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1

2 COMMONWEALTH OF PENNSYLVANIA HOUSE OF REPRESENTATIVES 3 APPROPRIATIONS COMMITTEE

4 MAIN CAPITOL 5 ROOM 140 HARRISBURG, PENNSYLVANIA 6

7 BUDGET HEARING PUBLIC SCHOOL EMPLOYEES' RETIREMENT SYSTEM 8 AND STATE EMPLOYEES' RETIREMENT SYSTEM 9

10 MONDAY, MARCH 7, 2016 10:01 A.M. 11

12 BEFORE:

13 HONORABLE WILLIAM F ADOLPH, JR., Majority Chairman 14 HONORABLE KAREN BOBACK HONORABLE JIM CHRISTIANA 15 HONORABLE GARY DAY HONORABLE GEORGE DUNBAR 16 HONORABLE GARTH EVERETT HONORABLE KEITH GREINER 17 HONORABLE SETH GROVE HONORABLE SUE HELM 18 HONORABLE WARREN KAMPF HONORABLE FRED KELLER 19 HONORABLE TOM KILLION HONORABLE JIM MARSHALL 20 HONORABLE KURT MASSER HONORABLE DAVID MILLARD 21 HONORABLE DUANE MILNE HONORABLE MARK MUSTIO 22 HONORABLE MIKE PEIFER HONORABLE JEFFREY PYLE 23 HONORABLE CURT SONNEY HONORABLE MIKE VEREK 24 HONORABLE JOSEPH MARKOSEK, Minority Chairman HONORABLE LESLIE ACOSTA 25 HONORABLE MATTHEW BRADFORD 2

1 BEFORE: (cont'd'

2 HONORABLE TIM BRIGGS HONORABLE DONNA BULLOCK 3 HONORABLE MARY JO DALEY HONORABLE MADELEINE DEAN 4 HONORABLE STEPHEN KINSEY HONORABLE MICHAEL O'BRIEN 5 HONORABLE MAKR ROZZI HONORABLE KEVIN SCHREIBER 6 HONORABLE PETER SCHWEYER

7 ALSO PRESENT:

8 HONORABLE CRIS DUSH HONORABLE MATT GABLER 9 HONORABLE MARK GILLEN HONORABLE ROBERT GODSHALL 10 HONORABLE ADAM HARRIS HONORABLE KRISTIN PHILLIPS HILL 11 HONORABLE DARYL METCALFE HONORABLE SCOTT PETRI 12 HONORABLE TINA PICKETT HONORABLE RICK SACCONE 13 HONORABLE STAN SAYLOR HONORABLE DOM COSTA 14 HONORABLE JARET GIBBONS HONORABLE MARK LONGIETTI 15 HONORABLE EDDIE PASHINSKI

16 DAVID DONLEY, MAJORITY EXECUTIVE DIRECTOR 17 RITCHIE LAFAVER, MAJORITY DEPUTY EXECUTIVE DIRECTOR CURT SCHRODER, MAJORITY CHIEF COUNSEL 18 MIRIAM FOX, MINORITY EXECUTIVE DIRECTOR TARA TREES, MINORITY CHIEF COUNSEL 19

20 BRENDA J. PARDUN, RPR P. O. BOX 278 21 MAYTOWN, PA 17550 717-426-1596 PHONE 22

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25 3

1 INDEX

2 NAME PAGE

3 MELVA VOGLER 9 CHAIRPERSON OF THE BOARD 4 PSERS

5 GLEN GRELL 11 EXECUTIVE DIRECTOR 6 PSERS

7 JAMES GROSSMAN 47 CHIEF INVESTMENT OFFICER 8 PSERS

9 DAVID FILLMAN 11 CHAIRMAN OF THE BOARD 10 SERS

11 DAVID DURBIN 13 EXECUTIVE DIRECTOR 12 SERS

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14

15

16

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18

19

20

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25 4 1 P R O C E E D I N G S

2 MAJORITY CHAIRMAN ADOLPH: Good

3 morning, everyone. I’d like to reconvene the

4 House Appropriations Committee for the

5 2016-’17 budget hearing.

6 Before we get started with the

7 testimony, we’d just go over a couple

8 housekeeping things. We have a full room

9 here. And I want to remind everyone that this

10 hearing is televised, and that if you just

11 take a second and check your cell phones and

12 your iPhones and iPads and all the electronic

13 equipment that you may carry on you and kind

14 of turn it off. Okay? Because it does

15 interfere with the testimony and the telecast.

16 Thank you.

17 We always have an opportunity to

18 introduce the Appropriations members in the

19 beginning of the day to give the testifiers an

20 idea of how large this committee is and also

21 give you an idea of all the areas that members

22 of this committee reside.

23 So, I’m going to start off. My

24 name’s Bill Adolph. I’m the Republican chair

25 of the Appropriations Committee. I’m from 5 1 Delaware County, 165th Legislative District.

2 MINORITY CHAIRMAN MARKOSEK: Good

3 morning. I’m state Representative Joe

4 Markosek, 25th Legislative District. I’m the

5 Democratic chairman of House Appropriations

6 Committee. My district, I represent an area

7 that is the eastern suburbs of the Allegheny

8 County.

9 MS. FOX: Hi. I’m Miriam Fox. I’m

10 the executive director for the Appropriations

11 Committee, Democrats.

12 REPRESENTATIVE SCHREIBER: Good

13 morning, everyone. Over here to your left.

14 Kevin Schreiber, state representative, 95th

15 District, York County.

16 REPRESENTATIVE DEAN: Good morning

17 and welcome. I’m Madeleine Dean, from the

18 133rd, Montgomery County.

19 REPRESENTATIVE DALEY: Good morning.

20 Mary Jo Daley, 148th, in Montgomery County.

21 REPRESENTATIVE BOBACK: Good morning.

22 Representative Karen Boback, House District

23 117, Luzerne, Lackawanna, and Wyoming

24 counties.

25 I see some additional members just 6 1 stepped in, so we’ll put the mic over to them.

2 REPRESENTATIVE BRIGGS: Good morning.

3 Tim Briggs, Montgomery County, 149th District.

4 REPRESENTATIVE SCHWEYER: Good

5 morning. Peter Schweyer, Lehigh County, 22nd

6 District.

7 REPRESENTATIVE HELM: Good morning.

8 Sue Helm, 104th District, Dauphin and Lebanon

9 counties.

10 MR. DONLEY: Dave Donley, Republican

11 staff executive director for the committee.

12 MR. SCHRODER: Curt Schroder, chief

13 counsel, Republicans.

14 REPRESENTATIVE METCALFE: Daryl

15 Metcalfe, House State Government Committee,

16 Butler County, 12th District.

17 REPRESENTATIVE MILNE: Good morning.

18 Duane Milne, from Chester County.

19 REPRESENTATIVE MASSER: Good morning.

20 Curt Masser, 107th District, Northumberland,

21 Columbia, and Montour counties.

22 REPRESENTATIVE KILLION: Good

23 morning. Tom Killion, Delaware County.

24 REPRESENTATIVE MARSHALL: Good

25 morning. Jim Marshall, 14th District, parts 7 1 of Beaver, parts of Butler County.

2 REPRESENTATIVE MUSTIO: Good morning.

3 Mark Mustio, 44th District, Allegheny County.

4 REPRESENTATIVE MILLARD: Good

5 morning. David Millard, 109th District,

6 Columbia County.

7 REPRESENTATIVE PEIFER: Good morning.

8 Mike Peifer, 139th, which includes Pike and

9 Wayne counties.

10 REPRESENTATIVE DUNBAR: Good morning.

11 George Dunbar, Westmoreland County, 56th

12 District.

13 REPRESENTATIVE SONNEY: Good morning.

14 Curt Sonney, 4th District, Erie County.

15 REPRESENTATIVE KAMPF: Good morning.

16 Warren Kampf, 157th District, Chester and

17 Montgomery counties.

18 REPRESENTATIVE GREINER: Good

19 morning, everyone. Keith Greiner, 43rd

20 District, and I'm Lancaster County.

21 REPRESENTATIVE DAY: Good morning,

22 everyone. Gary Day, 187th District, Lehigh

23 and Berks counties.

24 REPRESENTATIVE EVERETT: Garth

25 Everett, 84th District, Lycoming and Union 8 1 counties.

2 REPRESENTATIVE KELLER: Good morning.

3 Fred Keller, Union and Snyder counties, 85th

4 District.

5 REPRESENTATIVE GROVE: Good morning.

6 Seth Grove, 196th District, York County. And

7 this cup is for you, Glen.

8 MAJORITY CHAIRMAN ADOLPH: Okay.

9 Thank you very much.

10 And after we hear from the

11 testifiers, I will acknowledge the presence of

12 some other members that have joined us. Okay.

13 But this morning, we will hear from

14 the public schools Public School Employees'

15 Retirement System and as well as State

16 Employees’ Retirement System.

17 I would be remiss if I did not

18 specifically welcome an old friend, an old

19 member of this committee, not in age, but a

20 very bright individual who, during his

21 legislative career, took on his own as one of

22 his issues the pension systems. And we

23 certainly appreciate his leadership in that

24 issue. And we certainly miss him on the

25 Appropriations Committee. 9 1 Welcome back, Glen Grell.

2 MR. GRELL: Thank you, Mr. Chairman.

3 MAJORITY CHAIRMAN ADOLPH: Each year

4 during this time, we are reminded about the

5 need for pension reform. Pennsylvania’s

6 facing a pension liability of over 50 billion

7 dollars. Our rating agencies continue to cite

8 pension cost as a concern of our bond rating.

9 This committee has talked about the structural

10 deficit over the last couple weeks, and it’s

11 important that we recognize the reason that

12 our expenses are outpacing our revenues, and

13 as a result, our ballooning pension costs.

14 Therefore, I’m very much looking for

15 this hearing, looking for some suggestions,

16 looking for some professional advice as we

17 move on with the budget process.

18 Ladies first.

19 MS. VOGLER: Okay. Good morning.

20 MAJORITY CHAIRMAN ADOLPH: Good

21 morning.

22 MS. VOGLER: I’m Melva Vogler, and

23 I’m currently the board chair for PSERS. I am

24 elected by the retired members of our system.

25 And I was formally a math teacher at 10 1 Wallenpaupack area in Representative Peifer's

2 district.

3 I have with me today Glen Grell, as

4 you already noted, our new executive director.

5 And we appreciate having him. I also have Jim

6 Grossman, our chief investment officer.

7 They are prepared to answer your

8 questions, and should they need some expertise

9 help, we have a large group with us that can

10 provide that assistance.

11 I am pleased to present this year, in

12 addition on our board book, this summary. I

13 hope that you will find it very interesting.

14 I'm very proud of it. I can't claim any

15 credit at all for its production. That goes

16 to Glen Grell and the staff.

17 So, we will attempt to answer

18 whatever questions you have for us, and I'm

19 going to give the microphone to our experts.

20 Thank you.

21 MAJORITY CHAIRMAN ADOLPH: Okay. I

22 think possibly, Mr. Fillman would like to have

23 some opening comments, and then because

24 these -- the questions are going to be

25 directed to either PSERS or to SERS so, we're 11 1 going back and forth, but I’d like to hear

2 from the heads of both agencies.

3 MR. FILLMAN: Thank you,

4 Mr. Chairman. My name’s Dave Fillman. I’m

5 the chairman of the SERS board, as of August

6 of this year. I’ve been on the board since

7 2001, appointed by Governor Schweiker at that

8 time.

9 I echo the chairwoman’s questions and

10 comments as far as us being able to answer as

11 many questions as you can in these challenging

12 times, as we hope to continue with a — a good

13 effort by this board and the folks with me,

14 David Durbin, who’s the chief executive

15 officer, and Tom Brier, the chief investment

16 officer, and in couple of years, both of our

17 funds will be a hundred years old. So, we

18 want to keep that tradition going.

19 Thank you.

20 MAJORITY CHAIRMAN ADOLPH: Okay.

21 Thank you.

22 Do the executive directors have

23 opening comments?

24 MR. GRELL: Mr. Chairman, if I may, I

25 just want to make three very quick points. 12 1 First, thank you for the warm

2 welcome. It’s nice to be back here, and ask

3 me the same question in a couple hours and

4 hopefully the same answer.

5 First, I want to thank the members of

6 the Appropriations Committee and the general

7 assembly generally for the passage of our tax

8 qualification bill last December. This was

9 some legislation that was noncontroversial,

10 and yet it took till the end of December to

11 get it passed, finally. But it was very

12 important for us to maintain our status with

13 the IRS. So, we appreciate the leadership of

14 our legislative members.

15 I see Chairman Godshall is here.

16 Representative Bloom is your representative on

17 our board, the House Republicans. And

18 Chairman Markosek. Thanks to all of the

19 sponsors of that legislation. It was very

20 important that we got that finished in

21 December.

22 Second, I want to note the retirement

23 of our former legislative liaison, with whom

24 you probably have worked a lot over the years.

25 Frank Ryder made his swan song on Christmas 13 1 day last year, but we're fortunate to have

2 hired Tony Parisi, whom many of you know if

3 you're involved with pension issues. Tony

4 joined us a few weeks ago, and we will be

5 sending out a formal introduction to members

6 of the general assembly, but Tony is here and

7 just wanted to recognize him.

8 Finally, we also have, in addition to

9 my CIO and myself, we have a large contingent

10 from PSERS here, representing my senior

11 management team, which has been terrific in

12 terms of helping me orient to my first year in

13 the position.

14 In addition, just extend some thanks

15 to all the dedicated folks back at our

16 headquarters on Fifth Street and also out in

17 our eight regional field offices for the

18 outstanding work that they do on behalf of the

19 600,000 educators in Pennsylvania.

20 And with that, we're open to

21 questions.

22 MAJORITY CHAIRMAN ADOLPH: Thank you,

23 Mr. Grell.

24 Mr. Durbin.

25 MR. DURBIN: I would echo Mr. Grell 14 1 and his comments regarding Act 2015-93. That

2 was a significant piece of legislation needed

3 by both systems, passed in a very bipartisan

4 fashion, with I believe no negative votes,

5 which we were really pleased to see. So,

6 thanks to this chamber and to our colleagues

7 down the hallway for accomplishing that,

8 We’re prepared for your questions,

9 sir.

10 MAJORITY CHAIRMAN ADOLPH: Thank you,

11 Mr. Durbin.

12 Before I turn the mic over to

13 Chairman Markosek, I’d just like to

14 acknowledge some other representative that are

15 present. Obviously, you mentioned Chairman

16 Godshall, who’s a member of the SERS board.

17 Thank you, Bob, for your service.

18 Representative Petri, Saccone,

19 Phillips Hill, Gabler, and Dush is here, along

20 with Representative Longietti.

21 Chairman Markosek.

22 MINORITY CHAIRMAN MARKOSEK: Thank

23 you, Chairman.

24 Just also would like to recognize

25 some of our committee members who have arrived 15 1 since the opening introduction, Representative

2 Kinsey and Representative Bullock, from

3 Philadelphia County, and Representative Rozzi,

4 from Berks County have also arrived.

5 First of all, let me welcome all of

6 you. Thank you for attending. As Executive

7 Director Grell mentioned, full disclosure, I

8 am a member of the PSERS board. Like all the

9 rest of the -- or I think all the rest of the

10 committee members here, I am an active member

11 of the SERS system. So, you know, I obviously

12 am very close to the pension issues here for

13 the last couple of years.

14 And it’s interesting, you know, we

15 have a former house member here in front of

16 us. Through these hearings, we’ve had a

17 number of those come in front of us, former

18 house members that have gone on, I think, to

19 bigger and better things. I don’t know that

20 says something, Chairman, about, you know, the

21 people looking for greener pastures or maybe

22 just trying to find something else. But

23 nevertheless, serving in the House of

24 Representatives, in my opinion, is one of the

25 great things that anyone can do in a career. 16 1 So, I want to welcome all of you here

2 for that.

3 I have — first of all, I'm glad to

4 see for this coming budget year that the

5 governor's proposing to create a special

6 restricted account for the employer payments

7 to the school employees' retirement system,

8 the PSERS. I think creating a separate

9 account will help ensure that the payments are

10 not compromised in any way down the road.

11 As we all know, failing to make the

12 full payments, not only to PSERS but also to

13 SERS, in the past is one of the main causes

14 that we have the current debt that we have.

15 We are finally at the point where we are

16 making the full actuarially required payments

17 for PSERS. That is Act 120 payment collars

18 are now or will be off. This will be the

19 first time in fifteen years that the

20 commonwealth is making its full payment.

21 As newer members come into the

22 retirement systems under the reduced benefit

23 plan, close to seventy cents of every dollar

24 will now be going towards paying down the

25 debt, and more and more will be going to the 17 1 debt every year, which is a very good thing.

2 The number of -- the number one

3 challenge we are facing with the pension

4 system is, of course, that debt. Most of the

5 so-called reform proposals we have seen so far

6 failed to pay down the debt any faster than

7 our current payment system. As I said, I

8 serve on the PSERS board, and with that

9 appointment comes a fiduciary responsibility.

10 When it comes to our retirement systems, I

11 believe we first need to do no harm. Do no

12 harm.

13 The commonwealth, as an employer,

14 must make its payments to the systems. We

15 cannot cut our way out of that debt.

16 I do have a question. There seems to

17 be a misconception that defined benefit plans

18 are more expensive than defined contribution

19 plans.

