Retirement Finance: The changing landscape for finance officials. February 28, Presented by:

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1 Retirement Finance: The changing landscape for finance officials February 28, 2019 Presented by: Sean McNeeley and Paul Matteo PFM Center for Retirement Finance 1735 Market St. 43 rd Floor pfm.com PFM Philadelphia, PA

2 Headlines / The Challenge PFM 2

3 Framing the Public Policy Issue Total net pension liabilities of the 50 states: $733 billion (Standard & Poor s) Total with more realistic discount rate and reinvest assumptions: $1.6 trillion (Moody s) Starting in 2016, ten thousand baby boomers will retire or reach age 65 each day for the next 17 years (Kiplinger) Only 26% of individuals believe they will be financially ready to retire (Mercer s 2018 Workplace Survey) By 2033, thirty million individuals will have reached age 65 leaving both Medicare and Social Security unable to pay their bills from current revenue, with adjustments Today, retiree spending equals 5.3% of our GNP and retirees hold 36% of the nation s invested capital PFM 3

4 Liabilities Grow Ever Higher Total Liabilities of State and Local Government Defined Benefit Pension Funds and Related Funded Ratios, Liabilities Funded Ratio 7 140% 6 120% 5 100% $ in Trillions % 60% 2 40% 1 20% q1 1979q1 1984q1 1989q1 1994q1 1999q1 2004q1 2009q1 2014q1 Source: Federal Reserve Board, Financial Accounts of the United States 0% PFM 4

5 Pension Milestones American Express establishes first pension plan Federal employees pension plan established Social Security established Private employee participation in pension plans : 46% State and local gov participation in DB plans peaks: 91% Massachusetts establishes first state pension plan Pension asset earnings excluded from income tax Contributions to DC plans excluded from income tax 401(k) Private employee participation in DB plans peaks: 28% PFM 5

6 Pensions by Sector: Divergence 80% Worker Participation in Pension Plans by Sector and Type % 70% 60% 50% 44% 40% 30% 20% 10% 15% 15% 0% State and Local Government Private Industry Defined Benefit Defined Contribution Source: Bureau of Labor Statistics National Compensation Survey, March 2016; note participation is not mutually exclusive, total participation in private industry in a retirement plan was 49% PFM 6

7 OPEB by Sector: Even More Divergence Access to Retiree Health Care Benefits, Private Sector and State and Local Government 80% 70% 60% 50% 40% 30% 20% 10% Under age 65 Age 65 and over 0% State and local government workers Private industry workers Source: Bureau of Labor Statistics, National Compensation Survey, March 2012 PFM 7

8 Why the Divergence? 1. Differences in accounting and financial focus Private sector accounting of long-term liabilities has required valuing the entire present value of the benefits and any unfunded liability on the balance sheet Discounted at the rate of borrowing/bond rate Expense recognition based on market value Incentives are to reduce liability and avoid volatility Public sector accounting prior to GASB 67 & 68 only recorded a portion of unfunded liability on the balance sheet Discounted at the earnings rate Limited expense recognition based on actuarial value 2. Differences in legal and labor framework State and local governments have tended to have more unionized workforces Slower to change More emphasis on retirement security than control, portability Benefits granted by public employers are protected to various degrees by state law Not backstopped by PBGC or covered by ERISA Typically greater protections of accrued and future service benefits than available to private employees under federal law Financial focus primarily on budgetary basis results PFM 8

9 Pension Fund Inflows and Outflows Investment Earnings / Losses Employee Contributions Employer Contributions Full Funding (100%) Current Funding (<100%) Pension Fund Expenses Benefit Payments PFM 9

10 State and Local Funding: Different Perspectives 120% 100% 80% 60% 40% 20% 0% Actuarial Value of Assets Market Value of Assets Assets Using Riskless Discount Rate Source: The Funding of State and Local Pensions: , The Center for Retirement Research at Boston College, May 2012 The Funding of State and Local Pensions: , The Center for Retirement Research at Boston College, June 2015 State and Local Pension Plan Funding Sputters in FY 2016, The Center for Retirement Research at PFM Boston College, August

