The Future of Public Pensions

Retirement Issues for the 21stCentury National Press Foundation Washington, D.C.
June 11, 2012 Diane Oakley Executive Director National Institute on Retirement Security

www.nirsonline.org

Private Sector: Lower Income Now, Less Retirement Security Later

Private Sector Workers Participating in Employer Based Retirement Plan by Plan Type, 1979-2008 (all workers)

Source: New American Foundation, Bureau of Labor Statistics, Westwood Capital

Source: New American Foundation, DOL, PBGC, EBRI

American Retirement Panic Attack

84% Americans Concerned Current Economic Conditions Hurt Retirement

Source: National Institute on Retirement Security, Pension and Retirement Security 2011, A Roadmap for Policymakers

Americans Believe Workers Should Have Access to Pensions

81% of Americans Say They Need Pension For Independence, Self-Reliance

Source: National Institute on Retirement Security, Pension and Retirement Security 2011, A Roadmap for Policymakers

Towers Watson: Attraction and Retention, What Employees Value Most

Between 2009 and 2011, the percentage of workers younger than 40 who agreed their retirement program was an important factor in accepting their job jumped from 28% to 63%.

Among DB plan participants in 2011, 51% say the companys retirement program played a strong role in their decision to join the company, up considerably from 31% in 2009.

Public Pensions: Strong Financials for Most Plans Going into Financial Crisis
Aggregate State and Local Pension Funding Levels Assets as a Share of Trust Fund Liabilities (percent)

Source: Center for Retirement Research at Boston College (data not provided for 1995, 1997, 1999)

Private and Public Sector Pensions Comparisons Funding and Plan Contribution Volatility
Corporate vs. Public Pension Funding Levels, Costs
Comparison of corporate and public pension funding levels, 2000 to 2010
Funding Level 120%
60% Corporate

Comparison of change from prior year in corporate and public pension contributions, 1989 to 2009

80%

Corporate 100%

40%

20%

Public

0%

80%

Public
-20%

00

01

02

03

04

05

06

07

08

09

10*

Wilshire, Milliman, and Public Fund Survey

*Estimate

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 US Dept of Labor, *Estimate US Census Bureau, Milliman

Vast Majority of Public Plans Well Funded

Distribution of Funded Ratios for 126 Largest State, Local Pensions, 2010
30%

25%

20%

15%

10%

5%

0% 40-49 50-59 60-69 70-79 80-89 90-99 100+

Funding Ratio (Percent)

Source: Center for Retirement Research, Boston College

Distinguishing Elements of Public Pension Plans that Best Balance Stakeholder Objectives
Mandatory participation Employee-employer cost sharing Assets that are pooled and professionally invested Lifetime benefit payments Benefit adequacy

Public Pensions Typically Are Shared Funding Responsibility

Employee and Employer Pension Contributions, 1982 to 2009

Source: U.S. Census Bureau

On Average, Public Pension Benefits Modest, With 30% of Workers Not Eligible for Social Security
Average Monthly Public Pension Benefit, 1993-2008
(2008 Constant Dollars)
2,000 1,888 1,900 1,800 1,847 1,775 1,716 1,871 1,865 1,852 1,871

1,700
1,600 1,557 1,500 1,400 1,326 1,300 1,200 1,100 1,000 1993 1994 1995 1996 1997 1998 1999 2000 2001 1,306 1,430 1,377 1,488 1,584 1,497

2002

2003

2004

2005

2006

2007

2008

Source: U.S. Census Bureau

Strong Investment Returns: Exceed 8% Over Two Decades

Median public pension investment returns for periods ended 12/31/11
11.4%

8.3% 7.7% 5.7%

2.0% 0.8% 1 3 5 10 20 25

Years ended 12/31/11

Source: NASRA based on Callan Associates Data

Historical Snapshot: Investment Returns

Source: Gabriel, Roeder, Smith & Company

Using Theory Rather Than Reality Artificially Creates Surplus

Risk-Free Rate Leads to Excess Funding

Source: Government Finance Review, February 2011

Future Outlook?
States will continue to implement changes to ensure long-term pension sustainability. State & local government will continue to offer pensions with supplemental DCs. Closing an underfunded pension plan does not save money. Public pensions will continue to recover.

Public Pensions Implementing Changes to Ensure Long-Term Sustainability

In 2011, 32 states enacted significant changes in public pension plans
In 2010, 21 states enacted changes In all, 41 states acted in 2010-2011 (some

Source: National Conference of State Legislatures, 2011

Major Pensions Legislation in 20102011: All Topics

41 States Represented
Source: National Conference of State Legislatures, 2011

Increase in Employee Contributions, 2010 and 2011

26 states represented
Future Members Only (5 states) At Least Some Current Members (21 states)
Source: National Conference of State Legislatures, 2011

Higher Age and Service Requirement for Normal Retirement, for New Members, 2010 and 2011
4 24 States Represented
Source: National Conference of State Legislatures, 2011

Reduced Post-Retirement Benefit Increases Enacted in 2010 and 2011

18 States Represented
Future hires only (6 states) At least some active employees (6) People already retired and active employees (6)
Source: National Conference of State Legislatures, 2011

Some States Have Replaced DB Plans

In 2010, Utah closed its DB plan for all state and local employees. As of July 1, 2011, Utah offers new employees the choice of a defined contribution plan or a hybrid plan that includes a DB plan and a mandatory 401(k). As of July 1, 2010, Michigan replaced its School Employees DB plan with a hybrid plan. Rhode Island will transfer all members of the state DB plans (except judges and public safety) to a hybrid plan in 2012.
Source: National Conference of State Legislatures, 2011

