Transcript Pennsylvania Public Pension and Retiree Medical Plans: A

City of Springfield
Police Officers and Fire Fighters’
Retirement Fund and Employee Benefit
Review
Analysis and Recommendations
May 20, 2009
Rick Dreyfuss
[email protected]
Purpose of My Comments

To provide independent commentary on recurring
trends and themes applicable to the public pension
systems.

To leverage my background and experience as an HR
executive and actuary.

To provide specific analysis and recommendations on
The Police Officers and Fire Fighters’ Pension Plan.

This is not an audit or a legal review.
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Managing Pension Liabilities
The Wall Street Journal
The Public Pension Crisis
August 18, 2006; Page A14
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“…. the fundamental problem is that
public pensions are inherently political
institutions.”
“… the current public pension system
simply isn't sustainable in the long run.”
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What is the Real Problem to
be Solved?

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The charge to the ad-hoc committee is effectively to solve a financial
crisis.
My contention is you are dealing with an institutional political problem
manifesting itself as a financial problem. To focus principally on new
and creative funding strategies will not result in sustainable reform.
To truly reform this financial problem you must reform the institutional
system. This will prove difficult.
You have a problem of a high level of over-promised benefits where
funding has been politically manipulated – all this is compounded by
poor investment results. However, this crisis is being represented as
fundamentally a taxpayer funding problem.
My analysis will identify a prerequisite set of true reform principles in
contrast to those proposals which seek to maintain the institution with
some incremental funding.
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Operating Principles


Ensuring public safety is a core function of government.
Public sector costs specifically compensation and
employee benefits liabilities must begin and end with the
taxpayers’ ability to pay.

The prospect of increasing taxes competes directly with
private sector growth.

Deferred liabilities such as pensions and retiree medical
plans are taxes to be paid by future taxpayers.

Pension funding is generally poorly understood. You
cannot solve a problem which you do not properly
understand.
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What are the Real Issues that
should be addressed?

What lessons should we learn from the past?

What is an affordable level of costs for these benefit programs
in the short and long-term?

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How can we best meet the ongoing safety needs of the
community consistent with the taxpayers ability to pay?
 Properly understanding this relationship is important.
Why are provisions and cost benchmarks which are unaffordable
and obsolete in the Missouri private sector considered
commonplace in the Missouri public sector?
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The Institutional Problems of Defined Benefit Public
Pension Plans emanate from Three Basic Sources:
Problem #1: Benchmarking

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The overwhelming majority of public pay and benefit
programs are benchmarked only against other public
plans rather than the entire marketplace.
 Ignores the entire labor market
 This fosters “financial relativity”
 Comparison is often to other unaffordable plans
One-dimensional benchmarking yields one
dimensional results.
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Problem #2: Relative Metrics and
the Risk to Taxpayers

No absolute metrics defining the affordability or
reasonableness of costs given the “perpetual life of
the government entity”.
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Creates unreasonable risks to taxpayers.

Actuarial assumptions do not create certainty.
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Problem #3: The Politics of Public Pensions
Public Pensions are a major source of significant political capital

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Pension surplus is considered the source of benefit
improvements and deficits represent under-funding by
taxpayers. This paradigm will not change.
A complete system breakdown involving

the plan design – the participants

the actuarial funding policies – politically manipulated

the affordability of the cost by the taxpayer – the reconciling item
Public Pension Plans are also an esoteric afterthought

