Critical Issues for Key Public Pension Stakeholders PENSION TASK FORCE Phoenix, AZ October 3, 2014 Diane Oakley Executive Director

NIRS: Nonpartisan Research Focused on Pension Facts Nonprofit, nonpartisan research organization founded in Contribute to informed policy making by fostering a deep understanding of the value of retirement security to employees, employers, economy. National research and education programs available at 2

Agenda Stakeholders Economics of DB Pensions Investing Pension Assets Pensions and Workforce Management Overview of Pension Reforms Pensions in the Larger Economy Q&A 3

Public Pension Stakeholders Purpose of providing retirement plan is to achieve stakeholder objectives. Employers who seek to attract and retain qualified workers needed to perform essential public services and have orderly workforce turnover. Taxpayers who seek the provision of public services at a cost that is fair and reasonably stable and predictable; also seek to minimize dependence on public assistance.. Employees who seek compensation that is competitive and a retirement benefit that promoted retirement security. 4

Important to Keep Focus on Retirement Policy Retirement security benefits everyone. Employer-sponsored retirement benefit is a workforce management tool, old-age poverty insurance, and stabilizing factor in the economy. As a stable employer, government is well-suited to sponsor pensions. Core elements of pension promote retirement security: –Mandatory participation –Employee-employer cost-sharing –Benefit adequacy –Pooled assets invested by professionals –Lifetime benefits Source: NASRA, The State Landscape on Pensions,

Strong Support for Public Pensions Because Employees Pay To what extent do you agree/disagree that state/local employees deserve benefits because they finance cost by contributing from every paycheck?

Americans Believe Public Pension Benefits Levels Just Right The average retirement benefit for public workers is $2150/month. Some may be more or less. Is that too high, low, about right? 7 Source: NIRS Pensions & Retirement Security 2013

Police/Fire Deserve Pensions to Compensate for Risk To what extent do you agree/disagree that police/fire have agreed to take jobs that involve risk and therefore deserve pensions that will afford a secure retirement? 8 Source: NIRS Pensions & Retirement Security 2013

What Do Americans Think About Retirement? Anxious How concerned are you about current economic conditions affecting your ability to achieve a secure retirement? 9 Source: NIRS Pensions & Retirement Security 2013

Americans Want Pensions for All To what extent do you agree/disagree that all workers, not just those employed by state/local governments, should have a pension?

DB More Economically Efficient Longevity Risk Pooling Manage the chance of running out of money in retirement Avoid the “over-saving” dilemma and do more with less Only 6% of DC account holders purchase annuities as cost can be more than twice that of DB income. Source: Pension Trustee Advisors, 2011

DB More Economically Efficient Maintenance of Portfolio Diversification Take advantage of enhanced investment returns from an ongoing balanced portfolio Superior Returns Achieve greater investment returns vs. individual accounts Source: Pension Trustee Advisors, 2011 How $10,000 Invested Grows over 30 Years

DB Plan Can Deliver Same Benefit at About Half the Cost of DC Plan DB Cost No Longevity Risk Pooling Less Balanced Portfolio Lower Returns/Higher Fees 46% Savings 13

Pension Benefit Design Study 14. Source: Teacher Retirement System of Texas and Gabriel, Roeder, Smith & Company

Pensions Are Sustainable Lessons from Well-Funded Pensions Studied Six Well- Funded Public Pension Plans: New York, Delaware, Idaho, Illinois Municipal, North Carolina, Texas

Lessons from Well-Funded Pensions Annual Required Cost Contributions Paying the full ARC each year maintains a well-funded plan with stable contributions. Texas TRS: Constitution mandates payment. Idaho PRF: Statute mandates state government payment. 16 Distribution of ARC received by 86 plans, 2013 Public Fund Survey

Lessons from Well-Funded Pensions Normal Cost & Shared Cost with Employees Paying the normal cost rate leads to stability. Idaho: The employer rate cannot fall below the NCR. Texas: Requires that the employer contribution rate cannot fall below a certain level. Employee contributions to help share the plan cost 17 Employee and Employer Pension Contributions, 1982 to 2009

Other L essons Learned…  Benefit improvements that are actuarially valued before adoption and properly funded;  COLAs granted responsibly;  Anti-spiking measures that ensure actuarial integrity, transparency;  Economic, actuarial assumptions that can reasonably be expected to be achieved long term.

