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The Colorado Office of the State Auditor‐Colorado PERA Hybrid Defined Benefit Plan
A Comprehensive Study Comparing the Cost and Effectiveness to Alternative Plan Designs Authorized by Senate Bill 14‐214
Today’s Agenda
Climate Leading to the Study Purpose of the Study Establishing the Baseline‐Measuring Colorado PERA Comparing to Alternatives‐Public and Private Sector Comparisons Key findings‐State Division
Alternative # 1 Side‐by‐Side DB and DC plans Alternative #2 Cash Balance Plan Alternative #3 Defined Contribution Only Alternative #4 Private Sector Social Security and DB Alternative #5 Private Sector Social Security and DC
Summary of Alternative Comparisons Lower Returns in the Defined Contribution Plan Peer Group Comparisons Impacts and Costs What I Learned Along the Way… Summary2
Climate Leading to the Study
Legislators asking “why don’t we model PERA after the private sector?” Less interest in plans with an explicit unfunded accrued liability Greater interest in Defined Contribution plans as a primary vehicle
A desire to see whether there is something better out there
A desire to have science based work to support statements
A desire to provide legislators with “budget displacement “ numbers as well as more explicit policy statements to aid in their review
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Purpose of the Study
Statutory purpose: To compare the cost and effectiveness of PERA to other public and private sector plans
To compare the benefits, costs and portability of benefits with alternative plan designs
Highlight transition, disruption and costs
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Establishing the Baseline‐Measuring Colorado PERA
First, a representative group of members was selectedVarying entry ages, service yearsThis was done so that the retirement policy as well as portability could be assessed at many different points in a member’s career
Note: the entire study of the benefits portion will examine future benefits, so we only look at the benefits for new hiresLater, when there are comparisons to other plans, the latest tier of those plans will be used
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Establishing the Baseline‐Measuring Colorado PERA
Next, use replacement ratios (replacement ratios are used to normalize benefits all to one single age)
Examine the targets from all sources for retirement incomeThe target RR should be 77% to 85% of pre‐retirement income in order to maintain the same standard of living
Many sources make up retirement income
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Establishing the Baseline‐Measuring Colorado PERA
PERA, a non Social Security State, replaces 72.2% for a 30 year career terminating at age 65; replaces 60.2% for a 25 year career terminating at age 65
This leaves some replacement income from other sources
Partial career members have partial income replaced
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Establishing the Baseline‐Measuring Colorado PERA
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72.2%
60.2%
72.2%
60.2%
75.0%
62.5%
0%
25%
50%
75%
100%
Hire age 35, Terminated age 65 Hire age 40, Terminated age 65
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PERA Replacement Ratios for Age 65 RetirementPercent of Pre-Retirement Salary at Age 65
State and Local Government Schools/DPS Judges
Establishing the Baseline‐Measuring Colorado PERA
Portability and value retentionMembers who terminate early are able to leave their money in PERA and can receive a 100% match at retirement age
• Note: portability became an issue back in the 80’s because members wanted their retirement benefits to retain value instead of being frozen; hence they wanted to be able to withdraw their funds and invest
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Comparing to Alternatives‐Public and Private Sector Plans
The study looked at three public sector alternative plans and two private sector plans (private sector includes Social Security)
Legislators have heard “why doesn’t Colorado follow the private sector”?The private sector model is Social Security (a defined benefit plan with member and employer contributions each at 6.2% of pay) plus either a defined benefit or a 401(k) plan
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Comparing to Alternatives‐Targeting Retirement Age 65
The study looked at age 65 as the retirement age‐this allows for the optimal comparison for the private sectorOther ages and replacement ratios are shown for illustrative purposes
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Comparing Alternative PlansCash Balance‐Same Retirement Benefits
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Comparison of Cash Balance Plan with PERA Hybrid Defined Benefit Plan
Targeted Benefit ApproachState Division
PERA Hybrid Defined Benefit Plan
Cash Balance Plan1
Employer Contribution2 0.82% 8.08%
Member Contribution2 8.00% 8.00%
Relative Cost (to replace the same age‐65 benefits as under the PERA Hybrid Defined Benefit Plan)
100% 179%
REPLACEMENT RATIOS
Age atHire Age at Termination Years of Service
Benefit Commencement Age
35 65 30 65 72.2% 72.2%
35 62 27 62 62.5% 59.1%
35 60 25 60 49.7% 51.7%
40 60 20 65 39.6% 48.8%
25 45 20 65 20.6% 47.0%
40 50 10 65 13.0% 24.9%
40 43 3 65 4.4% 7.5%
Source: Gabriel, Roeder, Smith & Company1 Features of the Alternative Plan: Cash Balance Plan structure with a member contribution of 8%, an employer contribution of 8.08%, interest crediting to the member’s
account of 5%, and actual fund earnings of 7.5%. At retirement the account balance converts based on 5.5% and the valuation mortality table.2 Contribution amounts are calculated as a percentage of employee salary.
