City of Springfield Police Officers and Fire Fighters’ Retirement Fund and Employee

Benefit Review Analysis and Recommendations

May 20, 2009

Rick Dreyfussrcdreyfuss@aol.com

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Purpose of My Comments To provide independent commentary on

recurring trends and themes applicable to the public pension systems.

To leverage my background and experience as an HR executive and actuary.

To provide specific analysis and recommendations on The Police Officers and Fire Fighters’ Pension Plan.

This is not an audit or a legal review.

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Managing Pension LiabilitiesThe Wall Street Journal The Public Pension CrisisAugust 18, 2006; Page A14

“…. the fundamental problem is that public pensions are inherently political institutions.”

“… the current public pension system simply isn't sustainable in the long run.”

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What is the Real Problem to be Solved? The charge to the ad-hoc committee is effectively to solve a financial

crisis.

My contention is you are dealing with an institutional political problem manifesting itself as a financial problem. To focus principally on new and creative funding strategies will not result in sustainable reform.

To truly reform this financial problem you must reform the institutional system. This will prove difficult.

You have a problem of a high level of over-promised benefits where funding has been politically manipulated – all this is compounded by poor investment results. However, this crisis is being represented as fundamentally a taxpayer funding problem.

My analysis will identify a prerequisite set of true reform principles in contrast to those proposals which seek to maintain the institution with some incremental funding.

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Operating Principles Ensuring public safety is a core function of government.

Public sector costs specifically compensation and employee benefits liabilities must begin and end with the taxpayers’ ability to pay.

The prospect of increasing taxes competes directly with private sector growth.

Deferred liabilities such as pensions and retiree medical

plans are taxes to be paid by future taxpayers.

Pension funding is generally poorly understood. You cannot solve a problem which you do not properly understand.

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What are the Real Issues that should be addressed? What lessons should we learn from the past?

What is an affordable level of costs for these benefit programs in the short and long-term?

How can we best meet the ongoing safety needs of the community consistent with the taxpayers ability to pay?

Properly understanding this relationship is important.

Why are provisions and cost benchmarks which are unaffordable and obsolete in the Missouri private sector considered commonplace in the Missouri public sector?

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The Institutional Problems of Defined Benefit Public Pension Plans emanate from Three Basic Sources:

Problem #1: Benchmarking

The overwhelming majority of public pay and benefit programs are benchmarked only against other public plans rather than the entire marketplace. Ignores the entire labor market This fosters “financial relativity” Comparison is often to other unaffordable plans

One-dimensional benchmarking yields one dimensional results.

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Problem #2: Relative Metrics and the Risk to Taxpayers

No absolute metrics defining the affordability or reasonableness of costs given the “perpetual life of the government entity”.

Creates unreasonable risks to taxpayers.

Actuarial assumptions do not create certainty.

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Problem #3: The Politics of Public Pensions

Public Pensions are a major source of significant political capital

Pension surplus is considered the source of benefit improvements and deficits represent under-funding by taxpayers. This paradigm will not change.

A complete system breakdown involving the plan design – the participants the actuarial funding policies – politically manipulated the affordability of the cost by the taxpayer – the reconciling item

Public Pension Plans are also an esoteric afterthought Not well understood – not transparent Benefit commitments can be over 50 years Funding is easily manipulated – proper funding should

occur as benefits are earned over the “working career of the employee”. Easy to (re)defer costs to the next generation.

State-wide pension deficits will be problems at the local level. Consider the problems of MOSERS, PSRS and PEERS.

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Actuarial Value of Assets

$138.9 M / $140.8 M

Market Value as of 11/30/08=$ 98 M

Unfunded ActuarialAccrued Liability

$139.0 M /$154.8 M

Annual Interest @7.5% =$11.6 M

PresentValue ofFutureNormalCosts

$60.6 M /$60.3 M.

Actuarial Value of AssetsUnfundedActuarialAccruedLiability

PresentValue ofFutureNormalCosts

Annual Payment (“Normal Cost”) +Annual Amortization Payments +

=Total Employer Pension Rate

Member Portion Taxpayer Portion

Asset Related AnnualChanges:

Investment Income +Employee Contributions +Employer Contributions -

Benefit Payments -Administrative Fees

Author’s estimate is indicatedby “*”

ACTUARIAL PRIMER - Springfield, MO - Police and FireBased on JUNE 30, 2007 / JUNE 30, 2008 Actuarial Valuations

Present Value of All Benefits Payable(Current and Future)

to All Participants

$338.5 Million / $355.9 Million

PresentValue ofFutureNormalCosts

$60.6 M /$60.3 M.

