Commonwealth of Pennsylvania House of Representatives

COMMONWEALTH OF PENNSYLVANIA HOUSE OF REPRESENTATIVES

JOINT PUBLIC HEARING

STATE GOVERNMENT COMMITTEE/EDUCATION COMMITTEE

STATE CAPITOL MAJORITY CAUCUS ROOM ROOM 140 HARRISBURG, PENNSYLVANIA

THURSDAY, MARCH 26, 2009 9:08 A.M.

PRESENTATION ON PENNSYLVANIA PUBLIC PENSION FUND ISSUES

BEFORE: HONORABLE BABETTE JOSEPHS, MAJORITY CHAIRMAN, STATE GOVERNMENT COMMITTEE HONORABLE JAMES R. ROEBUCK, JR. MAJORITY CHAIRMAN, EDUCATION COMMITTEE HONORABLE H. SCOTT CONKLIN HONORABLE LAWRENCE H. CURRY HONORABLE FLORINDO J. FABRIZIO HONORABLE JARET GIBBONS HONORABLE RICHARD T. GRUCELA HONORABLE PATRICK J. HARKINS HONORABLE BARBARA McILVAINE SMITH HONORABLE MICHAEL H. O'BRIEN HONORABLE RICK TAYLOR HONORABLE ROSITA C. YOUNGBLOOD HONORABLE JOHN T. YUDICHAK

* * * * * DEBRA B. MILLER REPORTING (717)439-3785 [email protected] 2

1 BEFORE (cont.'d): HONORABLE KERRY A. BENNINGHOFF, 2 MINORITY CHAIRMAN, STATE GOVERNMENT COMMITTEE HONORABLE PAUL I. CLYMER 3 MINORITY CHAIRMAN, EDUCATION COMMITTEE HONORABLE JIM COX 4 HONORABLE TOM C. CREIGHTON HONORABLE SHERYL M. DELOZIER 5 HONORABLE MATT GABLER HONORABLE GLEN R. GRELL 6 HONORABLE DUANE MILNE HONORABLE BERNIE O'NEILL 7 HONORABLE KATHY L. RAPP HONORABLE BRAD ROAE 8 HONORABLE WILL TALLMAN

10 ALSO PRESENT: RODNEY L. OLIVER 11 MAJORITY EXECUTIVE DIRECTOR, STATE GOVERNMENT COMMITTEE 12 CHRISTOPHER S. WAKELEY MAJORITY EXECUTIVE DIRECTOR, 13 EDUCATION COMMITTEE JENNIFER A. BELZ 14 MAJORITY LEGISLATIVE ASSISTANT, STATE GOVERNMENT COMMITTEE 15 BRIAN J. DELL MAJORITY RESEARCH ANALYST, 16 STATE GOVERNMENT COMMITTEE JOSEPH M. HURLBURT 17 MAJORITY RESEARCH ANALYST, STATE GOVERNMENT COMMITTEE 18 TRACEY ANN McLAUGHLIN MAJORITY RESEARCH ANALYST, 19 EDUCATION COMMITTEE SONIA I. TERECH 20 MAJORITY LEGISLATIVE ASSISTANT, EDUCATION COMMITTEE 21

25 3

1 ALSO PRESENT (cont.'d): SUSAN S. BOYLE 2 MINORITY EXECUTIVE DIRECTOR, STATE GOVERNMENT COMMITTEE 3 DUSTIN E. GINGRICH MINORITY RESEARCH ANALYST, 4 EDUCATION COMMITTEE EILEEN R. KRICK 5 MINORITY LEGISLATIVE ADMINISTRATIVE ASSISTANT, EDUCATION COMMITTEE 6

7 DEBRA B. MILLER 8 REPORTER

25 4

1 I N D E X

2 TESTIFIERS

3 NAME PAGE 4 SUJIT M. CANAGARETNA 5 SENIOR FISCAL ANALYST, SOUTHERN OFFICE OF THE 6 COUNCIL OF STATE GOVERNMENTS (CSG)...... 11

7 LEONARD M. KNEPP EXECUTIVE DIRECTOR, 8 PA STATE EMPLOYEES' RETIREMENT SYSTEM (SERS)...46

9 JEFFREY B. CLAY EXECUTIVE DIRECTOR, 10 PA PUBLIC SCHOOL EMPLOYEES' RETIREMENT SYSTEM (PSERS)...... 55 11

25 5

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

2 * * *

3 CHAIRMAN JOSEPHS: Good morning, everybody.

4 I'm Babette Josephs. I'm the Chair of the

5 State Government Committee.

6 We're doing a joint hearing here with the

7 Education Committee.

8 After I finish making a short statement, I'm

9 going to ask Representative Roebuck, who is the Chair

10 of the Education Committee, if he would like to make

11 a statement.

12 My Republican counterpart, Mr. Benninghoff,

13 is not here. He will be here in about a half hour.

14 We will note when he comes in.

15 After we finish with the statements from the

16 committee Chairs, I will be asking the members and

17 the people who are not members but are here out of

18 interest, the Representatives, to introduce

19 themselves in a sentence.

20 Thank you all for being here.

21 We are also joined by Representative

22 Paul Clymer, who is the Republican Chair of the

23 Education Committee.

24 I am happy to see you all here. These are

25 and have always been, the question of the State 6

1 pension funds and their investment practices and

2 their beneficiaries and the people who pay into the

3 State pension funds have always been of very great

4 importance, but they are now, because as everybody

5 knows, because of the economic situation in the

6 country and the world, they have become even more

7 important and there is more focus on their practices

8 and the yields and the benefits that might be yielded

9 from them.

10 We are very happy to have experts here, both

11 from the funds and somebody who will give us an

12 overview when we finish introducing ourselves.

13 And I am happy to be joined here by my

14 colleague, Representative Jim Roebuck, the Chair of

15 the Education Committee. Mr. Roebuck.

16 CHAIRMAN ROEBUCK: Thank you,

17 Chairman Josephs.

18 Good morning.

19 REPRESENTATIVE McILVAINE SMITH: Good

20 morning.

21 CHAIRMAN ROEBUCK: I'm still at heart a

22 teacher, as you can see.

23 I would like to welcome everyone here today

24 for the joint hearing of the State Government and

25 Education Committees. 7

1 Under these economic conditions that we are

2 currently going through, I think it is important that

3 we hear from experts in the field of retirement

4 pensions who can give us an overview of where we are

5 and where we are headed with our pension systems.

6 With the recent stock market decline and the

7 showing of an uphill climb in changing demographics,

8 there is a burden on our retirement systems to keep

9 up with actuarial liabilities.

10 It is our hope that today we can hear where

11 our State is and what we can do to respond to the

12 current economic climate.

13 I would also like to allow my Republican

14 counterpart, Representative Paul Clymer, to give

15 introductory remarks.

16 REPRESENTATIVE CLYMER: Thank you,

17 Chairman Roebuck.

18 And I, too, extend greetings to everyone.

19 This is indeed a very important meeting that

20 we are holding here this morning as we look at the

21 liquidity, if you will, of the pension funds, both

22 SERS and PSERS.

23 And obviously it impacts on a wide range and

24 a large number of our State employees, so we need to

25 see whether or not we're going to be able to continue 8

1 to fund these in the manner that we have in the past,

2 or will there be exceptions to the rule and we're

3 going to have to increase the funding for both the

4 State from the employees and from the school

5 districts, depending on the pension fund that is

6 being funded.

7 So again, I look forward to the testimony of

8 our experts here this morning, and thank you for

9 attending.

10 CHAIRMAN JOSEPHS: Thank you.

11 We will start, I think, here at the table

12 with the State Reps who are here. Introduce

13 yourself, please.

14 And I also would like the staff who are

15 connected with these two committees to say their

16 names as well.

17 REPRESENTATIVE O'NEILL: Good morning. I'm

18 Representative Bernie O'Neill of Bucks County.

19 REPRESENTATIVE GRELL: Good morning.

20 Representative Glen Grell, Cumberland County.

21 REPRESENTATIVE FABRIZIO: Good morning.

22 Flo Fabrizio, Erie County.

23 MR. OLIVER: Good morning. Rodney Oliver,

24 Executive Director for the Democrats, House

25 State Government Committee. 9

1 REPRESENTATIVE McILVAINE SMITH:

2 Representative Barb McIlvaine Smith from Chester

3 County.

4 REPRESENTATIVE YUDICHAK: John Yudichak,

5 Luzerne County.

6 REPRESENTATIVE TAYLOR: Rick Taylor,

7 Montgomery County.

8 REPRESENTATIVE GRUCELA: Rich Grucela,

9 Northampton County.

10 REPRESENTATIVE HARKINS: Pat Harkins,

11 Erie County.

12 REPRESENTATIVE CREIGHTON: Tom Creighton,

13 Lancaster County.

14 REPRESENTATIVE DELOZIER: Sheryl Delozier,

15 Cumberland County.

16 REPRESENTATIVE TALLMAN: Will Tallman,

17 Adams and York Counties.

18 REPRESENTATIVE ROAE: Brad Roae,

19 Crawford County.

20 REPRESENTATIVE RAPP: Kathy Rapp, Warren,

21 Forest, and McKean Counties.

22 REPRESENTATIVE GABLER: Matt Gabler,

23 Clearfield and Elk Counties.

24 REPRESENTATIVE O'BRIEN: Mike O'Brien,

25 Philadelphia County. 10

1 CHAIRMAN JOSEPHS: Oh, we have some other

2 staff people in the audience.

3 MR. WAKELEY: Chris Wakeley, Executive

4 Director of the Education Committee.

5 CHAIRMAN JOSEPHS: Anyone else?

6 Susan Boyle.

7 MS. BOYLE: I'm the Republican Director of

8 State Government.

9 MR. GINGRICH: Dustin Gingrich, the

10 Education Committee staff on the Republican side.

11 MS. McLAUGHLIN: Tracey McLaughlin,

12 Education staff for Representative Roebuck.

13 REPRESENTATIVE CLYMER: I have Eileen Krick,

14 my Administrative Assistant, Education. Eileen.

15 CHAIRMAN JOSEPHS: Okay; did we do that?

16 Did we get everybody?

17 Oh, I think Jen Belz is here from the

18 Democratic State Government staff.

19 I see Representative Conklin in the

20 audience.

21 Matt Hurlburt and Brian Dell from my staff.

22 All right; we're ready, and we're not even

23 terribly late.

24 The first person we are going to hear from,

25 who will give us an overview on trends in pensions 11

1 around the States, is Sujit CanagaRetna from the

2 Council of State Governments, Southern Office.

3 Mr. CanagaRetna, please proceed.

4 MR. CANAGARETNA: It is a great honor to be

5 here this morning, and I thank Chairman Josephs and

6 Chairman Roebuck for extending this invitation to me

7 and to the Council of State Governments.

8 While I work for the CSG's southern region,

9 the Southern Legislative Conference in Atlanta,

10 Pennsylvania is served by CSG's eastern region, the

11 Eastern Regional Conference, located in New York

12 City.

13 I have with me my colleagues,

14 Wendell Hannaford, who is the Director of the ERC,

15 and Mike Jackson, also who works at the ERC.

16 And I know a number of Pennsylvania

17 Legislators are active with the ERC, and we do

18 appreciate their support and involvement.

19 My presentation deals with a topic that has

20 enormous implications for State finances -- public

21 pensions. This is a topic that I have been

22 exploring for some years now, and I continue to study

23 and highlight this critical issue in presentations

24 and publications before legislative and other

25 audiences. 12

1 It is important to note that there are

2 two issues here: one, the enormous investment losses

3 that public pension plans have experienced in the

4 last 6 months; and two, the fact that even before

5 these losses, an increasing number of public pension

6 plans faced significant funding challenges.

7 Broadly, my presentation comprises five

8 interconnected parts. Part one explores the impact

9 of recent market losses on State retirement systems.

10 Part two reviews why it is important for policymakers

11 to focus on the financial position of State

12 retirement plans. Part three looks at where we stand

13 in terms of State pensions, and part four provides a

14 snapshot of several key developments related to these

15 plans. Finally, part five describes the various

16 strategies deployed in States across the country to

17 bolster their pension systems.

18 Part one:

19 State pension funds, like almost every other

20 investment category, have taken a severe beating in

21 the last 6 months or so.

22 In fact, between October 2007, the market

23 peak, and early March 2009, stocks lost $11 trillion

24 in market value based on the Dow Jones Wilshire 5000

25 index, which includes nearly every U.S. listed stock. 13

1 Losses between the beginning of 2009 and the

2 first week of March totaled $2.6 trillion, with

3 nearly half of all stocks in the Wilshire 5000

4 trading at less than $5 and 37 percent less than $3.

5 In such a Bear market, State pension funds

6 have also been battered. According to the Center for

7 Retirement Research at Boston College, State

8 Governments ran up pension fund losses totaling

9 $865 billion when assets for 109 pension plans

10 dropped 37 percent in the 14-month period ending

11 December 16, 2008.

12 For individual State plans, the losses

13 remain staggering. CalPERS, the California State

14 employee retirement plan, the largest in the U.S.

15 and the fourth largest in the world, dropped from

16 $260 billion in October 2007 to $186 billion at the

17 end of 2008, one of the plan's worst annual declines

18 since its inception in 1932.

19 In the light of such overwhelming losses,

20 what is the prognosis for public pension plans? The

21 important point here is that public pension

22 investments are geared toward the long term, which

23 allows these plans to phase in investment gains and

24 losses, a strategy that often softens the negative

25 blows of short-term market volatility. 14

1 These smoothing strategies, based on

2 actuarial tools, facilitate gradual changes to public

3 pension funding levels and required contributions,

4 spreading adjustments over several years.

5 As a result of smoothing, not only will the

6 investment losses be phased in, most often over

7 5 years, investment gains from previous years will be

8 incorporated, tempering the losses experienced

9 recently.

10 In some, the volatility of assets in public

11 pension plans do not immediately equate to volatility

12 in the State's annual budget.

13 Experts also note that public pensions have

14 recovered to emerge with strong investment returns

15 after periods of extreme turbulence.

16 For instance, median public pension fund

17 investment returns remain positive in 22 of the

18 25 years between 1982 and 2007, a period that

19 included the 1987 market crash, the '91 and 2001

20 recessions, the bursting of the dot-com bubble, 9/11,

21 and assorted corporate scandals.

22 Nevertheless, despite the protection of

23 asset smoothing techniques, public pensions are not

24 completely immune from financial turmoil, even in the

25 long term. Consequently, higher contribution rates 15

1 and benefit cutbacks might be necessary in the

2 future.

3 Part two:

4 Before the extreme financial turbulence of

5 fall 2008 and the ongoing recession, there was

6 growing consensus across the country that more

7 attention needed to be directed towards retirement

8 planning and developing a retirement infrastructure

9 with the capacity to absorb the needs of all

10 Americans.

11 Reforming public pensions was an important

12 element of these discussions, and many States had or

13 were in the process of initiating remedial measures.

14 This included setting aside funds to pay for "other

15 post-employee retirement benefits," OPEB, comprising

16 mostly retiree health care.

17 Even though these remedial efforts have been

18 displaced by the severity of the ongoing recession

19 and the need to come up with solutions to bridge the

20 significant budget shortfalls, it is a certainty that

21 once State finances stabilize and the current

22 recession ends, policymakers will have to pay

23 attention to public pensions.

24 There are four major reasons why the

25 financial future of State retirement systems requires 16

1 the undivided attention of policymakers, particularly

2 once State economies recover.