Comparing Alternative Plans‐Cash Balance Plan‐Same Contributions
Comparison of Cash Balance Plan with PERA Hybrid Defined Benefit PlanTargeted Contribution Approach
State DivisionPERA Hybrid Defined
Benefit PlanCash Balance Plan1
Employer Contribution2 0.82% 0.82%
Member Contribution2 8.00% 8.00%
Relative Cost (set equal) 100% 100%
REPLACEMENT RATIOS
Age atHire
Age at Termination
Years of Service
Benefit Commencement Age
35 65 30 65 72.2% 26.3%
35 62 27 62 62.5% 21.6%
35 60 25 60 49.7% 18.8%
40 60 20 65 39.6% 17.8%
25 45 20 65 20.6% 17.1%
40 50 10 65 13.0% 9.1%
40 43 3 65 4.4% 2.7%
Source: Gabriel, Roeder, Smith & Company1 Features of the Alternative Plan: Cash Balance Plan structure with a member contribution of 8%, an employer contribution of 0.82%, interest crediting to the member’s account of 5%, and actual fund earnings of 7.5%. At retirement the account balance converts based on 5.5% and the valuation mortality table.
2 Contribution amounts are calculated as a percentage of employee salary.
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Key Findings‐State Division
When costs are held constant (defined as the normal costs for new hires), Colorado PERA provides the highest retirement benefits when compared to all the alternative plans
Similarly, when benefits are held constant, costs increase under all the alternative plansPERA’s normal cost for new hires is 8.82%
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Alternative Plan #1 Defined Benefit and Defined Contribution Side‐by‐Side
DB (employer provided) multiplier 1.50%; DC plan (member provided) contribution 9.03%
To provide the same benefits as the current PERA plan for new hires, the costs would need to be increased 60%
If keeping costs the same, the benefits would be reduced from 72.2% of replacement income to 54.4% of replacement income At age 65, for a 30 year career employee
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Alternative Plan #2 Cash Balance Plan
Member contribution of 8%, interest at 5%, actual fund earnings at 7.5%, at retirement the annuity conversion is at 5.5%
To provide the same benefits as the current PERA plan for new hires, the costs would need to be increased 79%
If keeping costs the same, the benefits would be reduced from 72.2% of replacement income to 26.3% of replacement income At age 65, for a 30 year career employee
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Alternative Plan #3 Self Directed Defined Contribution Plan
Assumed interest earnings of 5.5% To provide the same benefits as the current PERA plan for new hires, the costs would need to be increased 142%
If keeping costs the same, the benefits would be reduced from 72.2% of replacement income to 28.3% of replacement income At age 65, for a 30 year career employee
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Alternative Plan #4 “Private Sector” Defined Benefit and Social Security
DB (employer provided) multiplier 1.15%; Social Security of 6.2% for member and employer
To provide the same benefits as the current PERA plan for new hires, the costs would need to be increased 83%
Cannot keep costs the same! (Because Social Security costs more for new hires than the current PERA plan).With minimized costs, the benefits would be reduced from 72.2% of replacement income to 39.0% of replacement income and costs would still need to increase 39% At age 65, for a 30 year career employee The benefit is Social Security only
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Alternative Plan #5 “Private Sector” Defined Contribution and Social Security
DC earnings assumed at 5.5% per year; Social Security contributions of 6.2% for member and employer
To provide the same benefits as the current PERA plan for new hires, the costs would need to be increased 150%
Cannot keep costs the same! (Because Social Security costs more for new hires than the current PERA plan).With minimized costs, the benefits would be reduced from 72.2% of replacement income to 39.0% of replacement income and costs would still need to increase 39% At age 65, for a 30 year career employee The benefit is Social Security only
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Summary of Alternative Comparisons
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Summary of Alternative Comparisons
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Lower Returns in the Defined Contribution Plan
Assumed 2% less than the expected return in the defined benefit plan
There is no single consensus on the differential
Key issues for creating the difference are: Defined benefit plans hire professional consultants Defined benefit plans are able to spread fees over a larger base Defined benefit plans have access to a greater variety of investment vehicles
Investment fee structure is more expensive for the individual investor “Individual investor effects” related to the skill level of the member, as well as the fees and lack of access to alternative investments
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Peer Group Comparison
Showed that PERA is neither too generous nor too low in benefits when compared to other similarly situation public sector employers
PERA’s funded ratios are lowest within the peer group and are low for the entire peer group
Member contribution rates were low compared to the peer group
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Peer Group ComparisonPeer Group of Non Social Security States
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72.2%
57.8%63.5%
72.2% 72.2% 72.2%
0%
25%
50%
75%
100%
Colorado PERA Maine State andTeachers
Ohio PERS Louisiana SERS MassachusettsSERS
Nevada RegularEmployees
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Statewide Systems (Excluding Teachers)Replacement Ratios
Non Social Security Statewide SystemsPercent of Pre-Retirement Pay at Age 65 and 30 Years of Service
Peer Group ComparisonPeer Group of Non Social Security Teacher Systems
