Funding Public Pensions Tax Economist Forum, January 13, 2010

1. Funding Public PensionsTax Economist Forum, January 13, 2010 by Jon Forman Professor in Residence IRS Office of Chief Counsel & Alfred P. Murrah Professor of Law University of Oklahoma Norman, Oklahoma

2. Overview • Operation and funding of public plans • Financial, accounting, and legal issues • How to ensure adequate funding now and in the future

3. Overview of Public Plans • State and local governments typically provide their employees with • a traditional defined benefit pension plan • A supplemental defined contribution plan • Employer and employee contributions

4. Funding Public Plans • Plan actuary • Makes assumptions • Estimates the plan’s future liabilities to its retirees • Discounts those liabilities to present value • And compares that liability value to the actuarial value of the plan’s assets

5. Table 1. Actuarial Valuationfor OPERS, June 30, 2008

6. Table 1. Actuarial Valuation for OPERS, 2008, cont.

7. Funded Ratio & Assumptions • Funded Ratio – 73% • Key Assumptions • Investment return rate – 7.5%/year • Inflation rate – 3.0%/year • Wage growth – 4.25%/year • Cost-of living increase – 2%/year

8. Table 1. Actuarial Valuation for OPERS, 2008, cont.

9. Method & Contribution Rate • Entry-age normal actuarial cost method • Contribution Rates as a % of Payroll • Normal cost – 12.46% • Amortization of UAAL –10.13% • Actuarial Required Contribution (ARC) –22.98% • Contribution shortfall – 4.44%

10. Table 2. Asset Class Assumptions

11. Table 3. Asset Allocation of the OPERS, June 30, 2008

12. Figure 1. Average Asset Allocation for State Pensions

13. Table 4. Asset Allocation for 125 State Pension Plans (%)

14. Table 5. Contributions Needed to Fully Fund Pensions, 2006

15. Financial Pressures on Public Plans • Fiscal pressures on state and local governments • Demographic pressures • Pension envy

16. Standard & Poor’s, Ratings Direct: Market Declines Will Shake Up U.S. State Pension Fund Stability (February 26, 2009), at 3.

17. National Association of State Retirement Administrators & National Council on Teacher Retirement, Market Declines and Public Pensions (NASRA/NCTR Issue Brief, December 2008), at 3.

18. Table 6. Life Expectancy for Men and Women, 1940–2060

20. Table 7. Percentage of Workers Electing SS Retirement Benefits

22. Table 8. Public and Private Sector Compensation, 2008

23. Table 9. Public and Private Sector Retirement Benefits

24. Accounting for Public Pensions • Government Accounting Standards Board (GASB) • 80 percent funding target • Actuarial versus market valuation of assets and liabilities

25. Public Plans Are in a Hole • Stop digging • Stop promising benefits w/o funding • Climb out • Make Actuarial Required Contributions • Improve governance • Avoid future holes • Restructure Public Pensions • At least for new workers

26. About the Author • Jonathan Barry Forman (“Jon”) is • the Professor in Residence at the Internal Revenue Service Office of Chief Counsel, Washington, DC, for the 2009-2010 academic year; • the Alfred P. Murrah Professor of Law at the University of Oklahoma College of Law, teaching tax and pension law; and • the author of Making America Work (Washington, DC: Urban Institute Press, 2006). • Prior to entering academia, Professor Forman served in all three branches of the federal government. He has a law degree from the University of Michigan and master’s degrees in both economics and psychology. • Jon can be reached at jforman@ou.edu, 405-325-4779, www.law.ou.edu/faculty/forman.shtml 26