State of the State Pension Systems

August 24, 2006

Agenda

• Introduction/Overview  Actuarial Methodology  Budget Implications • History • Current Status • Questions

The Nature of a Defined Benefit Plan

• Employer guarantees a specific monthly amount at retirement • Employer makes contributions • Employee required to make contributions • Employee does not make investment decisions • Employer and employee contributions grow over time • Oversight of Plan assets and liabilities

Risks?

• Benefits guaranteed • Benefits erode without protection from inflation • Benefits not portable • Asset growth not guaranteed  Requires steady contributions  Miracle of compound interest • If assets cannot match promised benefits, pension payments have to be covered out of operating income through the budget

Tracking Assets & Liabilities Key to:

• Control Risk • Proportion “Funded” • Budget Stability

Experience Determines “Key Drivers for Funding”

• Life Expectancy • Size of Workforce • Career Service • Salary Growth • Inflation

“Key Drivers for Funding”

• Gains and losses are recognized, or smoothed, over 5 years to limit volatility • Actuarial value of assets versus actuarial liabilities determines  funding status  need for employer contributions

Funding Requirements are Dynamic and Change over Time

• Normal Cost – present value of service earned for that year • Accrued liability – present value of all past service • If liabilities exceed assets, we have an accrued unfunded liability which is amortized over a number of years

2.5

2.0

1.5

1.0

0.5

Unfunded Liability is Growing

FY07 FY08 FY09 Normal Contribution Unfunded Accrued Liability FY10

What Is The Challenge?

• Growth in cost of pension and other employee benefit programs • Finding adequate funding to meet ever growing demand among competing interests

Asset/Liability Comparison All Systems Funded Ratio: 82.3%

110 100 90 80 70 60 50 40 1995 1997 1999 2001

Fiscal Year

Liability Assets 2003 2005

Asset/Liability Comparison PERS State Funded Ratio: 79.1%

6 3 0 15 12 9 1995 1997 1999

Fiscal Year

2001 2003 Liabilities Assets 2005

Asset/Liability Comparison TPAF Funded Ratio: 80.3%

50 45 40 35 30 25 20 15 10 5 0 1995 1997 1999 2001

Fiscal Year

2003 Liabilities Assets 2005

Asset/Liability Comparison PERS Local Funded Ratio: 89.9%

20 15 10 5 0 1995 1997 1999 2001

Fiscal Year

2003 Liabilities Assets 2005

Asset/Liability Comparison PFRS Funded Ratio: 80.1%

30 25 20 15 10 5 0 1995 1997 1999

Fiscal Year

2001 2003 Liabilities Assets 2005

Asset/Liability Comparison SPRS Funded Ratio: 92.6%

10 5 0 25 20 15 1995 1997 1999

Fiscal Year

2001 2003 Liabilities Assets 2005

Are We Alone?

SPRS PFRS

Public Fund Survey May 2006

The “’97 Gimmicks”

• Issuance of Pension Obligation Bonds-$2.8 billion • Authorized temporary change in actuarial method (Mark to Market) • Authorized use of surplus assets to offset employer contributions-State and local employers get pension holiday • Reduced employee contributions for PERS and TPAF • Backloaded Debt Service

Debt Service On Pension Bonds

More of “How Did We Get Here?”

• Surpluses grow  positive returns of late 90s  bond proceeds  Mark to Market • Investment returns go south beginning in FY2001 • Benefits enhanced for PERS & TPAF (FY 2002), & PFRS (FY 2000) adding over $5 billion in liabilities to the systems  end  Another Mark to Market (retroactive to 1999) • Limited or no employer contributions for seven years • By FY 2004 pension contribution holiday comes to an Budget problems make contributions difficult  All benefit costs affect budget - Pension and Health • Phase-in adopted in FY 2004

New Jersey’s Liabilities are Growing Faster than our Assets

• Limited/No Employer Contributions • Benefit Enhancements • Benefit Payouts: $5B/yr. and growing • Investment Returns meeting benchmark targets • Retirees living/collecting benefits longer • Actives with higher salaries & more service credit

What Needs To Be Done?