Rhode Island Pension Reform: Cost Implications

State Liabilities will decrease by $3 billion Employer costs will decrease by $276 million the first year

About a quarter of this savings is due to use of a reasonable actuarial method change
The rest more than $200 million comes from the workers, in the form of benefit cuts

Source: Pension Trustee Advisors, 2011

More than $150 Million Savings Could Have Been Realized Without Cutting Benefits

H6319/S1111

Lengthened Amortization

Source: Pension Trustee Advisors, 2011

Rhode Island Pension Reform: Major Benefit Implications

Freeze cost of living adjustments for many years for retirees Shift current workers into a Hybrid plan, which is a much reduced DB plan with 5% worker contributions and 1% employer contributions going to a DC plan
Source: Pension Trustee Advisors, 2011

Illustration of Impact of COLA Freeze

Source: Gabriel, Roeder, Smith & Company

Rhode Island Pension Reform: Illustration of Impact of Hybrid Mid-Career Female Teacher
Currently age 45
Hired at 32, so 13 years of service Current Salary of $69,000

She anticipated retiring at 62 with 30 years

Now must wait until 67 for full benefit Or take an actuarially reduced benefit This illustration will be based on age 62 benefit
Source: Pension Trustee Advisors, 2011

Rhode Island Pension Reform: Typical Teacher Illustration - Contributions

Shes contributed 9.5% of pay for 13 years
She planned on another 17 years of 9.5% Under hybrid, shell be contributing: 3.75% to DB plan 5.00% to DC plan Lifetime average contribution has decreased by 4% from 9.5% to 9.1%

Source: Pension Trustee Advisors, 2011

Typical Teacher Illustration Benefit Replacement at Age 62

Source: Pension Trustee Advisors, 2011

Pensions Make Sense for Public Sector Sector Employers, Taxpayers

State and local governments also have a strong comparative advantage relative to private industry in offering pension benefits. Since many of the most common government jobs firefighter, police officer, corrections officer, regulatory overseerhave no direct private sector analog, the lifetime-with-one employer career path scorned by many in the private sector makes a lot of sense for government employees.
Eli Lehrer, Heartland Institute, Weekly Standard, March 28, 2011

Overwhelmingly, Public Employees Choose the DB Plan Over Time

Source: Decisions, Decisions: Retirement Plan Choices for Public Employees and Employers, 2011

Most Important Factors in Attracting Employees Younger Than 40 to a Company

Source: Towers Watson, Retirement Plan Changes and Employer Motivation, 2012, Figure 8

DB More Economically Efficient

Longevity Risk Pooling
DB plans better manage longevity risk, or the chance of running out of money in retirement DB plans avoid the over-saving dilemma and do more with less

Maintenance of Portfolio Diversification

DB plans are able to take advantage of the enhanced investment returns that come from a balanced portfolio throughout an individuals lifetime

Superior Returns
DB plans, which are professionally managed, achieve greater investment returns versus those of individual accounts

Source: Pension Trustee Advisors, 2011

Pensions Most Economically Efficient Retirement Plan: HALF the cost of DC

Cost of DB and DC Plan as % of Payroll
25% 20% 15% 10% 5% 0% 12.5% DB Plan 22.9% DC Plan
Lower Returns/Higher Fees Less Balanced Portfolio No Longevity Risk Pooling DB Cost

46% Savings

Source: National Institute on Retirement Security, A Better Bang for the Buck

Trends in DB Plans
States are shifting more of the eventual cost of retirement to members.
Higher contributions; Longer service requirements; Higher ages for normal retirement; and Lower post-retirement benefit adjustments.

More restrictions on retirement before normal age and on retired people returning to covered service (often called "double-dipping).
Source: National Conference of State Legislatures, 2011

Most States Find Closing an Underfunded Plan Does Not Save Money
Closing a plan does nothing to address the existing unfunded liabilities and can actually add costs Most states have determined the appropriate response to their pension challenges is to make adjustments to the existing benefit design and financing structure. Closing a public pension plan has unintended consequences, including:
decreasing contributions accelerating pension costs for employees in the closed plan increasing administrative costs increasing costs for survivor and disability insurance

Source: National Association of State Retirement Administrators

Future Outlook?
States will continue to implement changes to ensure long-term pension sustainability. State & local government will continue to offer pensions with supplemental DCs. Closing an underfunded pension plan does not save money. Public pensions will continue to recover.

Public Pensions: Projected State and Local Funding Ratios Under Three Scenarios, 2011-2015

Source: Center for Retirement Research at Boston College (data not provided for 1995, 1997, 1999)

Additional Resources
American Benefits Council Lynn Dudley Boston College Center for Retirement Research Alicia Munnell Chamber of Commerce Aliya Wong Center on Budget and Policy Priorities Elizabeth Liz McNichol Center for Economic & Policy Research Dean Baker Center for State & Local Govt. Excellence Beth Keller Groom Law Group Ian Lanoff ERISA Industry Committee Mark Ugoretz Employee Benefits Research Institute Dallas Salisbury Government Accountability Office Frank Todisco Heritage Foundation David John National Assn. of State Retirement Administrators Keith Brainard Penn State University Ron Gebhardtsbauer Segal Company Cathie Eitelberg University of Massachusetts Christian Weller Yale University Jacob Hacker

www.nirsonline.org

Diane Oakley 202.457.8190 doakley@nirsonline.org