In This Issue:

Articles, Research & Spotlights 

• Montana’s plan to improve pension funding and governance
• Efforts to undo Alaska’s pension reforms could cost close to $1 billion
• North Dakota’s potential pension reform
• State pension plans’ poor investment results in 2022
• Reason’s PRO Plan offers a modern approach to public retirement

News in Brief
Quotable Quotes on Pension Reform
Data Highlight
Contact the Pension Reform Help Desk

Articles, Research & Spotlights

Two Bills in Montana Could Improve Pension Plan Design and Funding

Montana’s Public Employee Retirement System has $2.2 billion in unfunded liabilities, and if left unaddressed, funding issues are likely to continue. A new reform proposed in the state’s legislature would address some of Montana’s ongoing pension challenges, first by committing employers to make adequate annual contributions and second by setting the existing defined contribution retirement plan as the default benefit for new employees. In recent comments to the House Committee on State Administration, Reason Foundation’s Steven Gassenberger explained how House Bill 226 would reduce long-term costs by locking the state into eliminating its pension debt and reshaping its retirement offerings to fit the modern workforce better. Gassenberger also testified on House Bill 228, which would improve governance by setting stronger boundaries on what pension plan administrators can consider when making investment decisions.

Alaska Pension Bills Could Undo Previous Reform and Cost $800 Million

Following an effort to reopen a pension plan for public workers during last year’s legislative session, Alaska policymakers are again deliberating on several bills that could undo the state’s decision to close its defined benefit pension plans in 2006. Two identical proposals—House Bill 22 and Senate Bill 35—would allow public safety workers to retroactively switch from the existing defined contribution plan to a newly opened defined benefit plan. A Pension Integrity Project evaluation of these bills and an actuarial analysis of potential long-term costs find that this change would add more expensive debt to the plan’s already $5 billion in existing unfunded liabilities and could cost the state an additional $800 million over the next 30 years. Since public safety employees only make up around 10% of the system’s members, this proposal would be a costly move that would benefit a relatively small group.

Updates to North Dakota’s Pension Reform Effort

North Dakota lawmakers continue to discuss House Bill 1040, which would commit participating employers to make required annual payments in full and make the state’s defined contribution plan the only option for new hires. This backgrounder from the Pension Integrity Project responds to a recent statement from the North Dakota Public Employees Retirement System (NDPERS) that claims the adoption of proposed House Bill 1040 would require a drastic reduction to the plan’s discount rate. The system’s claim is inconsistent with other state plans that have undergone similar reforms, and there is no legal or financial requirement to change discounting like this when a pension plan is closed.

Updated 2022 Fiscal Year Investment Results for State Pension Plans

Investment returns are a crucial part of a pension plan’s funding of promised retirement benefits. While the ultimate success and cost of a public pension do not hinge on a single year of market results, each year that a pension plan falls below investment expectations adds to the growing—over $1 trillion nationally by the latest estimates—unfunded liabilities of state-run pension plans. An update to our October 2022 analysis compiles the investment returns reported by state pensions from the 2022 fiscal year. As expected, the research shows 2022 was a notably poor year of investment returns. All state-run pensions saw results that fell short of expectations, leading to significant growth in unfunded liabilities. Reason Foundation finds the median investment return achieved by the listed pension plans was -5.2% in 2022, well below the national average expected rate of return of 7.0%. Following an exceptional 2021, the latest investment results demonstrate that public pensions still have a steep hill to climb to get back to full funding.

PRO Plan: A Better Public Sector Retirement Plan for the Modern Workforce

Beyond the crippling growth of expensive unfunded liabilities, public defined benefit (DB) plans have failed to adjust to the evolving needs of today’s increasingly mobile workforce. Defined contribution (DC) plans aren’t without their shortcomings either, a common concern being that retirees can outlive their retirement savings. Both types of plans suffer from a lack of flexibility and personalization. The Pension Integrity Project’s Personalized Retirement Optimization Plan (PRO Plan) addresses these issues by structuring a guaranteed lifetime income on the foundation of an enhanced DC plan. In this commentary, the developers of the PRO Plan, Richard Hiller and Rod Crane, summarize the advantages of this approach to retirement for public employees.

News in Brief

Paper Proposes a Novel Discounting Method for Public Pensions

Discounting is how pensions calculate the future value of liabilities they have promised, and the rate used for this calculation has a massive impact on their funding. A new paper by Florida International University researchers identifies the problems with current discounting norms, namely their tendency to understate required contributions. They also acknowledge that discounting at a zero-risk rate—a method promoted by some to reflect the guaranteed nature of government pensions—likely overstates funding shortfalls and is too disconnected from financial reality. To strike a more appropriate balance between these two approaches, the researchers propose a new discounting method that applies a lower limit based on the lowest expected return among risky assets. A historical back-testing using this new discounting method going back to 2001 saw most plans (94%) exceeding these investment return expectations, resulting in funding improvements. The full paper is available here.

Quotable Quotes on Pension Reform 

“Divestment of these holdings would do nothing to stop climate change. The companies in question can easily replace CalPERS with new investors.”

—Marcie Frost, CEO of the California Public Employees’ Retirement System, on proposed legislation to force divestment from fossil fuel companies, in “Keep Politics Out of CalPERS, Reject Senate Bill 252,” Whittier Daily News, Feb. 8, 2023.

“Each year I’ve been in office, we have reduced the assumed rate of return…If we had the more rosy assumptions, we’d probably be 86, 87% funded…So the fact that we’ve had all this turmoil, had some market turmoil, and we’re basically where we were and probably much better if you had that, I think that’s a good sign. I think we’re going to be able to build from here…At the end of the day, we really want honest accounting. And we can fudge the numbers a little bit, but you know, so we’ve been reducing that assumed rate of return. I think that’s the conservative approach. I think that’s something that makes the most sense.”

—Florida Gov. Ron DeSantis, in “Gov. DeSantis Pushes for More Pension Spending in New Budget,” Florida Politics, Feb. 1, 2023.

Data Highlight

Each month we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analysts Jordan Campbell and Steve Vu show the distribution of investment returns for state pension plans in 2022. You can access the graph and find more information here.

Contact the Pension Reform Help Desk

Reason Foundation’s Pension Reform Help Desk provides technical assistance for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org. 

Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please send your questions, comments, and suggestions to zachary.christensen@reason.org.

The post Pension Reform News: Montana’s proposed reforms, poor 2022 investment results, and more appeared first on Reason Foundation.

The interactive map below shows the funded ratios for state-managed public pension systems from 2001 to 2022. A funded ratio is calculated by dividing the value of a pension plan’s assets by the projected amount needed to cover the retirement benefits already promised to workers. The funded ratio values for 2022 are projections based on a -6% investment return. 

Year-to-year changes in investment returns and funded ratios tend to grab attention, but longer-range trends give a better perspective of the overall health of public pension systems.

In 2001, only one state, West Virginia, had an aggregated funded ratio of less than 60%. By the end of 2021, four states—Illinois, Kentucky, New Jersey, and Connecticut—had aggregate funded ratios below 60%.

If investment returns are -6% or worse in the 2022 fiscal year, Reason Foundation’s analysis shows South Carolina would be the fifth state with a funded ratio below 60%. 

Over the same period, 2001 to 2021, the number of states with state-managed pensions with funded ratios above 90% fell from 33 to 20. If all plans return a -6% investment return assumption for 2022, Reason Foundation projects the number of states that have funded levels above 90% would shrink from 20 to six.  The six states with funded levels that would still be above 90% after -6% returns for 2022: Delaware, Nebraska, New York, South Dakota, Washington, and Wisconsin. 

Importantly, the -6% investment return assumption for the 2022 fiscal year used in this map may be too optimistic for some public pension plans. The S&P 500 lost 12% of its value over the 2022 fiscal year from July 1, 2021, to June 30, 2022. Vanguard’s VBIAX, which mimics a typical 60/40 stock-bond portfolio, was down 15% for the fiscal 2022 year ending in June 30, 2022. Thus, given the condition of financial markets this year, the public pension plans with fiscal years that ended in June 2022 are likely to report negative returns for the 2022 fiscal year.  

Another useful long-term trend to look at are the unfunded liabilities of state-run pension plans. Whereas a pension system’s funded ratio takes the ratio of assets to liabilities, unfunded liabilities are the actual difference between the pension plan’s assets and liabilities. Unfunded liabilities can be conceptualized as the pension benefits already promised to workers that are not currently funded by the plan. Again, the values for the 2022 unfunded liabilities map are a projection using an investment return of -6%. 

The five states with the largest unfunded liabilities are California, Illinois, New Jersey, Pennsylvania, and Texas. In fiscal year 2021, the unfunded liabilities of those states totaled $434 billion and would jump to $620 billion in 2022 with a -6% return.  

For more information on the unfunded liabilities and funded ratios of state-run pensions, please visit Reason’s 2022 Public Pension Forecaster.

Notes

ⁱ The state-funded ratios in this map were generated by aggregating (for state-managed plans) the market value of plan assets and actuarially accrued liabilities. Prior to 2002, Montana and North Carolina reported data every two years, therefore for 2001 figures from 2002 are used. Figures for Washington state do not include Plan 1, an older plan that is not as well funded.

ⁱⁱ The discount rate applied to plan liabilities will impact the funded ratio of a plan. Therefore, the map above can be best thought of as a snapshot of state-funded ratios based on plan assumptions by year. Overly optimistic assumptions about a pension plan’s investment returns will result in artificially high-funded states. Conversely, pulling assumptions downward, while prudent, will result in a worse-looking funded ratio over the short term.

ⁱⁱⁱ In addition to projections for fiscal 2022, some public pension plans in 29 states have yet to report their complete fiscal 2021 figures and therefore include a projection estimate for 2021 as well. Thus, 2021 projections were used for at least one plan in the following states: Alabama, Alaska, Arkansas, California, Colorado, Georgia, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Missouri, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oregon, Pennsylvania, Texas, Tennessee, Utah, Virginia, Washington, West Virginia, Wisconsin, and Wyoming.

The post Projecting the funded ratios of state-managed pension plans appeared first on Reason Foundation.

Based on a -6% return for fiscal 2022, the aggregate unfunded liability of state-run public pension plans will be $1.3 trillion, up from $783 billion in 2021, the Pension Integrity Project finds. With a -6% return in 2022, the aggregate funded ratio for these state pension plans would fall from 85% funded in 2021 to 75% funded in 2022. 

The 2022 Public Pension Forecaster below allows you to preview changes in public pension system funding measurements for major state-run pension plans. It allows you to select any potential 2022 investment return rate to see how the returns would impact the unfunded liabilities and funded status of these state pension plans on a market value of assets basis.

The nation’s largest public pension system, the California Public Employees’ Retirement System (CalPERS), provides a good example of how much one bad year of investment returns can significantly impact unfunded liabilities, public employees, and taxpayers.

If CalPERS’ investment returns come in at -6% for 2022, the system’s unfunded liabilities will increase from $101 billion in 2021 to $159 billion in 2022, a debt that would equal $4,057 for every Californian. Its funded ratio will drop from 82.5% in 2021 to 73.6% in 2022, meaning state employers will have less than three-quarters of the assets needed to pay for pensions already promised to workers. 

Similarly, the Teacher Retirement System of Texas (TRS) reported $26 billion in unfunded liabilities in 2021. If TRS posts annual returns of -6% for the fiscal year 2022, its unfunded liabilities will jump to $40 billion, and its funded ratio will drop to 83.4%. The unfunded liability per capita is estimated to be $1,338. 

The table below displays the estimated unfunded liabilities and the funded ratios for each state if their public pension systems report -6% or -12% returns for 2022. 

Estimated Changes to State Pension Unfunded Liabilties, Funded Ratios

The first three quarters of the 2022 fiscal year clocked in at 0%, 3.2%, and -3.4% for public pensions, according to Milliman. The S&P 500 is down more than 20% since January, suggesting that the fourth quarter results will be more bad news for pension investments.

Considering the average pension plan bases its ability to fund promised benefits on averaging 7% annual investment returns over the long term, plan managers are preparing for significant growth in unfunded liabilities, and a major step back in funding from 2021. 

The significant levels of volatility and funding challenges pension plans are experiencing right now support the Pension Integrity Project’s position last year that most state and local government pensions are still in need of reform, despite the strong investment returns and funding improvements in 2021. Unfortunately, many observers mistook a single good year of returns—granted a historic one—as a sign of stabilization in what was a bumpy couple of decades for public pension funding. On the contrary, this year’s returns, as well as the growing signs of a possible recession, lend credence to the belief that public pension systems should lower their return expectations and view investment markets as less predictable and more volatile. 

