The Current State of Public Pensions LAPERS Annual Conference 2010 Conference September 22, 2010

1.   The Current State of Public PensionsLAPERS Annual Conference 2010 ConferenceSeptember 22, 2010  Keith Brainard, Research Director National Association of State Retirement Administrators

2. Size and scope of the state and local government pension community 14.7 million actives 12+ percent of the nation�s workforce 7.5 million annuitants ~$2.65 trillion in assets $175 billion in annual benefit payments $86+ billion in employer (taxpayer) contributions $38+ billion in employee contributions

3. Retirement Benefits Comparison Private Sector Two-thirds work for employers that sponsor a retirement benefit One-fourth of those eligible do not participate Barely one-half participate in an employer-sponsored plan Fewer than one in five have a traditional pension (DB) benefit Some employers have suspended or eliminated their 401k plan match Universal Social Security Public Sector Nearly all have access to an employer-sponsored retirement benefit Ninety percent participate in a traditional pension (DB plan) Three-fourths participate in Social Security

4. Why have traditional pensions diminished in the private sector? Increased international economic competition The US retirement model is more employer-centric than those of most other nations A workforce that is more mobile and service-based Is less conducive to traditional pensions Federal regulations and accounting standards State and local government employers are largely immune from these factors

5. Reliance on Social Security Of those who receive Social Security benefits: More than half (56 percent) rely on Social Security for more than half of their income For 30 percent, Social Security accounts for 90 percent of retirement income For almost one of five, (19 percent) Social Security is the sole source of income Source: Social Security Administration

6. Social Security Finances

7. Distinguishing features of the public sector workforce Public employees are older and almost twice as likely to have a college degree Many others are involved in positions that involve physical risk � police, fire, correctional officers More than one-half of public sector workers are employed in career-oriented jobs � teachers, firefighters, police Among other objectives, pension benefits are designed to enable a) public employers to retain these workers, and b) public employees to retire at an appropriate age

8. Distinguishing features of public pension plan designs Mandatory participation Cost-sharing between employers and employees Pooled assets Reduce administrative costs and distribute risk Assets that are professionally invested Annuitized benefits These elements are at the heart of many of the problems with other retirement plan models. As I mentioned, many employees elect to not participate in their plans; employees typically are not required to contribute to corporate pension plans; individual accounts in defined contribution plans are expensive and shift risk from a large group to a single participant. The problem with that risk-shift is that it forces the individual to save for the worst case scenario, if you will, i.e., living the longest possible time, and being more conservative than they otherwise would need to be with respect to managing their assets. This is a far less efficient method for saving for retirement, By contrast, by pooling assets, assets can be managed for the group as a whole, which functions like an insurance policy, where plan sponsors and plan participants can set aside funding for the group�s average longevity, rather than all participants needing to save as if they�ll all live to be 100 years old. Asset pooling also reduces costs and produces higher investment earnings.These elements are at the heart of many of the problems with other retirement plan models. As I mentioned, many employees elect to not participate in their plans; employees typically are not required to contribute to corporate pension plans; individual accounts in defined contribution plans are expensive and shift risk from a large group to a single participant. The problem with that risk-shift is that it forces the individual to save for the worst case scenario, if you will, i.e., living the longest possible time, and being more conservative than they otherwise would need to be with respect to managing their assets. This is a far less efficient method for saving for retirement, By contrast, by pooling assets, assets can be managed for the group as a whole, which functions like an insurance policy, where plan sponsors and plan participants can set aside funding for the group�s average longevity, rather than all participants needing to save as if they�ll all live to be 100 years old. Asset pooling also reduces costs and produces higher investment earnings.

9. Differences within core elements of pension plans in the private and public sectors Private Sector Employer contributions only Lump-sum payouts prevalent Costs based on interest rates Plans can be terminated and/or employer can go bankrupt; accrued benefits guaranteed only to the extent they fit within PBGC parameters/maximums; future accruals not guaranteed. Public Sector Employer and employee contributions Lifetime payouts prevalent Costs based on long-term expected investment return Backed by full faith and credit of government sponsor; accrued benefits guaranteed; future accruals often guaranteed.