20 Can each system tell me, and I’ll

21 start with Representative Grell -- I’ll start

22 with Executive Director Grell, can each system

23 tell me what the employer costs for new

24 employees, those hired post Act 120, is as a

25 percentage of your payroll? And how, if you 18 1 can speculate, that is somewhat less than what

2 a defined contribution plan would cost you?

3 MR. GRELL: Well, Chairman Markosek,

4 taken in the abstract, our employer normal

5 cost for new employees coming in post Act 120

6 is a little under 3 percent, and that's

7 because, in Pennsylvania, the employee is

8 paying such a large share for their own

9 pension. They're paying 7 and a half percent.

10 Now, that isn't the total cost of the

11 pension. What has to be added on to that is

12 the additional assessment owing to the

13 unfunded liability. But if you look at the

14 employer normal cost, which is the cost -- the

15 present value of the cost to providing that

16 benefit for that year, it's under 3 percent

17 normal cost.

18 Our overall employer normal cost is

19 about 8 and a half percent, because that

20 includes the pre-Act 120 folks. But the

21 specific answer to your question is about 3

22 percent.

23 The information we would have in

24 terms of an average contribution in a private

25 sector defined distribution plan is in the 19 1 range of about 4 and a half percent.

2 MINORITY CHAIRMAN MARKOSEK: So,

3 you’re lower.

4 MR. GRELL: Well, our normal employer

5 cost under Act 120 would be lower than a DC

6 plan with a 4 and a half percent employer

7 contribution.

8 MINORITY CHAIRMAN MARKOSEK: Okay.

9 Thank you.

10 MR. DURBIN: And for SERS, the normal

11 cost for post-Act 120, what we referred to as

12 Class A3 members, is about 4.95 percent,

13 slightly under 5, right around 5 percent.

14 MINORITY CHAIRMAN MARKOSEK: Okay.

15 And if you were to go to a defined

16 contribution, in your opinion, how would that

17 change?

18 MR. DURBIN: Our research is about

19 the same as Mr. Grell talked about. We’re

20 right in the ballpark with the majority of

21 corporate plans. It varies, depending on the

22 plan itself, and it depends on what the

23 structure of that particular plan is. Some

24 are more, some are less.

25 MINORITY CHAIRMAN MARKOSEK: Okay. 20 1 All right. Thank you.

2 You know, I just want to say that,

3 you know, we got into this mess because of

4 policy decisions that were made about fifteen

5 years ago. And it’s really — Act 120 is

6 sometimes forgotten by a lot of folks that we

7 did have a major reform back in 2010, Act 120,

8 cut a lot of employee benefits, moving

9 forward, and mandated that the employer -­

10 employees have always paid their fair share,

11 but mandated that the employer -- the

12 commonwealth and the school districts -- pay

13 their fair share. And we’ve been on a tract

14 to do that over time, as painful as that may

15 be. Over time, it will get us back to a fully

16 funded system or a reasonably funded system,

17 as opposed to what we have now, where we’re

18 dealing with a large debt.

19 We have to pay down the debt one way,

20 shape, or form or another. We don’t need to

21 do it overnight, but over time we have to do

22 that. And Act 120, as it is right now, does

23 that.

24 So, I want to thank you all for

25 attending, and I’ll be waiting to hear a lot 21 1 of the questions. I'm sure we'll have some

2 good ones.

3 Thank you.

4 MAJORITY CHAIRMAN ADOLPH: Thank you,

5 Chairman Markosek.

6 Gentlemen and ladies, just what I

7 hear from folks back home, and I hear from

8 both sides, is obviously I hear from my many

9 friends that are public school teachers. They

10 are concerned about the health of their

11 system. And they hear about this unfunded

12 liability. And they've heard about other

13 systems throughout the nation unable to meet

14 their benefits.

15 So, I'd like one of you to address

16 that. This unfunded liability, could we have

17 a definition for those on this committee, as

18 well as those that are viewing this, what

19 exactly -- I know our unfunded liability is

20 about 50 billion dollars, which is a scary

21 number. But, generally speaking, is the

22 system in trouble? And should someone my age

23 be worrying about the pension that we've put

24 into for over two decades?

25 MR. DURBIN: I guess I'll start. 22 1 From the SERS perspective, and we have

2 reported that our unfunded liability is

3 expected to reach 18.8 billion dollars in

4 valuation that we’re expecting in April. So,

5 that’s where we are at this moment. It has

6 risen slightly since last year.

7 The reason for that is, of course,

8 last year was a very challenging year from the

9 investment perspective, and we can talk about

10 that if you’re interested in those numbers.

11 But the unfunded liability represents the long

12 term, the long term needs of the plan. We

13 don’t have sufficient assets right now to be

14 able to pay everybody the benefit that they’re

15 due.

16 But we’re an ongoing concern. We

17 measure our time horizons in ten, twenty, and

18 thirty years. A new member joins today, and

19 in thirty, thirty-five years they’re coming to

20 be eligible for their benefit. So, as a long­

21 term investor with a long-term horizon on

22 these things, we have plan in place.

23 The general assembly, in its wisdom,

24 has placed Act 120. You have met the

25 challenge each and every year for the last 23 1 five years. And those were very different

2 challenges. But you have met that challenge.

3 As a result, the funds are growing healthier

4 than we would have been otherwise. And we’re

5 on the pathway, I believe, to being a

6 healthier system.

7 It’s not a quick solution, and I

8 recognize that everybody would like quick

9 solutions, but in this case, there really are

10 no quick solutions to the problem. That would

11 be my response.

12 MR. GRELL: From PSERS’ standpoint,

13 in answer to your question, I don’t believe

14 anybody who’s currently retired or about to

15 retire from the PSERS system has any real

16 reason to be concerned. We have never missed

17 a monthly payment. We pay out about 450

18 million dollars a month in retiree benefits.

19 And we are certainly capable of paying those

20 benefits well into the future.

21 We do also have an unfunded

22 liability. Ours is about 37.3 billion

23 dollars. We have what I think is probably a

24 helpful chart for you on page eight of our

25 supplemental handout. It shows the three 24 1 major reasons why we have that unfunded

2 liability. It's not all because of the

3 failure of the state government to properly

4 and adequately fund the pension plan, but that

5 accounts for 46 percent of it, about 17

6 billion dollars of that comes from the

7 underfunding of the plan for the period from

8 roughly the early 2000s until about 2012. And

9 technically, it's still being underfunded each

10 year because of the collaring of the employer

11 contribution rate.

12 But, in addition to that investment

13 performance, we had two very significant

14 downwards periods during the past fifteen

15 years -- 2001, 2008 and '09 in particular.

16 That accounts for 32 percent of the unfunded

17 liability. And then there were benefit

18 enhancements and various changes to the

19 requirement code that had the effect, in some

20 cases, of masking the true amount of the

21 unfunded liability. That accounts for about

22 22 percent of that unfunded liability.

23 As Mr. Durbin said, the commonwealth

24 has made great progress in the past five

25 years. Five years ago, the Commonwealth was 25 1 paying about 27 percent of the actuarially

2 required contribution, meaning that the state

3 was only funding the plan to about 27 percent

4 of the level that it should have been.

5 With the passage of Act 120, although

6 the employer contribution rate had to go up,

7 it went up in very measured steps, that’s, in

8 our case, school district employers were able,

9 with great difficulty, to work into their

10 budgets. But if you go back to pre Act 120,

11 the employer contribution rate was around 4

12 percent. It was scheduled to go to 29 and a

13 half percent in three years if nothing had

14 been done.

15 So, by stepping that up, the

16 commonwealth has gradually gone from paying 27

17 percent of the ARC, to, this year, paying 80

18 percent of the ARC. And with the rate that we

19 certify that will go into effect July 1st, for

20 the first time in fifteen years, the

21 commonwealth will be paying a hundred percent

22 of the actuarially required contribution. And

23 that bodes very well, as long as that fiscal

24 discipline is maintained on the part of

25 general and the future administrations. 26 1 We’re very well on the track to

2 turning the corner on our unfunded liability

3 and paying that off. In fact, next year we

4 will begin paying off some of the unfunded

5 liability.

6 MINORITY CHAIRMAN MARKOSEK: Thank

7 you.

8 I just want to throw these numbers

9 out, and that’s just for, you know, part of

10 the budget hearings, you know. In ’16-’17,

11 PSERS, the state contribution will be a little

12 over 2 billion dollars. Okay? And the state,

13 for SERS, total from all sources is a little

14 over 1.8 billion dollars. But the general

15 fund it will be about 770 million dollars.

16 Do you folks agree with those

17 figures?

18 MR. DURBIN: Yes, sir.

19 MR. GRELL: Yes.

20 MAJORITY CHAIRMAN ADOLPH: And this

21 is one of the cost drivers that we’re dealing

22 with, okay, you know, during this budget. And

23 it’s very difficult and also very important

24 issue.

25 So, thank you for answering those 27 1 questions.

2 As is customary, Chairman Markosek

3 and I, we invite the chairmen of the standing

4 committees of the House that have a

5 relationship with the various agencies that

6 come before us. And it's my pleasure to

7 introduce you to the Republican chair of the

8 House State Government Committee, Chairman

9 Daryl Metcalfe.

10 REPRESENTATIVE METCALFE: Thank you,

11 Chairman Adolph.

12 Good morning, everyone.

13 MR. DURBIN: Good morning.

14 MR. GRELL: Good morning.

15 REPRESENTATIVE METCALFE: My first

16 question would be more directed to PSERS, due

17 to the information that I was able to obtain.

18 On page seven of the 2015

19 Comprehensive Annual Financial Report, to

20 quote it, it says: The board has continued to

21 fulfill its mission to maintain stability and

22 the long-term optimum value of the fund. This

23 is evidenced in the long-term growth of the

24 system's assets and the actuarial soundness of

25 the fund. 28 1 And on page thirty-one of the same

2 report, it says, to quote it: The ratio of

3 the fiduciary net position to the total

4 pension liability also decreased from 57.2

5 percent at June 30th, 2014, to 54.4 percent at

6 June 30th of 2015.

7 Saw a decrease. My question is, how

8 do we reconcile the claim of the, quote,

9 actuarial soundness, with a funding ratio that

10 is under 55 percent and dropping? And what

11 funding ratio would you actually declare that

12 PSERS is not actuarially sound any longer?

13 MR. GRELL: Well, I believe our

14 funding ratio is about 60.6 percent, and it

15 will continue to go down for another year or

16 so, because of the fact that due to the

17 collaring of the employer contribution rate,

18 we’re still, in the current year, not getting

19 the full amount that should be paid by

20 employers into the fund. Once we get to the

21 point where 100 percent of the required

22 contributions are coming in, that’s when you

23 start to turn the corner and move both -- you

24 move the unfunded liability down and you move

25 the funding ratio up. 29 1 We’re certainly not happy with a 60

2 percent funding ratio. It puts us on the

3 lower end of national public pension plans.

4 But it is significant that we’re turning the

5 corner and moving that -- we’ll be moving that

6 number upward in the future.

7 REPRESENTATIVE METCALFE: So, the

8 54.4 percent that was reported in June 30th of

9 last year is now at 60 percent?

10 MR. GRELL: Well, I’d have to see

11 exactly what that number is, but according to

12 my most recent information, our funding ratio

13 is 6 0.6 percent.

14 I think we have one of the exhibits

15 that may show that a little more clearly.

16 Bear with me one second here.

17 REPRESENTATIVE METCALFE: Another

18 factor in that was -­

19 MR. GRELL: Okay, I’m sorry. I have

20 your answer.

21 The June 30, 2015, valuation had it

22 at 60.6 percent. And right now, the estimated

23 is -- I’m sorry, 56.8, estimated, is 2016.

24 But then, if you look at page seven of the

25 highlights material we gave you today, it 30 1 bottoms out and starts turning the corner in

2 2 016-'17.

3 REPRESENTATIVE METCALFE: And for

4 SERS, the same ratio of the fiduciary net

5 position of total pension liability, the

6 numbers that I was able to obtain was December

7 '13 to December '14. I didn't have any for

8 the end of last year. It had listed SERS at

9 67.1 and dropping to 65.1.

10 What are your -­

11 MR. DURBIN: There's really two

12 calculations that we have to monitor. With

13 the Government Accounting Standards Board,

14 they established what's called GASB 67 and 68.

15 That is an accounting methodology. And that's

16 the ratio that you're referring to. That has

17 specific differences between how that

18 methodology works as opposed to the actuarial

19 calculation itself.

20 For example, one of the differences

21 is when you recognize gains and losses. In

22 what you're referring to it's immediate. In

23 the actuarial, we have a smoothing period over

24 five years. So there will be differences in

25 that. 31 1 The actuarial is much more sensitive

2 to changes in the market and market

3 underperformance, which we’ve had. And that

4 market underperformance, as reflected in the

5 GASB numbers, we’ll see that reflected more

6 slowly in the actuarial returns.

7 REPRESENTATIVE METCALFE: So, do you

8 have the current numbers?

9 MR. GRELL: I don’t have those

10 numbers with me today. I do not have them.

11 They’re in April.

12 REPRESENTATIVE METCALFE: What were

13 they for last year? Do you know?

14 MR. DURBIN: If you give me a second,

15 I’ll look.

16 REPRESENTATIVE METCALFE: While

17 you’re looking for that, there’s been a lot of

18 discussion in the public pension circles about

19 the need to reduce the return of the -- the

20 rate of return assumption, since the financial

21 markets are not likely to produce a 7 and a

22 half percent rates of return consistently the

23 way they have in the past.

24 My question is, what’s PSERS -- and

25 then I would have the same for SERS -- what 32 1 are you thinking on that matter? And do you

2 feel it’s prudent to reduce the assumed rate

3 from 7 to 6 and a half percent? And how would

4 that impact the unfunded liabilities?

5 MR. GRELL: Did you want to answer —

6 MR. DURBIN: Yes. I have that number

7 for you now. 2014, we were 64.8 percent on

8 the GASB calculation.

9 REPRESENTATIVE METCALFE: What date?

10 MR. DURBIN: 2013 we were 66.7. And

11 I don’t have a number for 2015 yet.

12 With regard to the assumed rate of

13 return, if I could just go ahead and answer

14 that one, we are currently at 7.5 percent

15 assumed rate of return. That is a number that

16 the board examines every year in consultation

17 with its general consultant and its actuary.

18 That happens typically in March and April of

19 the year. So, we’ll be looking at that number

20 again.

21 7.5 puts in a band of forty-four

22 other systems out of, I think, a hundred

23 twenty-six in the survey. There are thirty-

24 three between 7 and a half and 8, and forty-

25 four between 7 and 7.5. We’re firmly in the 33 1 middle.

2 If the board felt that that was not

3 an attainable, long-term horizon goal, because

4 that's what we're looking at, long-term

5 horizons for our investments, then they could

6 modify that by moving that in a different

7 direction, perhaps down.

8 REPRESENTATIVE METCALFE: Oh, I know

9 they could. My question was -- I mean, based

10 on what a lot of the talk is around here and

11 the country, I mean, it's to assume that

12 you're going to still have 7 and a half

13 percent, the way the markets have been

14 performing.

15 I mean, aren't you concerned that

16 we're too high and that we should be reducing

17 it to 7 or 6 and a half?

18 MR. DURBIN: We're always concerned.

19 We're always watching it. But if you look at

20 our thirty- and twenty-year returns, we've

21 exceeded both of those numbers. The ten-year

22 return we didn't, but you have 2008, there

23 were massive losses within those averages.

24 It's the economic conditions that

25 exist. It depends upon the liquidity of the 34 1 plan itself, how much we have to pay out in

2 benefits each month versus where we think the

3 risk can be taken. The board looks at that

4 very carefully, when they make that choice

5 about 7.5. And if they feel that it’s not

6 attainable as a long-term range, then they

7 will adjust it. And they’ll be looking to do

8 that or they’ll be looking to consider that

9 question this spring.

10 MR. GRELL: At PSERS, our assumed

11 rate of return is also 7 and a half, which

12 puts us in that same band that SERS is in

13 among our peer organizations.

14 We also look at it regularly. We do

15 what we call a five-year experience study.

16 And the last one was done in 2001 (sic). And

17 at that time, as a result of reviewing a lot

18 of factors, the assumed rate of return was

19 lowered from 8 percent to where we are now, 7

20 and a half percent.

21 We are currently in the end process

22 of our five-year experience study, and that’s

23 scheduled to be before our board in June of

24 this year.

25 REPRESENTATIVE METCALFE: Glen, could 35 1 I -- not to interrupt you -­

2 MR. GRELL: Sure.

3 REPRESENTATIVE METCALFE: Just to

4 make sure I heard you correctly, you said the

5 last one was in 2001?

6 MR. GRELL: ’11, 2011.

7 REPRESENTATIVE METCALFE: I thought I

8 misheard.

9 MR. GRELL: I’m sorry.

10 So, yeah, we’re in the process of

11 doing that right now. But we don’t look at

12 assumed rate of return in a vacuum. We

13 certainly look with our investment advisors on

14 assumed rate of return. But, at the same

15 time, we take into consideration demographic

16 features, factors, such as mortality tables.

17 We’ll reevaluate whether we’re using the

18 proper mortality table.

19 We also look at the growth of

20 employee payroll. And you have to weigh all

21 of those factors. Frankly, right now,

22 employee payroll growth is flat or, in some

23 cases, declining. So, that’s an offsetting

24 factor.