NIRS Public Pension Plan Investment Primer Outlines How Public Pensions Invest …..

Overview of Public Pension Investment Process Goal is to generate enough returns, combined with contributions, to pay promised benefits over long term Each plan has unique liabilities Determination of Liabilities Board determines acceptable level of risk Investment consultants and staff update capital market assumptions Actuaries model risks/returns for different asset mixes Board selects target asset allocation and sets performance benchmarks for the fund and each portfolio Actuaries estimate fund returns based on asset mix Investment Policy Statement (IPS) Staff and/or external money managers buy and sell securities and monitor performance Investment Management Investment managers report short-and long-term returns Board evaluates the returns and risk incurred Evaluation

Diversification & Modern Portfolio Theory Diversifying investments reduces risk for a given expected return. Why? The values of stocks, bonds, real estate, commodities, and other asset classes do not move together in tandem. An “efficient” portfolio delivers maximum expected return for a given level of risk. Expected Return Risk (Std Dev of Returns) Portfolios below line are inefficient Portfoli os with highes t possibl e return at each level of risk

Source: Federal Reserve Flow of Funds Accounts, Public and Private Funds Similar in Risk until 2006

Change in Average Asset Allocation among State Pension Plans Source: Adapted from Wilshire Consulting Public Equity and Fixed Income subtotals are authors’ calculations. “Other” category includes cash and alternative non-equity assets.

>5% Real Return over Past Years Not Exceptional Source: Adapted from Stubbs 2012, p. 19, Table 3. Real Returns on a Hypothetical Pension Portfolio 58% Equity/42% Fixed Income Rolling Periods,

Public Plans Are Reaching Their Long-term Investment Return Goals Source: Callan Associates; For Periods ending 6/30/14

DB Plans are Powerful Labor Management Tool DB plans prevalent in the public sector, make up 6.5% of total compensation. Roughly 30% of public employees not covered by Social Security, making the DB benefit all the more important. DB plans make up a smaller share of total compensation earlier in employees’ careers than later. 26

Towers Watson: Attraction and Retention; What Employees Value Most In 2011, 63 percent of workers under 40 agreed their retirement plan was an important factor in accepting their job – jumping up from 28% in 2009%. More than three-quarters of new hires at companies sponsoring DB plans say the retirement program gives them a compelling reason to stay on the job. Among DB plan participants in 2011, 51% say the company’s retirement program played a strong role in their decision to join the company, up considerably from 31% in Source: Towers Watson, Attraction and Retention; What Employees Value Most

Importance of Retirement Plans to Attract Workers Under Age 40 Source: Towers Watson, Attraction and Retention; What Employees Value Most

Importance of Retirement Plans to Retain Workers Under Age 40 Source: Towers Watson, Attraction and Retention; What Employees Value Most

Most Important Factors in Attracting Employees Younger Than 40 to a Company Source: Towers Watson, Attraction and Retention; What Employees Value Most

Most Important Factors in Attracting Employees in 40s to a Company Source: Towers Watson, Attraction and Retention; What Employees Value Most

Most Important Factors in Attracting Employees Age 50 and Older to a Company Source: Towers Watson, Attraction and Retention; What Employees Value Most

DB Plans Increase Recruitment and Retention Strong recruitment and retention effects mean that DBs serve as an effective Human Resource tool. This results in lower employee turnover: –DB firms have lower turnover rates than non-DB firms, ranging from 20 – 200%. –DB coverage increases tenure by 4 years compared to no plan, by 1.3 years compared to a DC plan. 33

DB Plans Increase Productivity 34 Recruitment and retention effects translate into productivity gains due to DB plans: –Research finds productivity gains linked to DBs. –Firms moving from DB to DC experienced productivity losses relative to firms that kept DBs.