11 Pension Contributions Through the Years 100% 90% 80% 70% 60% 50% 40% 100% 95% 88% 86% 84% 83% 87% 10.6% 11.1% 11.5% 92% 86% 11.8% 12.1% 81% 13.6% 79% 15.7% 81% 82% 17.1% 17.8% 86% 17.6% 25.00% 91% 92% 20.00% 18.6% 18.6% 15.00% 10.00% 30% 20% 6.4% 6.1% 7.4% 9.0% 5.00% 10% 0% % Percent of ARC Contributed ARC as Percent of Payroll Source: The Funding of State and Local Pensions: , The Center for Retirement Research at Boston College, May 2012 The Funding of State and Local Pensions: , The Center for Retirement Research at Boston College, June 2016 State and Local Pension Plan Funding Sputters in FY 2016, The Center for Retirement Research at Boston College, August 2017 PFM 11

12 Annual Funding Levels Acting as Indicators CA 79% AK 424 % OR WA 108 % 151% NV 88% ID 159% UT 139% AZ 86% 2015 Net Amortization % Contributed MT 110% WY 76% NM 86% HI 92% CO 65% ND 111 % SD 870% NE 197% KS 86% TX 67% OK 162% MN 91% IA 114 % MO 132% AR 117 % LA WI 158 % 143% IL 72% MS 100 % MI 113 % OH IN % % KY 46% TN 184% AL 105 % WV 164% GA 100% NY 163 % PA 74% VA 101 % NC 171% SC 84% FL 118 % ME 149 % NH 107% VT 121% MA 98% CT 101% RI 102% NJ 32% DE 136% MD 101% 75% or Above Below 75% SOURCE: The Pew Charitable Trust, The Fiscal Health Of State Pension Plans July 2017 PFM 12

13 To Overall Plan Funding CA 74% AK 68% WA 87% OR 92% NV 75% ID 92% UT 86% AZ 63% MT 75% WY 73% CO 61% NM 71% HI 62% 2015 State Funded Status ND 70% SD 104 % NE 91% KS 65% TX 76% OK 79% MN 80% IA 85% MO 81% AR 82% WI 98% LA 63% IL 40% MS 62% MI 64% IN 65% KY 38% TN 95% AL 67% OH 76% WV 77% GA 81% PA 56% VA 75% NY 98% NC 96% SC 58% FL 87% ME 83% NH67% VT 67% MA62% CT 49% RI 57% NJ 38% DE 89% MD68% 91% or Above 76% - 90% 66% - 75% 51% - 65% Below 50% SOURCE: The Pew Charitable Trust, The Fiscal Health Of State Pension Plans July 2017 PFM 13

14 Retirement Plan Trends PFM 14

15 Let s Do Something PFM 15

16 but What? Increase Age and Service Requirements 34 states Increase Employee Contributions 37 states Reduce COLAs for active and/or Retired Members 24 states Increase the Years Included in Final Average Salary 21 states Reduce the Benefit Multiplier 12 states Replace DB Plans 8 states PFM 16

17 Not Just the States Trends in Plan Changes, NCPERS Public Retirement Systems Study Shorten the amortization period to improve funded status Hold or lengthen the amortization period to improve affordability Increase employee contributions Raise benefit age/service requirements Lower the actuarial assumed rate of return 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Already Implemented Considering Implementing Source: NCPERS Public Retirement Systems Study, January 2019 PFM 17

18 Rates of Return: Near-term Volatility with Long-term Stability 18.00% Pension Plan Annualized Rate of Return 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 1 Year 3 Years 5 Years 10 Years 20 Years 25 Years Annualized Rate of Return YE 2013 Annualized Rate of Return YE 2014 Annualized Rate of Return YE 2015 Annualized Rate of Return YE 2016 Annualized Rate of Return YE 2017 Source: NASRA Issue Brief: Public Pension Plan Investment Return Assumptions, National Association of State Retirement Administrators, February 2018 PFM 18

19 Discount Rates Used By Public Plans Distribution of Investment Return Assumptions 30.0% 26.4% 25.0% 23.3% 20.0% 17.8% 15.0% 14.0% 10.0% 9.3% 8.5% 5.0% 0.0% < Investment Return Assumptions (%) 0.8% Source: NASRA Issue Brief: Public Pension Plan Investment Return Assumptions, National Association of State Retirement Administrators, February 2018 PFM 19