3 One, while our economy remains ensnared in a

4 recession, one that is already longer than all the

5 recessions since the Great Depression, public

6 pensions are only one in the list of expenditure

7 categories that policymakers will have to contend

8 with in the post-recessionary period.

9 In fact, the huge revenue shortfalls and

10 yawning budget gaps that practically every State

11 currently faces masks a number of enormous fiscal

12 challenges that States will have to grapple with in

13 such areas as health care, education, emergency

14 management, corrections, infrastructure, unemployment

15 insurance, transportation, and, of course, public

16 pensions.

17 Two, a close review of national financial

18 and demographic trends reveals that every element of

19 our nation's retirement architecture faces serious

20 challenges, a development that threatens to

21 jeopardize the retirement plans of a majority of

22 Americans.

23 Alongside the weaknesses in public

24 retirement systems, the other strands in our

25 retirement architecture -- the looming shortfalls 17

1 expected in Social Security and Medicare in coming

2 decades; the precarious financial position of

3 corporate pension plans and the Federal Pension

4 Benefit Guaranty Corporation; and the low personal

5 savings rates of most Americans, notwithstanding the

6 improvement in this category recently, coupled with

7 high rates of consumer and household debt -- remain

8 very troubling.

9 Three, our society is an aging one, and

10 Census Bureau figures indicate that in 2030, when all

11 of the baby boomers will be 65 or older, nearly one

12 in five U.S. residents will be at least 65.

13 The 65-and-over age group is projected to

14 increase to 88.5 million in 2050, more than doubling

15 the number in 2008, 38.7 million, and increasing from

16 13 percent of total population in 2008 to 20 percent

17 in 2050. In contrast, in 1935, this age cohort

18 amounted to 6 percent of total population.

19 Four, along with the wave of baby boomers

20 that were eligible to retire in 2008, experts point

21 to the fact that people are living longer.

22 According to June 2008 Federal statistics,

23 life expectancy at birth in the U.S. hit a new record

24 high of 78.1 years, a .3-year increase from the

25 previous period. 18

1 This trend has led to a steady decline in

2 worker-to-beneficiary ratio in terms of workers

3 paying into Social Security, from 16.5 to 1 in 1950,

4 to 3.3 to 1 in 2007, to 2 to 1 in 2032.

5 In fact, the 18-to-64 age cohort, the peak

6 working cohort, will decline from 63 percent of the

7 population in 2010 to 57 percent in 2030, further

8 demonstrating the shrinking workforce.

9 These four reasons cumulatively amount to a

10 fiscal tsunami looming ahead on our nation's

11 financial horizon that requires the urgent attention

12 of policymakers at all levels of government.

13 Part three:

14 Before the onset of the current recession, a

15 number of research studies had indicated that a

16 majority of public pension plans were underfunded or

17 unfunded to varying degrees; i.e., assets were less

18 than their accrued liability.

19 Many experts consider a funded ratio,

20 actuarial value of assets divided by actuarial

21 accrued liabilities, of about 80 percent or better to

22 be an adequate level for government pensions.

23 The farther a plan's funding level is below

24 this optimal amount, the greater the contributions

25 the government will eventually be required to make to 19

1 finance its unfunded liability.

2 It should be noted that issues related to

3 the release of timely and uniform pension data make

4 reaching conclusions a challenge. Nevertheless,

5 several national studies highlight some of the

6 financial difficulties confronting public pension

7 plans.

8 For instance, a very comprehensive

9 Pew Center on the States report released in

10 December 2007 indicated that while States had socked

11 away enough to cover about 85 percent of their

12 pension costs, at the end of fiscal year 2006, they

13 had put aside very little for non-pension benefits

14 such as retiree health care. This report noted that

15 States faced about $731 billion in unfunded bills

16 coming due.

17 A July 2008 U.S. Government Accountability

18 Office report noted that 58 percent of the 65 large

19 pension plans reviewed reached the 80-percent

20 threshold in 2006, a decrease compared to 2000 when

21 about 90 percent of the plans were so funded.

22 More recently, in February 2009, a

23 Standard & Poor's report noted that for 2007, the

24 mean-funded ratio for State pension plans was

25 83 percent, the number recorded in the early 20

1 nineties.

2 Similarly, the March 2009 Wilshire report

3 noted that the funding ratio for all 125 State

4 pension plans reviewed in 2008 declined to

5 84 percent, down sharply from 96 percent in

6 2007.

7 In line with the timeliness issues

8 mentioned earlier, it is certain that when the market

9 losses of the last 6 months are factored in, public

10 pension plan performances will be negative.

11 Notwithstanding these challenges and the

12 fact that the extreme market losses of the last

13 6 months are not factored in, several plans did

14 secure an actuarial funded ratio greater than

15 100 percent.

16 According to the February 2009 Standard &

17 Poor's report, seven States -- Delaware, Florida,

18 Idaho, New York, North Carolina, Oregon, and Utah --

19 all secured funded ratios greater than 100 percent.

20 Pennsylvania stood at 89.5 percent.

21 At the other end of the spectrum,

22 Connecticut, Illinois, Indiana, Louisiana,

23 New Hampshire, Oklahoma, Rhode Island,

24 South Carolina, and West Virginia were the State's

25 with funded ratios lower than 70 percent. 21

1 Part four:

2 My ongoing review of public retirement plans

3 reveals several trends.

4 First, the increasing move by State plans to

5 invest in nongovernmental securities such as

6 corporate bonds, stocks, foreign investments, hedge

7 funds, and real estate, away from government

8 securities such as U.S. Treasury bills.

9 For instance, in 1993, State and local

10 government retirement plan investments in

11 nongovernmental securities amounted to 62 percent as

12 a percent of total cash and investment holdings. By

13 2007, this percentage had escalated to 78 percent.

14 As expected, while pension plans enjoyed

15 above-average investment returns when the equity

16 markets soared, they experienced steep declines when

17 they disintegrated.

18 Second, given the spate of accounting and

19 corporate scandals and the significant losses

20 experienced by public pension plans, there's a great

21 deal more activism on the part of the boards

22 overseeing these plans and State lawmakers to monitor

23 their performance and manage them more closely.

24 A number of State pension plans -- Maryland,

25 Iowa, North Dakota -- were plagued by financial 22

1 scandals, leading to lawmakers in those States

2 initiating reviews and reforms.

3 Third, the impact of a Governmental

4 Accounting Standards Board, GASB, ruling on teetering

5 public pensions plans. GASB is the independent

6 standard-setter for 84,000 State and local government

7 entities.

8 According to this ruling, State and local

9 governments have to place a value on "other

10 post-employee retirement benefits," consisting mostly

11 of health care, they promise to employees.

12 They have to record as an expense the amount

13 -- the annual required contribution -- they would

14 need to stash away to fully fund this long-term

15 liability over 30 years.

16 This is because nearly all governments pay

17 for health benefits for their retired employees on a

18 pay-as-you-go basis each year and generally do not

19 set aside funds to address future benefit

20 obligations.

21 Given that health-care costs in the

22 United States are rising so rapidly, this GASB ruling

23 is designed to provide a complete and reliable

24 reporting on the costs of future financial

25 obligations such as retiree health care. 23

1 Part five:

2 In responding to the growing crisis

3 associated with their pension plans, lawmakers around

4 the country have either proposed or adopted a number

5 of strategies to buttress the finances of these

6 systems.

7 Pension obligation bonds:

8 Given their increasing fiscal problems,

9 States and localities opted to issue debt to raise

10 money to plow into their pension systems and pay off,

11 in a lump sum in today's dollars, their unfunded

12 liabilities.

13 Since interest rates have been at

14 historically low levels for some years now and the

15 fact that raising taxes continues to be politically

16 radioactive, the opportunity to raise funds via

17 enhanced borrowing quickly loomed as an attractive

18 strategy.

19 Some of the States that pursued the pension

20 obligation bond strategy earlier on in this decade

21 to replenish their pension plans include California,

22 $2 billion; Illinois, $10 billion; Kansas,

23 $500 million; Oregon, $2 billion; and Wisconsin,

24 $1.8 billion.

25 In May 2008, Alaska authorized the sale of 24

1 up to $5 billion in pension obligation bonds to

2 offset State and local government unfunded retirement

3 liabilities, while Wisconsin, also in 2008,

4 authorized Milwaukee County to do so.

5 In selling these bonds, States are counting

6 on the interest payable on the bonds being lower than

7 their pension investment earnings. If a State

8 pension plan can earn 8 percent by investing money

9 the State borrowed at 6 percent, the State is ahead

10 of the game.

11 Another advantage is that States experience

12 immediate budget relief, because their current year

13 contributions to a pension plan can be secured from

14 the proceeds of the bond issue.

15 On the flip side, there is always the

16 possibility that the market may not generate the

17 returns to cover the interest rate.

18 Furthermore, once a State issues a bond, it

19 is locked into paying the debt, whereas the State has

20 much more flexibility in deciding on future pension

21 contributions, including size, rate, and regularity.

22 New Jersey's experience in the 1990s offers

23 a cautionary tale for States mulling this option.

24 Then-Governor Christine Todd Whitman led an effort

25 that resulted in the State issuing $2.8 billion in 25

1 bonds that promised to pay off its unfunded pension

2 liability, solve all of its pension problems for the

3 next 36 years, make the State's contribution to the

4 plan for that year, and free up $623 million for tax

5 cuts.

6 The State banked on getting returns

7 exceeding 7.6 percent, the interest it was paying on

8 the bonds. For the first few years, while the

9 economy surged ahead and the stock market roared, the

10 gamble appeared to have paid rich dividends. Then

11 the economy slumped and the stock market collapsed,

12 resulting in a severe drop in investment earnings.

13 By mid-2003, even after the stock market had

14 recovered, the State only saw returns of 5.5 percent,

15 significantly lower than the required 7.6 percent.

16 New Jersey's pension system was in deep trouble.

17 The anemic earnings were only compounded by

18 several Governors in New Jersey balancing budgets by

19 skipping pension contributions and granting "pension

20 holidays."

21 In fact, Governor Corzine recently indicated

22 that in his first 3 years in office, the State had

23 allocated more money into the pension system than

24 Governors had done in the previous 15 years, though

25 the State is still short of what is actuarially 26

1 needed to fully fund benefits.

2 As of June 2007, the State pension fund had

3 an unfunded liability of $28 billion, an amount that

4 is indisputably higher now given recent market

5 losses.

6 Of course, given the recent credit freeze

7 that swept across the economy starting in

8 October 2008, State and local governments have found

9 it increasingly difficult to secure funds from the

10 bond markets. Even though the situation has improved

11 marginally in recent months, the pension bond option

12 might not be as straightforward as it was before the

13 fall of 2008 credit crisis.

14 Trimming benefits:

15 Several strategies crop up under this

16 category.

17 One, moving workers hired in the future to

18 401(k)-style investment accounts away from the

19 current format of a guaranteed pension based on years

20 of service and highest salary.

21 Alaska became the first State in the country

22 to switch all State workers hired after July 2006 to

23 401(k)-type accounts.

24 Governor Schwarzenegger in California,

25 Governor Sanford in South Carolina, Governor Corzine 27

1 in New Jersey, have advocated this approach, and so

2 have lawmakers in Michigan, Illinois, Kentucky,

3 Oregon, and Virginia.

4 More recently, in Rhode Island, a House

5 panel recommended that State employees hired after

6 July 1, 2009, be placed in a 401(k)-style account.

7 Two, reviewing and reducing the annual

8 cost-of-living adjustment or COLA increases for

9 retiree pensions.

10 Rhode Island has proposed paying an annual

11 COLA tied to the yearly cost-of-living index as

12 opposed to an automatic percentage increase.

13 Kentucky reduced the COLA in the State's

14 legislative plan, while Vermont replaced its existing

15 COLA with a smaller increase.

16 Three, adjusting the age at which employees

17 are paid full benefits.

18 In New Jersey, there is a proposal to raise

19 the retirement age for public employees and teachers

20 from 60 to 62.

21 Rhode Island has proposed a minimum

22 retirement age of 65 for State employees and

23 teachers.

24 Kentucky has set eligibility for retirement

25 medical benefits at a minimum age of 60 with 15 years 28

1 of service.

2 Governor Paterson and Mayor Bloomberg in

3 New York have called for a minimum retirement age of

4 50 in New York City where no minimum age currently

5 exists.

6 Four, creating different benefit tiers for

7 current and future employees.

8 Governors Paterson in New York and Quinn in

9 Illinois have proposed a new, less-generous

10 retirement tier for future employees, while Governor

11 Gibbons in Nevada called for trimming retiree

12 benefits across the board.

13 Five, capping annual retirement benefits.

14 New Hampshire in 2008 set a limit of

15 $120,000 as an annual retirement benefit.

16 Six, reducing retiree pay, with Rhode Island

17 proposing that an employee's pension be based on a

18 5-year salary average instead of the current 3-year

19 average.

20 Wisconsin has an unusual policy of adjusting

21 the amount of benefits paid based on its pension

22 fund's performance. Now, for the first time in

23 25 years, a majority of retirees will see a benefit

24 reduction.

25 Seven, eliminating programs like the 29

1 Deferred Retirement Option Plan, or DROP, which

2 allowed State workers with 30 years on the job to

3 retire and continue working up to 3 years while

4 escrowing their retirement benefits at a guaranteed

5 rate of return.

6 Florida is also cracking down on

7 double-dipping, a system that allows officials to

8 retire by taking 30 days off and returning to work in

9 their old jobs with a salary and a pension.

10 New Mexico also placed salary caps on State

11 and local government retirees who return to work in

12 government jobs.

13 Eight, ending lucrative retirement plans

14 where certain State employees serve a brief period in

15 a position to secure a significant boost in personal

16 pension income.

17 Missouri eliminated its Administrative

18 Law Judge retirement system which allowed this

19 practice.

20 Nine, debating and enacting restrictions on

21 the ability of public-sector systems to continue

22 offering lucrative retiree health care.

23 In North Carolina and Michigan, until a few

24 years ago, any State employee with 5 years of service

25 was eligible to receive free retiree health care for 30

1 life.

2 Indiana ended lifetime health insurance for

3 lawmakers subsidized by taxpayer dollars.

4 Kentucky increased the vesting requirement

5 for retiree medical benefits from 10 to 15 years.

6 Increasing costs:

7 A number of States have increased the cost

8 for employees to participate in their pension

9 systems.

10 For instance, Kentucky increased employee

11 contributions for Legislators and Judges joining

12 the system after September 2008 and instituted a

13 new 1-percent employee contribution for public

14 workers hired after September 2008 to fund medical

15 benefits.

16 New Jersey increased membership eligibility

17 in the State retirement plan for teachers and public

18 employees.

19 Also in 2008, Iowa enacted numerous changes

20 to its retirement plans, including increased

21 contribution rates.

22 Wyoming hiked its required employee

23 contributions for Judges, and in Vermont, members'

24 contribution rates increased from 3.25 percent to

25 5 percent until July 1, 2019. 31

1 Consolidating boards:

2 West Virginia teachers merged their two

3 retirement systems to create greater efficiencies,

4 while Minnesota merged the troubled Minneapolis

5 teachers' pension fund with the larger statewide

6 fund.

7 In Vermont, the Governor and lawmakers

8 agreed to combine the funds of its three State

9 retirement systems for investment purposes.

10 Indiana lawmakers weighed a proposal to

11 merge the State's employee and teacher pension

12 plans.

13 Guaranteed returns:

14 In a contrarian approach that hailed it as

15 the first pension fund in the United States to do so,

16 Maine adopted a strategy known as matching; i.e.,

17 deliberately aiming for low but guaranteed investment

18 income to pay for retirement benefits.

