A BALANCED APPROACH TO PENSION REFORM

The Three Buckets Plan

SERS PSERS

229,908 state employees

106,152 active117,061 retired$25.3 billion in

assets$2.5 billion

paid/year

597,805 public school employees

273,504 active202,015 retired$49.7 billion in

assets$6 billion paid/year

Pennsylvania Has Two Public Pensions

Numbers reported by SERS in February 2013

Numbers reported by PSERS in April 2013

How do they work?

Both are defined benefit plans.Employee enrolls upon

employment.Employee pays 6.25% (SERS) or

7.5% (PSERS) of salary via payroll deduction.

Employer contributes (annually) an amount based on a formula and actuarial review.

SERS & PSERS invest these dollars.

A “Benefit” Is Calculated at Retirement

Years Employe

dMultipli

er*Final Salary

Annual Annuity

Annual Annuity Paid Monthly for Life

* Average of the 3 highest years

A Real Example of a Career Employee

Meet “Pat”Hired 35 yrs. ago @ $6,000/yr.

Retired in 2013 w/an $81,000 final salary.

Pat paid $89,500 into the system.Pat’s account value was $152,710 at

retirement (Present value = $867,245).

Pat withdrew all $152,710 and receives an annuity of $4,660/mo. for life.

How Account Value May Be Drawn

Provide maximum annuity.

Provide reduced annuity with survivor benefits (such as a spouse).

Lump sum withdrawal (with reduced monthly annuity).

What Is the “Pension Crisis”

All About?

“Unfunded Liability”

The gap that exists between what is necessary to meet the pension benefit obligations of future retirees and the actual dollars that will be available in the SERS and PSERS accounts.

PSERS – 33.6% underfunded, or $29.5 billion

SERS – 41.4% underfunded, or $17.9 billion

As reported by SERS in February 2013 and PSERS in April 2013.

Causes

Act 9 of 2001 benefit enhancements.

Investment market poor performance.

Years of employer underfunding.

20-Year SERS Employer Contributions

20-Year PSERS Employer Contributions

Rating Agency Reports (Part 1)

Fitch RatingsJuly 16, 2013

“Pension Funding Demands: The funding levels of the Commonwealth’s pension systems, which have been historically adequate, have materially weakened, with annual contribution levels remaining well below actuarially required levels…..Maintenance of the ‘AA’ rating will require action over the next one to two years to make substantive progress towards addressing the state’s structurally unbalanced budget, restoring reserves, and addressing the rapid growth of fixed costs, including for pension funding……Unfunded pension obligations now represent the dominant share of the state’s long-term liabilities.”

Moody’s Standard and Poor’sMarch 29, 2013

“Due to recent investment losses and a seven-year history of low, statutory pension contribution levels, the Commonwealth’s unfunded pension liability has increased substantially and funded ratios have declined below 70%.....What could make the rating go down: Growth in long term liabilities, increase in fixed cost pressures, or additional deferral of pension costs….”

April 2, 2013

“The negative outlook on Pennsylvania reflects our view that growing expenditure pressures, primarily pensions, coupled with a slow economic growth environment and limited available reserves, could place downward pressure on the rating…..Should the Commonwealth make significant strides in addressing its pension liabilities or experience substantial economic growth that would mitigate the impact of these liabilities on the budget, we could revise the outlook to stable.”

Rating Agency Reports (Part 2)

Options to Address the Problem

Close the defined benefit (DB) plan to new employees and direct them into an alternate plan:

Cash Balance Plan Defined Contribution (DC) Plan Hybrid Plans.

Put more money into the system(s). Employee Contribution Employer Contribution Borrowing

Reduce benefits paid out.Enhance investment returns.

Obstacles to Reforms

Budgets General Fund School District Budgets

Contract Impairment – Pennsylvania Constitution

Prevents unilateral changes to current/active members and retirees.

Enhanced Returns Chasing higher returns requires greater investment

risk.Borrowing

Risky if done incorrectly and unwise if done to avoid the problem without further reforms.

