HomeMy WebLinkAbout04/05/2005, C5 - SUPPORT FOR RESPONSIBLE PENSION REFORM AND EXPRESSION OF CONCERN WITH ACA 5 AND OTHER SIMILAR INITI j
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j acEnna RepoRt G�
CITY OF SAN LUIS OBISPO
FROM: Monica Moloney, Director of Human Resources Y^"
SUBJECT: SUPPORT FOR.RESPONSIBLE PENSION REFORM AND EXPRESSION
OF CONCERN WITH ACA 5 AND OTHER SIMILAR INITIATIVES
CAO RECOMMENDATION
Adopt a resolution supporting pension reforms developed in cooperation with the League of
California Cities Task Force, Ca1PERS, and public employees unions while expressing
opposition to Assembly Constitutional Amendment 5 (ACA 5) and other similar "quick fix"
initiatives.
DISCUSSION
Overview
During the Communication Section of the March 1, 2005 Council meeting, at the request of
Council Member Settle, the City Council directed staff to return to Council on April 5, 2005 with
a resolution that expands upon the position taken on public pension reform in the Council's 2005
Legislative Action Program. The position in the program is presently stated as follows:
"Supporting pension reform efforts in concert with the League of California Cities positions."
This report summarizes the overall issue and includes a recommended resolution for adoption by
Council that will expand on this position.
Background
For almost 60 years, California state and local governments have offered "defined benefit"
retirement plans to their employees. These plans provide a guaranteed annual pension based
upon a formula that considers retirement age, years of public service, and some period of highest
salary (typically the last one or the last three years of work). These defined benefit plans also
generally provide for an annual cost of living adjustment and additional inflation protection so
that the retired employee's purchasing power is maintained over time at a specified level. The
City of San Luis Obispo is enrolled in the California Public Employees' Retirement System
(CalPERS) which is a defined benefit retirement plan. In recent years retirement costs for public
agencies throughout the State have escalated dramatically due to a variety of reasons, including
Ca1PERS investment losses and the authorization of significant benefit increases by the State
Legislature.
Proposed Legislation
In the fall of 2004, constitutional and statutory initiatives were proposed that would close all state
and local public sector defined benefit plans to new entrants effective July 1, 2007. Instead, all
newly hired state and local employees would be placed into "defined contribution" plans. A
participant's benefit under a defined contribution plan is based upon contributions made by the
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Support for Responsible Pension Reform Page 2 of 3
employee, the employer, and any investment gains or losses on those contributions. Therefore, a
defined contribution plan provides no predictability of the benefits paid upon retirement.
Assembly Constitutional Amendment 5 Defined Contribution Plan (ACA 5 Richman) and
Assembly Constitutional Amendment 1 Extraordinary Session — Defined Contribution Plan
(ACA lx Richman) are two such initiatives.
Concerns with this Approach
These proposals define "newly hired" as any employee hired by any public agency after July 1,
2007, regardless of whether the public employee is merely hired by another public agency. This
means that a current public employee would participate in two types of pension plans if he or she
were hired by a different agency after July 1, 2007 (the employee's current defined benefit plan
and the proposed "defined contribution" plan). Additionally, an employee starting his or her
public sector career after the July 1, 2007 date would have a completely different retirement
benefit plan than his or her co-workers. This two-tier system would not only decrease the public
sector's ability to attract highly qualified individuals but also deter experienced public sector
employees from working at different agencies over the course of their careers. Such systems
with unequal benefits frequently lead to morale issues. Further, the proposed legislation requires
that the defined contribution plans be administered by the private sector, where administrative
costs are likely to be higher than those currently charged by PERS. Finally, it is not clear that a
defined contribution plan such as those proposed under ACA 5 or ACA lx addresses the root of
the issue to those advocating pension reforms (e.g. rate fluctuation, pension benefit levels, shared
risk, disability retirement, etc.). Attachment 2 is a "white paper" prepared by CalPERS which
addresses several of these issues in more detail, and illustrates why "quick fix cures" could be
more harmful than the problem and undermine a system that has fundamentally worked very well
for many years.
Reform Supported
However, the League of California Cities and cities throughout the State agree appropriate
revisions and reforms to the current system are needed. Therefore, the League has asked the City
Managers Department's standing task force on PERS to undertake a study of the defined
contribution proposal and other potential defined benefit reforms. A group of appointed and
elected officials were subsequently added to the task force to provide broader input. This group
has included police and fire representatives, since public safety concerns have been a discussion
focus. Since early December the task force has met regularly to study the problems with the
existing defined benefit retirement systems and to evaluate the defined contribution proposal.
The League also retained the services of retirement actuary, John Bartel of Bartel Associates,
LLC, who worked with the task force to ensure its recommendations for defined benefit system
reform were actuarially sound.
Reform recommendations currently under consideration by the League include changes to
pension benefit levels, improved management of rate volatility, and assurance that reforms are
actuarially sound. Perceived abuses of the current defined benefit retirement programs also need
to be addressed. Benefit plans which result in retirement benefits that exceed the levels
established as appropriate to maintain employees' standards of living should be reformed. It is in
GAagenda reportsTension Refonn03_21_05.doc
Support for Responsible Pension Reform Page 3 of 3
the interest of all public employees, employers, and taxpayers that retirement programs are fair,
economically sustainable, and provide for adequate benefits for all career public employees,
without providing excessive benefits for a select few. Attachment 3 outlines the League's draft
position on these issues.
The CalPERS Board of Administration has also approved the first reading of proposed changes
to actuarial policies aimed at reducing employer rate volatility. Key recommendations include
the following: 1) in the calculation of the,actuarial "value of assets, spread market value asset
gains and losses over 15 years as opposed to the current three years, 2) calculate the annual
contribution amount with regard to gains and losses as a rolling 30-year amortization of all
remaining unainortized gains or losses, as opposed to the current 10% of such gains and losses
and, 3) adopt a new Board policy imposing a minimum employer contribution rate. Minutes of
the CalPERS Benefits and Program Administration Committee first reading on employer rate
stabilization are attached (Attachment 4). CalPERS staff also received direction to bring specific
information regarding the implementation plans and to gather information regarding pension
stabilization accounts and reports to their next meeting. The League and CalPERS proposed
reforms address the root of the problems, not just the symptoms, while maintaining a pension
system that attracts and retains high quality public employees.
CONCURRENCES
The City of San Luis Obispo's employee association presidents have reviewed this report and
support the recommendation.
FISCAL IMPACT
Support of responsible pension reform has no fiscal impact at this time. Proposed change to a
defined contribution retirement system may have significant negative fiscal impact. It is difficult
to quantify at this time.
ALTERNATIVES
No alternatives are recommended at this time.
ATTACHMENT
Attachment 1 Resolution
Attachment 2 CalPERS "White Paper"
Attachment 3 League of Cities Draft Position Statement
Attachment 4 Minutes of Ca1PERS Benefits and Program Administration Committee item on
Employer Rate Stabilization—First Reading
GNagenda reportsTension Ref=03_21_0S.doc �� 2
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ATTACHMENT 1
Page 1 of 2
RESOLUTION NO. (2005 Series)
A RESOLUTION OF THE COUNCIL OF THE CITY OF SAN LUIS OBISPO
SUPPORTING RESPONSIBLE PENSION REFORM AND EXPRESSING CONCERNS
WITH ACA 5 AND OTHER SIMILAR INITIATIVES
WHEREAS, the City of San Luis Obispo, along with other local agencies throughout the
state of California, welcomes a comprehensive discussion about pension reform, focused on curbing
the increased costs of providing public pensions in the context of the critical role that public pension
benefits play in the recruitment and retention of a skilled public workforce; and
WHEREAS,the defined benefit model used for public employee pensions has been in place
for about sixty years in California, and has ensured that California residents receive high quality
services from motivated,highly professional public employees;and
WHEREAS, the City of San Luis Obispo recognizes that problems exist and must be
addressed in the defined retirement benefit plans in California; such concerns are: a)Increased cost to
the public employer and ultimately the taxpayer; 2) volatility of employer pension contributions;3)
some excessive benefit formulas; and, 4) permitted abuses due to the lack of proper restraints in
retirement law; and
WHEREAS, solutions to problems in the defined benefit retirement plans require a wide
variety of options and strategic approaches and one-size-fits-all solutions, which fail to take into
account the complexity of the issues, such as ACA 5 and ACA lx, should be avoided; and
WHEREAS, defined contribution plans as the only alternative raise the immediate costs of
public pension plans and seriously erode the ability of public employers, such as the City of San Luis
Obispo, to retain and recruit skilled public employees.
