Posted on 2016-04 in Pensions
Among the myriad fiscal challenges confronting states is adequately funding their public pension plans. The most important way states carry out this function is by making the Annual Required Contribution (ARC) toward the public pension plan, an appropriation designated to cover the benefits accrued that year and to pay down a portion of any liabilities that were not funded in prior years. Since 1994, when the Governmental Accounting Standards Board (GASB) introduced the concept of the ARC, policymakers and those reviewing the performance of public pension plans have often looked to a state’s ARC to determine their commitment in bolstering the funding position of their pension plans.
In determining the ARC for a public pension plan, experts and actuaries calculate expected revenues flowing into the plan from several sources, such as investment earnings and employee contributions, and then alert policymakers about the precise ARC number based on actuarial and other calculations. The legal foundation for states continuing to make their ARCs flow from a variety of sources including statutes, ordinances, bound rules, case law and, in certain instances, state constitutions. For most states, there is an implicit or explicit legal obligation that the ARC will be paid in full. In addition, some state laws require that any increase in either benefits or employee contributions have to be approved by the appropriate authorities, in some instances the state legislative body, in that state. In the past three or so years, the credit rating agencies have started paying a great deal of attention to ARCs and the funding position of public pension plans. In fact, these rating agencies have indicated that the funding ratio of the public pension plan in question remains one of the factors considered when determining the overall credit rating of that particular state or local government.
In recent years, there has been a great deal of scrutiny of the funding position of public pension plans. This scrutiny usually involves the performance of the state and local government in regularly and reliably making their ARCs to fund their pension plans. Recent research on this topic indicates that most states have made a diligent effort to fund their pension plans through the ARC. A study by the National Association of State Retirement Administrators (NASRA), released in March 2015 of 112 state-sponsored and statewide plans between fiscal years 2001 and 2013, demonstrated that on a weighted average basis, the median ARC experience is 95.1 percent. Specifically, this study revealed that one-half of the plans received at least 95.1 percent of their ARC. In addition, the study reached the following conclusions:
In terms of the SLC states, their ARCs have been most impressive. Table 1 below provides details on the ARC experience for the region between fiscal years 2001 and 2013.
(click on headers to sort by column)
|State||Weighted ARC Average (Percent)||(Shortfall) or Surplus (In Dollar Millions)||Approximate ARC Paid in FY 2013 (In Dollar Millions) *|
|Weighted Average for SLC||94.2|
|Weighted Average for U.S.||84.3|
* Please note that the ARC contribution paid in fiscal year 2013 is an extremely approximate number and should not be construed as the final amount paid by the state. This number was tabulated from the bar graphs presented on the following pages.
As evident in Table 1, the record of the SLC states is quite notable, with six states contributing an amount either equal or greater than the ARC during the review period. The weighted average for the SLC region also is considerably higher than national average (94.2 percent versus 84.3 percent).
The bar charts below provide details on the ARC experiences in the SLC states for the fiscal year 2001 to 2013 period by highlighting the percent of the ARC received, the dollar amount paid for the ARC and the ARC in dollars. These bar charts reflect trends associated with the ARCs specified by the actuaries and the payments made by the SLC member states. Many of the states have done a laudable job of meeting their ARCs, though there are instances when in certain years, an SLC state failed to make this contribution. In fact, a review of the 12 years represented in the bar graphs indicates that there was only a single instance where an SLC state (North Carolina in fiscal year 2003) failed to make its ARC. In subsequent years, North Carolina remedied this lapse and continues to have an ARC average that is higher than both the national and SLC average.
Posted on 2015-07 in Pensions
The Southern Legislative Conference (SLC) has intensely focused on public pensions and the entire retirement architecture of the United States for more than 15 years. An SLC presentation before the Alabama Legislature a few years ago captures some of the important trends and developments on the topic. Even though the presentation is several years old, the essential elements of the presentation remain valid and provide a good synopsis of the topic. This presentation may be viewed here. Some of the strategies adopted by dozens of states to bolster their public pension plans include: increasing employee contributions; limiting COLA increases (a strategy complicated by recent court decisions); increasing age and vesting limits; trimming benefits; and issuing pension obligation bonds.
In the wake of the 2008-09 market decline and Great Recession, nearly every state and many cities have taken steps to improve the financial condition of their retirement plans and to reduce costs. Although some lawmakers have considered closing existing pension plans to new hires, most determined that this would increase – rather than reduce – costs, particularly in the near-term. Based on the most recent information provided by the U.S. Census Bureau, 3.9 percent of all state and local government spending is used to fund pension benefits for employees of state and local government. Pension costs have remained within a narrow range over a 30-year period, declining from a high point of 5 percent to a low of 2.3 percent in FY02, and reaching 3.9 percent in FY12. State and local governments contributed, in aggregate, an estimated $109 billion to pension funds in FY13, a figure equal to 3.9 percent of projected state and local direct general spending for that year. This February 2015 National Association of State Retirement Administrators Issue Brief, entitled 'State and Local Government Spending on Public Employee Retirement Systems,'provides more details on these trends.
