Protecting Workers and Taxpayers: Responsible Public Pension Reform

Transcription

1 Protecting Workers and Taxpayers: Responsible Public Pension Reform

2 Table of Contents 1. Introduction 3 2. What is the current situation? 7 3. What does this mean f or the future? Is the structure of retirement b enefits a problem? What should pension reform seek to accomplish? Which plan design is best? Who is leading pension reform efforts? What is a good process for considering reform? 58 2

3 Retirement benefits are an important and valued part of public workers total compensation package. 3

4 However, governments have failed to responsibly manage their retirement systems. Policymakers have engaged in a number of practices that threaten the sustainability of these systems: Accounting gimmicks Insufficient contributions Retroactive/unfunded benefit increases 4

5 As a result, rising pension costs, particularly pension debt service costs, are straining state and local budgets. Services have been cut, and workers have been forced to endure benefit cuts, wage freezes, and job reductions. 5

6 By taking steps to address the issue today, we can prevent a crisis tomorrow. 6

7 What is the current situation? 7

8 The plans own estimates show that public pension debt has more than quintupled over the last decade. State and local governments owe public workers at least $1.097 trillion for retirement benefits they have already earned. 8

9 The plans own estimates show that pension debt is now larger than all of the financial crisis bailouts and nearly as large as all other state debt. 9

10 The plans own estimates show that public pension debt is now larger than it has ever been. Public pension debt is larger than it has ever been relative to the size of the U.S. economy even after the market recovery that followed the 2008 financial crisis. And the volatility of pension financing has increased dramatically since the mid 1990s. 10

11 On average, public pension plans are only 73 percent funded, putting workers retirement security at risk. 11

12 State and local governments pension debt exposure could be much larger. Pension accounting rules allow governments to discount liabilities using relatively high interest rates (e.g., 7 to 8 percent), but since the rate of return is uncertain, the cost of financing pension liabilities could turn out to be much higher. The true size of the current pension debt could be as high as $4.6 trillion if liabilities were discounted at the risk-free rate. And paying off the pension debt could cost up to 4 times more than all of the financial crisis bailouts or 3 times more than all other state debt. 12

13 Arizona PSPRS s liabilities have outpaced its assets over the past decade. 13

14 The divergence between assets and liabilities began in 2001, following the burst of the dot-com bubble. 14

15 The pension debt held by local governments in Arizona has grown precipitously since

16 PSPRS has gone from being 113 percent funded in 2000 to only 51 percent funded today. 16

17 The current situation cannot all be blamed on the 2008 financial crisis. Other factors that governments control have played an even greater role in eroding pension plans finances. These include poor funding practices and retroactive/unfunded benefit increases. 17

18 Funded ratios are declining because governments are not adequately paying for their retirement promises. Only 14 states paid at least 90 percent of their actuarially required contribution (ARC) b etween 2001 and Inadequate contributions and negative amortization account for at least $250 billion of the pension debt. 18

19 Paying the minimum contribution has not been a problem for participants in PSPRS. 19

20 Although making the minimum payment has not been a problem, Arizona, like many other states, has historically calculated its minimum payment in such a way that it keeps annual payments low and is not responsive enough to negative plan experience. 20

21 Additionally, Arizona increased benefits without a credible plan to pay for those benefits a trend that was ubiquitous through the 1990s. 21

22 Rising retirement costs are making it difficult to adequately fund essential public services. Retirement contributions have more than doubled, primarily for benefits workers have already earned, which leaves less m oney f or public workers and services. This is especially true for public schools, where rising retirement costs are limiting the funds for today s classrooms and teachers salaries. 22

23 Rising legacy costs have pushed average PSPRS contribution rates much higher. 23

24 Public leaders are voicing their concerns about the effects of rising retirement costs. we coped with those rising {pension} costs by reducing our workforce we cut services in every part of the city. There s no department that escaped the cuts... we laid off firefighters, we laid off cops, we laid off librarians. We cut, cut, cut for a decade -San Jose Mayor Chuck Reed We are not yet at the point where we are making decisions about {whether} we are going to pay for pensions or plow roads, but it is very close to that. -Syracuse Mayor Stephanie Miner Without {pension} reform, we cannot make the critical investments in our future and the future of our children. Without reform, we cannot be the city that we want to be. -Chicago Mayor Rahm Emanuel 24