19 In 2003, Maine put a third of its assets

20 into very conservative bonds. The bonds pay a low

21 interest rate, but their values will rise or fall in

22 conjunction with the value of the pensions the State

23 must pay its retirees, regardless of the trajectory

24 of the markets.

25 A review of how Maine fared in the downturn 32

1 reveals that between January 1 and October 30, 2008,

2 while U.S. stocks were down 34 percent, Maine's

3 investments were down between 24 and 28 percent.

4 Deferring contributions:

5 Governor Corzine in New Jersey proposed and

6 both Houses of the Legislature recently approved that

7 counties, municipalities, and school districts

8 temporarily defer 50 percent of their retirement

9 payments into the public employee pension system for

10 a year.

11 Kentucky is considering cutting the amount

12 of funds that State and local governments contribute

13 to their public pension plans and also proposed

14 spreading out payments that cities and counties are

15 supposed to make into the State's retirement system

16 from 5 to 10 years.

17 Unorthodox investments:

18 The Retirement System of Alabama embarked on

19 a series of unorthodox investments that enabled the

20 fund to progress from $500 million in assets in 1973

21 to $35 billion by 2007.

22 Some of these acquisitions include New York

23 City real estate, media outlets -- television,

24 newspapers -- hotels, a cruise ship terminal,

25 golf courses, and becoming the largest stakeholder of 33

1 US Airways.

2 Massachusetts considered a proposal to allow

3 all State residents to invest in the State's public

4 employee pension fund.

5 In conclusion, when States emerge from the

6 current recession with their balance sheets in better

7 shape, unfortunately, they will be pummeled by

8 several expenditure categories, including unfunded

9 and underfunded pension liabilities.

10 Even before the current recession, public

11 pensions faced challenges that have now heightened

12 given the collapse of the equity markets in the last

13 6 months.

14 While in certain instances this weakened

15 pension outlook was the result of State's skipping

16 their required contributions, the severity of the

17 recent fiscal downturn, demographic changes, and a

18 steep rise in health-care costs will pose additional

19 challenges.

20 Then the implementation of the GASB ruling

21 could propel unfunded pension liability levels to new

22 heights, a trend that could damage State bond

23 ratings.

24 Yet, the "graying" of America, the fact that

25 States will have more retirees living longer in the 34

1 coming years and the ability of the public sector to

2 attract quality employees in an era of dwindling

3 retirement benefits, requires innovative solutions.

4 Further complicating the public pension

5 outlook is the fact that the financial viability of

6 every other element of our retirement infrastructure

7 remains shaky.

8 Ensuring both the short-term and long-term

9 financial viability of the different elements in

10 America's retirement systems, both private and

11 public, remains of paramount importance.

12 In fact, first resuscitating and then

13 sustaining the financial health of our different

14 retirement income flows provides the foundation of

15 the United States as an economic, political, and

16 military powerhouse in the global context.

17 Thank you for your attention and invitation

18 to speak here today.

19 CHAIRMAN JOSEPHS: Mr. CanagaRetna, I'm

20 overwhelmed, and I believe I am not alone in the

21 people sitting in this room. Your expertise and the

22 breadth of your testimony is really extraordinary.

23 MR. CANAGARETNA: Thank you very much.

24 CHAIRMAN JOSEPHS: I would like you to

25 please direct me, my staff, to a Web site where we 35

1 can get this testimony.

2 MR. CANAGARETNA: Sure; of course.

3 CHAIRMAN JOSEPHS: And your PowerPoint.

4 MR. CANAGARETNA: Sure.

5 CHAIRMAN JOSEPHS: Or e-mail that to my

6 staff, and I will distribute that information to

7 anybody who wants that.

8 MR. CANAGARETNA: Sure. No problem.

9 CHAIRMAN JOSEPHS: And I'm hoping that you

10 don't have to immediately, after the questions are

11 finished, go back to Atlanta but that you can stay

12 here and join in a general discussion after our own

13 pension fund managers have testified.

14 MR. CANAGARETNA: Okay. Yes.

15 CHAIRMAN JOSEPHS: Thank you.

16 I want to mention that Representative

17 Gibbons, Representative Youngblood, and my Republican

18 counterpart, Representative Benninghoff, is here.

19 Mr. Benninghoff, do you want to come up

20 here---

21 REPRESENTATIVE BENNINGHOFF: All right.

22 CHAIRMAN JOSEPHS: Is that all right?

23 REPRESENTATIVE BENNINGHOFF: Yes.

24 CHAIRMAN JOSEPHS: Thank you.

25 Jen, from my staff, would you come over 36

1 here, please, while we're talking?

2 Are there any questions?

3 Representative McIlvaine Smith.

4 REPRESENTATIVE McILVAINE SMITH: Thank you,

5 Madam Chairman.

6 I wanted to ask, and I'm sorry I missed and

7 I'm very interested in when you were talking about

8 trimming benefits---

9 MR. CANAGARETNA: Right.

10 REPRESENTATIVE McILVAINE SMITH: ---that you

11 said other States defer pension contributions, and

12 I'm sorry I missed the explanation. Would you mind

13 just repeating that, please?

14 MR. CANAGARETNA: Yes; I think what is

15 happening is the fact that we are in such a budget

16 hole, you see a number of States trying to obtain

17 some temporary relief in terms of their budget

18 situations by deferring or granting pension holidays,

19 and that's a strategy that has been pursued in the

20 past.

21 Even in the last recession in 2001, you saw

22 States doing that. But thankfully there were some

23 States that actually came back and made up the

24 contributions they did not make. For instance, the

25 State of North Carolina did exactly that. 37

1 In 2001-2002, they skipped contributions,

2 but when the economy recovered, they came back in

3 '05-06 and added up what they did not do, so that

4 kind of enabled them to catch up a little bit.

5 REPRESENTATIVE McILVAINE SMITH: And my

6 second and last question: When you said about and

7 you mentioned consolidating the retirement boards?

8 MR. CANAGARETNA: Yes.

9 REPRESENTATIVE McILVAINE SMITH: Do you have

10 any idea how much that saved the States that did

11 that?

12 MR. CANAGARETNA: I don't have the exact

13 numbers right off here, but I will be happy to get it

14 to you.

15 But it is in the expectation that it will

16 create greater savings. That's the rationale for

17 going ahead with those mergers.

18 REPRESENTATIVE McILVAINE SMITH: I'll look

19 forward to getting that information.

20 Thank you so much.

21 CHAIRMAN JOSEPHS: Mr. Roae, do you have a

22 question?

23 REPRESENTATIVE ROAE: Yes. Thank you,

24 Madam Chairwoman.

25 Thank you, sir, for your testimony. 38

1 I'm just kind of curious, do you know from

2 your research, what is typical out there among the

3 States as far as, you know, like what's the typical

4 size of a pension for a State employee? I'm just

5 kind of curious if Pennsylvania is high or low.

6 And then also, what is typical in terms of

7 how that is calculated? I mean, do most States give

8 somebody, you know, 1 percent per year? 2 percent

9 per year? What is pretty normal out there?

10 MR. CANAGARETNA: It varies, and you're

11 right. In the COLA increases -- is that what you're

12 talking about now?

13 REPRESENTATIVE ROAE: No; I mean like how

14 pensions are calculated. Like as far as, you know,

15 for every year of service, do States typically give,

16 you know, 2 percent or 3 percent or 4? What is

17 typical out there?

18 MR. CANAGARETNA: There's a huge -- I guess

19 there's a great deal of variation in terms of where

20 we stand.

21 REPRESENTATIVE ROAE: Okay.

22 MR. CANAGARETNA: But you're right. I mean,

23 it's in that general ballpark. Between 2 and

24 3 percent, I guess, is sort of average.

25 But again, you have some States that are on 39

1 the high end of it and then other States that are on

2 the lower end, and, you know, I'll be happy to pull

3 together some of that information for you if you are

4 particularly interested in sort of like a median

5 number, I guess. Is that kind of what you're looking

6 at?

7 REPRESENTATIVE ROAE: Okay.

8 Then you don't have any idea of what the

9 average pension would be for a retired State worker,

10 you know, all across the country?

11 MR. CANAGARETNA: It's sort of -- I'm

12 hesitant to give out of those numbers---

13 REPRESENTATIVE ROAE: Okay.

14 MR. CANAGARETNA: ---because of the fact

15 that you have so much variety. And, you know,

16 creating an average will sort of not -- I don't think

17 it provides the actual accurate picture.

18 REPRESENTATIVE ROAE: Okay. Okay.

19 Yeah; because I was just thinking, you know,

20 we want to make sure we're being fair to retirees,

21 but we want to make sure we're being fair to the

22 taxpayers also.

23 MR. CANAGARETNA: Sure.

24 REPRESENTATIVE ROAE: And it would just be

25 kind of interesting to see, you know, how does the 40

1 Pennsylvania plan compare to what typical States are

2 doing out there.

3 MR. CANAGARETNA: Right.

4 I think the more reasonable comparison might

5 be looking at Pennsylvania vis-a-vis neighboring

6 States.

7 REPRESENTATIVE ROAE: Okay.

8 MR. CANAGARETNA: That might be a more

9 accurate indication of where the State stands as

10 opposed to looking at it across the board, across all

11 50 States.

12 I don't know if that's a more reasonable

13 approach. That might be something that might be

14 pursued.

15 REPRESENTATIVE ROAE: That may be.

16 Thank you, sir.

17 MR. CANAGARETNA: You're welcome.

18 CHAIRMAN JOSEPHS: We have been joined by

19 Representative Curry.

20 Mr. Chairman Clymer with a question.

21 REPRESENTATIVE CLYMER: Thank you,

22 Madam Chair.

23 And thank you, sir, for your testimony here

24 this morning.

25 MR. CANAGARETNA: You're welcome. 41

1 REPRESENTATIVE CLYMER: I have two

2 questions.

3 Number one, on the issue of double-dipping,

4 that is what you were saying about no State employee,

5 schoolteacher or State employee, should be getting

6 two State pensions. Is that correct?

7 MR. CANAGARETNA: That's what you have seen

8 some States move towards, and I gave the example of

9 Florida.

10 REPRESENTATIVE CLYMER: Yes.

11 MR. CANAGARETNA: There was a big hue and

12 cry in the last 8 months or so on that count, and now

13 you see the State aggressively moving to trying to

14 eliminate that as much as possible.

15 REPRESENTATIVE CLYMER: Suppose an employee

16 worked for the county or worked for the local

17 municipality and then they became a State worker.

18 MR. CANAGARETNA: Right.

19 REPRESENTATIVE CLYMER: Would that be

20 included as double-dipping in your definition?

21 MR. CANAGARETNA: The example that I, you

22 know, followed in Florida is where they worked for

23 the State and then came back -- retired -- and then

24 came back and did another stint for the State.

25 REPRESENTATIVE CLYMER: Okay. 42

1 MR. CANAGARETNA: So the county-city

2 breakup, I guess, again, it would probably vary from

3 State to State.

4 REPRESENTATIVE CLYMER: Okay.

5 MR. CANAGARETNA: But in this instance I was

6 talking about the Florida example where they were

7 trying to crack down on this as a means to conserve

8 costs.

9 REPRESENTATIVE CLYMER: Okay.

10 And my final question is that you had

11 mentioned where States are seeking alternatives to a

12 defined pension as we have here in Pennsylvania.

13 MR. CANAGARETNA: Yes.

14 REPRESENTATIVE CLYMER: They are going to

15 401(k)s.

16 MR. CANAGARETNA: Right.

17 REPRESENTATIVE CLYMER: Now, how do they do

18 that?

19 There have been various options available

20 for States to go into this second option, if they so

21 desire.

22 MR. CANAGARETNA: Right.

23 REPRESENTATIVE CLYMER: But if you are in a

24 defined pension right now, then do you say in 5 years

25 all new employees will go into a 401(k)? Because you 43

1 still have to make sure that you have liquidity for

2 those employees, you know---

3 MR. CANAGARETNA: Exactly.

4 REPRESENTATIVE CLYMER: ---that are in the

5 older pension. So could you just maybe explain?

6 MR. CANAGARETNA: And that's exactly the

7 point there, because moving to the 401(k) option does

8 not take care of the unfunded liability portion of

9 the folks that are on the defined benefit plan that

10 are already in existence.

11 So what is happening here and, you know,

12 what I have seen across the country is that you have

13 future employees that are assigned to the 401(k)

14 status, as it were, or the DC status.

15 And we had the State of Alaska; that was the

16 first State that actually moved where every State

17 employee hired after July 1, 2006, was automatically

18 assigned to this DC plan as opposed to a DB plan,

19 which some States have now. There's an ad hoc mix of

20 both DC and DB elements, whereas in the State of

21 Alaska, everybody hired after July 1 is in this DC or

22 401(k)-style plan.

23 REPRESENTATIVE CLYMER: Thank you.

24 Thank you, Madam Chair.

25 CHAIRMAN JOSEPHS: Mr. Taylor. 44

1 REPRESENTATIVE TAYLOR: Thank you very much,

2 Madam Chair.

3 The question I have for you is, I was

4 looking at the number of people who, in 1950, the

5 multiple was 16.5 to 1---

6 MR. CANAGARETNA: That's correct.

7 REPRESENTATIVE TAYLOR: ---to help fund the

8 pool.

9 MR. CANAGARETNA: Correct.

10 REPRESENTATIVE TAYLOR: And I think you said

11 at about 2030, it would be 2 to 1.

12 MR. CANAGARETNA: 2 to 1; that's right.

13 REPRESENTATIVE TAYLOR: That's a massive

14 flip.

15 MR. CANAGARETNA: Right.

16 REPRESENTATIVE TAYLOR: What is driving

17 that? Because I understand in the private market,

18 you know, people are moving away from DB plans to

19 DC plans, but in government, I haven't seen that so

20 much. So why is it going from 16.5 to 1 to be

21 projected to 2 to 1?

22 MR. CANAGARETNA: Right. Well, those are

23 the estimates that came out of the U.S. Census Bureau

24 in terms of where they expect people contributing to

25 Social Security will end up being. And that is an 45

1 area that is pretty scary, and it's an indication

2 that we are an aging population.

3 And I think I put up some numbers indicating

4 where we are and where some States are going to be.

5 So that's just an indication of where we are in terms

6 of a nation.

7 It is going to be an aging group. We are

8 going to be living longer, which means there are

9 going to be fewer workers out there contributing to

10 Social Security, for instance.

11 REPRESENTATIVE TAYLOR: Thank you.

12 CHAIRMAN JOSEPHS: Are there any other

13 questions from members?

14 Do any of the four Executive Directors,

15 minority or majority, have any questions?

16 I think we're overwhelmed, but I think that

17 two things we have been talking about here, and which

18 we will work on later, one is that we need to follow

19 this up with some sort of working group of

20 Legislators and experts, and I hope whatever form

21 that takes, that you will help us with that.

22 MR. CANAGARETNA: Sure.

23 CHAIRMAN JOSEPHS: And secondly, it just

24 strikes me that what you have said to us, with all of

25 this astounding detail and accumulation of different 46

1 kinds of bad news, is for the first time in this

2 country, our next generation is very likely to be

3 poorer than the generation that preceded it, and

4 that, to me, is pretty depressing.

5 If we can have the two gentlemen from --

6 thank you so much---

7 MR. CANAGARETNA: Thank you.

8 CHAIRMAN JOSEPHS: ---from both of our

9 employees' retirement systems, Mr. Knepp and

10 Mr. Clay.

11 And you tell us when your PowerPoint is up

12 and when you're ready to proceed.

