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

1/12/2012

Pension Tension:

How big is this problem? How did we get here? What is being --and can be -- done about it?

Mark Haveman, Executive Director Minnesota Center for Fiscal Excellence www.fiscalexcellence.org 651-224-7477 mhaveman@fiscalexcellence.org

Citizens League Mind Opener Series 4.17.18

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

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How Big is the Problem?

“Tale of the Tape” for Two Funding Gaps

2017 MNDOT Highway Capital Investment Plan State and Local Pensions Funding Shortfall $18 billion Over $16 billion (current market value basis) Nature of Funding Gap Evolving gradually over the next 20 years As of July 1, 2017 Key interest rate influencing growth rate

• f funding gap

Around 5.0% 8.0% and higher Nature of Obligation Really should do it Have to do it

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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
• f 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

• ut 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

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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.

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Breaking Down the Reasons for our Pension Hole The real problem is not that we are living longer, it’s policy

6,461,362 (4,520,172) 16,477,711 (6,346,918) 3,677,787 1,374,543

(10,000,000) (5,000,000) 5,000,000 10,000,000 15,000,000 20,000,000

Contribution deficiency Salary increases Investment Income Change in plan provisions Change in actuarial assumptions & methods Other factors

Contributing Factors to Changes in Unfunded Accrued Actuarial Liability: FY 2002 - FY 2017

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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

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Summary of State Pension Sustainability Strategy

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.

“Do ya feel lucky?”

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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.

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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

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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