Retirement insights from a Colorado PERA perspective

A distant view shows a mountainous landscape with sloping peaks, green trees in the foreground, and a cloudy sky above.

A recent paper from the National Association of State Retirement Administrators, <a href="https://www.nasra.org/files/Spotlight/Risk%20Sharing%20in%20Public%20Retirement%20Plans.pdf">In-Depth: Risk Sharing in Public Retirement Plans</a>, looks at how different public retirement plans have incorporated a variety of risk-sharing features into their plan designs. Colorado PERA is included as a case study for its use of automatic changes to contribution rates and benefit levels.



<h4 class="wp-block-heading">Why risk sharing</h4>



As the paper notes, a primary objective of any retirement plan is to provide income during retirement by moving a portion of compensation from the working to the retirement years. And while a variety of factors impact the effectiveness of a retirement plan, a few things are especially important: adequate contributions and investment returns, as well as predictions of inflation and the life expectancy of plan members. There are risks – meaning there is a chance of a financial loss compared to what is expected – with each of these factors.



Long-time
readers of PERA on the Issues will be familiar with the following formula:



C+I=B+E 



Which stands for: Contributions + Investment earnings = Benefits + Expenses.



The revenue a retirement plan receives must, over time, equal the cost of the benefits and expenses the plan pays. If the assumptions underlying any of those factors change over time – if contributions decrease or investments earn less than expected, or if benefits or expenses grow faster than inflation – another factor of the equation must shift or the plan gets out of balance.



Who bears the impact of those changes – who takes on the risk and when those changes should occur – must be addressed. As the paper notes, “Nearly every state in recent years enacted reforms to [their] pension plans&#8230;. As a result, although most public employers in the U.S. have retained [Defined Benefit] plans, in many plans, more risk has shifted from employers to employees.”



In different states, cost-of-living adjustments have been reduced, employees have been required to work longer or to a higher age, employee contributions have been increased, and employers have paid higher costs.



The paper focuses on risk sharing plans that do two things compared to traditional defined benefit or defined contribution plans. First, they distribute risk among both employees and employers. And second, they articulate who bears what risk and how, before the loss or gain actually occurs.



Plans in which either the employees or the employers bear all the risk may experience bad outcomes. “Plans in which risks are strategically and optimally assigned&#8230;may be found to be more sustainable,” the paper notes.



The paper points to the automatic adjustment feature of <a href="https://leg.colorado.gov/bills/sb18-200">Senate Bill 200</a>, <a href="https://www.copera.org/pera-staff-keep-legislators-prepared-for-2019-legislative-session">approved in 2018</a>, as an example of risk sharing based on the relationship between contribution rates, which are set by the Legislature, and the rate determined by the actuarial experience of the plan’s level of funding (the actuarially-determined contribution, or ADC). Put simply, when the actual rate of contributions to PERA is less than 98 percent of the ADC, the statute requires that employer and employee contribution rates go up by up to 0.5 percent in any one year, not to exceed an additional 2 percent total increase. Conversely, if the rate of contributions were to reach 120 percent or more of the ADC, the contribution rates would decrease. A direct payment to PERA from the state as well as changes to retirees’ cost-of-living adjustments are also triggered. 



The paper notes that it is unusual for such contribution and benefit increases or decreases to be contingent on the ratio between actual contribution levels and the ADC, and that they are projected to eliminate PERA’s unfunded liability by 2047.



<h5 class="wp-block-heading">Read more about PERA’s Automatic Adjustment Provision <a href="https://content.copera.org/peras-automatic-adjustment-provision-a-case-study-for-pension-risk-sharing/">here</a>.</h5>



<blockquote class="wp-block-quote"></blockquote>

PERA’s Automatic Adjustment Provision a Case Study for Pension Risk Sharing

As percentage of government spending, employer contributions to Colorado’s public pensions remain low.



Contributions to Colorado’s
public pensions from government employers remain low as a percentage of direct
general spending, according to <a href="https://www.nasra.org/files/Issue%20Briefs/NASRACostsBrief.pdf">information recently released from NASRA</a>, the National Association of State Retirement
Administrators.



For Fiscal Year 2016,
contributions made by state and local governments to pension trust funds
accounted for 4.7 percent of all direct state and local government spending. In
Colorado, that percentage was lower: 3.6 percent of all direct state and local
government spending was pension contributions, NASRA found.