Actuarial Accrued Liability(Present Value of Benefits Earned

Prior to 6/30/07 // 6/30/08 )

$277.9 M / $295.6 M Liability Related AnnualChanges:

Benefit Improvements

Demographics (Actives andRetirees): - Adds (New Employees,Transfers) - Outs (Resignations,Retirements, Deaths) - Salary Changes - Employee Contributions

Changes in ActuarialAssumptions: - Mortality Rates - Investment Assumptions - Retirement Ages - Salary Increases - Definition of Value of Assets

Current Contribution% Payroll In Dollars28.75% $ 7.1 M34.77% $ 8.6 M63.52% $15.7 M 11.16% $ 2.8 M52.36% $12.9 M

Actives - $150.7 B* / $158.4MInactives - $187.8M* / $197.5 M

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A Political Problem: Nine Pension Half-Truths

Contention Fact

1) The fiscal problems typified by The Police Officers and Firefighters pension plan is principally a matter of under-funding by taxpayers.

Since the problem is defined as one of funding the answer must be one of funding.

This is a convergence of a high level of over-promised benefits and funding manipulation compounded by poor investment returns. Often advocates of prior legislation which increased benefits resulting in significant deferred costs are conveniently critical of their funding policies. This affirms the politics of public pensions.

2) Forgoing pension contributions saves money.

Deferred costs are not savings Pension plans operate in a pay-me-now versus pay-me-later environment Time value of money is deemed to be 7.5%

3) Pension costs are favorable and are lower than national averages of public plans. Employee contributions lower costs to affordable levels.

Employer pension costs should be in the range of 5% to 7% of payroll. For non-Social Security participants the range is 10% to 12% of payroll.

A Political Problem: Nine Pension Half-Truths4) 72% of pension assets result

from investment earnings.

Defined contribution (DC) plans can present a similar profile. Proper response should be “I hope so”.

5) DC plans are more/less costly than defined benefit (DB) plans.

Totally depends on the design and the DB funding method. The politics of public pensions are the unaffordable component.

6) DC plans have excessive administrative fees and individuals are incapable of investing wisely.

Not any more, some costs are charged to participants Significant advances in technology and broader array of low cost funds

7) DC plans produce inferior pensions.

2005 EBRI study suggests meaningful (85% to 103%) replacement ratios at retirement

A Political Problem: Nine Pension Half-Truths8) 80% is an acceptable funded

ratio and reflects plan which is “financially healthy”.

Targeting a 20% unfunded liability presents significant risks and defers significant costs to taxpayers.

“Financial health” is a relative term without a uniform definition. This subjective standard is used by some to justify ongoing pension deficits.

The 2006 Pension Reform Act (applicable to private-sector plans) requires plans to achieve a 100% funded ratio* over an 8 year period.

*(Based upon uniform federal guidelines)

9) The term “actuarially sound” means proper actuarial funding

This simply means that the cash inflows will equal the cash outflows over a period of time. It is a quantitative term not a qualitative term.

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Key funding principles Benefit plans should be funded over the working

careers of the workforce.

Benefit plans must be designed upon the taxpayer’s ability to pay.

You have comprised or ignored these key principles.

Without guiding principles you default to political principles – that is those designed to achieve a political rate of return masked in half-truths.

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Liability Management:The goal should be Current, Affordable and Predictable pension contributions

The anchor is what benefits are to be payable at normal retirement. Key is to properly define normal retirement – age 62 is suggested.

Current is funding the accrued liability at 100% over the working career of the workforce. (Average age actives: Police is 37 and Fire 40)

Affordable is 5% to 7% of payroll (w/o SS participation 10% to 12%) after any required member contributions.

Pension funding should be increased to responsibly amortize the unfunded liability – however this is likely to prove unaffordable so you should also consider reducing unearned liabilities and prevent new open-ended liabilities from being created.

What assurances are there that any incremental funding will not be ultimately “diverted” before achieving 100% funding? Is the system beyond fiscal discipline?

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If you view this reform effort as simply a funding challenge - this ad-hoc group will become the precursor for a “2013 taskforce”. Why not reform the institution for the benefit of the next generation?

Begin with a plan where costs are predictable, affordable and current. First place new hires into a defined contribution plan with a cost of 10% to 12% of payroll.