NOW,THEREFORE,BE IT RESOLVED that the Council of the City of San Luis Obispo
as follows:
SECTION 1. Responsible Pension Reform. The Council hereby supports responsible
pension reform, developed through collaborative input from Ca1PERS, the League of California
Cities, and public employee unions, aimed at elimination of pension abuse and at employer rate
stabilization.
SECTION 2. Opposition to ACA 5 and ACA lx. The Council hereby specifically opposes
Assembly Constitutional Amendment 5, Special Session Assembly Constitutional Amendment 1, as
well as any and all measures proposed for the upcoming special election statewide ballot that would
mandate the replacement of the current defined benefit retirement system with a private defined
contribution system, whether for new or existing employees.
Upon motion of seconded by
and on the following roll call vote:
AYES:
NOES:
ABSENT:
GARESOLUTIONS AND ORDINANCES\PensionRefonnResolution03_2I_05.doc
Resolution No. (2005 Series))
Page 2
The foregoing resolution was adopted this day of 2005.
Mayor David F. Romero
ATTEST:
Audrey Hooper
City Clerk
APPROVED AS TO FORM:
Jona well, City Attorney
ATTACHMENT-2-
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California Public Employees' Retirement System
c�P 5 Research Brief
Pension Debate: The Myths and Realities of
Defined Benefit and Defined Contribution
Plans
January 2005
Moving from a Defined Benefit Plan to a Defined Contribution Plan
Won't Help Current Budget Crisis
The change to a defined contribution (DC) plan would not save the State and
local government money for at least 10 years, and in fact, it will add a second
pension system that will add start up costs to government budgets. In addition,
the State would also have to pay more money to cover disability and death
benefits for these employees, as well as Social Security, which State safety
personnel and others don't currently receive.
The Ca/PERS Defined Benefit Plan Works Very Well
CalPERS has been a proven great investor for the taxpayers of California.
Over the last 10 years ended June 30, 2004, CaIPERS returns averaged 9.7
percent even with two years of negative returns. It has generated positive
investment returns 18 of the last 20 years, and costs less than a DC plan. Some
75 percent of income to fund pensions came from good investment earnings
during the last 10 years.
CalPERS investment earnings have made up the lions share of the fund
over the last 22 years. According to its pension consultant Wilshire Associates,
wealth created through investments has totaled $171.9 billion from 1982-2004.
During the same period, employer and employee contributions totaled $29.7
billion and the System paid out$48.6 billion in retirement benefits.
A report compiled by Cost Effectiveness Measurement Inc. found that CalPERS
investment staff added $7 billion in excess returns over the five-year period
ended December 31, 2003, while taking less risk than other public pension funds
in the United States, Europe, Canada and Asia.
Updated 2123105
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Excessive Benefits in the Defined Benefit Plan Is a Myth
Average pension is small. No one is getting rich on pensions. Some 25,000
CaIPERS members retire each year. The average age at retirement for the
largest segment of workers is 60, with 19.5 years of service, and a benefit
allowance of$1,673.82 a month. The average CHP employee retires at age 55,
with 27.9 years of service, and receives an allowance of$3,811:27 a month.
The majority of State cost increases are due to market downturn, not to
increased benefits. Nearly 80 percent of increases in employer rates between
2002-04 are due to the two-year downturn in the economy. And as a percent of
payroll, the State pays less per employee than it did 25 years ago for school
employees, state miscellaneous employees, state industrial workers, state safety
workers and state peace officer and firefighters.'
Defined Contribution Plans Don't Cost Less,
They Cost More
Dollar for dollar, DC plans cost more. Administrative costs of DC plans are
higher—often much higher—than a DB plan.Z The average cost of administering
CaIPERS defined benefit plan from 1997 to 2003 was 0.18 percent. The annual
cost of a DC plan can rise to as much as 2 percent of assets. The expense ratio
for a stock mutual fund is 1.1 percent of assets.
CaIPERS investment portfolio is low cost and less risky than other public
pension funds. A Cost Effectiveness Measurement Inc., found that CaIPERS
saved $144 million compared to its peers, paying less for consulting, custodial
and active management services. Costs to run the pension fund's investment
portfolio were $413.2 million in 2003, compared to a peer benchmark of$557.1
million.
In a typical DB plan, 80 cents of each $1 is spent on members who retire; in
a DC plan 50 cents of each $1 is spent on benefits with the other 50 cents
spent prior to retirement. For retiring members to receive the same amount of
benefits, contributions to the fund would need to increase substantially.3
There is no guarantee that tax dollars put into an employee account will be
used for retirement. Research indicates that most employees who leave one
job for another, cash out their accounts— including the monies contributed by the
employer for the purpose of retirement— rather than roll them over to the next
employer's retirement plan.4 If DC proceeds fall short of basic retirement income
needed, the State will end up paying more in public assistance when employees
are old, ill and infirm.
A comparison of operation expenses favors DB plans. Employees pay big
fees to mutual funds and other investment mangers on their investment dollars in
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DC plans. On average, mutual funds charge $1.35 for"load" and/or
administrative expenses for every $100 invested. For each of the last 6 years,
CalPERS spent less than two tenths of one percent of the fund's value— 18
cents on every $100 invested.5
The State will bear start-up costs of a DC plan, bringing to two the number
of plans it will need to budget for.The State's contributions to the CalPERS
plan do not require direct payment of administrative costs to run the system. If
the State were to set up a DC plan, it would have to pay for start-up costs. The
DC plan does not cover costs of disability retirements and death benefits, which
are embedded in the cost of the DB plan. The State would also have the added
expense of starting to pay 6.7 percent of payroll for police, firefighters, and others
in safety classes who don't get social security under the existing DB plan.
The State throws away an opportunity to use future investment returns to
cover retirement costs, relieving taxpayers from some of the burden of
funding pensions. A DC plan does not give the State the ability to use
investment returns to pay for a portion of pension costs. For example, investment
returns and employee contributions generated enough income in the mid-1990s
that the State did not pay any contributions during four years — Fiscal year 1998-
99 through Fiscal Year 2001-02 -- for 350,000 classified school workers. That
represented a savings of over$4 billion alone.
Over the last 10 years, 75 percent of the income to CaIPERS has been from
investments, not employer or employee contributions. Over the last decade,
members' contributions have actually exceeded the amount of employer
contributions by $1.1 million.
Replacing a Defined Benefit Plan with a Defined Contribution Model
Tums Off The Future Spigot of Pension Dollars For Investments in the
State Of California
Under the existing CaIPERS defined benefit plan, more than $19.5 billion in
pension dollars is set aside for California investments. Replacing CalPERS with a
DC plan would mean that future contributions needed for a DC plan could not be
re-deployed for California investments. It would tum a blind eye to the opportunity
to redeploy capital to strengthen California business, promote job growth, and
build communities and infrastructure. These investments—a part of CalPERS
diversified portfolio of investments — help strengthen the State's economy and
-tax base.
Currently, CalPERS invests more than $10.7 billion in companies based in
California —from blue chip corporations on the New York Stock Exchange to
start-up firms in south central Los Angeles and the Silicon Valley.
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CaIPERS holds $2.4 billion in fixed income assets, including corporate bonds in
California, that enable corporate expansion. And CaIPERS invests $6.4 billion in
California real estate. These include investments in industrial office properties,
office buildings, senior housing and retail establishments. CaIPERS is also one of
the largest real estate developers, financing more than $2 billion worth of single
family homes.
CaIPERS pension dollars have financed the building of more than 43,000 homes
and developed 33,000 lots for single family homes. This public pension capital
has provided $13.8 billion in mortgages for nearly 100,000 California families.
The private equity portion of the CaIPERS portfolio has invested in many start-up
companies, including biotechnology which capitalizes on the advent and
convergence of new technologies including genomes, bioinformatics and
therapeutic agents.
During the recession of the late 1980s, CaIPERS was among the only sources of
construction capital in the State. After the terrorist attacks on September 11,
2001, CaIPERS helped stabilize the New York Stock Exchange by continuing to
invest into the stock market in spite of the market uncertainty.
Defined Contribution Plans Threaten
Employee Retirement Security
DC Plans Make Future Uncertain. Tax dollars set aside for employees' use to
finance their pension under a DC plan may never be used as is intended. That is
because under a DC plan, participants will face daunting risks investing on their
own. Some may not be able to resist cashing out retirement assets prematurely.