DB Plans Provide Workforce Management - Efficient Retirement 35 DB plans encourage “efficient retirement”: –Employees withdraw from the labor force as their productivity declines. –DBs can—and are—designed to facilitate appropriate and optimal retirement decisions. Efficient retirement is crucial during economic downturns; no “job lock” with DBs.

DB Role in the Public Sector 36 Public workers prefer DBs when given a choice: –4% of Ohio employees opt for DC plan. –68% of Washington employees choose the DB plan over the default combined DB-DC plan. –75% of young teachers in West Virginia opted out of their DC plan and back into the DB plan. DBs may improve public sector productivity: –More likely to value their work than private workers. –Tend to invest more in their skills. Moving to a DC design could affect recruitment, retention, productivity among this workforce.

ON THE RIGHT TRACK? Public Sector Difference Commitment to stable employment relations and internal labor markets. Greater ability to smooth out the effects of business cycles on funding requirements. Public interest mission: DB pensions help provide high quality public services in a cost effective manner, while also providing retirement security. Public employers have more in common with the largest private employers, who have maintained DBs.

States’ Fiscal Challenges 38 State revenues have declined: –2012 Q1, revenues 5.5% below pre-recession levels. –$425 billion cut from budgets –2013 budget gap of $55 billion, closed. Pension funding levels have declined: –Wall Street losses affected all investors. –92% of Annual Required Contributions were made between –Funding levels fell from 85% in 2008 to 73% in

Assets held in Public Pensions Totaled $3.7 billion as of 2Q2014 Actuarial value of assets and liabilities, and funding level, FY 01 to FY 13

Public Pension Reforms After 2008 Financial Crisis Vast majority have modified their existing pension plans. Most common: –increased Employee contributions; –reduced DB benefits for new hires, including higher retirement age –Cost of Living Adjustment (COLA) reductions for retirees and existing workers.

Aggressive Reforms In Virtually All States to Ensure Sustainability of Public Pensions Source: Author’s analysis of NCSL data. Changes affect some or all members of state-run plans in each state. Types of Changes Enacted 41

After 2008 Financial Crisis: All States Make Pension Reforms One state - Oklahoma, has shifted to a DC-only plan since Four states - mandatory hybrid arrangements with a DC component, new hires only. Three states - Cash Balance Plans for new hires

Annual Wealth Changes for New Employee, Relative to Earnings 43

Alternative Plan Designs 44

Alternative Plan Designs Employees face more risk under DC plans –Longevity risk –Investment risk –Inflation risk Cash balance plans are a “hybrid” of sorts –Technically DB plans –Pooled and professionally invested assets, like DB –Notional (hypothetical) account, like DC but funding is not required Both accrue benefits as a fixed earnings share, higher in earlier years than later, unlike traditional DB plans. 45

KEY FACT Pensions Keep Americans Out of Poverty million fewer poor and “near poor” households.

In 2010 We Found: Income from DB Pensions is Associated with … Rates of poverty among older households nine times lower than households without DB pension million fewer households receiving means-tested public assistance, saving taxpayers $7.9 billion. 47

KEY FACT Pension Spending Fuels State and Local Economies 48

Pensionomics : What We Found Expenditures from public and private pension benefits supported… 49 Over $940 billion in economic output nationwide Over 6 million jobs that paid over $300 billion in income Over $550 billion in value added nationally $130 billion in federal, state, and local tax revenue

Impact of Pension Payments to Arizona Public Retirees Source: NIRS, Pensionomics 2014 Expenditures by government retirees provide steady economic stream to Arizona and its communities expenditures supported: 42,542 jobs that paid $1.9 billion in wages. $5.9 billion in total economic output. Each dollar in DB benefits supported $1.77 in total economic activity. $793 million in federal, state, and local tax revenues. Each taxpayer dollar “invested” in plans supported $5.93 in total economic activity in the state. 50

Drive Public Assistance Savings Help Recruit & Retain Quality Employees Ensure Self- Sufficiency Are Extremely Cost-Efficient Create Jobs, Fuel the Economy Over Regulation Cause of Private DB Plan Decline All Americans Want Pensions Pensions Get Retirement Right Value of DB Pensions

Questions?