13 EXECUTIVE DIRECTOR KNEPP: We did not plan

14 on -- if I could -- we did not plan on a PowerPoint.

15 What we handed out here was the presentation itself.

16 CHAIRMAN JOSEPHS: Okay.

17 EXECUTIVE DIRECTOR KNEPP: And our game plan

18 there is to walk you through, and we thought the best

19 way to approach this -- does everyone have a copy of

20 this right now? We'll see that you get a copy.

21 Does everyone have a copy? Okay.

22 My name is Leonard Knepp. I'm the Executive

23 Director of PA SERS.

24 With me is Jeff Clay. He's the Executive

25 Director of the school system. 47

1 Our thought today was to walk you through,

2 first of all, the basic facts of SERS and PSERS, of

3 the pension funds.

4 Once we move beyond that, then we'll take

5 you to where the funds have come, how they have come

6 through over the last year and then the various

7 funding options that have or issues that have been

8 created by this year's return, this past year, and

9 then finally some of the options that are available.

10 So with that being said, if I could

11 proceed.

12 What we're talking about on page 1 -- and

13 again, this is very high level. We thought we would

14 just give you some of the specific facts relating to

15 the two pension funds. If you have any questions,

16 feel free to provide those, and we would like to keep

17 this as interactive as possible.

18 CHAIRMAN JOSEPHS: Yes; I would like you to

19 finish your presentation, though, before we take

20 questions. We're just too big a group to have

21 informal conversation, I think.

22 EXECUTIVE DIRECTOR KNEPP: Okay.

23 On page 1, it points out that the SERS Fund

24 was established in 1923, and the PSERS Fund was

25 established in 1917. 48

1 The primary "plan document" for SERS is

2 under Title 71. It's the State Employees' Retirement

3 Code. And for PSERS, the "plan document" would be

4 the Public School Employees' Retirement Code under

5 Title 24.

6 Now, the SERS Board is governed by

7 11 individuals, covering 108 Commonwealth and

8 non-Commonwealth employers. PSERS is governed by a

9 15-member board. It has over 730 employers, school

10 employers.

11 In addition, they administer a Health

12 Options Program. This is a voluntary group insurance

13 program for over 61,000 annuitants, spouses, and

14 dependents.

15 This is funded by the premium payments by

16 the members, and no funding is provided by PSERS --

17 no direct funding is provided by PSERS or the

18 employer.

19 In addition, they administer a premium

20 assistance program that provides eligible

21 participants up to $100 per month in health-care-cost

22 coverage.

23 SERS does not administer a health-care

24 program. The majority of our members are retirees.

25 They worked for employers that were members of the 49

1 Retired Employee Health Care Program, which is

2 administered by PEBTF.

3 We also administer a deferred comp program

4 on the SERS side.

5 Now, moving on to slide 3, some of the key

6 facts I would like to point out: As of 12/31 this

7 data is from, and SERS has an asset balance of

8 approximately $24 billion; with PSERS, approximately

9 $45 billion.

10 We paid out over $2.2 billion in benefit

11 payments last year, and PSERS paid out $4.9 billion

12 in benefits.

13 The ratio that was talked about earlier, the

14 actuarial value of assets to the liabilities, is

15 93 percent for SERS and 86 percent for PSERS. And

16 again, this is based on a 5-year -- the ratio that he

17 was talking about, we use a 5-year smoothing

18 mechanism to lower the volatility, if you will, of

19 these various returns from year to year.

20 Another number we should point out is that

21 with this fund -- it is rare for a lot of the

22 retirement funds -- that approximately 91 percent of

23 our annuitants withdraw a portion of their moneys

24 they paid in, either all or a portion of it,

25 91 percent; PSERS is 88 percent. 50

1 Then moving on to, on the same slide, the

2 second chart, it just gives you the various numbers

3 of the types of retirements that we have experienced.

4 Approximately 50 percent retire under what

5 we call a normal retirement. That is an unreduced

6 retirement.

7 Moving down to slide four, something I would

8 like to point out, we talk about the cost of this

9 program. Over the last 10 years, the funding for

10 this program, 74 percent for SERS, 77 percent for

11 PSERS has come from the investment earnings of the

12 fund, with 17 percent and 14 percent respectively

13 coming from SERS and PSERS for the member

14 contributions, and then only 9 percent came from the

15 employer.

16 Now, from the SERS side, this was done while

17 we paid out over $17 billion in benefits. This is

18 over the last 10 years.

19 Moving on to page 5, we talk about the

20 employee contribution rate. For SERS, the normal

21 rate is 6 1/4 percent. For PSERS, it varies between

22 5 1/4 and 7.5.

23 There is a study that was done by NASRA, the

24 National Association of State Retirement

25 Administrators, that looked at the various employee 51

1 and employer contributions that were paid. The

2 average rate was approximately 5 percent. So the

3 employee for SERS and PSERS is paying a higher rate

4 than normal throughout the country.

5 Something else I would like to point out in

6 the first chart, if you look at the employer rate in

7 the dark bar? It ran anywhere from 6 percent up to

8 in excess of 8 percent for the employer between '02

9 and '06. During that same period for SERS, we were

10 paying zero in '02, 1, 2, 3, 4 for the years 3

11 through 6. Right now, that rate is at the floor at

12 4.0 percent for the year. And PSERS was about the

13 same. It is very comparable to what we paid.

14 Moving on to tab 6, we show you the benefit

15 structure for the member.

16 The basic benefit is calculated at

17 2 1/2 percent times years of service times final

18 average salary. You were talking earlier if that is

19 comparable, and right now we see -- and we'll talk

20 about that a little later -- that 2 1/2 is at the

21 high end.

22 This is not tied -- I should say that this

23 is a normal way for a DB plan to work. This is not

24 tied to investment returns.

25 In addition to that, this benefit is 52

1 pre-funded. It is not a pay-as-you-go system. So

2 when the member retires, there are the funds there

3 necessary for that member.

4 On page 7, we talk about the various plan

5 structures, the benefit options available to the

6 member. We talk about the MSLA, which is the Maximum

7 Single Life Annuity. That is what is eligible to the

8 member. That is the maximum benefit they can

9 receive. If that member would die, there is nothing

10 available to the beneficiaries.

11 Option 1 protects PV. It's a lower benefit.

12 Option 2 provides the same benefit to the member as

13 to the benny, and then 3 is 50 percent.

14 Moving on to tab or page 8, we talk about

15 accumulated deductions. These are the member's

16 contributions plus the interest that that earns

17 throughout their career.

18 We allow the members to withdraw this, and

19 as I had stated before, this is unusual in a lot of

20 public pension funds. Approximately 91 percent of

21 the members retiring from SERS take Option 4 and

22 approximately 88 from PSERS.

23 On page 9, we give you an example of what a

24 normal benefit calculation would result in. What you

25 can see here is the various reductions that the 53

1 member will experience through the options that they

2 select.

3 On page 10, what you were talking about

4 earlier. This is the result of a Joint State

5 Government Commission study where they reviewed or

6 surveyed various States, and you can see there that

7 from the normal retirement, it has the various

8 features in where we stack up against other

9 States.

10 And some of the items I would like to point

11 out, we do have a higher benefit accrual rate, and it

12 is a favorable option for a member to withdraw, which

13 we have discussed before.

14 One of the less favorable is we do require

15 higher contributions, and we do not offer an

16 automatic COLA.

17 On page 11, we talk about the funding of the

18 system and how it is done. It is done -- one of the

19 calculations that is required by the actuary is the

20 normal cost, and this is the cost of the benefit

21 earned for that year of service.

22 It is part of the actuary's calculation to

23 determine not only liability but what the employer

24 rate will be. You will see that SERS was 8.42,

25 PSERS was 7.35. 54

1 Then we get into what we call right now, on

2 page 12, "No Place to Hide," and what we wanted to

3 give you is an example of what was just provided,

4 what happened last year in comparison to prior years.

5 And you'll see on the first slide the Dow Jones at a

6 negative 33.8. It was the third worst year in

7 Dow Jones' history.

8 Then also if you look at January of this

9 year, it was the worst January on record for the S&P,

10 and that is outdone by February of this year, the

11 negative 10.99.

12 Then I continue on page 13 with additional

13 indices. I would like to point out a few items.

14 You will see the EAFE is also, which is the

15 foreign markets, it's also a negative 45.09 for last

16 year. You will also notice that in the fourth

17 quarter, the majority of the losses came in the

18 fourth quarter of last year.

19 So you can see that although we had an

20 extremely challenging year, this fund's performance

21 last year, 2008, was a negative 28.6. This is

22 breaking a string of five strong positive years in

23 which the annualized return exceeded 17 percent.

24 The PSERS Fund reported an investment

25 performance of minus 29.68 in 2008, and they were 55

1 breaking a string of five strong positive years in

2 which the annualized return exceeded 16.57.

3 Moving on to page 15, we have two charts

4 that show the PSERS return and the SERS return over

5 the last several years.

6 The item I would like to point out is the

7 orange bar going through the chart, and that

8 represents the actuarial assumed rate of return.

9 You will see ours is straight right now at

10 an 8 1/2-percent return. The board is looking at

11 that. They discussed this at the March board

12 meeting. We will also be discussing it at the April

13 board meeting, the possibility of reducing this below

14 8 1/2.

15 I would like to point out that PSERS has

16 reduced it to 8 1/4 for the one year and also to

17 8 percent as of June 30, 2009.

18 Now, that being said, moving on to the next

19 issue we would like to discuss, I'll turn this over

20 to Jeff Clay from PSERS.

21 EXECUTIVE DIRECTOR CLAY: Good morning, and

22 thank you again for the opportunity to come address

23 the joint committees.

24 I get the privilege of doing, you know, the

25 bad news with respect to the funding. We'll start 56

1 off with just sort of an overview of where we stand

2 with the employer contributions.

3 And if you turn to slide 17, taking a look

4 first at PSERS, the fiscal year employer contribution

5 rate of return -- and this is for fiscal year '08-09;

6 that's the year we're currently in -- it is

7 4.76 percent. That number is multiplied against the

8 total school payroll, which I'll show you some

9 numbers of what that looks like a little bit later.

10 When we talk about the SERS number, again, that's

11 against the Commonwealth payroll.

12 The current 4.76 percent is made up of two

13 components for PSERS. One is the pension rate, which

14 is 4 percent; the other is at .76 percent or 76 basis

15 points, which represents the separate funding for the

16 premium assistance benefit that Len mentioned that we

17 administer according to statute.

18 Unlike the State system, the school

19 employers get a Commonwealth reimbursement, so

20 there's a split payment of the contribution rate.

21 That split is not less than 50 percent from the

22 Commonwealth to the school employers but it is

23 adjusted due to income aid ratio.

24 If you take an average across the State at

25 this point, it is basically a 54/46 split, although 57

1 it is now moving up to about a 55/45 split, if I

2 understand, talking to the folks from the Department

3 of Education. Again, the Commonwealth is paying the

4 54 percent.

5 If you take a look at the SERS employer

6 contribution rate, it is currently at 4 percent.

7 That matches the contribution rate, obviously, for

8 the school system for the pension component. Since

9 they don't have a health-care component, they don't

10 have another addition on to that.

11 I would like to point out, for both systems,

12 there was a mention that there is a rate floor, an

13 employer contribution rate floor. That rate floor is

14 4 percent. The rate floor is in effect for both

15 systems.

16 If you were to take the rate floor off, the

17 contribution rate for pensions would actually be

18 below 4 percent, which when you understand the

19 funding issues, you understand the dilemma that we're

20 in.

21 If you turn over to slide 18, looking

22 forward to next year, PSERS already has certified its

23 contribution rate for fiscal year '09-10.

24 One thing I do want to note for the

25 committee, the systems are on different fiscal years. 58

1 PSERS is actually on a typical Commonwealth fiscal

2 year of July 1 to June 30. SERS is on a

3 calendar-year basis. So there are some, you know,

4 differences in trying to match up the two systems.

5 Again, our rate next year is going to be

6 4.78 percent. Again, the 4 percent is for pensions,

7 the .78 percent is for premium assistance.

8 One of the things I want to note for the

9 committee, this pension rate -- and this is both for

10 PSERS and SERS -- is below what we call the normal

11 cost. The normal cost, the employer normal cost, is

12 the amount that needs to be paid by the employer to

13 pay for the benefits that are earned in that year.

14 Okay?

15 So another way to look at that is if the

16 pension systems are operating perfectly -- we earn

17 the money we're supposed to earn according to our

18 assumptions; people live as long as they are supposed

19 to live according to their assumptions; the salary

20 growth went according to assumptions -- if everything

21 operated perfectly, the amount that would need to be

22 required to be paid in the system on an annual basis

23 would be the employer normal cost.

24 There's a misconception among some of our

25 employers that if the system is operating perfectly, 59

1 the amount to be paid is zero. That is not the case.

2 It is the employer normal cost.

3 I will talk to you about the consequences of

4 not paying the normal cost a little bit later.

5 Again, the SERS employer contribution rate

6 for fiscal year '09-10 is projected to be 4 percent,

7 although they have not certified that yet at this

8 stage.

9 Taking a look at slide No. 19, we are now

10 going to start talking about the well-known spike in

11 the employer contribution rate in '12-13.

12 Again, based on PSERS latest actuarial

13 valuation, which is the June 30, 2008, valuation,

14 which was presented to the board in December of last

15 year, our most current projection of the rate spike

16 shows it to be 20.16 percent. That would be the

17 contribution rate. I'll show you some details about

18 that in a minute.

19 If you were to take a look, use our number

20 that we are projecting for the rate of return for

21 this fiscal year -- so this would be the '08-09

22 fiscal year -- presuming that we maintain that rate

23 until the end of this year, our rate of return for

24 the fiscal year as of December 31 was an estimated

25 negative 25.5 percent. 60

1 If we utilize that as the rate of return for

2 this fiscal year, that rate spike is going to be

3 projected to be 29.03 percent in fiscal year '12-13,

4 but that is not the -- that is actually the good

5 news, I should say, because the actual peak in the

6 rate spike will be in 2014-2015 when it goes to

7 33.26 percent. I will show you the numbers of what

8 that means in dollars in a minute.

9 I want to have you focus on the chart that

10 is next to the text. Just to explain those lines

11 there, if you look at the black line that goes up to

12 32.1 percent, this is what was facing the General

13 Assembly and school employers when Act 40 was being

14 done. This is what prompted Act 42 be done.

15 Obviously it's a dramatic increase, and of course

16 that was caused by the recessionary time frame in

17 2001-2003.

18 What Act 40 did, if you take a look at that

19 purple line that is there, it basically pushed off

20 liability to the future. Okay? But if you notice

21 the tail that takes place, again, it pushed it off

22 for a long time. Just like if you were to extend a

23 mortgage for a long time, you are going to actually

24 pay more over the time frame, and that is what the

25 purple line indicates. 61

1 And the blue line reflects our current

2 estimate based on our '08 valuation. If you went

3 back to our '07 valuation, the projection there was

4 11.23 percent. So the net effect between what

5 happened in '08 basically increased the projection

6 from 11.23 percent to 20.16 percent.

7 If you go down to page 20, this is the SERS

8 numbers. Again, SERS is currently in the process of

9 doing their actuarial valuation. They will not have

10 that completed, so the numbers that I have here are

11 estimated numbers. But they are projecting the rate

12 spike to be 25.2 percent in '12-13, and again,

13 increasing the 28.65 percent in 2013-2014, again

14 presuming that the negative 28.6 number is the

15 accurate number for the rate of return for '08.

