Understanding PSERS and the Employer Contribution Rate January 11, 2008 Understanding PSERS and the Employer Contribution Rate Presentation to PASA Public School Employees’ Retirement System January 11, 2008 PASA

Agenda PSERS’ Overview PSERS’ Health Programs Investment Update January 11, 2008 Agenda PSERS’ Overview PSERS’ Health Programs Investment Update Employer Contribution Rate and the Pending Rate Spike What is the Current Employer Contribution Rate? Why is there a Projected Employer Rate Spike in FY 2012/2013? What can be done to Mitigate the Spike? January 11, 2008 PASA PASA

PSERS’ Overview

PSERS’ Overview PSERS currently manages assets of approximately $67.2 January 11, 2008 PSERS’ Overview The Public School Employees’ Retirement System (PSERS) is a governmental, (non ERISA), mandatory, multi-employer, defined benefit pension plan for Pennsylvania school employees PSERS was established on July 18, 1917 and thus is one of the oldest public pension plans in the United States PSERS “plan document”is the Public School Employes’ Retirement Code, 24 Pa.C.S. §8101 et. seq. PSERS is governed by a 15 person Board of Trustees, and has a complement of 306 employees PSERS serves approximately 519,000 members PSERS currently manages assets of approximately $67.2 billion as of June 30, 2007 PSERS is the 13th largest public defined benefit pension fund in the nation and the 23rd largest public or corporate fund in the nation As of January 2, 2008 PSERS Net Asset Value was over $66 billion January 11, 2008 PASA PASA

PSERS’ Overview Basic Benefit Formula 2.5% or 2.0% Multiplier Years of A defined benefit (DB) plan is different from many private sector pension plans, e.g. Individual Retirement Accounts (IRAs), Keogh and 401(k) plans These private sector plans are generally defined contribution (DC) plans The chief differences between the two are in how the actual pension benefit is determined and who bears the risk of investment In a DC plan, the ultimate benefit is determined by the investment performance of the member’s account and the member bears the investment risk In a DB plan, the final benefit is typically based on a fixed formula and the employer bears the investment risk PSERS also offers a disability benefit for eligible members with 5 or more years of service Basic Benefit Formula 2.5% or 2.0% Multiplier Years of Service Final Average Salary Maximum Single Life Annuity X X = PSERS paid out in excess of $4.0 billion in pension benefits for the fiscal year ending June 30, 2007 January 11, 2008 PASA

PSERS’ Overview PSERS is funded by three sources: Employee Contributions, Employer Contributions, and Investment Earnings Investment earnings have been the primary source of funding for PSERS benefits, dwarfing the contributions from both school employers and PSERS active members Over the last 25 years, only 16% of PSERS’ funding has come from school employers. Another 11% has come from PSERS’ active members. All the rest – 73% – has come from investment earnings January 11, 2008 PASA

HEALTH OPTIONS PROGRAM PSERS Health Programs Premium Assistance Benefit HOP HEALTH OPTIONS PROGRAM www.HOPbenefits.com

Health Options Program (HOP): Overview Besides administering a DB pension plan, PSERS sponsors the Health Options Program (HOP) The HOP is a voluntary group health insurance program for over 61,000 PSERS annuitants, their spouses (including surviving spouses) and dependents The program was first started in the late 1960’s solely as a Medicare supplement indemnity plan and in 1994 the program was transformed into HOP Funding is through the premium payments of the participants, with no direct funding by the employers or PSERS HOP provides access to coverage 65 Special Program – Medicare eligible Traditional Program – Not Medicare eligible High and Standard Options w/ Rx coverage Fee-for-service plans HOP Medical Plan Basic & Enhanced Medicare Part D Rx Options PSERS is one of only nine employer/union direct Prescription Drug Plans (PDP) HMO, POS and PPO plans (where available) January 11, 2008 PASA

Premium Assistance Benefit (PAB) PSERS also offers a Premium Assistance Benefit (PAB) to qualified members The PAB is an employer funded (pay-as-you-go) benefit that provides eligible annuitants up to $100.00 per month or their actual out-of-pocket costs for health insurance, whichever is less To be eligible for the PAB one must: have 24.5 years of service; or be a disability annuitant; or have 15 years of service AND retired on or after age 62 And eligible annuitants must participate in either: PSERS’ Health Options Program; or School Employer Health Plans January 11, 2008 PASA