• Make/Increase the employer pension contribution • Work to improve investment performance • Better match growth in assets and liabilities

0.6

0.4

0.2

0.0

1.4

1.2

1.0

0.8

Current Budget Recommends Pension Contribution of $1.1B

1.1B

860.8M

1997 - 2006 2007

Fiscal Year

Q & A

Benefits Review Task Force Recommendations

What is the Purpose of a Retirement Benefit

• To attract and retain a qualified and capable workforce • To deliver a form of compensation on a deferred basis reducing immediate cost of employment • To ensure an adequate “replacement” income to career employees

Areas of Concern

• Those recommendations that have a financial impact on the benefit systems • Those recommendations that address the integrity of the systems

System Integrity

• Make full, actuarially sound pension payments • Over $8 billion dollars in actuarially required contributions have been avoided • Practice good fiscal stewardship and do not use unsound techniques • Do not alter actuarial assumptions to meet budgetary constraints or to finance other initiatives

System Integrity

• Any proposed legislation must include the following elements for PHBRC consideration: • A fiscal note in the body of the bill • Description of revenue sources to cover costs • Certification that costs and revenue projections are based on generally accepted actuarial principles

System Integrity

• End boosting, padding and tacking • No pension for contractors/vendors • No DB Participation for elected or appointed officials • No tacking of several jobs • Restrict end of career salary hikes • End sick day manipulation

Division of Pensions Recommendations

• All employees and retirees should be required to contribute towards the cost of health insurance coverage • Cost have risen by 150% over the past five years and will double by 2010 • Majority of taxpaying public is required to make contributions towards their health care • At 5%, State and Local Savings exceed $348M • At 10%, savings exceed $489M

End Traditional Plan and Offer a PPO

• Indemnity plans not typically offered anymore • PPOs far more prevalent that plans such as NJ PLUS and meet the diverse needs of broadly dispersed population (e.g. retirees) • Annual savings if Traditional and NJ PLUS are replaced with a PPO • State • Local $40M $64M

Reduce Rx Costs

• Contract directly with a PBM • Currently through health plans • Estimated savings of $27M - $45M • Encourage generic drug utilization • Require mandatory mail-order • At State and Local level, more than 55% of drug spend is for maintenance drugs; less than15% is mail order • Generic & Mail-Order will save an estimated $35M

SHBP Program

• Apply State negotiated changes in health benefits to local employers; return SHBP to UNIFORMITY • Local Savings/Medical $25M • State PRM Savings $ 5M • Local Savings/Rx $13M

Short-Term Gains

• End Pension Loans or Charge Market Rate Interest • Current outstanding balance exceeds $1.1B

• At 4% interest and with State assuming an 8.25% rate of return, lost earnings potential exceeds $45M per year • For “pension purchase”, determine a way to factor in the cost of health insurance • Current purchase cost address pension benefits only

Short-Term Gains

• End Dual Health Coverage within SHBP • Cannot implement State limits without imposing on a system wide basis • Potential Savings • Coordination of Benefits $15M • Administrative Expenses $ 3M • Declare a moratorium on ERIs • Declare a Moratorium on Benefit Plan Changes

Longer-Term Solutions

• Adhere to “n/55” Retirement Calculation • Not an unusual or overly generous formula; see NASRA data • Anti “two tier” philosophy • Think the Committee need to look at all options; actuary will present additional information next week • Provide for Part-Timers • Again, encourage this Committee to consider the originally stated intent of a retirement plan

Longer-Term Solutions

• Whether under the current system or a new design, early retirement age must be moved from 55 to 60 • Estimated savings are very long term since it would only affect: • employees not yet on the payroll • or those with less than 5 years service

Longer-Term Solutions

• No pension credits for jobs paying less than $5,000 • Recommend that hours worked would be a better indicator of need for retirement income • Use of a recognized benchmark, such as 1000 hours, or limits based on “full-time” status may be more appropriate • Those who do not meet the threshold could be covered under an alternative design such as a deferred compensation plan

Other Recommendations

• Standardize Life Insurance Fees and Benefits • Basic benefit – Employer Paid • PERS = 1.5x Base Salary • TPAF = 2.0x Base Salary • PFRS = 3.5x Salary • Entire group life system needs overhaul • Break linkage to pensions • Standardize employer paid benefit • Allow for employees to buy varying levels of optional coverage

Other Recommendations

• Amend dual pension and salary • Too many cases of retirement and reemployment • Inconsistencies in application (statute) across systems • Complicated to administer and manage • Difficult for participants to understand

Other Recommendations

• Revise Pension “pop Up” Increases • Upon death of a beneficiary, participants can revert to their full unreduced benefit • Limit the “pop up” to a period of up to 5 years from retirement • COLA • Eliminate COLA for those who vested in State system but who are not actively working at the time of retirement

Other Recommendations

• Change disability pensions to a disability insurance system • No middle ground today between retirement and disability • Guarantees salary replacement while disabled but allows time to determine if an employee can be returned to employment • Estimated Annual Savings • State $28.2M

• Local $53.5M

Division of Pensions View

• Pension laws and regulations are too complex; costly to administer and difficult for the members to understand • Major overhaul should be a goal to: • Reduce administrative expenses • Eliminate disparities between systems • Help participants better understand and appreciate their benefits