20 Discount Rates Used By Public Plans 30.0% Distribution of Investment Return Assumptions 25.0% 26.6% 25.0% 20.0% 19.5% 15.0% 10.0% 12.5% 11.7% 5.0% 4.7% 0.0% < Investment Return Assumptions (%) 0.0% Source: NASRA Issue Brief: Public Pension Plan Investment Return Assumptions, National Association of State Retirement Administrators, February 2019 PFM 20

21 Recent Returns and Volatility Public plans continue to de-risk their plans by reducing the investment return assumption/ discount rate The 2018 NASRA average of 7.4% was down from 7.9% in 2010 According to Callan Associates, the median return for public pension funds was 3.2% for the period ending June 30, 2015, and 0.5% for the period ending June 30, 2016, far below median return assumptions of 7.5%. Returns of 12.4% and 8.2% were much stronger for the periods ending June 30, 2017 and June 30, 2018 respectively. Moody s projected that factoring in the lags of actuarial smoothing, the Adjusted Net Pension Liability for state pensions would decrease by 6.6% for FY18 and then decline by 4.7% for FY19 to reflect the results above. Moody s has found that more than half of States, and 40 of the 50 largest rated local governments do not contribute at a level sufficient to reduce net pension liabilities. Sources: NASRA Issue Brief: Public Pension Plan Investment Return Assumptions, National Association of State Retirement Administrators, February 2018; Moody s Investors Service, Market Volatility Points to Growing US Pension Debt in 2016, March ; Medians - Moderate Adjusted Net Pension Liability Growth in 2016 Precedes Spike in 2017, September ; Medians Adjusted Net Pension Liabilities Spike in Advance of Moderate Declines, August ; Retiree Benefits Drive Growth in PFM Fixed Costs, Posing Greater Challenges than Debt, February

22 Average Funded Ratios and Percentage of Required Contribution Received for States Average Funded Ratio by 2017 Funded Status, Percentage of Required Contribution Received by 2017 Funded Status, % 110% 100% 100% 90% 75% 50% 25% 0% Top third Middle third 90% 73% 55% % 80% 60% 40% 20% 0% 85% 72% 67% 95% 80% 74% Top third Middle third Source: PPD ( ). Sources: 2017 AVs and PPD (2017). Average Total Normal Cost as a Percentage of Payroll by 2017 Funded Status, 2001 and % 15% 10% Top third Middle third 11.2% 12.2% 10.8% 16.6% 15.0% 13.7% 5% 0% Source: PPD ( ). Source: Center for Retirement Research at Boston College, Stability in Overall Pension Plan Funding Masks a Growing Divide, October 2018 PFM 22

23 Illustration: Commonwealth of Kentucky Pension Project Summary Components of $25.3 Billion Increase in Unfunded Pension Liabilities: All Systems Funding Funding < ARC, 15% Funding Method: Actuarial Backloading, 25% Actuarial Assumption Changes 22% Investment: Market Performance < Assumption 15% COLAs 9% Investment: Plan Performance < Market 8% Plan Experience 6% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% PFM 23

24 Illustration of Actuarial Back-Loading: Commonwealth of Kentucky Pension Project Comparison of Pension Amortization Schedules KERS-NH June 30, 2016 Valuation and Actuarial Assumptions Level % of Payroll (Current Baseline Amortization Method as Defined in 2013SB2 vs. Level $ Amortization ($ in Millions) Year Employer Contribution Unfunded Liability Funded Ratio Level % Level $ Level % Level $ Level % Level $ 2019 $731.7 $1,082.2 $11,620 $11, % 15.6% , ,741 10, % 17.9% , ,789 10, % 20.5% , ,814 10, % 23.6% , ,805 9, % 26.5% , ,767 9, % 29.7% , ,692 9, % 32.7% , ,581 8, % 36.1% , ,428 8, % 39.2% , , ,229 7, % 42.7% , , ,983 7, % 46.0% , , ,683 6, % 49.7% , ,327 6, % 53.1% , , ,907 5, % 57.0% 2033 $1,190.7 $929.8 $9,422 $5, % 60.7% Source: Cavanaugh MacDonald Note: Actuarial assumptions include 6.75% earnings assumption, 4% payroll growth, and 26-year remaining amortization period. PFM 24

