Pension reform continues to capture the headlines in various forms such as proposed changes to plan structure, the effect of public pension debt on governments and taxpayers, the question of who should bear the risk inherent in the capital markets, and the issue of retirement security for current and future generations. Within all of the debate, the fundamental question is whether the best vehicle to provide pension benefits is through a defined benefit (DB) or a defined contribution (DC) approach. Some pension reform advocates call for the public sector to adopt changes that mirror what has been done in the private sector, which has been primarily a move to defined contribution plans.

Like many statewide systems, Colorado’s pension reform resulted in elements of both DB and DC features, but unlike many state systems, Colorado does not participate in Social Security. Despite pension reform, scrutiny regarding the plan’s fiscal efficiency remained and some stakeholders continued to ask about alternatives.

The State determined that only a comprehensive study could respond to the questions being asked. The Colorado State Auditor’s Office commissioned Gabriel, Roeder, Smith & Company to conduct this comprehensive analysis.  Ms. Leslie Thompson, FSA, EA, MAAA served as the lead consulting actuary on the study and the main author for the report.

The key elements of the study include an analysis of retirement income, a review against peer groups, and a review of what new hires would receive under a mix of both public sector and private sector plan structures. By comparing the most recent tiers of benefits under all alternative plans, the study looked at the cost for keeping the new hire benefits the same and, conversely, the benefits for keeping the cost the same. This comprehensive report fully tackles the DB versus DC comparison using generally accepted quantification techniques to move the discussion to a more data driven and independent basis. It also provides a great deal of information on the delivery of benefit adequacy to public sector employees and retirees.

In July 2015, the Auditor’s Office released the report examining Colorado PERA’s retirement plan design comparing it to alternative public and private sector retirement savings options and Social Security. The study found the current Colorado PERA hybrid design is more efficient and uses taxpayer dollars more effectively than the other types of plans in use today.

The impact of this study is clear based on comments by highly regarded industry professionals and associations.

• In a recent communication to NCTR members , Meredith Williams, current NCTR Executive Director and former CO PERA Executive Director stated:  “Indeed, alternative plans would provide a lower retirement benefit/replacement ratio for the same cost as the current COPERA model, according to the report, and would require greater contributions in order to replace the same retirement income. As I have said before, I think this is such an important new tool in all of our member systems’ toolkits, For any plan that is facing a “reform” challenge that would replace the DB model, this report is “just invaluable” in showing how all of the other alternatives are not as efficient or cost effective,” Williams stressed.
• CO PERA Executive Director Gregory W. Smith has stated: “This independent analysis of the Colorado PERA retirement plan design provides policymakers with sound information and comprehensive comparisons of the costs and benefits provided by alternative plans.”

Read the report.

In 2008, GRS began serving the Texas Municipal Retirement System (TMRS). Our consultants soon noticed that the structure and operation of the plan had the potential to create extreme contribution volatility for participating employers. The team’s actuaries were able to detect the potential volatility problems because of their expertise with multiple-agent employer plans and the dynamics of cash balance design.

The source of the problem lay in the structure of the cash balance plan and the method of crediting the rate of return. TMRS had three separate funds within the cash balance plan: 1) active employee contributions 2) employer asset balances 3) retiree reserve. Each fund was credited with a proportional rate of return. This method resulted in participating employers holding the largest burden for absorbing investment and contribution rate volatility.

TMRS employers tend to be small cities with relatively limited budget flexibility. Unexpected or extreme volatility could create a level of fiscal difficulty for local governments such that benefit reductions could be deemed as the only option to mend the financial picture. GRS actuaries were confident that there was a better solution.

Beginning in 2010, GRS began studying various options and ultimately recommended that assets of the retiree reserve and employer asset funds be combined. This approach would have a deleveraging effect on employer contribution rates and result in less volatility and lower, more predictable contributions in future years. GRS’ funding and risk management expertise was central to helping the State of Texas Legislature adopt this solution in 2011.

The outcome provided local government employers with stable and manageable contribution requirements and helped sustain benefit levels adequate to continue recruiting qualified employees. As a testament to the effectiveness of the solution we helped craft, employer contribution rates have remained almost constant since the passage of the legislation.