10. Who bears the risk? The critical, overarching difference between a traditional pension, or defined benefit plan, and a defined contribution plan is who bears the risk, especially of: Investment performance and longevity In most of the private sector, this risk has been shifted to employees For most public employees, employers (taxpayers) bear this risk

11. Overarching trends affecting public pensions Funding levels are declining Costs are rising Plan sponsors are in fiscal distress Benefits for new hires are being reduced Accounting standards are under review Actuarial methods and assumptions are being challenged

12. Multiple, competing studies of pay and benefits: Many fail to distinguish between federal and state & local government workers Many fail to acknowledge key facts: Public employees are twice as likely to have a college degree than the private sector workforce Many public employees work in positions involving physical risk � police, fire, corrections The public sector workforce stays on the job longer Public employee compensationhas become the focus of growing attention

13. Recent and latest aggregatepublic pension funding levels

14. Historical aggregate public pension funding levels

15. Historical and projected aggregate public pension funding levels

16. According to the National Conference of State Legislatures, some state employees have been laid off in 23 states and furloughed in 25 states A large portion of the federal stimulus package targeted state and local government employees Most of these funds have been spent Last month, a survey found that cities and counties could lay off nearly half a million employees if more federal help was not provided New stimulus funding for teachers was approved last summer Other economists estimate state and local governments will lay off 200,000 to 400,000 employees over the next year 1.3 percent to 2.6 percent of total S&L government employment Furloughs, layoffs, slow membership growth

17. Median public fund investment returns for periods ended 6/30/10

18. Daily close of Russell 3000,6/1/95 to 7/31/10

19. Median public fund returns for periods ended 12/31/09

20. Resources on investment return assumption: NASRA Issue Brief: �Public Pension Plan Investment Return Assumptions� www.nasra.org/resources/InvReturnAssumption_Final.pdf �Investment Return Assumptions for Public Funds: The Historical Record,� Callan Associates www.nasra.org/resources/Callaninvreturn.pdf CalSTRS, �Analysis of Investment Return Assumption,� Milliman USA, February 2010 www.nasra.org/resources/CalSTRS_invreturnanalysis.pdf

21. Public pension fund sources of revenue, 82 - 09

22. GASB and public pensions The Governmental Accounting Standards Board currently is reviewing Statements 25 and 27 These statements provide guidance to public sector employers and retirement systems regarding the calculation and disclosure of public pension liabilities Overarching question under review: should financial statements pertaining to public pensions focus on Unfunded pension obligations (accounting focus), or The cost of paying those obligations (funding focus) Current focus is on funding Employer obligation is defined as ARC shortfall Should public pension liabilities be presented on employers� basic financial statement or in the notes? How should plans discount their liabilities? Should pension plans be allowed to smooth their investment gains and losses, and if so how much? What should be the permissible amortization period? What actuarial funding method should plans use?

23. Key GASB questions Are employer pension obligations considered to be liabilities, i.e., �present obligations to sacrifice resources that the government has little or no discretion to avoid� ? Should pension obligations, or liabilities be presented on employers� basic financial statement or in the notes? How should plans discount the present value of their future pension obligations? Should pension plans be allowed to smooth their investment gains and losses, and if so how much? What should be the maximum amortization period? What actuarial funding method should plans use?

24. Where does GASB appear to be headed? Preliminary Views was published in June; responses were due September 17 Publication of an ED � 2011 Preliminary Views signals a shift from a focus on funding to a focus on accounting Employer�s pension obligation would be defined as unfunded pension liability based on market value of assets Discount rate: long-term rate of return, but with some limits Asset smoothing as long as market value is within 15 percent of actuarial value Amortization period, currently 30 years, may be shortened to 10 to 15 years