25 OPEB/Medical Cost Trends 20% 18% Total National Health Expenditures as a Percent of Gross Domestic Product % 16% 14% 12% 10% 8% 6.9% 6% 4% 2% 0% Source: Kaiser Family Foundation analysis of National Health Expenditure (NHE) data from Centers for Medicare and Medicaid Services, Office of the Actuary, National Health Statistics Group PFM 25

26 Medical Cost Increases Moderating 16% Annual Change in Average Family Coverage Premium Cost for Employer-Based Health Insurance % 12% 10% 8% 6% 4% 2% 0% Source: Calculated from Kaiser Family Foundation analysis of Agency for Healthcare Research and Quality, Center for Financing, Access and Cost Trends. Medical Expenditure Panel Survey. PFM 26

27 OPEB Funded Ratio Distribution 0% Funded 0% - 1% 1% - 5% 5% - 10% 10% - 20% 20% - 40% 40% - 60% Above 60% WA OR NV CA ID AZ UT MT WY CO NM ND SD NE KS OK MN IA MO AR WI IL MS NY MI PA OH IN WV VA KY NC TN SC AL GA ME NH VT MA CT RI NJ DE MD TX LA AK FL HI Note: Oklahoma does not report implicit subsidy of its retirement plan death and disability benefits as a separate unfunded OPEB. Nebraska and South Dakota do not offer other OPEBs. PFM Source: Standard & Poor s

28 Percentage of Retiree Health Care Premiums Paid by the Employer, % 60% 58% 50% 40% 40% 36% 30% 20% 22% 21% 14% 10% 0% None 1-99% 100% Pre-Medicare Medicare-Eligible Source: Cobalt Community Research, Health and OPEB Funding Strategies, 2014 National Survey of Governments PFM 28

29 Accounting and Reporting PFM 29

30 Asset Depletion and the Calculation of the Discount Rate The discount rate is now dependent on a depletion calculation. Depletion occurs when assets plus expected contributions and earnings (collectively, Assets ) are less than current and future benefit payments and expenses (collectively, Liabilities ). During the period of time in which expected contributions and assets will be sufficient to cover future benefit payments, the long-term expected rate of return may be used to discount those benefit payments. Once the assets are depleted and the benefit payments are being paid out of pocket (pay-go), the benefit payments must be discounted at a rate equal to a 20-year, AA/Aa (or higher), tax-exempt yield. The overall discount rate associated with the plan will be a blended discount rate of the long-term investment rate of return and the lower 20-year, AA/Aa, tax-exempt yield. This rate will be the single rate that calculates the same present value of future benefits as the combination of the two separate present value of future benefits based on the different rates mentioned above. PFM 30

31 Asset Depletion and the Calculation of the Discount Rate (Cont d) Below is an example of future benefit payments and which rate will be used to discount the cash flows associated with those payments. Future Benefit Payments and Their Associated Discount Rate Benefit Payments in Millions ($) Assets are Depleted Long-Term Investment Rate of Return 20-Year, AA, Tax-exempt Yield PFM 31

32 Implications of Recent GASB Statements Individual funding policies will be necessary to define how a plan will be funded going forward. Those policies need to consider the blended rate calculation and its impact on liabilities. Employers participating in multi-employer plans now report a share of liability and have related additional visibility OPEB net liability now all reported in financials, and the method for discounting liabilities is more standardized Initial estimates were that approximately 20-25% of plans in the Public Plan Database would be negatively impacted by blended discount rate According to a 2015 Moody s analysis of early statements with the new standard, only 4 of 54 plans analyzed used a blended discount rate: Illinois (Employees and Universities), Kentucky, and Texas A Stanford University Hoover Institution analysis of FY14 data for 564 state and local plans found that only 11% used a blended discount rate Generally, if the employer is fully funding their actuarial contribution regardless of whether the assumptions are optimistic, the funded ratio is low, etc. then the blended discount rate does not come into play Sources: Center for Retirement Research at Boston College, How Would GASB Proposals Affect State and Local Reporting, September 2012; Hoover Institution at Stanford University, Hidden Debt, Hidden Deficits: How Pension Promises Are Consuming State And Local Budgets, April 2016 PFM 32

