Spring Conference

Update on Pensions and Other Long Term Obligations

April, 2012

David Boomershine

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Agenda

• Background• Private Sector vs. Public Sector• Recent Changes/Update: Pension Plans

– Funding: Cost Volatility

– Actuarial Assumptions

– Accounting

– Plan Design – Roundup• Maryland

• State Summary

• Hybrids

• DB vs. DC Plans• Recent Changes/Update: OPEB Plans

– Funding

– Actuarial Assumptions

– Plan Design

• Current Issues

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Background

Interested Parties: Retirement Plans/Budget Concerns• Governing Bodies• Employees/Retirees• Unions• Taxpayers• Bond Rating Agencies• Federal Government -?

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Background

U.S. Senate Committee on Finance

State and Local Defined Benefit Pension Plans: The Pension Debt Crisis that Threatens America

– Orrin Hatch (R-Utah)

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Background

Hatch Report Highlights:• Pension liabilities are contributing to our nations debt crisis• Funding levels declining since 2000• This is a Federal concern• Large State/Municipal insolvency risk• State/Municipal efforts – some DC plans• Federal efforts - “Public Employee Pension Transparency

Act”• GASB Proposal• Conclusion: DB plans are inappropriate for State and Local

Governments

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Private Sector vs. Public Sector

Issues Impacts:

Private Sector Public Sector

PensionRetiree Medical Pension

Retiree Medical

Federal Legislation

Accounting

Asset Losses

Valuation Interest Rates

Result: Increased cost and liability volatility for Private Sector Pension Plans

Recent Changes

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Recent Changes/Update: Pension Plans

• Funding: Cost Volatility– Cost Increases

• Asset losses• Discount rate• Unfunded Liability impact - examples

Asset Losses Discount Rate

Prior Year

Current Year

Prior Year

Current Year

Actuarial Liability $100 $105 $100 $115

Assets 80 75 80 85

Unfunded Actuarial Liability 20 30 20 30

($ in millions)

• Amortization costs increase 50%

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Recent Changes/Update: Pension Plans

• Funding: Cost Volatility– Cost Decreases

• Asset gains

• Plan population limits (employment freeze, layoffs)

• Compensation controls (freeze, decreases, furloughs)

– Other Funding Approaches• Pension Obligation Bonds: pay off Unfunded Liability

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Recent Changes/Update: Pension Plans

• Actuarial Assumptions– Discount Rate – Key

• Median at 8.0%• Average at 7.8%• Trending down from 8.0% to 7.5%• CALPERS adopted 7.5%• Some at 7.0%

– Other Economic Assumptions• Salary increases• COLAs

– Mortality Table Update

• Indicate Cost Increases

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Recent Changes/Update: Pension Plans

• Accounting – GASB Proposal Update• Impacts:

– Net pension liability– Discount rate basis - ?– Use of Entry Age Normal Cost Method– Amortization periods– Additional required information– Cost Sharing multiple employee plans

• Accounting vs. Funding Separation – Less Clarity

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Recent Changes/Updates: Pension Plans

• Plan Design – Roundup: Maryland– Prior plan changes:

• Increased employee contributions

• COLA cap

• Normal/Early Retirement eligibility

• Benefit formula

– Current budget proposed changes:• Shift ½ of Teacher pension costs to Counties

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Recent Changes/Updates: Pension Plans

• Plan Design – Roundup: Typical changes from 2008 to 2011– State Sponsored Plans (2012 GAO Study)

• Usually for new employees

• Adjusted benefits – 24 States

• Eligibility requirements – 29 States

• COLAs – 18 States

• Increased employee contributions – 25 States

• Switched to Hybrid approach – 3 States

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Recent Changes/Update: Pension Plans

# States includingchanges for current

• Plan Design – Roundup: employees/retirees

– State Plans: More Details• Adjusted Benefits 6

– Benefit % reduced

– Increased pay averaging period

• Eligibility requirements 6– Increased retirement age/service

– Vesting

• COLAs 5/8

• Increased employee contributions 20

• Switched to Hybrid 0

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Recent Changes/Update: Pension Plans

