Spring Conference Update on Pensions and Other Long Term Obligations April, 2012 David Boomershine

2 Agenda Background Private Sector vs. Public Sector Recent Changes/Update: Pension Plans –Funding: Cost Volatility –Actuarial Assumptions –Accounting –Plan Design – Roundup Maryland State Summary Hybrids DB vs. DC Plans Recent Changes/Update: OPEB Plans –Funding –Actuarial Assumptions –Plan Design Current Issues

3 Background Interested Parties: Retirement Plans/Budget Concerns Governing Bodies Employees/Retirees Unions Taxpayers Bond Rating Agencies Federal Government -?

4 Background U.S. Senate Committee on Finance State and Local Defined Benefit Pension Plans: The Pension Debt Crisis that Threatens America –Orrin Hatch (R-Utah)

5 Background Hatch Report Highlights: Pension liabilities are contributing to our nations debt crisis Funding levels declining since 2000 This is a Federal concern Large State/Municipal insolvency risk State/Municipal efforts – some DC plans Federal efforts - “Public Employee Pension Transparency Act” GASB Proposal Conclusion: DB plans are inappropriate for State and Local Governments

6 Private Sector vs. Public Sector IssuesImpacts: Private SectorPublic Sector Pension Retiree MedicalPension Retiree Medical Federal Legislation Accounting Asset Losses Valuation Interest Rates Result: Increased cost and liability volatility for Private Sector Pension Plans Recent Changes

7 Recent Changes/Update: Pension Plans Funding: Cost Volatility –Cost Increases Asset losses Discount rate Unfunded Liability impact - examples Asset LossesDiscount Rate Prior Year Current Year Prior Year Current Year Actuarial Liability$100$105$100$115 Assets Unfunded Actuarial Liability ($ in millions) Amortization costs increase 50%

8 Recent Changes/Update: Pension Plans Funding: Cost Volatility –Cost Decreases Asset gains Plan population limits (employment freeze, layoffs) Compensation controls (freeze, decreases, furloughs) –Other Funding Approaches Pension Obligation Bonds: pay off Unfunded Liability

9 Recent Changes/Update: Pension Plans Actuarial Assumptions –Discount Rate – Key Median at 8.0% Average at 7.8% Trending down from 8.0% to 7.5% CALPERS adopted 7.5% Some at 7.0% –Other Economic Assumptions Salary increases COLAs –Mortality Table Update Indicate Cost Increases

10 Recent Changes/Update: Pension Plans Accounting – GASB Proposal Update Impacts: –Net pension liability –Discount rate basis - ? –Use of Entry Age Normal Cost Method –Amortization periods –Additional required information –Cost Sharing multiple employee plans Accounting vs. Funding Separation – Less Clarity

11 Recent Changes/Updates: Pension Plans Plan Design – Roundup: Maryland –Prior plan changes: Increased employee contributions COLA cap Normal/Early Retirement eligibility Benefit formula –Current budget proposed changes: Shift ½ of Teacher pension costs to Counties

12 Recent Changes/Updates: Pension Plans Plan Design – Roundup: Typical changes from 2008 to 2011 –State Sponsored Plans (2012 GAO Study) Usually for new employees Adjusted benefits – 24 States Eligibility requirements – 29 States COLAs – 18 States Increased employee contributions – 25 States Switched to Hybrid approach – 3 States

13 Recent Changes/Update: Pension Plans # States including changes for current Plan Design – Roundup: employees/retirees –State Plans: More Details Adjusted Benefits6 –Benefit % reduced –Increased pay averaging period Eligibility requirements6 –Increased retirement age/service –Vesting COLAs5/8 Increased employee contributions20 Switched to Hybrid0

14 Recent Changes/Update: Pension Plans Hybrids –In public sector: combination DB and DC plans –In private sector: Cash Balance Plan –6 States and District of Columbia have DC or Hybrid primary plans –1 State has a Cash Balance primary plan –6 States offer DC or Hybrid optional alternatives to primary DB plans Note definite private sector trend from DB to DC/Hybrid Some public sector trend from DB to DC/Hybrid Also note 1 State plan has cap on employer contribution commitment to DB plan Clear interest in DC plans due to private sector trends

15 DB vs. DC Plans General Plan Comparisons DB PlansDC PlansHybrid Plans Lifetime retirement incomeYesNoYes Retirement income determinableYesNoYes Easy to understandNoYesMixed PortableNoYes Investment control and riskEmployerEmployeeEmployer Level of paternalismHighLowMixed Level of cost and liability volatility for Employer HighNoneLow

16 DB vs. DC Plans Sample Plan Case Study: DB Plan:Benefit Formula = 1.5% times final average pay times service, up to 35 years DC Plan: Employer contribution formula = 7% of pay plus 50% match of employee’s 1 st 6% of pay savings CB Plan: Employer contribution credit = 10% of pay for each year of service

17 DB vs. DC Plans Age (Hired at age 35) DB CB DC Accrued Benefit Typical Benefit Accrual Patterns

18 DB vs. DC Plans Replacement Ratios: % of final pay replaced with lifetime pension benefits Profile Employee Attained Age Accrued Service Current Compensation DB Plan DC Plan CB Plan I302$35,00051%38%42% II355$40,00051%38%42% III409$45,00049%36%39% IV4512$50,00046%34%37% V5014$55,00041%30%33% VI5419$60,00043%33%36% Actuarial Assumptions: -Mortality: RP2000 Table -Interest: 6% Retirement Benefit Comparisons

19 DB vs. DC Plans Cost comparisons as a % of payroll: DB Plan8.5% DC Plan9.0% CB Plan8.0%

20 DB vs. DC Plans Why are DB plans more cost efficient? Reward long service – back loading due to final average pay Forfeitures remain in plan – more with DB plans Younger terminations – similar to forfeitures

21 DB vs. DC Plans Conclusions of Case Study: For similar long-term plan costs, traditional DB plans provide about 130% of lifetime benefits provided by DC plans Other studies claim traditional DB plans provide up to 150% more in benefits for the same cost vs. DC plans Career average DB plans provide about 20% more in benefits for the same cost vs. DC plans

22 Recent Changes/Update: OPEB Plans Funding: Cost Volatility –Contribution Policy Continue pay-as-you-go (Paygo) Partial funding Full funding –Discount rate basis –Healthcare cost trending –Reduced funding vs. original plan –Other funding approaches: OPEB Bonds – pay off Unfunded Liability

23 Recent Changes/Update: OPEB Plans Actuarial Assumptions –Discount rate basis: sample ARC comparison Paygo4%$ 120 M Partial Funding6%100 M Full Funding8%75 M –Healthcare trending –Mortality Table Update

24 Recent Changes/Update: OPEB Plan Plan Design: variety of changes –Cost sharing: retirees’ % share of costs –Eligibility requirements –Tiered coverage/subsidies: years of service –Employer contribution caps Hard cap Increasing cap –Spouse/family coverage –Cost containment provisions –Wellness programs –Access only Mostly Soft Freeze approach: –Future new hires –Future retirees –Future retirees not close to retirement Buyout of benefits

25 Current Issues Comparison vs. Private Sector Plans Taxpayer Concerns –DB plans –OPEB plans Union Reactions Pension Plan Changes –Soft freezes –Employee contributions –COLAs –DC plans –Capping employer contribution commitment Valuation Discount Rate Basis/Reduction

26 Current Issues Current Questions Not enough cost reduction? Cost/liability volatility concerns remain; especially vs. Private Sector? Changing workforce? More changes coming? Future of economy?

27 Questions?