An Overview of Public Pensions in the U.S.

1. An Overview of Public Pensions in the U.S. Keith Brainard Research Director National Association of State Retirement Administrators June 14, 2012

2. Comparison of Retirement Benefits in the U.S. Private Sector Public Sector Nearly all full-time workers have access to an employer-sponsored retirement benefit 85%+ participate in a traditional pension (DB plan) Three-fourths participate in Social Security • Between employers that do not sponsor a retirement benefit and employees that elect to not participate when one is sponsored, just 65% of full-time private sector workers participate in an employer-sponsored retirement plan • Fewer than one in five have a traditional pension (DB) plan • Social Security coverage is universal

3. Bird’s-eye view of public pensions in the U.S. Defined benefit plans for employees of state and local government in the U.S.: • $3.0 trillion in assets • ~15 million active (working) participants • 12 percent of the nation’s workforce • 8.0 million retirees and their survivors receive $200 billion annually in benefits • 85%+ of state and local government workers participate in an employer-sponsored pension plan • Of 3,000+ public retirement systems, the largest 75 account for ~80 percent of assets and members • Aggregate funding level = ~77% Sources: US Census Bureau, Public Fund Survey

4. Distinguishing elementsof public pension plans • Mandatory participation • Employee-employer cost sharing • Assets that are pooled and professionally invested • A benefit that cannot be outlived, i.e., mandatory annuitization

5. Overarching Issues • Pension benefits for employees of state and local government are in the midst of unprecedented change • Public employee compensation, including retirement benefits, is the recipient of an unprecedented level of attention from the media, academics, and policymakers • An unprecedented number of lawsuits challenging changes to pension benefits are outstanding • State and local government employment is lower today by some 650,000 jobs, or 3.5%, from its August 2008 peak

6. Overarching Issues (continued) • Pension accounting standards are on the verge of drastically changing the way public pension liabilities and costs are calculated • Interest rates are at their lowest levels in decades and are projected to remain low through at least 2014 • Longevity is improving

7. Changes to public pension plans in the U.S. • Higher required retirement ages • Longer vesting periods • Higher employee contributions • Fewer/lower cost-of-living adjustments • Greater use of hybrid retirement plans • Increased emphasis on employee-employer cost-sharing • No shift to defined contribution plans as the primary retirement benefit

8. Historical and projected aggregate public pension funding levels Standard & Poor’s, Public Fund Survey

9. Distribution of public pension actuarial funding levels and relative size Bubbles are roughly proportionate to size of plan liabilities

10. Median change in actuarial value of assets and liabilities, FY 02 to FY 10

11. Unprecedented changes in benefits Since 2009, 42 states have made changes to their pension benefits, required employee contributions, or both

12. Retirement eligibility has become more stringent • More normal (unreduced) retirement age requirements of 60, 65, and even 67 • Elimination of retirement eligibility at any age based on designated years of service • Increased movement from five years as the predominant vesting period • Iowa: from four years to seven, affecting non-vested participants • Florida: from six years to eight • Several states have moved from five-year vesting to ten years

13. Retirement benefits are being reduced • Since 2010, seven states have modified COLAs for existing retired members: CO, ME, MN, NJ, OK, SD, RI • Maine COLAs are suspended for 3 years, then will apply only to the first $20k of benefit (indexed for inflation) • New Jersey COLAs are suspended until plan attainment of designated funding level and approval of board • South Dakota COLA tied to plan funding level • Florida terminated new COLA accruals • COLAs: • applied to only a portion of the benefit • More COLAs delayed until attainment of designated retirement age • More COLAs tied to actuarial condition of plan or fund’s investment performance • Movement of final average salary period from three years to five and longer

14. Higher employee contributions • Many states have approved higher employee pension contributions for existing plan participants • In some states, this is held or perceived to be illegal • A Florida judge in March ruled against the legislature’s establishment of a three percent employee contribution to a plan that had been non-contributory • Ruling is under appeal • Some higher rates are phased in over several years • Missouri established contributions for new hires • Pennsylvania established a flexible employee rate, based on actuarial condition

15. Growing use of hybrid plans • Two main types of hybrid plan: • “Combination” DB-DC, and cash balance • DB-DC plans feature a traditional, more modest pension, combined with a defined contribution plan • Mandatory: GA, IN, MI, OR • Optional in OH, WA • Cash balance plans feature pooled assets with notional accounts that pay a guaranteed minimum interest rate, with possibility of sharing “excess” investment earnings • In use in Texas, for workers of all counties and many cities; Nebraska, for state and county workers, and California, for community colleges

16. More on hybrids • Cash balance plans are receiving serious legislative consideration in Kansas • Retirement benefit for Wisconsin public employees has two parts: base benefit and a benefit tied to investment performance • The portion tied to investment performance can go up and down, and has gone down the last three years • Oregon’s DB-DC plan pools the DC plan assets and invests them in a fund like the DB plan