Risk has become a focal point in pension plan management in recent years. Plan sponsors’ obligations for retirement benefits have been affected by a number of risks. One of the primary risks, investment risk, was borne out by the 2008-2009 financial crisis and continues to play a role due to a slower than expected economic recovery. When investment risk is further considered together with longevity risk and other material financial risks, plan sponsors may certainly wonder what solutions are available to avoid fiscal uncertainty or distress. The State of Utah state legislative pension committee came to GRS with this very inquiry.

Historically, the state and participating employers of the cost sharing system were responsible for all of the cost and risk associated with financing the defined benefit pension liability. Due to the 2008-2009 financial crisis, the state and participating employers had clearly felt the fiscal pressure that resulted as unfunded actuarial accrued liabilities and contribution rates rose. The pension committee asked that we help them develop a more equitable risk sharing arrangement between the employer and employees. The solution that GRS helped them design was accepted by the employers, labor representatives, and employees.

The design for new employees involved a choice where the employee could elect to participate in a hybrid plan design (i.e. a retirement program providing a defined benefit and defined contribution feature) or a defined contribution plan. Under this design, the state and participating employers contribute a fixed 10% of pay to fund benefits, either to the hybrid or defined contribution plan.

The advantages of the innovative design are clearly demonstrated in the operation of the hybrid structure. Under this design, when the actuarially determined contribution rate for the defined benefit plan is less than 10%, the difference goes to the employees’ defined contribution account. Conversely, if the cost of the defined benefit plan is equal to or exceeds the employer’s fixed 10% of pay contribution rate, the contribution to the defined contribution plan is eliminated and employee contributions are required to finance the cost of the defined benefit plan in excess of 10%.

In this way, the employers and employees share in the risk and rewards of the pension plan. Employers are now able to limit their downside risk for new employees’ pension benefits. New employees will continue to have access to a guaranteed benefit, while also receiving an upside reward (increased contribution to their DC) when investment markets are performing particularly well.

The City of Seattle wanted to explore alternative benefit designs so it could continue to provide meaningful benefits to long-service employees and achieve cost savings that would not adversely impact recruitment and retention goals. Through a competitive bidding process, the City hired GRS to provide benefit and cost projection technology that the City’s Retirement Team could use in-house. GRS responded by delivering a powerful benefit design projection software solution which incorporated all of the City’s specific benefit design items (e.g., eligibility, benefit multipliers, early retirement factors, COLA, etc.), data, and actuarial assumptions.

The City was then able to easily model a myriad of scenarios finally settling on five alternative benefit designs that allowed them to identify both short-term and long-term savings, plan sustainability, and benefit adequacy. The scenarios modeled by the City included a benefit design that accomplished the desired level of savings, without changing the benefit multiplier, and several innovative hybrid alternatives to the traditional defined benefit approach.

Our software solution and GRS consultants’ expert guidance on plan changes and implementation helped the City adopt changes to its system in 2016.  The City continues to use our solution to manage its retirement system.

During the last decade, one of our public defined benefit plan clients began to experience a declining workforce and shrinking payroll, which subsequently resulted in lower than expected contributions to the plan trust.   The plan, like many others, also suffered a severe decline in its funded status due to the 2008 financial crisis leading to a substantially lower funded ratio and substantially higher contribution rate requirements.

To minimize the effect of a shrinking payroll, we advised the Board of Trustees (and they adopted) a funding policy that moved the system to a dollar amount contribution rather than a percent of payroll.

With respect to ongoing monitoring of the declining payroll situation, GRS used its proprietary projection technology to test multiple scenarios that modeled changes in rates of return, payroll growth assumptions, and amortization periods.    Our interactive projection technology was used at meetings to help the Board see the impact on funded status, which ultimately led the plan to adopt a new amortization policy to further improve funding progress for the plan, and thereby improve benefit security.

Using projection technology has become part of GRS’ core valuation and consulting process for this client. Through regular scenario testing, GRS consultants will help the system refine its assumptions and funding policy on an ongoing basis, furthering the system’s goal of improving the financial condition of the plan.  We are pleased to see the trend in funding progress is now moving upwards.