Pension Tsunami: Looming Pension Liquidity Crisis Threatens Municipal Markets The Belle State Fund: Illusionary Returns and Unfunded ARCs Dr. Kathleen Connell University of California Retirement Security Institute

“New Normal” Economy Impacts Public Pensions Lower than projected returns on investment portfolios Weak public sector labor markets Unexpected growth in early retirement and layoffs Failure to fully fund employer pension contributions

Pension “Bubble” Municipal defaults and bankruptcies Erosion of investor confidence in municipal markets Reduced budgetary support for other public programs – education, infrastructure Derails national recovery Upends commitment to public sector defined benefit programs

Legacy Gap Problems Joshua Rauh, Northwestern University Kellogg School of Management Alicia Munnell, Boston College Center for Retirement Research NASRA Center for State and Local Government Excellence

Liquidity Crisis Dire cash shortfalls reduced tax receipts Lower than targeted 8% investment returns Defined employer contributions Record baby boomer retirements Lump sum payment policies Reduced contributions as pension membership drops

Belle State Fund Test relationships of variables impacting pension solvency Review financial impacts of aging pension fund demographics Measure the likelihood of achieving targeted investment returns Explore full funding assumptions Propose needed reforms

History of Belle State Fund 1960 Founded in 1960, average pay $10,000, 4% annual increase Reviewed 60 year history All participants enter at 22; retire at 61; die 83 Employer 8.7% contribution 2% x yrs. service x average pay final 3 yrs. 2010 Average age: 44 years 32% within 5 yrs. Retirement Salary of $71,000 2010 – 2020 27% reduction in active staff

Solvency Status at Constant 8% Level Contributions make significant impact: 1960 – 1990 – no distributions until yr. 19 (1989) Maximum yrs. service contribute solvency fund Belle State Fund grows an average 14% – 16% yrs. with 8% constant returns Asset Growth 6.7% – 1990 – 2020 due to distributions to retirees By 2020: 80% money derived from returns on investments at 8%

Impact of Volatile Investment Returns 10 year cycle of returns 20% spike in IRR/Decennial Census Year 20% decline in IRR following year 20% increase – 3rd year 8% for all remaining 7 years In only 5 of 60 yrs. does fund suffer decline in investment returns For 55 yrs., fund achieves returns of of 8% or higher Total Fund Assets: 54% base scenario

Level of Investment Return Required to net 8 Level of Investment Return Required to net 8.0% in volatile environment 9.3%

Deferred Employer Contribution Not Harmful – Unless Correlated with Volatility Correlation certain to occur Full funding is assumed with high IRR’s Underfunding in market decline, reduced tax revenues Double Whammy Less than fully funded ARC Volatile investment markets Fund assets at 46% base scenario

Belle State Fund Employee Contributions (ARC) & Volatility Analysis Baseline Alternative 2 Alternative 3 Alternative 4 Volatility None ARC Contribution 100% 88% Assets Remaining 2020 54% Base Scenario 90% Base Scenario 46% Base Scenario

Public Pension Fund Fallacies Unrealistic return rates Excessive income replacements levels Lump sum policies while declining membership base “Full Funding” – not valid measure of pension solvency Oct. 2007 – Market Peak 14,000 Feb. 2009 – Cyclical Low 7,000

Open Membership in Public Pension Funds Solicit new civilian employee contributions bolstering investment dollars/reducing liquidity pressures Facilitate necessary State & Federal legislation Provide access to 50% working Americans without employer based plan Target self-employed and small business employees

Benefits of Civilian Accounts: Public Pension Plan Highly Diversified Investment Pool – Professionally Managed Reduced Management Fee – drop from 150 Basis Pts. To 50 Basis Pts. Buffer Market Volatility – Larger Fund and Hedges Financial Literacy Programs * Result in savings that increases nest egg by 20% - 20 yrs. – 5 to 7 additional yrs. retirement security

Municipal Resources Facility “Too Big to Fail” Lend credit support to weakened municipalities to access market Additional supplemental stimulus funds – fungible for other services, freeing general fund dollars to support pensions “Moral hazard” standard applicants must reform pension systems Reforms include: FRTIB menu choices Best Practices

Other Reforms Reduce Income Replacement to 50% Return 3 Leg Retirement Stool – Support Social Security Pension Governance Reforms Financial Credentials Pension Trustees Annual Employer Contribution Commitment Transparent Actuarial Models, Reduced Discount Rates Reasonable 6.5% IRR targets (Buffet and Blackstone)