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Reforming an Unsustainable System and Managing “Generational Theft”
Business Consultant and Actuary Senior Fellow - The Commonwealth Foundation Pennsylvania Business Council Education Foundation Pennsylvania Competitiveness Council Public Policy Seminar May 3, 2011 – Camp Hill, PA
Richard C. Dreyfuss
Managing Pension Liabilities
The Public Pension Crisis
August 18, 2006; Page A14
“… the fundamental problem is that public pensions are inherently political institutions.” “… the current public pension system simply isn't sustainable in the long run.”
Three Factors Drive the Political Institution of Public Pensions
1. Poor Benchmarking 2. Poor Risk Management Practices 3. Politics
#1 Poor Benchmarking
Pennsylvania public pay and benefits are typically benchmarked only within the public sector rather than the entire PA marketplace Market trends in the private sector are directly relevant to the public sector 2010 Hewitt Survey: only 11 of 33 major PA employers sponsor defined benefit plans
All sponsor 401(k) plans with an average employer match of 72 cents per dollar and an average matched employee contribution of 5.4 percent of pay.
Towers Watson Survey Average DC Employer Cost - 5.77%
Fortune 100 Companies - Trends in Retirement Plans
80% 70% 60% 50% Traditional DB Plans 40% 30% 20% 10% 0% 1998 67 7 26 1999 61 13 26 2000 60 14 26 2001 55 18 27 2002 48 24 28 2003 42 30 28 2004 40 30 30 2005 39 29 32 2006 36 25 39 2007 30 23 47 2008 22 26 52 2009 20 25 55 2010 17 26 58 Hybrid DB Plans DC Plans
Traditional DB Plans
Hybrid DB Plans DC Plans
Poor Risk Management Practices
Few absolute metrics defining the affordability or reasonableness of pension costs given the “perpetual life of the government entity”. Entire defined-benefit (DB) funding system is based upon annual investment assumption in the 8% range. Little consistency in funding assumptions and funding methods making comparisons most difficult.
The Federal Pension Protection Act (PPA) of 2006 requires private sector DB plans funding based upon:
Lower interest rate assumptions (an index: currently ~ 6%) Shorter amortization periods (generally 7 years)
2011 Wilshire Report on State Retirement Systems
“Funding Levels and Asset Allocations”
None of the state retirement systems studied by Wilshire Associates will be able to meet its actuarial assumed rates of return over the next 10 years. (Includes PSERS and SERS)
Among 126 systems studied, the median plan will return an estimated annualized 6.5% on assets over the next 10 years, 1.5 percentage points short of the median actuarial long-term assumed rate of 8%.
Milliman's annual pensions study shows the average equity allocation has fallen more than 15% over the past three years.
“Pension Magic” in Florida
(and elsewhere) Orlando Sentinel – July 7, 2010
"Warren Buffett would close down his shop and give his money to the city of Orlando" if it could get 8 percent, says Edward Siedle, a former federal securities lawyer and president of Benchmark Financial Services in South Florida.
Cities like Orlando have three choices, Siedle says.
1)"They can cut benefits, which is politically unacceptable” 2)"They can increase contributions from the employer and employees, which is politically unacceptable.” 3)“The third choice is called magic. That's what public pension funds across the country are doing, coming up with magic.”
Pensions as political capital
Pension Fund Surplus = Benefit Improvements for Participants Pension Fund Deficits = Underfunding by Taxpayers Maintaining or Improving Benefits = High Political Rate of Return Reforming and Properly Funding Plans = Low Political Rate of Return
PA Public Pension Recap
“In any collaboration between two groups who hold different basic principles, it is the more irrational one who wins.” What good is an unprincipled bipartisan reform?
This helps explain the irrational pension legislation of
Act 9 (2001) – 25%/50% increase in pensions Act 38 (2002) – Retiree pension COLA Act 40 (2003) – Deferring unaffordable costs to 2012 and beyond Act 44 (2009) – City of Philadelphia & Municipal Pension Non-reform Act 120 (2010) – PSERS & SERS Non-reform (Generational Theft Bill)
Negative Implications of Act 120
Unacceptable Risks, Generational Theft, Non-Reform
During the next 30 years all this will be made worse if we: 1. Fail to earn the 8% annual assumed rate-of-return on the assets. 2. Revise the investment assumptions to reflect lower expectations. (March 2011 action by PSERS reduced rate to 7.5% - this will immediately increase the unfunded liabilities by $3.5B. Act 120 “savings” for PSERS over the next 30 years was estimated at $1.4B) 3. Once again defer scheduled contributions to “save” money 4. Once again “fresh start” or re-amortize the unfunded liability 5. Grant retirees an ad-hoc COLA, implement an early retirement incentive or otherwise enhance current or future pension benefits
HB 2497 Projection of PSERS Taxpayer Contribution as Percentage of Payroll
(in FYE 2011, 1% pay =~$135M)
20.00% Prior Law 15.00% Act 120
0.00% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2041 2042 2043 2044
50% 2011 2012
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
HB2497 Current Law
PSERS Projection of Funded Ratio
2032 2033 2034 2035 2036 2037 2038 2039 2040 2041 2042 2043 2044
PSERS Projection of Funded Ratios
True Pension Reform Must Satisfy Three Basic Principles – Using Realistic Funding Assumptions