• Hybrids– In public sector: combination DB and DC plans

– In private sector: Cash Balance Plan

– 6 States and District of Columbia have DC or Hybrid primary plans

– 1 State has a Cash Balance primary plan

– 6 States offer DC or Hybrid optional alternatives to primary DB plans

• Note definite private sector trend from DB to DC/Hybrid

• Some public sector trend from DB to DC/Hybrid

• Also note 1 State plan has cap on employer contribution commitment to DB plan

• Clear interest in DC plans due to private sector trends

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DB vs. DC Plans

• General Plan Comparisons

DB Plans DC Plans Hybrid Plans

Lifetime retirement income Yes No Yes

Retirement income determinable Yes No Yes

Easy to understand No Yes Mixed

Portable No Yes Yes

Investment control and risk Employer Employee Employer

Level of paternalism High Low Mixed

Level of cost and liability volatility for Employer

High None Low

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DB vs. DC Plans

Sample Plan Case Study:

• DB Plan: Benefit Formula = 1.5% times final average pay times service, up to 35 years

• DC Plan: Employer contribution formula = 7% of pay plus 50% match of employee’s 1st

6% of pay savings

• CB Plan: Employer contribution credit = 10% of pay for each year of service

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DB vs. DC Plans

35 45 55 65Age

(Hired at age 35)

DB

CB

DC

Acc

rued

Ben

efit

Typical Benefit Accrual Patterns

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DB vs. DC Plans

• Replacement Ratios: % of final pay replaced with lifetime pension benefits

Profile Employee

Attained Age

Accrued Service

Current Compensation

DB Plan

DC Plan

CB Plan

I 30 2 $35,000 51% 38% 42%

II 35 5 $40,000 51% 38% 42%

III 40 9 $45,000 49% 36% 39%

IV 45 12 $50,000 46% 34% 37%

V 50 14 $55,000 41% 30% 33%

VI 54 19 $60,000 43% 33% 36%

Actuarial Assumptions:- Mortality: RP2000 Table- Interest: 6%

Retirement Benefit Comparisons

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DB vs. DC Plans

Cost comparisons as a % of payroll:

• DB Plan 8.5%

• DC Plan 9.0%

• CB Plan 8.0%

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DB vs. DC Plans

Why are DB plans more cost efficient?

• Reward long service – back loading due to final average pay

• Forfeitures remain in plan – more with DB plans

• Younger terminations – similar to forfeitures

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DB vs. DC Plans

Conclusions of Case Study:

• For similar long-term plan costs, traditional DB plans provide about 130% of lifetime benefits provided by DC plans

• Other studies claim traditional DB plans provide up to 150% more in benefits for the same cost vs. DC plans

• Career average DB plans provide about 20% more in benefits for the same cost vs. DC plans

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Recent Changes/Update: OPEB Plans

• Funding: Cost Volatility– Contribution Policy

• Continue pay-as-you-go (Paygo)

• Partial funding

• Full funding

– Discount rate basis

– Healthcare cost trending

– Reduced funding vs. original plan

– Other funding approaches: OPEB Bonds – pay off Unfunded Liability

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Recent Changes/Update: OPEB Plans

• Actuarial Assumptions– Discount rate basis: sample ARC comparison

• Paygo 4% $ 120 M

• Partial Funding 6% 100 M

• Full Funding 8% 75 M

– Healthcare trending

– Mortality Table Update

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Recent Changes/Update: OPEB Plan

• Plan Design: variety of changes– Cost sharing: retirees’ % share of costs– Eligibility requirements– Tiered coverage/subsidies: years of service– Employer contribution caps

• Hard cap• Increasing cap

– Spouse/family coverage– Cost containment provisions– Wellness programs– Access only

• Mostly Soft Freeze approach:– Future new hires– Future retirees– Future retirees not close to retirement

• Buyout of benefits

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Current Issues

• Comparison vs. Private Sector Plans

• Taxpayer Concerns– DB plans

– OPEB plans

• Union Reactions

• Pension Plan Changes– Soft freezes

– Employee contributions

– COLAs

– DC plans

– Capping employer contribution commitment

• Valuation Discount Rate Basis/Reduction

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Current Issues

Current Questions

• Not enough cost reduction?

• Cost/liability volatility concerns remain; especially vs. Private Sector?

• Changing workforce?

• More changes coming?

• Future of economy?

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Questions?