Overview of Public Pension Funding Issues

Keith Brainard

NASRA Annual Conference August 7, 2016 Coeur d’Alene, Idaho

NASRA Research Director

◀  Pay-as-you-go funding of pension plans had ended and actuarial funding was the norm

◀  In the wake of the inflation spike that began in late 60s, auto-COLAs were emerging

◀  Early stage of equity investing ◀  Dawn of retirement systems offering retirement

counseling ◀  Manual and general ledger accounting giving way to

reliance on mainframe computers Other interesting conditions: ◀  More emphasis on unfunded liabilities than on actual

assets ◀  40-year amortization of unfunded liabilities was common

1974 was a transitional period in public pension plan history

Accounting/data processing in 1974

Retirement counseling in 1974

Actuarial data in 1974

Terms not present: entry age, normal cost, actuarial value of assets, smoothing, level dollar, funded ratio, and others.

Investments in 1974

Terms not present: hedge funds, real estate, infrastructure, private equities, options, tactical asset allocation, billion.

◀  Data is culled and analyzed by NASRA staff from the Public Plans Database, CAFRs and other source documents

◀  PPD is an online compendium of public pension information maintained by the Center for Retirement Research at Boston College, in collaboration with NASRA and the Center for State & Local Government Excellence

◀  www.publicplansdata.org ◀  FY 15 information presented here is not yet complete

and is subject to change ◀  Complete analysis of FY 15 will be published this fall as

the Public Fund Survey Summary of Findings for FY 15

About the funding data

◀ Stabilization of funding levels after more than a decade of decline

◀ Required costs are still rising for some plans due to higher unfunded pension liabilities and insufficient contributions

◀ Gradual movement from open amortization periods to closed and fixed periods, and toward shorter amortization periods

◀ Assumptions: lower inflation and nominal investment return

◀ Growing use of phased-in lower investment return assumptions

Notable funding trends

Aggregate

Public Pension Funding Level,

FY 01 to FY 15

Median Change in Actuarial Value of

Assets and Liabilities, FY 02 to

FY 15

Size of bubbles is roughly proportionate to size of plan liabilities

Latest Public Pension Funding Levels

Median change in membership, FY 01 to FY 15

Median Contribution Rates, Social Security–eligible and –ineligible, FY 02 to FY 15

*

Distribution of Employer Contribution Rates, Social Security-

eligible, FY 15, (general employees and teachers)

Public Fund Survey

Distribution of Employer Contribution Rates, Social Security-ineligible, FY 15

(general employees and teachers)

Public Fund Survey

Distribution of percentage of pension plan normal cost* paid by employees

Public Fund Survey *Normal cost is the cost of benefits accrued each year

Median and aggregate net cash flow, FY 02 to FY 15

Jul 2013

Net cash flow equals contributions minus benefit payments and expenses, divided into assets

Median and aggregate net cash flow and change in assets, FY 02 to FY 15

Jul 2013

Distribution of net cash flow and size of benefits distributed, FY 15

Jul 2013

Median annual change in payroll, FY 06 to FY 15

Public Fund Survey

Median annual change in payroll, employment, and wages and salaries, FY 06 to FY 15

Public Fund Survey

◀ The inflation assumption typically serves as the basis of actuarial assumptions for payroll growth and investment return

◀ Payroll growth is a major driver of liability growth

◀ The investment return assumption has a major effect on a pension plan’s cost and funding level

The role of inflation in public pension funding

Annual change in CPI-U for periods ended in June, 1992-2016

Jul 2013 US Bureau of Labor Statistics

10-Year Rolling Average Inflation (CPI-U)

Jul 2013 US Bureau of Labor Statistics

Change in CPI-U compared to change in prices for eggs and unleaded gasoline, Jul-13 to Jun-16

Jul 2013

Bureau of Labor Statistics

Expectations for inflation over the next 10 years

Jul 2013 Cleveland Fed

Yields on 10-year notes: US, Germany and Japan, Jan-03 to Jul-16

Jul 2013

Wall Street Journal

Change in distribution of investment return assumptions, FY 01 to present

Jul 2013

Change in average assumption for inflation and real rate of return, FY 05 to FY 15

Jul 2013 Public Fund Survey

Median annualized public pension fund investment returns for periods ended 6/30/15 and 12/31/15

Jul 2013

Callan Associates

Median annualized public pension fund investment returns for periods ended 6/30/16

Jul 2013

Average asset allocation, FY 01 to FY 15

Jul 2013

◀  Funding levels are stabilizing, but funding experience and required costs vary widely

◀  Inflation remains very low, reducing wage growth rates and rates of liability growth

◀  Liability growth rates remain low due to slow hiring, low inflation and salary growth, and benefit reductions

◀  Liability growth rates would be lower still were it not for the headwind of lower investment return assumptions

◀  Assumed rates for inflation and nominal investment returns have decreased and may continue

◀  Required contribution rates will remain high for plans with large unfunded liabilities

◀  Pension challenges vary from state to state and plan to plan; every case is unique

Summary

NASRA Research Overview

Alex Brown

NASRA Annual Conference August 7, 2016 Coeur d’Alene, Idaho

Research Manager

◀ NASRA Issue Briefs & Papers ◀ NASRA.org

▲ Economic Indicators ▲ NASRA Member Surveys

Research Update

◀ Policy discussion of elements pertaining to public pension plan design, cost, financing, etc.

