Transcript Funding Public Pensions Tax Economist Forum, January 13, 2010 by Jon Forman Professor in Residence IRS Office of Chief Counsel & Alfred P.

Funding Public Pensions
Tax Economist Forum, January 13, 2010
by Jon Forman
Professor in Residence
IRS Office of Chief Counsel
&
Alfred P. Murrah Professor of Law
University of Oklahoma
Norman, Oklahoma
Overview
 Operation and funding of public plans
 Financial, accounting, and legal issues
 How to ensure adequate funding now
and in the future
2
Overview of Public Plans
 State and local governments typically
provide their employees with
 a traditional defined benefit pension plan
 A supplemental defined contribution plan
 Employer and employee contributions
3
Funding Public Plans
 Plan actuary
 Makes assumptions
 Estimates the plan’s future liabilities to
its retirees
 Discounts those liabilities to present
value
 And compares that liability value to the
actuarial value of the plan’s assets
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Table 1. Actuarial Valuation
for OPERS, June 30, 2008
1. Participant Data
Number of
Active Members
Retired and Disabled Members &
Beneficiaries
45,120
26,033
Inactive Members
5,580
Total Members
76,733
Projected Annual Salaries of Members
$1,682,663,413
Annual Retirement Payments for Retired
$376,147,494
Members and Beneficiaries
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Table 1. Actuarial Valuation
for OPERS, 2008, cont.
2. Assets and Liabilities
Total Actuarial Accrued Liability
$8,894,287,254
Market Value of Assets
$6,255,207,565
Actuarial Value of Assets
$6,491,928,362
Unfunded Actuarial Accrued Liability
$2,402,358,892
Funded Ratio
73.0%
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Funded Ratio & Assumptions
 Funded Ratio – 73%
 Key Assumptions




Investment return rate – 7.5%/year
Inflation rate – 3.0%/year
Wage growth – 4.25%/year
Cost-of living increase – 2%/year
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Table 1. Actuarial Valuation
for OPERS, 2008, cont.
3. Employer Contribution Rates as a Percent of
Payroll
Normal Cost Rate
Amortization of Unfunded Actuarial Accrued
Liability
Budgeted Expenses
Actuarial Required Contribution Rate
Less Estimated Member Contribution Rate
Employer Actuarial Required Contribution Rate
Less Statutory State Employer Contribution Rate
Contribution Shortfall
12.46%
10.13%
0.39%
22.98%
4.04%
18.94%
14.50%
4.44%
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Method & Contribution Rate
 Entry-age normal actuarial cost
method
 Contribution Rates as a % of Payroll
 Normal cost – 12.46%
 Amortization of UAAL –10.13%
 Actuarial Required Contribution (ARC) –
22.98%
 Contribution shortfall – 4.44%
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Table 2. Asset Class
Assumptions
U.S. Equity
Non-U.S. Equity
Private Equity
Real Estate
U.S. Bonds
Non-U.S. Bonds
Expected Return
8.50%
8.50%
11.55%
7.00%
4.00%
3.75%
Risk
16.0%
17.0%
26.0%
15.0%
5.0%
10.0%
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Table 3. Asset Allocation of
the OPERS, June 30, 2008
Actual
Low
Allocation
U.S. Equity
38.6%
37.3%
Non-U.S. Equity 37.8%
31.9%
U.S. Bonds
23.2%
21.0%
Non-U.S. Bonds
0.4%
0.0%
Target
High
40.0%
36.0%
24.0%
0.0%
42.7%
40.1%
27.0%
0.0%
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Figure 1. Average Asset
Allocation for State Pensions
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Table 4. Asset Allocation for
125 State Pension Plans (%)
Equity
US Equity
Non-US Equity
Real Estate
Private Equity
Equity Subtotal
Debt
US Bonds
Non-US Bonds
Other
Debt Subtotal
Return
Risk
2003
2008
Change
42.3
12.9
4.0
4.2
63.4
38.1
18.8
5.9
5.6
68.4
-4.2
5.9
1.9
1.4
5.0
35.2
1.4
0.0
36.6
7.3
10.3
26.7
0.9
4.0
31.6
7.5
10.9
-8.5
-0.5
4.0
-5.0
0.2
0.6
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Table 5. Contributions Needed
to Fully Fund Pensions, 2006
Simulation
assumption for the
rate of return on
investment
Projected government
contribution level
needed to fully fund
the liability
Difference between
projected contribution
level and the actual
9.0% of salaries
Higher return
scenario: 6% real
Base case: 5% real
Lower-return
scenario: 4% real
Risk-free scenario:
3% real
5.0% of salaries per
year
9.3% of salaries
13.9% of salaries
- 4.0% of salaries per
year
+ 0.3% of salaries
+ 4.9% of salaries
18.6% of salaries per
year
+ 9.6% of salaries
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Financial Pressures on
Public Plans
 Fiscal pressures on state and local
governments
 Demographic pressures
 Pension envy
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Standard & Poor’s, Ratings Direct: Market Declines Will Shake Up U.S. State Pension Fund
Stability (February 26, 2009), at 3.