State and local government
spending on pensions varies widely among states, from 1.9 percent of spending
to nearly 10 percent. There are a number of reasons for this variation,
including levels of benefits, conservative assumed investment returns, and
historic underfunding, thus requiring governments to increase contributions if
they are making a good-faith effort to pay the necessary level of funding to
pay benefits.



Additionally, states like
Colorado that don’t participate in Social Security tend to have higher pension benefit
levels and, therefore, higher costs. If not for the pension plan, those
employers and employees would be contributing 12.4 percent of payroll to Social
Security.



Colorado’s 3.6 percent was
also lower than the median (half higher/half lower) of the 10 other non-Social
Security states and the District of Columbia, or 3.9 percent of direct
government funding, according to NASRA.



The research also found that,
since 1988, investment earnings have accounted for 62 percent of public pension
revenue. Employer contributions have made up another 26 percent, and employee
contributions the remaining 12 percent.



While employer and employee
contribution rates to Colorado PERA <a href="https://www.copera.org/contributions-to-colorado-pensions-lower-than-average">will increase</a>
on July 1, 2019, as required by provisions of SB 200, the state will still
enjoy relatively low pension contributions as a fraction of government spending,
particularly considering that PERA is a replacement for Social Security.

Contributions to Colorado pensions lower than average

By now, Colorado PERA members are well aware that their annual increase (AI), or cost-of-living adjustment (COLA), has undergone some belt-tightening changes with the passage of <a href="https://www.copera.org/trend-states-make-adjustments-to-retiree-cost-of-living-payments" target="_blank" rel="noreferrer noopener">Senate Bill 200</a> last year. What members and retirees may not know is that this action followed a broader trend for public pension plans throughout the U.S. In the past decade, pension funds in 18 states, including Colorado, <a href="https://www.nasra.org/files/Issue%20Briefs/NASRACOLA%20Brief.pdf">have enacted reforms</a> that <a href="https://content.copera.org/trend-states-make-adjustments-to-retiree-cost-of-living-payments/">changed COLAs</a> for existing retirees. Seven states have adjusted COLAs for current employees and new hires, and another six have changed them for new hires only.



While there are many types and variations of annual increases and COLAs (ad hoc, fixed, simple, compounding), essentially the adjustments to retirement benefits are meant to counterbalance inflation, which reduces the purchasing power of a fixed income. These adjustments are of additional importance to states such as Colorado, where a majority of public employees do not participate in Social Security. But unlike Social Security, defined benefit plans, including PERA, typically pre-fund COLAs via employee and employer contributions over the course of employees’ careers.



The structure of pension plans varies widely, so it’s only natural that COLAs do, too. PERA’s COLA is automatic, or predetermined by a set formula; and it’s compounded, meaning that annual benefit increases are calculated based on the original benefit plus any prior benefit increases. PERA’s annual COLA changes are influenced by the financial performance of the fund. For some PERA retirees, the COLA is based on factors such as the rate of inflation and the health of the Annual Increase Reserve for each membership division.



The COLA may also be affected by a person’s age, date of hire, or years of service and the length of time in retirement. If all of this seems complex, it is – because it varies for different PERA members. For a full explanation of how PERA’s COLA calculations work in practice, refer to the <a href="https://www.copera.org/trend-states-make-adjustments-to-retiree-cost-of-living-payments" target="_blank" rel="noreferrer noopener">Annual Increase (AI) fact sheet</a>.



The primary reason so many states have targeted COLAs in their pension reform efforts is cost, along with the U.S. economy’s recent track record of historically low inflation. The <a href="https://www.nasra.org/files/Issue%20Briefs/NASRACOLA%20Brief.pdf" target="_blank" rel="noreferrer noopener">NASRA research</a> (on page 3) notes that a compounded automatic COLA of 1.5 percent will add 11 percent to the lifetime cost of a retirement benefit, and a 3 percent COLA adds 26 percent to that cost.



The changes to PERA’s pension fund were enacted by the State Legislature, as is often — though not always — the case with pension alterations around the country. One key component of the Colorado General Assembly’s efforts in 2018 was the addition of an <a href="https://www.copera.org/trend-states-make-adjustments-to-retiree-cost-of-living-payments" target="_blank" rel="noreferrer noopener">automatic adjustment provision</a>, which could enable COLAs to decrease or increase depending on PERA’s progress toward reaching full funding within a closed 30-year time frame. The upshot for PERA members and retirees: The recent changes to the pension plan are not without pain and angst, but they’re part of a national trend toward protecting the long-term viability of public pension funds as well as stabilizing the funded status of the PERA plan which benefits all stakeholders.