Redefine normal retirement age. Age 62 is suggested. Determine what it would take to get your plan 100% funded over the working career of the workforce. Private sector plans must adhere to reducing unfunded liabilities over 8 years using a federal standard.

Assess taxpayers ability to pay in the short and long term.

Reduce unearned benefits for Tier 1 and Tier 2 participants (not limited to pensions) to achieve this norm.

Enact strict funding requirements to prevent funding from being diverted for a political rate of return.

Increase funding and stick to it. How?? Do not create outside debt such as pension obligation bonds.

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Tier 1 and Tier 2 Benefits Suggested Design Changes New employees should be enrolled in a DC plan to achieve these goals.

Accrued benefits (earned to date) should be preserved. Consider freezing the plan and adopting a DC plan for future benefits.

Unearned benefit accruals will need to be modified if you are to avoid generational transfers while establishing costs which are current, predictable and affordable.

Normal Retirement should be redefined as age 62, early retirement should be actuarially reduced using the valuation basis of 7.5%.

Pension COLAs should be curtailed. Multiplier 2.8 should be reduced to approximately 2%. Increase member contributions up to 50% of the cost of the plan. There are various permutations and combinations on the above but

lasting reform needs to be anchored based upon definitive and affordable cost principles.

Factor in the cost of active and retiree health care plans with same cost considerations. Reform GASB 45 funding as well.

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Be in control of your pension costs. Taxpayers need to take charge of the future

Clearly the current system is not working. Dramatic changes in design are needed prior to any funding considerations.

Consider establishing a new pension board composed predominately of independent individuals who are not current or former plan members, who do not sell “financial services products”, who are qualified, committed and capable of discharging their responsibility as fiduciaries.

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Consider the HR impact Ability to attract and retain qualified talent to

ensure public safety. Do this in real-time.

Any required adjustments are made in base pay.

“Burn-out” considerations – utilize workforce management strategies.

Carve-out disability benefits (duty and non-duty related: duration and severity) up to 50% of base pay to age 62. Consider a separate oversight body.

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Actuarial Suggestions Value the liabilities using the assumption the members

will retire on the earliest date eligible for normal retirement benefits.

Break out liabilities, assets and contributions between Tier one and Tier two members.

Review/affirm 7.5% pay assumption in early career.

Consider adding corridors of 90% to 110% of market values to existing definitions of the actuarial value of assets.

Annually develop a 10+ year forecast of liabilities and assets to project funded ratios.

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Retirement assumptions used in determining Pension Costs

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“Temporary” Taxes in PennsylvaniaConsider: The 1936 Johnstown Flood In March 1936, three days of rain and runoff from melting snow led

to the second of three great floods that hit Johnstown.

The recovery plan involved a 10 percent temporary tax that was placed on the sale of all alcohol in the Commonwealth of Pennsylvania. It was only supposed to last a few years.

The property damage total from the 1936 Johnstown flood was $41M.

The flood tax had generated that much revenue by the end of 1942.

Over 70 years later, that tax is still in place and now stands at 18 percent.

When you add the 6 percent sales tax, the 18 percent Johnstown flood tax, then the 30 percent PA Liquor Control Board markup, the cost of a bottle of wine has now climbed by at least 54 percent.

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Defined Contribution Challenges (and proven strategies to overcome them)

Issue Strategy1) Employee non-participation Default enrollment

2) Low Employee Contribution Rates

Default 6% employee rate (earns 6% employer match). 12% total is an important threshold.

3) Improper Investment Diversification

Life-cycle funds (default option). Based upon member’s retirement horizon – funds’ investment mix automatically adjusts over time

4) Inability to manage retirement payouts

Managed payout funds - designed to provide regular monthly payments without exhausting capital

5) Excessive start-up costs and on-going fees

Competitive marketplace result in manageable costs to affordable levels

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How do you compare DB and DC costs?

DC employer costs are 10%-12% of payroll. DB employer “costs” are estimated deposits – not true costs. Comparability is at best debatable.

What assurances exist that the existing DB plan designs will not be improved in the future?

How certain can one be in the future projections of the plan? This creates doubt against the true DB baseline measure.

The more important savings relate to the benefits of having current, predictable & affordable costs plus taking the politics out of public pensions – these are the non-quantifiable savings.

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Trends in the MarketplaceMercer 2008 - National Survey of Employer-Sponsored Health Plans Approximately 3000 employers

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