25 So, the five-year experience study 36 1 takes that and the rate of inflation and a lot

2 of factors into consideration and looks at the

3 same long-term horizon that SERS looks at from

4 the investment standpoint. And probably -­

5 most likely, at our June meeting, there will

6 be action taken, based on all of those

7 factors, in setting what our assumed rate of

8 return would be going forward. But we are

9 very attentive to it.

10 REPRESENTATIVE METCALFE: My next

11 question is going to deal with PERC. The

12 governor's troublesome unilateral action

13 dismantled the Public Employee Retirement

14 Commission has raised some legal questions, of

15 course, which are currently under review in

16 the Commonwealth Court courtesy to the

17 challenges brought by Representative Seth

18 Grove and Representative Steve Bloom.

19 I understand that there's an

20 agreement that was signed by the parties to

21 the legal challenge that will allow PERC

22 employees to fulfill the commission's

23 statutory responsibilities, independent of the

24 governors' budget office, where the staff are

25 currently housed. But the governor's reckless 37 1 actions relating to PERC reminded many of us

2 of the importance of PERC’s independence in

3 its oversight role regarding pension

4 legislation.

5 In other words, the funds allocated

6 to PERC are worth the investment, and PERC

7 shouldn’t be a pawn in the governor’s budget

8 strategy.

9 Both systems contract with actuaries

10 to perform the actuarial work that’s required

11 by retirement codes and the other laws and

12 standards. And this includes actuarial work

13 that’s related to legislative proposals.

14 PSERS incurred, I believe, over 490,000

15 dollars in those costs relating to legislation

16 and policy during the ’14-’15 year.

17 I understand the systems’ actuaries

18 have a fiduciary responsibility relationship

19 with those whom with they contract. And you

20 would agree with that, I would assume.

21 MR. GRELL: Well, they’re under

22 contract with us, but they also have their

23 actuarial standards that they adhere to.

24 REPRESENTATIVE METCALFE: Would your

25 systems’ actuaries be in a position to provide 38 1 an independent actuarial analysis of pension

2 legislation, such as Milliman or Cheiron would

3 have done for PERC?

4 MR. GRELL: Well, Chairman, PERC does

5 serve a valuable role. The process basically

6 is, whenever there’s pension legislation that

7 affects either of our retirement systems, our

8 actuaries provide the data to PERC. And then,

9 in an ideal world, given proper funding and

10 given proper time, PERC takes the actuarial

11 work that we submit to them, and they conduct

12 an independent evaluation. Sometimes they’ll

13 ask questions about the data that we send.

14 Our actuaries will talk to their actuaries and

15 clear up any confusion or questions about the

16 assumption, and then an actuarial note is

17 produced on bills and amendments.

18 That’s in an ideal word. But I know

19 that PERC has been under significant pressure

20 in recent years in terms of the time given to

21 them to perform an independent review and the

22 resources, in some cases. So, the independent

23 role of PERC is very important and, you know,

24 should be maintained, but in order to maintain

25 it, they would have to have more time than 39 1 they have been given in recent years to

2 respond to legislative requests.

3 REPRESENTATIVE METCALFE: But the

4 systems certainly wouldn't be willing to

5 accept us just requiring you to use the PERC's

6 actuarial work instead of having your own.

7 MR. GRELL: Well, they would really

8 not have -- it would be a major undertaking

9 for PERC to independently gather all the data

10 they need.

11 REPRESENTATIVE METCALFE: I'm just

12 saying, theoretically, if it was vice versa,

13 the systems wouldn't -- I mean, you'd want

14 your own analysis. You wouldn't -- you

15 wouldn't like to go along with an analysis

16 that would have been performed by someone

17 else's actuary.

18 MR. GRELL: Well, for our board to

19 take action on anything, we would need our

20 actuaries to look at it. No question about

21 that.

22 MR. DURBIN: I think that's the key

23 there, is the fiduciary obligation of the

24 trustees on the board would, I think, demand

25 that they actually validate those numbers. 40 1 REPRESENTATIVE METCALFE: And I

2 think, likewise, I’m trying to make the point,

3 our fiduciary responsibility is that we have

4 an independent analysis.

5 So, thank you. Thanks for your time.

6 Thank you, Mr. Chairman.

7 MAJORITY CHAIRMAN ADOLPH: Thank

8 you, Chairman.

9 I’d like to acknowledge

10 Representative Eddie Pashinski has joined us,

11 as well as Chairman Stan Saylor, of the House

12 Education Committee, and Representative Mark

13 Gillen.

14 At this time, the next question will

15 be asked by Representative Daley.

16 REPRESENTATIVE DALEY: Thanks,

17 Mr. Chairman.

18 So, I was not a member of the general

19 assembly in 2010, but I actually wanted to

20 just take a minute and acknowledge those

21 members who were here at that time for the

22 legislation that they passed, because it’s

23 pretty clear, sitting on this committee and -­

24 well, just sitting on this committee and as a

25 member, that it was really important work that 41 1 was done in a bipartisan fashion. And it

2 changed the game in a way that we’ll be

3 looking at pensions.

4 But I also -- my questions, as a

5 member of the State Government Committee, we

6 heard a lot of different pension proposals

7 over the past several years.

8 Did any of these plans significantly

9 reduce our unfunded liability? Or did any of

10 them provide any immediate budgetary relief?

11 And I would like to hear from both SERS and

12 PSERS.

13 MR. DURBIN: There were a number of

14 proposals that were reviewed that had long­

15 term savings. Immediate savings, that’s a

16 different issue. We’d have to go back and

17 take a look at year over year. I wasn’t -­

18 didn’t come prepared to actually look year

19 over year.

20 But I think some of the proposals we

21 view were a savings of roughly 2 billion

22 dollars, but that would be over thirty,

23 thirty-five years before that would be seen.

24 So, I’m not sure exactly how to qualify long­

25 term savings versus short-term savings. 42 1 They do have some savings down the

2 road, but most of them didn't have what I

3 would refer to as immediate relief. Some of

4 that's because of the collars and the need to

5 get to the peak rates as quickly as we can.

6 That would be -- I hope that answers your

7 question.

8 REPRESENTATIVE DALEY: It does,

9 actually. Because I'm -- a lot of the

10 discussions happen around -- obviously around,

11 you know, this time of year and as we're

12 approaching the budget. And I think there are

13 times when I think there's an impression that

14 some of those plans will bring us an immediate

15 budgetary impact. And so that's -- that was

16 the reason for the question.

17 And also, we do hear about the

18 unfunded liability, and I know there's a

19 different effect on that, but it's always

20 viewed in the long-term as far as my

21 understanding is.

22 So, thank you.

23 And how about for PSERS?

24 MR. GRELL: Yeah. I would agree with

25 Dave as far as long term versus short term. 43 1 The only element of the plans that made it to

2 a real review, either by the general assembly

3 or by PERC, the only thing that would have had

4 an immediate effect on the employer

5 contribution rate would have been further

6 collaring of the employer contribution rate,

7 which was in one of the bills. That’s the

8 only thing. And that would have been just

9 extending the collar and making it longer

10 before we get to that point where the

11 commonwealth is paying a hundred percent.

12 REPRESENTATIVE DALEY: So, then,

13 understanding that the long-term effect of the

14 collar is not necessarily such a positive

15 effect.

16 MR. GRELL: No. The long -­

17 REPRESENTATIVE DALEY: We have to be

18 careful of that.

19 MR. GRELL: The long-term effect of

20 the collar, even under Act 120, the general

21 assembly knew at that time that it was going

22 to result in an underfunding, but, at the

23 time, we were at 27 percent, so anything

24 better than 27 percent of the ARC was moving

25 us in the right direction. 44 1 But, yeah, as long as the collars

2 stayed on, it perpetuated the underfunding.

3 And we would certainly not like to see a

4 return to suppressing the

5 employer contribution rate.

6 As far as the long-term savings for

7 the proposals, generally speaking, the

8 proposed changes that were being made for

9 existing members, they would have more savings

10 up front. And the changes that pertain to

11 design plan changes for new members, in most

12 cases, for PSERS, had a net cost, because, as

13 I mentioned earlier, our employer normal cost

14 right now for a new employee coming in is 3

15 percent, so any proposal that would have an

16 employer contribution, whether it’s DB, DC, or

17 a combination, if the employer contribution

18 normal cost is more than 3, it would have a

19 net cost to the system.

20 REPRESENTATIVE DALEY: Thanks. And

21 so, if there were a change to be made to the

22 current retirement benefit structure, and the

23 requirement benefit over, then, the longer

24 term proved to be inadequate for the retirees,

25 what should we be looking at to safeguard our 45 1 taxpayers when ot her public resources are

2 required, for instance, through the safety

3 net?

4 MR. GRELL: Well, I mean, if you get

5 to a point where -- whether it's private

6 sector employees or public sector employees,

7 retire with inadequate resources, it puts a

8 strain on your social safety net, your medical

9 assistance costs, and other human services

10 programs. One thing you might do, if the

11 public pension benefit was reduced, I mean you

12 would have to encourage private savings to

13 make up whatever shortfall might come if the

14 benefit under the public plan, whether DB, DC,

15 or hybrid, would be reduced in the future.

16 REPRESENTATIVE DALEY: Okay. Did you

17 have anything to add?

18 MR. DURBIN: Nothing to add to that.

19 REPRESENTATIVE DALEY: All right.

20 So, obviously, as the government, in some ways

21 we could be looking at the long-term benefits.

22 I mean, the long-term sufficiency of the

23 benefits should potentially be something that

24 we would be looking at as a factor in

25 evaluating any pension reform proposals or 46 1 design plan reforms.

2 MR. GRELL: Well, I mean, I think a

3 policy maker would be prudent to look at the

4 cost of the benefit that’s being provided, but

5 also the value of the benefit to the employee,

6 whether it’s, you know, public sector or

7 private sector employee. But public stewards,

8 that certainly is part of the equation, what

9 kind of benefit will state and school

10 employees have under -- whether it’s the

11 legacy plan, the Act 120 plan, or some new

12 plan design in the future.

13 REPRESENTATIVE DALEY: Thanks.

14 Anything to add?

15 MR. DURBIN: No, ma’am.

16 REPRESENTATIVE DALEY: All righty.

17 Thank you very much.

18 Thanks for being here today.

19 Thank you, Mr. Chairman.

20 MAJORITY CHAIRMAN ADOLPH: Thank you,

21 Representative.

22 Representative Warren Kampf.

23 REPRESENTATIVE KAMPF: Good morning,

24 Mr. Grell, Mr. Durbin, ladies and gentlemen.

25 Mr. Chairman, I might have a couple 47 1 of extra questions, based on, you know, just

2 kind of going down my list. So, if there is a

3 second round, I might have one or two.

4 And the questions I'm going to be

5 asking right away are about the investment

6 losses. And I know you -- you both and your

7 teams, you know, do a very good job. I'm not

8 trying to beat you up for making bad

9 investment choices, but I just want to explore

10 what some of that has done to the unfunded

11 liability and our contribution rates.

12 So, I'll start with you, Mr. Grell.

13 I think I noticed on page eighteen of the -­

14 essentially the budget book that you submitted

15 to us, that for this first six months of your

16 fiscal year, that is this year, investment

17 losses on the order of 2 and a half billion.

18 Am I right about that?

19 MR. GRELL: I'm going to ask our

20 chief investment officer to answer questions

21 relating to the investments.

22 MR. GROSSMAN: Yes. For the first

23 six months we were down, and 2 billion I think

24 is about right.

25 REPRESENTATIVE KAMPF: I'm sorry. I 48 1 didn’t hear that last part.

2 MR. GROSSMAN: Yeah, I think 2

3 billion is about right. We were done about,

4 say, 4 percent in the first six months of the

5 fiscal year, our fiscal year.

6 REPRESENTATIVE KAMPF: Okay. So, how

7 about since that time, has there been any

8 recovery of that money in the last couple of

9 months?

10 MR. GROSSMAN: Through March, through

11 last Friday, you know, for -- it hasn’t been

12 much of a change, maybe lightly down, but

13 other than that, the markets have really

14 rebounded in March so far. So, maybe slightly

15 a little bit worse than 4, down 4, but not

16 materially.

17 REPRESENTATIVE KAMPF: Down 4

18 percent.

19 MR. GROSSMAN: Correct. For the

20 fiscal year from July 1st up through, say,

21 March. But there’s private market valuations

22 we don’t have yet, we won’t have until the end

23 of the quarter.

24 REPRESENTATIVE KAMPF: All right.

25 So, that last comment maybe -- maybe that 49 1 helps the numbers. Are you saying that while

2 your equity investments are off 4 percent -­

3 and not off of the 7 and a half percent

4 assumed rate, literally they’re down 4

5 percent, there may be some private investment

6 returns that could offset that?

7 MR. GROSSMAN: Possibly.

8 REPRESENTATIVE KAMPF: Have you

9 gotten any gauge on that so far from your

10 advisors?

11 MR. GROSSMAN: No. It’s early. It’s

12 -- for the private equity and private real

13 estate portfolios, we would get -- we would

14 use our March -- or December 31st valuations,

15 but they’re in the process of being audited

16 right now, so they usually come in later.

17 This is the one period where those returns

18 actually come in usually late March or early

19 April. So, they tend to be — lag a lot more.

20 REPRESENTATIVE KAMPF: Okay. So,

21 last year, fiscal year, you reported about 3

22 and a half percent investment return overall,

23 which was obviously below the 7 and a half

24 percent rate of return. Were the private

25 investments that you’re referring to, were 50 1 they better than 3 and a half percent? In

2 other words, they beat the market, and so that

3 3 and a half percent number is a -- kind of an

4 amalgam?

5 MR. GROSSMAN: Yeah. I believe

6 the -- I have to go back to look at the

7 individual private markets' piece, but I

8 believe the private markets' piece did okay

9 last year. It was a difficult year, but I

10 believe they did okay.

11 REPRESENTATIVE KAMPF: Were they

12 better than 3 and a half percent?

13 MR. GROSSMAN: Yeah, real estate was

14 up 9. Private real estate was up 9 last year.

15 And I think -- and private equity was up I

16 think a little over 2. So, between the two,

17 they were probably up a little over 3, but

18 private real estate did better than private

19 equity last year.

20 REPRESENTATIVE KAMPF: Okay. The

21 thing I'm concerned about is with these losses

22 that you reported for the first six months,

23 that when you come out with your valuation,

24 which you'll come out with, I guess, after

25 June 30th -- 51 1 MR. GROSSMAN: Um-hum.

2 REPRESENTATIVE KAMPF: -- for this

3 past fiscal year, that we’ll actually have an

4 increase in what our payments are going to

5 have to be and an increase in the unfunded

6 liability. Can you give me any reaction to

7 that concern I have?

8 MR. GROSSMAN: Well, any investment

9 losses at the teachers’ retirement system are

10 amortized over a period of ten years, so I’d

11 have to look to see how that amortization

12 looks across the previous nine years as well

13 to be able to gauge whether they will have a

14 positive or negative impact. Obviously, the

15 year itself won’t have a positive impact

16 because you’re going to take one-tenth of

17 those losses into the valuation, into the next

18 valuation. So, I’d have to look at each of

19 the ten years and how that’s going to look.

20 REPRESENTATIVE KAMPF: So, you smooth

21 in your losses over ten years. How fast do

22 you smooth in your gains over the 7 and a half

23 percent?

24 MR. GROSSMAN: Same thing.

25 REPRESENTATIVE KAMPF: Ten and ten. 52 1 MR. GROSSMAN: Ten and ten. And

2 that’s, again, to try to smooth the

3 contribution rate that the employers have.

4 REPRESENTATIVE KAMPF: Okay.

5 Mr. Durbin, so your rate of return, as you

6 indicated, was actually 7 points off for last

7 year. It was .5 percent.

8 MR. DURBIN: Correct.

9 REPRESENTATIVE KAMPF: So, the

10 valuation that I have from you that was most

11 recently published was for calendar year 2014.

12 Is the valuation that I guess is

13 going to come out sometime soon going to show

14 any significant increase in the unfunded

15 liability or our conversation rates here at

16 the general assembly level?

17 MR. DURBIN: The contribution rates,

18 we’re still working on the final reports for

19 that. It certainly will reflect the fact that

20 we had shortfall in the current year. Rather

21 than adding as much as we had hoped, we added

22 13 million to the investment returns, which is

23 not substantial. But that -- as I mentioned

24 before, our unfunded liability is 18.8 billion

25 dollars estimated. We’ll get the final number 53 1 in June, when we publish the final report

2 itself. That will reflect a slight increase

3 in the cap rate.

4 Right now, we believe the cap rate

5 will be 31.4 percent in fiscal '17-'18, that

6 will be our peak rate. And then after that,

7 it should begin to drop.

8 REPRESENTATIVE KAMPF: And when you

9 say the cap rate, you mean that's the highest

10 percentage of payroll that the taxpayers will

11 have to contribute for the benefits.

12 MR. DURBIN: That is correct. And we

13 operate -- thank you for remembering we

14 operate on a calendar year. So, we're

15 slightly different than PSERS in that regard.

16 REPRESENTATIVE KAMPF: Okay. So, you

17 still think it will be about 31 percent.