1. Funding must be current.
Benefits should be funded as they are earned and “paid-up” in the aggregate at retirement Achieving a 100% funded ratio Significant private sector pension funding reforms occurred in 2006.
2. Costs must be predictable. 3. Costs must be affordable.
4-7% of payroll (net of employee contributions)
Five Step Statewide Pension Reform Plan
1. Establish a Unified Defined Contribution plan for new state and local government workers, school employees, judges, and legislators – Curtails open-ended liabilities; Eliminates long-term commitments on behalf of taxpayers – Removes politics from pensions 2. Prohibit pension obligation bonds or other post-employment benefit (OPEB) bonds – Prevents “generational theft” – deferment of liabilities 3. Mandate pension and OPEB liability management reforms for current and any newly created liabilities. – Achieve an annual employer cost of 4% to 7% of payroll with standardized actuarial assumptions, shorter amortization periods, all generally similar to PPA of 2006. Prohibit “fresh-starting”. – Prohibit benefit improvements if this would result in a funded ratio below 90%.
Five Step Pension Reform Plan
4. Consider modifying unearned pension benefits (if legal and feasible) – Reduced formula; Redefinition of eligible earnings; Increasing the normal retirement age; Curtailing early retirement subsidies; Eliminating COLAs and Deferred Retirement Option Programs (DROPs) 5. Consider funding reforms only after prior steps are achieved – Challenge is to do this without increasing taxes or through new borrowing
Omitting steps 1,2,3,4 ≠ pension reform
What good is budgeting 100% of an actuarially deficient rate?
Many in the state budget process are emphasizing the intent to fund “the full actuarial contribution” for 2011-12 for PSERS and SERS. Quoting from the actuarial note accompanying Act 120:
“However, it should be noted that the employer contribution collars (in effect through 2015) represent a departure from the norms of actuarial funding practice. The effect of the bill as amended would be to suppress the employer contributions to both PSERS and SERS resulting in significant underfunding of both retirement systems.”
The PSERS FY 2011-12 budgeted rate is 8.00% + .65% (retiree healthcare) = 8.65% of payroll or $1.2B. This plan has an unfunded liability of $20B ($31B using the market value of assets). Annual benefit additions are being earned at a rate of 8.12% payroll. SERS has an unfunded liability of $5.6B ($11.1B using market value). In addition, a separate unfunded liability for state employees retiree medical is estimated to be approximately $15B. 18
State officials are pondering where to direct a possible budget “surplus” of $78M?
The concept of a budget “surplus” given the underfunding of our long-term pension and retiree medical plans unsustainable liabilities is counterintuitive at best. Sound public policy requires that we consider the long-run effects and all people, not simply short-run effects and a few people.
These unfunded liabilities impacts Pennsylvania’s future competiveness
A recent Deloitte Growth Enterprise Services survey of 527 executives at mid-market companies (annual revenues of between $50 million and $1 billion) found “tempered optimism” that the economic recovery will continue. However, the survey also found significant concern over government fiscal and regulatory policies. 50 percent cited federal, state, and local debt as the greatest obstacle to U.S. growth in the coming year. Lack of consumer confidence (39 percent) Rising health care costs (33 percent). High tax rates (30 percent).
Final thoughts for Pension Reform
1. Deferring unsustainable pension liabilities does not make future liabilities sustainable. Why is contributing less into already underfunded plans considered “reform”? We have over-leveraged our pension system. The challenge is to finally restore proper funding while offsetting these increased costs elsewhere within the state and local budgets without increasing overall spending (or borrowing). PA Municipal Pension Plans are a variation of this theme. Retiree medical obligations are a parallel problem. Given all this, what are the financial incentives to live, work, or invest in Pennsylvania? This debate is effectively one involving self-reliance while removing politics from pensions, protecting the taxpayer and stopping generational theft.
3. 4. 5. 6.
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