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The New Future of Public Retirement Systems. CSMFO February 2009 Girard Miller Senior Strategist PFM Group. Topics. Impact of Market Meltdown of 2008 GASB 45 implementation progress Deferred compensation issues Retirement benefits: sustainability Benefits Bonds: POBs and OPEB-OBs.
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The New Future of Public Retirement Systems CSMFO February 2009 Girard Miller Senior Strategist PFM Group
Topics • Impact of Market Meltdown of 2008 • GASB 45 implementation progress • Deferred compensation issues • Retirement benefits: sustainability • Benefits Bonds: POBs and OPEB-OBs
Impact of 2008 Market Meltdown • After 5 decades of actuarial funding, public pension plans were reasonably well funded, on average • But some plans are grossly, chronically underfunded • Recent market meltdown changed all that • Unfunded liabilities will skyrocket and ARC will increase • Unfortunately, the 2008 Market Meltdown changed all that • Funding ratios typically declined 20-25 percent • Resulting increase in employer costs: 2 to 4 percent of salaries • The Public-Pension Straddle Option: • Heads employees win (when markets go up) and • Tails taxpayers lose (when markets go down) • Impact on OPEB plans much less significant since most were unfunded or just starting up
Legacy of the Public-Pension Straddle Option:Skyrocketing employer pension costs By 2012, employer costs may double from 2002 levels Chart source: NASRA public funds survey 2007 Employer costs have increased 40% and employee costs remained constant Heads employees win, tails taxpayers lose 4
What hasn’t worked • Abuses in pension systems draw public ire • Spiking • Retroactive pension increases • Especially behind closed doors • Unrealistic discount rates: investment assumptions • Ad hoc COLAs • Further accounting reforms seem likely • Amortization of unfunded liabilities Often fails the “intergenerational equity” test Need to better align with services provided Otherwise, it’s an ‘un-voted tax’ on future generations
GASB accounting issues • Market Value? • Issue now before the actuarial boards • GASB will evaluate • Better and more disclosure of discount rate? • Issue: comparability
GASB accounting issues • Market Value? • Issue now before the actuarial boards • GASB will evaluate • Better and more disclosure? • Issue: comparability • Amortization policies • Is 30 years with open amortization a proper limit? • Are retroactive benefits better expensed immediately? • COLAs: substance over form What to do about ad hoc COLAs?
Girard’s suggestions to GASB • Prohibit amortization periods longer than remaining average service lives of employees and remaining lives of retirees • Otherwise future taxpayers will be burdened with costs of deceased workers who provided services to their grandparents • Require immediate expensing of retro pension and benefit increases • Calculate and disclose liabilities using national average investment assumption if plan uses a higher number
Deferred Compensation Plans • Market meltdown impact on individuals • Horror, terror and fear • Deferred retirement dates for those with major dependence on 457 & 401 plans • Fiduciary challenges for plan sponsors • Review investment menus • Review fee structures • Resist higher-fee products from vendors seeking new revenues to replace asset-based fees • Opportunities to re-bid plans • Hyper-competition has returned
Retirement investingThe long-term view • This is clearly not a garden-variety recession • Significant risk of double-dip or longer malaise • Until housing and mortgage markets stabilize, federal stimulus is probably insufficient • Ultimately, long-term equity investments from the lows in this terrible period will appear attractive • But an entire generation will have lost confidence • Good news: historical returns have returned to long-term growth rate of 9.6%, so we have now “reverted to the mean”
Long-Wave Economics These graphs depict wholesale price trends, not GDP We are here Long-wave cycles = 55 years on average Chart: http://www.kwaves.com/kond_overview.htm 11
Long-term investment outlook • See Girard Miller’s historical research on Governing.com • http://www.governing.com/articles/0807gmmw.htm • Equities outlook over 20 year and longer periods: historically favorable from these levels • Suggests an equity-tilt strategy • Will eventually open a ‘Benefits Bonds window’
The Business Cycle and the Benefit Bonds Window Benefits Bond Window 13
The New Benefits Bonds Paradigm: POBs and OPEB-OBs • Issue only during recessionary window, not any time • Invest only in equities initially • Why sell bonds to buy bonds? • Eventually migrate to balanced asset allocation • Requires a separate POB trust • OPEB plans can set up new integrated OPEB trust • But not if a pooled investment is used • Enables surplus equity returns to pay off debt • Properly rewards taxpayers for the added risk they absorb • Prevents future earnings from funding another benefits increase that inevitably causes yet another deficit See Girard’s New Benefits Bonds Paradigm at http://www.governing.com/articles/0901gmillerc.htm
OPEB: (retiree medical)The “Other” retirement plan • Huge contrast with pension systems • Vast differences in approaches, history, and future outlook • GASB 45 and its aftermath • Where the public sector stands today • Phase I, II and III governments • Actuarial analysis vs. action planning and funding
Pensions: 60-65% funded Primary retirement benefit Defined benefit model fits the liabilities well Inflation caps for most plans Mature plans with large assets Governance well established; statutes well codified Homogeneous or comparable benefits structures OPEB: Almost completely unfunded ($1.5 trillion) Secondary retirement benefit An “undefined benefit” Medical cost inflation risks Startup plans w/ zero assets Governance TBD Very diverse plan structures Pools don’t necessarily work: variation in asset-liability profiles Comparisons: Pensions vs OPEB
Current Landscape for OPEB • Phase I & II work is done: larger plans know their liabilities • Few are actually funding their ARC • “No Money”: Recession is the perfect storm • When will rating agencies eventually take notice? • Few are doing strategic planning • Few are doing sustainability analysis • OPEB bonds window in 2009, maybe into 2010
Needed: OPEB Strategic Maps • Sustainability analysis • Comprehensive OPEB strategic plan • Includes both strategies and implementation path • Funding strategy & plan • Benefits design strategy • This is where the evolution will take place • Thoughtful leaders must also address sufficiency • Governance & trust structure • Investment infrastructure: DB & DC hybrids?
Outlook in OPEB benefits plan design • Sustainability is key issue at plan sponsor and taxpayer level • Look for tiered benefits plans to emerge • Employee contributions or increases • Higher retiree/employee cost shares on co-pays, deductibles, % of premium, etc. • Dependent coverage • Eligible retirement age • Vesting schedules and “early retirement” reforms • Eventually will see more defined contribution plan features here • Key issue here is sufficiency
Summary • Pension plans will require higher contributions • Expect to pay an additional 2 to 4% of payroll • Pay attention to GASB accounting study • Deferred compensation plans: Revisit and review • ‘Benefits Bonds Window’ expected later this year • Learn the 5 key principles of the New Benefits Bonds Paradigm • To achieve retirement finance sustainability, OPEB will be trimmed before pensions
Summary: OPEB • OPEB will likely evolve more dramatically • Key questions will be sustainability and sufficiency • Current benefits may be unsustainable • Sustainability audit is worth considering • Plan re-design and cost mitigation are foreseeable in the OPEB sector • OPEB bonds expected to be feasible in 2H09 • 65% of AAL liability is the ‘new paradigm’ limit See Girard’s New Benefits Bonds Paradigm at http://www.governing.com/articles/0901gmillerc.htm
Girard Miller’s contact infoand Governing.com columns link • Phone 310.795.1354 • Email: • girardinmalibu@charter.net • or: millerg@pfm.com • Governing.com: Column index link: • http://www.governing.com/articles/gmiller.htm
QUESTIONS? • Markets? • Defined benefit pension plans? • Deferred compensation plans? • OPEB? • GASB and Accounting? • Benefits Bonds: POBs and OPEB-OBs?