18 Mr. Grell, I notice that in some of

19 your remarks you indicated that the rate, I

20 think, was going up to 30 percent for this

21 year. I did see in your budget book, though,

22 in 1920 (sic), it's -- without factoring in

23 the losses that we just discussed, it's headed

24 up to 34 percent. Is that correct?

25 MR. GRELL: I think you meant 2020, 54 1 but -­

2 REPRESENTATIVE KAMPF: I’m sorry.

3 What did I say?

4 MR. GRELL: You said 1920.

5 REPRESENTATIVE KAMPF: Oh. sorry.

6 Must be the cold medicine I’m taking. Forgive

7 me .

8 MR. GRELL: What’s a century. I

9 don’t know what it was in 1920, although we

10 did exist in 1920.

11 REPRESENTATIVE KAMPF: 34 percent?

12 MR. GRELL: Our max rate is projected

13 at this time to 34.2 percent in fiscal 1920

14 (sic).

15 REPRESENTATIVE KAMPF: Is there any

16 thought that that number is going to go up,

17 based on those losses that we just went over?

18 MR. GRELL: Well, as Mr. Grossman

19 said, we smooth out over ten years, and the

20 point of that is to make that employer

21 contribution rate less volatile.

22 REPRESENTATIVE KAMPF: So, you don’t

23 think so.

24 MR. GRELL: Well, it’s four years

25 out, but, you know, depending on what happens 55 1 in the subsequent three years, it may go up,

2 it may go down.

3 REPRESENTATIVE KAMPF: Well, I just

4 meant for the valuation we’re going to see at

5 the end of the fiscal year. Do you think that

6 projected rate’s going to go up for 1920

7 (sic)?

8 MR. GRELL: I wouldn’t be able to

9 project out.

10 REPRESENTATIVE KAMPF: Okay. And

11 just one last -- Mr. Chairman, different

12 topic, very short number of questions.

13 Okay. I’m curious what the — sort

14 of the typical retiree is and the typical

15 person who leaves your systems, it looked to

16 me, Mr. Grell, that, from a chart, that about

17 70,000 of our PSERS annuitants had roughly

18 thirteen years of service. So, sort of half

19 of our annuitants had thirteen years of

20 service. Does that sound about right?

21 MR. GRELL: I don’t know, to be

22 honest with you. I can find that out, and

23 maybe somebody here with me can give me that

24 number. I just don’t know offhand. We can

25 certainly supply it to you. 56 1 REPRESENTATIVE KAMPF: So, page

2 thirteen of your budget book, and I think it's

3 also in your budget highlights. Do you see

4 that chart?

5 MR. GRELL: Well, I'm looking at page

6 four of the highlights.

7 REPRESENTATIVE KAMPF: Okay. That's

8 the one with the red lines that has the

9 numbers on it?

10 MR. GRELL: Yes. Yes. Average years

11 of service.

12 REPRESENTATIVE KAMPF: Did I

13 interpret that correctly that the 78,000

14 annuitants who received less than 10,000

15 dollars in an annual benefit, their average

16 years of service were thirteen years of

17 service?

18 MR. GRELL: Correct, for somebody

19 getting that -- the very small benefit, yes.

20 REPRESENTATIVE KAMPF: So, that's -­

21 that particular category of individuals -­

22 teachers, school workers -- that's, by far,

23 the biggest category of annuitants.

24 MR. GRELL: Yes.

25 REPRESENTATIVE KAMPF: And, 57 1 currently, is the system experiencing somewhat

2 something similar with new retirees, or -- I’m

3 sorry -- new people leaving PSERS service,

4 that they’re around -- the largest number is

5 around thirteen, or is it a higher years of

6 service, a lower one?

7 MR. GRELL: Well, I think, you know,

8 anecdotally, and we can get you more

9 information on this, but many individuals come

10 into the teaching profession and, for whatever

11 reason, either don’t continue to teach at all

12 or don’t continue to teach in Pennsylvania,

13 and they depart our system within the first

14 five to ten years, so that’s a significant

15 number of people. But they wouldn’t be

16 retiring with a pension benefit if they stayed

17 less than five years.

18 REPRESENTATIVE KAMPF: But these

19 people are -- these are annuitants, so what

20 I’m asking is, you know, somebody who actually

21 vests. This seems to me to be saying the

22 typical person who vests and gets a retirement

23 benefit is about thirteen years in, all in.

24 And my question is, is that trend continuing

25 today? 58 1 MR. GRELL: I would have to get back

2 to you on that.

3 REPRESENTATIVE KAMPF: All right.

4 And have you ever done an analysis on what

5 that person might receive if they had a DC

6 plan or a hybrid plan like some of the other

7 ones that are being discussed?

8 MR. GRELL: I don’t know that we’ve

9 ever looked at it in that segmented way, but,

10 I mean, I understand that for a certain cohort

11 of teacher or support staff person who might

12 be in PSERS, for a certain cohort that doesn’t

13 stay in the system for a long period of time,

14 a defined contribution plan or some sort of a

15 hybrid in some cases is better for them.

16 REPRESENTATIVE KAMPF: Okay.

17 MR. GRELL: But, you know, our

18 employers prefer to hire people for the long

19 term, and, in that case, as a recruitment and

20 a retention tool, there is no comparison

21 between offering a defined benefit versus a

22 defined contribution plan to some -- if you’re

23 trying to build a long, stable workforce.

24 REPRESENTATIVE KAMPF: Mr. Durbin,

25 same set of questions. What’s — I didn’t see 59 1 something like this in your submission.

2 MAJORITY CHAIRMAN ADOLPH:

3 Representative -­

4 REPRESENTATIVE KAMPF: Okay. I'll

5 come back, or maybe I won't.

6 MAJORITY CHAIRMAN ADOLPH: Thank you

7 so much. You know, Chairman Markosek's giving

8 me the elbow, and try to keep it under fifteen

9 minutes.

10 Representative O'Brien.

11 REPRESENTATIVE O'BRIEN: Thank you,

12 Mr. Chairman.

13 And good morning, folks. I will be

14 much briefer and much simpler than my

15 colleague.

16 So, we've had a complex and probative

17 discussion this morning. I really would like

18 to slow it down a second. So, how many years

19 has government failed to make contributions to

20 the pension fund?

21 MR. GRELL: Well, there was a period

22 of about fifteen years, running from roughly

23 2000-2001, frankly, until present because of

24 the collaring that the full contribution has

25 not been made. So, roughly fifteen years. 60 1 REPRESENTATIVE O ’BRIEN: So, through

2 the Corbett administration and Rendell

3 administration, the Ridge administration, so

4 we’ve had a bipartisan effort in not making

5 payments to the fund; correct.

6 MR. GRELL: Yes.

7 REPRESENTATIVE O ’BRIEN: Say yes.

8 MR. GRELL: Sure.

9 REPRESENTATIVE O ’BRIEN: Now,

10 obviously, as a legislator, I choose to

11 participate in the pension fund. My wife, as

12 a teacher, chooses to participate in the

13 pension fund. Now, each and every paycheck we

14 make a contribution. We don’t even think

15 about it. It just happens, just make a

16 contribution.

17 So, let me ask you a question. If

18 the roof caves in, can we decide not to make a

19 contribution so we can fix the roof?

20 No, we can’t, can we?

21 MR. GRELL: As an employee, no.

22 REPRESENTATIVE O ’BRIEN: No, we

23 can’t. I see.

24 So, ultimately, it’s reasonable to

25 say that the annuitant has been lifting their 61 1 load, and government has been the deadbeat.

2 Nothing more. Thank you.

3 MAJORITY CHAIRMAN ADOLPH: Thank you,

4 Representative.

5 Representative Tom Killion.

6 REPRESENTATIVE KILLION: Thank you,

7 Mr. Chairman.

8 Good morning, everyone.

9 Glen, great to see you again.

10 MR. GRELL: Same. Thanks.

11 REPRESENTATIVE KILLION: And mine

12 will be brief. Just one question.

13 In the governor’s Budget in Brief

14 booklet, he’s talking about both PSERS and

15 SERS, it contains the following statement, on

16 page eighteen: Consolidating investment

17 management operations could save millions of

18 dollars in staff costs, eliminate duplicative

19 contracts with private investment managers,

20 and exploit strategic strengths within the

21 existing administrative systems. Continuing

22 efforts to reduce management fees could save

23 nearly 200 million, annually shaving an

24 estimated 2.3 billion from our long-term

25 unfunded liability annually. 62 1 My question is, it's a math question

2 really -- I mean, I'm all for saving 200

3 million in fees and whatever we can do

4 administratively, but -- and that will be

5 annual savings going forward, I would assume.

6 But how does that result in a 2.3-billion-

7 dollar annual reduction in the unfunded

8 liability? Those numbers just don't seem to

9 add up.

10 MR. GRELL: I think what happened

11 there is, a simple explanation is a misplaced

12 comma. I think it's supposed to say that

13 "could save nearly 200 million annually,

14 shaving an estimated 2.3 billion from our

15 long-term pension liability.”

16 REPRESENTATIVE KILLION: So -­

17 MR. GRELL: Over ten years. Correct.

18 REPRESENTATIVE KILLION: Okay.

19 Because that just threw me for a loop. I

20 would like to see that happen.

21 MR. GRELL: We would love to see that

22 as well.

23 REPRESENTATIVE KILLION: Thank you.

24 MAJORITY CHAIRMAN ADOLPH: Thank you,

25 Representative. 63 1 Representative Dean.

2 REPRESENTATIVE DEAN: Good morning,

3 and welcome, everybody. I apologize for my

4 cold-sounding conversation here.

5 Representative -- former

6 Representative Grell, I wanted to welcome you

7 back.

8 MR. GRELL: Thank you.

9 REPRESENTATIVE DEAN: We miss you in

10 the house, but, of course, we’re well served

11 by you where you are.

12 I was looking over your report, and

13 on page nine, going back to the question of

14 investment management fees, it looks like over

15 the past two years the PSERS system has been

16 able to reduce investment management fees by

17 over a hundred million dollars. And I

18 wondered how you do that.

19 And, then -- and I ask you this as a

20 layman. This is so complicated, all of this,

21 and I try each year to really understand it.

22 But if you could, in very layman’s terms, how

23 do you do it?

24 And then how do you report your

25 investment management fees? And I’m going to 64 1 compare and contrast with SERS.

2 MR. GRELL: Well, I’m simpler than my

3 chief investments officer, so I’ll take the

4 first crack at it, and if you want more, I’ll

5 ask Jim.

6 Certainly, outside manager fees are

7 something that we pay close attention to. And

8 you’re correct that we have reduced those

9 external management fees by 103 million over

10 the past two years, and we’re looking to do

11 more.

12 At PSERS, we do that by managing a

13 substantial portion of our portfolio in-house,

14 without the use of any external manager. We

15 have roughly thirty investment professionals

16 who manage about -- I think it’s about 32

17 percent of our portfolio, roughly 17 billion

18 dollars of our portfolio, simply using the

19 professional staff at PSERS.

20 We would like to do more. We have

21 requested and we’re working with the

22 administration to try to get some additional

23 complement, so that we can increase our

24 internal investment management staff. We

25 believe that if we could get four to eight 65 1 additional investment professionals we would

2 probably shave 20 million additional off of

3 that. So, that's the simple answer.

4 If you'd like something more, I can

5 have Jim tell you. But, yeah, we use external

6 managers fairly infrequently, but we use them

7 for very sophisticated investments. And, you

8 know, the simpler stuff we can do internally,

9 although we do some very complex stuff

10 internally as well. But, you know, we've

11 tracked this over the past ten years or so,

12 and we might have paid out 4 billion dollars

13 over that period in outside manager fees, but

14 we've generated an additional 12 billion

15 dollars, so we've generated 16 billion

16 dollars. So, net of the manager fees, we've

17 generated an additional 12 billion dollars

18 that we would not have had had we passively

19 invested that money or indexed that money.

20 REPRESENTATIVE DEAN: And when you

21 report that, I think that's really important.

22 So, the rate of return is 12 billion dollars

23 greater after the fees are accounted for.

24 MR. GRELL: Correct. All of our

25 investment returns are always reported net of 66 1 fees. And there are different ways that funds

2 disclose their fees. We always try to be as

3 transparent as possible and disclose anything

4 that’s arguably a fee. And so, some of

5 comparisons that you see really aren’t apples

6 to apples. There is an industry-wide effort

7 to try to standardize that reporting so that

8 it would be more apples to apples. We are not

9 there yet.

10 There are some national organizations

11 that are trying to develop reporting templates

12 and those kinds of things so you’ll be better

13 able to compare one fund versus another. But

14 we’ve always tried to err on the side of

15 disclosure of our -- all of our fees.

16 REPRESENTATIVE DEAN: Well, that’s my

17 question, and I wanted to compare it with the

18 SERS system. What is reported in those

19 numbers as investment fees? As you say,

20 there’s not yet an industry standard. But

21 what is sort of the -- what is the most

22 transparent standard that you’re following?

23 MR. GRELL: That’s above my pay

24 grade.

25 MR. GROSSMAN: Yeah. When you look 67 1 at public pension plans, it — again, it’s all

2 over the board, Glen’s exactly right, on how

3 you report fees.

4 How we report fees is, for most of

5 the managers we have, we report both their

6 base fee, so what they get every year,

7 essentially keep their lights on, hire the

8 people to manage the assets, and their

9 performance fee as well. And the areas that

10 aren’t reported at this point by most public

11 plans would be what’s called carried

12 interest -- I’m sorry -- carried interest

13 which is generally in your private equity and

14 private real estate area. That’s viewed by

15 the industry as a profit share, so a lot of

16 funds don’t even look at that as a fee, they

17 look at eight profit share. So, most funds

18 today do not report that.

19 And when you go through the different

20 funds, there’s different ways you can manage

21 assets. You can manage assets directly, in

22 which you hire a manager. So, I can hire you,

23 and I pay you a fee and performance fee, and

24 we report that. Or could I hire Glen to hire

25 you. That’s a call a fund-to-fund. Glen goes 68 1 out and hires a bunch of people, and I would

2 report maybe Glen's fees but not your fees.

3 Okay? I just get the net of fee of return.

4 So, there are differences in how

5 funds report fees across the board, even in,

6 like, private equity, there's funds that don't

7 report any fees for private equity because

8 they don't view that as a fee. They view it

9 as -- the way the waterfall works in private

10 equity is, even if I pay you a fee, I get all

11 my money back first before you get to

12 participate in any profit share down the road.

13 So, some funds don't even report that as a

14 fee.

15 But what is consistent, I think,

16 across all public plans is, they'll show the

17 report net of whatever fees exist. It's just

18 how they report them may be different.

19 We have been fairly transparent in

20 how we go about reporting it. In fact, I

21 would argue, in some cases, it creates more

22 work for our staff to pull the fees out to

23 report them than otherwise. It would be

24 simpler just not to pull them out and report

25 them, just show them net fee of return. 69 1 REPRESENTATIVE DEAN: And your

2 effort, to your point, is to be more and more

3 transparent.

4 MR. GROSSMAN: Yes. I think -- yes.

5 We try to be as transparent as possible.

6 And even with the carried interest

7 going forward, we’re trying to gather that

8 data. There’s a new industry standard. It’s

9 called ILPA template to actually gather that

10 data that just came into effect at the end of

11 last year. So, we’re going to be working -­

12 our staff is going to be working with our

13 consultants to try to pull that information

14 out, get that information from managers. But

15 it is a rather labor-intensive effort to get.

16 REPRESENTATIVE DEAN: And then what

17 is the difference between the reporting with

18 the SERS systems to PSERS system?

19 MR. DURBIN: It’s -- essentially,

20 it’s exactly the same. What we -- in the

21 interest of equal time, we’ve been dropping

22 our fees also. Since 2009, we have dropped a

23 hundred million dollars, 18 million alone last

24 year. We’re down to about 59 basis point now

25 for management. 70 1 So, we’re very pleased with the sharp

2 pencil that the board directed the staff to

3 take to fees to try and keep the very best

4 managers and trim off those which were

5 collecting fees but were not performing as

6 well as we would have liked.

7 What we follow are Government

8 Accounting Standards Board practice, and that

9 is what we can actually audit, if we can audit

10 it, it’s a value that we can place on it that

11 we can rely on. We believe in increased

12 transparency. And Jim’s absolutely right,

13 there are industry groups that are advocating

14 for an additional layer of transparency. And

15 we’re interested in what those outcomes might

16 be, and we’ll be participating because we

17 agree with the whole idea of being as

18 transparent as possible with the dollars

19 entrusted to the board.

20 REPRESENTATIVE DEAN: And in terms of

21 your reporting standards and also I was

22 thinking, in the interest of equal time, your

23 rate of return net of fees, what do you

24 report?

25 MR. DURBIN: We report net of fees, 71 1 last year, we had a .5 net of fees rate of

2 return. Really, when you get down to it,

3 because fee structures are so different from

4 plan to plan, state to state, jurisdiction to

5 jurisdiction, we really believe and continue

6 to believe that net of fees is the story you

7 want to look at for comparability, because

8 that, absent all of the expenses that you may

9 have, did you return money and how much did

10 you return to the fund.

11 REPRESENTATIVE DEAN: And are the

12 things that you count that, you know, your

13 colleagues at PSERS do not count among

14 investment fees.

15 MR. DURBIN: Not that I'm aware of,

16 no .

17 REPRESENTATIVE DEAN: Okay. Thank

18 you very much.