These are uncertain factors on which to base a worker's retirement income
security. And research suggests that DC plan participants generally earn rates of
return on investment far below what DB plan funds typically eam.6
Even if employees in a DC plan do manage to earn the same rate of return
as a DB plan fund and resist the urge to cash out prematurely, at the end of
a full career they will likely receive a smaller benefit than similar employees
in the DB plan. For example, an employee in a DB plan (with a benefit formula
of 2% at age 60 and employer and employee contributions of 10% of pay) hired
at age 30 with a starting salary of$25,000 and 5% pay increases each year will
have a retirement benefit with a present value of$732,100 upon retirement at
age 60.
In contrast, the retirement benefit for an employee in a DC plan hired at the same
age with the same salary (assuming that the DB plan and DC plan both earn a
rate of return of 8%) will have a present value of$497,529 upon retirement at
age 60.'
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Employees could outlive their retirement assets in a DC plan. DC plans do
not take into account the risk that the employee will outlive their retirement
assets. If public servants didn't earn enough through their DC plan, the question
will become who will help them when their retirement nest egg runs out? Will the
State's safety net—currently stretched to its limits— be responsible?
DC plans do not include inflation protection, disability benefits or death
benefits. For retirees in a DC plan, an annual inflation rate of 2.5 percent from
age 65 to 93 would cut purchasing power in half. Employees would be without
either disability or death benefits in a DC plan. This is an inequitable
arrangement when workers with the DB plan work along side of them. (Disability
& death benefits are already factored into a DB plan.)
When offered a DC plan, some employees don't even contribute and most
contribute less than the maximum amount allowed. 26 percent of employees
who are eligible for 401(k) plans do not participate. Non participation is
concentrated in lower-income employees. Among all employees, less than 10
percent contribute the maximum allowable amount; which further restricts their
ability to match DB payout amounts.8
Chances that the DC plan would not provide an adequate benefit are high.
Research suggests employees do not invest well on their own to ensure an
adequate benefit through their later years. An annual study conducted by Dalbar,
a Boston fund consulting firm, found that the average stock fund investor had a 5
percent annual gain from 1984 to 2000; compared to a 16 percent annual
average gain for the Standard & Poors (S&P) 500 stock index for that period.9
Over the last 10 years ending June 30, 2004 CaIPERS returns averaged 9.7
percent.
A John Hancock Financial Services Retirement Survey of defined contribution
participants published in May 2002 showed that"many have a cockeyed view of
how investments work across the board. " John Hancock researchers said that
most defined contribution participants will fall well shy of the estimated 75
percent of pre-retirement income needed to maintain the same lifestyle in
retirement.70
One half of DC plan investors do not diversify, almost none rebalance portfolios
periodically.'�
Defined benefit plans outperform 401(k)'s in a down market.
According to a 2004 analysis by Watson Wyatt Worldwide, defined benefit plan
returns tend to do better than those of 401(k) plans during bad market years that
follow periods of hot stock market returns. Watson Wyatt Worldwide analyzed
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2000 and 2001 Form 5500 data for companies that sponsor both defined benefit
and defined contribution plans.
Previous studies by Watson Wyatt showed that from 1995 to 1998, defined
benefit plan returns beat those of 401(k) plans. Once the market turned sharply
downward in March 2000, defined benefit plan returns began to dominate again,
with Watson Wyatt researchers theorizing that better downside protection came
from the higher portfolio diversification of the professionally managed defined
benefit plans.12
DeFned Contribution Pans Will Hamper Recruitment and Retention and
Make State Attract.Less Capable, Not More Capable Work Force
DB benefits help recruit for classifications when the State experiences a
labor shortage. The State competes with the public sector for many specialized
workers—especially safety employees. The State has and will continue to have
challenges recruiting scientists, researchers, technology workers, nurses,.
doctors, accountants and other specialized workers. (This occurred when the
State had mandatory tier 2 programs in the early 1990s.) Human Resource
specialists indicate that it is not the pay that attracts people to work for the State,
but rather the retirement benefits. State workers have not kept pace in pay—
most of whom went without annual pay raises for many of the last 13 years.13
DB plans promote longevity which gives good return on the investment in
training specialized workers such as firefighters and safety personnel. In
contrast, under a DC plan, employee turnover may higher, causing the State
and local government to waste taxpayer dollars training a revolving door of
workers.
DC plans would encourage older, more expensive workers to continue
working longer, rather than retire. The performance of the markets would have
a significant influence on when people retire. When the economy is doing poorly
and individuals' DC accounts are down, they may decide to work beyond a
reasonable retirement date, creating less opportunity to replenish the workforce
with younger workers.14
People who retire with a defined contribution plan end up retiring later than
earlier. The expected retirement age of a DB plan is 63.9 nationwide; the
expected retirement age of a DC plan participant is 65.1 years.15
Market timing would determine when people retire. Retirement trends, not
age periods of market growth would spawn large numbers of employees retiring.
Down markets would restrict the number of workers retiring.
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Contrary to Popular Belief,
DC Plans Get Thumbs Down From Large Employers
The decrease in DB plans has been limited nearly exclusively to small, not
large employers. Companies that are electing to discontinue DB coverage have
been small employers, not large employers, and they are doing so because of
the expense of complying with complex federal regulations, most of which do not
apply to the public sector.16
Large employers have generally kepttheir DB plans rather than convert to
DC plans.
• Most of the decrease in DB plans has occurred among small and
medium size employers (employers with less than 1000 employees).17
• Eighty percent of professional service firms offer DB plans, with the
average contribution rate from companies with over 1,000 employees
sitting at$40 million in 2003.18
Due to their size, public employers are more comparable to large
private-sector employers, most of which offer DB plans. In 2003, 68%
of large private-sector employers offered DB plans compared to 45% of all
private sector employers. 9
• Although DB plans are more prevalent in the public sector, it is likely
that more private sector employers would adopt or continue DB
plans were it not for the cost and administrative burden imposed by
ERISA laws and regulations. Because public pension plans are exempt
from most of ERISA, DB plans are even more advantageous for public
employers than for private employers.20
• Large and medium private companies value DB plans as primary
recruitment and retention tool (American Benefits Council).
• Examples of large companies with DB plans:
- Chevron
- Unocal
- Lockheed Martin
- Boeing
Albertson's
Boise Cascade
Louisiana Pacific
Safeco
Weyerhaeuser
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Only 17 percent of Fortune 100 companies have a DC plan as their primary
benefit, according to Watson Wyatt. Most large employers continue to offer
defined benefit plans as their primary retirement program and its use among
large employers with 10,000 or more employees is increasing. The highly
regarded Employee Benefits Research Institute (EBRI) found that since 1985,
there was an actual increase in the number of large employers that offered a
defined benefit plan as their primary retirement plan. This occurred during a
period of many corporate mergers of large firms, who had a unique opportunity to
select one or the other.Z'
The majority of U.S. companies with 1,000 or more employees that offer a
DB plan believe their plan directly impacts employee retention. According to
a September 2004 study by Diversified Investment Advisors.
Public Sector Experience with DC Conversions Has Not Been Highly
Successful
Since 1997, large numbers of public employers have been given an opportunity
to participate in a DC plan as their primary retirement benefit. In Florida and
Michigan, an overwhelming majority— more than 90 percent of those eligible to
switch to a DC plan —elected to stay with the DB plan.zs
The state of Nebraska recently converted back to a DB plan from a DC plan. A
study showed that over 20 years, the typical worker posted an average annual
return of 6 to 7 percent. (Money managers running the state's old-fashioned
defined benefit plan ran 11 percent average returns.) Even though the state
made much effort to help individuals invest wisely, half of all employees stayed in
the default fund, even though they had 11 choices. Nebraska retirement system
officials were concerned that the state was wasting taxpayer money via matching
contributions to workers accounts.24
In Florida, where employees could leave the DB plan for the DC plan, most opted
to stay in the DB plan.
When the Illinois Municipal Retirement Fund looked into switching from a DB to
DC plan, it found that is total cost—administrative and investment expenses—
could rise from 0.44 percent of assets to as much as 2.25 percent of assets, a
difference that approached $315 million a year.ss
The Value of"Defined Contribution Portability"
Is Not What It's Cracked Up To Be
The conventional wisdom is wrong that workers today are more mobile and
want more portability of their retirement benefits.