State pension plans, in aggregate, have struggled to reduce unfunded liabilities to below $1 trillion ever since the Great Recession, seeing this number climb to nearly $1.4 trillion in 2020. Great results from 2021 seemed to finally break this barrier, with the year’s historically positive investment returns reducing state pension debt to about $783 billion. Now, state-run pension plans will again see unfunded liabilities jump back over $1 trillion, assuming final 2022 results end up at or below 0%. 

It is important not to read too much into one year of investment results when it comes to long-term investing. But during this time of economic volatility, policymakers and stakeholders should recognize that many of the problems that kept public pension systems significantly underfunded for multiple decades still exist. And many pension plans are nearly as vulnerable to financial shocks as they were in the past.

Going forward, state and local leaders should continue to seek out ways to address and minimize these risks, making their public retirement systems more resilient to an uncertain future. 

Webinar on using the 2022 Public Pension Forecaster:

The post Unfunded public pension liabilities are forecast to rise to $1.3 trillion in 2022 appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Florida Law to Improve State DC Plan
• Alaska Avoids Attempt to Unwind Pension Reform
• Examining NIRS’ Cost Efficiency Report
• Jacksonville’s Successful Reform Leads to Credit Rating Boost
• Proxy Voting May Be a Distraction to Pension Investors
• Lack of Focus on Lifetime Income Among Retirement Plans

News in Brief
Quotable Quotes on Pension Reform
Contact the Pension Reform Help Desk

Articles, Research & Spotlights

Major Florida Legislation Improves the State’s Default Defined Contribution Plan 

Adopting the long-time recommendation of the Pension Integrity Project, Florida lawmakers have now made much-needed improvements to the state’s defined contribution plan that serves the majority of new teachers and public employees. House Bill 5007—recently signed by Gov. Ron DeSantis and proposed as an element of his 2022 budget —will increase government contributions into public employees’ individual defined contribution accounts by 3%. This increase brings the state’s flagship vehicle for retirement benefits up to general standards for adequate savings, reinforcing the Sunshine State’s dedication to providing competitive retirement options. Now with this success solidified, Florida policymakers should continue to seek out ways to improve both defined contribution and defined benefit components of its retirement system.

Alaska Avoids Attempt to Roll Back 2005 Pension Reform 

Alaska was an early adopter of the defined contribution plan, which has been an effective plan design for providing valuable retirement benefits to public employees while not taking on additional unpredictable costs and risks. This last legislative session, two bills to replace the state’s defined contribution plan with poorly structured pension plans made it through the state House of Representatives, but eventually failed in the state Senate. The failed legislation was ostensibly introduced to help the state with its challenges with recruiting and retaining public workers, but little actual research was done to explore the fiscal effect this reform would have had, and it is unlikely that the change would actually improve the state’s ability to attract and keep employees. Seeing the need for informed analysis on these proposals, the Pension Integrity Project at Reason Foundation stepped in to educate key stakeholders of the potential risks and costs that could arise from the proposed changes. 

NIRS’ Assessment of the Retirement Efficiency Gap Leaves Out Some Key Details

Research from the National Institute on Retirement Security (NIRS) claims that an “efficiency gap” exists when comparing defined benefit (DB) and defined contribution (DC) plans. Theoretically, this gap suggests that, for the same amount of money, DB plans are able to generate more in retirement benefits. This analysis takes too narrow of a view, however, argues Reason’s Swaroop Bhagavatula. First, by only applying scenarios in which plans accurately predict actuarial outcomes–most notably returns–NIRS’ analysis seems to overlook the significant funding challenges that have plagued public pensions. Second, the analysis applies too much importance on cost efficiency, while not addressing other important factors in retirement policy, like what is optimal to the modern workforce. Devoting one’s entire attention on cost efficiency is missing the bigger picture when the majority of new workers will not remain long enough to enjoy the benefits of a DB plan.

Jacksonville’s Public Pension Reform Helps the City Get an Improved Credit Rating

Citing a package of pension reforms from 2017, Moody’s Investors Service just improved the credit rating for the city of Jacksonville, Florida. Five years ago, Jacksonville’s city council directed a major shift in retirement policy, electing to use a defined contribution plan for all new hires to slow the growth of costly and unpredictable pension debts. This, along with prudent payments to accelerate the elimination of legacy pension debt, has greatly improved the city’s financial standing. Reason’s Jen Sidorova explains the benefits that Jacksonville will enjoy thanks to its retirement reform and the improved credit rating that came about from these efforts.

Proxy Battles Are Usually an Inefficient Use of Public Pension Systems’ Resources

As major institutional investors, public pension plans can influence the companies they invest in. This influence is formally realized in the way a pension engages in what is called proxy voting, which is when a corporation allows its investors to vote on board membership decisions and other resolutions. Reason’s Marc Joffe examines some trends in how pensions have participated in this process, finding 81 recorded instances of funds formally making a case to their fellow shareholders to vote a particular way. California’s main pension for public workers, CalPERS, was the source of more than half of these, and they used their shareholder status to advance official positions ranging from climate change to board diversity. Joffe questions the purpose and effectiveness of this practice, and notes that public pensions usually have more pressing matters related to risk and funding that should take priority.

The Case for In-Plan Lifetime Income Solutions for DC Plans Is Clear, So Why the Reluctance to Implement? 

Annuity options offer an excellent solution to the largest critique of defined contribution plans, a lack of guaranteed lifetime income. But there is still a stark reluctance among retirement plans to offer these options to their members. Reason’s Rod Crane explores some of the barriers to providing annuities, namely the complexity of these options and a misaligned focus on wealth accrual over retirement income.

News in Brief

Proposed Funding Policies for Legacy Pension Debt

Jean-Pierre Aubry at the Center for Retirement Research at Boston College has published follow-up research on his previously introduced concept of legacy debt in public pensions. A number of pension plans began without policies to prefund promised benefits. As nearly all plans eventually changed this practice, a good deal of debt was generated that—as the author of this brief postulates—should not be under the same expectation of payment by the current generation. Aubry advises plans change the way they account for and pay down both legacy and new debt. For legacy debt, plans should adopt amortization policies that pay down the liability over multiple generations. For new debt they should adopt lower risk return assumptions and maintain amortization that ensures payment within the current generation. These changes would decrease annual contributions required for legacy debt, but would also reduce future funding risks with higher required contributions for new debt. The full brief is available here.

State Unfunded Liabilities Over $8 Billion When Discounting at Risk-Free Rates

The American Legislative Exchange Council (ALEC) releases an annual report that recalculates unfunded pension liabilities using a discounting method that accounts for the guaranteed nature of benefits backed by state governments. Using a risk-free rate, unfunded liabilities held by states have now exceeded $8.2 billion by 2021, which is a significant increase from the previous year. Much of this jump is attributed to declines in the risk-free rate. The report also examines the states that have enacted reforms, naming Alaska, Michigan, and Oklahoma as standouts for adopting effective changes that have significantly reduced taxpayer and budget risk. The analysis finds that 25 states have yet to adopt major contribution or plan design reforms. The full brief is available here.

Quotable Quotes on Pension Reform 

“Market volatility is the prevailing headwind for public pension funding, and over the first three months of 2022 we saw the majority of the plans in our study decline in asset values, ranging from losses of 5.52% to a mild gain of 0.50%…Given the continued fixed income and equity volatility in April and May, we expect this downward funding trend to continue in the near-term” 

– Author of Milliman’s Public Pension Funding Index Becky Sielman, cited in “Milliman Analysis: Rocky Markets Cause $167 Billion Drop in Public Pension Funded Status During Q1,” PR Newswire, May 20, 2022

“If you look at reasonable expectations going forward, it’s going to be very hard to maintain current asset/liability funded ratios in public pensions without making significant changes…Pensions have had a good decade-long run of strong investment returns, recently combined with higher liability discount rates. But those trends will eventually reverse, placing renewed downward pressure on funded ratios. If you combine that with boards that aren’t willing to make structural changes to their business model, it’s a Catch-22.”

– Co-founder of CEM Benchmarking and CEO of KPA Advisory Services Keith Ambachtsheer, cited in “Governance Issues Loom Over US Pension Funds,” Chief Investment Officer, June 2, 2022

Contact the Pension Reform Help Desk

Reason Foundation’s Pension Reform Help Desk provides information on Reason’s work on pension reform and resources for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org. 

Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org.

The post Pension Reform News: Florida improves defined contribution plan, Alaska pension reform roll back blocked, and more appeared first on Reason Foundation.

It is generally recognized that a defined contribution structured retirement plan needs a contribution rate of between 12% and 15% of a worker’s salary (where employees participate in Social Security) to produce an income that is likely to maintain the employee’s standard of living once they are in retirement. For teachers and most other non-safety public workers in Florida, the contribution rate in the Florida Retirement System’s Investment Plan has been 3% by the employees and 3.3% by the employer, for a total of 6.3%. Unfortunately, this is effectively half of the total contribution necessary to effectively fund an appropriate retirement income. 

In House Bill 5007, the Florida legislature increased the state’s contribution to the FRS IP by 3% to a total employer contribution of 6.3%. This brings the contribution rate of government employers, i.e. taxpayers, to 6.3% and the total contribution rate up to 9.3%, certainly a substantial improvement. The increase is expected to cost $249 million next year. Ideally, workers would’ve also upped their contributions to FRIS IP but the state legislature is to be applauded for recognizing this shortcoming and for acting to improve lifetime financial security for state employees. This change may also aid in recruiting and retaining quality employees into state service as taxpayers put more money toward workers’ retirements and the plan better meets employees’ long-term needs. 

The FRS IP has been a plan that effectively meets most other best practices for defined contribution (DC) plan design. It provides a robust communication and education package for employees and has an appropriate investment menu that includes target-date funds for workers who may be less financially active or sophisticated.  There is also a broad selection of distribution options for employees to choose from, including lifetime income options. With all these positive design elements, the insufficient contribution rate has kept the plan from being a truly effective retirement vehicle. While the government’s 3% contribution increase goes a long way toward making the plan more effective, the total contribution rate remains insufficient. 

The Florida Retirement System Investment Plan should now examine how it can increase the required employee contribution by 3% to 6%, so the total contribution rate would rise to 12.3%. Legislative action will likely be needed, but increasing the employee contributions would create no additional cost to the state’s taxpayers. This increased contribution from workers would bring the FRS IP contribution total from 9.3% to 12.3%, a rate just above recognized standards so that workers could then expect to have the appropriate amount of money set aside for retirement.  

An employee contribution rate of 6% is quite comparable to other states with defined contribution retirement plans and could be an appropriate reciprocal response considering not only the state’s increase in its contribution but also the recent 5.4% across the board increase in salaries for all state employees, with some workers also getting additional raises. If workers express concerns about increasing their contribution rate all at once, state policymakers could examine the possibility of implementing the 3% contribution increase gradually over several years. Again, this would likely need to be spelled out legislatively. 

The momentum initiated by the important and laudable state action to increase the government’s contribution rate to the FRS IP should not be lost. But to be a truly effective retirement plan for state employees, and best aid employer workplace objectives, including recruitment and retention of employees, the total contribution rate still needs to rise into the accepted range of 12% to 15%.  

With the passage of House Bill 5007, the Florida Retirement System’s Investment Plan is much closer to being a model of effective public retirement plan design. Florida policymakers should now seize the opportunity to take the necessary step—increasing employee contributions to 6%, thereby having a total contribution rate into the plan of over 12%, putting the contribution rate in line with best practices.  

The post Florida improves FRS Investment Plan, but more needs to be done appeared first on Reason Foundation.

With this move, Florida continues to demonstrate its commitment to maintaining a retirement system that works for both taxpayers and public workers. It will align the state’s default defined contribution retirement option offered to most newly hired public workers with private-sector retirement contribution best practices. This will have the long-term effect of mitigating financial risk to taxpayers while improving employees’ ability to contribute to a secure, future retirement no matter how long they work in public service. 

In combination with previous reforms, the Florida Retirement System Investment Plan (FRS IP) rate changes in House Bill 5007 make Florida a leader in providing attractive, choice-based, and affordable benefits to an increasingly flexible and diverse workforce. The change also improves the footing of the state’s defined contribution plan, which plays a critical role in addressing the financial risks borne by public employers and taxpayers. 

The Pension Integrity Project at Reason Foundation played an integral role in thought leadership related to this landmark reform, educating policymakers on the issue for years. After reporting on the needs of the Florida Retirement System (FRS) in 2019, the Pension Integrity Project began communicating the importance of ensuring the benefit offered in the FRS Investment Plan—the state’s default defined contribution plan—meets best practices typical of private sector corporate retirement offerings. From there, we engaged in educational outreach with policymakers, detailing the problem and proposing potential solutions to help bring the FRS Investment Plan up to industry standards. 