16 Again, their chart next to it shows similar

17 information with respect to what was being faced in

18 the Act 40 time frame and what Act 40 did.

19 If you take a look at page 21, this is a

20 detailed spreadsheet that is our rate projection with

21 respect to the '08 valuation. I want to just walk

22 down just briefly some of the columns here so you

23 understand what we are talking about.

24 Starting at the left, obviously the fiscal

25 year, that's the fiscal year ending. So, for 62

1 example, the first line there, that's the 2006-2007

2 fiscal year.

3 Next basically shows our projection, either

4 the actual numbers of our projection, what we think

5 the school payroll is going to be during these time

6 frames. You can see for this time frame, we are

7 basically in excess or $12 billion in payroll.

8 Next, the third column over shows the fiscal

9 year rate of return. The '07 and '08 are actual

10 numbers. Those are real rates of return for the

11 system. The numbers after that are the ones that are

12 at an assumed rate of return for the earnings

13 assumption for the system.

14 And again, as Len had indicated, the board

15 had changed the earnings assumption for the '08 time

16 frame, to drop it to 8.25 percent and after that to

17 go to 8 percent.

18 The next column shows the rate floor and

19 shows that being in effect.

20 You then have the employee contribution

21 rate. Now, as Len had indicated for PSERS, there are

22 multiple categories of rate. The number that you see

23 there is the weighted average of those rates coming

24 into the system.

25 Next is the employer normal cost. Remember, 63

1 that's the number that if everything runs perfectly,

2 that's what needs to be paid into the system.

3 The next column over shows the unfunded

4 liability. I draw your attention that if you look,

5 let's see, at the first six entries going down, there

6 are brackets on those numbers. Those are actually

7 credits -- okay? -- and that is because of the

8 funding methodology changes I'm going to show you and

9 talk about. So that's the impact of Act 40. So it

10 is actually showing you credits.

11 If you jump over to the last column, just to

12 show you the interesting part about that, you will

13 notice that that is the unfunded accrued liability.

14 That is the money that essentially is unfunded at

15 this stage, obviously a liability that is unfunded.

16 We have a credit in the unfunded liability

17 rate, but there is unfunded debt. As I am going to

18 explain shortly, essentially we are not making a

19 payment on the debt, which is causing problems. So

20 we'll come back to that.

21 If you take a look at the preliminary

22 employer contribution rate, that just basically shows

23 you what the calculation would be without the effect

24 of the rate floor. So again, for the '08-09 time

25 frame, you will see that the rate was supposed to be 64

1 3.31 percent. The rate floor, of course, kicks that

2 up to 4 percent.

3 Next is the health care premium assistance

4 contribution, and then the total employer

5 contribution. This is, obviously, what we certify

6 out to the employers.

7 Then you have the funded ratio, and as was

8 explained by the first speaker, the funded ratio is

9 basically as of the valuation date. If I were to

10 terminate the pension system, how much money would I

11 have on hand to pay the existing liabilities? So,

12 for example, it is 86 percent, so I would add

13 86 cents for every dollar of liability. Okay? So

14 that is our current projection.

15 If you turn down to page 22, this is the

16 projection, basically the same type of chart, a

17 little bit different on the columns, but you will

18 notice that I have inserted a negative 25.5-percent

19 rate of return for this fiscal year.

20 If you go over to where the arrows are, the

21 red arrows, you can see that's that 29.03-percent

22 rate spike year. If you drop down 2 years, you will

23 see the 33.26. That's the peak.

24 One of the things in talking about rate

25 spike, everybody focuses on that first year. But I 65

1 would just ask you to take a look from the rate spike

2 and just look down the column, because, you know, one

3 of the things you need to know, it is not a one-time

4 issue. This is what is called a rate plateau. If

5 you look at that, it is significantly double digit.

6 In fact, it is double digit out to 2038. Okay?

7 If you want to see the consequences of this

8 in dollars, that is what I have circled in red.

9 If you go to the '10 line where it is the bolded

10 4.78 percent, you can see that we are basically --

11 the employer contribution coming in is about

12 $616 million. The next year after that, and this is

13 before the rate spike, that is jumping to $1 billion,

14 and then it is going up to $1.4 billion, and then at

15 the rate spike year it goes up to $4.1 billion. That

16 is where the significant increase takes place. You

17 can see it stays in multiple billions for a

18 significant time frame going forward.

19 Turning to the next page, page 23, this is a

20 comparable chart from SERS. And again, using their

21 estimated rate of return for 2008, which would be the

22 negative 28.6 percent, you can see a similar pattern

23 here that is taking place. The rate spike is going

24 to be 25.2, but again, it really peaks out in the

25 next year at 20.68. 66

1 Again, if you look at their expected

2 employer contributions, for the rate spike year it

3 goes to $1.5 or $1.6 billion. So if you take a look

4 back at the PSERS side, if you combine the rate spike

5 for SERS and PSERS in dollars, it is going to be

6 basically a $5.7 billion issue that the State is

7 going to have to confront at that time. Then you can

8 see the numbers going forward.

9 Okay. So the question then comes up, how

10 did this happen? Obviously -- and this is on page

11 24, how did this actually happen? There are,

12 obviously, substantial funding issues here.

13 I want to basically give a fairly simple

14 explanation which I have been using for the school

15 employers. I want you to think about a balloon of

16 liability. We'll start with that. And one of the

17 long balloons, not the short balloons -- a long

18 balloon.

19 The liabilities that are in that balloon are

20 basically the investment returns from the 2001-2003

21 recessionary time frame. It's the Act 9 multiplier

22 increase, which created an unfunded liability for the

23 system. It's the Act 38 COLA that was granted in

24 2002. On top of that is obviously the investment

25 losses that the system incurred for us last year, for 67

1 our fiscal year, obviously for the year that we're

2 in. That's the balloon of liability, okay? So

3 that's creating that unfunded number that we are

4 talking about.

5 What has happened, however, because of the

6 funding methodology changes made by Act 38 and

7 Act 40, essentially what those funding methodologies

8 did, they squeezed the balloon, pushing the liability

9 off to the future. Okay? So that's where that rate

10 spike, and I'll give you a little better explanation

11 with the next slide on page 25.

12 I'm not going to go into a lot of details

13 about the two of these acts, but probably the one

14 that had the greatest impact is Act 40. As has been

15 mentioned, pension systems historically will smooth

16 out, the rate of the volatility and the rates of

17 return. We do not recognize all gains and losses in

18 one year.

19 For both SERS and PSERS, we basically

20 recognize only one-fifth of it, or 20 percent in any

21 given year, and then it is amortized into the mix

22 over some time frame. That can be from 10 years to

23 30 years.

24 Prior to Act 40, it was on a 10-year

25 amortization schedule. What Act 40 did is basically 68

1 say any gains and losses that were prior to Act 9 --

2 so prior to 2001 -- we are going to keep on a 10-year

3 basis.

4 "Coincidentally" -- and that's in quotes,

5 because we knew what was happening here -- that was

6 all credits. Those are all gains that were left at a

7 10-year basis.

8 They took the position then after Act 40,

9 any gains and losses are going to be amortized on a

10 30-year basis. Okay?

11 So what has happened, there has been a

12 mismatch of gains and losses for a 10-year time

13 frame, okay? That has had a dramatic impact to

14 suppress the rate. That's why those brackets to the

15 unfunded liability at that time. That's the credits

16 that are continuing to suppress the rates, and of

17 course it dramatically suppressed the rates to

18 basically below the normal cost.

19 The chart that is here on page 25 sort of

20 gives an illustration. It's not to scale, but it

21 sort of shows you from a pictorial perspective what

22 is happening.

23 I draw your attention to the line that is

24 going across there that says "Employer Normal Cost."

25 Again, what has happened is this: In the time frame 69

1 when we have had an unfunded liability, and think of

2 that as a mortgage, a debt, we are not making the

3 principal payments on that debt much less the

4 interest payments.

5 What happens then, those principal payments

6 get added on top of the debt, okay? That's the cost.

7 The cost of doing the cash-flow techniques were done

8 by Act 40. Those, I know the last time we looked at

9 this, it's a significant increase in the unfunded

10 liability for PSERS, about $4 billion-plus as a

11 consequence of that.

12 Okay. So that's how it happened.

13 You know, again, when Act 40 was done and

14 Act 38 was done, they were obviously intended to give

15 the State and also school employers breathing room

16 during other very difficult recessionary times. And

17 they were obviously intended to be something that was

18 going to be addressed before the rate spike took

19 place, because the 27.73-percent number that was

20 shown in the initial projection was also deemed not

21 to be acceptable.

22 Unfortunately, very little has been done to

23 address it. There have been some positive things.

24 The rate floor was put into effect at 4 percent by

25 Act 40. If that had not happened, we would be in a 70

1 worse situation because the rate would have been even

2 further below the normal cost.

3 There has been an increase in awareness to

4 the pension funding issues, not only in this State

5 but obviously across the country. Negative issues

6 that have happened or negative points that have

7 occurred: The below-normal-cost funding continues.

8 You will note, however, with respect to the

9 losses that we are looking at, that is going to

10 correct itself relatively quickly, because, you know,

11 the projected low numbers up to the rate spike are

12 going to start to creep up, plus, of course, we have

13 had a compounding of the current 2008-2009 investment

14 losses on the recessionary time frame.

15 So if you want to think about it, we have

16 not really dealt with the first recession this year,

17 this decade. We are now going to combine that with

18 the second and have to deal with them both.

19 So that brings up the question, what can be

20 done? I do compliment the first speaker. I thought

21 he had a good, sort of more detail than I'm going to

22 give you.

23 But basically if you take a look at this,

24 again, starting on page 27, there are really only

25 three strategic options to look at: you can increase 71

1 the funding to the system; you can decrease or cut

2 the liabilities of the system; you can defer the

3 liabilities of the system. Those are sort of your

4 three very strategic ways to deal with this.

5 So let's take a look at these in a little

6 more detail. Turn to page 28. Let's talk about the

7 increased funding.

8 Basically as Len had indicated in his

9 presentation, there are three sources of funding. So

10 we can increase the employer contribution rates.

11 That is already baked in the cake, as I have already

12 shown you. Those rates are going to be going up

13 significantly.

14 If you look at my third bullet point under

15 that first one, however, it is unlikely -- and this

16 is the understatement of the year -- unlikely the

17 Commonwealth and school employers can afford these

18 increased costs without significant tax increases.

19 Okay? And I underline "significant."

20 Second, we can obviously increase employee

21 contributions, and that was one of the ones that was

22 mentioned that has been contemplated across the

23 country.

24 From Pennsylvania's perspective, this can

25 only occur prospectively for new members after the 72

1 time, the effective date of the increase. This,

2 again, is because of constitutional impairment of

3 contract issues, which I'll give you a little more

4 details on the next page.

5 Because there is such a short time frame

6 between now and the rate spike, any increase in the

7 employee contributions would have a negligible effect

8 on the rate spike.

9 You can have increased investment returns.

10 I don't think that anybody in the current market is

11 ready to propose that that is going to be realistic

12 at this time, you know, so the net effect is, I would

13 suggest that we are not going to be able to earn our

14 way out of this in time for the rate spike to be

15 resolved.

16 Let's turn over to the next page, page 29.

17 This is where we now start to address the liability

18 side of the plan.

19 Again, one of the proposals that has been

20 out there is some sort of conversion of PSERS and

21 SERS to either a defined benefit or a hybrid plan.

22 For the members of the committee who are not

23 aware of what a hybrid plan is, it's a combination of

24 a defined benefit and a DC plan. As a matter of

25 fact, it tries to do the best of both. 73

1 For an example, for PSERS it would say,

2 okay, we're going to have a defined benefit

3 component, but the multiplier is 1 percent. That's

4 going to be your base to give you some downside

5 protection. Anything above that is going to be a

6 defined contribution with some sort of fixed employer

7 match, whatever that may be. That caps off the

8 volatility in employer rates and puts the investment

9 return risk over to the employee for that piece.

10 Those are two things that have been suggested.

11 Second, you could take the existing defined

12 benefit plans and make benefit modifications to that.

13 You can reduce the multiplier. You can repeal Act 9

14 in total. You can change the terms of retirement,

15 although Pennsylvania currently has one of the longer

16 superannuation time frames. You can go back to

17 10-year vesting. You can prohibit the withdrawal of

18 a member's contribution.

19 Also, I would suggest that no benefit

20 enhancements be made, because any benefit

21 enhancements at this point would obviously aggravate

22 the unfunded liability of the system.

23 This is not an exhaustive list. The first

24 speaker had a whole, much more detailed list of some

25 of the things that are being contemplated. 74

1 Again, with all these items -- this is where

2 I get into more detail about the constitutional

3 impairment issue -- this is prospective only because

4 of the constitutional impairment of contracts under

5 the Pennsylvania Constitution.

6 The two cases I have cited there actually

7 dealt with attempts to raise employee contributions

8 that apply to all current members, and the courts

9 rejected those, and that was a time frame back in the

10 eighties when the systems were facing basic funding

11 issues. So that is an issue.

12 And again, if you do this, it can have an

13 effect in the long-term, not have an effect on the

14 mid-term or short term to solve the rate spike.

15 The other thing you need to think about, if

16 you're going to make major changes to the system --

17 and as I always tell people about this, the key to

18 this is you need to have adequate retirement

19 security, however you want to do it, because people

20 are retiring, and if you don't provide adequate

21 retirement security, you have another unfunded

22 liability that will eventually end up back at the

23 State's door.

24 Next, if you go down to page 30, if you

25 defer the liabilities in the future to marginally 75

1 postpone the impact, again, take a look at the

2 funding methodologies of the system. Are there other

3 ways we can smooth out the impact of this?

4 I have made a couple of suggestions here.

5 These are not, obviously, the only ones that are

6 available. But you could go, instead of what we have

7 currently as level dollar-pay methodology, you can go

8 to level percent, you can adopt a projected unit

9 credit approach. That is a private-sector approach

10 that most private sector pensions plans use, again,

11 to try to smooth things out. You can adjust the

12 smoothing of actuarial gains and losses. Currently,

13 as I said, we're at 5 years. You can consider going

14 to 10 years or 15 years. I understand some other

15 systems are even looking at a longer time frame.

16 You can take the employer rate floor and

17 make sure that goes up to at least the employer

18 normal cost to prevent a reoccurrence of what had

19 happened going below that. We have had this the last

20 10 or 12 years.

21 The Governor has also introduced a funding

22 proposal that was publicly provided. It was not in

23 legislation, but it was publicly announced in 2008.

24 I have a Web site link that gives you a lot of

25 details about that. 76

1 Basically, this was looking to put some

2 established rate floors and collars. And just a very

3 simplistic way to think of the Governor's proposal,

4 it's an additional smoothing methodology, and

5 essentially what would happen, the actuary would

6 calculate the rate that is required.

7 If you compare it to a table, the table is

8 based on the funding of the system. If the rate was

9 in excess of what the table permitted, you used the

10 table. If it was less than, you would then use what

11 the actuary had calculated. So it's another way to

12 control volatility of the employer contribution

13 rate.

14 Again, no legislation was introduced, and I

15 don't expect any action on this, if at all, until

16 after, obviously, the State budget is resolved.

17 Over to page 31, sort of my concluding

18 remarks. You know, again, there is no silver bullet.

19 And when I speak to the school employers, I basically

20 also say there are no lead ones, copper ones, or any

21 other type that I can provide for you at this point.