• Workers are not necessarily more mobile. From 1983 to 2000, median
job tenure increased or stayed the same for all workers in the U.S. with
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the exception of workers in two sectors (manufacturing and
transportation/public utilities).26
• Public-sector workers are even less mobile. From 1983 to 2000, the
median tenure for government workers in the U.S. increased from 5.8
years to 7.2 years. In 2000, the median years of tenure for government
workers (7.2 years was more than twice that for workers in the private
sector (3.2 years). '
• DC plans are not necessarily the solution to deal with the issue of
pension portability. A significant proportion of workers with DC plans
"cash out" their accounts when they change employers rather than leave it
in the account or roll it over to their new employer's plan. For example, a
study conducted by the human resources consulting firm Hewitt
Associates found that 57% of employees who leave their companies
choose cash payments from their retirement savings plans instead of
rolling over the balances to their new employer's plans or into individual
accounts.za
• DB plans have been adopting changes to make benefits more
portable (e.g., shorter vesting periods and expanded reciprocity).
• In cases where public employees have the option of participating in
an alternative DC retirement plan, it appears that most opt for the DB
plan. During the first two years of Florida's optional retirement program,
only 3.4% of eligible employees opted for the DC alternative (8% of new
hires).29 In Michigan, state employees hired prior to March 31, 1997 had
the option to remain in a DB plan or switch to a DC plan that was
mandatory for all new employees. Only 6% of eligible employees switched
to the DC plan.so
DC plan would hurt "portability" via reciprocity with public agencies within
CaIPERS. One of the recruitment features of the CaIPERS DB plan is that there
is reciprocity with other public agencies in the State; these employees would not
have the same reciprocity benefit as others who work for the State.
Employees taking money out of CaIPERS when they leave State service will
drain the fund. The Sacramento Bee in a 1996 editorial pointed that"Every
worker intending to leave public service short of vesting for a pension — political
appointees, highly paid managers, and professionals who have private sector
skills—would likely choose the new option, draining funds from the system. That
would leave taxpayers with the same pension obligations but less money to fulfill
them."
Moving to a DC Plan Helps and Hurts the Wrong People
Higher costs and fees are charged for DC plans. Wall Street money managers
will make money on these assets even,if investors lose. Many people would
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rather have investment managers within public service manage the assets rather
than mutual funds whose goal is to make profits for itself. DC plans prevent
participation in the full range of investments such as real estate and private
equity investments.
' "Employer Contribution Rate History-CalPERS State and Schools Actuarial Valuation, June 30,
2003.
2"Myths and Misperceptions of Defined Benefit and Defined Contribution Plans."A NASRA White
Paper. December 2003.
3 National Conference on Public.Employee Retirement Systems White Paper on Defined Benefit
and Defined Contribution Plan, 1997
4"Myths and Misperceptions of Defined Benefit and Defined Contribution Plans."A NASRA White
Paper. December 2003.
5 Cost Effectiveness Measurement, Inc. Benefit Administration Benchmarking Analysis. May
2003.
5 Ian McDonald,"Fundholder's Lament:All Bear, No Bull,"Wall Street Journal,April, 25, 2002.
And"Benefit Review Study of the Nebraska Retirement Systems."August 2000. Buck
Consultants.
"The Search for Cheaper Benefits: Defined Benefit versus Defined Contribution,"Public Pension
Professionals, article viewed at www.i)ensioncube.com/Stories/DBvDC1 1.htm Feb. 2004.
8 Munnell and Sunden, Coming Up Short, p.150
9 Ian McDonald, "Fundholder's Lament:All Bear, No Bull,"Wall Street Journal,April 25,2002.
10"Myths and Misperceptions of Defined Benefit and Defined Contribution Plans."A NASRA
White Paper. December 2003.
" Munnell and Sunden, Coming Up Short, p.11
12"Diversification is Key: Defined benefit plans outperform 401(k)s in a down market," Pension &
Investments November 29, 2004.
13 Legislative Analyst Office 2000-01 Analysis.
14 Kosiba, Louis W., Illinois Municipal Retirement Fund General Counsel."The Defined Benefit vs.
Defined Contribution Debate:The$250 Million Question."October 13, 1999.
15.Myths and Misperceptions of Defined Benefit and Defined Contribution Plans."A NASRA
White Paper. December 2003.
15"How Has the Shift to 401 K's Affected Retirement Age?"by Alicia H. Munnell, et.A., Center for
Retirement Research, Boston College.
10
CS , (-(�7
ATTACHMENT 2
Page 11 of 11
17 W. Michael Carter,Actuary. February 6, 1998. Letter to comment on"Pension Liberation:A
Proactive Solution for the Nation's Public Pension Systems" (a report by the American Legislative
Exchange Council). Published on the National Council on Teacher Retirement website
www.nctr.org/contenVindexpg/carter.htm.And, Kosiba, Louis W., Illinois Municipal Retirement
Fund General Counsel. "The Defined Benefit vs. Defined Contribution Debate:The$250 Million
Question."October 13, 1999.
18 Results of a survey by Diversified Investment Advisors. "PLANSPONSOR.com" December 2,
2004
19 Hewitt Associates Newsletter,Jan. 6, 2004.
20"Myths and Misperceptions of Defined Benefit and Defined Contribution Plans." A NASRA
White Paper. December 2003.
21 "Myths and Misperceptions of Defined Benefit and Defined Contribution Plans." A NASRA
White Paper. December 2003.
22 Business Wine, September 7, 2004"Majority of U.S. Companies That Offer a Pension Plan Say
It Impacts Employee Retention, New Survey Shows"
23"Pension fund slowly gaining popularity."Tallahassee Democrat, Jan. 12, 2004.
And Cypen and Cypen Newsletter. December, 1998.www.cypen.com/pubs/1998dec.htm
24"Nebraska Sees Red Over its 401(k) Plans." K.C. Swanson. The Street.com. May 7, 2002.
http://www.thestreet.com/fundstbelowradar/10021041.html
25 Louis W. Kosiba, "The Defined Benefit vs. Defined Contribution Debate:The$250 Million
Question," Illinois Municipal Retirement Fund, October 13, 1999, as cited in Munnell and Sunden,
Coming Up Short.
28"Employee Tenure in 2000." Bureau of Labor Statistics News Release,August 29,2000.
http://stats.bis.gov/newsrels.htm, p. 11.
27"Employee Tenure in 2000." Bureau of Labor Statistics News Release,August 29, 2000.
http://stats.bls.gov/newsrels.htm, p. 11.
28 From Business Insurance Sept. 22, 1999 cited in"Are Your Retirement Benefits Important to
You?"Oklahoma Public Employees Association News,April 10, 2003.
http://www.opea.org/News/OPEA/opea-20030410e.htm
29"Pension fund slowly gaining popularity."Tallahassee Democrat, Jan. 12, 2004.
30 Cypen and Cypen Newsletter. December 1998.www.cypen.com/pubs/1998dec.htm
11
CS '
ATTACHMENT 3
Page 1 of 8
PENSION REFORM IN CALIFORNIA
League of California Cities
March 1, 2005
For close to 60 years California state and local governments have offered "defined
benefit" retirement plans to their employees which provide a guaranteed annual pension
based upon retirement age, years of service, and some period of highest salary (typically
the last one or three years of work). These plans generally provide an annual cost-of-
living adjustment and additional inflation protection that maintains the purchasing power
over time at a specified minimum level. The Public Employee's Retirement System
(PERS), the State Teachers' Retirement System (STRS), and a variety of individual cities
and counties administer these retirement plans.
Over the years local and state government retirement costs have risen and fallen based on
two principal factors: (1) the investment returns of the various systems; and (2) the level
of benefit payments provided to employees. In the late 1990s the California legislature
enacted dramatic benefit enhancements for public employees in the PERS system that
were optional for participating local governments. Some local governments adopted these
benefit enhancement plans—for a variety of reasons, typically to retain employees and at
times at a shared cost with the employees. When the retirement systems suffered serious
investment losses in the early part of this decade, these losses combined with the benefit
enhancements to cause dramatic increases in employer contribution rates.
Defined Contribution Mandate Proposed
In the fall of 2004 a proposed constitutional and statutory initiative (File No.
SA2005RF0007) was filed that would close all state and local public sector defined
benefit plans (including locally administered plans) to new entrants effective July 1,
2007. Employees hired after that date could only enroll in defined contribution retirement
plans. Defined contribution plans provide fixed annual employer contributions to
employee accounts that are invested, along with employee contributions. Unlike defined
benefit plans, the employee has no guaranteed pension benefit and employers never incur
any unfunded liabilities.