Not well understood – not transparent

Benefit commitments can be over 50 years

Funding is easily manipulated – proper funding should
occur as benefits are earned over the “working career of
the employee”. Easy to (re)defer costs to the next
generation.
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State-wide pension deficits will be problems at the local level.
Consider the problems of MOSERS, PSRS and PEERS.
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ACTUARIAL PRIMER - Springfield, MO - Police and Fire
Based on JUNE 30, 2007 / JUNE 30, 2008 Actuarial Valuations
Present Value of All Benefits Payable
(Current and Future)
to All Participants
$338.5 Million / $355.9 Million
Inactives - $187.8M* / $197.5 M
Actives - $150.7 B* / $158.4M
Actuarial Accrued Liability
(Present Value of Benefits Earned
Prior to 6/30/07 // 6/30/08 )
$277.9 M / $295.6 M
Present
Value of
Future
Normal
Costs
$60.6 M /
$60.3 M.
Unfunded Actuarial
Accrued Liability
$139.0 M /$154.8 M
Actuarial Value of Assets
$138.9 M / $140.8 M
Market Value as of 11/30/08
=$ 98 M
Annual Interest @7.5% =
$11.6 M
Actuarial Value of Assets
Unfunded
Actuarial
Accrued
Liability
Annual Payment (“Normal Cost”) +
Annual Amortization Payments +
=Total Employer Pension Rate
Member Portion
Taxpayer Portion
Present
Value of
Future
Normal
Costs
$60.6 M /
$60.3 M.
Present
Value of
Future
Normal
Costs
Asset Related Annual
Changes:
Investment Income +
Employee Contributions +
Employer Contributions Benefit Payments Administrative Fees
Author’s estimate is indicated
by “*”
Liability Related Annual
Changes:
Benefit Improvements
Demographics (Actives and
Retirees):
- Adds (New Employees,
Transfers)
- Outs (Resignations,
Retirements, Deaths)
- Salary Changes
- Employee Contributions
Changes in Actuarial
Assumptions:
- Mortality Rates
- Investment Assumptions
- Retirement Ages
- Salary Increases
- Definition of Value of Assets
Current Contribution
% Payroll In Dollars
28.75%
$ 7.1 M
34.77%
$ 8.6 M
63.52%
$15.7 M
11.16%
52.36%
$ 2.8 M
$12.9 M
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A Political Problem:
Nine Pension Half-Truths
Contention
1)
The fiscal problems typified by The
Police Officers and Firefighters
pension plan is principally a matter
of under-funding by taxpayers.
Since the problem is defined as one
of funding the answer must be one
of funding.
2)
Forgoing pension contributions
saves money.
3)
Pension costs are favorable and are
lower than national averages of
public plans. Employee contributions
lower costs to affordable levels.
Fact
This is a convergence of a high level of overpromised benefits and funding manipulation
compounded by poor investment returns.
 Often advocates of prior legislation which
increased benefits resulting in significant
deferred costs are conveniently critical of their
funding policies. This affirms the politics of
public pensions.

Deferred costs are not savings
 Pension plans operate in a pay-me-now
versus pay-me-later environment
 Time value of money is deemed to be 7.5%

Employer pension costs should be in the
range of 5% to 7% of payroll.
 For non-Social Security participants the
range is 10% to 12% of payroll.

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A Political Problem:
Nine Pension Half-Truths
4)
72% of pension assets result from
investment earnings.
5)
DC plans are more/less costly than
defined benefit (DB) plans.
6)
DC plans have excessive
administrative fees and individuals
are incapable of investing wisely.
7)
DC plans produce inferior
pensions.
Defined contribution (DC) plans can
present a similar profile. Proper
response should be “I hope so”.

Totally depends on the design and the
DB funding method. The politics of
public pensions are the
unaffordable component.

Not any more, some costs are charged
to participants
 Significant advances in technology and
broader array of low cost funds

2005 EBRI study suggests meaningful
(85% to 103%) replacement ratios at
retirement
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A Political Problem:
Nine Pension Half-Truths
8)
80% is an acceptable funded ratio
and reflects plan which is
“financially healthy”.
Targeting a 20% unfunded liability
presents significant risks and defers
significant costs to taxpayers.
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“Financial health” is a relative term without a
uniform definition. This subjective standard is
used by some to justify ongoing pension
deficits.

The 2006 Pension Reform Act (applicable to
private-sector plans) requires plans to achieve
a 100% funded ratio* over an 8 year period.

*(Based upon uniform federal guidelines)
9)
The term “actuarially sound”
means proper actuarial funding

This simply means that the cash inflows will
equal the cash outflows over a period of time.
 It is a quantitative term not a qualitative
term.
Key funding principles
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Benefit plans should be funded over the working
careers of the workforce.
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Benefit plans must be designed upon the
taxpayer’s ability to pay.
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You have comprised or ignored these key
principles.
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Without guiding principles you default to political
principles – that is those designed to achieve a
political rate of return masked in half-truths.
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Liability Management:
The goal should be Current, Affordable
and Predictable pension contributions
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The anchor is what benefits are to be payable at normal retirement.
Key is to properly define normal retirement – age 62 is suggested.
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Current is funding the accrued liability at 100% over the working
career of the workforce. (Average age actives: Police is 37 and Fire 40)
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Affordable is 5% to 7% of payroll (w/o SS participation 10% to 12%)
after any required member contributions.
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Pension funding should be increased to responsibly amortize the
unfunded liability – however this is likely to prove unaffordable so you
should also consider reducing unearned liabilities and prevent new
open-ended liabilities from being created.
What assurances are there that any incremental funding will not be
ultimately “diverted” before achieving 100% funding? Is the system
beyond fiscal discipline?
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If you view this reform effort as simply a funding challenge - this ad-hoc
group will become the precursor for a “2013 taskforce”.
Why not reform the institution for the benefit of the next generation?
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Begin with a plan where costs are predictable, affordable and current.
First place new hires into a defined contribution plan with a cost of
10% to 12% of payroll.
Redefine normal retirement age. Age 62 is suggested. Determine
what it would take to get your plan 100% funded over the working
career of the workforce. Private sector plans must adhere to reducing
unfunded liabilities over 8 years using a federal standard.
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Assess taxpayers ability to pay in the short and long term.
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Reduce unearned benefits for Tier 1 and Tier 2 participants (not
limited to pensions) to achieve this norm.
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Enact strict funding requirements to prevent funding from being
diverted for a political rate of return.
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Increase funding and stick to it. How?? Do not create outside debt
such as pension obligation bonds.
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Tier 1 and Tier 2 Benefits
Suggested Design Changes
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New employees should be enrolled in a DC plan to achieve these goals.
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Accrued benefits (earned to date) should be preserved. Consider
freezing the plan and adopting a DC plan for future benefits.