19 MAJORITY CHAIRMAN ADOLPH: Thank you,

20 Representative.

21 Representative Sue Helm.

22 REPRESENTATIVE HELM: Thank you,

23 Mr. Chairman.

24 And welcome.

25 I'd just like to follow up a little 72 1 bit on Representative Dean’s question. Like

2 what is the process by which outside

3 investment managers are chosen? Like, how do

4 you go about doing that?

5 MR. DURBIN: I think, first of all,

6 we have a strategic plan for the investment

7 shop, and it’s on our website. I’d like to

8 advertise it here a little bit. It’s an

9 excellent plan. It’s got a lot of good

10 information in there. Any investment that we

11 do has to fit within that strategic plan. The

12 board devises the plan to meet the long-term

13 obligations of the members of the system

14 itself. So, the asset allocation is drawn

15 from that.

16 If an idea comes, a possibility, an

17 investment opportunity arrives, it can arrive

18 from the staff. It can arrive from industry

19 news that we see. It can arrive from one of

20 the consultants. But nothing gets before the

21 board without a full due diligence review for

22 fit and for terms and conditions that we

23 believe will add value to the fund. We look

24 for adding value all the time.

25 If it passes the staff’s muster and 73 1 the consultant’s muster, then they get to go

2 before this board and try to convince them

3 that they fit within the strategy as well.

4 So, that’s the process that we go

5 through in a very general sense. I hope that

6 answered your question.

7 REPRESENTATIVE HELM: That’s fine.

8 I have one more question to PSERS.

9 PSERS administers a Health Option Program for

10 retired school employees. And I’d just like

11 to know, does the commonwealth subsidize the

12 HOP program costs?

13 MR. GRELL: The commonwealth does not

14 subsidize either the Health Options Program.

15 That’s all member-paid premiums. There is a

16 Premium Assistance Program that is available

17 to certain eligible retirees. That provides

18 them up to a hundred dollars per month of

19 contribution or subsidy toward their premium,

20 but that is factored into the employer

21 contribution rate. So, there’s no separate

22 subsidy coming from the state. It’s a small

23 piece. I think this year it’s about .8

24 percent of the employer contribution rate that

25 goes to fund the Premium Assistance Program, 74 1 which was created by the general assembly.

2 REPRESENTATIVE HELM: Thank you.

3 And thank you, Mr. Chairman.

4 MAJORITY CHAIRMAN ADOLPH: Thank you.

5 Representative Bullock.

6 REPRESENTATIVE BULLOCK: Thank you,

7 Chairman.

8 Could you explain or just share with

9 us what are the effects of the different

10 pension-related bills we had on the pension

11 system over the last fifteen years?

12 MR. GRELL: In five minutes or less?

13 REPRESENTATIVE BULLOCK: If you could

14 try.

15 MR. GRELL: Welcome to the general

16 assembly, by the way, Representative.

17 REPRESENTATIVE BULLOCK: Thank you.

18 MR. GRELL: Actually, probably the

19 best place to look, if you're looking for sort

20 of the net effect of all of that, I believe

21 it's at page eight of the highlights piece

22 that we gave you. It's a pie chart. And if

23 you look at the combination of the green pie,

24 which is 22 percent due to benefit

25 enhancements, that was as a result of 75 1 legislative change, and then there’s a small

2 piece that deals with changes to assumptions,

3 cost methods, net demographics, and salary

4 experience. So, the combination of those two,

5 about 22 percent of the unfunded liability is

6 a result of various legislative enactments

7 that have modified either the benefits that

8 are granted, making them retroactive, for

9 example, or the way that we calculate and

10 amortize the pension system.

11 REPRESENTATIVE BULLOCK: Thank you.

12 The second set of questions I have

13 for both SERS and PSERS, and that’s in regards

14 to your workforce. If you could share with me

15 the demographics of your work force and how

16 you -- what policies or activities does your

17 department take to reach diversity within

18 that.

19 MR. DURBIN: We have a hundred

20 ninety-seven individuals on the SERS

21 complement. And right now, roughly 10 percent

22 of them represent diversity in terms of their

23 ethnicity, their declared ethnicity. We are

24 more female than male in terms of our

25 workforce. And we’ve undergone quite a 76 1 generational shift. We have a lot younger

2 staff than we’ve had. We have retired out a

3 number of our senior people over the years,

4 and we’re -- so we’re changing in terms of our

5 character and our nature.

6 Am I getting at what you’re asking

7 about, ma ’am?

8 REPRESENTATIVE BULLOCK: You hit it

9 right on the nail. Thank you.

10 MR. GRELL: At PSERS, we have a

11 complement of about three hundred sixteen.

12 We’re currently capped because of hiring

13 restrictions at three hundred. We’re also a

14 little bit more female. We’re 53.5 percent of

15 the agency is female, 48.7 percent of our

16 agency management is female. In terms of

17 minority, we’re about 11.7 percent of the

18 total agency workforce is members of minority

19 groups.

20 REPRESENTATIVE BULLOCK: Great.

21 Thank you, gentlemen.

22 MAJORITY CHAIRMAN ADOLPH: Thank you,

23 Representative.

24 Representative Duane Milne.

25 REPRESENTATIVE MILNE: Thank you, 77 1 Mr. Chairman.

2 I'd like to raise a question about

3 fiscal strategy of de-risking and see if I can

4 solicit some thoughts from the assembled team

5 here.

6 As this team certainly knows,

7 de-risking takes a couple different

8 iterations, but the general concept being that

9 we would look at private sector approaches

10 to -- as possible ways to manage the public

11 sector plans, and one of those potential ideas

12 would be, could some or all of the portion of

13 the unfunded liabilities be transferred to

14 private insurance companies through some sort

15 of competitive bid process. This would

16 protect the annuitants themselves, give the

17 state a little bit of fiscal shield. And,

18 obviously, I would like to get a sense of what

19 your thoughts are about de-risking strategies.

20 Is that a feasible option for the state?

21 MR. GROSSMAN: I will touch on that

22 quickly. So, what you're thinking about would

23 be, so a retired employee, actually moving

24 them off the books would be one way to do it.

25 Would be to annuitize it. Correct? Do 78 1 something called a single premium immediate

2 annuity.

3 The issue with that today would be it

4 would be very expensive to do because when you

5 think about it, if you took an employee and

6 moved them off, and they have a benefit

7 they’re going to get or a cash flow they’re

8 going to get for the rest of their life, what

9 the insurance company will do or the

10 third-party provider, they’ll discount those

11 cash flows back at what they think they can

12 earn in a relatively risk free standpoint,

13 maybe add a little bit of risk to it.

14 So, it would probably be very

15 expensive at this point to do it, given the

16 ten-year treasury yield is around 1.9 percent.

17 You know, you might be able to get them to

18 present value, those cash flows, 2 to 3

19 percent, but that would be the best you could

20 get. And we’re discounting those liabilities

21 today at 7 and a half percent. So, it would

22 be very expensive. I mean, you could move the

23 longevity risk off but it would be a

24 significant amount of money today to do it.

25 REPRESENTATIVE MILNE: Significant 79 1 for the insurance companies, or significant

2 for the state, or -­

3 MR. GROSSMAN: For the state. Yeah.

4 the insurance company’s not going to take on

5 that risk unless they get compensated for it.

6 And they’re going to want to get a bigger

7 amount of money than we would have set aside

8 for those members at this point in time.

9 MR. DURBIN: If I could just add,

10 sir. From our perspective, the concepts are

11 often being floated with a variety of

12 different possibilities. What we’ve looked at

13 is what can you actually book? What can you

14 put on the books as an asset?

15 When we’ve had this question come up

16 before, we’ve researched the GASB

17 pronouncements on this or where they feel that

18 that ought to be, and what they have told us,

19 at least initially, the money actually paid is

20 what you can actually book. The face value of

21 policy is not something that can be booked.

22 When you do that, you don’t get very much bang

23 for the dollar. That’s at least our initials.

24 But I would suggest, as always, the devil’s in

25 the details on how the concept is actually 80 1 structured to work.

2 REPRESENTATIVE MILLARD: Um-hum.

3 MR. GROSSMAN: I think one other

4 point to make is you could move those

5 liabilities off, but you're still -- you're

6 still on the hook should that provider fail.

7 So, if the insurance company goes bankrupt,

8 the liability comes back to the commonwealth.

9 So, if you get a provider that's overly

10 aggressive in trying to price that product and

11 they're not able to meet the obligations ten

12 years down the road and they go bankrupt, we

13 would be back on the hook to have to make the

14 remaining payment to that individual's life.

15 MR. GRELL: Let me just add that we,

16 certainly -- as Jim's mentioning, we certainly

17 understand our responsibility to our

18 annuitants, and we certainly are not looking

19 at any proposals whereby we would sell off our

20 obligation to our retired school employees

21 under any circumstance.

22 REPRESENTATIVE MILLARD: All right.

23 Thank you.

24 Thank you, Mr. Chairman.

25 MAJORITY CHAIRMAN ADOLPH: Thank you, 81 1 Representative.

2 Representative Schreiber.

3 REPRESENTATIVE SCHREIBER: Thank you,

4 Mr. Chairman.

5 Thank you all for being here today,

6 and thank you for your testimony and all that

7 do you on a daily basis for the commonwealth.

8 A couple quick questions. And the

9 first one I’ll direct to PSERS and Mr. Grell.

10 It’s good to see you again, too.

11 MR. GRELL: Thank you.

12 REPRESENTATIVE SCHREIBER: Last year,

13 the Senate sent over a bill to the House,

14 Senate Bill 1082, that included -- in their

15 version of the bill, had included some

16 collars.

17 Could you just explain briefly what

18 the additional long-term costs would have been

19 if the rate had been set by the PSERS board

20 had included the capped amount that was

21 proposed by the Senate?

22 MR. GRELL: Well, the whole idea of

23 rate collars, that’s what we put into Act 120,

24 and the employer contribution could not go up

25 more than 4 and a half percent. 82 1 As we’ve said earlier, we’re finally

2 reaching the point where those rate collars

3 are no longer required. That is what kept us

4 from getting to a hundred percent of the

5 actuarial value.

6 Any proposal that would further

7 collar the rates or would reinstitute

8 collars -- I think that was one at 2.25

9 percent maximum increase for next fiscal

10 year -- that would have the effect of

11 continuing the underfunding for at least one

12 more year than would have otherwise been

13 required, and it would have added to the pie

14 shaped thing on page eight that shows the cost

15 to the fund due to previous employer

16 underfunding.

17 So, we typically do not take

18 positions on legislative proposals, but that

19 one aspect of the proposal goes so deeply to

20 the very funding of the pension fund that our

21 board, and I believe the SERS board also, felt

22 that that was an appropriate situation for our

23 board to take action to go on record against

24 the further collaring of rates.

25 REPRESENTATIVE SCHREIBER: Thank you. 83 1 And could you, either gentlemen, SERS

2 or PSERS, could you speak generally to the

3 economic impact that our retirees and the

4 pension plans themselves have to the

5 commonwealth of Pennsylvania?

6 MR. DURBIN: Sure. From the SERS

7 perspective, we distributed 3.1 billion

8 dollars in annuity payments, 2.9 billion of

9 that went to Pennsylvania addresses, some of

10 these in the northern tier counties. We

11 believe we're one the largest economic

12 drivers, along with PSERS, into those

13 communities.

14 MR. GRELL: Well, on page five of our

15 highlights, we show that separately for you

16 all. We paid out 6.3 billion dollars to

17 retirees in calendar year 2015, 90 percent of

18 those, the 1099s went to Pennsylvania

19 residents, representing 5.7 billion dollars

20 going directly to Pennsylvania and to local

21 economies.

22 And on that page five, we show a

23 breakdown by county, showing the economic

24 impact of retirement benefits to each county

25 in the commonwealth. And we translate it into 84 1 a total economic impact of our system of 10.2

2 billion dollars per year.

3 REPRESENTATIVE SCHREIBER: Thank you.

4 And one final question. And this I

5 understand is a much larger discussion,

6 probably saved for not in a room like this

7 today. But just as a practice, you are our

8 experts, do you ever look at a comparison and

9 contrasting of the state of pensions in

10 Pennsylvania and the state of 401Ks from a

11 retirement -- purely from a retirement

12 security perspective? And if so, is that

13 information you could ever share or would be

14 of value to this body?

15 MR. DURBIN: I can say from SERS’

16 perspective, that’s not a study we’ve ever

17 done.

18 REPRESENTATIVE SCHREIBER: Okay.

19 MR. GRELL: We’ve not done it, but

20 more studies come across my desk and my e-mail

21 than you could imagine. And there are some

22 very good studies, some fairly current

23 studies, from the Boston College Center for

24 Retirement Research, and also Cal Berkeley did

25 a study of the California state teachers’ 85 1 retirement system, contrasting the value of a

2 traditional DB versus a DC plan. And also the

3 National Institute on Retirement Security,

4 NIRS, does a lot of research on the area of,

5 you know, generating that exact kind of data.

6 So, if you’d ever like to read a lot

7 of studies, I’ll be happy to share them with

8 you.

9 REPRESENTATIVE SCHREIBER: Excellent.

10 Thank you very much.

11 Thank you, Mr. Chairman.

12 MAJORITY CHAIRMAN ADOLPH: Thank you.

13 Representative Keith Greiner.

14 REPRESENTATIVE GREINER: Thank you,

15 Mr. Chairman.

16 Good morning, everyone.

17 MR. GRELL: Good morning.

18 REPRESENTATIVE GREINER: I have one

19 quick question, and then I want to switch

20 gears to PERC.

21 But to start, the boards of trustees

22 for both PSERS and SERS have mission

23 statements that prescribe maintenance of

24 financially sound pension systems and prudent

25 investment of the system’s assets as part of 86 1 their outlined missions. And while I respect

2 that fiduciary responsibility of the board and

3 employees, I do need to ask that, when you

4 make decisions, are the taxpayers of this

5 commonwealth taken into consideration in the

6 way that you undertake your missions?

7 MR. DURBIN: I would suggest always.

8 The board's very much aware of the fact that

9 the employer contributions, whether they come

10 from tax dollars or from permittee fees,

11 license fees, grants, whatever source they

12 arrive to us, they're representing the

13 contributions that are made. And for that

14 reason, the board is very prudent as far as

15 the investment and the operation of the fund

16 itself.

17 So, yes, I believe that that is

18 always in the mind of the board.

19 REPRESENTATIVE GREINER: I think

20 that’s very important. I just wanted to get

21 you thoughts on that, because I know it’s a

22 very complex issue. Appreciate your answer.

23 I don’t know if anybody else has any

24 thoughts.

25 MR. GRELL: I would agree. I mean, 87 1 certainly our fiduciary obligation as trustees

2 of a trust fund and employees of that trust

3 fund goes principally to our members. But, as

4 part of our mission to maintain the stability

5 of that fund into the future so that we know

6 that a hundred years from now that fund will

7 still be paying out monthly benefits to

8 retirees, we have to run that fund in as

9 economical a way as possible. And we always

10 keep in mind the fact that a portion of the

11 money that comes to us does come from

12 employers, in our case, school districts and

13 the commonwealth, so we have to be mindful to

14 be as efficient as we can with those dollars.

15 REPRESENTATIVE GREINER: I know,

16 because a lot -- the taxpayers help foot this

17 bill, that’s why I wanted to ask.

18 Let’s follow up on PERC. Chairman

19 Metcalfe had brought it up earlier. The

20 Public Employer Retirement Commission was

21 created by Act 66 of 1981 to provide an

22 ongoing mechanism to monitor public employee

23 retirement plans and to assure their actuarial

24 viability by review of proposed changes and

25 reforms in the plans and to review relevant 88 1 statutes.

2 PERC was created as an independent

3 commission to provide an independent

4 assessment of legislation affecting state

5 municipal pension systems. I think we all

6 know that until February 12th of this year,

7 the government -- governor then tried to turn

8 the lights out on PERC. And -- because he

9 entirely vetoed their funding.

10 What was the extent of each of the

11 systems — of your system's contact with PERC?

12 Was there any contact with that before that

13 happened? Do you know?

14 MR. GRELL: Well, we were not aware

15 that that was going to happen before it

16 happened.

17 But in terms of what contact we have

18 with PERC generally, we work with them closely

19 in the preparation of actuarial notes for

20 legislature.

21 REPRESENTATIVE GREINER: Let me

22 just -- I just have a series of about three

23 more questions.

24 Are PERC -- on page seventeen of the

25 governor's Budget in Brief, he -- his budget 89 1 proposes to abolish the Public Employer

2 Retirement Commission to eliminate redundancy.

3 That’s his term, to eliminate redundancy.

4 From your perspective, do you think

5 the PERC actuarial notes are redundant?

6 MR. DURBIN: Well, to the extent -­

7 answering for SERS at this point, to the

8 extent that we get accurate, independent

9 information from our actuary, we absolutely

10 agree that we can rely on those numbers.

11 What's -- setting aside the municipal

12 issue entirely, but looking at state plans in

13 itself, I would harken back to the act that

14 created it. The reason that you created it

15 was because tax -- not tax law, but retirement

16 codes are complex. They're very complicated.

17 The average pension bill that we've seen is in

18 excess of three hundred pages, and I think the

19 general assembly decided they wanted some

20 assistance, some expertise, to be able to

21 analyze that in an objective fashion. I think

22 that was the original objective of that.