The initiative (which has a legislative counterpart by Assembly Member Richman) would
establish maximum employer contributions of 9 percent for police officers and
firefighters and 6 percent for other employees, assuming participation in federal Social
Security (3 percent higher if no Social Security). Local agencies could exceed these limits
with a two-thirds vote of their electorate. The state could do so with a three-fourths vote
of both houses of the Legislature in two consecutive sessions. Mr. Richman has informed
the League in a letter dated February 17 that he is willing to enter into negotiations to
avoid the need for the initiative.
In his 2005 State of the State message, Governor Schwarzenegger recommended a
defined contribution pension mandate for new state and local employees. In a
presentation to the League board of directors on February 25, 2005 Tom Campbell,
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ATTACHMENT 3
Page 2 of 8
Director of Finance, explained the Governor's proposal contains no caps on employer
contribution and would not require lower state or local contributions. It would simply
remove the risk of increased costs to the taxpayer due to future stock market declines by
requiring that all new state and local employees be provided a defined contribution plan
in place of the traditional defined benefit plan. Mr. Campbell indicated that in all other
respects (e.g:, PERS administration, employer contributions, employer contributions,
etc.) the plans would be identical.
League Pension Reform Task Force
In late 2004 the Executive Director asked the City Manager's Department's standing task
force on PERS to undertake a study of the defined contribution proposal and potential
other defined benefit reforms. A group of other appointed and elected officials were
subsequently added to the task force to provide broader input, and since early December
it has met regularly to study the problems with the existing defined benefit retirement
systems and to evaluate the defined contribution proposal. The task force is chaired by
Bob LaSala, Lancaster City Manager.
The League also retained the services of a retirement actuary, John Bartel of Bartel
Associates, LLC, who worked with the Task Force to ensure its recommendations for
reform of the defined benefit system were actuarially sound. He assisted the Board in its
discussions. His report to the Pension Reform Task Force, dated February 26, 2005 and
entitled Replacement Ratio Study: Preliminary Results, is available from the League.
Review and Comment on Discussion Draft Sought
The task force report was reviewed by subcommittee of the Public Employee Relations
Policy Committee on Wednesday, February 23, 2005 and forwarded to the League board
of directors with a favorable recommendation. On Saturday, February 26, 2005 the board
accepted the report, with modifications, and authorized staff to circulate the report as a
discussion draft for review and comment. It is important to note the ideas contained in
this report represent an initial assessment by the League on pension reform. It is offered
for discussion and consideration in the pension reform debate. Comments are requested
from League member cities, other local government associations, local government labor
organizations, state legislators and the Administration. Comments should be sent to the
League of California Cities, c/o Anthony Thomas, Legislative Representative, 1400 K
St., Sacramento, CA 95814. athomas@cacities.org
2
ATTACHMENT 3
Page 3 of 8
A Framework for Public Pension Reforms
March 1,2005
General Pension Reform Principles
Any serious discussion of public pension reform must begin with a set of principles/goals
to guide any following recommendations. Until questions about the appropriate role and
purpose of public pension benefits in local government compensation packages are
answered, it would be at least premature and perhaps self-defeating to make any specific
benefit recommendations. In keeping with this philosophy, it is recommended that the
following principles precede any benefit recommendations:
• The primary goal of a public pension program should be to provide a full-career
employee with pension benefits that maintain the employees' standard of living in
retirement.
• The proper level of public pension benefits should be set with the goal of providing a
fair and adequate benefit for employees and fiscally sustainable contributions for
employers and the taxpayers.
• Public pension benefits should be supported with proper actuarial work to justify
pension levels. .The Legislature should reject any and all attempts to establish
pension benefits that bear no relation to proper actuarial assumptions and work.
• Pension benefits should be viewed in the context of an overall compensation structure
whose goal is the recruitment and retention of employees in public sector jobs. In
recognition of competitive market forces, any change in the structure of retirement
benefits must be evaluated in concert with other adjustments in compensation
necessary to continue to attract and retain an experienced and qualified workforce.
• The reciprocity of pension benefits within the public sector should be maintained to
ensure recruitment and retention of skilled public employees - particularly in light of
the retirement of the post World War II "Baby Boom" generation which will result in
unprecedented demand for public sector employees.
• Perceived abuses of the current defined benefit retirement programs need to be
addressed. Benefit plans which result in retirement benefits which exceed the levels
established as appropriate to maintain employees' standard of living should be
reformed. It is in the interest of all public employees, employers and taxpayers that
retirement programs are fair, economically sustainable and provide for adequate
benefits for all career public employees, without providing excessive benefits for a
select few.
This report constitutes the recommendations of the League Pension Reform Task Force that was accepted
by the League of California Cities Board of Directors for distribution as a discussion draft..
3 C� t9
ATTACHMENT 3
Page 4 of 8
• The obligation to properly manage public pension systems is a fiduciary
responsibility that is shared by PERS, employers and employees. This joint
responsibility is necessary to provide quality services while ensuring long-term fiscal
stability. These parties need to be held responsible to ensure a high level of
protection against mismanagement of public resources that could jeopardize a
community'sability to maintain services and provide fair compensation for its
workforce.
• Charter cites with independent pension systems should retain the constitutional
discretion to manage and fund such pension plans.
Reform Recommendations
Public employee defined benefit programs have been appropriately criticized in a number
of areas. The following reform recommendations address short-comings within some
defined benefit retirement programs, while preserving the aspects of the program that
have served the employees, employers and taxpayers of California well for over 60 years.
Pension Benefit Levens
Principles: Public pension benefit plans should:
➢ Allow career-employees to maintain standard of living post-retirement.
➢ Be designed with consideration of age at retirement, length of service, compensation
level and applicability of Social Security.
➢ Be supported with proper actuarial work to justify pension levels. The Legislature
should reject any and all attempts to establish pension benefits that bear no relation to
proper actuarial assumptions and work.
➢ Promote career public service without creating incentives to work past retirement age,
nor disincentive to early retirement. Employees who voluntarily choose to either work
beyond retirement age or retire early should not.be penalized or rewarded.
Recommendations
• Maintain the defined benefit plan as the central pension plan for public employees in
California.
Rollback/repeal public retirement plans that provide benefits in excess of levels
required to maintain a fair, standard of living that are not financially sustainable and
may have no actuarial justification. The new and exclusive benefit formulas to
achieve these goals should be:
2 This should be determined in accordance with a Cal PERS 2001 target replacement benefit study and/or
the Aon Georgia State Replacement Ration Study(60s update since 1988).
4 C�� �
ATTACHMENT 3
Page 5 of 8
I. Safety Employees: 3% @ 55 formula, offset by 50% of anticipated social
security benefit for safety employees with social security coverage. Safety
employees retain the current cap on retirement at 90% of final compensation.
2. Miscellaneous Employees(Non-safety): 2% @ 55 formula, offset by 50% of
anticipated social security benefit for miscellaneous employees with social
security coverage. A cap of 100% of final compensation is placed on newly-
hired, miscellaneous(non-safety) employees.
• The above formulas would incorporate "Three-Year-Average" for "final
compensation" calculation. All "Highest Final Year" compensation calculations
would be repealed for newly-hired employees.
• Provide alternatives to a defined benefit plan for job classifications not intended
for career public service employment.
• Give employers greater flexibility to determine when a part-time employee is
entitled to public pension benefits. The current hourly threshold in PERS is too
low.
Rate Volatility
Principles
➢ Responsible fiscal planning suggests the need to "manage" volatility in defined
benefit plan contribution rates.
➢ Rates have historically been relatively constant and comparable to rates currently paid
by most public agency employers.
➢ Recent rate volatility is primarily due to large fluctuations in annual investment
returns for the retirement plan investment portfolios, causing significant changes in
plan funding status..
➢ Normal Costs for defined benefit plans have remained relatively constant overtime.
Recommendations
• Public Agency retirement contribution rates, over time, should be constructed to stay
within reasonable ranges around the historical "normal cost" of public pension plans
in California. Sound actuarial methods should be adopted to limit contribution
volatility while maintaining a sound funding policy.
• Establish "reserve" funding for public pension systems that will help smooth the
volatilityof pension benefit costs. Plan surpluses are to be retained within plan
5 Oc_`Jd
ATTACHMENT 3
Page 6 of 8
assets, but should be reserved for amortization of future unfunded liabilities, and
should not be used to offset plans' normal cost contribution rates.
Shared Risk
Principles
➢ Currently, in most local jurisdictions, employers shoulder the burden of rate volatility
risk — both positive and negative. This principle should be carefully examined with
the intent of better spreading the risk of rate volatility among both employers and
employees.
➢ Negotiated labor agreements containing language whereby employers "pick-up"
employees' retirement contributions are assumed to be part and parcel of a "total
compensation" package; this implies that agencies with Employer Paid Member
Contributions would also typically reflect correspondingly lower base salaries.