Balanced Approach – Three Buckets Plan

Future Employees

•New Cash Balance Plan

Past Underfunding

•General Fund borrows $9 billion to make up for 10 year underfunding

Current Members

•Agree to modest plan changes:•Lump sum option modification•5-year final avg. salary

•Receive a reduction in their employee contribution rate

NOTE:Nothing affects anyone who is

already retired!

Cash Balance Plan

Employe

e Contributio

n

Employe

r Contributio

n

Guaranteed Return

Account Value

For New Members Enrolled after June 30, 2015

7% 4/5% 4%

At retirement turns into a monthly annuity

General Borrowing

General Fund borrows $9 billion in two steps.

Step One: $2 billion to PSERS and $1 billion to SERS, amortized over 24 years.

Step Two: $4 billion to PSERS and $2 billion to SERS, amortized over 24 years.

Current Member Modifications

Lump Sum formula – “actuarially neutral”Based on a $55,000 salary with accumulated deductions of $120,000

Current annuity = $3,945.33/month

Actuarially Neutral = $3,684.86/month

Current Member Modifications continued

Based on 5 highest years instead of 3 highest years.

Reduces final year “spiking.”

Years Employed

Multiplier

Final

Average

Salary

Annual Annuity

Final Average Salary Calculation

Effects on Future Employer

Contributions

Cash Balance Plan

Market Returns: 7.50% for all future yearsAlternative Funding assumptions:- One-time contribution of $2,000,000,000 is made as of 7/1/2013 and the lump sum amount is amortized over 24 years, beginning with FY 2016.- One-time contribution of $4,000,000,000 is made as of 7/1/2016 and the lump sum amount is amortized over 24 years, beginning with FY 2019.- Pension collar limits contribution to prior fiscal year + the collar: 4.50% for FY2014, 1.00% for FY2015, 2.00% for FY2016, 2.00% for FY2017, 2.00% for FY2018, 3.00% for FY2019, 3.00% for FY2020 and later.New members after 6/30/15 enrolled in a Cash Balance (CB) plan (not subject to Act 120 cost share): For Legacy PSERS Members who retire after 6/30/15:- Member contributes 7.0% of pay - Employer CB contribution of 5.00%/year - FAS5 for all service- Statutory Interest Rate of 4.00% - 50% share in MVA returns exceeding 4% - Cost neutral Option 4

Public School Employees' Retirement System of PennsylvaniaMarket Returns Set by User and are the same for both Current and Alternative Funding

Projection of Total Employer Contribution Rate

0%

5%

10%

15%

20%

25%

30%

35%

Current under Act 120 Alternative Funding

Barriers to Achieving Compromise

Aversion to new debt Is this really “new” debt?

Concerns of active members Ongoing discussions with union leaders and

othersHardened positions

“Defined Contribution is the only answer.” “Let Act 120 work.”

The Cost of Doing Nothing

If we just “Let Act 120 work.”

Schools in the 87th District

2013-2014 2014-2015 2015-2016 2016-2017 2017-2018

Cumberland Valley SD $4,170,000 $5,391,000 $6,729,000 $7,585,000 $8,011,000

Camp HillSD $746,000 $965,000 $1,204,000 $1,358,000 $1,434,000

East PennsboroArea SD

$1,383,000 $1,788,000 $2,232,000 $2,516,000 $2,657,000

Benefits to Achieving Compromise

Savings to the General Fund Savings to School Districts

Savings to the Philadelphia School District Positive message to bond rating agencies Current employees retain a DB plan with minimal impact—with

the the same multiplier and reduced employee contributions—all deferred until they retire.

Future employees have a reasonable and sustainable retirement benefit.

Provides a level of protection for employers (school districts, the state) when the markets have a downturn.

Avoidance of transition costs, which would be triggered by a switch to a DC plan.

Elimination of a constitutional contract impairment challenge.

I Welcome Your Questions

Rep. Glen Grell3 East WingP.O. Box 202087Harrisburg, PA 17120Ph: 717-783-2063Fax: 717-705-7012 ggrell@pahousegop.com

www.RepGrell.com