23 We'll certainly cooperate with

24 whatever organization has that responsibility

25 going forward. But what the actuaries, from 90 1 at least SERS’ perspective -- and Glen can

2 answer for buck — what they do is they

3 validate the numbers. They show you what the

4 impact is. What they do not do is tell you

5 what the public policy decision ought to be.

6 REPRESENTATIVE GREINER: So, you say

7 you think it is redundant, or you don’t think

8 it’s redundant, the job that they do?

9 MR. DURBIN: I think that’s for you

10 to decide whether or not you’re willing to

11 accept one set of numbers as being sufficient.

12 MR. GRELL: From our standpoint, we

13 typically do not add what PERC calls "policy

14 considerations” to their actuarial notes. We

15 provide them with the data, and we try to

16 resolve any questions they have.

17 A good example of the value of PERC

18 was, in the recent flurry of activity a couple

19 months ago on pension legislation, both

20 systems were asked to draft some legislation,

21 and there was a disconnect between the sponsor

22 of the bill and the funds in terms of how

23 disability retirements were to be handled. We

24 wrote it one way; SERS wrote it another way.

25 And our actuaries crunched the numbers, based 91 1 on the way that provision was written, one

2 value. It was not a mistake on either part,

3 but there was an inconsistency between what we

4 sent to PERC and what SERS sent to PERC, and

5 their actuaries, even though they had very

6 little time to review our work, they picked

7 that discrepancy up, and they asked us which

8 i s right.

9 And -- so, there is sort of an

10 oversight role, but as I mentioned before,

11 unless PERC is given the resources and the

12 time to do their job, the veil of independence

13 may not really be there.

14 REPRESENTATIVE GREINER: And I would

15 agree with that. I understand that.

16 Let me ask your opinion, both of you,

17 what do you think about PERC being aligned as

18 a government support agency, similar to maybe

19 the independent fiscal office? Do you have

20 any thoughts on that?

21 MR. DURBIN: I go back to my previous

22 comments, sir, how the general assembly

23 decides that they need obtain this advice,

24 where that resides, on whose staff they

25 report, those kinds of decisions are -- you’re 92 1 better attuned to that than we are, and we’re

2 fully prepared to cooperate with that effort.

3 REPRESENTATIVE GREINER: Understood.

4 MR. GRELL: I would agree with that.

5 REPRESENTATIVE GREINER: Thank you.

6 One last question. PERC is also

7 responsible for preparing actuarial notes for

8 constitutional amendments. Do you prepare

9 actuarial notes for constitutional amendments?

10 MR. DURBIN: We do cost notes that

11 affect the pension plan only.

12 MR. GRELL: I mean, if there was a

13 pension — a pension -- a constitutional

14 amendment related to a pension provision, we

15 would generate the data, but we wouldn’t draft

16 an official note.

17 REPRESENTATIVE GREINER: Understood.

18 Like I said, I appreciate it. You know, it’s

19 in the courts right now. And I just wanted to

20 follow up with the question that Chairman

21 Metcalfe had. And I know that — I tried not

22 to be redundant in my questions, but I did

23 want to clarify some of the things that he

24 asked before.

25 Thank you, Mr. Chairman. 93 1 MAJORITY CHAIRMAN ADOLPH: Thank you,

2 Representative.

3 Representative Matt Bradford.

4 REPRESENTATIVE BRADFORD: Thank you,

5 Chairman Adolph.

6 I just wanted to follow up with one

7 thing originally, which is Act 120. I think,

8 whether you are a fan of the plan design as we

9 currently have it, or prior to Act 120, I

10 think one thing that is worth noting is that

11 it really ramped us up to a day where, after

12 fifteen long years, we can honestly say we're

13 making our actuarially required payment. And

14 I just think that is such an important thing.

15 I know it's been mentioned a couple times, but

16 that really sets the stage for having a real

17 honest conversation.

18 And while bipartisan blame is often

19 given, I think bipartisan credit, even to our

20 former governor, who I think, over the last

21 four years, while legislators and governors

22 were tempted to pull back from the

23 requirement, that Act 120 really set us moving

24 in a direction of making the payment.

25 I think it's important that now we 94 1 can have an honest discussion when we’re

2 finally making the payment and start to really

3 see, okay, what has the bad decisions in the

4 past meant and what’s going to be the

5 cumulative cost about that. I think that

6 really sets us up for a more intelligent

7 conversation, and hopefully we can start

8 looking at the real costs of making pension

9 changes for future employees, with an eye

10 towards, frankly, we incurred a debt, and that

11 debt’s going to have to be paid off and

12 there’s an amortization schedule.

13 But I won’t say there’s a light at

14 the end of the tunnel, but at least there’s a

15 payment plan. And we’re not accruing more

16 debt as we’re going through it. And I think

17 that’s important to recognize the achievement

18 of both Democratic and Republican legislative

19 leaders. I think it’s a much better spot than

20 where we’ve been in the past.

21 One of the things, though, I did want

22 to follow up, and Representative Kampf had

23 mentioned kind of, you know, looking at

24 individual years, in particular the market

25 losses or the tough market that we’re dealing 95 1 with currently and, I guess, in the year prior

2 and how that plays out in terms of an overall

3 picture. And, again, one of the good things

4 that I think we’ve gotten past was in the

5 early 2000s, again, Democratic governor,

6 Republican legislature, but we kind of

7 divorced market gains from market losses, and,

8 again, that had a real screwy impact on the -­

9 and I guess screwy’s a nice way, maybe a

10 generous way, of saying, really, was less than

11 ideal in terms of saying how frankly -- I

12 don’t want to say disingenuous, but

13 disingenuous we were in what the debts were

14 and what the cost of not making pension

15 payments and such and how we were accruing

16 those costs.

17 I guess one of things, though, is,

18 after listening to Representative Kampf, and

19 saying, okay, if we lose -- we have a 3

20 percent gain this year, and we were supposed

21 to have 7 and a half percent, you know, does

22 that mean that the unfunded liability goes up

23 4 percent? Does that mean the employer

24 contribution goes up 4 percent? I think the

25 answer, obviously, was no, you’re looking at a 96 1 long-term view of things. And I was kind of

2 looking over the -- you know, I guess the last

3 thirty years, which is the window we typically

4 look at, and I guess over the last thirty

5 years, twenty-one years had a rate of return

6 above 7 and a half percent. It seems,

7 eighteen years were above 10 percent. Three

8 years had rate of return of above 20 percent.

9 And one year, the great recession of ’08,

10 obviously, the loss was in excess of 20

11 percent.

12 After any one of those particularly

13 volatile up or down years, the impact — if

14 the market lost 20 percent, God forbid,

15 tomorrow, that doesn’t mean the employer

16 contribution goes up 20 percent or vice versa.

17 Is that — that’s a fair assessment? They’re

18 completely -- they’re not divorced from each

19 other, but the impact isn’t all felt in one

20 year. That’s why we smooth over a period of

21 years. Is that correct?

22 MR. GRELL: That’s correct.

23 REPRESENTATIVE BRADFORD: So, again,

24 not to belabor the point, but the debt isn’t

25 going away because we have one good year, and 97 1 the debt isn’t going to balloon

2 astronomically, though it’s already pretty

3 large, conversely, if we have a bad year.

4 Okay. One of the things I also want

5 to follow up was the issue of fees. And

6 Montgomery County, which I’m from, has been in

7 the forefront of dealing with the fees. And I

8 know the governor has spoken quite a bit about

9 the need to deal with fees. And I know, I

10 think it was tab sixteen in the PSERS book

11 goes into laying out who received fees from

12 the commonwealth — or from the -- from the

13 pension fund for this past year.

14 Just so I understand, are these

15 contractual management fees that are separate

16 from -- from gains or losses that they may

17 have with the funds that they manage, or how

18 does that play out?

19 MR. GROSSMAN: Yeah. The fees that

20 we show are the fees that were paid directly

21 to them. So, it could be either a management

22 fee, so they’re managing the fund, you know.

23 When we enter a contract with them, we’ll pay

24 them a fixed management fee. And then it

25 could, if they have a performance component, 98 1 if they earn their performance component, that

2 would be included in the fee as well.

3 REPRESENTATIVE BRADFORD: So, if it's

4 like a hedge fund or private equity and

5 there's a carry fee in it, does that show up

6 in this?

7 MR. GROSSMAN: In the hedge funds'

8 case, yes, we show the performance fees. In

9 private equity, no, the carried interest does

10 not show up in those numbers.

11 REPRESENTATIVE BRADFORD: Okay. Is

12 that kind of standard? Is that kind of the

13 best you can do in light of how it's kind of

14 baked into the cake, so to speak?

15 MR. GROSSMAN: Yeah. The collection

16 of carried interest is very difficult and it's

17 time consuming. As I indicated earlier, ILPA

18 has a new template, Institutional Limited

19 Partners Association -- Partnership

20 Association, we're going to try to start

21 gathering that data.

22 But, again, there's no consensus in

23 the market on whether that's a fee or not. I

24 mean, even if you look at federal tax code,

25 they have a special treatment for carried 99 1 interest, right? It’s a 20 percent capital

2 gains-type tax. You know, and one fund -- it

3 will be an example, if you and I were to go

4 buy a house together, and you have really the

5 construction expertise; I don’t know how to

6 deal with a hammer. But I have the capital,

7 right? I have the capital; you have the

8 expertise. I put up 90 percent; you put up 10

9 percent. You really put your work into the

10 house. The house price goes up. I give you

11 20 percent of the excess gains, because you’re

12 putting the labor in to make the company

13 better or the house better, so that when you

14 sell it, there’s a -- there is that carried -­

15 that’s essentially what carried interest

16 represents. So, a lot of people would not

17 consider that a fee. They consider that,

18 well, that’s just a profit share, because you

19 have the expertise and I don’t, and we’re just

20 splitting the gains. I have the capital but

21 not the expertise and so on.

22 So, there’s only -- I would say,

23 if -- I can count on one hand the number of

24 funds that actually report carried interest as

25 an expense. Very few do. 100 1 MR. DURBIN: I would add to that that

2 I agree. That's exactly the difficulty that

3 we face in trying to look at that issue of

4 carried interest and how do you analyze it,

5 and how do you analyze it fairly in

6 comparison.

7 But it is something of interest to

8 us. So, the board has taken that on as one of

9 their objects that they would like to look at

10 this year, to see if there's a way to get at

11 that number to have increased transparency.

12 And we're not sure exactly how that will come

13 out yet.

14 REPRESENTATIVE BRADFORD: Great.

15 Thank you, gentlemen.

16 Thank you, Chairman.

17 MR. GROSSMAN: Thank you.

18 MAJORITY CHAIRMAN ADOLPH: Thank you.

19 Representative Seth Grove.

20 REPRESENTATIVE GROVE: Thank you,

21 Mr. Chairman.

22 Lady and gentlemen, thank you so much

23 for coming in today.

24 I first want to hit on the fifteen

25 years of kind underfunding the pension system. 101 1 Is there a cap on employer payments when a

2 plan hits a certain percent funded level?

3 MR. DURBIN: A cap on payments.

4 REPRESENTATIVE GROVE: Yes.

5 MR. DURBIN: If you do an actuarial

6 calculation that shows -- and this happened

7 for two years for SERS at least, where we had

8 sufficient assets that we didn’t need an

9 employer contribution, and actually a rate of

10 zero was ascribed, because we were overfunded

11 at that point. So, that’s what we chose -­

12 that’s what the board chose to do, was to

13 certify a rate at zero. So, there would be no

14 employer contributions for two fiscal years.

15 There’s no cap, per se, that I know

16 of. It’s the natural calculation of the

17 actuarial valuation that we use. That would

18 be how I would respond to that.

19 MR. GRELL: Yeah, I’m hearing what

20 you’re asking is a floor on the rate? A

21 minimum? There’s -­

22 REPRESENTATIVE GROVE: Or a maximum.

23 Let’s say the plans are 103 percent funded.

24 Is -- could we, as a general assembly,

25 continue to just appropriate money into those 102 1 funds and create almost -­

2 MR. GRELL: Well, I mean, you don’t

3 appropriate money into the fund. It comes

4 into the fund through the employer

5 contribution rate. I mean, I guess there

6 could be a situation where you’re 120 percent

7 funded and still requiring an employer

8 contribution. But I don’t think there would

9 be a cap on it.

10 The problem that Mr. Durbin was

11 talking about is, you know, do you have a

12 floor, so that even if times are good, do you

13 say, under no circumstance will the employer

14 contribution be zero. They’ll always be

15 paying 2 or 3 or 4 percent into the fund. I

16 would call that a floor.

17 REPRESENTATIVE GROVE: Okay. Got

18 you. But there’s no -- even if the federal

19 government allows overfunding of pension plans

20 over certain percentages, there’s no really

21 excess amount you can put in.

22 MR. DURBIN: Not that I’m aware.

23 MR. GRELL: I’m not aware of that.

24 REPRESENTATIVE GROVE: For the

25 fifteen years where money didn’t flow into the 103 1 pension plans, where did that money go? It

2 was at zero. We basically reappropriated

3 money in the general assembly and the school

4 districts at the same time they were at zero,

5 so I assume that money went somewhere else.

6 Correct?

7 MR. DURBIN: If I could, sir, I would

8 just like to make a slight adjustment to that.

9 There have always been, other than those two

10 years, employer contributions flowing into the

11 fund. It's not as if they haven't paid.

12 The point is that they have not made

13 perhaps what the ARC payment was during those

14 periods of time. And there's a distinction

15 between those two. And I assume that those

16 funds were used for other purposes, the

17 general government.

18 MR. GRELL: Or possibly, at the

19 school district level, they were retained by

20 the taxpayers because their taxes didn't go up

21 that year to cover the increased employer

22 contribution rate.

23 REPRESENTATIVE GROVE: Okay. But on

24 the other hand, they could have also -­

25 MR. GRELL: They could. 104 1 REPRESENTATIVE GROVE: -- been up if

2 they weren’t paying their allocation in. They

3 could have increased contracts -­

4 MR. GRELL: They could have done

5 that.

6 REPRESENTATIVE GROVE: -- programs,

7 et cetera.

8 MR. GRELL: And this is anecdotal,

9 but I know some school districts saw what was

10 coming and they put money into pension

11 reserves. So, that when the day of reckoning

12 came, they would be better equipped to handle

13 the increased employer cost.

14 REPRESENTATIVE GROVE: Okay. Fair

15 enough.

16 Both of your budgets, you’re asking

17 for increases in your employee benefits. For

18 SERS, you’re asking for 4.5 percent increase,

19 little over a million dollars, IT and cover

20 employee benefits. And PSERS, you’re looking

21 for employee benefit increases of 682,000

22 dollars.

23 What is the cause of that employee

24 benefit increase?

25 MR. GRELL: It’s SERS employer 105 1 contribution that we have to -­

2 MR. DURBIN: Contribution rate

3 increase.

4 REPRESENTATIVE GROVE: All right.

5 So, it’s your own pension costs.

6 MR. DURBIN: That’s correct.

7 MR. GRELL: In part. And also, you

8 know, benefits, the other benefits.

9 REPRESENTATIVE GROVE: Benefits.

10 Salary increases?

11 MR. GRELL: Very modest.

12 REPRESENTATIVE GROVE: Very modest.

13 MR. DURBIN: Small ones, yeah.

14 REPRESENTATIVE GROVE: Okay. Just

15 wanted to clarify that.

16 Recently S and P came out with

17 analysis from March 3rd, just kind of hitting

18 the press right now. Summary of Pennsylvania

19 appropriations general obligation, more

20 obligation, tax increments.

21 Within the analysis, both -- it cites

22 on page four and page five, one about the,

23 quote, compromised budgets, states that it

24 exceeds — expenditures exceed revenues. And

25 then for the governor’s proposed budget, for 106 1 ’16 and ’17, it says expenditures exceed

2 revenues.

3 When we have expenditures that exceed

4 revenue, is that a method for paying off

5 unfunded liability and fixing a structural

6 deficit imbalance?

7 MR. GRELL: Is that a trick question?

8 REPRESENTATIVE GROVE: It’s a

9 question.

10 MR. GRELL: If your expenses exceed

11 your revenues.

12 REPRESENTATIVE GROVE: Yes.

13 MR. GRELL: That does not bode well

14 for paying all of your debts, let alone

15 prepaying on, you know, future debts.

16 REPRESENTATIVE GROVE: Okay. Thank

17 you.

18 MAJORITY CHAIRMAN ADOLPH: Thank you,

19 Representative.

20 Representative Acosta.

21 REPRESENTATIVE ACOSTA: Good morning.

22 And thank you, Chairman.

23 And thank you, gentlemen and ladies,

24 for being here today this morning.

25 I have a quick question. As a member 107 1 of the State Government Committee, we have

2 debated, discussed, and assessed pension bills

3 using Act 20 as a benchmark. But the pension

4 bills thus far presented in committee, they do

5 not provide a clear path in paying off the

6 pension debt any sooner. It may impair

7 contracted benefits, reduce benefits

8 significantly, and do not provide immediate

9 relief.

10 The question is, when will we see a

11 proposal that pays off the debt faster than

12 Act 120?

13 MR. DURBIN: That's a question for

14 this committee, for the general assembly as a

15 whole, to develop whatever proposals you

16 believe would be more effective in that. The

17 responsibility on this side of the table is to

18 administer the benefits as you give them to

19 us .