Recommendations
• When employer contribution rates exceed the "normal costs" threshold, employees
should be expected to take some of the financial responsibility for those excessive
increases.
Disability Retirement
Principles
➢ Retirement-eligible employees who are injured in the workplace should be entitled to
full disability retirement benefits; disability retirement benefits should, however, be
tied to individual's employability and be structured so as to encourage return to work,
where applicable.
➢ Larger disability reform measures should be considered outside of the scope of
general pension reform.
Recommendations
• Full tax-exempt disability retirement should be retained for employees who are
injured and can not work in any capacity
• Reform the disability pension provisions of public retirement systems to restrict
benefits when a public employee can continue to work at the same or similar job after
sustaining a work-related injury.
ATTACEA=3
Page 7 of 8
• Employees eligible for disability retirement should be first afforded applicable service
retirement benefits, and THEN provided disability retirement benefits up to
applicable"cap" on total retirement benefits.
Portability of Plan Benefits
Principles
➢ Reciprocity of public agency retirement benefits is critical to recruitment of qualified,
experienced public sector employees.
➢ Limiting portability of retirement plan benefits to non-public sector employment
helps in the retention of senior and management level employees.
Recommendation
■ Any pension reform package should retain transferability of retirement benefits across
public sector employers. No employee currently in a defined benefit plan should be
required to involuntarily give up a defined benefit formula before retirement.
Tiered Plans
Principles
➢ Agencies should strive to avoid multi-tiered compensation structures where there are
large discrepancies in benefits accruing to employees. In addition to having adverse
impacts on recruitment and employee morale, multi-tiered approaches can raise issues
of comparable worth and equity.
Recommendations
• Any pension reform measures should seek to minimize disparity between current and
prospective public agency employees.
• Any reduction(s) or change(s) to current Defined Benefit plans should be considered
in context of other compensation issues that will tend, over time, to "equate"
compensation plans within and across public agency employers.
Management Oversight
Principles
➢ The obligation to properly manage public pension systems is a fiduciary
responsibility that is shared by PERS, employers and employees. This joint
responsibility is necessary to provide quality services while ensuring long-term fiscal
stability. These parties need to be held responsible to ensure a high level of protection
7 cs-a3
ATTACHMENT 3
Page 8 of 8
against mismanagement of public resources that could jeopardize a community's
ability to maintain services and provide fair compensation for its workforce.
Recommendations
o Public agencies that do not make the Annual Required Contribution under GASB 27
should be made subject to appropriate oversight.
o The membership of the Public Employees and Retirement System Board should be
changed to achieve both a better balance of employer and employee representatives as
well as a better balance of public agency representatives.
Conclusion
Defined benefit retirement plans have been the traditional approach for close to 60 years
in California and have produced fair and sustainable retirement benefits that have been
central to recruiting and retaining quality public employees. Defined benefit plans should
be retained as the central component of public pension systems in California.
8
C��
ATTACHM ENT 4
C Actuarial & Employer Services Division
P.O. Box 942709
Sacramento, CA 94229-2709
Telecommunications Device for the Deaf-(916) 795-3240
(888) CaIPERS (225-7377) FAX (916) 795-3005
March 15, 2005
AGENDA ITEM 4
TO: MEMBERS OF THE BENEFITS AND PROGRAM ADMINISTRATION
COMMITTEE
1. SUBJECT: Employer Rate Stabilization — First Reading
II. PROGRAM: Actuarial & Employer Services
Ill. RECOMMENDATION:
That the Committee recommends to the full CalPERS Board the approval as a first
reading of the following changes to help reduce volatility in employer contribution rates.
These changes will become effective with the June 30, 2004 actuarial valuations which
set employer contribution rates for fiscal 2005-06 for State and School plans and fiscal
2006-07 for public agency plans.
(A)Change the Board's actuarial asset smoothing policy No. 95-05C (see
Attachment (1) as follows:
1. In the calculation of the actuarial value of assets, spread market
value asset gains and losses over 15 years as opposed to the current
3 years; and
2. Change the corridor limits for the actuarial value of assets from 90%-
110% of market value to 80%-120% of market value.
(B)Change the Board's amortization policy No. ACT-96-05E (see Attachment
2) as follows:.
1. Calculate the annual contribution amount with regard to gains and
losses as a rolling 30 year amortization of all remaining unamortized
gains or losses as opposed to the current 10% of such gains and
losses; and
2. Eliminate (13) (6) from the existing policy which is obsolete language
regarding the amortization of the State plans' unfunded liability.
(C)Adopt a new Board policy (see Attachment 3) imposing a minimum
employer contribution rate:
1. Alternative 1 will superimpose a minimum employer contribution rate
equal to half the employer normal cost; or
2. Alternative 2 will superimpose the same minimum but will exempt
superfunded plans as defined in Government Code Section 20816(b)
from this minimum contribution requirement.
Also, staff would like direction from the Committee on the following:
California Public Employees'Retirement System
Lincoln Plaza-400 P Street-Sacramento,CA 95814 Il�!
J , ATTACHM ENT 4
Members of the Benefits and Program Administration Committee
March 15, 2005
• Whether to proceed with analysis of the possible implementation of pension
contribution stabilization accounts.
• If the answer is yes, whether the analysis should include accounts internal to
CalPERS or internal to employer's assets (but as a trust to be used only for
pension rate stabilization) and whether such accounts would be mandatory or
optional to employers.
• Direct staff, as the Committee deems appropriate, to conduct further analysis on the
use of future surplus for purposes other than rate stabilization.
IV. ANALYSIS:
Background
This item is the result of planning and work that began almost a year ago and
includes the following:
• Board workshop in September 2004 discussing employer rate stabilization
• Employer workshop on the same topic at the 2004 Employer Forum in
Anaheim at the end of October 2004
• Publication of an issue paper on the topic of rate'stabilization
• Asset/Liability workshop in October 2004
• Completion of a survey by Board members and employers regarding how
to address employer rate fluctuation
• Presentation of the survey results to this Committee in October 2004
(Board survey) and February 2005 (employer survey)
Based on the survey results completed by the Board members and the
employers, CalPERS actuarial staff performed in depth!analysis of all the
concepts described in the issue paper with the exception of the pension
contribution stabilization accounts and utilizing of different asset allocations for
different plans. Attachment 4 contains a list of all the methods that were studied
by CalPERS actuarial staff.
Objectives of the Study
As was presented at the Board workshop on rate stabilization in September 2004,
various methodologies used for smoothing of employer contribution rates will
impact the funded status of the plans at CalPERS differently. Therefore, the
investigation of which smoothing methods are appropriate must simultaneously
investigate the impact on the employer's contribution rates and the impact on the
funded status of the plans at.CalPERS.
The objectives of the analysis are to seek the smoothing method that"best"
simultaneously:
o Minimizes the impact on the funded status of the plans
o Minimizes the volatility in the employer's contribution
o Minimizes the average future employer contribution.
Page 2
ATTACHMENT 4
Members of the Benefits and Program Administration Committee
March 15, 2005
An additional objective is to find a method that accomplishes the three
objectives above and produces employer rates that comply with the generally
accepted accounting standards as provided by Governmental Accounting
Standards Board Statement No.27 (GASB 27).
Methodology Used in the Study
Over the last two months, CaIPERS actuarial staff performed analysis using
stochastic projection models for each of the methods listed in Attachment 4.
These stochastic projection models randomly generated 50 years of future
investment returns based on the CaIPERS asset allocation and calculated the
actuarial valuation results over this 50 year period, including the funded status of
the plan and the required employer contribution rates based on the generated
investment return. In total, 1,500 unique 50 year scenarios were projected.
Since the fluctuation in employer contribution rates is directly related to the ratio of
the actuarial accrued liabilities to the payroll,.CaIPERS actuarial staff performed
modeling of each rate stabilization method for plans with liability to payroll ratios of
4, 6, 8, 10 and 12. These ratios represent the majority of plans at CaIPERS.
Note that the State Miscellaneous plan has a liability to payroll ratio of about 6 and
the Schools pool has a liability to payroll ratio of about 4. Attachment 5 contains
tables showing the liability to payroll ratio for the State plans, the Schools pool,
the public agency risk pools and all non-pooled public agency plans.
In order to evaluate each method, the analysis focused on the balance between
"smooth" rates, average employer rate, and the preservation/advancement of
funded status. Any method that resulted in fund insolvency at any time over the
50 year period in any of the 1500 generated scenarios was excluded. Also
excluded were any methods that did not reduce the volatility of the annual change
in employer rates by at least 50% from the current method.
