pension presentation - emerald investment forum

8/7/2019 Pension Presentation - Emerald Investment Forum

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Pensions & PoliticsManaging "Generational Theft

The Absence of Sound Public Policy Principles

Richard C. DreyfussBusiness Consultant and Actuary

Senior Fellow - The Commonwealth Foundation

Emerald Asset Management, Inc.

Investment Forum

February 2, 2011Philadelphia, PA


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Managing Pension Liabilities

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The Public Pension CrisisAugust 18, 2006; Page A14

the fundamental problem is that publicpensions are inherently political institutions.

the current public pension system simplyisn't sustainable in the long run.


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In any collaboration between two groups who hold differentbasic principles, it is the more irrational one who wins.

What good is an unprincipled bipartisan agreement?

This helps explain the irrational pension legislation of Act 9 (2001) 25%/50% increase in pensions

Act 38 (2002) Retiree pension COLA

Act 40 (2003) Deferring unaffordable costs to 2012 and

beyond Act 44 (2009) City of Philadelphia & Municipal Pension

Non-reform

Act 120 (2010) PSERS & SERS Non-reform

(Generational Theft Bill) 3

Summary of the Problem


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Three Factors Drive the PoliticalInstitution of Public Pensions

1.Poor Benchmarking

2.Poor Risk Management Practices

3.Politics

4


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#1 Poor Benchmarking

Pennsylvania public pay and benefits aretypically benchmarked only against other publicplans rather than the entire marketplace

Affordability and market trends in the privatesector are directly relevant to the public sector

2010 Hewitt Survey: only 11 of 33 major PAemployers sponsor defined benefit plans All sponsor 401(k) plans with an average employer match of 72

cents per dollar and an average matched employee contributionof 5.4 percent of pay.

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Towers Watson Survey

Average DC Employer Cost - 5.77%http://www.towerswatson.com/united-states/research/2106

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Traditional DB Plans 67 61 60 55 48 42 40 39 36 30 22 20 17

Hybrid DB Plans 7 13 14 18 24 30 30 29 25 23 26 25 26

DC Plans 26 26 26 27 28 28 30 32 39 47 52 55 58

0%

10%

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30%

40%

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60%

70%

80%

90%

100%

Fortune 100 Companies - Trends in Retirement Plans

Traditional DB Plans

Hybrid DB Plans

DC Plans

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Government has nothing to give anybodyexcept what it first takes from somebody.

Public sector financing is ultimatelydependent upon private sector growth.

Consider the significant pay and benefitsdifferentials favoring the public sector.

Source: Seven Principles of Sound Public Policy Remarks before the Economic Club of Detroit by Lawrence W. Reed | Oct. 29, 2001

Public Policy Principle #1


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#2 Poor Risk Management Practices

Few absolute metrics defining the affordability or

reasonableness of pension costs given the perpetuallife of the government entity.

Entire defined-benefit (DB) funding system is based

upon annual investment assumption in the 8% range.

Little consistency in funding assumptions and fundingmethods making comparisons most difficult.

Private sector pension plans must fund their plans inaccordance with The Pension Protection Act (PPA) of2006 which requires lower interest rate assumptionsand shorter amortization periods.

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What belongs to you, you tend to takecare of - what belongs to no one or

everyone tends to fall into disrepair.

Who ultimately owns the investment

risk in the public pension system?




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#3 Politics

Pensions as political capital

Pension Fund Surplus = Benefit Improvementsfor Participants

Pension Fund Deficits = Underfunding byTaxpayers

Maintaining or Improving Benefits = High

Political Rate of Return

Reforming and Properly Funding Plans = LowPolitical Rate of Return

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Sound public policy requires that weconsider the long-run effects and all

people, not simply short-run effectsand a few people.

We are 180 degrees out of phase




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Politics

Pensions are not well understood

Abundance of half-truths

Benefit commitments can be over 50 years

Funding is easily manipulated Easy to (re)defer costs to the next generation

Local and city pension shortfalls are becomingpolitical problems for the state Philadelphia, Pittsburgh, Allentown, Erie and Reading

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"Warren Buffett would close down his shop andgive his money to the city of Orlando" if it couldget 8 percent, says Edward Siedle, a former federal

securities lawyer and president of BenchmarkFinancial Services in South Florida.

Cities like Orlando have three choices, Siedle says.1)"They can cut benefits, which is politically unacceptable,2)"They can increase contributions from the employer and

employees, which is politically unacceptable.3)The third choice is called magic. That's what public

pension funds across the country are doing, coming upwith magic.