Trend: States make adjustments to retiree cost-of-living payments

A digest of timely information and insight about finance, investing, and retirement.



<a href="http://files.constantcontact.com/701ae45c001/16bb371d-1d76-4b07-a4fd-3f2474997ee3.pdf?ver=1524054150000" target="_blank" rel="noreferrer noopener">Response to Pew report, The State Pension Funding Gap</a>&nbsp;|&nbsp;<a href="https://www.nasra.org/" target="_blank" rel="noreferrer noopener">National Association of State Retirement Administrators </a>The vast majority of public pension plans have assets to continue paying benefits for decades, according to a recent statement from the National Association of State Retirement Administrators (NASRA) in response to&nbsp;recently published research on public plans from <a href="http://www.pewtrusts.org/en" target="_blank" rel="noreferrer noopener">The Pew Charitable Trusts</a>. Nearly all states have made changes in recent years to benefit levels, financing structures, and actuarial methods and assumptions to preserve or restore their sustainability. Many of these reforms and adjustments result in near-term cost increases while advancing long-term sustainability, and have been recommended by Pew in the past.&nbsp;States and pension plans can be expected to continue to make changes as necessary to ensure their sustainability.



<a href="https://www.plansponsor.com/public-sector-pension-changes-create-residual-effects/" target="_blank" rel="noreferrer noopener">Public-sector pension changes create residual effects</a> |&nbsp;<a href="https://www.plansponsor.com/" target="_blank" rel="noreferrer noopener">PlanSponsor </a>A new Issue Brief publication from the <a href="https://slge.org/" target="_blank" rel="noreferrer noopener">Center for State and Local Government Excellence</a> (SLGE) seeks to answer the broad and challenging question, “How Have Pension Cuts Affected Public Sector Competitiveness?” The analysis explores the impacts of public pension reform from 2005 to 2014, finding some statistically significant evidence that cuts to pension benefits have reduced the ability of public-sector employers to compete with private-sector employers for workers. As the organization points out, there is a growing need for states and localities to consider in detail how <a href="https://www.plansponsor.com/case-study-warns-effect-move-public-db-public-dc/" target="_blank" rel="noreferrer noopener">pension benefit reductions may impact public-worker recruitment and retention</a>, and whether more analytical work can/should be done to further examine the workforce impacts of pension cuts. Read the <a href="https://slge.org/wp-content/uploads/2018/04/PensionCutsAndCompetitiveness.pdf" target="_blank" rel="noreferrer noopener">Issue Brief</a>.



<a href="http://money.cnn.com/2018/04/17/retirement/multiemployer-pension-committee/index.html" class="broken_link">1 million Americans are counting on Congress to save their pensions</a> |<a href="http://money.cnn.com">CNN Money</a> More than 1 million workers and retirees could lose their pension benefits within 20 years. Many of them were construction workers or truck drivers who belonged to a union and paid into pension funds set up to cover workers from multiple employers. But about 100 of these pension plans are expected to run out of money in the next two decades, according to a <a href="https://www.copera.org/pension-plans-continue-evolve">report</a> from the <a href="http://crr.bc.edu/">Center for Retirement Research at Boston College</a>. Lawmakers on both sides of the aisle agree that something must be done. A bipartisan committee headed by Republican Senator Orrin Hatch and Democratic Senator Sherrod Brown was created earlier this year with a mandate to come up with a legislative fix by November. &#8220;A number of the country&#8217;s biggest multiemployer pension plans are approaching insolvency, which poses a threat of small businesses going bankrupt, retirees seeing their benefits cut, and taxpayers getting stuck footing the bill,&#8221; Hatch said in a statement. (The Senate Finance Committee is currently accepting <a href="https://content.copera.org/pension-plans-continue-evolve/">public comment</a>.)