33 Supplemental Reporting Descriptions and current year financial disclosures Required 10-year schedules of sources of changes in the NOL and of the components of the NOL and related ratios e.g., actual contributions, payroll coverage, etc. Target asset allocations and expected asset class returns Sensitivity analysis to depict the liability at the baseline, +/- 1% in healthcare inflation, and +/- 1% rate of return (pension reports will only require sensitivity on the discount rate). 1% Decrease (6.0%) Discount Rate (7.0%) 1% Decrease (8.5% - 4.5%) $(61,284) 1% Increase (8.0%) Healthcare Cost Trend Rates (9.5% - 5.5%) $54,687 $6,366 $(51,620) 1% Increase (10.5% - 6.5%) $88,512 Source: Proposed Statement of the Governmental Accounting Standards Board, Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions, May 28, 2014; updated to reflect final version of Statements 74 & 75 PFM 33

34 Tools for Addressing the Challenge PFM 34

35 What Are the Tools? Consistent Budgetary Funding Establish/Update a Funding Policy Fund the ADC Rate Stabilization Fund Manage Benefit Liabilities Plan Design Reform Participant and Benefit Segmentation Evaluate Exchanges Risk Management Risk Sharing Risk Transfer Build Fund Assets Dedicated Taxes Asset Monetization Pension Obligation/OPEB Bonds PFM 35

36 Funding Policy A funding policy must be established with specific objectives. Lay out a plan to fund pensions Provide guidance in making annual budget decisions Demonstrate affordable financial management practices to taxpayers Reassure bond rating agencies Assure employees how pensions will be funded Sustainability through policy implementation. Have a pension funding policy that is based on an actuarially determined contribution Build funding discipline into the policy to ensure that promised benefits can be paid Maintain intergenerational equity so that the cost of employee benefits is paid by the generation of taxpayers who receive services Make employer cost a consistent percentage of its current and projected payroll Require clear reporting to show how and when pension plans will be fully funded PFM 36

37 Why Fund OPEB? Earn a higher rate of return than cash more efficient use of resources Reduce the unfunded liability that will be reported on the balance sheet following GASB 74/75 by: Dedicating assets to decrease Net OPEB Liability Allowing application of the higher discount rate to some portion of the liability Offset the 5%+ growth in costs of the medical benefits by investing in long-term assets The cost of the benefit is funded when earned, instead of passed to future taxpayers/ ratepayers 9,000,000 7,000,000 5,000,000 3,000,000 Growth of Initial $1 million Investment* Invest today vs. 5 years vs. 10 years Now 5 Years 10 Years $7,612,255 $5,427,433 $3,869,684 1,000, *Example represents growth of original deposit at an annual earnings rate of 7%, which is an average long-term rate of return for a balanced fixed-income and equity portfolio; assumes no redemptions of funds. Model returns may not reflect material economic or market factors. Returns are shown before any fees. Do not assume that the recommendations made in the future will be profitable or will equal the performance cited. PFM 37

38 Asset Monetization as a Funding Strategy Many governments own significant assets that provide a stable and long-term source of cash-flows. Governments may sell or lease these assets to match long-term cash-flows with the long-term liabilities associated with retirement systems. Pittsburgh, PA rejected a bid of $453 million for a 50-year lease on parking revenues to fund its pension deficit. Instead, it sought to accomplish the same purpose by transferring the yearly parking revenue directly to the pension system. While the economics of this were similar, no changes were made to the pension system s benefits, and the funded ratio is falling. Allentown, PA leased its water utility for 50 years to a public authority in return for $211.3 million, of which $160 million was used to reduce the unfunded pension liability. Future rate increases were limited and there was no initial cost to taxpayers. As a result, Standard & Poor s revised Allentown s ratings outlook from stable to positive. Scranton, PA sold its wastewater system to Pennsylvania American Water for $195 million. The net proceeds of the transaction were utilized to pay off debt and a deposit to the pension system, which was roughly 25% funded in aggregate at 12/31/14. The City s Recovery Coordinator has recommended an exit within the next three years from the state s fiscally distressed status, which has been in place since PFM 38

39 Pension Obligation Bond Mechanics Issuers of Pension Obligation Bonds ( POBs ) issue debt in the taxable fixed rate markets and deposit the proceeds into their pension system. POBs are a risk-bearing arbitrage strategy between the cost of financing and the return on investment. Investment rates that are greater than borrowing costs will achieve net savings to the pension obligation. POB proceeds should be invested in asset classes that provide the best risk/return trade-off (i.e. Equities). POBs replace a soft liability with a hard liability. PFM 39