With the help of several key stakeholders in the state, including Gov. DeSantis’ office, legislative leaders such as State Sen. Jeff Brandes and State Rep. Jay Trumbull, and local groups like Americans for Prosperity-Florida, we were able to raise awareness of the issue in preparation for the 2022 regular session. We most recently testified on the subject before the Florida Senate Committee on Governmental Oversight and Accountability in October 2021. The collaborative effort was rewarded when Gov. DeSantis released his administration’s 2022 budget proposal, which included the recommended policy proposal that ultimately became law with the recent signing of HB 5007.

The Problem

Originally adopted during the 2000 legislative session as an alternative option to the state’s traditional defined benefit pension, the Florida Retirement System Investment Plan (FRS IP) has taken on increasing importance in Florida state and local government administration and now serves as the state’s primary vehicle for providing retirement security to most public workers. 

Seeing that most public employees weren’t staying in the system long enough to maximize their pension benefits, Florida lawmakers appropriately switched the FRS IP to be the default choice for most new workers (excluding first responders in the “Special Risk” class) in 2016. Today, over a quarter of the FRS membership has either selected or defaulted into the Investment Plan, and its share continues to grow rapidly. 

With so many teachers and public employees dependent on the FRS IP as a means to support a dignified retirement, it is crucial that the default retirement plan provide sufficient contributions to allow workers to make continuous progress toward saving for a healthy and comfortable post-employment lifestyle. Financial advisors and industry experts typically recommend total contributions into a plan like the FRS IP should total at least 10% of an employee’s pay—with many even preferring 12% to 15% percent to ensure benefit adequacy—for the eventual accrued benefits to be sufficient for retirement. 

For over two decades, Florida’s public employers at the state and local levels were required to contribute 3.3% of an employee’s salary to their FRS IP account for the largest grouping of employees (the “Regular Class”), which includes teachers and most civilian government employees. Employees in turn contributed a fixed 3% of their pay to their FRS IP account to bring the historic savings rate of FRS IP members to 6.3%,  far below industry standards. This contribution combination placed Florida well below other states who offer defined contribution plans, further highlighting the unique need to address the funding flowing into the IP (see Table 1).

Table 1. Contribution Rates for State-Run Primary Defined Contribution Retirement Plans

Insufficient contributions to a public retirement plan should be a major concern for employees, policymakers, and taxpayers alike. A generation of retirees inadequately prepared for retirement creates a risk of increased reliance on the state’s social safety net. This shortcoming also creates more immediate challenges that can impact many stakeholders. Benefits below industry standards and below those available in the private sector can significantly hinder the state’s ability to compete for talent—especially in areas like information technology and data security—to ensure the continued delivery of quality public services to Floridians. Before the governor’s recommendation and the subsequent policy enactment, public employers were at risk of falling behind in attracting qualified employees and creating a generation of retirees with benefits insufficient to outlast them.

The Reform: Summary and Evaluation of HB 5007

For FRS Investment Plan members, HB 5007 increases the employer contribution to employee IP accounts by 3% of payroll over current levels, covering all membership classes, meaning all present and future members of the FRS IP will see an equal increase. The largest grouping of employees—the Regular Class, which includes teachers and most non-public safety workers—will see the employer rates into their IP accounts rise from 3.3% of pay to 6.3%. In combination with their own 3% contribution, which will remain unchanged, the total contribution into the IP plan for Regular Class members will now be 9.3%. Those in the Special Risk class, which includes public safety officers—will see their total contributions rise from 14% to 17%.

According to the House’s fiscal analysis of the House Bill 5007, the 3% increase in employer contributions to the FRS IP is estimated to require an additional $249 million in the first year from all state and local government employers in aggregate.

With the passage of HB 5007, lawmakers have moved the state into a more competitive position by providing employees with more resources to meet their retirement needs. The increased amount employers will contribute to their employees’ FRS IP accounts comes on the heels of lawmakers also agreeing to a 5.38% across-the-board pay increase for public employees. For those participating in the FRS Investment Plan, this will bring the total increase in compensation to more than 8%.

As states around the country scramble to recruit qualified employees, HB 5007 and the FRS Investment Plan will make Florida a more competitive employment option for new workers, especially those highly skilled technical professionals the state expects it will need in the future. 

This notable step also improves the long-term viability of the Florida Retirement System. The more the FRS IP membership continues to increase, the less the inherent risk of cost overruns associated with the alternative FRS Pension Plan, which remains $7.6 billion underfunded today. By bringing contributions up closer to industry best practices, HB 5007 ensures that the defined contribution plan will continue to be an attractive option for future public workers. This, in turn, will result in more members joining a retirement plan that, unlike the pension, has a steady and predictable price tag with no risk of runaway costs and debt.

House Bill 5007 also included an unrelated policy provision that expanded law enforcement officers’ access to an existing Deferred Retirement Option Program (DROP) for those participating in the traditional FRS pension system. Reason has not performed an in-depth analysis of this particular aspect of the bill, but there are many risks involved in DROPs that are frequently overlooked, and there are likely more efficient ways to improve the retention of public workers.

Conclusions and Next Pension Reform Steps

Through a collaborative effort grounded in Reason Foundation’s experience with best practices of retirement policy, House Bill 5007 changes the FRS IP in a way that is undeniably important for the long-term future of Florida’s taxpayers and retirees. While the 3% increase appears simple at face value, this reform marks a significant improvement in the retirement security of most incoming workers. It will also improve the ability to attract and keep quality employees at a time when this is a growing concern for state and local employers. 

Another important, and quite possibly longest-lasting impact of the reform is that it bolsters the FRS IP so it can continue to be a valuable retirement option for employees while also working for employers—or taxpayers—by managing risks and runaway costs.

Florida policymakers and those involved in this reform process deserve credit for achieving meaningful and lasting change. This should not be the end of thoughtful improvements to the state’s retirement system, however. To build on this session’s success and remain competitive with the private sector, stakeholders should continue searching for ways the FRS IP can better serve public employees. 

In the fall of 2021, the Pension Integrity Project testified before the Florida Senate Committee on Governmental Oversight and Accountability that, in addition to addressing the below standard contribution rates, there were a few other opportunities for the FRS IP to better serve its members:

• The first opportunity to expand on HB 5007 lies in the stated objectives of the FRS IP, or lack thereof. Currently, the Florida Retirement System as a whole is governed by a set of objectives, but the unique nature of its two retirement options presents an opportunity for additional mission clarity and transparency. Framing explicit language delineating the specific objectives of the Investment Plan—such as lifetime income and retirement security—could help communicate the goals of the plan to new and existing public workers. 

• The second area of opportunity lies in the types of investments offered to those participating in the Investment Plan. Well-designed plans like the FRS IP should also offer the correct age-appropriate investment mix. This is generally accomplished by using target date funds that adjust investment risk to the employee’s retirement horizon. Given the serious role these funds play in the lives of public workers and their families, protecting the value of a member’s FRS IP account from market fluctuations as the worker nears retirement should be a high priority.

• Providing annuities to improve members’ retirement security has long been an established practice in the FRS IP, but it could still be improved. Offering annuitization at retirement allows retirees to use their accrued retirement funds to buy a stream of guaranteed lifetime income. Despite a lifetime annuity option being available to members already, distribution choices offered by the FRS IP are limited. Expanding those offerings to include deferred annuities could present an opportunity to further improve this offering to retirees. 

• Lastly, the increases in HB 5007 brought total contributions nearly, but not quite, to the 10% minimum standard set by industry experts. Despite the prudent dedication of funds to address this pressing issue, Florida will still be below all other states in total contributions for most members of the FRS IP. There is still room for improvement in this regard, and it may be prudent to consider ways to increase the fixed employee contribution toward their own retirement. Lawmakers should recognize that with future efforts they can build upon the benefits that will come from this latest legislation.

Although there are still potential improvements to be made to the Florida Retirement System Investment Plan, there is no denying lawmakers took the most important step in HB 5007 by raising total contributions to be closer to the levels needed to provide for an adequate retirement. Gov. Ron DeSantis and members of the state legislature deserve recognition for their work to bring the Florida Retirement System one step closer to becoming a model for public retirement systems around the country. 

The post Major Florida legislation improves the state’s default defined contribution plan appeared first on Reason Foundation.

Five years ago, the Jacksonville City Council approved a pension reform package while enacting innovative changes, reducing debt by more than $585 million and adding over $155 million to pension reserves. A key element of the pension reform that led to reduced debt was closing the city’s three pension plans to new public employees in 2017. Since that change was put in place, over $715 million has been used to grow Jacksonville’s economy and invest in public services for its population. In addition, credit rating agencies, such as Moody’s, assign “grades” to governments’ ability and willingness to service their bond obligations, taking into consideration the jurisdiction’s economic situation and fiscal management. Since the pension reform reduced budgetary pressure, it improved the chances of the city getting a credit upgrade. 

The Jacksonville Daily Record reports:

Moody’s cited the closing of three pension plans to new employees as a factor for the rating improvement along with others:

• Material improvement in the city’s cash and liquidity position (issuer and non-ad valorem ratings.) 

• Significant reduction in the growth of the city’s pension obligations (issuer and non-ad valorem ratings).

• Material economic improvement reflected in tax base growth, lower unemployment and increased median family income (issuer and non-ad valorem ratings).

• Improved coverage from pledged revenues (special tax ratings).

Facing billions in unfunded public pension liabilities and increasingly expensive debt service payments, city leadership decided to stop adding risk to the budget by making the defined contribution plan the primary vehicle of a secure retirement for new hires beginning in 2017.

In addition, Jacksonville prioritized paying down the $2.86 billion in unfunded retirement benefit liability owed to current employees and retirees over the coming decades. While the city does not accumulate any pension debt from new hires, existing pension promises previously made to workers with defined benefit retirement accounts must be fulfilled. Overall, the pension reforms reduced the city’s risk, brought long-term costs under control, and improved pension funding policy overall.  

The 2017 pension reform is expected to lower unfunded pension liabilities and get the city’s pension plan closer to 100% funded in the coming years. Since getting existing liabilities under control makes the city more likely to honor its future debts, it inevitably has a positive effect on the city’s credit rating.  

When a city like Jacksonville receives a credit rating upgrade, it can issue bonds at a lower interest rate. This process is similar to an individual becoming eligible for lower interest rates as their credit scores improve. With lower interest rates available, the city can lower long-term costs and has more flexibility to invest in infrastructure projects and other public services.

“Roads and bridges and programs, parks, libraries, public health, and safety. All of that impacts our community and our citizens as they go about their daily lives. These things that we just sometimes take for granted that, you know, take a lot of money to keep in good working shape,” said Joey Grieve, the city’s chief financial officer, in a recent interview. 

Jacksonville’s experience shows how sensible public pension reforms can positively impact the fiscal outlook of a major city while also improving public workers’ retirement security. The full effects of Jacksonville’s 2017 pension reform will be realized over decades, but it is clear from Moody’s credit rating upgrade that the reform has already contributed to improving the city’s finances. 

The post Jacksonville’s public pension reform helps the city get an improved credit rating  appeared first on Reason Foundation.

This fluidity means retirement plans that were once advantageous to these lifetime workers are now less attractive to a growing number of more mobile workers. To address this trend, many public employers have introduced defined contribution retirement plans to provide a more portable and optimal retirement benefit to workers who aren’t planning on sticking around at that job for multiple decades.

A defined contribution plan uses an individual retirement account, like private sector 401(k) accounts, to which regular contributions are made, eventually resulting in a lump sum that is accessible at the worker’s retirement. This type of retirement plan does not place retirement saving risk on the public employer and taxpayers. And it provides the employee with a chunk of money that can move with them from one employer to the next if they change jobs. It also affords the worker more personal control over investments and other disbursement options in retirement, like annuities.

Unlike defined benefit pension plans, defined contribution plans do not depend on actuarial predictions on the market or other demographic assumptions. The feature that most impacts a defined contribution plan is the total contributions flowing into the member’s account. For a defined contribution plan to provide an adequate retirement, the contributions that are paid into that personal account must be sufficient.

What is ‘sufficient’ depends on various factors, including the type of job being performed and the existence of other supplementary benefits like personal savings and social security. Figure 1 shows the various contribution rates that are used for the primary defined contribution plans run by state governments.

Figure 1: Contribution Rates for State-Run Primary Defined Contribution Retirement Plans

As the table above demonstrates, there is quite a bit of variance in contribution levels among state-run defined contribution plans. For example, public safety workers tend to have earlier retirement ages, so they need higher contributions to achieve a sufficient sum by the time they exit the workforce. Some government employers also decline participation in Social Security, which should be counteracted with higher defined contributions to make up for the loss of that income stream. This is visible in the above chart, with most of the top total contributions coming from either public safety plans or non-Social Security plans.

