Team Luna – PowerPoint Presentation

1. Team Luna – PowerPoint Presentation Group project For Professor Joshua RauH’sFinance of RETIREMENT and pensions Class 2013/12/01

2. III. Calculations

3. Please see Excel for Answers and Calculations. Methodology Discussed Here. Question 1: Recalculate AAL Question 2 & 3 Population Calculations SEE EXCEL “PS Questions 1 and 2” Tab DATA USED: Treasury rates, and Municipal Bond Rates ASSUMPTIONS: Had to assume that the 20y rate on a Washington bond is the same as the 15y rate, since there is no 20y product CALCULATION: new AAL = AAL(stated) * [(1+expected return)^t]/[(1+discount rate)^t] • SEE EXCEL “P3 PERS 2 3 Calc” Tab • DATA USED: Numbers on rolls, retirees, inactive, active, as well as probabilities on termination and mortality • ASSUMPTIONS: Because of the lack of information on population and years of service distribution, we had to work off of averages and assume growth rates based on historical trends. We felt more comfortable doing this for PERS 1 (already a frozen plan since 1977) versus PERS 2/3. In some parts, we benchmarked the average years of service and average retirement age according to the rate of active people going to inactive, as well as the mortality rates, which were directly observable. Question 2: Frozen Plan Question 3: Continued Contributions • SEE EXCEL “P3 PERS 2 3 Calc” • DATA USED: market assets, deductions (which include benefits, as well as admin fees and transfers), estimated number of retirees from Population Calculations (see top right slide). Went with total deductions to be more conservative about actual cost of benefits. • ASSUMPTIONS: created sensitivity analysis to account for variations in the growth rates of average deductions per retiree, as well as returns on assets. Also examined liabilities. Modeled with both discounted (treasury rates) and nondiscounted scenarios. Our base case assumed historical growth rate in deductions and Washington’s current return of 7.9%. • SEE EXCEL “PS Question 3” • DATA USED: Retiree population calculations from “P3 PERS 2 3 Calc,” as well as the same hard CAFR data concerning liabilities and assets. Went with total deductions to be more conservative about actual cost of benefits. • ASSUMPTIONS: Contributions will increase at the same rate as benefit payments. This assumption is backed up by the government's clear funding commitment to meet required costs for all years.

4. IV. Policy Recommendations

5. Question 1: Some General Questions What are some good features of the system? What are some bad features of the system? • The majority of the State’s pension plans are well funded • The largest, PERS 2&3, representing nearly 90 thousand workers, is funded to 99% of its accrued actuarial liabilities • The State’s pension assets have earned an average return of 8% over the past 20 years, one of the highest long-term investment returns in the country • The pension system has a tremendously positive impact on the state economy, creating roughly $1.37 dollars in economic activity for every dollar spent • Pension plans cover a large majority of public workers, 286 of 302 thousand • The scheme is incredibly complex; some simple details are not transparent (such as the age distribution of pensions, methods to arrive at assets/liabilities, the origin of funds at the State Government level etc.) • Though most of the plans are solvent, chronic underfunding has resulted in a severe asset/liability mismatch for PERS 1. See below • Some pension plans may not provide adequate benefits to its members. See below Does the system provide adequate benefits for its members? Is the system fiscally stable? • The system may not provide enough benefits to its members • In 2010, the average elderly person in Washington faced between $18 and $28 thousand dollars in annual expenses. Given that the average public employee retirement benefit amounted to just under $20 thousand that year, many retirees stand to face significant budgetary gaps • Newer plans have consistently reduced the level of benefits to workers and transferred more of the contribution burden to employees themselves • The system is broadly stable, but could face asset/liability mismatches in specific plans • PERS 1, a large state plan that was closed to new entries in 1977, has been chronically underfunded, leaving the plan only 69% funded today. This plan, under almost any of our stress tests will become completely insolvent (1-year liabilities greater than available assets) in the early 2020’s. Our findings are corroborated broadly by pension experts • PERS 2/3, enacted after PERS 1 and promising lower benefits, is fiscally stable. Even assuming 0% return on assets, the plan is solvent until at least the year 21000

6. Question 2: Questions on Recent History Have Reforms been proposed to the system? Have reforms been implemented to the system? • Many reforms have been proposed to Washington State’s pension system since the plan’s inception in 1937 • Recognizing an unstable level of pension obligation, significant reforms were proposed in 1977 • Gain-sharing, a win-fall increase to defined contribution plans, has been the focus of many reforms • Many experts and politicians today continue to push for reforms in the system • Reforms have been implemented numerous times • In 1977, the state closed new entries to a host of public pension plans, including PERS 1. • In 2003, reforms were implemented again shifting more of the burden to workers by opening more plans with a heavy emphasis on defined contributions • Gain-sharing was allowed for PERS 3 accounts, then later repealed in 2007 How have reformed impacted benefits and solvency of the plans? If reforms were proposed but not implemented, what happened? • Reforms has lowered the governments obligations to workers and shifted the economic burden of retirement more towards workers • Reforms in 1977 lowered pension obligations to new workers and shifted more of the contribution obligation to workers themselves. These reforms also addressed the long-term solvency of the state’s pension system. Washington was one of the first states in the country to reduce its retirement obligations • Reforms in the early and mid-2000s had similar results • There are currently many reforms that have been proposed but never implemented • A long-time topic if reforms is the solvency of PERS 1. Reforms to PERS 1 have been proposed since the 70s. However, successful attempts at reform have focused on drawing down befits for new and future workers, instead of addressing ways to pay for the promised befits to current active members/retirees. Solvency reforms have been stymied by the lack of political will to address existing unfunded, pension obligations, which can only be funded by tax increases or shifting greater parts of the government budget to pensions