25. High level of scrutiny on public pension benefit levels and costs At least one dozen states approved retirement benefit structures with higher years of service, age, or both, needed to qualify for normal retirement benefits Most affected new hires only Nine states reduced COLA provisions Three�CO, MN, SD�affected existing retired members Ten states raised employee contribution rates, affecting existing participants in most cases Other popular changes: Longer final average salary periods, more restrictive return-to-work policies, anti-spiking provisions The breadth of changes made this year to pension benefits was unprecedented

26. Lawsuits filed against changes affecting existing participants Lawsuits have been filed in Colorado, Minnesota, and South Dakota challenging the authority of those states to reduce automatic COLAs for existing retired members A lawsuit also has been filed in Rhode Island, challenging reductions in pension benefits for existing plan participants A lawsuit has been filed in Michigan challenging the state�s authority to charge active participants three percent for retiree health care benefits, with no assurance of receipt of the benefit

27. New hires in Utah will have a choice of a hybrid or defined contribution plan Illinois (SERS, TRS, and MRF) and Missouri (SERS) raised normal retirement age for new hires to 67 Higher vesting periods in Iowa and Mississippi Other notable changes

28. An increase in the last 18 months of studies calculating unfunded pension liabilities on the basis of a so-called risk-free return Timing of these studies may be intended to influence GASB One paper projects insolvency dates of state pension plans Projected insolvency dates begin in 2018 and continue through 2047 Five states would not run out of money Conclusions are derived chiefly by understating projected contributions Notable studies and reports

29. More states now offer hybrid or cash balance pension plans Recent additions: Georgia ERS, Kentucky RS, Utah RS, Michigan teachers Other hybrids: Indiana, Texas municipal and county plans, Nebraska state and counties, Ohio (optional), Oregon, Washington (optional) Conversion to cash balance or hybrid is getting more academic and policymaker attention Hybrid and cash balance plans

30. Key challenges facing the public pension community Political: responding to the gap in compensation between public and non-public employees Legal/regulatory: perceptions and realities of self-dealing Professional standards: actuarial and accounting standards under review Actuarial/financial: restoring long-term sustainability in a difficult plan sponsor fiscal environment Retirement security: preserving retirement security in an age where others have lost theirs and plan sponsors lack resources to raise contributions These elements are at the heart of many of the problems with other retirement plan models. As I mentioned, many employees elect to not participate in their plans; employees typically are not required to contribute to corporate pension plans; individual accounts in defined contribution plans are expensive and shift risk from a large group to a single participant. The problem with that risk-shift is that it forces the individual to save for the worst case scenario, if you will, i.e., living the longest possible time, and being more conservative than they otherwise would need to be with respect to managing their assets. This is a far less efficient method for saving for retirement, By contrast, by pooling assets, assets can be managed for the group as a whole, which functions like an insurance policy, where plan sponsors and plan participants can set aside funding for the group�s average longevity, rather than all participants needing to save as if they�ll all live to be 100 years old. Asset pooling also reduces costs and produces higher investment earnings.These elements are at the heart of many of the problems with other retirement plan models. As I mentioned, many employees elect to not participate in their plans; employees typically are not required to contribute to corporate pension plans; individual accounts in defined contribution plans are expensive and shift risk from a large group to a single participant. The problem with that risk-shift is that it forces the individual to save for the worst case scenario, if you will, i.e., living the longest possible time, and being more conservative than they otherwise would need to be with respect to managing their assets. This is a far less efficient method for saving for retirement, By contrast, by pooling assets, assets can be managed for the group as a whole, which functions like an insurance policy, where plan sponsors and plan participants can set aside funding for the group�s average longevity, rather than all participants needing to save as if they�ll all live to be 100 years old. Asset pooling also reduces costs and produces higher investment earnings.

31. Funding levels will continue to decline Higher contribution rates for employers and for many employees Continued focus on public employee compensation and benefits Increased consideration of hybrids, cash balance plans, and plan designs that shift more risk to participants Efforts to reduce future accrual rates Pressure to reduce investment return assumptions Pressure to switch to DC plans Forecast

32. www.nasra.org www.publicfundsurvey.org Keith Brainard, NASRA Research Director keithb@nasra.org 512-868-2774 More information