In general, most financial experts recommend that total contributions for a member participating in Social Security need to be 10% to 15% of their pretax earnings to ensure they have enough money for a secure retirement. For public workers not participating in Social Security or any other supplementary benefit, a higher 18% to 25% contribution rate is advised. 

Judging by the advice of experts, Florida—which is positioned dead last in the ranking of total contributions—needs to increase its contributions to ensure that its public workers will be retiring with enough in their defined-contribution accounts. In fact, policymakers in Florida are proposing just this, with Gov. Ron DeSantis including a 3% increase on state contributions in his proposed budget. More recently, the Florida state legislature introduced House Bill 5007, which would implement that increase.

As more government employers turn to defined contribution plans to better serve their evolving workforces, they must consider the various plan features needed to provide employees a secure retirement. The most important consideration is the level of contributions that go to the plan. It is useful to see how other states are handling this crucial aspect of retirement policy and useful for state employers to closely monitor where their contribution rates stand in this aspect.

Government employers that fall close to or below recommended contribution rates should revisit their retirement contribution policies to ensure that they are providing a benefit that can be a valuable primary retirement vehicle capable of providing the type of income that workers need in retirement.

The post Comparing how much states contribute to public workers’ defined contribution retirement plans appeared first on Reason Foundation.

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My name is Steven Gassenberger, and I serve as a policy analyst for the Pension Integrity Project at Reason Foundation, a national 501(c)3 public policy think tank. Our team offers pro-bono consulting to public officials and stakeholders to help them design and implement policy solutions aimed at improving plan resiliency and promoting retirement security for public employees. We have played a technical assistance role in major retirement system reforms in states like Texas, Michigan, Arizona, Colorado, South Carolina, and New Mexico since 2015.

Regarding House Bill 971 authorizing the State Board of Administration (SBA)—which manages the Florida Retirement System Pension Plan trust fund—to expand their holding of alternative assets from 20% to 30%, we are not taking a position on House Bill 971. Rather, this testimony is intended to contextualize the underlying logic behind, and implications of, the investment class expansion based on our analysis of the FRS data. To mitigate the implications of HB 971, we highlight two opportunities before legislators to build on the legislation in a way that ensures the FRS Pension Plan’s long-term resiliency and solvency.

Florida Retirement System Investment at a Glance

• The FRS Pension Plan trust fund holds nearly $200 billion in assets, making it one of the largest investors in the world.
• According to the latest FRS reporting, historic post-pandemic market gains in the 2021 fiscal year resulted in private rquity investments returning 67.93%, followed by global equity with 41.78%, strategic investments with 17.14%, real estate with 8.58%.
• According to SBA Investment Reports, since 2013, the FRS Pension Plan trust fund has spent over $250 million in alternative asset management fees and commissions each year, most recently spending nearly $467 million in FY 21.
• Lowering the artificially high investment return bar for SBA and requiring fee reporting broken down by limited partners would build on House Bill 917 and give future members and taxpayers a more resilient FRS Pension Plan trust fund.

What Are Alternative Assets?

Alternative assets are investments that fall outside traditional cash, publicly traded stocks, and bonds. Commonly, alternative investments take the form of shares in limited partnerships, such as with private equity funds. As a statutorily protected fund worth nearly $200 billion, the Florida Retirement System is one of the largest institutional investors globally and, along with other state-level public pension systems across the country, is considered a major source of capital for alternative investment providers.

Why Would the SBA Seek to Expand its Alternative Asset Holdings?

Globalization taking hold of the world economy began the shift from high bond yields to today’s low-yield environment, pushing fund managers away from safe fixed-income sources to more exotic assets with increased potential upside.

According to the latest SBA annual investment report, private equity has been the highest performing asset class for three of the past four years for FRS. In the same report, SBA classifies private equity assets as having the greatest expected future returns along with the highest annualized risk, followed by global equities and hedge fund assets.

With an investment return assumption set at 6.8% and low-risk bonds yielding less than 4%, the SBA wants to double down on success by moving more of the FRS investment portfolio to high-risk, high-reward-style alternative assets. That logic is used widely by public pension plans throughout the country because many, like FRS, remain underfunded by billions of dollars and are seeking higher risks in hopes of avoiding the fiscal pain of higher contributions. Those missing funds need to be made up somehow. Florida House Bill 917 suggests the SBA be allowed to try its hand in the alternative asset market to make up that difference over time.

Concerns with Expanding Alternative Investments

Ask a group of public pension investment managers if a portfolio full of alternative assets is as safe as a classic large-cap stock and bond mix and odds are some will say yes, others no, and some will say it depends on your investment goals. Calling an investment “safe” implies a guarantee that no investments can claim outright, but traditional fixed income assets like U.S. Treasury bonds come close. Returns on bonds and large, publicly-traded stocks are what sustained large public pension systems like the FRS Pension Plan for generations without the need for unexpected infusions of public funds to close pension funding gaps.

Until the mid-1990s, Treasury bond rates were well above the FRS Pension Plan’s assumed rate of investment returns used by plan actuaries to calculate the cost of constitutionally protected retirement benefits until the mid-1990s. The FRS Pension Plan then began slowly drawing down its surplus, which totaled $13.5 billion in 2000 until the 2008 financial crisis flipped the fund from having a surplus to being underfunded.

The FRS Pension Plan historically assumed an investment return rate as high as 8%, before lowering the assumption to 7.75% in 2004. The plan adjusted the investment return rate assumption routinely throughout the years to reach the current 6.8% for 2022.

With the average FRS market valued returns between 2001 and 2020 barely reaching 5.6%, it would seem that investment market changes over the last two decades have left SBA managers with an outdated and artificially high investment return bar to exceed. The results have seen SBA investing more of the FRS Pension Plan trust fund into assets that they hope will not only meet expectations but greatly exceed expectations to make up for years of underfunding.

That kind of actively managed asset comes with management, administrative, and performance fees that can drain hundreds of millions from the FRS Pension Plan trust fund. Such hefty fees are not inherently bad for the Florida Retirement System if they result in equally hefty returns for the fund, but just like other investments, there is no guarantee those extra fees will result in returns that exceed those gained by passively managed, much less expensive, assets like index funds.

Currently, FRS is a leader in investment reporting among its peers because it provides details regarding its commitments and returns from limited partners, and reports fees by asset class. Combining those two reports to show which limited partners are receiving funds for little return and which deserve additional commitments increases stakeholder involvement and confidence in the funds’ ability to drive strong investment performance overall.

Building on House Bill 917

Although alternative assets are not inherently harmful to public pension systems, it would be prudent for policymakers to install boundaries around the investment decision-making process as well as provide increased oversight capabilities to the public.

Option #1 – Systematically Reduce the Need for Higher Investment Returns

Because SBA feels that alternative assets are more likely to produce the higher yields necessary to avoid the need for future funding increases—and their ability to eventually achieve this greatly depends on the assumed rate that they must achieve—our first suggested course of action is to continue to systematically reduce the assumed rate of return (ARR) used by the SBA from its current 6.8% set in Oct. 2021 by the Florida Retirement System Actuarial Assumption Estimating Conference.

Option #2 – Increase Investment Cost Reporting Details

Shifting to alternative assets usually involves higher costs, as actively managed private equity and hedge funds tend to demand higher fees for the services. A 2018 report by the Pew Charitable Trusts found pension plans spend at least $2 billion a year on investment fees alone, and FRS is no exception to this trend. Despite efforts to reduce fees through increased in-house investment management, unreported fees such as carried interest (i.e., performance fees) are not addressed in the current SBA reporting on FRS. Performance fees for private equity investments are typically far higher than the ordinary management fees for those assets, and most public pension funds—including FRS—do not report those performance fees.

Improving current fee reporting by adopting a robust investment cost report would directly address the issue of opaque fee reporting by outlining the fees and other expenses the public pension system incurs in the process of managing its portfolio. California’s teacher pension system, CalSTRS, offers a model in this regard. CalSTRS produces a report showing investment costs by type and asset category. An example of the report can be found at resources.calstrs.com.

This report is designed to provide stakeholders with detailed fee data and trends over a four-year period for each asset class and investment strategy. Reporting this ratio analysis to show the cost-effectiveness of the total fund, asset classes and strategies over time provides a quantitative metric to compare costs against the returns generated from those costs.

The retirement benefits of the Florida Retirement System’s members are paid for from net returns and not from gross returns. Since increased investment costs reduce net returns, the system’s fees and expenses should be consistently monitored and managers should be held accountable for the effectiveness of investments relative to the overall growth and resiliency of the Florida Retirement System.

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Since 2002, the FRS Investment Plan has served as a valuable retirement option for the majority of newly hired teachers and state employees that do not plan to spend their entire careers in public employment. Because the vast majority of public employees leave public employment before earning any meaningful benefit, in 2017, the Florida state legislature set the Investment Plan as the default for most employee classes, automatically enrolling new employees in the more portable plan, and leaving the FRS Pension Plan for those aiming to dedicate a full career to state employment.

Florida’s Investment Plan could be held up as a standard for other public employers to emulate but for one major flaw: insufficient contributions.

Most retirement experts advise that to sufficiently fund a dignified post-employment lifestyle, employee and employer contributions into a plan like Florida’s should total at least 10 percent—and preferably 12 to 15 percent—of pay for those participating in Social Security. As has been the case since its inception, the Investment Plan’s Regular Class—the grouping that includes teachers and most state workers—uses contributions of 3.3 percent from the employer and 3 percent from the employee, totaling a paltry 6.3 percent. This combined contribution rate places Florida well below other states that offer a defined contribution plan as a primary source of retirement.

Contribution Rates for State-Run Primary Defined Contribution Plans

Insufficient contributions from employers weaken the Investment Plan’s ability to provide a secure retirement for Florida’s public servants, making this one of the largest challenges facing state policymakers. A generation of retirees who are not adequately prepared for retirement could increasingly rely on public services to take care of them as they age.

Gov. DeSantis’ budget proposal addresses this issue head-on with a 3 percent increase in contributions from employers to the Investment Plan, for all employee classes. This near doubling in employer contributions would bring total contributions to Regular Class accounts to 9.3 percent, still below industry standards, but a marked improvement. This change would be a significant increase in total compensation and would bring the state closer to providing a secure retirement for its employees.

According to the appropriation report attached to the budget proposal, the aggregate cost of this contribution increase will be $270 million over the next year across all units of government. Much of that additional cost will be the responsibility of local governments, with the state estimated to pay $42.4 million of that increase in the 2022-23 fiscal year.

The proposed contribution increase would be in line with recommendations from the Pension Integrity Project, which has spotlighted the Investment Plan’s contribution insufficiencies in several reports and commentaries. A recent Reason analysis explored the idea of increasing Investment Plan contributions by 4 percent (2 percent from employers and 2 percent from employees), finding that this, along with several risk reduction policies applied to the FRS pension plan, could improve retirement security for most new workers while reducing long-term risks and costs for the state and its taxpayers.

The proposed increase is also expected to make the FRS Investment Plan more attractive to new workers and thereby reduce the inherent risk of cost overruns associated with the FRS Pension Plan.

While Florida’s retirement system would benefit from a number of reform efforts, Gov. DeSantis deserves credit for recognizing a major challenge facing Florida employees. As they consider the proposed budget, state legislators ought to see this as an opportunity to reaffirm their commitment to the retirement security of Florida’s public workers.

The post Gov. DeSantis’ proposed budget would improve Florida’s defined contribution retirement plan for teachers, workers appeared first on Reason Foundation.

During the 2021 legislative session, Florida lawmakers considered a proposal that they hoped would eliminate the financial risk public sector pensions currently pose for the state. The legislation, Senate Bill 84, aimed to limit the growth of the nearly $30 billion in Florida Retirement System (FRS) unfunded liabilities by requiring newly hired state and local employees to join the state’s defined contribution FRS Investment Plan. The measure ultimately stalled in the Florida House of Representatives after being approved by the majority of senators. Since then, Senate President Wilton Simpson has signaled interest in renewing the conversation during the 2022 legislative session while Governor Ron DeSantis included FRS Investment Plan benefits increases as part of his 2022-2023 budget recommendations.

Senate Bill 84 intended to close the defined benefit FRS Pension Plan to all new hires (except Special Risk members). But the bill did not include other funding or risk-related policy changes. Increasing contributions to bring FRS Investment Plan benefits up to industry standard is required for long-term solvency but only if reform includes a plan to tackle current liabilities.