20 MR. GRELL: I would add to that, that

21 we work with members of the general assembly

22 quite often and to quite an extent to take

23 their ideas and give them honest feedback and

24 numbers to support those proposals.

25 We don't make proposals, but we work 108 1 with any member of the general assembly who

2 has an idea on how to address the problem. We

3 typically draft the legislation. We typically

4 crunch some numbers internally. And when it

5 reaches a certain level, we engage our outside

6 actuaries to provide actuarial data. But we

7 don’t make proposals.

8 We’re happy to talk to any legislator

9 or committee about those proposals. But the

10 proposals have to come from within.

11 REPRESENTATIVE ACOSTA: Can you at

12 least say, on record today, that Act 20 (sic)

13 is working?

14 MR. GRELL: Act 120 has done a lot of

15 very good things. As I said earlier, it has

16 taken -- it has put the state on a very

17 disciplined fiscal course to pay our

18 actuarially required contribution. We

19 currently have about 50,000 employees that are

20 covered under the Act 120, which is the less

21 expensive -- the less generous, but the less

22 expensive benefit. But the major

23 accomplishment of Act 120 is that, next year,

24 the commonwealth will be paying 100 percent of

25 the actuarially required contribution. And 109 1 that is a monumental first step in finally

2 addressing this problem.

3 REPRESENTATIVE ACOSTA: Thank you. I

4 tried.

5 Thank you so much.

6 Thank you, Chairman.

7 MAJORITY CHAIRMAN ADOLPH: Thank you,

8 Representative.

9 Representative Karen Boback.

10 REPRESENTATIVE BOBACK: It was

11 discussed about the HOP program, but is that

12 still the same as the Premium Assistance

13 Program?

14 MR. GRELL: No. It’s two separate —

15 well, it’s part of the same program. The HOP

16 program is the Health Options Program, under

17 which we do -- we provide the ability for our

18 retired teachers to obtain well-priced health

19 insurance post retirement. We have about a

20 hundred thousand retirees who participate in

21 that program. They pay their own premiums for

22 their health insurance.

23 The Premium Assistance Program is a

24 program that was enacted by the legislature to

25 provide a modest amount of assistance to those 110 1 HOP enrollees to go to help pay their premium.

2 As I said, it covers up to a hundred dollars

3 per month toward the premium that the member

4 is paying. And that fund comes from an

5 assessment as part of the employer

6 contribution of currently about .8 percent per

7 year.

8 REPRESENTATIVE BOBACK: So, anyone

9 who wants to opt into that program is

10 eligible?

11 MR. GRELL: Well, there are certain

12 eligibility requirements. You have to be

13 retired from a school district. And it's -- I

14 believe it's pre age sixty-five, so it's for

15 that gap period where folks may retire but not

16 yet be eligible for Medicare.

17 But, yeah, if they're eligible, they

18 are — I mean, we do group purchasing. We

19 have many different providers across the

20 state. And we think we get fairly competitive

21 pricing.

22 REPRESENTATIVE BOBACK: And it's not

23 subsidized by the commonwealth.

24 MR. GRELL: The health insurance

25 program is not -- neither the premiums nor the 111 1 administrative costs of the Health Options

2 Programs are subsidized at all by the

3 commonwealth.

4 REPRESENTATIVE BOBACK: Thank you.

5 And a question for SERS. How much

6 was expended in legal costs last year -- I

7 think it was maybe two -- in the Jerry

8 Sandusky case with the forfeiture?

9 MR. DURBIN: It was over actually two

10 years, two calendar years, that outside legal

11 counsel, 447,000 dollars.

12 REPRESENTATIVE BOBACK: Thank you.

13 Thank you, Mr. Chairman.

14 MAJORITY CHAIRMAN ADOLPH: Thank you,

15 Representative.

16 Representative Dunbar.

17 REPRESENTATIVE DUNBAR: Thank you,

18 Mr. Chairman.

19 Good afternoon. I guess we’re to

20 afternoon now.

21 I just wanted to follow up briefly on

22 what Chairman Adolph had said at the beginning

23 of the hearing. He had referred to, you know,

24 concerns that a lot of retirees and future

25 retirees had about the health of the plan, and 112 1 he had mentioned the unfunded liability.

2 But in addition to the unfunded

3 liability, another concern that we hear quite

4 a bit, you may read it in the paper or hear

5 discussions is the negative cash flow

6 situations that you both go through. And in

7 the last ten years, I read estimates that that

8 negative cash flow for PSERS was about 32

9 billion and for SERS about 16.9 billion.

10 Could you tell me what you were -­

11 what your amounts for your negative cash flow

12 was for last year, either in dollars -­

13 preferably in percentage?

14 MR. DURBIN: On a percentage basis, I

15 think we’re at 5.1 for SERS.

16 REPRESENTATIVE DUNBAR: 5.1.

17 Glen?

18 MR. GROSSMAN: For the last fiscal

19 year ending June 30th, 2015, was about 5

20 percent.

21 REPRESENTATIVE DUNBAR: Okay. So -­

22 and everything I’ve read that other public

23 pension funds, I’ve read anywhere from 2.1 to

24 2.7 percent is an average. Is that correct?

25 MR. GROSSMAN: Yeah. I think last 113 1 year it was 2.1 percent. But it ranged over

2 the last five years between, I think, 2.7 and

3 2. 1.

4 REPRESENTATIVE DUNBAR: And how long

5 do you anticipate it -- I understand that the

6 reason why, in past years, why we had the big

7 negative cash flows, but as Representative

8 Bradford had said, now that we are starting to

9 fund these appropriately, how long do you

10 anticipate it will be till these funds are at

11 the national average for negative cash flow?

12 MR. GROSSMAN: Yeah. I'm actually

13 doing a presentation to our board on Thursday

14 that -- I actually have a slide on that.

15 Assuming we get the contribution rate that's

16 projected to come in to the employer

17 contribution rate, and assuming we have

18 earnings of 7 and a half percent, we would hit

19 that 2.1 around 2024.

20 REPRESENTATIVE DUNBAR: Okay.

21 And following up on Chairman Metcalfe's

22 questions as far as anticipated rate of

23 return, the negative cash flow situation, does

24 that put you into a position where you have to

25 be more risk aversive, have more dollars in 114 1 cash and, therefore, makes it more difficult

2 to attain the 7 and a half percent?

3 MR. GROSSMAN: Yes. It would require

4 us to be more liquid, because you don’t want

5 to be selling assets when the market’s going

6 down. And when you sell assets, you can’t

7 make any more money on them in the future.

8 So, we do keep a liquidity reserve. We try to

9 keep enough cash on hand so we’re not what we

10 call force sellers into a distressed market.

11 But, yeah, it does create issues where you

12 have to be more risk averse than a plan that

13 maybe has less negative cash flow or even

14 positive cash flow. Because there is

15 something called a variance drag that really

16 negatively impacts your performance over time.

17 MR. DURBIN: We have been very

18 careful to keep enough cash assets on hand to

19 be able to make pension payments and the

20 obligation that we need to do, but there’s no

21 question, as Jim’s pointed out, that it does

22 at least constrain your thinking regarding the

23 ways that you can invest money going forward,

24 because you need to be sure that you have

25 those assets always readily available. 115 1 REPRESENTATIVE DUNBAR: So, come 2024

2 or somewhere near there, if we are in a better

3 position as far as negative cash flow, then it

4 would be easier than to meet those anticipated

5 rates of return. Is that correct?

6 MR. DURBIN: It would. If the

7 situation improves, then we’ll look at

8 rebalancing, take a look at other

9 opportunities, and maybe that formula changes

10 slightly, we can change our asset allocation

11 as a result.

12 REPRESENTATIVE DUNBAR: And to change

13 gears real quickly, another member had asked

14 me to ask, as far as your plan’s attorneys,

15 are they hired by the plan, or are they hired

16 by someone else?

17 MR. GRELL: Our attorneys are part of

18 the Office of General Counsel, which is led by

19 the governor’s general counsel.

20 REPRESENTATIVE DUNBAR: Okay.

21 MR. DURBIN: Same for us.

22 REPRESENTATIVE DUNBAR: Thank you.

23 Thank you, Mr. Chairman.

24 MAJORITY CHAIRMAN ADOLPH: Thank you,

25 Representative. 116 1 Representative Fred Keller.

2 REPRESENTATIVE KELLER: Thank you,

3 Mr. Chairman.

4 Thank you members of both the SERS

5 and PSERS board.

6 And good to see you again, Glen.

7 MR. GRELL: Thanks, Fred.

8 REPRESENTATIVE KELLER: Pleasure.

9 I’m not going to get into a lot of

10 technical terms here, for — I just sort of

11 want to try to boil this down to simple terms

12 here. Our expected rate of return for each

13 system is currently 7 and a half percent.

14 Correct?

15 MR. GRELL: Um-hum.

16 REPRESENTATIVE KELLER: And that

17 changed as recently as 2011 for PSERS and 2012

18 for SERS.

19 MR. DURBIN: Correct.

20 REPRESENTATIVE KELLER: So, when we

21 earn 10 percent on our investments, we’re

22 actually only 2 and a half percent above our

23 expectation? We’ve actually gained 2 and a

24 half percent.

25 MR. GRELL: Um-hum. 117 1 REPRESENTATIVE KELLER: And when we

2 lose 10 percent, we've lost 17 and a half

3 percent. Is that correct?

4 MR. GRELL: That's correct.

5 REPRESENTATIVE KELLER: Because,

6 actually I looked at the -- and I'm not

7 picking on any one agency, but I pulled out

8 the SERS book here, and if you look at page

9 twenty-nine, and you start if -- I'm going to

10 start with 2008, because that was for the

11 first year, but I can go back farther. And if

12 I just do that calculation, 28.7, and subtract

13 another 7 and a half, that puts me at a

14 negative 36.2 that we -- I'm just letting

15 these guys -- I'm not -­

16 MR. GRELL: You're looking at me.

17 REPRESENTATIVE KELLER: This is -­

18 I'm just looking at the table.

19 MR. GRELL: Okay.

20 REPRESENTATIVE KELLER: That's a

21 minus 36.2 that year from what we expected to

22 get. The next year, we come in at 2009, and,

23 woo, we got 9.1. We actually only got 1.6

24 above what we expected to get. So, of that

25 36.2, we only gained back 1.6. Is that 118 1 correct?

2 MR. DURBIN: Well, it’s a little more

3 complicated than that.

4 REPRESENTATIVE KELLER: But you’re

5 still in the hole.

6 MR. DURBIN: Still in the hole.

7 REPRESENTATIVE KELLER: And we didn’t

8 gain 9 percent. I mean, if a lay person were

9 to look at this -- and, again, we can debate

10 about how much we’re in or out of the hole,

11 because a lot of the times about a ten-year

12 average and everything else. If I just do

13 that simple calculation over the ten years,

14 I’m still minus. Correct?

15 MR. DURBIN: If you -­

16 REPRESENTATIVE KELLER: And I can

17 even pull in 2007, which was 17 percent above,

18 and I’m probably still in a negative when

19 you’re talking raw dollars.

20 MR. DURBIN: Depending on where you

21 start, that’s correct.

22 REPRESENTATIVE KELLER: And if you go

23 back far enough, you can -- I guess what I

24 look at is, I look at the ten-year average

25 that you’re publishing, and it’s on twenty- 119 1 seven of the same book, is 5.2 percent.

2 MR. DURBIN: For the ten-year

3 average, that's correct.

4 REPRESENTATIVE KELLER: That's

5 ten-year average.

6 And for PSERS, it's 6.31 on page

7 twenty of your book.

8 MR. GROSSMAN: That's correct.

9 REPRESENTATIVE KELLER: That's

10 ten-year average.

11 MR. GROSSMAN: That's through June

12 3 0th, yes.

13 REPRESENTATIVE KELLER: That's

14 through June 30th. So, when we look at these

15 things, for each person we continue to add

16 into these over that period of time, we've

17 gone backwards for all the new people we've

18 put into them, based upon what we're

19 contributing, with our collared rates?

20 I put an employee in there. And I

21 made, as an employer, a contribution,

22 expecting to get 7 and a half percent rate of

23 return. When I didn't hit 7 and a half

24 percent rate of return, we basically went

25 backwards because we didn't redo our 120 1 calculation as far as what we have to put in.

2 MR. GRELL: Well, but the employer

3 contribution rate’s recalculated each year.

4 REPRESENTATIVE KELLER: Okay. And

5 does it adjust for — but we’re doing the

6 collared rate right now.

7 MR. GRELL: Well, that’s correct.

8 Yeah.

9 REPRESENTATIVE KELLER: So, we’ve

10 gone backwards for each new person we’ve put

11 into the system.

12 MR. GRELL: Under the collars,

13 absolutely.

14 REPRESENTATIVE KELLER: Absolutely.

15 Okay. I just wanted to point that out,

16 because we’re putting more people into the

17 system, and we’re going farther and farther

18 behind.

19 I mean, right now what we need to do

20 is we need to pay the bill. I get that. And

21 I think that’s what the credit rating agencies

22 see: Pay the bill. Quite frankly, I don’t

23 think they care whether we create a special

24 account or not. They care about if we pay the

25 bill. 121 1 I mean, my mortgage company doesn’t

2 care that I have a special savings account

3 that I have a portion of my check put into to

4 make my mortgage payment. They care that

5 I make my mortgage payment.

6 MR. GRELL: Well, but they require

7 you to put your taxes into a special account

8 to make sure they get -­

9 REPRESENTATIVE KELLER: No, they

10 don’t. No, they don’t.

11 MR. GRELL: Maybe not you, but a lot

12 of people they do.

13 REPRESENTATIVE KELLER: But my point

14 is, that’s the mortgage --- that’s not the

15 credit rating. They care that you pay your

16 bills, quite frankly.

17 MR. GRELL: Yeah.

18 REPRESENTATIVE KELLER: That’s what

19 it really gets down to.

20 MR. GRELL: Sure.

21 REPRESENTATIVE KELLER: So, I wanted

22 to go on to a couple other things here. You

23 mentioned, I think it was Chairman Markosek

24 was questioning about the normal cost. And

25 you mentioned for PSERS that it’s just under 3 122 1 percent for a post 120 employee.

2 MR. GRELL: Correct.

3 REPRESENTATIVE KELLER: And for SERS,

4 it’s around 4.95 percent?

5 MR. DURBIN: Correct.

6 REPRESENTATIVE KELLER: Is that

7 figuring on a 7 and a half percent rate of

8 return?

9 MR. GRELL: Yes.

10 MR. DURBIN: Yes.

11 REPRESENTATIVE KELLER: Okay. What

12 would it be if we took our ten-year average of

13 what we actually got for each of those

14 systems?

15 I mean, you may not have that, but if

16 you could get that for us. It would be

17 higher, right? It would be higher than that

18 around 3 percent or -­

19 MR. DURBIN: Yes, it would.

20 MR. GRELL: Yeah, slightly. I mean,

21 we missed our 7 and a half percent by a little

22 bit, so, yeah, if you came under -- what’d we

23 say? 6.8?

24 MR. GROSSMAN: 6.3.

25 MR. GRELL: 6.3. 123 1 REPRESENTATIVE KELLER: You missed

2 that.

3 MR. GRELL: Slightly under.

4 REPRESENTATIVE KELLER: Over ten

5 years you missed that. I mean, it sounds -­

6 we didn’t miss it just on one year. We missed

7 it over a ten-year period. So, it would be -­

8 would it be 1 percent, 2 percent? I mean -­

9 MR. GRELL: We can try to calculate

10 that, but I don’t think it would be that

11 significant.

12 REPRESENTATIVE KELLER: Okay. The

13 other point I wanted to make, we’ve been

14 reducing our assumed rate of return over the

15 past decade. It was as high as 8 and a half

16 in 2007. The logic for reducing that?

17 MR. GRELL: Well, as I said earlier,

18 a lot of factors come into what your assumed

19 rate of return is going to be.

20 REPRESENTATIVE KELLER: Um-hum.

21 MR. GRELL: And it has to do with

22 morality tables, which change, rates of

23 inflation, actual investment returns,

24 projected investment returns.

25 REPRESENTATIVE KELLER: Salary 124 1 increases?

2 MR. GRELL: Salary increases or

3 leveling, all of that goes into the mix.

4 REPRESENTATIVE KELLER: So, are we

5 anticipating reducing our rate of return?

6 MR. GRELL: Well -­

7 REPRESENTATIVE KELLER: Again?

8 MR. GRELL: I don’t know if you were

9 here at the beginning. We discussed the fact

10 that our five-year experience study is being

11 finished and will be presented at the board at

12 our June meeting for their consideration.

13 REPRESENTATIVE KELLER: What other

14 factors weigh in, as far -- I guess probably

15 the biggest factor would be what we project

16 we’ll be able to earn in the future?

17 MR. GRELL: Correct. That’s a big

18 factor. But the morality tables and,

19 particularly, the rate of growth among our

20 school employees. It was going up fairly

21 significantly, and it’s leveled off in recent

22 years. So, that will be a factor that will

23 mitigate against -- it’s a downward pressure

24 on that.

25 REPRESENTATIVE KELLER: Okay. And, 125 1 again, I'm going to refer to something that we

2 got in some audits from the auditor general,

3 because they do many audits. And they talk

4 about some of the municipal systems that are

5 defined benefit systems. And I know they can

6 select their rate of return anywhere from

7 between, like, 5 and 9 or something like that,

8 or, you know, I'm not sure exactly what it is,

9 but they have a range that they can choose.