Unearned benefit accruals will need to be modified if you are to avoid
generational transfers while establishing costs which are current,
predictable and affordable.
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Normal Retirement should be redefined as age 62, early retirement
should be actuarially reduced using the valuation basis of 7.5%.
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Pension COLAs should be curtailed.
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Multiplier 2.8 should be reduced to approximately 2%.
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Increase member contributions up to 50% of the cost of the plan.
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There are various permutations and combinations on the above but
lasting reform needs to be anchored based upon definitive and
affordable cost principles.
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Factor in the cost of active and retiree health care plans with same
cost considerations. Reform GASB 45 funding as well.
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Be in control of your pension costs. Taxpayers
need to take charge of the future
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Clearly the current system is not working. Dramatic changes in
design are needed prior to any funding considerations.
Consider establishing a new pension board composed
predominately of independent individuals who are not current or
former plan members, who do not sell “financial services
products”, who are qualified, committed and capable of
discharging their responsibility as fiduciaries.
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Consider the HR impact

Ability to attract and retain qualified talent to ensure
public safety. Do this in real-time.
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Any required adjustments are made in base pay.
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“Burn-out” considerations – utilize workforce
management strategies.
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Carve-out disability benefits (duty and non-duty
related: duration and severity) up to 50% of base
pay to age 62. Consider a separate oversight body.
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Actuarial Suggestions
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Value the liabilities using the assumption the members will retire
on the earliest date eligible for normal retirement benefits.
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Break out liabilities, assets and contributions between Tier one
and Tier two members.
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Review/affirm 7.5% pay assumption in early career.
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Consider adding corridors of 90% to 110% of market values to
existing definitions of the actuarial value of assets.
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Annually develop a 10+ year forecast of liabilities and assets to
project funded ratios.
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Retirement assumptions used
in determining Pension Costs
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“Temporary” Taxes in Pennsylvania
Consider: The 1936 Johnstown Flood
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In March 1936, three days of rain and runoff from melting snow led to
the second of three great floods that hit Johnstown.
The recovery plan involved a 10 percent temporary tax that was placed
on the sale of all alcohol in the Commonwealth of Pennsylvania. It was
only supposed to last a few years.
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The property damage total from the 1936 Johnstown flood was $41M.
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The flood tax had generated that much revenue by the end of 1942.
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Over 70 years later, that tax is still in place and now stands at 18
percent.
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When you add the 6 percent sales tax, the 18 percent Johnstown flood
tax, then the 30 percent PA Liquor Control Board markup, the cost of a
bottle of wine has now climbed by at least 54 percent.
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Defined Contribution Challenges (and proven
strategies to overcome them)
Issue
Strategy
1)
Employee non-participation
Default enrollment
2)
Low Employee Contribution Rates Default 6% employee rate (earns 6%
employer match). 12% total is an
important threshold.
3)
Improper Investment
Diversification
Life-cycle funds (default option).
Based upon member’s retirement
horizon – funds’ investment mix
automatically adjusts over time
4)
Inability to manage retirement
payouts
Managed payout funds - designed to
provide regular monthly payments
without exhausting capital
5)
Excessive start-up costs and ongoing fees
Competitive marketplace result in
manageable costs to affordable levels
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How do you compare DB and DC costs?

DC employer costs are 10%-12% of payroll. DB employer “costs” are
estimated deposits – not true costs. Comparability is at best debatable.

What assurances exist that the existing DB plan designs will not be
improved in the future?

How certain can one be in the future projections of the plan? This
creates doubt against the true DB baseline measure.

The more important savings relate to the benefits of having
current, predictable & affordable costs plus taking the politics
out of public pensions – these are the non-quantifiable savings.
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Trends in the Marketplace
Mercer 2008 - National Survey of Employer-Sponsored Health Plans
Approximately 3000 employers
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