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72.2%
57.8% 62.6% 63.5% 63.5% 66.4% 69.3% 72.2% 72.2% 72.2% 72.2%
0%
25%
50%
75%
100%
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Teacher SystemsReplacement Ratios
Non Social Security Statewide SystemsPercent of Pre-Retirement Pay at Age 65 and 30 Years of Service
Peer Group ComparisonPeer Group of Non Social Security States
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8% 8% 8% 8% 10% 8% 9%13%
18% 17%14%
23%14%
31%
11%
13%
58%
73% 73%
83% 82%
59%
70% 72%
0%
20%
40%
60%
80%
100%
0%
10%
20%
30%
40%
50%
Funded Ratio
Con
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% of
Pay
Statewide Systems (Excluding Teachers)Employer and Employee Contribution Rates versus Funded Ratios
For Colorado includes AED and SAED and shows Funded Ratio by DivisonCompared to State-Wide Retirement Systems not in Social Security
Employee Contribution Rate Employer Contribution Rate (including medical) Funded Ratio
Peer Group ComparisonPeer Group of Non Social Security Teacher Systems
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8% 8% 6%9% 11% 9%
6% 9%12%
8%11%
15%
18% 18% 24%
29%
14%
34%
7%
11%
24%27%
16%15%
60%
81%
59%
52%
74%
41%
80%
67%
54%57% 56%
83%
0%
20%
40%
60%
80%
100%
0%
10%
20%
30%
40%
50%
Funded Ratio
Con
trib
utio
n as
% of
Pay
Teachers SystemsEmployer and Employee Contribution Rates versus Funded Ratios
For Colorado includes AED and SAED and shows Funded Ratio by DivisonCompared to State-Wide Retirement Systems not in Social Security
Employee Contribution Rate Employer Contribution Rate Funded Ratio
Peer Group Comparison
Private sector plans provide greater lump sum benefits to early terminating employeesThere is no requirement that members participate in the 401(k) plan
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Impacts and Costs
The issue of the unfunded accrued liability is handled separately from the issue of the benefits for new hiresThe UAL is a debt which cannot be eliminated through structural change
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Impacts and Costs
Actuarial recommendations are to accelerate funding if a plan is closed to new entrants Since a point in time is coming where there will be no more actives (contributing employees) in the plan
There is dialogue in the industry that the actuarial standards need not be followed
• Also, there is a good chance that if the system could afford the accelerated payments then they may not be discussing plan structural changes
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Impacts and Costs
Using the cash balance plan as an exampleWith acceleration of the payment of the UAL (so it is paid off in time for the last person to retire) the first year additional cost is nearly $800 million
With no acceleration the first year additional cost is $22 million
• The additional cost of $22 million reflects the fact that the same benefits are being provided, but through a less efficient benefit structure
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Impacts and Costs
Closing the plan may alter the risk profile and also the rate of return
If Colorado were to transition to a cash balance plan for new hires and accelerate the payment on the UAL the additional costs over the 40 year period is $8.85 billion
To transition without accelerating the payment the additional costs over the 40 year period is $16 billion
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Impacts and Costs
Due to acceleration of the payoff of the unfunded accrued liability
The higher cost of the new planThe changing risk profile and investment earnings of the trust
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Impacts and Costs
To say that costs do not need to be accelerated may be true, but that can add up to greater costs over the 40 year period
Need to examine costs over a longer period of time
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What I Learned Along the Way…
Relate any discussion of change to the retirement benefits and related policyLegislators will want to know that a DC plan is less expensive because benefits are lower
A DC plan that provides the same benefits is more expensive (less efficient)
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What I Learned Along the Way…
Eliminating the UAL (e.g., DB to DC plan) does not mean it does not existThe UAL is hidden from viewIt will become known when the member is close to retirement
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What I Learned Along the Way…
The implicit policy of a DB plan is:Non‐decreasing lifetime annuity
The implicit policy of a DC plan is:No lifetime guaranteeFlexibility in the payment stream
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What I Learned Along the Way…
DC plans have a place in the retirement pictureWhen the member needs flexible income
• Early retirement, cost‐of‐living adjustments, additional expenses beyond what the fixed annuity (i.e., Social Security, defined benefit plan) provides
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Summary
The study of cost and effectiveness is measured against the retirement policy of PERA
The study aligned the use of funds against the retirement policy in order to measure efficiency and the efficient use of taxpayer dollars
Thus, benefits and/or costs that did not contribute directly to retirement benefits made the plan “less efficient”
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Disclaimers
This presentation shall not be construed to provide tax advice, legal advice or investment advice
Readers are cautioned to examine original source materials and to consult with subject matter experts before making decisions related to the subject matter of this presentation
This presentation expresses the views of the author and does not necessarily express the views of Gabriel, Roeder, Smith & Company
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Questions
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