Results of the Study
After the elimination of methods that did not preserve funded status or did not
reduce employer rate volatility by at least 50% of that produced by the current
method, the following 4 methods remained:
• Method #13— Eliminate entirely the corridor around market value in
determining the actuarial value of assets (AVA) corridor and spread asset
gains and losses over 10 years
• Method #19 - 5 year direct rate smoothing
• Method #20 - 10 year direct rate smoothing
Page 3 C S'
ATTACHMENT 4
Members of the Benefits and Program Administration Committee
March 15, 2005
• Method #27— Increase the AVA corridor to 80%-120% of market value, spread
asset gains and losses over 15 years and amortize any unamortized gains and
losses using a rolling 30 year amortization.
Impact on Funded Status: The first objective looked at the impact of.each
method on the preservation/advancement of funded status. The graph below
shows the impact of each method on the probability of each particular funded
status for plan with a liability to payroll ratio of 6. The graphs with dotted lines
are methods that produce employer rates that are not GASB 27 compliant.
Impact of Rate Stabilization on Funded Status
IMPACT OF RATE STABILRATION METHODS ON FUNDED STATUS
PLAN WITH LIABILITY TO PAYROLL RATIO OF 6
100% —
Probability of Funded
90% Status Riolnp ARM a Probability of Funded.San"Failing BEL=s Certain Love.
f:wrtala l.e"of (Owr a SO yam Period)-
(Over a 50 Year Period) -
80%
70%
qD 80%
g 50% lo
g 40%
30%
,b
20%
104E '�
O%
300% 200Y. 140% 100% 90% 80% 70% 50%. 50% 40% 30% 20% 10% 0%
Funded Status
—Mathod 1-Curterd Methods
—al—Method 27-Increase AVA corridor to 8094120%with 15 year smoothing and 30 Year Rating Fresh Start(52%reduction in valadfiW
o- Mamod 19-5 Year Direct Smoothing(52%reduction In volatility)
— Mathod 13-No AVA corridor with 10 year smoothing(87%reduction In volatility)
- Method 20-10 Year OIMM Smoothing(87%reduction In volatility)
Attachment 6 contains the same graph for each of the plans being studied. It is
the opinion of the actuarial staff that none of the four methods selected as finalists
would increase the likelihood of under-funding to a point that should raise Board
member concerns about fiduciary responsibilities.
The Remaining Objectives: Each of the remaining objectives are discussed
below and summarized in the table below.
Employer Rate Volatility: Each of the four methods selected as finalists was
evaluated as to how"smooth" the employer contribution rates would be under
that method. The volatility of employer rates under each method was
measured as the standard deviation of the annual change in rates over the 50
year study period for each of the 1,500 scenarios on either side of the
average.
Page 4 C
AT7ACHMENT4
Members of the Benefits and Program Administration Committee
March 15, 2005
Change in Average Employer Contribution: Because the statistical
distribution of employer rates is not symmetrical (i.e. there is a lower limit of
zero but no upper limit), increased smoothing of employer contribution rates
tends to increase the average employer contribution rates.
Compliance with GASB Statement #27: Two of the four methods selected
as finalists would produce employer rates that are not in compliance GASB 27.
In such cases, the employer would have to track and "book" the difference
between a GASB compliant rate and the actual rate paid to CalPERS in order
to satisfy GASB Statement #27 requirements.
The table below summarizes the impact on employer rates for each of the four
final methods for plans with a liability to payroll ratio of 6. The same table for each
of the plans being studied can be found in Attachment 7. As can be seen in those
tables, the relative impact of each method remains the same for plans with
different liability to payroll ratios.
With regard to the "standard deviation" column, two-thirds of all outcomes fall
within one standard deviation on either side of the average of all results and
ninety-five percent of all results fall within two standard deviations. The "reduction
in volatility column" shows the percentage reduction in the standard deviation as
compared to that of the current method. The "impact on average employer
contribution rate" column shows the increase in average employer rate produced
by the additional smoothing over the 50 year period as compared to the current
method. The GASB 27 column is self explanatory.
Impact of Rate Stabilization on Employer Rates
Impact on
Standard Average Produce
Deviation of Reduction Employer Rates that
Annual Change in Contribution Comply With
Method in Rate Volatility Rate GASB 27
Current Methods 3.3% N/A N/A Yes
Eliminate the AVA Corridor 67% Increase by
with 10 Year spread of Asset 1.1% Reduction 0.5% Yes
G&L
5 Year Direct Rate 1.6% 52% Increase by No
Smoothing Reduction 0.8%
10 Year Direct Rate 1.1% 67% Increase by No
Smoothing Reduction 1.6%
Increase AVA Corridor to
80%-120% with 15 Year
spread of Asset G&L with 1.6% 52% Increase by Yes
Rolling 30 Year Amortization Reduction 0.2%
Page 5 C �^ 39
- ATTACHMENT 4
Members of the Benefits and Program Administration Committee
March 15, 2005
Recommended Rate Stabilization Method
In deciding on the final recommendation, CalPERS actuarial staff considered all of
the results presented above and the results of the employer survey which
indicated a preference for a method that would be in compliance with GASB 27,
and utilized longer amortization periods and increased asset smoothing.
Advantages of the recommended method include:
• it is GASB 27 compliant
• it utilizes an actuarial asset value (80% to 120% of market value) that is
the maximum corridor allowed under ERISA minimum funding standards.
While these standards do not apply to public employee plans, it does
provide additional comfort in utilizing a common approach.
• It produces a very low increase in the average employer contribution rate.
There is one negative aspect to having an asset corridor around market value.
When there are extended upturns or downturns in market value, the actuarial
value of assets tend to "hug"the corridor (i.e. tends to stay at 80% or 120% of
market value for some period of time). This translates into employer rates with
greater volatility because actuarial assets become as volatile as the market value
of assets.
Minimum Employer Contribution Rate
Staff also recommends that the Board adopt a mandatory minimum contribution
rate for all employers equal to half the employer normal cost. Not having the
employer contribution rate decrease to zero will produce more stable employer
budgets. It becomes easier to accept a rate that is increasing from 5% to 8% than
it is to accept a rate increasing from 0% to 8% of payroll.
The Board should choose whether to apply this minimum employer contribution to
plans which are superfunded, i.e. plans that have assets that exceed the present
value of benefits as defined in Government Code Section 20816 (b). The new
Board policy in Attachment 3 provides two alternatives to the.Board.
Impact of Minimum Employer Contribution on Funded Status: The graph
below shows how the impact on funded status of the recommended smoothing
method with and without the use of a minimum employer contribution rate of one-
half of the employer normal cost. The probability of under-funding is slightly
reduced and the probability of over funding is slightly increased when the
minimum employer contribution is included in the methodology. The dashed
curve is the recommended method coupled with the recommended minimum
employer contribution.
Page 6
ATTACHMENT 4
Members of the Benefits and Program Administration Committee
March 15, 2005
Impact of a Minimum Rate on Funded Status
IMPACT OF RATE STABILIZATION METHODS ON FUNDED STATUS
PLAN WITH LIABILITY TO PAYROLL RATIO OF 6
100X ...__ _..___._.........._.............................................................................................................................._..................
.._.__.._�_.
00% Probability o/Funded Probability of Funded Status Fainno REUM a Certain Level
Cwtdn LovM
Status Risingval a (Ova,a 80 your Perlot)""...
-
(Ovii a W Yse Parleen ♦.
80%
♦
♦
70%
Wotnoa e27 a4tn
Method 027 with No Mint e run -
60% MInmum of N05
the Normal Coat
♦
50%
40%
f
30%
20%
10%
0% .._
300% 200% 140% 100% 00% 80% 70% 80% 50% 40% 30% '20% 10% 0%
Fumed Status
Impact of Minimum Employer Contribution on Rate Volatility and Average
Employer Contribution: As seen by comparing the table below to the table on
page 5, including a minimum employer contribution of one-half of the employer's
normal cost slightly reduces rate volatility but increases the average employer
rate.