After its creation in the 1990s, the annual required contribution (ARC) quickly became recognized as the unofficial measuring stick of the effort states and local governments are making to fund their pension plans. A government that has paid the ARC in full has made an appropriation to the pension trust to cover the benefits accrued that year and to pay down a portion of any liabilities that were not pre-funded in previous years. Failing to meet its ARC is one of the primary reasons for a public pension plan to be in a financially perilous position. This March 2015 NASRA publication, entitled 'The Annual Required Contribution Experience of State Retirement Plans, FY 01 to FY 13,' contains additional information on the topic.
The Center for Retirement Research at Boston College is one of the nation's top research institutes studying state and local government pension plans. In February 2013, the Center issued a report entitled 'State and Local Pension Costs: Pre-Crisis, Post-Crisis, and Post-Reform.' The publication notes that in the aftermath of the Great Recession, states responded to their pension challenges by enacting a mix of revenue increases and benefit cuts. The paper poses a number of salient questions: First, whether plans stick with the reforms, or instead, expand benefits again when the economy improves is an open question. Second, the projections presented in this study assume that plans consistently make their annual required contribution, a degree of fiscal discipline that has been lacking in some jurisdictions. Third, retiree health plans represent an additional and growing claim on state-local budgets, given the rising number of retirees and healthcare cost inflation. Finally, plan finances are sensitive to the performance of the stock market, so lower-than-expected returns going forward could raise costs.
Another June 2015 publication from the Center for Retirement Research is entitled The Funding of State and Local Pensions: 2014-2018 As the publication notes, a strong stock market and the elimination of 2009 from the smoothing process led to a sharp increase in actuarial assets and to the first improvement in the funded status of public sector plans since the financial crisis. What happens from here depends very much on the performance of the stock market. In 2018, assuming plans achieve their expected return, they should be 81 percent funded. If returns are lower, as predicted by many investment firms, funding will stabilize at about 77 percent.
A March 2015 publication prepared by the Municipal Securities Research Division of Wells Fargo Securities, entitled 'State Revenues and Public Pensions,' contains valuable information. This publication reflects on how the states have become much more dependent on the financial markets' performance since 2000. This Wells Fargo publication also concludes that:
Posted on 2012-07 in PensionsSujit M. CanagaRetna, Senior Fiscal Analyst
Public pension systems continue to face significant challenges, a trend that has continued for more than a decade. While public pension difficulties alone would not be a destabilizing force on the economy, the fact that every other element of our nation's retirement architecture also faces complex challenges requires the urgent attention of policymakers at all levels of government. The funding difficulties facing the Social Security and Medicare systems; the rising funding gap at corporate pension plans, record deficits at the Pension Benefit Guaranty Corporation (or PBGC, the federal entity that insures the benefits of private pension plans), low personal savings rate of so many Americans alongside the minimal amounts they have set aside for retirement, the "graying" of America with an increasing number of Americans now reaching retirement age and living longer; and the aforementioned public pension challenges cumulatively amount to a tsunami of red ink.
Two recent reports offer some guidance on the trajectory of public pension plans. In March 2012, Wilshire Associates, the investment consulting and services firm, released its 2012 Report on State Retirement Systems and in June 2012, the Pew Center on the States released The Widening Gap Update. The Wilshire Report indicates that the ratio of assets-to-liabilities, or funding ratio, for all 126 state pension plans was 77 percent in 2011, up from an estimated 69 percent in 2010. The report concluded that the improvement of the funding ratio was driven by the strong global stock market performance in the 12 months ending June 30, 2011. The conclusions in the Pew report were gloomier and noted the $1.38 trillion gap between states' assets and their obligations for public sector retirement benefits in fiscal year 2010, which included $757 billion in pension promises and $627 billion in retiree healthcare obligations. According to the Pew report, only Wisconsin had fully funded its pension plan (100 percent) and 34 states were below the 80 percent threshold, the level experts urge as representing a financially sound pension system. Among the states with well-funded plans were North Carolina, South Dakota, Washington and, of course, Wisconsin, all funded at 95 percent or higher. At the other end of the spectrum was Connecticut, Illinois, Kentucky, and Rhode Island, all funded below 55 percent.
One of the major drawbacks in evaluating public pension is the timeliness of the data, a limitation apparent in the Pew report, which references the fiscal year that ended on June 30, 2010. This report includes a particularly dark fiscal period for states when the rigors of the Great Recession were particularly intense. In fact, the report included the addendum that, since the end of fiscal year 2010, states have initiated an unprecedented number of pension reforms and that these reforms, along with strong investment gains and continued fiscal discipline, will enhance the financial security of these public pension plans. Given the significant improvement in the equity markets, this recovery is already evident in the portfolios of a number of public pension plans.