40 POB Considerations There are numerous factors that must be evaluated when considering a POB that directly impacts the funding strategy. Conversion of a soft liability to a hard liability Issuance timing Issuer debt load and capacity Ratings impact Covenant risk mitigation strategies while debt is outstanding (to the extent legally enforceable) Create separate trust structure within retirement system to facilitate a POB investment strategy that is different than system-wide asset allocation Limit ability to provide benefit enhancements while POB debt is outstanding Consider a rate stabilization fund from POB excess returns once funded ratio exceeds 90% PFM 40

41 What is the Pension Obligation Bond Window? The period of time an issuer of benefits bonds can most reasonably expect to invest bond proceeds in the stock market without witnessing lower stock prices in the subsequent economic recession. Measured from the bottom of the stock market (which typically corresponds to the trough of an economic business cycle) until the stock market breakeven level with the subsequent stock market bottom. Theoretically, the period in which the risk of subsequent cycle loss is < 50%. Quantifiable only in hindsight. No one can ever predict in realtime when there is a bottom. PFM 41

42 Evaluating POB Strategy Outcomes It is important that POB issuers commit to taking a long-term view on the results of the strategy. History shows that over a long-term period (30-year), equities predominantly outperform POB funding costs; whereas shorter term views (5-year) provide more erratic performance results and greater risks. Data source: Ibbotson Associates, Inc. PFM 42

43 Investment of POB Proceeds Proceeds of a POB issuance should be invested differently than the balance of the retirement system assets. Typical pension plan investment strategies have asset allocation targets that include equities, fixed income, and other asset classes. Plan sponsors should not issue bonds to buy bonds. POB proceeds should primarily be invested in equity asset classes. Over a 20-year history, equity asset classes have regularly out-performed fixed income classes, on a relative basis. PFM 43

44 Asset Class Annual Returns Annual Returns by Asset Class ( ) Source: Callan Associates PFM 44

45 POB Analysis Investment Return Funding Levels Comparison Funded Percentage # Results B 80% Funded Ratio Scenario 79.69% 79.41% 79.10% 78.77% 78.70% 78.36% 79.28% 95.44% 4B 80% Funded Ratio Scenario % Return 79.69% 80.54% 81.44% 82.40% 83.70% 91.81% % % 5B 80% Funded Ratio Scenario % Return 79.69% 78.27% 76.79% 75.25% 73.92% 66.44% 46.83% 31.00% 6B 80% Funded Ratio Scenario - Shock Return 79.69% 79.41% 79.10% 58.55% 54.75% 54.53% 36.59% 20.10% # Comparison to 80% Funded Ratio Scenario - Base Case B 80% Funded Ratio Scenario % Return 0.00% % % % % % % % 5B 80% Funded Ratio Scenario % Return 0.00% - (1.14%) - (2.31%) - (3.52%) - (4.78%) - (11.91%) - (32.45%) - (64.45%) 6B 80% Funded Ratio Scenario - Shock Return 0.00% 0.00% 0.00% - (20.23%) - (23.96%) - (23.82%) - (42.69%) - (75.34%) PFM 45

46 Rating Agency Pension Funding Metrics & Data Similarly, for Moody s and Fitch, the addition of a POB of this magnitude has a far more substantial impact on debt than pension ratios. This could result in the POB being viewed as a credit negative, if done in isolation. (1) All Current Values for debt metrics use the most recent rating report assumptions from Moody's. (2) All Current Values for pension metrics use a combination of actuarial figures to calculate past ANPL values. (3) All Revised Values use the same assumptions as the Current Values, with the $5 billion POB layered in. (1) All Current Values for debt metrics use the most recent rating report assumptions from Fitch. (2) All Current Values for pension metrics use baseline actuarial figures. Current Value (3) All Revised Values use the same assumptions as the Current Values, with the $5 billion POB layered in. Current Score Revised Value ($5 Bn POB) Revised Score Moody's Rating Considerations Net Tax Supported Debt / Total Governmental Fund Revenues 26% Aa1 44% Aa2 3- Year Average of ANPL / Total Governmental Fund Revenues 112.9% Aa3 110% Aa3 Fitch Rating Considerations Current Value Current Score Revised Value ($5 Bn POB) Revised Score Net Tax Supported Debt / Personal Income 2.8% Average 4.6% Average Debt Amortization Rate 62% Average 46% Average Combined Debt and Unfunded Pension Liability as a Percent of Personal Income 10% Below Average 11% Below Average PFM 46