10 And he did an audit, I believe it was

11 last year, maybe even might have been shortly

12 after he got in that it said that for a define

13 benefit plan on the municipal pension side,

14 they should probably be assuming, like, a 5

15 percent rate of return.

16 And I'm just wondering, why would

17 that be so different than what we would expect

18 to get 7 and a half on ours.

19 MR. GRELL: Well, I haven't done a

20 study of it, because we don't get too involved

21 in the municipal, but a lot of those municipal

22 plans have a very limited number of members.

23 And if you have a very small cohort of

24 members, the pressure on you for making

25 regular monthly payments is much greater than 126 1 in a system of 600,000 members.

2 REPRESENTATIVE KELLER: But our

3 systems are designed to be pay-as-you-go.

4 Correct? So, you should have the money in the

5 bank to make the payments, if everybody makes

6 their contributions and you get your rate of

7 return and everything else.

8 MR. GRELL: Yeah. I don't know

9 what's driving the municipal, but that's one

10 factor that I could point to that might

11 explain why they need more liquidity and a

12 more conservative asset allocation.

13 REPRESENTATIVE KELLER: But even

14 based on our own performance, even based on

15 our own performance, we could say that our

16 normal cost, using the past ten-year average

17 of what we got under each system, would be

18 closer to the 4 percent for, like, a defined

19 contribution was being talked about?

20 MR. GRELL: I -­

21 REPRESENTATIVE KELLER: In other

22 words, we've already acknowledged the fact

23 that we are not getting -- over the past ten

24 years, we haven't hit our mark. So, the

25 question is, actually, if we looked at the 127 1 last ten years, our normal cost wouldn’t be 3

2 percent. It would be higher than that. And

3 SERS would be higher than 4.95 percent.

4 So, would we actually have, based on

5 the last ten-years performance, would we

6 actually have a higher cost, just giving

7 people a defined contribution of 4 percent?

8 MR. GRELL: I can’t evaluate it

9 that -- in the abstract. I mean, if we were

10 to reduce our assumed rate of return, we

11 wouldn’t do that on its -- just by itself. We

12 would do it in the context of the experience

13 study. But if that rate of return goes down,

14 it does push your unfunded liability up, and

15 that has an upward pressure on your total

16 employer cost -- your total cost and the

17 portion of the cost that’s attributed to the

18 employer.

19 REPRESENTATIVE KELLER: For the 120

20 employees, it does have an impact on them,

21 too, depending what your experience rate is.

22 MR. GRELL: It would have a effect on

23 all of our members, yeah.

24 REPRESENTATIVE KELLER: The one point

25 I want to make to everybody is that, you know, 128 1 anybody that’s in this system has earned their

2 benefit and deserves to be paid. I don’t

3 think there’s going to be -- you’re going to

4 hear argument from anybody on that. That

5 needs to happen. We need to pay that bill.

6 It just a matter of how we get there.

7 And I’ m j ust trying to understand a

8 few things.

9 What was the rate of return last year

10 for PSERS? Is that 3.04?

11 MR. GROSSMAN: That was 3.04 for -­

12 REPRESENTATIVE KELLER: And did we

13 have one for SERS for the -­

14 MR. DURBIN: For the past year?

15 REPRESENTATIVE KELLER: For the past

16 year.

17 MR. DURBIN: That’s 6.4.

18 REPRESENTATIVE KELLER: 6.4. That’s

19 not the year that closed December 31.

20 MR. DURBIN: No. The current year

21 that just closed, 2015?

22 REPRESENTATIVE KELLER: Yes.

23 MR. DURBIN: We have an estimated .5

24 percent. I’m sorry.

25 REPRESENTATIVE KELLER: .5. Okay. 129 1 And I’ll just get into one other

2 thing, if I may. If PSERS and SERS began to

3 move a portion of the fund assets to passively

4 managed funds in order to save investment

5 expenses and management fees, how much would

6 earning theory assumptions for the funds need

7 to be decreased? And what would this do to

8 the unfunded accrued liability?

9 MR. GROSSMAN: Well, it depends on

10 what piece you want to move to passive. So,

11 if you look at our U.S. equity portfolio, it’s

12 100 percent passive today. We’re already

13 there.

14 Our non-U.S. equity portfolio is

15 about 50 percent passive -- or large cap

16 non-U.S. equity portfolio. The other half of

17 that’s active.

18 Moving money from active to passive,

19 especially when managers are outperforming,

20 would actually -- you could reduce cost, but

21 actually you’d reduce your net of fee returns

22 as well because these managers have been

23 outperforming their benchmarks. So, you could

24 save fees but, at the end of the day, have

25 less money at the end of the day because 130 1 they’ve been generating excess returns above

2 the fees we’ve been paying.

3 REPRESENTATIVE KELLER: Okay. And

4 the reason I ask that question, I read a book

5 by a colleague of mine, colleague of many

6 people in the general assembly, John McGinnis,

7 and he talks about his naive index that’s

8 outperformed, you know, our systems over the

9 last ten years. And I would assume that

10 that’s, you know, 60 percent S and P, 500

11 stocks, and then 40 percent ten-year treasury

12 bonds, and then takes out 16 basis points for

13 fees each year.

14 You know, I’m just wondering,

15 comments on that, thoughts? I mean, if that

16 actually works -­

17 MR. GROSSMAN: Well, I think you want

18 to look at the long term. I think recently it

19 has. I mean, I think the U.S. equity market

20 has done extremely well since the crisis, and

21 part of that’s lent to interest rates falling

22 from 5 percent to zero, the federal reserve

23 printing 4 trillion dollars in new money, and

24 that has driven asset prices up, but it’s also

25 driven the future returns down. So, I think 131 1 the U.S. has had a very good time of it over

2 the past ten years but -­

3 REPRESENTATIVE KELLER: When I look

4 at the example in the book, and I think this

5 is example 8.2, and I forget the page number

6 here, but, you know, he looks at -- I look at

7 each one that he has on there, PSERS, SERS,

8 and his naive index, as he quotes it, and

9 every -- the one year it’s above, the three

10 year it’s above, the five year it’s above, the

11 ten year it’s above, twenty years it’s above.

12 I guess -­

13 MR. GROSSMAN: I haven’t looked at

14 it, but -­

15 REPRESENTATIVE KELLER: Maybe that

16 would be something for us to look at. Again,

17 I don’t want to take up all the time, but the

18 point I guess I want to make is that we’re

19 assuming a 7 and a half percent rate of

20 return, and I tell you what, if somebody was

21 guarantee me 7 and a half rate of return on my

22 money, I would mortgage my house today and

23 take it. I don’t think there’s anybody in

24 this room that wouldn’t. Okay? Because we —

25 that’s a good gig. 132 1 And if we think that's reality, then

2 we can post normal cost of 3 percent and 4.95.

3 I don't think that's -- I don't think anybody

4 thinks that's reality to get on your money

5 right now in the economic times.

6 And, again, I am a proponent -- just

7 a full disclosure -- I'm a proponent of

8 defined contribution. I don't participate in

9 the state pension system. I've had 401Ks my

10 entire life before I got into the general

11 assembly. I think they're great. I think it

12 gives people control. And it doesn't have to

13 be this complex.

14 And, again, then you get out of some

15 of the political things that have happened

16 that everybody's talked about, not funding,

17 and, you know, I realize there's still a

18 little bit of what's the rate and everything

19 else. But I think it eliminates a lot of

20 problems.

21 And people can say, well, you know,

22 we've got to keep the systems open because

23 people are retiring. The money should have

24 already been there for that. And we need to

25 pay that bill. 133 1 So, I thank you for your time.

2 And, thank you, Mr. Chairman.

3 MAJORITY CHAIRMAN ADOLPH: Thank you.

4 That's the last committee member that

5 has a question on the first round.

6 My understanding, Representative

7 Warren Kampf has a question for the second

8 round.

9 REPRESENTATIVE KAMPF: Thank you for

10 not collectively groaning, at least loudly.

11 David -- I'm sorry, Mr. Durbin, I was

12 asking you about what is the typical years of

13 service of a current annuitant and is that

14 trend continuing. Do you know what I'm

15 asking?

16 MR. DURBIN: I do, and I haven't

17 brought that number with me today. I'll have

18 to get that number to you. We haven't done

19 the studies regarding the years of credit of

20 service at retirement. I think that's what

21 you're asking.

22 REPRESENTATIVE KAMPF: Yes. Yeah.

23 And the question is both current annuities -­

24 or annuitant and then also the group of

25 individuals who are now retiring, is that 134 1 changing?

2 MR. DURBIN: Interestingly enough -­

3 I thank you for the question, because we’re

4 also completing experience study, and we’ve

5 noticed, in the early returns, some different

6 impacts than we anticipated. And the board

7 will be receiving a formal presentation from

8 the actuaries on that.

9 One of the things we’ve noticed is

10 that people are retiring a little later than

11 they used to. In 2011, in our last experience

12 study, people kind of retired when they first

13 became eligible for Social Security. And that

14 is no longer the case. We find people saying

15 longer, until more towards full Social

16 Security age, which is an interesting trend.

17 And also, we see this past year, the

18 largest class of new members that we’ve had in

19 anyone’s memory, 11,800 new members joined the

20 system. The majority of those -- almost all

21 of those, of course, will be A3 or A4 members

22 under the Act 120. So, we’re up to about 28

23 percent of our membership now is covered under

24 the new benefit tier. We are seeing some

25 interesting trends that are changing slightly 135 1 in the demographics.

2 REPRESENTATIVE KAMPF: And it would

3 be great if you track those new members to see

4 how long they stay. All right.

5 There was a comment about the initial

6 rates of returns from last year or the year

7 before and what impact they have over the life

8 of the system.

9 What are your ten-year rates of

10 returns, David?

11 MR. DURBIN: The ten-year average is

12 5.2 percent.

13 REPRESENTATIVE KAMPF: Okay. So,

14 we’re at least 2 points below the 7 and a half

15 percent.

16 MR. DURBIN: The important factor —

17 of course that includes 2008, which were

18 devastating losses for us. But we’ve

19 completed amortizing those gains and losses

20 through the five years, so that now we move

21 forward on new trends, 2008 won’t be holding

22 the average down any longer. We’ll be able to

23 move past that point.

24 REPRESENTATIVE KAMPF: You say we’re

25 at least 2 points below for the ten-year 136 1 average.

2 MR. DURBIN: Correct.

3 REPRESENTATIVE KAMPF: And actually

4 in that period of time, you were at 8 percent,

5 weren’t you?

6 MR. DURBIN: For part of it, yes.

7 REPRESENTATIVE KAMPF: And then,

8 Mr. Grell, what’s your ten-year?

9 MR. GRELL: That’s the 6.3.

10 MR. GROSSMAN: 6.3 through June 30th.

11 REPRESENTATIVE KAMPF: 6.3, so a

12 point and a quarter below.

13 MR. GROSSMAN: Correct.

14 REPRESENTATIVE KAMPF: And were you

15 also at 8 percent at some time during that

16 period?

17 MR. GRELL: In 2011.

18 MR. GROSSMAN: Yes.

19 REPRESENTATIVE KAMPF: Okay. All

20 right.

21 And then, just lastly, one of my

22 colleagues who’s not on the committee was

23 asking about shared risk. So, we’ve had a

24 couple of years that haven’t been too great,

25 and I guess shared risk is coming up. 137 1 With that, is there an anticipation

2 that the employee contribution rates are going

3 to go up?

4 MR. DURBIN: This is a measurement

5 year. This is the third measurement year now

6 in the set. Our first set, we looked at it

7 and the investment rate of returns were

8 sufficiently over that no shared risk came

9 into play at that point. It will depend on

10 what happens in 2016, whether or not an

11 adjustment’s necessary in 2017.

12 REPRESENTATIVE KAMPF: Any

13 preliminary speculation or what-have-you?

14 MR. DURBIN: A back-of-the-envelope

15 estimate would be somewhere above 5.2. A

16 return of 5.2 would negate the necessity of

17 shared risk at least for us. And that’s

18 unofficial.

19 REPRESENTATIVE KAMPF: So, if you

20 could get to 5.2, the employees would dodge

21 that.

22 MR. DURBIN: Probably.

23 REPRESENTATIVE KAMPF: Okay. All

24 right.

25 And then, Mr. Grell. 138 1 MR. GRELL: At PSERS, the first

2 review period, there was no change, in 2014,

3 because the returns were well in excess of the

4 7 and a half.

5 The next look back would be 2017. I

6 don’t have a back-of-the-envelope on what

7 we’re going to -- where we’re going to be in

8 2016 -- or 2017. But, remember, it’s -- at

9 that point, it’s not a three-year look-back,

10 it’s a six-year look-back. Ultimately, we’re

11 going to get to a ten-year look back, so the

12 first three years that we had were very good.

13 So, the second three years would have to be

14 significantly below that for it to be

15 triggered.

16 REPRESENTATIVE KAMPF: Okay. Okay.

17 MR. GRELL: But I’m glad you

18 mentioned shared risk, because that is one of

19 the often unrecognized elements of Act 120,

20 that is that downside protection. In the

21 event that the returns are not realized,

22 there’s an automatic kick-in of an increase in

23 the employee contribution.

24 REPRESENTATIVE KAMPF: Right.

25 Although, so far, it hasn’t delivered for 139 1 us -­

2 MR. GRELL: It hasn't been needed.

3 And that's a good thing.

4 REPRESENTATIVE KAMPF: And then I -­

5 lastly, Representative Dunbar asked a

6 question. I thought with negative cash flow,

7 you all, both systems, were put in a situation

8 where you actually had to chase higher

9 returns.

10 I mean, isn't that the philosophy of

11 the two systems, to try to make up for some of

12 these issues with, you know, very actively

13 managed investments?

14 MR. GRELL: Not at the expense of

15 having liquidity in order to make the monthly

16 payments.

17 REPRESENTATIVE KAMPF: Aside from the

18 question of liquidity, isn't it true that you

19 are both trying to chase higher returns to get

20 us out of this hole?

21 MR. GRELL: Actually, our risk

22 portfolio -- and if you need details, Jim can

23 give you much more detail -- our asset

24 allocation has intentionally lowered the risk

25 levels over the past -- well, since 2008, 140 1 2009.

2 MR. DURBIN: We've done the same

3 thing. We've lowered our risk, but we're also

4 mindful of liquidity.

5 REPRESENTATIVE KAMPF: So, I'm still

6 asking the question. Are you chasing higher

7 returns? Are some of the fees that you've

8 been paid on the notion that you're going to

9 get higher returns than 7 and a half?

10 MR. GROSSMAN: The fees that are paid

11 are active management returns that we're

12 hoping to get more returns than the index

13 returns that are provided. But the allocation

14 itself is much more diversified coming out of

15 the crisis in 2007, 2008, because of the cash

16 flow situation. So, it's a very diversified

17 portfolio.

18 If you look at our actual risk

19 relative to even our peers, it's one of the

20 lowest in the country.

21 REPRESENTATIVE KAMPF: Dave, the

22 question I asked is, are you chasing higher

23 returns?

24 MR. DURBIN: I wouldn't characterize

25 it as chasing higher returns. I think what 141 1 we’re trying to do is find the best mix of

2 assets. And where we get -- where we’re

3 paying additional management fees, we’re

4 looking for that return above the index, as

5 Mr. Grossman pointed out. So, it’s through a

6 variety of different sources.

7 One of the most, I guess, fee heavy

8 would be a way of describing it is the

9 alternative investments, and they’ve been, by

10 far, our best returns. They, last year,

11 returned 7.5 to the portfolio. So, that seems

12 like that’s money well spent for the return

13 that we received off of that.

14 REPRESENTATIVE KAMPF: Thank you,

15 Mr. Chairman.

16 MINORITY CHAIRMAN MARKOSEK:

17 Chairman, just briefly, I’d ask a couple of

18 speakers, if we look back over thirty years,

19 the rate of return for PSERS, I believe, is

20 just under 9 percent, which is a point and a

21 half higher than the current expected rate of

22 return.

23 So, when you’re just going back ten

24 years, it’s skewed, but if you go back all

25 thirty years, we are actually over the current 142 1 rate of return -- expected rate of return.

2 MR. GRELL: Correct.

3 MAJORITY CHAIRMAN ADOLPH: Okay. I

4 do not see any other members that have

5 questions. I’d like to thank the members of

6 the SERS and the PSERS board and their

7 investment counselors and their executive

8 directors.

9 And I’ll tell you, Melva, that your

10 student, Representative Mike Peifer, is doing

11 very well here. And he says everything is -­

12 any part of his success is due to his early

13 education.

14 So, looking forward to working with

15 you between now and the end of the June. And

16 thank you for being here.

17 And for the members’ information, we

18 will reconvene at 1:30 with the Department of

19 Banking and Securities.

20 Thank you very much.

21 (Whereupon, the hearing concluded at

22 12:19 p.m.)

23

24 ~k k k k k

25 143 1 REPORTER’S CERTIFICATE

2 I HEREBY CERTIFY that I was present

3 upon the hearing of the above-entitled matter

4 and there reported stenographically the

5 proceedings had and the testimony produced;

6 and I further certify that the foregoing is a

7 true and correct transcript of my said

8 stenographic notes.

9

10 BRENDA J. PARDUN, RPR 11 Court Reporter Notary Public 12

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