Investment Update

PSERS’ Investment Rates of Return as of: FY 1999/2000 - 11.9% FY 2000/2001 - (7.4)% FY 2001/2002 - (5.3)% FY 2002/2003 - 2.7% FY 2003/2004 - 19.67% FY 2004/2005 - 12.87% FY 2005/2006 - 15.26% FY2006/2007 - 22.93% Below PSERS’ annual actuarial earnings assumption of 8.5%, therefore resulting in an actuarial loss As of December 31, 2007 FYTD Return= 2.34% CYTD Return= 13.02% January 11, 2008 PASA

PSERS’ Net Plan Assets as of: June 30, 2002 $43.6 Billion (audited) March 31, 2003 $38.3 Billion (unaudited) June 30, 2003 $42.5 Billion (audited) June 30, 2004 $48.5 Billion (audited) June 30, 2005 $52.1 Billion (audited) June 30, 2006 $57.0 Billion (audited) June 30, 2007 $67.2 Billion (audited) January 11, 2008 PASA

PSERS’ Funded Ratio: 1990 – 2007 (percentage) PSERS total funded ratio is measured by comparing the actuarial value of assets (based on a 5 year moving average market value) with the accrued liability Historically PSERS was only 50% funded in 1982 PSERS first achieved fully funded status in FY 1996/1997 (105.0%) PSERS reached the highest funded ratio in the history of the Fund in FY 1999/2000 (123.8%) PSERS’ current funded ratio is 85.8% as of June 30, 2007, an increase from 81.2% as of June 30, 2006 PSERS’ Funded Ratio: 1990 – 2007 (percentage) January 11, 2008 PASA

Employer Contribution Rate and the Pending Rate Spike

What is the Current Employer Contribution Rate?

Employer Contribution Rate The Public School Employees' Retirement Board met on December 13, 2007 and certified the employer contribution rate for FY 2008/2009 The FY 2008/2009 rate is 4.76% The 4.76% rate is composed of a 0.76% rate for health insurance premium assistance and a pension rate of 4.00% The Commonwealth reimburses school employers for not less than 50% of the employer contribution rate Statewide average is 52/48% split with the Commonwealth paying 52% January 11, 2008 PASA

Employer Contribution Rate The FY 2008/2009 rate of 4.76% is a decrease from the current rate of 7.13% The FY 2008/2009 rate is below the employer normal cost of 6.68% for FY 2008/2009 January 11, 2008 PASA

Employer Contribution Rate The “employer normal cost” is the amount needed from the school employers to fund the benefits earned by the active members for that year It can be thought of as the minimum payment that would be made by school employers if the System’s actual experience perfectly matched its economic and demographic operating assumptions In other words, the employer’s base line contribution in a perfect actuarial world January 11, 2008 PASA

Employer Contribution Rate In preparing 2008-09 school district budgets, the Pennsylvania Department of Education recommended that school districts plan for the current PSERS employer contribution rate of 7.13% to remain in effect The PDE memo stated: If pension reform is enacted, it will likely require school districts to maintain their existing employer contribution rate rather than reducing it. The Department of Education therefore recommends that school districts plan accordingly by budgeting based on a 7.13% employer contribution rate PDE Memo January 11, 2008 PASA

Why is there a projected large employer rate increase in FY 2012/2013?

Projected Employer Rate Spike The projected sharp rise in the employer contribution rate to 11.23% (down from last year’s projection of 18.73%) in FY 2012/2013 is primarily the result of: The unfunded liabilities created by Act 2001-9 The 2001-2003 down investment markets; The Act 38 phased COLA The changes made by Acts 2002-38 and 2003-40 to PSERS’ funding methodologies January 11, 2008 PASA

What can be done to mitigate the rate increase?