The following analysis examines Senate Bill 84 and its impact on risk and cost compared to maintaining the state’s retirement plan status quo. Drawing on public pension policy best practices, the analysis offers an alternative policy package that, unlike Senate Bill 84, preserves the current retirement choice structure and applies solutions to pay down current debts, avoids future unfunded liabilities, and build on making the FRS Investment Plan much more attractive to future public employees.

The alternative reform scenario offered by the Pension Integrity Project keeps both the FRS Pension Plan and FRS Investment Plan open but also institutes the following changes:

• Gradually reduces the FRS Pension Plan’s assumed rate of return from 6.8% to 6% over 8 years.
• Adopts a 50-50 cost sharing policy for new Regular employees.
• Raises by 2% each the employee and employer contribution towards a member’s FRS Investment Plan – a 4% increase in total. (Governor DeSantis 2022-2023 Budget Proposal)
• Reduces the amortization period for new UAAL layers from 25 years to 15 years.

In order to make a comparison between the status quo, SB 84 and the alternative reform scenarios, the following assumptions were made:

• FRS is assumed to reset amortization payments and UAAL bases to zero after full funding.
• FRS is assumed to reset the AVA to match the MVA after full funding.

The alternative scenario intends to:

• Allow current unfunded liabilities to be paid off under most future market scenarios,
• Cost approximately the same or less than SB 84, and
• Ensure benefit adequacy.

Full Analysis: Modernizing Florida Retirement

The post Modernizing Florida retirement: Analyzing recent reform concepts appeared first on Reason Foundation.

Prepared by: Zachary Christensen, Steven Gassenberger, Leonard Gilroy, & Ryan Frost

Presented by: Zachary Christensen Date: October 20, 2021

Chairman Brandes, members of the committee, thank you for the opportunity to offer our brief analysis of the current state of the FRS Investment Plan.

My name is Zachary Christensen, and I am a managing director of the Pension Integrity Project at Reason Foundation, a national 501(c)3 public policy think tank, and prior to that, I was a public pension analyst for the Hoover Institution at Stanford University.

The Pension Integrity Project offers pro-bono consulting to public officials and other stakeholders to help them design and implement policy solutions aimed at improving plan resiliency and promoting retirement security for public employees. We have played a technical assistance role in over 50 state-level retirement system reforms in states like Texas, Michigan, Arizona, Colorado, South Carolina and New Mexico since 2015.

To consult on the state’s public retirement plans, we developed an actuarial model of the Florida Retirement System (FRS), which we believe can be a valuable asset to you as you consider possible changes. As researchers who have analyzed FRS for years, we appreciate the opportunity to discuss our perspective on the current FRS Investment Plan, the important role it plays in public service in Florida, and potential enhancements to bring it more in line with national best practices and better serve both employees and taxpayers.

FRS, with its choice-based retirement offerings, is a plan design leader in this nation. Most states provide a one-size-fits-all retirement option to public workers, while Florida provides two distinctive paths towards financial security in retirement. All new hires, except those in the Special Risk class, are automatically enrolled into the FRS Investment Plan by the end of their eighth month of employment unless they choose the FRS pension option. Since most public employees hired into FRS-participating employers today leave the public workforce within 10 years—and the FRS Investment Plan is inherently a portable retirement benefit—we believe that setting the Investment Plan as the default was a prudent policy established by this legislature. Using the Investment Plan as the default most appropriately matches the dynamics of your public workforce.

When the FRS Investment Plan was created during the 2000 legislative session, the intent was to offer public employees an additional path to a financially secured retirement. In its first year available to new hires, the plan saw less than 5% of public employees elect the option. Between 2002 and 2017, the percentage of active members who had selected the FRS Investment Plan option increased steadily, exceeding 20% before it was made the default option in 2018.

Our analysis of the FRS system’s membership retention data shows just a 33% probability that new hires will stay in public employment long enough to meet the 8-year vesting requirement for the alternative FRS Pension Plan. With these trends in mind, Florida lawmakers appropriately switched the default choice to the Investment Plan, but it is still up to them to ensure this option provides an adequate and secure retirement.

Additionally, the FRS Investment Plan offers a solid mix of proprietary investment funds with market average fees, as well as a series of reasonably priced target-date funds for participants preferring a “one-choice, set-it-and-forget-it” option.

The architects of the Investment Plan also deserve credit for structuring the plan in a way that in no way hinders the state’s ability to eventually pay off legacy pension debt. Although more newly-hired members are now selecting the Investment Plan, the state’s contribution policy ensures that this has no effect on amortization payments to the legacy FRS pension plan. This is exactly what we recommend to other states that are establishing new optional retirement plans.

Overall, we see these as very positive attributes of the FRS Investment Plan forming a good foundation for a public retirement plan. That said, we have identified four additional opportunities to strengthen the plan with some adjustments we believe will make it more sustainable and better serve both future public workers and the average taxpayer for the long run:

• The most immediate challenge facing the Investment Plan are insufficient contribution rates. Retirement experts agree that a total contribution rate of between 12% and 15% to a defined contribution plan is necessary over a career to adequately fund a retirement benefit, when combined with Social Security and personal savings. For the largest membership class in FRS—Regular Class—the current combined 6.3% FRS Investment Plan contribution rate, split 3% Employee/3.3% Employer, falls short of this standard. This means that most of Florida’s public workers (close to 88 percent) are not receiving adequate contributions into their account to provide a secure retirement. This is the largest shortcoming of the FRS Investment Plan, and it will require legislative leadership to commit financially in the plan’s mission.

• There is little reference in the FRS Investment Plan material that specifically speaks to plan objectives. The “Summary Plan Description” states, “[e]ach FRS plan is designed to provide you with a good foundation for financial security when considered along with Social Security, other retirement programs, and your own personal savings (including savings accounts, IRAs, and deferred compensation programs offered through your employer, among other resources).” This statement may be sufficient for FRS generally but falls short of stating specific plan objectives, as it is too general and lacking in supporting detail. If future employees are going to elect the FRS Investment Plan as their path to financial security, they need to be confident that the FRS Investment Plan mission aligns with theirs. Policymakers could add specific language about providing valuable options for lifetime income, as well as objectives on providing this benefit in a way that is cost-efficient and without the creation of unfunded liabilities.

• In the area of products offered to FRS Investment Plan members, FRS stakeholders can update some of the already positive aspects of the FRS Investment Plan by improving on target- date portfolio constructions in ways that allow more flexibility for individual life and retirement situations.

• The standard distribution method offered under the FRS Investment Plan is a lump-sum withdrawal upon separation of service. The employee can roll this distribution over to an IRA or take periodic distributions. Despite a quality lifetime annuity option being available to members, stakeholders could further mitigate the risk on employees through deferred annuities.

Beyond these four opportunities for improving the Investment Plan, there are other small changes that can also be explored like improvements to the FRS disability benefit (which Investment Plan members participate in) and adjustments to the vesting of employer contributions. More information on all of these options is available in a commentary published on the Reason.org website.

The Florida legislature has been a national leader in introducing retirement choice and plan design options that empower public employees to choose the best retirement path for themselves and their families. Implementing the recommendations discussed here will provide public employees and taxpayers more stability, predictability, and accountability, ensuring FRS can provide financially sustainable and attractive benefits for generations to come.

Thank you again for the invitation to speak today, and I would be happy to answer any questions.

Full Testimony Presentation: FRS Investment Plan – Assessment and Recommendations

A recording of the committee meeting on October 20th, 2021 is available here.

The post Testimony: Recommendations for the FRS Investment Plan appeared first on Reason Foundation.

In future retirement reform efforts, Florida policymakers trying to address the challenges facing the Florida Retirement System should recognize that a more collaborative process, which brings together important stakeholders like taxpayer advocates, public employee unions, and retirement experts, is a necessary component to enacting comprehensive reforms.

Using actuarial modeling of the Florida Retirement System (FRS), the Pension Integrity Project identified key policies and practical solutions that could both provide retirement security for state workers and reduce long-term costs for taxpayers.

In 2000, the FRS defined benefit pension plan for state and local government employees had a surplus of $13.5 billion for employee retirement benefits and was 118 percent funded. Today, the pension plan stands at just 82 percent funded, meaning it has only 82 cents of every dollar it owes in retirement benefits.

The Florida Retirement System also has a total of $36 billion in unfunded liabilities, more simply viewed as public pension debt. Perhaps even more concerning, FRS’ debt is growing quickly and over $6 billion of the system’s debt has accumulated in the last two years, as shown in Figure 1 below.

Figure 1 – Florida Retirement System’s Pension Plan Debt Accrual

This pension debt is the result of a variety of factors, including policymakers waiting too long to adjust to changing market conditions and economic trends.

In 2021, the Florida legislature considered Senate Bill 84, a pension reform bill that was a priority of Senate leadership. The reform bill aimed to stop the state government from accumulating future pension debt. The measure, which passed the State Senate, would not have fundamentally altered the conditions driving the rapid growth of FRS’ unfunded pension liabilities and ultimately the legislation failed to receive consideration in the House before the legislature adjourned.

If enacted, SB 84 would have completely closed the FRS Pension Plan to most future hires. This move would have built upon Senate Bill 7022, which was enacted in 2017 and switched the FRS enrollment default from the defined benefit (DB) plan to the primary defined contribution (DC) plan known as the FRS Investment Plan.

The Pension Integrity Project evaluated SB 84 during the 2021 session, identified the bill’s shortcomings, and proposed substantive areas of improvement. Our analysis found that closing the defined benefit option for new workers would produce some long-term risk reduction for taxpayers because the remaining defined contribution plan would have fixed costs and could not accumulate debt, but this positive impact would take decades to realize. That’s because closing the FRS Pension Plan to new employees alone would do nothing to address the system’s existing debt, which would continue to grow even if the FRS Pension Plan was closed. Thus, SB 84 was not a sufficient proposal to meet the state’s debt challenges and additional provisions would be needed to solve the problems that helped create the system’s $36 billion of debt. Senate Bill 84 also met serious opposition from special interest groups, primarily public education associations. Although the concerns levied by these groups were generally misdirected and sometimes ill-informed, including these groups in future reform efforts may help minimize future policy conflict.

With the failed 2021 attempt at retirement reform now in the rear-view mirror, Florida is still in need of a polciy solution to its public pension problems. Below we outline a few of the issues that still face both the FRS defined benefit pension plan and the FRS Investment Plan. Using actuarial modeling we present our long-term evaluation of SB 84’s proposed closure of the existing defined benefit plan for new workers, along with an alternative reform option that would better address the challenges facing stakeholders and the state of Florida. Under the Pension Integrity Project alternative reform option, future workers would still have the option to participate in a defined benefit plan and, with the introduction of improved risk and contribution policies, the alternative would reduce long-term costs and financial risk in ways that SB 84 would not have achieved.

Florida Retirement System’s Funding Challenges

The first pension-funding challenge that Florida policymakers need to face is the system’s unrealistic expectations for market returns. Over the last 13 years, $16.4 billion of Florida’s pension debt has come from failing to meet overly optimistic investment return assumptions.

Every year that FRS fails to meet its investment return assumption, public pension debt grows. Adopting more realistic investment return assumptions should be a top priority for state policymakers because this problem will likely continue to add debt to the system if it is not addressed.

FRS historically assumed an investment return rate as high as 8 percent before lowering the assumption to 7.75 percent in 2004. The system has adjusted the investment return assumption annually since 2014, to reach the current assumed rate of 7 percent for 2021.

Although progress has been made on this front, the system’s expectations are likely still too high for the long term. The FRS modeling that was developed in 2017 by Milliman and Aon Hewitt found that the 50th percentile geometric average annual long-term future returns would be in the 6.6 percent-to-6.8 percent range. Models developed in 2018 by Milliman and Aon Hewitt showed FRS should expect average annual long-term future returns in the 6.4-6.7 percent range, yet the FRS Actuarial Assumption Conference adopted a 7.4 percent return assumption. Presenters at the 2020 FRS Actuarial Conference suggested return assumptions within the range of 6.46 percent (Aon) to 6.56 percent (Milliman).

The Florida Retirement System’s average investment return for the last 20 years was 6.81 percent, well below the current 7 percent assumption (see Figure 2). The market forecasts for the next 10 to 15 years indicate that FRS is more likely to see returns around 6 percent. That means FRS is still likely to experience perpetually growing pension debt unless the system’s investment return assumptions are reduced even further.

Figure 2 – Florida Retirement System’s Investment Return History, 1996-2020

Source: Pension Integrity Project analysis of FRS actuarial valuation reports and CAFRs.

Florida’s policymakers also need to address the amortization policies of the state’s retirement system. Long debt-payment schedules have contributed to Florida’s inability to pull itself out of its pension debt over the past decade. It is expensive to hold large amounts of unfunded pension liabilities and the longer the state takes to pay off these pension debts, the more it will cost taxpayers in the long run. Florida policymakers need to address this challenge going forward by shortening amortization schedules for any newly accrued debt.