In calendar years 2009 through 2011, 43 states initiated reforms to stabilize their pension systems including:
Beyond these measures, two other trends have surfaced in public pension circles in recent years that require attention: 1) government-run retirement plans for private-sector employees and 2) cash benefit plans, which include features of both a traditional DB pension and a 401(k)-style system.
Having state pension funds run retirement plans for private sector employees is an idea that catalyzed in Maryland five years ago. Since that time, policymakers in over a dozen states (including California, Connecticut, Illinois, Maryland, Massachusetts, Michigan, Pennsylvania, Rhode Island, Vermont, Virginia, Washington, West Virginia and Wisconsin) have discussed and even proposed legislation adopting a similar approach. At the local level, the comptroller of the city of New York, the nation's largest local government, also has expressed interest in the idea.
At the outset, it is important to stress that none of the proposals being discussed or proposed require any public funds to be allocated to pay for private sector retirement plans. The funds managed for private companies would be kept strictly separate from the monies managed for public sector employees. Specifically, the proposals revolve around permitting the state retirement system to administer retirement plans for these private sector individuals by collecting their pension contributions and overseeing the portfolio managers administering these accounts. Supporters of the measure indicate that economies of scale would ensure that administrative costs would be kept to a minimum. In fact, in a large state like California, the opportunity to bring in a significant number of private workers of varying ages enhances the likelihood of the plan "riding out" market downturns and faring well in the long term.
The impetus to offer an option for private sector employees to participate in a state-administered retirement plan springs from two important trends related to private sector pensions: 1) the pension plans in an increasing number of private companies are in serious financial difficulty and 2) an increasing number of Americans have failed to save adequately for retirement.
At the end of 2011, pension plan assets at S&P 500 companies covered only 74 percent of estimated liabilities, a deficit of roughly $450 billion. In addition, in fiscal year 2011, the PBGC's deficit increased to $26 billion, an increase from the $23 billion in the prior year. In its role as the insurer of private pension plans, the PBGC already is responsible for the retirement benefits of about 1.5 million Americans. Its obligations for these and other purposes totaled $107 billion in fiscal year 2011. A corollary to this trend is that an increasing number of private companies simply are discontinuing their pension plans or not offering retirement benefits at all.
The Washington, D.C.-based Employee Benefit Research Institute, an organization that seeks the development of employee benefit programs and sound public policy through research and education, notes in its 2012 Retirement Confidence Survey that a mere 14 percent of American workers are confident that they have sufficient funds to live comfortably in retirement. More disturbingly, the survey reported that many workers have virtually no savings and investments, and a dismal 60 percent of workers reported the total value of their household's savings and investments, excluding the value of their primary home and any defined benefit plan, as less than $25,000. Also of interest is the survey's finding that 81 percent of eligible workers (or 38 percent of all workers) contribute to an employer sponsored retirement savings plan, such as a 401(k). John Liu, New York City Comptroller, became interested in government-run retirement plans for private-sector employees after realizing that the metropolis was in "the early stages of a burgeoning retirement crisis," given that "more than a third of all retirement-age households had nothing to rely on except Social Security."
Given these twin trends, legislators in the aforementioned states have pursued enhancing the retirement security of private sector workers without company established retirement plans, not only for the individuals benefit, but also to mitigate the likelihood that these individuals will seek public assistance during retirement. In Wisconsin, state Senator Dave Hansen has proposed a separate but equal system for non-government workers such as small business owners and farmers. Similarly, in California, state Senator Kevin DeLeon sponsored legislation that would create a state-run, privately insured plan for private workers in companies that do not offer retirement benefits, and calls for private employees contributing 3 percent of their wages to deliver the sort of safe returns found in long-term U.S. Treasury bonds. He maintains that there is a crucial difference between his proposal and the DB pensions provided to state employees by the state's giant public sector retirement plans (CalPERS and CalSTRS): "the private employee pensions are designed as modest supplements to retiree Social Security benefits. The point is simply to improve the safety net that Social Security provides, keeping more people from relying on state aid." In contrast, the CalPERS and CalSTRS pensions are designed to sustain career state employees after retirement.
