1. Funding Public Pensions Seventh Annual Employee Benefits Symposium John Marshall Law School April 20, 2009 by Jon Forman Alfred P. Murrah Professor of Law University of Oklahoma

2. Overview  Operation and funding of public plans  Financial, accounting, and legal issues  How to ensure adequate funding now and in the future 2

3. 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

4. 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 4

5. Table 1. Actuarial Valuation for OPERS, June 30, 2008 1. Participant Data Number of Active Members45,120 Retired and Disabled Members & Beneficiaries 26,033 Inactive Members 5,580 Total Members76,733 Projected Annual Salaries of Members$1,682,663,413 Annual Retirement Payments for Retired Members and Beneficiaries $376,147,494 5

6. 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 Ratio73.0% 6

7. 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 7

8. Table 1. Actuarial Valuation for OPERS, 2008, cont. 3. Employer Contribution Rates as a Percent of Payroll Normal Cost Rate12.46% Amortization of Unfunded Actuarial Accrued Liability 10.13% Budgeted Expenses0.39% Actuarial Required Contribution Rate22.98% Less Estimated Member Contribution Rate4.04% Employer Actuarial Required Contribution Rate18.94% Less Statutory State Employer Contribution Rate14.50% Contribution Shortfall4.44% 8

9. 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% 9

10. Table 2. Asset Class Assumptions Expected ReturnRisk U.S. Equity 8.50%16.0% Non-U.S. Equity 8.50%17.0% Private Equity11.55%26.0% Real Estate 7.00%15.0% U.S. Bonds 4.00% 5.0% Non-U.S. Bonds 3.75%10.0% 10

11. Table 3. Asset Allocation of the OPERS, June 30, 2008 Actual Allocation LowTargetHigh U.S. Equity38.6%37.3%40.0%42.7% Non-U.S. Equity37.8%31.9%36.0%40.1% U.S. Bonds23.2%21.0%24.0%27.0% Non-U.S. Bonds 0.4% 0.0% 11

12. Figure 1. Average Asset Allocation for State Pensions 12

13. Table 4. Asset Allocation for 125 State Pension Plans (%) 20032008Change Equity US Equity42.338.1-4.2 Non-US Equity12.918.8 5.9 Real Estate 4.0 5.9 1.9 Private Equity 4.2 5.6 1.4 Equity Subtotal63.468.4 5.0 Debt US Bonds35.226.7-8.5 Non-US Bonds 1.4 0.9-0.5 Other 0.0 4.0 Debt Subtotal36.631.6-5.0 Return 7.3 7.5 0.2 Risk10.310.9 0.6 13

14. 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 5.0% of salaries per year - 4.0% of salaries per year Base case: 5% real9.3% of salaries+ 0.3% of salaries Lower-return scenario: 4% real 13.9% of salaries+ 4.9% of salaries Risk-free scenario: 3% real 18.6% of salaries per year + 9.6% of salaries 14

15. Financial Pressures on Public Plans  Fiscal pressures on state and local governments  Demographic pressures  Pension envy 15

16. 16 Standard & Poor’s, Ratings Direct: Market Declines Will Shake Up U.S. State Pension Fund Stability (February 26, 2009), at 3.

17. 17 National Association of State Retirement Administrators & National Council on Teacher Retirement, Market Declines and Public Pensions (NASRA/NCTR Issue Brief, December 2008), at 3.

18. Table 6. Life Expectancy for Men and Women, 1940–2060 Year Life expectancy at birthLife expectancy at age 65 MaleFemaleMaleFemale Actual 194061.465.711.913.4 196066.773.212.915.9 198069.977.514.018.4 200074.079.415.919.0 200775.279.916.719.2 Projected 202076.980.917.619.8 204079.082.618.820.9 206080.884.219.821.9 208082.485.620.822.8 18

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20. Table 7. Percentage of Workers Electing SS Retirement Benefits YearAge 62 Ages 63–64Age 65 Ages 66+ Average age 196523.017.723.435.965.9 197535.724.531.18.763.9 198557.221.117.74.063.6 199558.319.516.36.063.6 200457.519.018.64.863.7 20

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22. Table 8. Public and Private Sector Compensation, 2008 Cost per hourBenefits Retirement and Savings State and local government $39.18$13.41 (34.2%)$3.09 (7.9%) Private sector$27.07$7.93 (29.3%)$0.79 (3.0%) 22

23. Table 9. Public and Private Sector Retirement Benefits Public Sector Employees Private Sector Employees Defined benefit plan90%20% Median pension in 2005$17,640$7,692 Retiree health benefit of any kind 82%33% 23

24. Accounting for Public Pensions  Government Accounting Standards Board (GASB)  80 percent funding target  Actuarial versus market valuation of assets and liabilities 24

25. 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 25

26. About the Author  Jonathan Barry Forman (“Jon”) is the Alfred P. Murrah Professor of Law at the University of Oklahoma College of Law, where he teaches courses on tax and pension law.  Professor Forman is also Vice Chair of the Board of Trustees of the Oklahoma Public Employees Retirement System (OPERS) 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 economics and psychology.  Jon can be reached at jforman@ou.edu, (405) 325- 4779, or www.law.ou.edu/faculty/forman.shtml.jforman@ou.eduwww.law.ou.edu/faculty/forman.shtml 26