Pension Reform Ken Parker City Manager City of Port Orange Pension Reform ► 20 million Americans working in the Public Sector are covered by Defined Pension Programs. ► Another 9 million retired Public Sector Employees are covered by Defined Pension Programs. Source: U.S. Government Accounting Office Report to the United States Senate, August 15, 2010 Pension Reform ► 79% of Public Sector Employees are covered by a Defined Benefit Program. ► 21% of Public Sector Employees are covered by another type of Pension Program. Source: U.S. Government Accounting Office Report to the United States Senate, August 15, 2010 Pension Reform ► Discussion on Public Pensions is not limited to the State of Florida. It is a national discussion. ► Some States and Local Governments are not covered by Social Security. In those States benefits tend to be higher than States and Local Governments covered under the Social Security System. Pension Reform ► Essentially there are three types of Pension Plans Defined Benefit Defined Contribution Combination Pension Reform ► Funding comes from three sources Employer Employee Investment Income Pension Reform ► 42% of the contributions to a Defined Benefit Program come from Employers/Employees with the Employer Contribution being the largest portion. ► 58% of the contributions to a Defined Benefit Program come from Investment Income. Source: U.S. Government Accounting Office Report to the United States Senate, August 15, 2010 entitled: State and Local Government Pension Plans: Governance Practices and Long Term Investment Strategies Have Evolved Gradually as Plans Take on Increased Investment Risk. Pension Reform ► DefinedBenefit Programs-Employer is the guarantor. The employer assumes the risk. This means that the employer in additional to normal retirement contributions is responsible for any shortfalls. Defined Pension ► Defined Contribution- Employer makes a specific contribution to an account for the benefit of an employee. Employee assumes the risk of investment. The employer does not guarantee benefit. The employee may or may not be required to contribute to the Plan. Pension Reform ► In 1972, ICMA developed the first portable Defined Contribution Program for Public Employees. City/County Managers identified a need for a program that would allow Public Employees who changed jobs frequently to save money for their retirements. Initial program was a deferred income program. It was created under Section 457 of the IRS Code. All public employees are now able to participate in a 457 Deferred Income Program. This allowed the employee to set aside a portion of salary free from taxes. When employee retired, then the employee would pay taxes on that income. Today, Public Employers are able to participate in 401 Plans, which qualifies as Qualified Plans as well as 457 Plans. Pension Reform ► Issues facing Local Governments Whether you are in the State Plan or have your own local plan, you can expect to see continued increases in your required contributions. Pension Reform more discussions about the ► Expect Unfunded Actuarial Accrued Liability (UAAL) Two components of your Pension Payment ►Normal Cost- This is what the benefit cost on an annual basis. ►Unfunded Liability- This can be caused by several factors, including plan benefit changes, not meeting the actuarial assumptions, not meeting the rate of return as established by the Plan. Pension Reform ► As the private sector moves away from Defined Compensation Programs, there will be increased pressure for the Public Sector to follow suit and adopt Defined Contribution Programs. Note: the only way a governmental entity can truly fix its cost related to retirement is to change from a Defined Benefit Plan and adopt a Defined Contribution Plan. Pension Reform ► Forthose local governments that retain a Defined Compensation Pension Program, there will be increased discussion on how the Unfunded Actuarial Accrued Liability should be reflected on the City’s balance sheets. Governmental Accounting Standards Board has circulated a proposed rule that would change how Pension liabilities are shown on you balance sheets. Pension Reform ► For those who decided to retain Defined Benefit Pension Plans for their employees, expect a debate to ensue about the proper rate of return on investments. There are two models being discussed in the literature, the actuarial model and the economist model. ► Source: Issue Briefing: Valuing Liabilities in State and Local Plans. Center for State and Local Government Excellence, Washington, D.C. June, 2010. Pension Reform ► Economist Model insist that the rate of return assumptions are too high. They argue that because of the guaranteed nature of public pensions, the rate needs to be based on a blended rate. Immediate impact would be to increase the unfunded liability of the plan. However, because of the assumed rate of return is lower, then in those years that the Plan earns more than the “riskless” rate of return, then it will quickly reduce the liability. ► Source: Issue Briefing: Valuing Liabilities in State and Local Plans. Center for State and Local Government Excellence, Washington, D.C. June, 2010. Pension Reform ► Advocates for Economist model state that if it were in place, many of the benefit changes that were approved in the late 1990’s would not have been approved. ► An example: In 1997, the California Pension Plan would have been funded 77%if the “Riskless Rate of Return” had been used rather than the reported 111%. ► Source: Issue Briefing: Valuing Liabilities in State and Local Plans. Center for State and Local Government Excellence, Washington, D.C. June, 2010. Pension Reform ► What percentage of your budget is allocated to Pension? In a recent report that I sent to the City Council, I noted that the City’s contribution to the Police Pension Plan was now consuming 8% of the total City General Fund budget and 22% of the total Police Dept. budget. Because of the guaranteed nature of Pension benefits and the requirement to keep Plans actuarially sound, the increase contributions are reducing funds that would normally be available and used for tax reductions, services, and infra-structure. Pension Reform ► Advocates of the “Riskless Rate of Return” state the following advantages: It would accurately reflect the guaranteed nature of public sector benefits. It would increase the credibility of public sector accounting with private sector analysis. It could well forestall unwise benefit increases when the stock market soars. The literature indicates in today’s market it would be around 5%. ► Source: Issue Briefing: Valuing Liabilities in State and Local Plans. Center for State and Local Government Excellence, Washington, D.C. June, 2010. Pension Reform ► Over the next several months, we can expect increased debate on the GASB Rules. Actuaries will attempt to demonstrate that