Another trend that has surfaced in several states in recent years, most notably in Louisiana, Kansas, Maryland, Montana and Pennsylvania, is cash balance plans, which contain features of both a traditional DB system and a 401(k)-style system. One of the first states to move to a cash balance system was Nebraska. In 2003, the state shifted all new hires to the cash balance plan, a fairly uncommon approach among public retirement systems at the time. While both employees and the state contribute to individual accounts, the plan is administered by the state's retirement agency, the Nebraska Public Employees Retirement Systems. The state contributes $1.56 for every dollar the employee contributes and the state guarantees that each account will earn at least 5 percent a year. During a period when investment earnings are strong and the plan meets minimum funding requirements, the retirement system pays out an annual dividend to employees in the plan. Importantly, the state does not pay for automatic COLA increases, though employees may finance this out of their retirement accounts. The fact that the state retirement system manages the investments for employees is an appealing feature to employees that have neither the expertise nor the discipline to competently manage their accounts. Upon retirement, employees have the option of claiming their individual retirement accounts as an annuity, lump sum, rollover or a combination of these approaches.
While states have the potential to save significant amounts of money by moving to the cash balance system adopted in Nebraska (as much as $1 billion annually, according to a study in Maryland), there is speculation on whether it provides an adequate source of retirement income. If the goal is to provide supplementary income to other sources of retirement income, it might be appropriate. However, the Maryland study noted that a state worker earning $40,000 a year and saving the maximum allowed amount would exhaust their entire account 13 years after retiring. From the state perspective, the opportunity for employees to inflate their final three years of salary through "spiking" (sick leave, overtime, promotions, last-minute raises) is eliminated since retirement payments are not based on a formula, a development that generates savings for the state.
In conclusion, states continue to face significant challenges in grappling with public pensions but, importantly, policymakers continue to devise solutions to mitigate the adverse consequences of these difficulties. Since unfunded pension liabilities are long-term liabilities that do not require resolution in a year or two, continued state action to enhance the retirement architecture of all Americans remains critical.
Posted on 2008-10 in Pensions
The turmoil on Wall Street in the last few weeks–with the Dow careening 778 points downwards on a single day in September 2008, the largest point drop ever, when the U.S. House of Representatives rejected a financial bailout plan–continues to befuddle policymakers and citizens alike. As we await the positive developments of the recently enacted Emergency Economic Stabilization Act of 2008, Americans across the country anxiously monitor their own perilous financial positions. The current turbulence on Wall Street comes at a time when state finances were already under a great deal of pressure. Even though state revenues had begun to recover from the recession that swept over the country at the beginning of this decade, several disturbing fiscal signs began to appear by late 2006 and early 2007. The nation's housing market, which had been a major contributor to the surge in economic activity in the aftermath of the 2001 recession, began to crumble as a result of a mortgage meltdown.
How have these developments from impacted state finances? One of the ways involves the adverse impact of the ongoing Wall Street tumult on a state's investment portfolio. In the last 15 years or so, states have moved aggressively away from the more staid but secure U.S. Treasury bills to more exposure to non-governmental equities, such as stock in many of the financial firms that have either disintegrated or been negatively affected by recent trends. Thus, it is a safe assumption that most states have some exposure and that their overall portfolios have eroded.
The October 2008 Question of the Month relates to an inquiry that sought to determine the asset mix of the nation's state retirement plans. Four of the top 10 plans in the nation are under SLC states, while at the other end of the spectrum, three of the bottom ten belong to SLC states.
|Top Ten Plans|
|Bottom Ten Plans|
Funded Ratio Percent (1)
Percent of Cash & Deposits in Total Portfolio (2)
Percent of Governmental Securities in Total Portfolio (3)
Percent of Non-Governmental Securities in Total Portfolio (4)
Percent of Other Investments in Total Portfolio (5)
|North Carolina||106.1|| |
|New York||100.9|| |
|South Dakota||96.7|| |
|North Dakota||81.0|| |
|New Mexico||80.4|| |
|New Jersey||77.4|| |
|South Carolina||71.6|| |
|Louisiana *||66.3|| |
|New Hampshire||61.4|| |
|Rhode Island||53.4|| |
|West Virginia||52.7|| |
|District of Columbia||N/A|| |
|National Totals/Averages||81.0|| |
|(1) Funded ratio: the ratio of the actuarial value of assets over its actuarial accrued liability.|
|(2) Cash and deposits include cash and demand deposits along with time, savings deposits and non-federal short-term investments.|
|(3) Governmental securities include United States Treasury, federal agency and state and local government instruments.|
|(4) Non-governmental securities include corporate bonds, corporate stocks, mortgages, funds held in trust, foreign and international securities and other instruments.|
|(5) Total other investments include real property and miscellaneous investments.|
|* Louisiana State Senate staff provided additional information to the SLC indicating that the Funded Ratio Percent (based on a report by Standard & Poor's) reflects data for the two largest (of the four) state-sponsored and -funded retirement systems in the state. In addition, Louisiana staff indicated that the $33 billion total portfolio comprised $31 billion from nine consolidated statewide systems for local employees with the additional $2 billion comprising funds from 21 various local plans that do not participate in the consolidated systems.|
|Funded Ratio Percent from Standard and Poor's, February 2008|
|Cash and Investment Holdings from U.S. Department of Commerce, December 2007|