the information on any municipal website when tentative budgets are published.

• Required information for reporting purposes only – not for determining plan funding requirements.

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2013 Legislation

HB 1810 -- FRS Employer Contribution Rates Effective 7/1/13 -- passed:

• Regular Class – 7.0% (was 5.18%)• Special Risk: 19.11% (was 14.9%)• Senior Mgt – 18.36% (was 6.49%)• Local Elected Officers – 33.08% (was

10.23%)• DROP – 11.64% (was 4.33%)

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2013 Legislation

SB 458 / HB 1399 – Police & Firefighter Pension Plans – did not pass

• Would have revised rules on use of Ch. 175/185 premium tax revenues

• Would have required a greater portion of premium taxes to be used for enhanced benefits for police officers and firefighters

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2013 Legislation

HB 7011 – Florida Retirement System – did not pass• would have closed FRS defined benefit

pension plan to new members, and required all new hires to participate in defined contribution plan

• passed House; defeated in Senate on 22-18 vote

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What Are the Options to Reduce City Pension Costs?

• No “silver bullet”• Keep current City pension plans, but:

Reduce benefits, and/orIncrease employee contributions

• Terminate, freeze or close exiting pension plans, and set up lower cost plans

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Pension Reform Options

• Join FRS• Set up Defined Contribution (DC) plan• Reduce Benefits for New Hires• Reduce Benefits for All Employees• Hybrid Plan• Increase Employee Contributions

and/or Cost-Sharing29

Key Concepts

• “Close” – existing plan closed to new members; current members stay in existing plan until they retire or leave the city; future employees join new plan.

• “Freeze” - accrued benefits of current employees in existing plan “frozen” and paid out at retirement; all current and future employees join new plan.

• “Terminate” – existing plan liquidated; accrued benefits paid out to plan members; City responsible for any deficit; all current and future employees join new plan.

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Join FRS for New HiresAdvantages

• Reduced cost over time(FRS rates are going up)

• Standardized FRS benefits• 3% employee contribution• Portability – easier for City

to attract employees from other FRS agencies

• Gets City out of pension business (eventually)

Disadvantages• No immediate savings -- may

take many years to achieve cost savings; City still must pay off current plan liabilities

• Lose premium tax revenues immediately

• Portability – City employees can move to another FRS employer and take their pension with them

• State legislature sets benefits and contributions

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Join FRS for All EmployeesAdvantages

• Reduced city cost in shorter time (but FRS rates are going up)

• Standardized FRS benefits• 3% employee contribution • Portability – easier for City

to attract employees from other FRS agencies

• Gets City out of pension business (eventually)

Disadvantages• Current City pension plans

must be terminated or frozen• City still must pay off current

plan liabilities• Lose premium tax revenues

immediately• Portability – City employees

can move to another FRS employer and take their pension with them

• State legislature sets benefits and contributions 32

Reduce Benefits for New Hires (2 Tier Plan)

Advantages• Reduced cost over time• Current employees keep

current benefits• Can be designed to keep

premium tax

Disadvantages• No immediate savings --

may take many years to achieve cost savings

• Creates lower level of benefits for new hires

• New hires can be expected to press for greater benefits

• City stays in pension business

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Reduce Future Benefits for All Employees

Advantages• Immediate cost savings• Reduces UAAL• Same benefits for all

employees going forward• Can be designed to keep

premium tax

Disadvantages• Reduces future benefits for

current employees (employees keep what they have already earned)

• City stays in pension business

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Defined Contribution Plan Advantages

• Predictable employer costs• City does not bear

investment risk • Appeals to younger, mobile

employees• Portability – DC account

balance may be “rolled over” to an IRA or other retirement plan

• Lower admin. Costs• No actuarial liabilities

Disadvantages• Employees bear investment risk• Possible that DC benefits will

run out while employee is still alive

• No inflation protection (COLA)• Portability – employees can

easily move to another employer and take their DC balance with them

• Loss of premium tax revenues

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Hybrid Plan• DB plan plus separate DC plan

DB plan provides guaranteed “base” benefit (eg. 1.25%) DC plan reduces risk and cost to City

• DB plan plus DC plan – variable DC contribution If DB cost goes up, city contribution to DC plan goes

down• “Variable Annuity” DB Plan

If DB cost goes up, DB benefit goes down (eg. multiplier reduced from 2% to 1%)

• Hybrid plan results in sharing of risk and cost between the City and employees

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Increase Employee Contributions or Cost - Sharing• One percent increase in employee contribution =

one percent reduction in City contribution• Legal issue: Ch. 175/185 says employee

contributions can be increased only if union agrees (but equivalent pay reduction can be imposed).