Furthermore, the existing defined contribution option, the FRS Investment Plan, which is offered to new hires, has major problems of its own that are worth tackling as part of any future retirement reform effort. The employer and employee contribution rates for the Investment Plan are low relative to typical private-sector standards, suggesting that many government employees could eventually retire without having sufficient post-retirement income.

Retirement professionals recommend contributing between 10 to 15 percent of an employee’s annual income toward the main retirement account for those participating in Social Security. FRS Investment Plan members, however, contribute just 3 percent of their salaries to their individual retirement accounts, with the state contributing another 3.3 percent. In total, about 6.3 percent of an employee’s pay is going into employees’ retirement accounts, far below even the low end of industry norms. 

Sadly, many workers in the defined contribution plan may be under the false impression that they are saving enough for retirement. If these issues are not addressed, many FRS Investment Plan members may find themselves with income replacement that is substantially below their needs or expectations when they retire.

Evaluating Retirement Reform Options

The Pension Integrity Project has incorporated the above reform elements into actuarial modeling to demonstrate the varied impacts of potential reforms. The analysis below displays the contribution and funding outcomes of three different options:

• Status Quo (baseline)—Represents the current state of FRS, no changes are made.

• Senate Bill 84 (as passed in Senate)—Closes the DB Pension Plan to all new hires except special risk members. Includes no other funding or risk-related policy changes.

• Alternative (a better option for future retirement reform efforts) — This option gives all new hires, regardless of class, the choice between a new, risk-managed, 50/50 cost-sharing FRS Pension Plan and a higher funded FRS Investment Plan. It gradually lowers the FRS assumed investment rate of return to 6 percent and adopts 15-year layered amortization for any new unfunded liabilities as risk-reduction measures for the legacy defined benefit plan.

Reason’s analysis of SB 84 during the legislative session indicated that simply closing the state’s defined benefit plan for new workers would do little to affect contributions into the fund over the next 30 years and therefore would not sustainably improve the state’s ability to fully fund FRS amid a volatile and unpredictable financial future.

By contrast, the alternative reform proposed in this analysis would gradually reduce the Florida Retirement System’s assumed rate of return and would reduce the amortization period used for paying down any new pension debt. These moves would noticeably alter the state’s contributions to the plan over the next three decades. As shown in Figure 3, if we assume a 7 percent constant rate of return over 30 years, the alternative will require higher employer contributions upfront to accelerate the elimination of unfunded liabilities. But in return, rates level out near or below the status quo and SB 84 over the mid-and long-term, a prudent tradeoff to eliminate risk.

Figure 3 – State Contributions for Reform Options if Experience Matches FRS Assumptions

Source: Pension Integrity Project actuarial forecast of FRS. The state is assumed to make 100 percent actuarially required contributions. Values are adjusted for inflation.

Assuming economic uncertainty in the decades ahead, the next figure models two recessions, in 2021 and 2036, and 6 percent constant returns in the remaining years. Figure 4 shows that the changes proposed in SB 84 would make little difference to year-to-year state contributions. Since these rates would be based on the same assumptions and amortization policies that generated the system’s current $36 billion in pension debt, SB 84 would not have prevented further debt from accruing if FRS’ assumptions prove inaccurate.

Figure 4 – Contributions for Reform Options in Volatile Market Scenario

Source: Pension Integrity Project actuarial forecast of FRS. The state is assumed to make 100percent actuarially required contributions. Values are adjusted for inflation.

Under the proposed alternative reform the state would agree to higher up-front contributions that would be more reflexive to market returns, as shown in Figures 3 and 4. This change would be the key to establishing a more resilient retirement system that could maintain a path to full funding even under market stress scenarios. Actuarial modeling of the system’s unfunded liabilities (see Figure 5) shows that outside of the idyllic and unrealistic status quo assumptions, FRS is still very vulnerable to the same pressures that caused the system’s $36 billion shortfall in the first place. The reforms proposed in SB 84 would have done nothing to rectify this issue.

Committing to more realistic return assumptions and accelerating amortization payments, however, would insulate the system from future market volatility. Adopting the reform options outlined in our proposed alternative would ensure that Florida is on a path to reducing unfunded liabilities, even while facing a volatile and unpredictable future.

Figure 5 – Florida Retirement System Funding Under Reform Options

Source: Pension Integrity Project actuarial forecast of FRS. The state is assumed to make 100 percent actuarially required contributions. Values are adjusted for inflation.

Table 1 shows that under the current 7 percent investment return rate assumption, SB 84 would have only marginal reduced the system’s debt and would have failed to generate the same cost savings as the alternative reform design under most market scenarios. Under stress-tested scenarios, SB 84 outperforms the status quo but fails to contain the overall debt, leaving taxpayers still exposed to major risk of continuing unfunded liabilities at the end of the 30-year forecast period.

Florida is facing the very real possibility of dedicating hundreds of billions of additional dollars toward FRS over the next 30 years. Apart from the unrealistic status quo investment return assumption, these extra funds would make practically no progress in reducing the state’s expensive pension debt. While requiring a commitment of higher annual contributions upfront, the alternative proposal would steer FRS away from this no-win situation.

Table 1 – Long Term Results of Different FRS Reform Options

Source: Pension Integrity Project actuarial forecast of FRS. The state is assumed to make 100 percent actuarially required contributions. Values are rounded and adjusted for inflation.

A Summary of Policy Suggestions

Florida policymakers are right to be concerned about the solvency of the state’s pension plan. However, simply closing the Florida Retirement System’s Pension Plan for future hires isn’t a complete solution. For Florida legislators seeking to implement meaningful pension reform next session, it is important that the state address the structural issues plaguing FRS in order to restore solvency and avoid making costly long-term mistakes. This means both tackling the still-growing debt of the defined benefit FRS Pension Plan and building a better-defined contribution FRS Investment Plan for current and future workers.

Next session, pension reform efforts should be centered upon the goals of all stakeholders. State policymakers can do this by considering the following:

• Reducing risk
  • Close the existing FRS pension to new hires and offer a new FRS defined benefit pension option for new workers with the same level of benefits as the current plan, but with features to reduce long-term governmental risks and costs (e.g., 50/50 employer/employee cost sharing and a conservative investment return assumption).
  • Gradually lower the assumed rate of return for the legacy plan to 6 percent.
  • Reduce the amortization period to 20 years or less for legacy debt and to 15 years for new debt.
• Improving the defined contribution plan rates.
  • Gradually increase both employer and employee contributions to the DC plan so contribbutions are above 10 percent of pay.

Conclusion

Florida’s policymakers, public workers, and taxpayers should seek to secure the Florida Retirement System so its ability to keep promises made to workers does not depend on everything going exactly as planned—a recipe that has not panned out over the last decade. The above analysis demonstrates the importance of testing any future potential reforms with an actuarial analysis that includes a variety of potential market outcomes, including those that fall below the plan’s expectations, a practice that is commonly known as stress testing.

There are various ways to achieve the legislative goals of eliminating or vastly reducing current and future public pension liabilities while improving the overall resilience of the Florida Retirement System. However, if Florida doesn’t address the rising debt within its defined benefit plan and continues to use insufficient contributions into the defined contribution plan, taxpayers will likely continue to be saddled with billions more in debt and the long-term retirement security of many public workers will be at risk.

The latest retirement reform effort fell short, both in the actual proposal and the ultimate legislative outcome. The good news is that state legislators do appear to be aware of the problem. Going forward, policymakers should try to foster a more collaborative process that involves as many stakeholders as possible, which will improve the chances of success in the end. To avoid perpetually growing public pension debt and costs, policymakers should also seek out a more comprehensive solution. Lastly, it is crucial to use actuarial analysis and stress testing to properly identify the changes that will effectively address all of the challenges FRS faces.

The post The Florida Retirement System Is Still in Need of Reform appeared first on Reason Foundation.

The three pension systems offered by the city of Hollywood, which provide benefits for firefighters, police officers, and general employees, are each approximately 58 percent funded. This means that for every dollar in retirement promises made to Hollywood’s employees, the city only has 58 cents in assets to pay for them.

By pulling more and more funds from the city’s budget each year, this pension debt could threaten other public priorities like road repairs, public safety, and other key government services. If Hollywood’s economic growth plateaus or another economic recession hits, there will likely not be enough money to both pay retirees and fund essential services. This would likely mean increased taxes, higher contribution rates for employees, or benefit cuts.

Funding for Hollywood’s pension plans has deteriorated sharply since the year 2000, when all three pension plans had more than 80 percent of the assets they needed to pay for future benefits. One reason for this is that the city’s pension plans use overly optimistic investment return assumptions. For example, the city’s fire and general pension plans assume annual investment returns of 7.5 percent, and the police plan assumes an 8 percent return on investments. The average assumed rate of return nationwide is only 7 percent. And a half of a percentage point difference can add hundreds of thousands more in debt each year.

Although Hollywood’s pension plans have had a few years with good investment returns recently, much of this growth has gone to current retirees rather than improving the position of the severely underfunded municipal pensions. As the Sun-Sentinel reported in 2019, Hollywood is one of only five Florida cities to offer pensioners a so-called “13th check” — an extra monthly pension payment when asset returns are strong.

In addition to Hollywood’s pension debt, the city makes no effort to save for retiree health care benefits. Instead of putting aside funds each year and letting the assets grow in the investment market, the city chooses to take the more expensive route and pay retirees out of pocket each year. As a result, the city’s balance sheet shows another $530 million in retiree health care benefit debt.

Relative to other Florida cities, Hollywood’s retiree health care benefits are quite expensive. The city offers retirees similar health benefits to those it provides active employees at an average monthly cost of over $1,200 per retiree. By contrast, nearby Fort Lauderdale only provides retirees insurance premium subsidies of between $100 and $400 per month and stopped offering this benefit to anyone hired after 2015. As a result, Fort Lauderdale’s other post-employment benefit (OPEB) liability is a fraction of Hollywood’s despite its larger population. The city of Weston does not subsidize retiree medical benefits at all, and thus has no OPEB liability.

Thus far, Hollywood’s outsized retirement obligations have not weighed heavily on its bond rating or ability to raise funds on the municipal bond market. But taxpayers’ continued ability to shoulder these large obligations is not guaranteed.

Ninety years ago, Hollywood was among the many South Florida governments that defaulted on municipal bond payments after expected growth failed to materialize. If a natural disaster such as a major hurricane or a sea-level rise stunts Hollywood’s growth, the city could once again struggle to service the billion-dollar debt.

To secure the retirement of its public servants and protect taxpayers, Hollywood’s policymakers need a better plan to fund the city’s pension plans and manage the costs of its health care plan.

A version of this column previously appeared in the South Florida Sun-Sentinel.

The post Hollywood, Florida’s Pension Debt Problem appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Analyzing Florida’s Proposed Pension Reform
• North Dakota Pension Reform Should Prioritize Paying Down Pension Debt
• Recreational Marijuana Revenues Could Help Pension Solvency in Montana
• What Factors Impact Pension Reform?
• Protecting Public Workers from Retirement Risks
• Alternative Assets and Pose Risks to Pension Systems

News in Brief
Quotable Quotes on Pension Reform
Contact the Pension Reform Help Desk

Articles, Research and Spotlights

Analysis of Florida’s Proposed Pension Reform

As Florida’s unfunded pension liabilities have grown to $36 billion, the debate over potential reforms to the Florida Retirement System (FRS) pension plan continues. Reason Foundation’s analysis finds that over the next eight years, FRS’ annual employer costs are estimated to rise by $2.3 billion, which is the same amount the state currently spends on highway and bridge construction each year. The pension reform currently under consideration in the state legislature would limit future accrual of pension debt by directing all new workers, except public safety workers, to the state’s existing defined contribution plan. Unfortunately, despite this proposed change, the legislation would leave FRS nearly as vulnerable to market stresses as it is now.

Testimony: Pension Reform in North Dakota Should Tackle Pension Debt, Funding Risks

In an effort to address the state’s growing public pension debt, the North Dakota legislature is considering reform to the North Dakota Public Employees Retirement System (NDPERS). As currently written, the legislation—Senate Bill 2046—would close the current defined benefit plan to most new workers, diverting them to the existing defined contribution plan. The reform would also include additional payments to cut down on the system’s growing debt. In testimony given to the House Government Affairs and Veterans Committee, and in a more detailed commentary, Reason’s Raheem Williams explains that while the reform would help the state by limiting financial risk and capping future liability accrual, more funding policy challenges would be needed to complete the job of putting NDPERS on a sustainable path.