◀ Comprehensive data set

▲  COLA formulas ▲  Employee contribution rates ▲  Hybrid plan characteristics ▲  Investment return assumptions

Issue Briefs

Updated Issue Brief: State Hybrid Retirement Systems

◀  Cash balance and combination hybrid plans are optional or mandatory for groups of general, public safety, or educational employees

◀  Many hybrid plans retain all or most distinguishing elements of sound retirement plan design

◀  Many public plans already feature elements of hybrid plan design

Updated Issue Brief: Public Pension Plan Investment Return Assumptions

◀  Of all actuarial assumptions, investment return assumption has the most significant impact on pension liabilities and costs

◀  Plans continue to reduce

investment return assumptions

◀  The median investment return

for the 25 year period ended 12/31/15 exceeds the current average return assumption

Updated Issue Brief: State and Local Government Spending on Public Employee Retirement Systems

◀  Pensions accounted for approximately 4.1 percent of all state and local government general expenditures in FY 13.

◀  Spending by state varies

widely, from around 1.6 percent to nearly 8 percent.

◀  Spending on pensions is projected to increase in FY 14, but still below levels observed in prior years.

Employer (taxpayer) spending on public pensions, 1985 to 2014

“State and Local Government Spending on Public Employee Retirement Systems,” NASRA 2016

New Issue Brief: State and Local Government Contributions to Statewide Pension Plans: FY 14

◀  Receipt of full actuarially determined contributions are vital to pension plan funding and sustainability

◀  State and local government

funding discipline improved in FY 14

◀  Individual state contribution experiences vary widely

Distribution of ARC/ADC received by 112 plans, FY 14

“State and Local Government Contributions to Statewide Pension Plans: FY 14,” NASRA 2016

Median and average ARC/ADC received by 112 plans, FY 01 to FY 14

“State and Local Government Contributions to Statewide Pension Plans: FY 14,” NASRA 2016

Significant Reforms to State Retirement Systems

States that reformed pension plans by year, 2007-2015

“Significant Reforms to State Retirement Systems,” NASRA 2016

States that increased employee contributions

“Significant Reforms to State Retirement Systems,” NASRA 2016

States that reduced pension benefits

“Significant Reforms to State Retirement Systems,” NASRA 2016

States that reduced automatic COLAs

“Significant Reforms to State Retirement Systems,” NASRA 2016

States that established new hybrid plans

◀ Most states retained plan features known to promote retirement plan sustainability and balance stakeholder objectives

◀ While most states retained their defined

benefit plan, a greater share of the risk of accumulating and funding benefits was shifted to employees

◀ Generally, reforms were calibrated to states’ specific conditions

Final Reform Thoughts

Relative change in private and state and local government employment, Jan 06 to July 16

U.S. Bureau of Labor Statistics

Annualized quarterly change in wage and salary costs for private and state and local government employees, 2006-2016

U.S. Bureau of Labor Statistics

Annualized quarterly change in wage and salary costs for private and state and local government employees, 2006-2016

U.S. Bureau of Labor Statistics

Annualized quarterly change in benefit costs for private and state and local government employees, 2006-2016

U.S. Bureau of Labor Statistics

Total public pension assets at year-end, FY 03 to FY 15

Federal Reserve

Nominal change in annual state and local tax revenue by source

U.S. Census Bureau

◀ Delayed Employer Contributions ▲  Many retirement systems provide an extension to employers who

fail to make required contributions on time ▲  Most systems charge interest on late contributions; interest rates

range from 1 percent up to the plan’s full assumed rate of investment return

◀ Service Purchase Calculations ▲  Most retirement systems allow members to purchase credit for

service not covered by a participating employer of the system ▲  Some systems allow service to be purchased at a rate

approximating missed contributions plus interest; others charge the full actuarial cost.

◀ Source of Teacher Pension Contributions ▲  Primary responsibility for funding teacher pensions varies among

states ▲  In some states, teacher pensions are funded exclusively at the

state or local level; in other states, funding responsibility is shared

Survey Highlights

Q u e s t i o n s / C o m m e n t s