7. Question 2: Questions on Recent History Have Reforms been proposed to the system? Have reforms been implemented to the system? • Many reforms have been proposed to Washington State’s pension system since the plan’s inception in 1937 • Recognizing an unstable level of pension obligation, significant reforms were proposed in 1977 • Gain-sharing, a win-fall increase to defined contribution plans, has been the focus of many reforms • Many experts and politicians today continue to push for reforms in the system • Reforms have been implemented numerous times • In 1977, the state closed new entries to a host of public pension plans, including PERS 1. • In 2003, reforms were implemented again shifting more of the burden to workers by opening more plans with a heavy emphasis on defined contributions • Gain-sharing was allowed for PERS 3 accounts, then later repealed in 2007 How have reformed impacted benefits and solvency of the plans? If reforms were proposed but not implemented, what happened? • Reforms has lowered the governments obligations to workers and shifted the economic burden of retirement more towards workers • Reforms in 1977 lowered pension obligations to new workers and shifted more of the contribution obligation to workers themselves. These reforms also addressed the long-term solvency of the state’s pension system. Washington was one of the first states in the country to reduce its retirement obligations • Reforms in the early and mid-2000s had similar results • There are currently many reforms that have been proposed but never implemented • A long-time topic if reforms is the solvency of PERS 1. Reforms to PERS 1 have been proposed since the 70s. However, successful attempts at reform have focused on drawing down befits for new and future workers, instead of addressing ways to pay for the promised befits to current active members/retirees. Solvency reforms have been stymied by the lack of political will to address existing unfunded, pension obligations, which can only be funded by tax increases or shifting greater parts of the government budget to pensions

8. Question 3: Proposals (please see Write-Up for elaboration) #1 Accounting, Reporting and Transparency #2: Pension Design • Forego asset smoothing. (already occurred with the new GASB rules) • Clearly report all investment gains and losses, plus asset classes • Consider UAAL per capita as a measurement • Cleary document the reasons for choosing the discount rateP • Provide competing liability valuations • Provide an age distribution for all plans, as well as a distribution of their years of service. • In general, shift to a digital open source government • 1. Place a cap on salaries so as to avoid ratcheted-up pensions • 2. Gradually lower the expected return on investments, or otherwise transparently justify that there is a high likelihood of attaining them. • 3. Maintain the alternative investment strategy, but be more transparent about risk and returns: #3 Scenarios (part i) #3 Scenarios (part ii) • Scenario #1: Tie defined benefit pension schemes to a mandatory cap on new hires in negotiations with public sector unions • Scenario #2: Offer retirees on PERS 1 an outsize lump sum to shift into a 401(k), perhaps five years’ worth of payments. • Scenario #3: Rather than having one pension system for everyone, divide the plans and conditions into cohorts depending on years of service and age. • Scenario #4: Phase in a new set of jobs, perhaps guest worker jobs, that would explicitly pay for the PERS 1 pensions. • Scenario #5: Facilitate the creation of annuity plans that are not tied to the state’s obligation. This is similar to Senator Orrin Hatch’s proposal, the SAFE act. • Scenario #6: Create a sovereign wealth fund to undertake riskier investments and seek higher returns that would be reimbursed to states on a pro rata basis, but otherwise consign the state pensions to lower-risk assets

9. V. Strategy

10. Strategy: Commission non-partisan study group to review and issue policy recommendations for pension reform. List of Key Stakeholders Pension Funding Council Study Group: Composition • Public sector unions • Pension Funding Council: the director of the department of retirement systems, the director of the office of financial management, the chair and ranking minority member of the House of Representatives appropriation committee, and the chair and ranking minority member of the Senate ways and means committee. • Experts, academics and researchers • Private sector companies, workers and citizens who are not using defined benefit, but are nevertheless taxholders and whose experiences of pensions are shaped by their use of 401(k)s • Insurance Companies, Financial Industry • Collaborate with the Pension Funding Council to create a semi-public forum and study group to review and issue policy recommendations for pension reform (maybe call it the “Pension Funding Council Study Group”) • Members of this group should include all key expert stakeholders, with their recommendations and conclusions subject to public review and comment. • The study group should be designed to both tackle specific funding shortfalls, as well as think long-term about what new strategies Washington may experiment with to adequately provide pensions Pension Funding Council Study Group: Activities Why not a gov’t press conference, online forum or grassroots org? • 1. Exploring potential financial products that can better judge retirement scenarios • 2. Investigating legal possibilities for changing pension fund parameters • 3. Understanding holistically how salaries and work need to be restructured for an increasingly globalized workforce • 4. Agreeing on a valuation that will assist in long-term planning • A sample policy brief is in the Write-Up. • These three choices are too top-heavy or bottom-heavy, and are not conducive to buy-in from the key stakeholders. • Convening a government press conference, for example, would feel like an ambush to public sector unions, who would not feel included in the process. Even if it was a joint press conference, this makes the issue seem more closed book rather than open ended. • An online forum in this day and age is not quite engaging, unless it was somehow tied to an online platform for pensions, whereas the goal of “pension reform” is not narrow enough (and the interested parties not broad enough) to truly mobilize a grassroots movement.