22 You know, the Act 40 decreases that were

23 previously projected over the time frame are not

24 going to occur, but they are going to start to rise

25 even before the 2012-2013 rate spike. 77

1 Under all options, no matter what you do

2 here, there is going to be a need for significant

3 additional funding into the system, you know, so you

4 can do a combination of all these different things,

5 which is probably what is going to have to happen,

6 but it is still going to require significant

7 additional funding into the system.

8 Again, taking the system to a defined

9 contribution or hybrid plan will not affect the

10 current liabilities and immediate funding concerns

11 and in fact may actually aggravate the cash-flow

12 situation for the Commonwealth, because in essence

13 what you are going to have is two houses with

14 mortgages on both because you haven't sold the other

15 one.

16 Again, we are more than ready to work with

17 you and provide whatever assistance. I understand

18 you're talking about a small working group, and I

19 think that's a good idea, and we would be ready to

20 participate in that when you are ready for us.

21 That concludes my presentation.

22 CHAIRMAN JOSEPHS: Thank you, both

23 gentlemen.

24 Questions?

25 Mr. Chairman. 78

1 REPRESENTATIVE CLYMER: Well, it has been a

2 very interesting morning so far.

3 EXECUTIVE DIRECTOR CLAY: Yes.

4 CHAIRMAN JOSEPHS: Did you say dreary but

5 interesting?

6 REPRESENTATIVE CLYMER: Madam Chair, you

7 might be right.

8 Well, the weather outside is the same as it

9 is inside. Is that what you're referring to?

10 CHAIRMAN JOSEPHS: Yes.

11 REPRESENTATIVE CLYMER: Well, thank you,

12 gentlemen, for your testimony here this morning. I

13 have a number of questions, but I want to try to just

14 convey a few thoughts.

15 One of the things that you had mentioned,

16 Mr. Clay, was an increased rate floor above

17 4 percent to employer normal cost, which means that

18 we would raise it like to 4 or 5 percent for the

19 school districts to pay their portion.

20 What would that mean if that went up by

21 1 percent? And quite frankly, I thought we had

22 legislation last session that passed that did exactly

23 that. Am I missing something here?

24 EXECUTIVE DIRECTOR CLAY: Yes; I believe the

25 legislation you are talking about -- I have to get my 79

1 dates right -- for the '07-08 time frame, our

2 employer contribution rate was 7.13 percent. Because

3 of the outstanding returns, that was going to drop to

4 the 4.76 percent.

5 There was an effort to introduce legislation

6 to keep it at least at 7.13 percent, anticipating

7 what was going to happen. You know, as my board

8 chair would say, there is no sense digging a trench

9 before the cliff, okay? That was sort of her analogy

10 of what happened. That legislation did not pass,

11 which is why the rate dropped to the 4.76 percent.

12 REPRESENTATIVE CLYMER: Okay.

13 EXECUTIVE DIRECTOR CLAY: Again, if you were

14 to have the rate go up to the employer normal cost,

15 it is not really going to have a significant impact

16 at this point going forward, because if you look at

17 the chart that is, again, on page 21 -- or I'm sorry,

18 page 22 -- next year's rate has already been

19 certified, and that is the '09-10 rate. That is at

20 4.76 percent. If you look at the year after that, it

21 is 8.04, 10-point -- I mean, we're already going to

22 be above the normal cost.

23 The point about having a normal cost rate is

24 you want to prevent this from happening in the

25 future. 80

1 REPRESENTATIVE CLYMER: Okay.

2 EXECUTIVE DIRECTOR CLAY: I mean, presuming

3 we resolve the issues, and we just do not want the

4 rate to go down to zero again.

5 REPRESENTATIVE CLYMER: What happened back

6 in 2001 when the rates for the employers paying in

7 was 7.5 percent? It jumped. In other words, when

8 the benefits were increased back in 2001, so did the

9 contribution rates by the employees.

10 EXECUTIVE DIRECTOR CLAY: That's right.

11 REPRESENTATIVE CLYMER: And wasn't that to

12 over -- wasn't that to stabilize the fund to some

13 degree?

14 EXECUTIVE DIRECTOR CLAY: Yes. To a certain

15 extent, they wanted to have increased funding of the

16 increased benefit by the employees.

17 You might ask the question, why is that not

18 a violation of the contract impairment rules? Two

19 things happened.

20 When you give a benefit enhancement, the

21 contract impairment rules generally don't apply, but

22 if you were a member when Act 9 was constructed, the

23 members had to elect the benefit. They had to

24 choose, voluntarily choose to do that in exchange

25 that they picked up the new contract which required 81

1 the 7.5 percent or whatever rate would apply to their

2 class at that time.

3 So, you know, it was a conscious decision by

4 the members to do that. Not all members did that, by

5 the way.

6 REPRESENTATIVE CLYMER: Okay.

7 You had also mentioned that at this point in

8 time, that no benefit enhancements such as COLAs or

9 early retirement windows would be a benefit. I just

10 want to make certain that that would be more negative

11 than positive on the pension funds.

12 EXECUTIVE DIRECTOR CLAY: Right. Well, any

13 benefit enhancement, since we do not pre-fund them --

14 as Len indicated, we basically pre-fund the benefits

15 that currently exist.

16 REPRESENTATIVE CLYMER: Right. I understand

17 that.

18 EXECUTIVE DIRECTOR CLAY: When someone comes

19 to retirement, 100 percent of their benefit is fully

20 funded and it is going to reserve for that account.

21 COLAs are not pre-funded. Thirty-and-outs

22 are not pre-funded or any type of early retirement---

23 REPRESENTATIVE CLYMER: Okay.

24 EXECUTIVE DIRECTOR CLAY: ---so they create

25 an unfunded liability. And of course what happens, 82

1 essentially the money is being borrowed from the fund

2 at an earnings assumption, and then a debt has to be

3 paid off. Okay?

4 So there is an unfunded liability that is

5 created, and like I said, it is going to add to the

6 unfunded liability we have noted plus increase the

7 employer contribution rates.

8 REPRESENTATIVE CLYMER: Thank you. And I

9 just wanted to have that clarified for the members

10 here and staff.

11 My final question -- and I have more, but

12 I'll just ask this one question, this final

13 question.

14 You said that there are no silver bullets,

15 correct?

16 EXECUTIVE DIRECTOR CLAY: Yes.

17 REPRESENTATIVE CLYMER: Well, as much as I

18 hate to see this occur, if it would happen, it would

19 certainly probably impact favorably on the issue, and

20 that is, we went to double-digit inflation, because

21 double-digit inflation would provide more funding or

22 more money into the system.

23 We're working on a defined benefit, so the

24 pension benefits would not increase. If you were

25 getting a thousand dollars a month, that would stay 83

1 the same. However, the dollars that would occur from

2 both the school districts and from the State because

3 of the inflation rate, wouldn't that alleviate the

4 problem?

5 EXECUTIVE DIRECTOR CLAY: Well, remember

6 that the formula is composed of three components.

7 It's the multiplier -- okay? -- it's the years of

8 service, and it's the final average salary. And if

9 you start to go to a highly inflationary time frame,

10 my guess is the payroll numbers are going to start to

11 move up and start to counterbalance that.

12 REPRESENTATIVE CLYMER: But wouldn't you

13 have a short-term impact that would be favorable---

14 EXECUTIVE DIRECTOR CLAY: Well---

15 REPRESENTATIVE CLYMER: ---because the

16 numbers of employees that would be certified under

17 what we'll call the inflation rate would be limited

18 to that first 1 or 2 years while you are dealing with

19 thousands of other employees who are already

20 receiving the benefit.

21 EXECUTIVE DIRECTOR CLAY: Right. Yeah; I

22 have not looked at those.

23 I mean, in theory that may be true, because

24 obviously at the school level, the employer

25 contracts, the union contracts, are all at different 84

1 time frames for expiration. They are not going to be

2 adjusted, you know, immediately to deal with

3 inflation.

4 REPRESENTATIVE CLYMER: I'm not speaking for

5 double-digit inflation.

6 EXECUTIVE DIRECTOR CLAY: Oh, no, I

7 understand.

8 There are other consequences to double-digit

9 inflation.

10 REPRESENTATIVE CLYMER: Yes. That I

11 understand. Okay.

12 EXECUTIVE DIRECTOR CLAY: All right.

13 REPRESENTATIVE CLYMER: Thank you,

14 Madam Chair.

15 CHAIRMAN JOSEPHS: Mr. Chairman Benninghoff.

16 REPRESENTATIVE BENNINGHOFF: Thank you,

17 Madam Chairman.

18 A couple of quick questions.

19 You testified earlier on in your comment

20 that these are two of the oldest systems established,

21 SERS in 1923 and PSERS in 1917.

22 I'm just curious, I suspect that a lot of

23 that terminology and data was based on life

24 expectations. Have we made adaptations for the fact

25 that people are living longer? 85

1 I'm concerned that while I like and

2 appreciate things that are historical, that sometimes

3 we don't continue to move up with the times, and the

4 reality is that people are living into their late

5 eighties, late nineties, and 100 years old, and we

6 have a system that may have been established with

7 the live expectancy of 15 years maximum

8 post-retirement.

9 EXECUTIVE DIRECTOR CLAY: No; you are

10 correct.

11 One of the things, and it is all part of the

12 actuarial valuation process, both systems obviously

13 have a valuation done on a yearly basis. Both

14 systems also have what is known as a 5-year

15 experience study, done every 5 years to take a look

16 at and make sure their assumptions are matching their

17 experience.

18 One of the things that is looked at on a

19 periodic basis is the mortality. Mortality tables

20 have been adjusted frequently by both systems.

21 I think the last time we did it was in 2005

22 to come to an updated mortality table, which would

23 reflect the greater life expectancies.

24 REPRESENTATIVE BENNINGHOFF: And what age

25 are you looking at or are you using for that? 86

1 EXECUTIVE DIRECTOR CLAY: I would have to

2 find that information for you and get it to you.

3 REPRESENTATIVE BENNINGHOFF: Could you

4 provide that to the committee?

5 EXECUTIVE DIRECTOR CLAY: Sure.

6 REPRESENTATIVE BENNINGHOFF: Another quick

7 question.

8 Several years ago the vesting was changed, I

9 believe from 10 years to 5 years.

10 EXECUTIVE DIRECTOR CLAY: Correct.

11 REPRESENTATIVE BENNINGHOFF: How has that

12 significantly impacted the liability? And if we

13 were to reverse that, would that have a significant

14 positive impact in trying to find additional

15 dollars?

16 EXECUTIVE DIRECTOR CLAY: Yes.

17 My recollection from looking at, remembering

18 looking at the actuarial note from Act 9 when it was

19 done, it was not a major increase, you know, on the

20 unfunded liability. It was probably basis points

21 increase in the employer contribution rate at that

22 time.

23 It would have an impact, but it would not be

24 a significant impact, and I can get you those numbers

25 also. 87

1 One thing I do note, the reason that they

2 went to 5-year vesting was because that is the

3 standard ERISA number, for vesting for ERISA plans,

4 and you want to be consistent with that.

5 REPRESENTATIVE BENNINGHOFF: How standard is

6 that in the private sector?

7 EXECUTIVE DIRECTOR CLAY: Five-year vesting

8 is the standard that ERISA mandates. A lot of

9 private-sector plans actually have a lower vesting.

10 Again, it also depends on the nature of

11 their plan. If it's a defined contribution plan,

12 there's a tendency to vest it a lot earlier than for

13 a defined benefit plan.

14 REPRESENTATIVE BENNINGHOFF: And just for

15 the listeners, I'm interested -- and this is actually

16 my last question, because I want to give time for

17 some other members -- but you said you offer no

18 automatic COLA. And I was curious if that is

19 primarily because the majority of participating

20 members upon retirement -- I think you gave the

21 numbers 91 percent of them in the one plan, and 88

22 percent of them -- pull all their money out of there

23 and generally reinvest it somewhere else.

24 Is that one of the driving factors of why we

25 don't just automatically give a COLA that would show 88

1 no reflection of the market?

2 EXECUTIVE DIRECTOR CLAY: Yeah; I'm not sure

3 whether that's the reason. I know historically there

4 really has never been a COLA, you know, an automatic

5 COLA.

6 The pattern in Pennsylvania has always been

7 ad hoc COLAs---

8 REPRESENTATIVE BENNINGHOFF: Correct.

9 EXECUTIVE DIRECTOR CLAY: ---over many, many

10 decades to do that, usually on a 4- to 5-year cycle.

11 Whether they have thought about it in that

12 context that you have, I'm not sure they have.

13 REPRESENTATIVE BENNINGHOFF: And I suspect

14 that's pretty routine in the private sector that you

15 would not see an automatic COLA as well?

16 EXECUTIVE DIRECTOR CLAY: Yes, that would be

17 an accurate statement.

18 REPRESENTATIVE BENNINGHOFF: Very good.

19 Thank you.

20 Thank you, Madam Chairman.

21 CHAIRMAN JOSEPHS: I neglected to ask you,

22 Mr. Canaga -- I'm sorry.

23 MR. CANAGARETNA: Call me Sujit.

24 CHAIRMAN JOSEPHS: Mr. CanagaRetna. I'm

25 trying to do this a little formally. 89

1 If you would join us at the table, because I

2 think there are some questions for you as well.

3 Representative McIlvaine Smith.

4 REPRESENTATIVE McILVAINE SMITH: Thank you,

5 Madam Chairwoman.

6 I wanted to ask you -- well, first of all,

7 where you had that fundamentally -- it is on page 27

8 -- there are only three ways to remedy the funding

9 issues?

10 Well, the increased funding to the systems,

11 we can't do that because we don't have the money. We

12 have already tried deferring the liabilities of the

13 system, so that hasn't worked successfully.

14 So it seems like the decreasing or cutting

15 the liabilities of the system is the only way to go,

16 and if we look at that, if we convert PSERS and SERS

17 to a defined contribution plan, I just want to be

18 clear, we can only do that with new members.

19 Correct?

20 EXECUTIVE DIRECTOR CLAY: Yes, that is

21 correct.

22 REPRESENTATIVE McILVAINE SMITH: And then

23 when you go to the next point, bullet point,

24 maintaining the existing defined benefit plans, but

25 if we modify them, all of those that are listed, that 90

1 could be done -- that would not affect the existing

2 membership in any way constitutionally, by contract

3 or anything?

4 EXECUTIVE DIRECTOR CLAY: No. Those changes

5 would also be prospective only.

6 REPRESENTATIVE McILVAINE SMITH: Oh, okay.

7 So they are only new.

8 EXECUTIVE DIRECTOR CLAY: That's right.

9 REPRESENTATIVE McILVAINE SMITH: Okay.

10 And then, because the COLA issue was the

11 first thing I heard when I was running for

12 office---

13 EXECUTIVE DIRECTOR CLAY: And it may be the

14 last you will hear of it.

15 REPRESENTATIVE McILVAINE SMITH: Yes. Well,

16 I always tell the funny that my mom, who was a

17 32-year veteran of teaching, it got to the point that

18 it was such an issue in my district that she no

19 longer said "Hello, Dear. It's so nice to see you."

20 It was, "Where is my COLA?"

21 EXECUTIVE DIRECTOR CLAY: Yes.

22 REPRESENTATIVE McILVAINE SMITH: So I know

23 that that's not happening, but do you know of any

24 other State plans that have built in some sort of

25 COLA to their system successfully? 91

1 EXECUTIVE DIRECTOR CLAY: Yes; there are

2 numerous systems around the country that have done

3 that, and they typically do that on a pre-funded

4 basis.

5 REPRESENTATIVE McILVAINE SMITH: Okay. And

6 could you give me an example or get back to me so

7 that I could look into them further?