Testimony: Using Marijuana Tax Revenue to Pay for Montana’s Unfunded Pension Liabilities

Earlier this month, the Montana legislature considered how revenues from the legalization of adult-use recreational marijuana could help fund the state’s retirement plans. Due to ongoing funding challenges, Montana’s two largest pension plans will likely not be able to rely on market returns to achieve full funding in the future. Reason’s Steven Gassenberger and Geoffrey Lawrence recently testified that tax revenues from legalized recreational marijuana sales could be appropriately directed as an ongoing payment for long-term pension liabilities.

What Factors Impact Public Pension Reform?

As state pension plan funding shortfalls and annual costs continue to grow, public pension reforms are becoming more common. While pension funding challenges are largely ubiquitous nationwide, some states have done more to address their public pension challenges than others. A new Reason Foundation policy brief by Grace College Professor Michael Bednarczuk, Ph.D., and Reason’s Jen Sidorova examines the factors that could encourage or stand in the way of pension reform across the states. The analysis finds that the variables with the largest positive effect on the likelihood of reform were passing a prior law or having nearby states pass reform. These findings reinforce the importance of continued, year-after-year efforts to fully address pension funding challenges.

Addressing the Retirement Risks Facing Today’s Public Workers

Pension Integrity Project senior fellows Rod Crane and Rich Hiller examine why many of the factors that affect an individual’s ability to have a financially secure retirement are not being considered by many state retirement plans. They emphasize the importance of accounting for all types of risk that both employers and members face in the design of public retirement plans. A clearer understanding of these risks could help policymakers build retirement options that better serve today’s employees, employers, and taxpayers.

Pension Plan Investments in Alternative Assets Can Pose Serious Risk to Taxpayers and Members

As returns from traditional investments in bonds and large-cap public equities have declined, public pension plans are increasingly moving towards greater allocations in “alternative assets,” such as private equity. These assets can potentially provide higher returns but also come with higher risk and volatility. Reason’s Steven Gassenberger warns about the growing use of private equity in pension fund investment, noting the high fees paid to many of these investment firms and the general lack of transparency involved in these types of investments.

News in Brief

Pension Contributions Continue to Grow

An update to NASRA’s annual brief on public pension contributions is now available with results through 2019. This analysis uses historic and current contributions from over 100 state and local pension plans around the country. They find that aggregate contributions in 2019 grew by 4.9 percent (from $116.6 billion to $121.9 billion) since the previous year. Annual contributions in the aggregate are still lagging behind actuarially determined rates, but plans have improved in this area over the past decade.

Do Smaller Public Employer Pensions Spur More Saving?

A new brief by the Center for Retirement Research argues that workers are unlikely to change their saving habits in response to lowered pension benefits. Laura Quinby and Geoffrey Sanzenbacher of the Center expand upon a recent study to investigate the relevance of a simple lifecycle model, which assumes that workers will respond to a one-dollar decrease in their pension benefit with a one-dollar increase in their supplemental saving. They find that the actual effect upon supplemental saving is small, potentially due to low levels of additional financial resources by workers.

Quotable Quotes on Pension Reform

“This is a financial problem that will not go away without legislative action…Now is the time to address ERS [Employees Retirement System] to illustrate that Texas can continue to be fiscally responsible with taxpayer funds by paying down existing debt to save on future interest payments.”

­—Texas State Sen. Joan Huffman, sponsor of Senate Bill 321, in an April 19 press release

“Had we paid our full pension (payment) every year between ’96 and this budget, the number I would have put up this year would have been $800 million. If you do the math, we are, in our [fiscal year 2022] budget, paying $5.6 billion, in one year’s budget, for the delinquency of the past 25 years.”

—New Jersey Gov. Phil Murphy quoted in “Murphy’s promise of full public-worker pension payment breaks 25 years of underfunding,” NJ Spotlight News, March 15, 2021

“Texas taxpayers will ultimately have to cover the fund’s liability. The failure to address this problem today means it will be even more expensive for taxpayers to fix in the future. Plus, unfunded pension funds can wreak havoc on the state’s bond rating, which increases the cost of borrowing and makes it more expensive to operate state government every day.”

—Richard Jankovsky, president of the Texas Department of Public Safety Officers Association, cited in “Texas’ public servants need a healthy retirement system,” Austin American-Statesman, April 3, 2021

“I think we need to look at…really incrementally decreasing that rate of return. What we end up doing are these large drops, which sort of cost a lot of money to do. We should really look at getting down and getting the pensions to 7 percent, or lower than that…From a dollar and cents standpoint, that big of a drop is very hard for the city to handle.”

—Mike Gormany, New Haven City budget director, cited in “City Plans $17.5M Pension Fix Start,” New Haven Independent, March 31, 2021

Contact the Pension Reform Help Desk

Reason Foundation’s Pension Reform Help Desk provides information on Reason’s work on pension reform and resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.

Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to zachary.christensen@reason.org.

The post Pension Reform Newsletter: Using Marijuana Revenue to Pay Pension Debt, Pension Reforms in Florida and North Dakota, and More appeared first on Reason Foundation.

Download the pdf here.

The post Florida Retirement Cost Increases Highlight the Need for Pension Reform appeared first on Reason Foundation.

The post Florida’s $36 Billion Problem appeared first on Reason Foundation.

The Florida Retirement System manages retirement benefits for almost 648,000 active members and over 584,000 retirees in the state and is comprised of a traditional pension plan and a defined contribution retirement plan option called the FRS Investment Plan.

Two decades ago the retirement system held a surplus of over $13 billion in assets and stood at 118 percent funded. Today, FRS finds itself $36 billion in debt with only 82 percent of the assets on hand needed to pay out benefits over the long-term, which represents a net change in position of almost $50 billion in just 20 years.

Investment returns falling short of the system’s expectations have been the largest contributor to the Florida Retirement System’s growing debt, adding $16.4 billion in unfunded liabilities since 2008.

The chart below shows the increase in the Florida Retirement System’s debt since the year 2000:

Despite pension reform efforts in 2011 and 2017, structural deficiencies within FRS continue to risk the retirement security of employees and retirees. The 2011 legislative effort reduced retirement benefits for employees and while such a change did lower some costs, it did not fundamentally address why pension debt continues to grow. Similarly, defaulting new FRS members into the Investment Plan in 2018 was a move that better aligned with workforce mobility trends and reduced future financial risks, but it did not address why the system’s pension debt has persisted for a decade.

Furthermore, the FRS Investment Plan is no closer to providing retirement security for Florida’s public retirees than the debt-riddled FRS Pension Plan, as it relies on contribution rates that fall far below industry standards for adequate retirement benefits. Industry experts estimate that 10 to 15 percent of annual income should be required as a contribution to a defined contribution retirement to provide adequate retirement income for public workers. FRS’s aggregate 6.3 percent contribution falls well short of this standard.

Bringing stakeholders together around a central, non-partisan understanding of the challenges the Florida Retirement System faces —complete with independent third-party actuarial analysis and expert technical assistance— is crucial to ensuring the state’s financial solvency in the long-term. The Pension Integrity Project at Reason Foundation stands ready to help guide Florida policymakers and stakeholders in addressing the shifting fiscal landscape.

Current Retirement Option Sets

FRS Pension Plan

• Type: Final Average Salary Defined Benefit Pension Plan
• Final Average Salary: Average of the 8 highest years
• Multiplier: 3%
• Vesting: 8 years
• Normal Retirement Eligibility: Any age @ 33 YOS or vested by age 65
• Regular Member Contribution:
  • 3.09% for Normal Cost
  • 4.30% for Unfunded Liability Payment (beginning FY2019-20)
• Employee Contribution: 3%

FRS Investment Plan

Default option as of January 1, 2018

• Type: Defined Contribution Retirement Plan
• Employee Contribution: 3%
• Employer Contribution:
  • 3.3% to member IP account
  • 3.56% to legacy FRS Pension Plan unfunded liabilities
• Vesting: 1 year
• Investment Options:
  • Investment Funds
  • Target Date Funds
• Default Investment Strategy: Target Date Funds

Reviewing Prior Reforms

Major Reforms to FRS

2000 – House Bill 2393

• Provided a defined, participant-directed contribution (DC) plan option to FRS members.
• One-year vesting for the portability of employer contributions.
• Based retirement benefits on market returns rather than a fixed benefit guarantee.
• Existing members given the option to switch future FRS participation into the DC plan without losing their already earned pension benefits.

2011 – Senate Bill 2100

• Created a new benefit tier for “special-risk” new hires.
• Renamed the FRS defined benefit plan the Florida Retirement System “Pension Plan.”
• Renamed the FRS defined contribution plan from the Public Employee Optional Retirement Program to the Florida Retirement System “Investment Plan.”
• Eliminated post-retirement increases on pension benefits earned after July 2011.
• Decreased both employer and employee contribution rates effective July 2012.
• Led to unfunded accrued liabilities decreasing from $16.7 billion to $15.6 billion.

2017 – Senate Bill 7022

• Defaults new employees hired after January 2018 into the FRS Investment Plan (DC plan) if no election taken after eight months of employment.

Previous Reforms Have Not Set the FRS on a Path to Sustainability

• The historic 10-year bull market has not helped FRS recover.
• The 2008 financial crisis weakened FRS’s funded status, but since then markets have recovered while pension funding has not.
• Reducing benefits in 2011 reduced some costs at the expense of inflation protection for retirees, but it did not fundamentally address why pension debt continues to grow.
• Defaulting new FRS members into the Investment Plan in 2018 was better aligned with workforce mobility trends and reduced future financial risk, but it did not address why pension debt has persisted for a decade.
• For three straight years (2016, 2017 & 2018) FRS’s consulting actuary has warned that the assumed rate of return is not reasonable.
• Additional reforms are necessary to ensure long-term solvency.

FRS Remains Unsustainable Despite Recent Reforms

Challenge #1:

FRS Defined Benefit Pension Plan Still Not on a Path to Solvency

• Overly optimistic assumed rate of return creates unnecessary risk.
• Unmet actuarial assumptions and slow-paced changes to those assumptions increases unfunded liabilities over time.
• Insufficient employer contributions inhibits plan assets from compounding growth over decades.
• Discount rate misaligned with risk, underpricing pension cost and undervaluing FRS unfunded liabilities.

Challenge #2:

FRS Defined Contribution Retirement Plan Not Built for Retirement Security.

• An inadequate contribution rate is shortchanging worker retirement security.

Challenge 1: FRS is Still Not on a Path to Long-Term Solvency

Driving Factors Behind FRS Pension Debt

• Changes to Actuarial Methods & Assumptions to better reflect current market and demographic trends have exposed over $16.6 billion in previously unrecognized unfunded liability.
• Deviations from Investment Return Assumptions have been the largest unintended contributor to the unfunded liability, adding $16.4 billion since 2008.
• Insufficient Contributions contributed $1.8 billion to FRS unfunded liability since 2008.
• Undervaluing Debt through discounting methods has led to the tacit undercalculation of required contributions.

Overly Optimistic Assumed Rate of Return

Unrealistic Expectations: Despite the recent change to 7.0%, the Assumed Investment Return for FRS continues to expose taxpayers to significant investment underperformance risk.

Underpricing Contributions: The use of an unrealistic Assumed Return has likely resulted in underpriced Normal Cost and an undercalculated Actuarially Determined Contribution.

FRS Actuaries on Current Return Assumption

• All models developed in 2017 by Milliman and Aon Hewitt had 50th percentile geometric average annual long-term future returns in the 6.6%-6.8% range.
• Models developed in 2018 by Milliman and Aon Hewitt show the average annual long-term future returns in the 6.4-6.7% range, yet FRS Actuarial Assumption Conference adopted a 7.4% return assumption.
• Presenters at the 2020 FRS Actuarial Conference suggested return assumptions within the range of 6.46% (Aon) to 6.56% (Milliman), with a lower inflation assumption of 2.1% to 2.2% relative to the previous conference assumption of 2.6%.
• The 2020 FRS Actuarial Assumption Conference adopted a 7.0% return assumption.

Investment Return History 1996-2020

Investment Returns vs. Assumptions

• FRS historically assumed an investment return rate as high as 8.00% before lowering the assumption to 7.75% in 2004. The plan has adjusted the assumption annually since in 2014, to reach the current 7.0% for 2021.
• FRS expanded investments in high-risk holdings in a search for greater investment returns over the past decade.
• The FRS Pension Plan investment portfolio’s trends have not matched longterm assumptions:

Note: Past performance is not the best measure of future performance, but it does help provide some context to the problem created by having an excessively high assumed rate of return.

FRS Funded Ratio Did Not Recover Despite a Historic Decade for the Stock Market

New Normal: The Market Has Changed

The “new normal” for institutional investing suggests that achieving even a 6% average rate of return in the future is optimistic.

