Overview of Public Pension Issues and Trends Keith Brainard Research Director National Association of State Retirement Administrators The Louisiana Public Retirement 2018 Seminar September 2018

Presentation Overview Public pension funding conditions Trends and changes in public pension plan design Groups affecting public pension policy discussions 2

Change in Aggregate Public Pension Funding Level, FY 01 to FY 17 Public Plans Data

Median Change From Prior Year in Actuarial Value of Assets and Liabilities

Distribution of Public Pension Funding Levels, FY 17

Headwinds Facing Public Pension Plans Declining investment return assumptions Slow payroll growth as a result of Sluggish hiring Tepid salary growth Higher required costs Updated mortality assumptions to reflect longer life expectations Negative cash flow

Tailwinds Supporting Public Pension Plans Stabilizing investment returns Stronger employer efforts to pay contributions More aggressive liability amortization strategies: More closed periods Shorter periods Lower benefit levels = lower long-term costs Improving economy Slow improvement in hiring and salary growth

Public Pension Fund Sources of Revenue, 1988 to 2017 US Census Bureau The typical public pension funding model is highly reliant on investment earnings.

Median Investment Returns for Periods Ended 6/30/17 and 12/31/17

Investment Return Assumptions, FY 01 to latest

Inflation Assumptions and Expectations

Actuarial Assumptions: Inflation, Nominal, and Real Public Plans Data Assumptions for inflation have dropped more quickly than assumptions for investment returns, causing the assumed real rate of return to rise.

Relative Change in Employment in Private and Public Sectors, 2007 to present U.S. Bureau of Labor Statistics

Change in Actives and Annuitants FY 01 to FY 17

Annualized Quarterly Change in Wage and Salary Costs for Private and State & Local Government Employees, 01-18 U.S. Bureau of Labor Statistics

Median Annual Change in Public Pension Payrolls, FY 02 to FY 17

Where Will Public Pension Funding Conditions Go From Here? Plans with relatively large unfunded liabilities face a long, uphill slog Many plans will continue to struggle with key actuarial challenges: downward pressure on investment return assumptions improving mortality demands for more aggressive amortization of unfunded liabilities

Where Will Public Pension Funding Conditions Go From Here? Rates of public sector hiring and salary growth may not soon return to historic norms Some employers are fiscally challenged to make required contributions The size of the challenge varies widely Some plans have relatively small UALs with costs that are affordable Other plans have UALs that are quite large and burdensome On a national level, a political consensus in support of resolving pension funding problems continues to strengthen

Number of Plans Reducing Their Investment Return Assumption Out of 128 Public Fund Survey

Median Public Pension Fund Investment Returns for Single Years Ended 6/30

Median Public Pension Fund Investment Returns for Single Years Ended 12/31

Trends in Plan Design

Overarching Trend: More Risk is Being Shifted to Employees In a retirement plan, risk is the possibility that key factors, or areas of risk, will be worse than expected. Key retirement plan risk areas include: Return on investments Inflation How long plan participants will live, aka mortality 23

Who Bears Retirement Plan Risk? Risk is distributed differently, depending on the plan and plan design In traditional defined contribution plans, employees typically bear all of the risk In traditional defined benefit plans, employers typically bear all of the risk In modern public pension plans The type and degree of risk-bearing varies More risk is being shifted from employers (taxpayers) to employees 24

Conceptual Illustration of Typical Risk-Sharing Arrangements, by Plan Type

Selected Examples of Risk-Sharing Plan Designs Contingent COLAs Delayed onset COLAs Variable employee contribution rates Hybrid plans Cash balance plans Others

Statewide Hybrid Plans, 1995 (portion of public employees in each state participating)

Statewide Hybrid Plans, 2017 (portion of public employees in each state participating) “State Hybrid Retirement Plans,” NASRA 2016

NASRA’s Position on Pension Plan Design Core elements of public pension plan design: Mandatory participation Employee-employer cost sharing Assets that are pooled and professionally managed Targeted income replacement Annuitized benefits Survivor and disability benefits Access to a supplemental retirement savings plan A hybrid plan can fulfill these elements NASRA Resolution 2016: Guiding Principles for Public Retirement System Plan Design and Sustainability

Hybrid Plans: DB-DC DB-DC plans combine a traditional pension plan with a defined contribution plan The pension component typically has a lower retirement multiplier, such as 1.0% or 1.5%, rather than 1.75%+, which is more typical for public sector DB plans Participation in the DC plan in most cases is required Employees bear all risk in the DC plan component Employer risk is reduced because the promised DB plan benefit is reduced

Examples of DB-DC Plans and Their DB Plan Multiplier Georgia state employees: 1.0% Indiana state employees: 1.1% Newly-hired Illinois state, teachers and university employees: 1.25% Michigan teachers: 1.5% Tennessee state and teachers: 1.0% Utah: 1.5% Washington state: 1.0% Social Security matters ! Employee contribution rates and other plan provisions vary NASRA Issue Brief: Statewide Hybrid Retirement Plans

Hybrid Plans: Cash Balance Cash balance plans combine features of traditional pension and defined contribution plans Employees have “notional” accounts that are pooled and invested by professionals in diversified portfolios Employers promise an annual minimum return on employee accounts In the public sector, annual minimum returns typically are 4% to 7%, and employers may distribute investment gains to employee accounts Employees may share in strong investment experience