Standard Impact on
Deviation of Reduction Average Produce
Annual in Employer Rates that
Change in Volatility Contribution Comply With
Method Rate Rate GASB 27
Current Methods 3.3% N/A _ N/A Yes
Eliminate the AVA Corridor with 10 70% Increase by
Year spread of Asset G&L & a 1.0% Reduction 1.3% Yes
minimum contribution
5 Year Direct Rate Smoothing &a 1.4% 58% Increase by No
minimum contribution Reduction 1.6%
10 Year Direct Rate Smoothing & a 1.0% 70% Increase by No
minimum contribution Reduction 2.3%
Increase AVA Corridor to 80%-120%
with 15 Year spread of Asset G&L
with Rolling 30 Year Amortization & 1.4% 58% Increase by Yes
a minimum contribution Reduction 1.0%0
Page 7 CS "
ATTACHMENT 4
Members of the Benefits and Program Administration Committee
March 15, 2005
Estimated Impact of Recommended Method on Prior Years
Board members requested that staff determine the impact of the methods studied
on a past full economic cycle. Calculations were performed as though the
recommended method had been initiated 10 years ago for the State plans and the
Schools pool.
The graph below compares the actual State Miscellaneous combined Tier 1 and
Tier 2 employer contribution rates over the past 10 years to an estimate of the
employer contribution rates that would have been produced had the
recommended method been implemented 10 years ago.
ACTUAL EMPLOYER CONTRIBUTION RATES VS
ESTIMATED RATES UNDER RECOMMENDED RATE STABILIZATION METHOD
State Miscellaneous(Average of Tler't and Tler 2)
30%-
26%-
20%-
10%
0%25%20%
15%
5%
tgctual Employer Rate - a- Employer Normal Cost —A—Estimated Smoothed Employer Rate
Below is the same graph for the Schools pool over the past 10 years.
ACTUAL EMPLOYER CONTRIBUTION RATES VS
ESTIMATED RATES UNDER RECOMMENDED RATE STABILIZATION METHOD
Schools
30%
25%
20%
Is% - ..
,
70%
5%
i
Ao al Employer Rate - - - Employer Noma]Coat --lbr—Eadmated Smoothed Employer Rate
Page C�' � a
- ATTACHMENT 41
Members of the Benefits and Program Administration Committee
March 15, 2005
The estimates of the impact.of the recommended method do include the impact of
SB 400, the actual market value of asset returns over the past 10 years, and the
change in actuarial assumptions in the June 30, 2003 valuation. However, the
estimates do not include the impact of the Board's decision to move the actuarial
value of assets from 90% of market value to 95% of market value in advance of
S6400. As a result, the estimates of the rates under the recommended method;,
use an actuarial value of assets at their regular smoothed value (80% of market;
value) in the June 30, 1998 under the recommended method.
i
Attachment 8 contains graphs comparing the actual contribution rates to the
estimated contribution rates under the recommended method for the last 10 years
for the State plans (except CHP because of its unique surplus asset account) and
the Schools pool.
Overview of Potential Pension Contribution Stabilization Accounts
This potential alternative contemplates the creation of a separate source of funds
for contributions and offsets by employers for purposes of stabilizing employer
payments to the retirement fund. It would not; however, affect the employer
contribution rate. Instead, it would provide for an additional means of funding the
required contributions.
In general, where the employer realizes revenues in excess of specified
projections, the employer provides a contribution to the stabilization account over
and above its otherwise required contribution amount to the retirement fund.
Where the employer realizes revenues less than specified projections, amounts!
from the stabilization account would be contributed to the employer's retirement
fund as a partial or full offset to the employer's otherwise required contribution.
Specific amounts of contribution or offset from the stabilization account could also
be based on the amount of required contribution to the retirement-fund for a
particular period in comparison to the employer's normal cost component for
retirement contribution.
The purpose of the stabilization account is to reduce or eliminate large
fluctuations in the amount an employer is required to contribute to the retirement'
fund as well as to act as a source of funding when employer revenues are
impaired based on economic or other conditions.
The stabilization account is further designed to provide integrity and security for
the source of funding for the payment of retirement benefits and is intended to
maintain an actuarially sound retirement system.
Pension contribution stabilization accounts were highly ranked by both employers
and Board members. However, the implementation of such concept is more
complex than the other concepts being considered.
i
Page 9
ATTACHMENT 4
Members of the Benefits and Program Administration Committee
March 15, 2005
There has been no modeling to suggest that pension contribution stabilization
accounts would "work". It remains to do analysis to determine whether there
would be enough "good" years to build assets in the stabilization account that
would prove sufficient to provide the offsets necessary in the "bad" years.
Therefore, if the Committee would like to consider this possibility, staff
recommends that further analysis be completed before the Committee and the full
Board decide whether to implement pension contribution stabilization accounts.
Further, decisions must be made on which form these accounts will take. There
are several options on how to implement pension contribution stabilization
accounts. The creation of such an account would require legislation or an
amendment to the California Constitution and could be set up in a few different
ways:
a) Stabilization Account as Part of the Public Employees' Retirement Fund
Under this approach, the stabilization account would be part of the assets of the
retirement fund and subject to the exclusive control and administration by the
board. The board would maintain plenary authority and fiduciary responsibility for
investing monies within the stabilization account as well as the administration of
the account pursuant to Article XVI, section 17 of the California Constitution.
Amounts within the stabilization account could be designated solely for use in
offsetting future employer contribution amounts to the retirement fund and for no
other purposes. Once a contribution to the stabilization account is deposited
within the Public Employees' Retirement Fund, it is unlikely that these amounts
could be redirected for other, non-retirement purposes. The employer would fund
the account when economic triggers are met and amounts would be withdrawn
from the account to offset employer contributions where other less favorable
economic conditions are met. The economic triggers are potentially subject to
legislative revision or amendment.
b) Stabilization Account Outside of the Public Employees' Retirement Fund
Employer contributions to the stabilization account could alternately be made to a
tax-exempt trust (e.g., a Section 115 trust) separate and apart from the Public
Employees' Retirement Fund. This account could be administered by the
employer or some other third party separate from the board. This approach,
however, places amounts within the account outside the plenary authority of the
board and creates the possibility that the account could be used for other, non-
retirement purposes if the Legislature subsequently amended the law governing
the fund. To reduce this risk, legislation creating the account should specify that
the intent in creating the account is to maintain the actuarial soundness of the
retirement system and that it is intended to be a reserve solely for the payment of
vested retirement benefits. Additional legislative intent language could be added
o�-
Page 10
ATTACHMENT 4
Members of the Benefits and Program Administration Committee
March 15, 2005
that specifically ties the account to the providing of retirement benefits pursuant to
employee collective bargaining at the state or local level.
c) Stabilization Account Administered by a Separate State Agency
Similar to provision "b" above, employer contributions could be made to a tax-
exempt trust administered by a newly created or otherwise existing agency of the
State of California. Existing state agencies could include, for example, the
Department of Finance or Department of Personal Administration. Similar risks
set forth in provision "b" above exist with respect to this type of arrangement. To
reduce to the possibility that funds in the account could be redirected for non
retirement purposes, legislation creating the account should specify that the
account is to maintain actuarial soundness of the retirement system and is
intended to be a reserve solely to provide for payments of vested retirement
benefits.
d) Stabilization Account Created by Constitutional Amendment
Under this approach, a stabilization account could be created by amending the
California Constitution. The amendment could specify the underlying purpose and
intent of the stabilization account itself. Responsibility for administration of the
account could be placed with the CaIPERS board, a separate state agency, or an
independent third party. As a constitutional provision, there is little risk that funds
within the account would be used for non-retirement funding purposes. Provisions
creating the account could also specify the economic trigger points for
contributions and offsets from the account or authorize further legislation setting
forth these parameters.
Overarching all of these alternatives is the question of whether the stabilization
accounts would be voluntary employer by employer or mandatory on all
employers.
At this point, staff is seeking direction from this Committee on whether staff should
proceed with analysis of any of these potential accounts and bring it.back to this
Committee and the Board.
Addressing the Potential of a Plan Becoming Over Funded
As shown on the graphs in Attachment 6, further smoothing of the impact of
investment return on employer rates increases the likelihood of plans again
accumulating large surpluses.
The Committee may wish to direct staff to conduct further analysis on this subject.
_ Page 11
ATTACHMENT 4
Members of the Benefits and Program Administration Committee
March 15, 2005
V. STRATEGIC PLAN:
The Board workshop on employer rate stabilization and the additional work that will
be performed by CalPERS actuarial staff support Goal IV of the CalPERS'
Strategic Plan. The Plan reads as follows:
Goal IV
Assure that sufficient funds are available, first, to pay benefits, and second, to
minimize and stabilize employer contributions.
David Lamoureux, Senior Pension Actuary
Actuarial & Employer Services Division
Ron Seeling, Chief Actuary
Actuarial & Employer Services Division
Attachments
CS - �U
Page 12