16
National Association of State Retirement Administrators & National Council on Teacher Retirement,
Market Declines and Public Pensions (NASRA/NCTR Issue Brief, December 2008), at 3.
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Table 6. Life Expectancy for
Men and Women, 1940–2060
Life expectancy at birth
Year
Actual
1940
1960
1980
2000
2007
Projected
2020
2040
2060
2080
Male
Female
Life expectancy at age 65
Male
Female
61.4
66.7
69.9
74.0
75.2
65.7
73.2
77.5
79.4
79.9
11.9
12.9
14.0
15.9
16.7
13.4
15.9
18.4
19.0
19.2
76.9
79.0
80.8
82.4
80.9
82.6
84.2
85.6
17.6
18.8
19.8
20.8
19.8
20.9
21.9
22.8
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Figure 2. Remaining Life Expectancies for Males at Various
Ages, by Cohorts from 1900 to 2100
100
At Birth
Remaining Life Expectancy
80
60
At Age 30
40
At Age 65
20
At Age 100
0
1900
1940
1980
2020
2060
2100
Year of Cohort
Source: Felicitie C. Bell and Michael L. Miller, Life Tables for the United States Social Security Area 1900-2100 (Social Security Administration, Office of
the Chief Actuary, Actuarial Study No. 120, 2005), table 10.
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Table 7. Percentage of Workers
Electing SS Retirement Benefits
Year
1965
1975
1985
1995
2004
Ages
Age 62 63–64
23.0
17.7
35.7
24.5
57.2
21.1
58.3
19.5
57.5
19.0
Ages
Age 65
66+
23.4
35.9
31.1
8.7
17.7
4.0
16.3
6.0
18.6
4.8
Average
age
65.9
63.9
63.6
63.6
63.7
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Table 8. Public and Private
Sector Compensation, 2008
Retirement
Cost per hour
Benefits
and Savings
State and local
$39.18
$13.41 (34.2%) $3.09 (7.9%)
government
Private sector
$27.07
$7.93 (29.3%) $0.79 (3.0%)
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Table 9. Public and Private
Sector Retirement Benefits
Public Sector
Employees
Defined benefit plan
Private Sector
Employees
90%
20%
Median pension in 2005
$17,640
$7,692
Retiree health benefit of
any kind
82%
33%
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Accounting for Public
Pensions
 Government Accounting Standards
Board (GASB)
 80 percent funding target
 Actuarial versus market valuation of
assets and liabilities
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Public Plans Are in a Hole
 Stop digging
 Stop promising benefits w/o funding
 Climb out
 Make Actuarial Required Contributions
 Improve governance
 Avoid future holes
 Restructure Public Pensions
 At least for new workers
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About the Author
 Jonathan Barry Forman (“Jon”) is
 the Professor in Residence at the Internal Revenue
Service Office of Chief Counsel, Washington, DC, for
the 2009-2010 academic year;
 the Alfred P. Murrah Professor of Law at the University
of Oklahoma College of Law, teaching tax and pension
law; and
 the author of Making America Work (Washington, DC:
Urban Institute Press, 2006).
 Prior to entering academia, Professor Forman served in
all three branches of the federal government. He has a
law degree from the University of Michigan and
master’s degrees in both economics and psychology.
 Jon can be reached at [email protected], 405-325-4779,
www.law.ou.edu/faculty/forman.shtml
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