1. Over the past two decades there has been a steady change in the nature of institutional investment returns. 30-year Treasury yields have fallen from near 8% in the 1990s to consistently less than 3%. New phenomenon: negative interest rates, designates a collapse in global bond yields. The U.S. just experienced the longest economic recovery in history, yet average growth rates in GDP and inflation are below expectations.
2. McKinsey & Co. forecast the returns on equities will be 20% to 50% lower over the next two decades compared to the previous three decades. Using their forecasts, the best-case scenario for a 70/30 portfolio of equities and bonds is likely to earn around 5% return.
3. The FRS Pension Plan 5-year average return is around 6.48%, well below the assumed 7% return assumption.

Expanding Risk in Search for Yield

Probability Analysis: Measuring the Likelihood of FRS Achieving Various Rates of Return

Probability Analysis: Measuring the Likelihood of FRS Achieving Various Rates of Return

FRS Assumptions & Experience

• A probability analysis of FRS historical returns over the past 20 years (2000-2020) indicates only a modest chance (28%) of hitting the plan’s 7.0% assumed return.
• FRS’s own investment return assumptions imply a 43% chance of achieving their investment return target over the next 20 years.

Short-Term Market Forecast

• Returns over the short to medium term can have significant negative effects on funding outcomes for mature pension plans with large negative cash flows like FRS.
• Analysis of capital market assumptions publicly reported by the leading financial firms (BlackRock, BNY Mellon, JPMorgan, and Research Affiliates) suggests that over a 10-15 year period, FRS returns are likely to fall short of their assumption.

Long-Term Market Forecast

• Longer-term projections typically assume FRS investment returns will revert back to historical averages.
  • The “reversion to mean” assumption should be viewed with caution given historical changes in interest rates and a variety of other market conditions that increase uncertainty over longer projection periods, relative to shorter ones.
• Forecasts showing long-term returns near 7.0% likely also show a significant chance that the actual long-term average return will fall far shorter than expected.
  • For example, according to the BlackRock’s 20-year forecast, while the probability of achieving an average return of 7.0% or higher is about 56%, the probability of earning a rate of return below 5.5% is about 26%.

Risk Assessment

How resilient is FRS to volatile market factors?

Important Funding Concepts

Statutory rates are more susceptible to the political risk inherent to the legislative process and often result in systemic underfunding, especially when legislatively established rates fall short of what plan actuaries calculate as necessary to ensure funding progress.

Employer Contribution Rates

• Statutory Contributions: Annual payments usually based on rates set in state statute, meaning contributions remain static until changed by legislation.
• Actuarially Determined Employer Contribution (ADEC): Unlike statutory contributions, ADEC is the annual required amount FRS’s consulting actuary has determined is needed to be contributed each year to avoid growth in pension debt and keep ERS solvent.

All-in Employer Cost

• The true cost of a pension is not only in the annual contributions, but also in whatever unfunded liabilities remain. The ”All-in Employer Cost” combines the total amount paid in employer contributions and adds what unfunded liabilities remain at the end of the forecasting window.

Baseline Rates

• The baseline describes FRS current assumptions using the plan’s existing contribution and funding policy and shows the status quo before the 2020 market shock.

Quick Note: With actuarial experiences of public pension plans varying from one year to the next, and potential rounding and methodological differences between actuaries, projected values shown onwards are not meant for budget planning purposes. For trend and policy discussions only.

Stress Testing FRS Using Crisis Simulations

Our risk assessment analysis shows that under likely market fluctuations, FRS funding could decline significantly more.

If you assume FRS will achieve an average six percent rate of investment return over the next 30 years plus experience one financial crisis in this time, analysis shows that the pension plans unfunded liability would spike to $80 billion before the year 2050.

This likely economic scenario would cost the state almost $120 billion more in pension contributions than what they currently plan to spend on the plan.

Seeing as FRS only averaged a 5.62 percent market valued investment return rate between 2000 – 2019, and that we have seen two major economic crisis in the last 20 years, it is reasonable to assume the next 30 years will look somewhat similar.

An additional $120 billion in pension costs would put significant strain on the state budget.

Stress on the Economy:

• Market watchers expect dwindling consumption and incomes to severely impact near-term tax collections – applying more pressure on state and local budgets.
• Revenue declines are likely to undermine employers’ ability to make full pension contributions, especially for those relying on more volatile tax sources (e.g., sales taxes) and those with low rainyday fund balances.
• Many experts expect continued market volatility, and the Federal Reserve is expected to keep interest rates near 0% for years and only increase rates in response to longer-term inflation trends.

Methodology:

• Adapting the Dodd-Frank stress testing methodology for banks and Moody’s Investors Service recession preparedness analysis, the following scenarios assume one year of -24.6% returns in 2020, followed by three years of 11% average returns.
• Recognizing expert consensus regarding a diminishing capital market outlook, the scenarios assume a long-term investment return of 6% once markets rebound.
• Given the increased exposure to volatile global markets and rising frequency of Black Swan economic events, we include a scenario incorporating a second Black Swan crisis event in 2035.

Outdated and Aggressive Actuarial Assumptions and Methods

• Deviations between actuarial experience and assumptions, and delays updating those assumptions, has led to an underestimation of the total FRS Pension Plan liability.
• Adjusting actuarial assumptions to reflect the changing demographics and new normal in investment markets exposes hidden pension cost by uncovering existing but unreported unfunded liabilities.
• If aggressive assumptions continue to misprice pension benefits, FRS experience will continue to deviate from the plan’s expectations and allow for the continued growth of unfunded liabilities.
• Generally, each assumption used by plan actuaries to calculate the cost of benefits over time come with the inherent risk of being wrong any given year resulting in unfunded liabilities.
• When an assumption is off, and assets actuaries were expecting from a given source are not contributed to make up the difference, the plan passively accrues unfunded.
• When an assumption is deliberately adjusted in a way that increases the probability of the expected outcome, cost hidden in the assumption are exposed, resulting in unfunded liabilities increasing in exchange for a more stable assumption and contribution rate.

Insufficient Contributions

Imprudent Funding Policy is Creating Structural Underfunding for FRS

1. From 2011-2013, FRS employer contributions failed to meet the actuarially determined contribution (ADC), increasing the Unfunded Actuarial Liability by $2.45 billion.
2. In 7 of the past 17 years, employer contributions have been less than the interest accrued on the pension debt (e.g., negative amortization), which allowed for the unfunded liability to grow in absolute terms.
3. The 30-year period FRS uses to pay off unfunded liabilities is greater than the Society of Actuaries’ recommended funding period of 15 to 20 years, resulting in higher overall costs for the plan. Due to the long 30-year closed amortization schedule used to pay off the annual unfunded liability employer pension contributions have not always kept up with the interest accrued on the pension debt.

Actual v. Required Contributions

Negative Amortization: Understanding the Current Funding Policy

• From 2011-2013, FRS employer contributions failed to meet the actuarially determined contribution (ADC), increasing the Unfunded Actuarial Liability by $2.45 billion.
• Starting in the 1998 actuarial valuation, the Legislature required all UAL bases in existence to be considered fully amortized, since the plan was in a surplus position.
• As part of the funding policy selected by the Florida Legislature, the actuarially calculated contribution rate is based on a “layered” approach that includes closed 30-year charge and credit bases for the amortization of any accrued UAL.
• The Unfunded Actuarial Liability (UAL) is amortized as a level percentage of projected payroll on which UAL rates are charged in an effort to maintain level contribution rates as a percentage of payroll during the specified amortization period if future experience follows assumptions.

Negative Amortization Growth (2009-2020)

Discount Rate & Undervaluing Debt

The “discount rate” for a public pension plan should reflect the risk inherent in the pension plan’s liabilities:

• Most public sector pension plans — including FRS — use the assumed rate of return and discount rate interchangeably, even though each serve a different purpose.
• The Assumed Rate of Return (ARR) adopted by FRS estimates what the plan will return on average in the long run and is used to calculate contributions needed each year to fund the plans.
• The Discount Rate (DR), on the other hand, is used to determine the net present value of all the already promised pension benefits and supposed to reflect the risk of the plan sponsor not being able to pay the promised pensions.

Setting a discount rate too high will lead to undervaluing the amount of pension benefits actually promised.

• If a pension plan is choosing to target a high rate of return with its portfolio of assets, and that high assumed return is then used to calculate/discount the value of existing promised benefits, the result will likely be that the actuarially recognized amount of accrued liabilities is undervalued.
• Milliman, argues the discount rate for calculating the total pension liability should be equal to the return assumption.

It is reasonable to conclude that there is almost no risk that Florida would pay out less than 100% of promised retirement income benefits to members and retirees.

• State law requires protection of pension benefit payouts. Florida State Statutes § 121.011- 121.40; 121.4501-121.5912 & Florida Administrative Code 60S-4

The discount rate used to account for this minimal risk should be appropriately low.

• The higher the discount rate used by a pension plan, the higher the implied assumption of risk for the pension obligations.

Sensitivity Analysis: Pension Debt Comparison Under Alternative Discount Rates

Change in the Risk-Free Rate Compared to FRS Discount Rate (2001-2020)

Challenge 2: FRS Defined Contribution Plan is Not Built for Security

FRS Defined Contribution Plan Overview

The FRS defined contribution retirement plan—the FRS Investment Plan—is the state’s current default (as of 2018).

• Members are vested after one year of service in the FRS Investment Plan.

Employees may choose to receive their account balance at the end of employment as a lump sum or take periodic withdrawals either on-demand or by a pre-determined payout schedule.

The FRS Investment Plan has shown consistent growth since its introduction in 2002.

•  FRS Defined Contribution Plan members currently account for nearly 23% of total FRS membership and 26% of total FRS payroll.

The Legislature can increase or decrease the amount employers and employees contribute to plan members’ accounts.

FRS Investment Plan Funding

Current FRS Investment Plan contribution breakdown:

Best practice says employers should continue making payments towards their legacy pension debt as if all new hires were still entering the Pension Plan.

Inadequate Contribution Rates are Jeopardizing Retirement Security

• The aggregate 6.3% FRS Investment Plan contribution rate falls far below industry standards for retirement benefit adequacy.
• Industry leaders, retirement experts and independent studies consistently estimate 10% to 15% of annual income to be required to provide adequate retirement income.
• For regular plan members alone contribution rates need to rise at least 400 basis points to provide retirement security.
• Higher contribution rates may be required for older workers to achieve adequate savings for retirement due to chronic underfunding.

FRS Investment Plan – Gold Standard Score

A Framework for Policy Reform

• Keeping Promises: Ensure the ability to pay 100% of the benefits earned and accrued by active workers and retirees
• Retirement Security: Provide retirement security for all current and future employees
• Predictability: Stabilize contribution rates for the long-term
• Risk Reduction: Reduce pension system exposure to financial risk and market volatility
• Affordability: Reduce long-term costs for employers/taxpayers and employees
• Attractive Benefits: Ensure the ability to recruit 21st Century employees
• Good Governance: Adopt best practices for board organization, investment management, and financial reporting

Defined Contribution Reform Best Practices

1. Adopt Better Risk Assessment and Actuarial Assumptions

• Lower the assumed rate of return to align with independent actuarial recommendations.
• These changes should aim at minimizing risk and contribution rate volatility for employers and employees.

2. Establish A Plan To Pay Off The Unfunded Liability As Quickly As Possible

• The Society of Actuaries Blue Ribbon Panel recommends amortization schedules be no longer than 15 to 20 years.
• Reducing the amortization schedule would save the state billions in interest payments.

3. Review Current Plan Options To Improve Retirement Security

• Consider offering additional retirement options that create a pathway to lifetime income for employees that do not stay in public service.

4. Adopt Better Funding Policy

• Financial experts strongly recommend contributions 10 to 15 percent of pre-tax earnings into a retirement account.
• Older workers with a closer retirement horizon and inadequate savings may need to contribute even more.

5. Encourage Use of Target Date Funds

• Well-designed DC plans should also offer the correct age-appropriate investment mix. This is generally accomplished by using target date funds that adjust investment risk to the employee’s retirement horizon to protect the value of the account from market fluctuations as the worker nears retirement.

6. Encourage Use of Annuities for Improved Retirement Security

• The mix of proprietary investment funds and reasonably priced target-date funds give participants adequate “one-choice” options. However, without guaranteed investments included in the target-date portfolio constructions and deferred annuities the FRS Investment Plan will continue to limit a members’ financial flexibility.
• Despite a lifetime annuity option being available to members, generally the distribution choices offered by the FRS Investment Plan limit its attractiveness as a true, core retirement option.

Full Florida Retirement System Pension Solvency Analysis 

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