Hybrid Plans: Cash Balance Benefit is annuitized upon attainment of retirement eligibility: age and years of service Value of benefit is based on age at retirement Employer risk is lower because they pay a benefit based on a lower investment return

Examples of Cash Balance Plans and Their Guaranteed Annual Accrual Rate Texas Municipal Retirement System 5.0% Texas County & District Retirement System 7.0% Nebraska State Employees Retirement Plan 5.0% Kansas Public Employees’ Retirement System 4.0% Kentucky Retirement System 4.0%* *plus 75% of investment returns above 4.0% NASRA Issue Brief: Statewide Hybrid Retirement Plans

South Dakota Retirement System Variable Retirement Account New hires since 2017 have a higher full retirement age 1.5% of the 6.0% employer contribution is directed to a variable retirement account (VRA) VRA assets are invested along with other pension assets and are credited with actual fund returns Assets are available to participants only upon retirement, disability, or death Assets may be rolled over, taken as a lump sum, or blended with the pension benefit as an annuity Reduces employer risk during employees’ active years by lowering promised pension benefit, and by shifting investment risk of VRA assets to active members

Utah Retirement System New hires since 7/1/11 must choose between a DC and a DB plan DB plan retirement multiplier is 1.5% For both DB and DC plans, employer contribution is fixed at 10 percent of pay The current cost of the DB plan is 8.85%; the difference of 1.15% goes to an employee DC plan If the cost of the DB plan rises above 10%, the employee pays the difference Employer risk is limited to 10% of pay, shifting other risks—investment, mortality, etc.—to active members Employees bear all plan risks for costs above 10% A defined benefit plan with a defined employer contribution

Cost-of-living adjustments COLA plan designs vary widely Examples of risk-sharing COLAs: ad hoc contingent delayed onset capped required minimum age Many changes made in recent years to retirement benefits for employees of state and local government have included COLA reductions

Variable Employee Contribution Rates Required pension plan contribution rates for most public employees are fixed, typically at 4.0% to 8.0% of pay Some plans have established contribution rates that vary from year to year based on the actuarial condition or total cost of the plan Such a policy distributes plan risks to active members in the form of higher required contribution rates

Variable Employee Contribution Rates Arizona State Retirement System participants are required to contribute roughly one-half of the actuarially determined contribution Most Iowa PERS participants must contribute 40 percent of required contribution rates Most employees hired in California since 2013 must contribute at least one-half of the normal cost of the plan Pennsylvania added variable employee contribution rates for state workers and teachers hired since 2011 These employees are sharing in all of their plan’s risks

Variable Plan Designs The City of Houston established a contribution rate corridor plan affecting all active and new members If/when the plan cost rises above or falls below designated levels, prescribed adjustments are made to benefits and employee contribution rates New Brunswick, Canada established a similar plan design several years ago with three key elements: a new design that splits plan benefits into highly secure “base” benefits and moderately secure “ancillary” benefits protocols that require pre-determined actions to change future benefits, contributions, and asset allocations in response to changes in the plan’s financial condition a new risk management regulatory framework to keep these plans on track* *Center for Retirement Research, “New Brunswick’s New Shared Pension Plan, 2013

Groups Participating in the Public Pension Plan Discussion

External Groups Group Modus Operandi Comments American Legislative Exchange Council (ALEC) State-focused reports; model DC plan legislation; annual conference and task force meetings Members are state legislators and are predominantly Republican; some participate in ALEC in lieu of NCSL. Main revenue source appears to be corporate contributions. Advocates for switch to 401k plans. Reports public pension liabilities using a risk-free investment return. Maintains model legislation to switch from DB to DC. Pew Center on the States State-focused research and reports; media commentary; free assistance to legislatures Seems supportive of cash balance plans. Has been providing assistance to NCSL for several years. Currently advocating for public pension stress-testing.

External Groups Group Modus Operandi Comments Reason Foundation Provides free legislative assistance to advocate for certain retirement plan objectives, e.g., keeping promises, reducing risk, sound governance, etc. Maintains a “Pension Reform Handbook,” intended to guide policymakers through the process of switching to a DC plan. Bellwether Advocates for public school reform; promotes use of charter schools. Sponsors research and publications; is affiliated with teacherpensions.org, which believes public pensions for teachers produce bad educational outcomes

External Groups Group Modus Operandi Comments National Council on Teacher Quality Focuses on teacher effectiveness; publishes annual evaluations of state pension policies affecting teachers; touts the “pension crisis.” Cites as funders many large foundations, including Gates, Arnold, and Joyce; overarching view is that public pension plans are unfair, especially to young and short-term teachers Retirement Security Initiative Advocacy, op-eds, offers of assistance Led by pension reform advocates Chuck Reed, Dan Liljenquist, and Richard Ravitch

External Groups Group Modus Operandi Selected Grantees Laura and John Arnold Foundation Uses deep pockets to fund many organizations that conduct research into or advocate for changes to public pensions. Bellwether: a primary funder of teacherpensions.org Brookings Institution: reports that promote cash balance plans George Mason University: to support symposia critical of public pensions National Council on Teacher Quality Pew Charitable Trusts Reason Foundation SUNY Research Foundation

Thank you for listening ! www.nasra.org keith@nasra.org 202-624-8464