25 When public retirement systems are underfunded, workers pay the price. 25

26 Governments are paying more for legacy costs, leaving less money for current and future workers. While private sector wages and jobs are growing, there are fewer teachers, police officers, firefighters, and other public workers in our communities today. A nd those that are on the job often have not received a pay raise in many y ears and have seen benefits reduced. These trends are at least partially explained by the downward pressure created b y rising retirement costs. 26

27 Arizona s public workers have also felt the pain of rising retirement costs. 27

28 Many cities and 48 states have cut workers retirement benefits due to rising costs. C u t s f o r n e w w o r kers: 33 states raised the retirement age. 30 states required workers to pay m ore. 29 states eliminated or reduced retirement cost of living adjustments (COLAs ). C u t s f o r c u r r ent w o r kers : 24 states required workers to pay more. 22 states eliminated or reduced COLAs. C u t s f o r r e t i r ees : 15 states have reduced COLAs for those who have already retired.

29 In cases of extreme fiscal mismanagement, some cities have filed for bankruptcy. Workers lose the most in these instances even if pensions are only a contributing f actor and are n ot the primary cause of insolvency. City Vallejo, CA (filed 2008) [1] Prichard, AL (filed 2009) [2] Central Falls, RI (filed 2011) [3] San Bernardino, CA (filed 2012) [4] Stockton, CA (filed 2012) [5] Detroit, MI (filed 2013) [6] Consequences for workers and retirees Slashed salaries and retiree health benefits, raised employee contributions Stopped providing retirees benefits Cut retirees current benefits by up to 55 percent Ceased pension payments to CalPERS for an entire year Trimmed retirees health insurance, reduced the workforce, and eliminated senior centers, library programs, and recreational services Cut retirees benefits by 4.5 percent for general workers and diminished annual cost of living adjustments for retired police officers and firefighters 29

30 What does this mean for the future? 30

31 While recent pension reforms and strong market returns have produced improvements, public pension systems remain in a very precarious position. 31

32 Government pension promises are now 30 percent of U.S. GDP. P ublic retirement promises are larger relative to the size of our economy than they have ever been, resulting in a reduced ability to pay for downside risk. So m inor investment return shortfalls can translate into serious b udgetary pressure. 32

33 Governments are making riskier bets with workers retirement savings. P ublic plans are expecting m arkets to yield a return that is more than three times larger than it was in the early 1990s relative to risk-free rates. To achieve this return, plans are investing in riskier assets. T he share of assets invested in equities, real estate, and alternatives is at an all-time high. 33

34 Arizona PSPRS is betting on a much bigger risk premium that in the past. 34

35 The structure of the PBI makes it very difficult for the plan to achieve its assumed rate of investment return. The probability of achieving PSPRS s expected investment rate of return is quite low even at higher PBI thresholds and expected portfolio return levels. P r o b a b i l i t y o f A c h i e v i n g a p e r c e n t r e t u r n Expected Portfolio Return Threshold 5% 6% 7% 8% 9% 10% 11% 15% 9% 1.3% 3.0% 6.5% 12.3% 21.2% 32.7% 45.8% 89.7% 12% 2.8% 6.0% 11.8% 20.3% 31.8% 45.2% 59.0% 94.4% 15% 4.7% 9.5% 17.3% 28.0% 41.0% 55.0% 68.2% 96.7% 35

36 Since 2006, public retirement plans have more than doubled the share of assets invested in alternatives. Alternatives, like hedge funds and private equity, are hard to value, have uncertain returns, and have higher fees. A s plans have increased their holdings of risky assets, money m anagement fees have increased by 30 percent. 36

37 The combination of a large and growing pension debt, governments reduced ability to pay, and riskier investments will continue to strain state and local budgets. 37

38 If costs continue to rise, workers will bear a significant share of the pain just as they have over the past decade. 38

39 Is the structure of retirement benefits a problem? 39

40 The vast majority (91 percent) of public workers earn retirement benefits under a defined benefit system based on final average salary and years of service (FAS DB). 40

41 FAS DB plans generally provide a good benefit to workers who spend their entire career in the same industry and geographic area. 41

42 FAS DB plans can have a number of unintended consequences. F A S DB plans can: leave some workers without enough savings for a secure retirement; create strong incentives to work only for a certain number of years and then to retire; and r esult in higher compensation for older entrants. 42

43 Arizona cut PSPRS benefits for new employees in T he benefit cut that resulted from SB1609 is estimated to be 35 percent for the average 25 year - old entrant. Early - and mid-career b enefits are also m uch lower under the new structure, creating retirement insecurity for workers over this period. 43

44 FAS DB plans are challenging to manage sustainably because they are very complex, and cost is uncertain, hard to predict, and difficult understand. 44