<a href="https://finance.yahoo.com/news/retirement-surprises-retirees-wish-had-163851006.html" target="_blank" rel="noreferrer noopener">Retirement surprises: What retirees wish they had known</a>&nbsp;|&nbsp;<a href="https://finance.yahoo.com" target="_blank" rel="noreferrer noopener">Yahoo! Finance</a> Retirement isn’t exactly as expected for many, with surprises including a younger-than-expected retirement age and higher health care costs, according to the <a href="http://news.gallup.com/topic/investor_and_retirement_optimism_index.aspx" target="_blank" rel="noreferrer noopener">Wells Fargo/Gallup Investor and Retirement Optimism Index</a>. Nearly one quarter of retired investors say they stopped working earlier than they’d have liked, which, according to Joe Ready, head of Wells Fargo Institutional Retirement and Trust, is a reason to consider different retirement scenarios in their planning. “Life events happen, and people don’t always get to choose when they retire — which is why it’s important to have a well thought-out plan that maps out different retirement age scenarios and projected costs in retirement,” said Ready. The average retirement age of those surveyed was 62, significantly below the age of 70 to which many are being encouraged to continue working to maximize savings and their Social Security benefits. Twenty-seven percent of men, and 19 percent of women, felt that their retirement age was earlier than they would have hoped.



<a href="https://www.marketwatch.com/story/how-retirement-investors-can-protect-themselves-even-without-a-fiduciary-rule-2018-04-13" target="_blank" rel="noreferrer noopener">How retirement investors can protect themselves — even without a fiduciary rule</a> |<a href="https://www.marketwatch.com" target="_blank" rel="noreferrer noopener">MarketWatch</a>A court may have blocked implementation of the fiduciary rule, but retirees can still protect themselves. That’s referring to the Department of Labor’s rule that, until it was <a href="https://www.marketwatch.com/story/appeals-court-shoots-down-labor-departments-fiduciary-rule-2018-03-15" target="_blank" rel="noreferrer noopener">blocked in mid-March by a U.S. appeals court</a>, would have legally bound brokers and advisers who handle retirement accounts to act in the best interests of their clients when they receive any compensation. Though that court ruling isn’t necessarily the final word on the matter, some are now <a href="https://www.barrons.com/articles/the-dol-fiduciary-rule-looks-grievously-wounded-1521670604" target="_blank" rel="noreferrer noopener">predicting that the rule will never get implemented</a>. To be sure, some think this is a good outcome, while others are lamenting it. But the point of this column is not to take a position either pro or con on the fiduciary rule but instead to show how you can still arrange it so that you are just as protected as you would have been had the fiduciary rule gone into effect.



<a href="http://www.governing.com/columns/smart-mgmt/col-states-retirement-savings-private-sector-social-experiment.html" target="_blank" rel="noreferrer noopener">The States’ Retirement-Savings Social Experiment</a> |<a href="http://www.governing.com/" target="_blank" rel="noreferrer noopener">Governing</a>Several states are undertaking what amounts to a significant social experiment, one that leaders and policymakers in other states will want to watch closely. Concerned about private-sector employees&#8217; lack of retirement savings and the potential impact on poverty levels, and subsequently on state budgets, legislators in nine states &#8212; California, Connecticut, Illinois, Maryland, Massachusetts, New Jersey, Oregon, Vermont, and Washington-have enacted programs designed to remedy both problems. They have good reason. Unlike most government employees, more than 30 million of the nation&#8217;s private-sector workers &#8212; about a third of the workforce &#8212; lack access to a retirement savings plan through their jobs. While some of these employees may have other savings vehicles, such as individual retirement accounts (IRAs), research by The Pew Charitable Trusts has shown that only 28 percent of those without access to an employer-provided plan have any retirement savings at all.

Retirement Roundup: State and local pension plans continue to evolve

PERA’s <a href="https://www.copera.org/understanding-the-role-of-trustees" target="_blank" rel="noreferrer noopener">Trustees</a> – the 16 professionals who oversee PERA’s investment program and benefits administration – are each bound by a set of fiduciary responsibilities requiring them to act in the best interest of PERA members and retirees.



As fiduciaries, Trustees have duties of loyalty, care, and prudence to act in the best interest of another party, acting <a href="https://www.copera.org/understanding-the-role-of-trustees" target="_blank" rel="noreferrer noopener">“solely in the interest of his or her client” and “perform with a high level of competence and thoroughness, in accordance with industry standards.”</a> Colorado law makes it clear that PERA fiduciaries have a responsibility to “carry out their functions solely in the interest of members and benefit recipients and for the exclusive purpose of providing benefits.” <a href="https://www.copera.org/understanding-the-role-of-trustees" target="_blank" rel="noreferrer noopener">(C.R.S. § 24-51-207(2)(a)).</a>



Both PERA employees and PERA Trustees receive regular training on what it means to be a fiduciary and the legal and ethical standards involved in fulfilling their roles.