17. Pension reform in Rhode Island • All plan participants effective 7/1/12 will be moved from the traditional pension plan to a new DB-DC hybrid • Reduced future rate of pension accrual • Higher normal retirement age • A portion of employee contribution is diverted to the DC plan • COLA is suspended until funding level = 80%

18. Pension reform in Utah • New hires since 7/1/11 may choose from a defined benefit or defined contribution plan • Employer contributes 10 percent of pay • For the DB plan, retirement multiplier = 1.5 percent • Total cost of the plan = 7.59 percent (10.45 percent for public safety) • Remaining 2.41 percent (1.55 percent for public safety) is deposited into employees’ defined contribution account • Employees pay any cost of the DB plan above 10 percent (12 percent for public safety) • Employers also contribute 5 percent to amortize UAL • “A defined benefit plan with a defined contribution”

19. Defined contribution plans • Conversions to defined contribution plans have been noticeably absent • Some states have considered switching, but none have • IN last year gave state employees the option to elect a DC plan as their primary retirement benefit • A primary impediment is that switching does not reduce costs, at least in the near-term, and possibly not in the longer-term • There may be an increased levels of awareness among policymakers of the shortcomings of defined contribution plans serving as an employee’s primary retirement benefit • “Combination” DB-DC hybrids feature a DC component

20. Pension Accounting Changes • Changes to public pension accounting standards will take effect in 2013 or 2014 • These changes will separate pension accounting from pension funding • This means the new pension expense measure will be disconnected from the actuarial measure used to fund the plan • The new, accounting pension expense will be more volatile than the actuarial funding cost most plans use • Most plans will have a lower funding level under the new standards • Many policymakers and media are likely to misunderstand or misinterpret these new numbers, creating additional challenges for public pensions

21. Taxpayer spending on pensions • Nationally, about three percent of all state and local government spending goes to pensions • Higher for cities, lower for states • Higher among non-Social Security entities • Needs to rise to around five percent to resolve unfunded liabilities • Needs to rise much higher in some states: Illinois, Rhode Island, New Jersey, and California, for example

22. Year-over-year change in real (inflation-adjusted) state and local tax revenues Rockefeller Institute of Government

23. Year-over-year change in real combinedstate and local tax revenues, by source Rockefeller Institute of Government

24. According to the Government Accountability Office, (GAO) the state and local government sector faces a long-term structural deficit that is projected to gradually worsen. The primary sources of this deficit are Medicaid (health care for the elderly) and health care costs for retired public employees. State and Local Operating Balance Measure, as a Percentage of Gross Domestic Product (GDP)

25. For public employees: Continuing furloughs and more layoffs and attrition Leaving positions unfilled Salary cuts or salary growth that is slow or non-existent Employees are paying a larger share of the cost of pensions and other benefits How are states and local governments dealing with tepid revenue growth combined with increased spending demands?

26. Cumulative changes in employmentState, Local and Private Local State Private Bureau of Labor Statistics

27. Annual change in public pensionactive and retired membership

28. Quarterly change in annualized wage and salary costs, State & Local and PrivateState and Local has been below two percent for eight consecutive quarters State & Local

29. Public pensions have been increasing their level of diversification Change in average asset allocationFY01 to FY10

30. Investment returns and assumptions • Significant attention is being given to investment return assumptions • Many public retirement systems have reduced their investment return assumption in the last 2-3 years • Low interest rates and a poor decade of equity returns are major factors • The investment return assumption is intended to reflect very long-term (20 to 50 years) expectations • This assumption contains two elements: inflation and the real rate of return

31. Distribution of public pension investment return assumptions

32. Median public pension investment returns for periods ended 12/31/11 Callan Associates

33. Forecast • Continuation of recent trends toward lower retirement benefits driven more by cost reduction than by replacement ratio or traditional retirement needs assessments • More hybrid plans, higher employee contributions • Continuing pressure to reduce return assumptions • Challenges to prevailing view of legal protections • Growing retirement benefit chasm between private and public sectors

34. The Wisconsin Retirement System National State Auditors Association June 14, 2012 Bob Conlin, Secretary Wisconsin Department of Employee Trust Funds

35. Statistics • Statewide (state, University, local government, school districts), except City and County of Milwaukee • Membership: 577,000 • 260,000 Active Employees • 177,000 Retirees • 140,000 “Inactives” • Assets: $79 Billion • Actuarial Funded Status: 99.8%

36. Keys to Success • Funding Discipline • Independent Contribution Rate-setting Process • Shared Risk • Reasonable Plan Design • Legislative Checks and Balances • Informed/Aware Stakeholders

37. Challenges • Funding Discipline • Shared Risk • Global Economy • Benefit Disparity • Education of Participants • GASB