Pension Tension: How big is this problem? How did we get here? - PowerPoint PPT Presentation

Pension Tension: How big is this problem? How did we get here? What is being --and can be -- done about it? Citizens League Mind Opener Series 4.17.18 Mark Haveman, Executive Director Minnesota Center for Fiscal Excellence www.fiscalexcellence.org 651-224-7477 mhaveman@fiscalexcellence.org 1/12/2012

Defined Benefit Plan 101 • Provides lifetime income stream based on years of public service employment and salary Benefit = (Yrs of service) x (“high five” salary) x (“multiplier”) 30 x $60,000 x 1.7% = $35,700 per year TRA members have a 1.9% multiplier, MSRS and PERA members generally have a 1.7% multiplier • Most plan beneficiaries “coordinated” with Social Security (i.e. receive SS benefits too) • Together system is designed to provide 85-90% of preretirement income for career employees ( functionally more since retirees no longer pay into Social Security, Medicare, or their pension plans • Cost of living adjustments to base benefit levels are provided annually 1/12/2012

How Big is the Problem? “Tale of the Tape” for Two Funding Gaps 2017 MNDOT State and Local Highway Capital Pensions Investment Plan Over $16 billion Funding Shortfall $18 billion (current market value basis) Nature of Funding Gap Evolving gradually over As of July 1, 2017 the next 20 years Key interest rate influencing growth rate Around 5.0% 8.0% and higher of funding gap Nature of Obligation Really should do it Have to do it 1/12/2012

Putting the Problem in Plain English • We should have $16 billion more invested right now just to pay for the retirement benefits state and local employees past and present have already earned . • That $16 billion is sufficient only if retirement assets can return an average of 8% or more every year forever. • We can’t expect investment performance to save the day because pension plans are now paying out twice as much in benefits than they are getting in contributions from employees and employers. Last year alone, cash flows out of Minnesota’s public pension funds exceeded inflows by nearly $2.3 billion. • We also need to pay for the new obligations being added every year 1/12/2012

How Did We Get Here? We gave up on intellectually honest, fiscally responsible pre- funding of retirement obligations a long time ago • Decade-plus practice of using “excess” investment returns for base benefit increases (instead of bolstering reserves for down market years). • Undervaluation of pension liabilities by using discount rates not found in any other area of public or private sector finance • Persistent use of aggressive investment return assumptions • 14 consecutive years (and counting) of failing to make our annually required contributions • Frequent extensions of payoff periods for any unfunded liabilities to keep current costs down. EQUALS An unacceptable and irresponsible transfer of both cost and risk to future citizens and public employees. 1/12/2012

Breaking Down the Reasons for our Pension Hole Contributing Factors to Changes in Unfunded Accrued Actuarial Liability: FY 2002 - FY 2017 20,000,000 16,477,711 15,000,000 10,000,000 6,461,362 3,677,787 5,000,000 1,374,543 0 (5,000,000) (4,520,172) (6,346,918) (10,000,000) Contribution Salary increases Investment Income Change in plan Change in actuarial Other factors deficiency provisions assumptions & methods The real problem is not that we are living longer, it’s policy 1/12/2012

What is Being Done? • Governor’s “blue ribbon task force” gave justification (and political cover) to lower investment return assumption to 7.5% (which is still higher than SBI’s median expected return outcome) • Final repair package in omnibus pension bill consists of now-familiar “shared sacrifice” features: • Phased in employee and employer contribution increases • Temporary reductions in retiree cost of living increases • New state aid to help cover employer contribution increases • Yet another fresh 30 year amortization period to pay off unfunded liabilities • A couple of new cost-saving features including the end of pension “augmentation” (which sounds great but has potential state labor force repercussions and consequences) • On paper, knocks out $3.4 billion in unfunded liabilities the day it passes -- assuming all assumptions are met -- leaving about $12.5 billion to attend to based on a discounting future benefit cash flows at 7.5% -- with investment markets already orbiting all time highs 1/12/2012

Summary of State Pension Sustainability Strategy “Do ya feel lucky?” A pension system based on discounting future pension benefit cash flows at a rate of 7.5% is really a pension system that must make sure adequate contributions are available to support a 7.5% annual growth rate in liabilities • regardless of actual investment performance, • regardless of recessions and stressed budgets, and • regardless of the fact that in a significantly underfunded situation (as exists today) smaller pools of assets actually have to grow faster than 7.5% to keep up with the larger pool of liabilities. 1/12/2012

A Simple Example of the Math Challenge Assume a public pension fund with $100 in liabilities and $80 in assets yielding a funded ratio of 80% and an unfunded liability of $20 Because we employ expected investment returns as a discount rate, liabilities grow 7.5% per year. As a result, those $100 in liabilities today will equal $107.50 a year from now, all else being equal. For the unfunded liability to stay at $20 one year from now, that means assets have to grow from $80 to $87.50 ($107.50 - $87.50 = $20). Which means that the pension fund needs to earn 9.3% ($80 times 1.093 = $87.50) just to tread water. Anything less than 9.3% and the unfunded liability will grow, again all else being equal. 1/12/2012

Redefining the Problem The issue is not solvency, we have about $68 billion in retirement assets The issue is : • the ongoing export of billions in current financial obligations onto future taxpayers (who will have their own public sector retirement obligations to pay for) • the accompanying risks to future taxpayers and public services • the opportunity costs and crowd out effects for current state and local services from addressing the problem in a fiscally responsible way 1/12/2012

Can the State DB Plans Be Put on a True Sustainable and Fiscally Responsible Path? Maybe , but not without a lot more sacrifice than stakeholders appear willing to consider. Some avenues: 1. Significant increases in contribution rates 2. Place caps on pensionable earnings or service years 3. Indefinitely eliminate cost of living adjustments 4. Reduce the multiplier for future years of service 5. Build a progressive salary contribution schedule 1/12/2012