Pension Magicin Florida(and elsewhere)

Orlando Sentinel July 7, 2010


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HB 2497 Projection of PSERS TaxpayerContribution as Percentage of Payroll

(in FYE 2011, 1% pay =~$135M)

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

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Current Law

HB 2497


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50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

2011

2012

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2015

2016

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2018

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PSERS Projection of Funded Ratio

Current Law HB2497 Senate Amended

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PSERS Projection of Funded Ratios


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During the next 30 years all this will be made worse if we:

1. Fail to earn the 8% annual assumed rate-of-return on theassets

2. Revise the investment assumptions to reflect lowerexpectations.

3. Once again defer scheduled contributions to save money

4. Once again fresh start or re-amortize the unfunded liability

5. Grant retirees an ad-hoc COLA, implement an early retirementincentive or otherwise enhance current or future pension

benefits 16

Negative Implications of HB 2497Unacceptable Risks, Generational Theft, Non-Reform


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True Pension Reform Must Satisfy Three BasicPrinciples Using Realistic Funding Assumptions

1. Funding must be current. Benefits should be funded as they are earned and

paid-up in the aggregate at retirement

Achieving a 100% funded ratio

Significant private sector pension funding reformsoccurred in 2006.

2. Costs must be predictable.

3. Costs must be affordable. 4-7% of payroll (net of employee contributions)

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Five Step Pension Reform Plan

1. Establish a Unified Defined Contribution plan for new state and local

government workers, school employees, judges, and legislators Curtails open-ended liabilities; Eliminates long-term commitments

on behalf of taxpayers

Removes politics from pensions

2. Prohibit pension obligation bonds or other post-employment benefit(OPEB) bonds

Prevents generational theft deferment of liabilities

3. Mandate pension and OPEB liability management reforms forcurrent and any newly created liabilities.

Achieve an annual employer cost of 4% to 7% of payroll withstandardized actuarial assumptions, shorter amortization periods,all generally similar to PPA of 2006. Prohibit fresh-starting.

Prohibit benefit improvements if this would result in a funded ratiobelow 90%.


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Five Step Pension Reform Plan

4. Consider modifying unearned pension benefits (if legal and feasible) Reduced formula; Redefinition of eligible earnings; Increasing the

normal retirement age; Curtailing early retirement subsidies;Eliminating COLAs and Deferred Retirement Option Programs(DROPs)

5. Consider funding reforms only after prior steps are achieved

Challenge is to do this without increasing taxes or through newborrowing

Omitting steps 1,2,3,4 pension reform


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1. Deferring unsustainable pension liabilities does not make futureliabilities sustainable. Why is contributing less into alreadyunderfunded plans considered reform?

2. We have over-leveraged our pension system. The challenge is tofinally restore proper funding while offsetting these increased costselsewhere within the state and local budgets without increasingoverall spending (or borrowing).

3. PA Municipal Pension Plans are a variation of this theme.

4. Retiree Medical Obligations are a parallel problem.

5. Given all this, what are the financial incentives to live, work, or investin Pennsylvania?

6. This debate is effectively one involving self-reliance while removingpolitics from pensions, protecting the taxpayer and stoppinggenerational theft.

Thoughts for Sound Public Policy


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Pensions Struggle With 'New Normal' YieldsOctober 14, 2010

While options for closing the funding gap abound, none are palatable.

1. They can de-risk by better matching existing bond holdings to the duration oftheir liabilities, but this would lock in their underfunded status to the point theymay need to make additional contributions.

2. They can implement various hedging strategies for the interest rate and

equity risk, which is costly and not a perfect solution.3. They can step up their investments into high yield bonds or alternatives such

as hedge funds and private equity, which would involve more risk-taking.4. Or, if they don't have cash on hand, they might be forced to revisit payouts.

Milliman's annual pensions study shows the average equity allocation has fallen

more than 15% over the past three years.

Thoughts for Pension Asset Managers


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1. How are future investment returns to be achieved given the need tofinance growing government deficits? The US dollar is/will be underpressure. Inflation will undermine any future returns.

2. Likely result is a crowd-out of private-sector capital investment neededto achieve productivity increases. Are your asset returns dependent upon

assumed/continued government subsidies?

3. Growing difficulties in determining proper pension asset allocations andefficient frontiers to satisfy long-term asset return targets. Lower long-term investment expectations will need to be acknowledged.

4. DB pension plans will face liquidity challenges as politicians are faced witha combination of raising taxes, enacting reforms or further deferring costswhile triangulating the politics bankruptcies likely to occur.

5. Historically, private sector pensions generally reflected market disciplinethereby differentiating themselves from public sector plans. However,government bailouts and subsidies are replacing bankruptcies and marketforces.

Thoughts for Pension Asset Managers

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