Rate Spike Options Although some criticize Acts 38 and 40, the Acts were intended to provide fiscal “breathing room” to both the Commonwealth and school employers so that a more permanent and sustainable solution could be found to PSERS’ funding issues That time is now as there has been both increased awareness of the pending rate increase and discussions of alternative solutions So what can be done about the pending rate increase? January 11, 2008 PASA

Rate Spike Options Fundamentally, the current problem has been been caused by the underfunding of the System This has practically occurred by way of Acts 38 and 40 It has also been abetted by the Retirement Code itself Prior to Act 2002-38, the funding methodology of the Retirement Code permitted the employer contribution rate to drop to zero thus giving school employers a false sense of fiscal prosperity January 11, 2008 PASA

Rate Spike Options To resolve the funding issues, these factors need to be corrected The first step is additional funding This has already partially occurred but not through large increases in the employer contributions On the contrary, it has come from the superior investment performance of PSERS’ investment assets in FY’s 2003/2004, 2004/2005, 2005/2006, and 2006/2007 Projected rate spike reduced from the initial spike of 27.73% to 11.23% January 11, 2008 PASA

Rate Spike Options It is unlikely, however, that PSERS will “earn” itself out of the rate spike problem PSERS’ investment consultants forecast a low return environment for the next ten years Also, PSERS’ past four years of investment returns (FY 2003/2004, 2004/2005, 2005/2006 and 2006/2007) have been top decile returns It is not likely that PSERS can continue to post such returns in today’s market conditions January 11, 2008 PASA

Rate Spike Options Therefore, additional employer contributions will be needed to mitigate the projected rate spike One proposal includes raising the employer contribution rate floor to the FY 2007/2008 preliminary employer pension rate SB 826- This proposal seeks to increase the Act 40 employer contribution pension rate floor for PSERS from 4% to 6.44% plus the premium assistance contribution (current rate) and increase the minimum employer rate for SERS from 4% to 5% January 11, 2008 PASA

Rate Spike Options This proposal is a step in the right direction, as it will help to avoid future under funding of the System This legislation, however, does not in and of itself eliminate the present projected rate spike Reflecting the 22.93% rate of return for FY 2006/2007, the projected impact of SB 826 causes the current rate spike of 11.23% to drop to 10.50% January 11, 2008 PASA

Rate Spike Options Another option includes increasing employer contributions in a predictable and controlled manner, that will permit the Commonwealth and school employers to adequately budget for the increases and spread out their impact For example, increase the employer pension rate beginning in FY 2008/2009 through 2011/2012 as follows: 7.25%-7.75%-8.50%-9.00% Projected rate spike drops to 10.08% and the rate plateau is smoothed out January 11, 2008 PASA

Rate Spike Options Instead of increasing the employer contributions as suggested, are there other options to reduce PSERS’ unfunded liabilities? Yes, several concepts have been raised in the media, principally being: Increasing the employee contribution rate Reducing benefits Repealing or modifying the Act 2001-9 multiplier increase Return to a 10-year vesting period Prohibit the withdrawal of a member’s contribution Converting PSERS from a DB plan to a defined contribution (DC) plan January 11, 2008 PASA

Rate Spike Options Although superficially attractive, these suggestions will not provide any meaningful mitigation of the projected rate spike Why? Any such changes would have to be prospective only to avoid the PA Constitution’s prohibition against the impairment of a contract (Article I, Section 17) The courts have ruled that PSERS’ pension benefits are contracts with the existing members of the System, regardless of vesting, and thus subject to the constitutional impairment of contract prohibition January 11, 2008 PASA

Rate Spike Options Therefore, they will only incrementally increase the funding and/or reduce the System’s current unfunded liability prior to the occurrence of the projected rate spike Moreover, in the case of the DC option, arguably it will increase the cash flow problems for both the Commonwealth and school employers since they will be simultaneously funding two separate pension systems January 11, 2008 PASA

PSERS Executive Director January 11, 2008 Questions? Jeff Clay PSERS Executive Director 717-720-4749 jclay@state.pa.us www.psers.state.pa.us January 11, 2008 PASA PASA

Rate Projection Assumptions The employer rate projections contained in this presentation are simply that; projections based on certain assumptions Therefore the projected rates can change The rates may decrease with investment performance over PSERS’ 8.5% actuarial assumption and vice versa Also the projected employer rates and related data are impacted by actual experience that varies from the mortality, salary growth, and other economic and demographic assumptions of the System Benefit enhancements will also impact the rate projections January 11, 2008 PASA