In addition to attending extensive education and training to prepare them for their role, Trustees participate in five regular board meetings each year as well as committee meetings and, potentially, special meetings to review and consider proposed legislation that could impact PERA.



While only the Colorado General Assembly has the authority to make changes to the PERA benefit and contribution structure, as fiduciaries, PERA Trustees play an important role in the administrative oversight of PERA and have the responsibility to set the actuarial assumptions used by the plan, including the long-term rate of return assumption. Trustees have access to world-class consulting firms to assist them in setting the assumptions (both demographic and economic) used in the measurement of the financial health of the system.



Setting the long-term rate of investment return – a case study



Economic assumptions used by PERA include price inflation, wage inflation, and the long-term investment rate of return. The long-term rate of return assumption is the most powerful of all the assumptions therefore it receives a lot of attention.



How does the Board determine what rate of return will be used?



In October 2016, the Board conducted an Actuarial Assumption Workshop. The purpose of the workshop was to review economic and demographic information and receive presentations from actuarial and investment professionals. The process began prior to the workshop when Trustees received:



<ul>
<li>Economic and market data analysis. Ahead of the workshop, as it relates to the rate of return, materials provided to the Board included economic and market data compiled by the Board’s Investment Consultant (<a href="http://www.aon.com/human-capital-consulting/default.jsp" target="_blank" rel="noreferrer noopener">Aon Hewitt</a>), and detailed investment and funded ratio history compiled by PERA staff.</li>



<li>Economic forecasts. The Board also received information from the <a href="https://www.copera.org/understanding-the-role-of-trustees" target="_blank" rel="noreferrer noopener">International Monetary Fund</a>, the <a href="https://www.cbo.gov/" target="_blank" rel="noreferrer noopener">Congressional Budget Office</a>, <a href="http://www.worldbank.org/" target="_blank" rel="noreferrer noopener">The World Bank</a>, <a href="https://www.bloomberg.com/" target="_blank" rel="noreferrer noopener">Bloomberg</a>, the <a href="https://www.mckinsey.com/mgi/overview" target="_blank" rel="noreferrer noopener">McKinsey Global Institute</a>, and <a href="https://www.moodys.com/" target="_blank" rel="noreferrer noopener">Moody’s Investor Services</a>.</li>



<li>Public pension fund research. This data was further informed by information from the <a href="http://www.nasra.org" target="_blank" rel="noreferrer noopener">National Association of State Retirement Administrators</a> (NASRA) including the NASRA Public Fund Survey, and economic information from the U.S. Bureau of Labor Statistics, the Federal Reserve, the U.S. Census Bureau, as well as an overview of the investment rate of return assumptions used by public plans in the U.S.</li>
</ul>



At the workshop, key activities included:



<ul>
<li>Investment professional presentations. Presentations from an economist from <a href="http://www.goldmansachs.com/" target="_blank" rel="noreferrer noopener">Goldman Sachs</a> and the Vice Chairman of <a href="https://www.blackstone.com/" target="_blank" rel="noreferrer noopener">Blackstone</a>.</li>



<li>Capital market analysis. Aon Hewitt provided a capital market analysis</li>



<li>Actuarial analysis. The Board’s actuarial consultant (<a href="https://www.cavmacconsulting.com/" target="_blank" rel="noreferrer noopener">Cavanaugh Macdonald Consulting, LLC</a>) presented the results of their analysis of future returns based on the capital market assumptions provided by Aon Hewitt. The Board also reviewed a presentation by Xerox (formerly Buck Consultants) which projected investment returns based on a proprietary model.</li>
</ul>



Following the workshop, at the November 2016 Board meeting, the Board adopted the following economic assumptions for the 2016 valuation:



<ul>
<li>Price Inflation – 2.4%</li>



<li>Investment Return – 7.25%</li>



<li>General Wage Growth – 3.5%</li>



<li>Wage Inflation – 1.1%</li>



<li>Total Salary Increase – Adjust all ages and divisions by 0.40% for decrease in general wage growth.</li>
</ul>



These assumptions are still in place today. As a leading public retirement plan, PERA conducts regular experience studies and examines its assumptions on a regular basis.

Tag Archives:

PERA’s Automatic Adjustment Provision a Case Study for Pension Risk Sharing

Contributions to Colorado pensions lower than average

Trend: States make adjustments to retiree cost-of-living payments

Retirement Roundup: State and local pension plans continue to evolve

Understanding the role of Trustees

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