47 POB Analysis Bond Structure Systems' # Scenario Name Bonding Amount Category of Analysis Return 5 $5 Bn POB - CIB Deferred Principal $5,000,000,000 Structure Comparison 7.50% Bond Structure CIBs, DS Uniform to ARC, 3 Years Deferred Principal Scenario 5 ($ Millions) PV Systems' Funded Percentage by Year 56% 55% 58% 58% 58% 63% 77% 98% Aggregate Employer/Employee Contributions 3,767 4,644 5,656 6,858 7,479 8,453 10,989 8,005 97,512 General Fund Impact (Annual Cost + POB DS) 1,248 1,709 2,291 2,904 3,238 3,663 4,781 2,214 40,932 Systems' # Scenario Name Bonding Amount Category of Analysis Return 6 $5 Bn POB - CIB Tranched Issues $5,000,000,000 Structure Comparison 7.50% Bond Structure CIBs 2 $2.5 Bn Issuances, 2014 & 2017 Scenario 6 ($ Millions) PV Systems' Funded Percentage by Year 56% 55% 56% 56% 58% 63% 77% 98% Aggregate Employer/Employee Contributions 3,767 4,706 5,780 6,922 7,486 8,463 11,002 8,009 97,803 General Fund Impact (Annual Cost + POB DS) 1,248 1,709 2,291 2,904 3,242 3,669 4,789 2,215 40,988 Systems' # Scenario Name Bonding Amount Category of Analysis Return 7 $5 Bn POB - Alt Bond Types $5,000,000,000 Structure Comparison 7.50% Bond Structure $250mm DIBs, $250mm CABs, $500mm VRDBs, $4 Bn CIBs Scenario 7 ($ Millions) PV Systems' Funded Percentage by Year 56% 55% 58% 58% 58% 63% 77% 98% Aggregate Employer/Employee Contributions 3,767 4,663 5,693 6,895 7,473 8,446 10,979 8,002 97,514 General Fund Impact (Annual Cost + POB DS) 1,248 1,709 2,291 2,904 3,196 3,656 4,773 2,211 40,816 PFM 47

48 Funding Concepts Today PFM 48

49 The Three Prongs of Retirement Funding To be effective and sustainable, a funding strategy must be considered across three primary areas. FUNDING CONSIDERATIONS Benefits Benefit Structure Demographics Labor Negotiations Budgetary / Financial Budget Flexibility Solution Options Credit Impact GASB Changes Investments Return Assumptions / Projections Asset Allocation Liquidity Needs PFM 49

50 The Importance of a Balanced Approach Prevailing Solutions Holistic view of total compensation Higher employee contribution Required ARC/ADC funding Caps on benefits Other Funding Solutions Asset monetization Benefits bonds Buy-outs Funding underfunded systems Fixed retirement age Elimination of retroactive increases Development of hybrid systems Create contribution certainty and risk parity Monitor with vigilance and engage employees PFM 50

51 Retirement Security & The Future of Retiree Benefits in the Public Sector Lasting solutions to retirement finance must be sufficient, affordable, and sustainable Views differ on whether the traditional defined benefit model is sustainable with reforms and adequate funding support A study prepared by the National Institute of Retirement Security found that DB plans can deliver the same retirement income at 48% less cost than an individually-directed DC plan, or 21% less cost than an ideal model DC plan The National Conference on Public Employees Retirement Systems identified a statistical correlation between reductions in state pension benefits and statewide income inequality The Manhattan Institute recently recommended that governments phase out OPEB entirely The Reason Foundation s policy view is that the most effective longterm reform for dramatically reducing unfunded pension liabilities is converting defined benefit plans (DB) to defined contribution plans (DC) Thoughts? PFM 51

52 Questions PFM 52

53 Sean McNeeley Practice Manager Center for Retirement Finance Daniel Kozloff Managing Director PFM Financial Advisors LLC Quantitative Strategies Group Jim Link Managing Director PFM Asset Management LLC Michael Nadol Managing Director PFM Group Consulting LLC PFM Center for Retirement Finance Contacts PFM 53