8 EXECUTIVE DIRECTOR CLAY: Do you want to

9 take that?

10 MR. CANAGARETNA: I think I may have to get

11 back to you on that, but there are several States

12 that do have it instituted, but it is all on a

13 pre-funded basis, like Jeffrey said.

14 REPRESENTATIVE McILVAINE SMITH: Okay.

15 And my last question is -- and I'm naive

16 when it comes to all of this, because I was a 28-year

17 business owner, and we just had set IRAs; we didn't

18 get into all this kind of thing.

19 But if we put everyone into this State plan,

20 if we did open it to all municipal workers, to anyone

21 who wanted to join the State plan, would that help

22 the plan, the pension plan?

23 EXECUTIVE DIRECTOR CLAY: Again, when you

24 say open it to everybody, would you open it, you

25 know, to all governmental employees? Is that what 92

1 you are saying?

2 REPRESENTATIVE McILVAINE SMITH: Yes. So

3 all my municipal officials -- anybody that is, you

4 know, working in my municipalities, my boroughs. If

5 they all wanted to join this State plan, would that

6 help the plan?

7 EXECUTIVE DIRECTOR CLAY: Right. Yeah; they

8 also have their own pension systems, all of them.

9 REPRESENTATIVE McILVAINE SMITH: So it would

10 be hard to roll them in.

11 EXECUTIVE DIRECTOR CLAY: Yeah.

12 Well, in theory, there has actually been

13 legislation contemplating doing that in the past---

14 REPRESENTATIVE McILVAINE SMITH: Yes.

15 EXECUTIVE DIRECTOR CLAY: ---to, you know,

16 come up with this sort of a mandatory municipal plan

17 as opposed to what currently exists.

18 Any time you bring new people in, there are

19 also liability issues that come with them.

20 REPRESENTATIVE McILVAINE SMITH: Yeah;

21 okay.

22 EXECUTIVE DIRECTOR CLAY: It's not like they

23 come in fresh. Okay?

24 My recollection, and I'm not an expert on

25 the municipal side, but there are a significant 93

1 number of municipal plans in the State that also have

2 significant funding issues.

3 REPRESENTATIVE McILVAINE SMITH: Right.

4 EXECUTIVE DIRECTOR CLAY: So the question is

5 going to be what type of liability you are bringing

6 in with you.

7 REPRESENTATIVE McILVAINE SMITH: And this is

8 probably a really naive question, but if we did join

9 the two boards, the SERS and the PSERS, do you see a

10 benefit of that? And would it be possible to not

11 only join the two boards but would we be able to join

12 the two pension plans eventually?

13 EXECUTIVE DIRECTOR CLAY: There are a couple

14 of ways you want to look at potential mergers.

15 If you think about what the systems do, they

16 basically have two different functions. They have

17 the investment function; they have the benefits

18 administration function.

19 Now, PSERS also has its health-care function

20 that sits out here -- okay? -- so we'll leave that

21 aside for the time being.

22 You could basically take the position, I'm

23 going to merge the investment operations only,

24 okay?

25 REPRESENTATIVE McILVAINE SMITH: Yes. 94

1 EXECUTIVE DIRECTOR CLAY: That would get you

2 some economies of scale on the investments,

3 presumably. Okay?

4 And by the way, pension systems are

5 organized in a lot of different ways across the

6 country. For example, Wisconsin has a Wisconsin

7 Investment Board. They do all the investing.

8 There's a separate entity that does the pension

9 administration, okay? That is one of the models.

10 If you were to do that, you actually would

11 have some probably economies of scale. Would it be

12 significant enough to offset the rate spike? The

13 answer would be no.

14 If you tried to merge the two boards, you

15 know, so you have two fairly disparate, not political

16 groups but two constituency groups you are dealing

17 with---

18 REPRESENTATIVE McILVAINE SMITH: Yes.

19 EXECUTIVE DIRECTOR CLAY: ---that could be a

20 problem. How are you going to have adequate

21 representation on the board without having a board of

22 55 would be the problem there.

23 Typically, most States have opted not to do

24 that. If they are going to consolidate, they

25 consolidate the investment function and leave the 95

1 boards to deal with their own particular areas.

2 REPRESENTATIVE McILVAINE SMITH: Thank you

3 very much.

4 CHAIRMAN JOSEPHS: I sort of lost my place

5 here.

6 I want to mention that Mr. Cox has joined us

7 at this hearing.

8 Mr. Roae, you had a question.

9 REPRESENTATIVE ROAE: Thank you,

10 Madam Chairwoman.

11 And thank you, gentlemen, for your

12 testimony.

13 It has been widely reported in the media

14 over the last several months, really the last 2 or

15 3 years, that when bonuses are paid, you know, if

16 PHEAA pays bonuses, if PSERS pays bonuses, if

17 Legislators' staffers get bonuses, it has been widely

18 reported that those count as salary as far as pension

19 calculations. Is that bad reporting by the media or

20 is that accurate?

21 EXECUTIVE DIRECTOR CLAY: Yes, that is

22 accurate, depending on how they are structured.

23 Again, there is a difference between

24 incentive payments and bonuses for retirement

25 compensation purposes, okay? 96

1 An incentive payment, if it is something

2 that is objective, it is easily understood that, you

3 know, for example, if I do this, I will get this. It

4 is contractually obligated. That would be included

5 in a retirement-covered compensation.

6 So, for example, on the PSERS side of the

7 operation we had investment professionals that if

8 they beat the benchmark by X, that is going to add

9 significant value to the system; they get an

10 incentive compensation. It is really well defined.

11 A bonus, on the other hand, is not typically

12 recognized by the systems because that is sort of

13 discretionary. So, for example, I'm the CEO of my

14 agency. If I just come in today and I say, "You've

15 done such a great job here and I like your smile, you

16 get a bonus of..." whatever. Okay? That doesn't

17 count for retirement-covered compensation. There is

18 no contractual obligation, no objective standard.

19 That is sort of the standard that the

20 systems look at. That has actually been set up by a

21 court case involving PHEAA back---

22 EXECUTIVE DIRECTOR KNEPP: I think in the

23 early eighties.

24 EXECUTIVE DIRECTOR CLAY: Probably back a

25 few decades. 97

1 EXECUTIVE DIRECTOR KNEPP: Yeah; it was

2 quite awhile ago.

3 REPRESENTATIVE ROAE: Okay. And then kind

4 of a related question.

5 Again, it was widely reported in the media,

6 I don't know if it is accurate or not, but back in

7 2005 when there was a legislative pay raise, it was

8 reported that Legislators who took the pay raise in

9 the form of unvouchered expense money, they said that

10 counted towards their pension.

11 Do you know, is that accurate?

12 EXECUTIVE DIRECTOR KNEPP: If that money was

13 never returned, and from what I understand, if it

14 came from the Clerk's Office, it did go into their

15 benefit calculation.

16 REPRESENTATIVE ROAE: How do they define

17 "salary"? Because, you know, when I think of expense

18 money, I think of, you know, that's not salary. Like

19 I get reimbursed expense money, you know, for mileage

20 reimbursement and for meals in Harrisburg. That

21 shouldn't be part of a pension calculation.

22 EXECUTIVE DIRECTOR KNEPP: That's something

23 I'll have to get back to you exactly the formula that

24 it would go into. If that's all right, I can get

25 back to you on that. 98

1 REPRESENTATIVE ROAE: Okay. I would

2 appreciate that.

3 And then one other quick question.

4 In 2008, there was a COLA bill that was

5 introduced---

6 EXECUTIVE DIRECTOR KNEPP: Right.

7 REPRESENTATIVE ROAE: ---for, you know,

8 teachers and State workers, retirees, and I think I

9 had heard, they were saying that would have something

10 like a $500-million-a-year cost, is the number they

11 were reporting.

12 EXECUTIVE DIRECTOR KNEPP: Right.

13 REPRESENTATIVE ROAE: Do you know, what

14 would the breakdown be as far as SERS and PSERS?

15 And for the PSERS level, how much of that,

16 you know, would have been for local school districts

17 and how much would have been the State

18 responsibility?

19 EXECUTIVE DIRECTOR KNEPP: The actual

20 overall costs, I believe, from the SERS side to the

21 unfunded liability I want to say was about

22 $1.6 billion. And I think the annual cost overall,

23 as you stated, was $500 million.

24 So it would have been about $150 million a

25 year for us. 99

1 REPRESENTATIVE ROAE: For how many years,

2 sir?

3 EXECUTIVE DIRECTOR KNEPP: It is funded -- I

4 forget whether that one is funded over 10 or

5 20 years.

6 EXECUTIVE DIRECTOR CLAY: It was over a

7 20-year period. Or maybe it was a 10-year period;

8 I'm not sure.

9 EXECUTIVE DIRECTOR KNEPP: Yeah.

10 REPRESENTATIVE ROAE: Okay. So it would

11 have been an extra $150 million for 20 years.

12 EXECUTIVE DIRECTOR KNEPP: And school is

13 normally double us, so I would say that would be

14 about the difference then.

15 Is that a fair statement, Jeff?

16 EXECUTIVE DIRECTOR CLAY: Right.

17 EXECUTIVE DIRECTOR KNEPP: Yeah. So it was

18 around -- what would that be? $150 or $160 million a

19 year for SERS and double that for PSERS, and that

20 would bring you to about your $500 million.

21 REPRESENTATIVE ROAE: Okay.

22 EXECUTIVE DIRECTOR KNEPP: And that was

23 based on the number that was granted in the 2002-2003

24 COLA. It was just replicated, and that is where we

25 got our cost numbers. 100

1 REPRESENTATIVE ROAE: Okay. And I want to

2 make sure I understand it.

3 As far as COLAs go, COLAs can't use the

4 money that is in the plans now? That has to be a new

5 batch of money that is appropriated just to pay for

6 the COLA, or can they use the money that is in the

7 PSERS and SERS?

8 EXECUTIVE DIRECTOR CLAY: Yes.

9 Essentially what happens, again, since they

10 are not pre-funded, okay?

11 REPRESENTATIVE ROAE: Right.

12 EXECUTIVE DIRECTOR CLAY: A debt is created

13 against the fund, because you are basically, since

14 you are starting to automatically pay it, you are

15 withdrawing money out of the fund to pay it.

16 So the money in the fund is being used, but

17 you basically borrowed the money for that purpose.

18 That money was there for another purpose -- okay? --

19 for the regular benefits.

20 REPRESENTATIVE ROAE: Okay.

21 EXECUTIVE DIRECTOR CLAY: The payments that

22 are mentioned, the $500 million payments, are those

23 debt payments being made to pay off the debt and

24 replace that with interest.

25 EXECUTIVE DIRECTOR KNEPP: And the liability 101

1 that we're talking about is something new, because

2 they have never been funded. So when you establish a

3 COLA, it is prospectively. So the $1.6 billion for

4 SERS would be added on top of our current liability.

5 REPRESENTATIVE ROAE: Okay.

6 EXECUTIVE DIRECTOR CLAY: And for PSERS, it

7 would have been about a $3 billion increase unfunded.

8 EXECUTIVE DIRECTOR KNEPP: Right.

9 EXECUTIVE DIRECTOR CLAY: A $3 billion debt.

10 REPRESENTATIVE ROAE: Okay.

11 Well, thank you, gentlemen. I do appreciate

12 it.

13 And I just think it is, you know, something

14 that we need to address legislatively, some of these

15 things, because it is blatantly unfair, I think, that

16 certain State workers can get a $50,000 or $100,000

17 bonus that counts towards pension, they end up with a

18 pension that is a lot bigger, but then there are

19 other retirees that go years and years and years

20 without a pension. But to do a COLA sounds like it

21 is not really affordable with our $2.3 billion

22 deficit.

23 So I would appreciate, you know, having the

24 opportunity for the Legislature and SERS and PSERS to

25 work together so we can find some kind of resolution 102

1 to some of these issues to make sure that we're being

2 fair to retirees and being fair to the taxpayers

3 both.

4 Thank you.

5 EXECUTIVE DIRECTOR CLAY: Great. Thank

6 you.

7 EXECUTIVE DIRECTOR KNEPP: Thank you.

8 CHAIRMAN JOSEPHS: Representative Tallman.

9 REPRESENTATIVE TALLMAN: Well, I don't have

10 a mike, so I'm going to switch seats here.

11 I have a couple of questions here. Well,

12 let me turn the mike on.

13 On page 21, you have a projected rate of

14 return for this fiscal year, 2009-2010, of

15 8.25 percent. Is that a correct assumption?

16 EXECUTIVE DIRECTOR CLAY: That is an

17 assumption. If you turn to the next page, which is

18 page 22---

19 REPRESENTATIVE TALLMAN: Yes.

20 EXECUTIVE DIRECTOR CLAY: ---you will see

21 that instead of that 8.25 percent, I have a negative

22 25.5 percent. Okay?

23 REPRESENTATIVE TALLMAN: Okay.

24 EXECUTIVE DIRECTOR CLAY: That is the rate

25 of return as of December 31 of this fiscal year. 103

1 REPRESENTATIVE TALLMAN: Well, the negative

2 25.5 is probably realistic.

3 Then my question, to follow on, then in

4 2010-2011 you have an 8-percent return?

5 EXECUTIVE DIRECTOR CLAY: Correct.

6 REPRESENTATIVE TALLMAN: Can I invest some

7 money with you? I just don't think it's going to be

8 there, and especially at 8 percent.

9 I mean, how do you -- in the light of our

10 current economic straits across and around the globe,

11 how do you project those numbers?

12 EXECUTIVE DIRECTOR CLAY: For projection

13 purposes, typically what the systems have done --

14 this is a practice across the country -- that

15 represents our earnings assumption going forward.

16 Okay?

17 And one of the things we do caution, there

18 is no guarantee we are going to get that, and it can

19 go either direction. Okay?

20 REPRESENTATIVE TALLMAN: But---

21 EXECUTIVE DIRECTOR CLAY: And one of the

22 reasons we did move our earnings assumption down to

23 8, that is the median earnings assumption for public

24 pension plans in the country right now.

25 REPRESENTATIVE TALLMAN: Looking on page 22, 104

1 in fiscal year 2010, we are going from -- then to

2 2011 -- we are going from $616 million to a billion

3 plus. That's a 43-percent increase.

4 EXECUTIVE DIRECTOR CLAY: Correct.

5 REPRESENTATIVE TALLMAN: They are in

6 employer contributions?

7 EXECUTIVE DIRECTOR CLAY: Correct.

8 REPRESENTATIVE TALLMAN: That's an accurate

9 number on my part?

10 EXECUTIVE DIRECTOR CLAY: I haven't done the

11 math, but that looks close, 40 percent or more.

12 REPRESENTATIVE TALLMAN: Then from 2012 to

13 2013, we are having a 76-percent increase in employer

14 contributions?

15 EXECUTIVE DIRECTOR CLAY: Yes. I haven't

16 done the math, but it looks pretty close.

17 REPRESENTATIVE TALLMAN: My personal IRA,

18 you know, I have lost over 50 percent. And by the

19 way, talking to some outside experts, they think you

20 folks have done a pretty conservative job on managing

21 your assets, so I can't fault you for that.

22 But my IRA, you know, has dropped over

23 50 percent, and, you know, you are asking the

24 taxpayer, who is really the employer here, to bail

25 out this fund, these two funds, and I'm going to 105

1 absorb those losses on my IRA. My personal IRA, I'm

2 going to absorb those. And now we're going to come

3 back and ask the taxpayer way out to, you know, 2038,

4 this is a huge liability that the taxpayer is taking

5 on.