• Cost sharing: if City contribution goes up, employees pay one-half of increase

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2011 Florida Retirement System Changes

Changes for current members:• 3% employee contribution eff. 7/1/11 (was zero)• No COLA for service after 7/1/11 (was 3%)

Changes for new hires:• Delayed normal retirement age

Regular: age 65 or 33 years service (was age 62 or 30 years serv.) Special Risk: age 60 or 30 years service (was age 55 or 25 yrs serv.)

• Average final compensation: highest 8 years (was high 5)• 8 year vesting period* (was 6 years)• DROP interest = 1.3% for members who enter DROP after 7/1/11 (was

6.5%)38

Pension Reform: What Florida Cities Have Done

Ft. Lauderdale (2007) - General

• Closed general employee defined benefit pension plan

• Set up defined contribution plan for new hires

• 36 Florida cities have replaced defined benefit pension plans with defined contribution plans

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Pension Reform: What Florida Cities Have Done

Miami Beach (2010) – All Employees• Wage freeze• Pension changes for current employees: Increased employee pension and health plan

contributions by 2% 5 year final averaging period (phased in) Reduced pension benefits for new hires

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Pension Reform: What Florida Cities Have Done

Delray Beach (2010) – General Employees• Final average comp period extended from 2 to 5 years• Normal retirement date delayed to age 62 (was 60)• Employee contributions increased from 2.5% to 3.05%• Standard benefit changed to single life annuity (was 60% joint

& survivor annuity)• Line of duty disability benefit reduced from 75% to 60%

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Pension Reform: What Florida Cities Have Done

Miami (2010) – Pension Changes (All Employees)* [Financial urgency declared – City Commission adopted wage and benefit reductions 8/31/10]:• Later normal retirement age (to “Rule of 70” with min. age 50 from

Rule of 64/68) • 5 year average final compensation (was highest year)• Reduce benefit formula for future service (to 3% from 3.5% after 15

yrs)• Normal form of benefit: life and 10 years certain (PF); life annuity

(General)• $100,000 cap on benefits

* litigation pending 42

Pension Reform: What Florida Cities Have DonePalm Bay (2011) – Fire • 3 year wage freeze• Reduction in pension benefits for current employees: Reduction in supplemental benefit (from $25 to $12 per month

per year of future service)• Reduction in pension benefits for future employees: Reduced multiplier - 3.2% after 20 yrs (was 5% after 20 yrs) 2% COLA deferred 6 yrs (was 3%) Line of duty disability benefit - 66% (was 75%) Stop/Restart – increased premium tax “frozen amt. from $437K

to $825K (can be used each year to offset City contribution); also one-time transfer of $825K excess premium tax reserve to reduce city contribution

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Pension Reform: What Florida Cities Have DoneCoral Gables (2011) – General [Settlement approved by union members and City Commission in July 2011]• Pension benefits frozen; reduced benefits for future service• Pension changes for current and future employees:

Reduced multiplier for future service (from 3.0 % to 2.25%) Increase employee pension contribution by 5% (to 10%) 5 year final averaging period (phased in from 3 year average) Delay retirement age to age 65 or Rule of 85 (from age 52 or

Rule of 70) Reduced disability benefits

• Future pension cost increases shared by City and employees• City may establish DC plan in the future for new hires. 44

Pension Reform: What Florida Cities Have DoneHollywood (2011) – All Employees [City declared financial urgency; pension changes approved by referendum on 9/13/11]*• Pension benefits frozen for all employees• Pension changes for current and future employees:

Delayed normal retirement date (Police/Fire - age 55 w/10 yrs or age 52 w/25 yrs; General – age 65 or age 62 w/25yrs or age 60 w/30yrs)

Reduced benefit multiplier (2.5% - police/fire; 2.0% - general) 5 year final averaging period (was 3 years) No COLA for future service No DROP* Litigation pending – police/fire 45

Pension Reform: What Florida Cities Have Done

Naples (2012) – Police [Agreement with FOP ratified 10/11; pension changes implemented in March 2012]• Pension changes for current and future employees:

Benefits frozen Multiplier reduced from 3.63% to 3.0% Final averaging period lengthened from 3 to 8 years COLA eliminated (was 3% per year from age 55 to 62) Salary reduced to exclude leave payouts Normal retirement delayed for future employees to age 60 with

8 yrs service or 30 yrs service (was age 50 or 25 yrs service) New DROP plan – 1.3% interest on DROP account

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Town of Palm Beach (2012) – All Employees • Pension benefits frozen• Pension changes for current and future employees:

“Hybrid Plan “ - Defined contribution plan on top of DB plan Reduced multiplier for future service under DB Plan (to 1.25%) Delayed normal retirement date (from age 50 with 10 yrs

service or 20 yrs service for police & fire, and age 55 or 30 yrs service for general; to age 65 for all employees (but DC plan distributions may begin earlier)

Automatic joint & survivor annuity replaced with life annuity (member may purchase survivor benefit)

No COLA Town has withdrawn from Ch. 175 & 185

Pension Reform: What Florida Cities Have Done

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Pension Reform: What Florida Cities Have DoneSarasota (2011) – Police [City Commission took final action to resolve impasse on 10/17/11; implemented July 2012]• Pension changes for current and future employees:

5 year final averaging period (was 3 years) Reduce COLA from 3.2% beginning one year after retirement to

1.0% beginning at age 65 Overtime pay included in pensionable earnings limited to 300

hours per year Standard form of benefit: 10 years certain & life (was 67%

automatic spouse survivor benefit for life of spouse) Reduce DROP interest to 2.0% (was 6.5%)

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Pension Reform: What Florida Cities Have Done

Coral Gables (2012) – Police [City Commission took final action to resolve impasse on 9/11/12]• Pension changes for current and future employees:

5 year final averaging period (was 3 years) Reduce multiplier to 2.5% after 10 years of service (was 3%) Reduce definition of pensionable earnings to exclude all OT

and leave payouts Defer normal retirement date to age 55 w/10 years of service

or 25 years of service regardless of age (was “Rule of 70”) Eliminate early retirement 5% Reduction in pay (in lieu of increase in member pension

contribution49

Pension Reform: What Florida Cities Have Done

Port Orange – Fire [Implemented 12/20/12]• Employee contribution increased by 7% (from 0.5% to 7.5%)• Reduced pension benefits for current and future employees Normal retirement date – changed to age 52 with 25 yrs service or

age 55 with 10 yrs service (was 20 and out). For vested members: alternate normal retirement date of age 48 with 25 yrs service.

Reduced pensionable earnings (exclude overtime, incentive pay and specialty pay)

Extended final averaging period from 3 to 5 years Reduced maximum benefit to lesser of 90% or $95,000 Reduced COLA Reduced DROP earnings

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Pension Reform: What Florida Cities Have Done

Port Orange – Fire - Continued

Reduced benefits for new hires: 2.5% multiplier Maximum benefit: 80% No COLA No DROP No supplemental benefit

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Pension Reform: What Florida Cities Have Done

Palm Beach Gardens (2012) – Fire [Changes agreed to by IAFF and implemented in 2012] Pension changes for current and future employees:

Redefine pensionable compensation to base pay (was total comp.)

Reduce COLA from 3.0% at age 55 to 1.5% for future service 75% maximum benefit cap (was 100%) Premium tax transfer from share plan - $507K First year savings (reduction in City contribution):

$1.15 million

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Pension Reform: What Florida Cities Have DonePalm Beach Gardens (2012) – Police [Changes imposed by City Council and implemented in 2012] Pension changes for current and future employees:

Reduce multiplier from 3.5% to 2.75% for future service Redefine pensionable compensation to base pay (was total

comp.) Eliminate COLA (was based on actuarial gains) 75% maximum benefit cap (was 100%) Defer normal retirement to age 59 with 10 years (was 20 and

out) First year savings (reduction in City contribution):

$1.1 million

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City of Oakland Park (2013) – Firefighters [imposed by City Commission and implemented in February 2013]

• Pension changes for current and future employees: Pension Benefits Frozen Multiplier reduced to 2.25% (was 3% for first 10 yrs, 4% for next

10 yrs, and 3% thereafter) Normal retirement date changed to age 55 w/10 yrs service or

age 52 w/25 yrs service (was 25 and out) Eliminate COLA Reduce DROP period to 3 years (was 5 years) Close share plan

Pension Reform: What Florida Cities Have Done

1.54

City of Ocala (2013) – General Employees [not yet implemented]• Pension changes for current employees:

Pension Benefits Frozen “Variable Benefit Hybrid Plan “ for future service Contribution corridor established Multiplier adjusts if City contribution goes above or below the

corridor (minimum: 1.0%; maximum 2.55%) No COLA No DROP Employee contribution can also adjust (3% - 5%)

• New hires: Defined contribution plan

Pension Reform: What Florida Cities Have Done

1.55

Questions?

Please send questions to Mr. Linn at:jlinn@llw-law.com

orLewis, Longman & walker, P.A.

315 South Calhoun Street, Suite 830Tallahassee, FL 32301

850.222.5702

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