their methodology produces near the same results. ► Advocates for a lower return on investment assumption will continue to present their case that the current rates of return are not accurate. ► State of Florida has already questioned rates of return on some pension plans. Pension Reform ► Let me pose few questions: Are employees willing to accept more of the risk in order to maintain a Define Compensation Program? I am aware of discussions that have occurred related to the concept of variable rate employee contributions. I’m not aware of any being implemented. Under this concept employees/employers share the risk. The employer is the backstop and guarantees the retirement plan regardless of the cost. Is the Public in your City aware of the cost of Pension and Benefits? Do they know the cost of your program? Are employees willing to accept less retirement benefits as well as increased employee contributions? Are Unions willing to negotiate freezing existing plans and prospectively implementing benefit changes to existing plan members. Are they willing to change the benefit structure for new hires? Pension Reform ► Questions Continued: Is the State of Florida willing to provide flexibility to local governments in order to address Pension issues? Will the State make changes to the State Plan? Will those same changes apply to 175/185 Plans? Will the State allow local governments who have 175/185 Plans adopt Defined Contribution Programs without sacrificing Insurance Premium Tax Dollars? Pension Reform ► Questions Continued Should the Pension Board composition be changed in 175/185 Plans? Should there be a prohibition for a member of the Plan serving as the fifth member? Pension Reform ► Port Orange resolved Pension issues at Impasse. City filed an Unfair Labor Practice when the Union failed to present the contract to member ratification vote. Union filed an Unfair Labor Practice. Parties are currently awaiting a ruling on an Unfair Labor Practice related to whether the City can impose reduction in Pension Benefits and impose a salary reduction for firefighters. ► Palm Bay has resolved at Impasse Pension with major changes to Pension Articles. ► City of Miami has declared Financial Urgency and is in the process of making changes to their Pension articles. Pension Reform ► Volusia County is preparing a white paper to be presented to the Volusia County Legislative Delegation on Pension Reform. ► Coral Gables has made changes in their General Employee Pension Plan. ► Port Orange for new hires not covered by a bargaining unit will be covered by a Defined Contribution program. Pension Reform ► CityCouncil’s should require at least annually the Board Chair and Actuary to appear before the Governing Body to present an annual report on the health of the Plan. Funded to Unfunded Ratios should be presented. Unfunded Actuarial Accrued Liability should be presented and a report on whether it is increasing or declining. Pension Reform Contribution Assumptions and Unfunded Liability Projections based upon the trend analysis. Investment Rate of Return should always be reported. The Pension Board and City Council should know the rate of return for 1 yr., 5 yr., 10 yr. and from inception Annual Required Contributions should be presented by the Pension Board to the City Council in an open meeting. Pension Reform Trend Analysis based upon 1, 5, 10, 20 and 30 years. What assumptions were met and which assumptions were not met. City Councils should require Pension Boards to report how their investment managers are performing against benchmarks and against the assumed rate of return. If the City has more than one Pension Plan, the City should compare Plan Managers of all of its Plans to each other. “It is easy to do good in an up market. The real challenge is to perform well in a down market against the benchmarks.” Pension Reform ► Pension Boards are Fiduciaries and have a responsibility to make sure that the Pension Plan can meet obligations to the participants. To a large extent Pension Boards have become Cheerleaders for Plan Participants. In their Fiduciary role, Plan Trustees are required to act in the best interest of the Plan. That may place them in conflict with both the Plan sponsor and/or the Plan participants. In my opinion, the Plan Board has a duty to make recommendations on how to strengthen the Plans and what benefit changes are needed in order to keep the Plan Actuarially Sound. Pension Reform ► City Councils should require Pension Boards to provide an investment risk analysis on an annual basis. As Pension Boards and their Plan Investment Managers attempt to increase yields, what is the level of risk? Since the City Council is required to fund losses, the City Council should understand the investment risk. Pension Reform ► Before making benefit improvements, local government should require Plan Actuaries to look at Plan Performance and make long term projections using both the Plan assumptions and Rate of Return as well as looking at the trend analysis of actual performance of the Plan. Don’t accept the one year performance estimate. Pension Reform ► City Council Members should determine what competencies are needed for Pension Board Members and then make those types of appointments. Pensions are technical and Councils need members on the Board who can advise them properly on Pension issues. Pension Reform ► Education is important. That includes Pension Board Members, City Council Members and staff members who are advising City Council. ► City Councils may want to consider employing its own actuary to review and advise the City on Pension issues. The same can be said about Pension attorneys. Remember: the Pension Board’s Attorney works for the Pension Board. Also, the Plan Actuary works for the Pension Board. Although the Board’s interest and the City’s interest should be the same, they may not be. It is good for the City to have its own set of eyes. Pension Reform ► Expect delays when making changes to Pension Plans. It is not in the Union’s best interest to make changes. You must be patient. ► It is far easier to change for new hires than it is freezing existing plans and implementing changes for existing employees. ► Political Will. Is there the political will to make changes? ► Develop a Plan to address the Plan unfunded liabilities. This may include increases in employer contributions, lowering benefits, changing benefits, increasing employee contributions. It probably will include all or a combination of the items. ► Educate the Public. They need to understand the issue and why the discussion is important to them. ► Educate the Employees. They need to understand the issue as well. Spend time with them explaining the issues and why it is important to them. ► Educate and Keep Elected Officials Informed. They need to understand that Pension Reform is more than just reducing cost.