6 EXECUTIVE DIRECTOR CLAY: I understand that,

7 and again---

8 REPRESENTATIVE TALLMAN: You said you have

9 no silver bullets or anything, but wow, I hope we can

10 come up with something.

11 EXECUTIVE DIRECTOR CLAY: Well, let me just

12 address that concern.

13 And I get letters all the time from both our

14 members and taxpayers about this issue. Again, this

15 is the difference between the two types of pension

16 systems, and it is based, your retirement benefit is

17 based on a formula. There is no up-side to a defined

18 benefit plan. That is why there are the demands for

19 COLAs, okay?

20 Defined contribution, the individual bears

21 the risk of that investment gain and loss, and the

22 net effect is, in the good years, people love defined

23 contribution plans, okay?

24 Now, likewise, in the good years, the

25 employers love defined benefit plans, because their 106

1 contribution rates are dramatically suppressed.

2 What has been happening, because of the

3 funding methodology changes, essentially the

4 employers are paying well below what they should have

5 been paying for over a decade. That money has been a

6 direct savings to taxpayers during that time frame.

7 During the nineties, the contribution rate

8 dropped, I think PSERS was up at like 28 percent in

9 1988, and from that time going forward to 1999-2000,

10 the rate went to basically zero. All during that

11 time, significant savings for the taxpayers, okay?

12 They are happy about it during those times;

13 they are not happy about it when the cows come the

14 other direction. That is what is happening now. But

15 there has been significant savings that have been

16 spent elsewhere in the State and local governments.

17 So again, when you do this, you have got to

18 be careful of the time frame you are looking at.

19 REPRESENTATIVE TALLMAN: Well, I just think

20 we need to work aggressively, and I would encourage

21 the Chairs, Madam Chair, you recommended forming a

22 smaller working group, and I really think that we

23 need to do that and we need to move aggressively.

24 And then if I could get the PowerPoint

25 presentation from the Council of State Governments, I 107

1 would appreciate it.

2 MR. CANAGARETNA: Sure. No problem.

3 REPRESENTATIVE TALLMAN: Thank you.

4 EXECUTIVE DIRECTOR CLAY: You're welcome.

5 CHAIRMAN JOSEPHS: Representative Rapp.

6 REPRESENTATIVE RAPP: Thank you,

7 Madam Chairman.

8 Thank you, gentlemen, for being here today.

9 I have a couple of questions.

10 When Mr. CanagaRetna was speaking, he talked

11 about a minimum retirement age.

12 MR. CANAGARETNA: Right.

13 REPRESENTATIVE RAPP: What is the minimum

14 retirement age in Pennsylvania?

15 EXECUTIVE DIRECTOR KNEPP: Well, for our

16 retirement system, it's age 60 for full retirement or

17 35 years of service. But for an early retirement,

18 you need 5 years of service.

19 REPRESENTATIVE RAPP: Okay. All right.

20 EXECUTIVE DIRECTOR KNEPP: So you can retire

21 on a pension with 5 years of service. That's the

22 investing requirement.

23 REPRESENTATIVE RAPP: Right.

24 He also talked about in other States that

25 they have done away with double-dipping, working in 108

1 one State position, retiring, and then being --

2 excuse me; I have a little bit of laryngitis today

3 -- and then also being employed in another State

4 system.

5 Do we know how many employees in the State

6 system in Pennsylvania that have done that? How many

7 employees we have that could possibly be under more

8 than one retirement system?

9 EXECUTIVE DIRECTOR KNEPP: Under one

10 retirement? We do have individuals in the State

11 retirement system due to what we call a 95-day

12 emergency recall. They are allowed to come back,

13 draw their pension, and work 95 calendar days within

14 a year.

15 Do we know how many people belong to the

16 State retirement system and go and work at the

17 county? No.

18 REPRESENTATIVE RAPP: We have no idea?

19 EXECUTIVE DIRECTOR KNEPP: I don't have

20 those numbers with me; no.

21 REPRESENTATIVE RAPP: Okay.

22 And then I have a question for

23 Mr. CanagaRetna.

24 In Pennsylvania, we allow people who retire

25 to take out a lump sum. 109

1 MR. CANAGARETNA: True.

2 REPRESENTATIVE RAPP: And are there other

3 States -- are we unique in Pennsylvania? Are there

4 other States who allow that, or are other States

5 looking at that and doing away with allowing that

6 lump-sum withdrawal?

7 MR. CANAGARETNA: You see that happening in

8 other States also, and at the same time there is a

9 move towards trying to do away with that benefit.

10 Again, it is an effort to try and preserve,

11 I guess, the bottom line figure that they have, and

12 that is a strategy that you do see happening in other

13 States as well.

14 REPRESENTATIVE RAPP: Is that a substantial

15 impact on them or---

16 MR. CANAGARETNA: As far as I know, it

17 doesn't make a huge difference.

18 REPRESENTATIVE RAPP: It does not.

19 MR. CANAGARETNA: No.

20 REPRESENTATIVE RAPP: Okay. All right.

21 Thank you, gentlemen.

22 MR. CANAGARETNA: Thank you.

23 CHAIRMAN JOSEPHS: Mr. Gabler.

24 REPRESENTATIVE GABLER: Thank you,

25 Madam Chair. 110

1 My question is directed to our distinguished

2 guest from the Council of State Governments.

3 MR. CANAGARETNA: Sure.

4 REPRESENTATIVE GABLER: You had listed some

5 suggested changes or improvements that we could make

6 in order to realize some fixes to the system.

7 Have you listed -- and I wish I had the copy

8 of the PowerPoint in front of me -- but were those

9 listed in any suggested order of effectiveness---

10 MR. CANAGARETNA: No.

11 REPRESENTATIVE GABLER: ---or could you

12 prioritize them in some order?

13 MR. CANAGARETNA: Well, it was just a

14 listing that I just pulled together based on my

15 research in other States. There was no real sequence

16 as such. But no, not really.

17 REPRESENTATIVE GABLER: Well, perhaps could

18 you speak to the effectiveness that has been realized

19 in any of the other States or what other States

20 perhaps have realized some benefit or some success

21 with implementing those strategies?

22 MR. CANAGARETNA: Right.

23 What you see happening is States trying to

24 integrate two or three or maybe even four aspects of

25 some of the things that I talked about. So it is not 111

1 sort of an event that has happened sequentially as

2 such. I mean, it is incorporating many of these

3 elements and trying to make a difference to the

4 bottom line, I guess.

5 So there is no real silver bullet, as

6 Jeffrey mentioned, on that front as well.

7 REPRESENTATIVE GABLER: All right. Thank

8 you.

9 MR. CANAGARETNA: Thank you.

10 CHAIRMAN JOSEPHS: Before we conclude -- oh,

11 Mr. Cox. I'm sorry.

12 REPRESENTATIVE COX: I'm not sure of the

13 best way to ask this question. I think I understand

14 the idea that we can't ask existing members to pay --

15 we can't require existing members to pay an increased

16 rate.

17 Is there any reason why -- and whether

18 there's a benefit to this or not, I don't know. Is

19 there any way that we can perhaps somehow incentivize

20 existing plan members to increase their rate that

21 would add to the overall positive structure of the

22 plan, but yet not require them constitutionally to do

23 it because of the limitation?

24 Is there any way to do a hybrid of sorts

25 that would have a positive financial impact but also 112

1 would allow them to do that?

2 EXECUTIVE DIRECTOR CLAY: Without doing the

3 math, and that would have to be a very delicate math

4 calculation to come to that.

5 You know, again, obviously in Act 9 they

6 incentivized them to go up to the higher contribution

7 rate, but it was a 25-percent benefit enhancement,

8 okay? Obviously, that's not necessarily going to pay

9 off in the short term for the State with the

10 increased contributions.

11 Other States that have gone to defined

12 contribution plans or hybrid plans tend to do an

13 incentive to try to move the existing employees over.

14 You have to do the math to make sure, you know, that

15 the additional cash out of pocket is going to -- you

16 know, you are basically going to achieve a savings,

17 and like I said, that is going to be based on a lot

18 of assumptions: how many people take it, and it could

19 be very difficult to calculate that.

20 REPRESENTATIVE COX: When the---

21 EXECUTIVE DIRECTOR CLAY: Most people, by

22 the way, in those situations, that are in defined

23 benefit, do not move, notwithstanding the

24 incentives.

25 REPRESENTATIVE COX: Okay. 113

1 The switch that was made under, I guess it

2 was Act 9---

3 EXECUTIVE DIRECTOR CLAY: Correct.

4 REPRESENTATIVE COX: What kinds of savings

5 were realized there, if at all? What was the overall

6 benefit to the system? Did it have the expected

7 benefit, I guess is the question.

8 EXECUTIVE DIRECTOR CLAY: Well, Act 9 was

9 not a savings to the system. It increased the

10 unfunded liability of both systems.

11 REPRESENTATIVE COX: Okay.

12 EXECUTIVE DIRECTOR CLAY: Even

13 notwithstanding the increased employee contributions

14 coming in the door.

15 REPRESENTATIVE COX: Okay.

16 The impact, the impact of offering that

17 incentive, that 25-percent benefit, if you will, for

18 switching over to the higher contribution rate, an

19 overall negative financial impact because it

20 increased the liability?

21 EXECUTIVE DIRECTOR KNEPP: Yes.

22 EXECUTIVE DIRECTOR CLAY: Yes.

23 REPRESENTATIVE COX: Was that a

24 miscalculation then that we offered too much of a

25 benefit for switching the contribution rate, or was 114

1 that a lack of realization due to the market changes

2 or---

3 EXECUTIVE DIRECTOR CLAY: You see, at that

4 time, they were not concerned about any rate spike.

5 There was no rate spike at that point in time.

6 REPRESENTATIVE COX: Okay.

7 EXECUTIVE DIRECTOR CLAY: Okay? The

8 projections that they had in front of them, this goes

9 back to one of the questions, I think it was over on

10 this side, about, you know, the assumed rate of

11 return going forward, when the calculations were

12 projected, the assumptions were based on an

13 8 1/2-percent rate of return going forward.

14 What happened right after Act 9 was done,

15 fairly quickly the recession started, and since then,

16 the markets dropped precipitously at that point,

17 which pushed off all the calculations.

18 REPRESENTATIVE COX: Had everything stayed

19 on the previous trend, though, the calculations

20 probably would have been -- there probably would

21 have been overall benefits? So it was just bad

22 timing?

23 EXECUTIVE DIRECTOR CLAY: It wasn't a

24 benefit -- that act was not done to mitigate any

25 funding issues for the system. 115

1 REPRESENTATIVE COX: But would it have had a

2 positive impact on the funding had the markets not

3 done what they had done? I guess in a perfect world,

4 would it have had a financial benefit?

5 EXECUTIVE DIRECTOR CLAY: It would have

6 created -- the unfunded liability was there

7 regardless of whatever.

8 I think what you are trying to indicate is,

9 would it have had a negative impact on employer

10 contribution rates?

11 I think for a 10-year period, if everything,

12 the assumptions had held true, there would not have

13 been a cost to increase the employer contribution

14 rates as a consequence of Act 9, but that is not what

15 happened.

16 REPRESENTATIVE COX: Okay. Thank you.

17 CHAIRMAN JOSEPHS: Mr. Gibbons.

18 I just want to remind everybody, we have

19 been at this for 2 hours, so if we can be as brief as

20 possible, I would appreciate it.

21 REPRESENTATIVE GIBBONS: Thank you,

22 Madam Chair. This will be fairly brief.

23 Actually, there is just one thing that I

24 want to ask about. It's in the section of your three

25 suggestions. 116

1 And we have talked a lot about reducing

2 liabilities and how that has to be prospective, and

3 increasing revenues, which, of course, requires more

4 tax dollars. And the third thing you offered was

5 deferring liabilities, and you offered three ideas on

6 the actuarial side.

7 And I know you talked about increasing to

8 the employer normal cost, which you said at this

9 point it is kind of late for that; that is not going

10 to have any major effect right now on the spike.

11 On the side of further adjusting the

12 actuarial funding of the systems -- adopt level

13 percent of pay, adopt projected unit credit, and

14 adjust the smoothing to 10 to 15 years -- I mean,

15 what would the effects of either of those three

16 be?

17 EXECUTIVE DIRECTOR CLAY: Again, we can get

18 calculations to show you what that is, what the

19 impact did. It has an impact, but it is not going to

20 avoid, again, significant funding to the system.

21 REPRESENTATIVE GIBBONS: Okay. Thank you.

22 CHAIRMAN JOSEPHS: I have a couple of

23 things, but they are mostly going to be requests for

24 information from more of the PSERS and SERS folks

25 than from the Council of State Governments. 117

1 I was planning to ask a question for

2 Mr. Chairman Pete Daley, which I will not ask, but I

3 will ask you to respond to my questions, which would

4 be about House Bill 30, which he is the prime

5 sponsor, and then House Bill 31.

6 There is a dialogue going on, really between

7 the members by e-mail and informally, about whether

8 incentivizing early retirement would save the systems

9 enough money to make a difference with these unfunded

10 liabilities. I really would like to see a response

11 in writing or in some other form later about

12 House Bills 30 and 31.

13 And for myself, I am interested in more

14 information about your assets. For instance, your

15 allocations say over the last 5 years, the returns by

16 asset type, the percentage of total.

17 Like some of the others, I'm not quite sure

18 how to ask all these questions, but I'm also

19 interested in collateralized mortgage investments

20 that you may have and whether or not -- and I put it

21 in quotes -- you have made "unorthodox investments"

22 and what they might be.

23 EXECUTIVE DIRECTOR CLAY: No golf courses.

24 CHAIRMAN JOSEPHS: No golf courses.

25 No airlines? 118

1 EXECUTIVE DIRECTOR CLAY: No airlines.

2 CHAIRMAN JOSEPHS: I know that you do

3 performance summaries. If we could see those.

4 I think you have given us actuarial

5 liability versus assets and percentages in this

6 already. If there is anything that you haven't given

7 us, I think that we would like to have it.

8 And I was reminded -- I am from Philadelphia

9 -- that the Philadelphia Employee Retirement

10 Commission, PERC, is at a 3-plus distress level,

11 which has something to do with the debt of the city

12 government.

13 I would be interested, I guess from

14 Mr. Canag -- I'm sorry; I did so well in the

15 beginning -- Mr. CanagaRetna what that is like across

16 the country and certainly for our pension systems as

17 we go back and project it forward.

18 And anything else you think that I have

19 missed which will help us, because I do think that it

20 is obvious to all of the members here and everybody

21 sitting in this room that we need to pursue this and

22 we need to pursue this in a thoughtful and

23 deliberative manner.

24 And I speak for myself, but I think many of

25 the Representatives will join me in that we need to 119

1 educate ourselves much, much more. So I thank you

2 for starting that process.

3 I thank Mr. Roebuck for being so cooperative

4 in bringing his committee to this hearing and for his

5 contributions, for his staff contributions.

6 And if any of the other Chairs have any

7 comments, please make them now, and I would then like

8 to adjourn.

9 REPRESENTATIVE BENNINGHOFF: Thank you for

10 hosting this.

11 CHAIRMAN JOSEPHS: Thank you, everybody.

12 This hearing is adjourned.

14 (The hearing concluded at 11:10 a.m.)

25 120

1 I hereby certify that the proceedings and

2 evidence are contained fully and accurately in the

3 notes taken by me on the within proceedings and that

4 this is a correct transcript of the same.

7 ______Debra B. Miller, Reporter 8