45 Given that benefits will be paid in the distant future, FAS DB plans give politicians the opportunity and incentive to avoid making responsible payments. 45

46 Although retirement planning will always involve uncertainty, governments can make public plans simpler and more transparent while also placing all workers on the path to retirement security. 46

47 What should pension reform seek to accomplish? 47

48 Pension reform should establish: A fair, workable plan to pay down the accumulated pension debt as quickly as possible. A retirement savings system that is affordable, sustainable, and secure. 48

49 LJAF s retirement design principles can be used to guide responsible reform efforts. 49

50 Retirement savings plans should incorporate principles in three key dimensions: Retirement Security Fiscal Sustainability Transparency and Accountability 50

51 Retirement Security: Retirement savings plans should place all workers, regardless of tenure or when they were hired, on a path to a secure retirement. Workers must: Accumulate adequate retirement savings across their entire careers. Have access only to professionally managed, lowfee investment options with appropriate asset allocation. Have access to lifetime income options (annuities) upon retirement. 51

52 Fiscal Sustainability: Retirement savings plans should remain financially sustainable across multiple generations of workers and taxpayers. Plan sponsors must: Fully pay for their retirement promises in a responsible, sustainable way. Pay the full actuarial cost every year. Use appropriate assumptions, which consider the sponsor s ability to pay for future shortfalls. Be informed about the potential for and have an ex ante plan to deal with cost uncertainty. 52

53 Key elements of a retirement plan funding policy include: Funding target at least 100 percent Should set rules for handling overfunding once target is reached Actuarial cost method EAN is the industry standard Asset smoothing less is better Discount rate used to set annual contributions Does not have to be equal to assumed portfolio return Target an appropriate probability of full funding SOA BRP recommends risk-free rate plus some predefined risk premium Amortization Policy Layered vs. fixed layered is best for future underfunding Level percent vs. level dollar Payroll growth/inflation if level percent (i.e., increasing payments) Open vs. Closed closed is best practice Length of schedule SOA BRP recommends no more than years 53

54 Transparency and Accountability: Retirement savings plans must have governance structures that ensure key decisions related to investment allocation, benefit design, and choice of actuarial assumptions represent the interests of all stakeholders and are made in a transparent and publicly accountable fashion. Plans must have: Representative boards of trustees with a fiduciary duty to preserve plans long-term sustainability. Independent boards of investment experts. A process to openly share data about the plan, its participants, and its fiscal condition. 54

55 Which plan design is best? 55

56 There is no one-size-fits-all solution. A variety of plans can be tailored to meet LJAF s design principles, including FAS DB, Hybrid, Cash Balance DB, and Defined Contribution. 56

57 Retirement plan design does not run on a smooth continuum from FAS DB to Defined Contribution, with the former offering workers the most protection and the latter the least. 57

58 All plan designs can incorporate important protections for workers including: Adequate savings/benefit accrual rates. Pooled, professionally managed, low-fee, and appropriately allocated investments. Limited lump sums and annuities upon retirement. 58

59 While all plan types can be designed to meet LJAF s design principles, Cash Balance and Defined Contribution represent the simplest, most transparent models for providing secure retirement benefits. 59

60 Cash Balance and Defined Contribution plans tie benefits more closely to contributions and investment returns, eliminate unnecessary variables from cost estimation, and allow governments to more flexibly and transparently offer workers investment and longevity protection. 60

61 Who is leading pension reform efforts? 61

62 Public pension reform is a bipartisan issue. Elected officials on both sides of the political aisle have recognized that reform is needed to protect workers and essential public services. 62

63 Notable champions of responsible pension reform include: T reasurer Gina Raimondo (D), Rhode Island Mayor Chuck Reed (D), San Jose, CA Governor Steve Beshear (D), Kentucky Mayor Rahm Emanuel (D), Chicago, IL Mayor Kasim Reed (D), Atlanta, GA T reasurer David L illard (R), T ennessee State Senator Dan Liljenquist (R), U tah 63

64 What is a good process for considering reform? 64

65 The public task force model has worked well in a number of jurisdictions including: Rhode Island Kentucky Jacksonville 65

66 A responsible pension reform process should: be nonpartisan and objective, include advice from subject matter experts, include open communication with all important stakeholders, and establish reform principles and pursue those principles using data. 66

67 Public workers and taxpayers deserve a public retirement system that places all workers on the path to retirement security, is fiscally sound, and is managed in a transparent and publicly accountable manner. 67