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Survey of state and local government employee retirement systems.

This article presents summary statistical analyses of state and local government employee retirement systems surveyes by the Public Pension Coordinating Council (PPCC) in mid-1991. The council is composed of four national associations whose members are directly involved in the administration of public employee retirement systems: the Government Finance Officers Association (GFOA), the National Association of State Retirement Administrators (NASRA), the National Conference on Public Employee Retirement Systems (NCPERS) and the National Council on Teacher Retirement (NCTR).

The purpose of the survey was to obtain in-depth information about the current practices of public employee retirement systems (PERS) with regard to administration, membership, benefits, contributions, funding, investments and reporting. The information collected in the survey is believed to constitute the most detailed single source of data on state and local government retirement systems currently in existence, and a report that summarizes the data has been issued. Since no single report can present all of the different facets of something as complex as a retirement system, the PPCC is making computer disks containing the survey data available so that the systems can conduct their own analyses. The disks are available from the Government Finance Officers Association.

The PPCC survey respondents constitute a diverse group of state and local government employee retirement systems: The 201 systems providing data represent 73 percent of the 11.7 million active members covered by state and local employee retirement systems in the United States and 71 percent of the $808 billion in assets held by these systems. The respondents also represented all of the major geographic regions, types of covered employees and administrating jurisdictions in the United States.

The survey was conducted between May and August 1991, using a questionnaire that was developed by analyzing the surveys conducted by the council's member organizations and combining the questions into the survey document. One of the unique aspects of the PPCC survey design was that it requested separate information about the retirement system and its retirement plans. Since one system may administer several plans, each with its own set of benefits, contributions and liabilities, the questionnaire was divided into two parts: the first part requesting information about the retirement system as a whole and the second part requesting information about each individual plan. The 201 responding systems administer 269 plans. The findings of the analysis, as they pertain to system administration, retirement benefits, actuarial valuations, liabilities, assets, contributions and investments are discussed below.

Administration

State and local retirement systems exist within an administrative framework that is structured by state and local laws and overseen by retirement boards consisting of elected, appointed and ex officio members. State statutes were the basis of governing laws of 78 percent of the systems. In addition, many of the systems were governed by more than one legal source. For example, of the systems administered by local governments, 54 percent were governed both by local ordinances and state statutes.

For most retirement systems, overall management is the responsibility of the system's Retirement Board or Board of Trustees, which is made up of individuals who are either appointed to the position, elected by system members or otherwise designated to serve. Board members make policy decisions within the framework of the system's enabling statutes and usually employ an administrator to carry out the system's day-to-day operations. Ninty-nine percent of the responding systems were governed by retirement boards with substantial authority and responsibilities.

The day-to-day activity of the system is usually directed by an administrator and conducted by staff. System staff are responsible for performing a wide range of duties, including: overseeing the receipt of payments made to the retirement system and ensuring that they are properly deposited or invested; authorizing payments for benefits or services rendered; maintaining all records, files and accounts; and maintaining proper communications with all interested parties.

Staff sizes varied by system size and exhibited substantial efficiencies of scale. Exhibit 1 shows that systems with 50,000 or more members averaged approximately one staff person per 1,000 active members while systems with less than 1,000 members averaged about four staff per 1,000 members. This should not be interpreted as a criticism of the smaller systems, however, since even systems with a few members must employ staff to properly administer the system.

The system administrator (often called the director, executive director or executive secretary) is responsible for the day-to-day operation of the system. In this capacity, he or she acts as coordinator for the board, directs the system staff and deals with membership and other constituencies, such as taxpayer organizations, the legislature and the community. Exhibit 2 shows the range of salaries of system administrators and that more than half of them received less than $70,000 per year.

Retirement Benefits

Retirement benefits were generally provided to members of the surveyed plans using single-rate defined benefit formulas that were not directly integrated with Social Security. Most of the 269 retirement plans covered in the survey were defined benefit plans. Although some of the systems provided additional benefits through defined contribution plans, 89 percent of the respondents were defined benefit plans, 3 percent were defined contribution plans and 8 percent were a combination of the two.

The unit benefit earned for each year of service ranged from less than 1.0 percent to 4.16 percent and averaged 2.05 percent. On average, general employees earned benefits at a rate of 1.89 percent per year, teacher/school employees at a rate of 1.76 percent, police and fire fighters at a rate of 2.50 percent. As discussed in the report, at least part of these differences may be explained by the fact that fewer police and fire fighters are covered under the federal Social Security program.

Most systems calculated final average salary based on the last three or five years of employee service. Forty-two percent of the systems used three years as the period for determining final average salary, and 22 percent used five years. It is interesting to note that 2 percent of the plans used the last year of service as the basis for determining final average salary.

The majority of plans provided post-retirement cost-of-living adjustments (COLA), either through fixed rates or formulas that varied with the consumer price index. The averate COLA was 3.63 percent. COLAs varied by geographic region and type of employees.

Recent legislative activity resulted in changes to benefit formulas and contribution rates for a number of the systems. Legislative changes to benefit formulas and contribution rates were made for 20 percent and 17 percent of the respondents, respectively. State constitutional or statutory prohibitions against reductions in earned benefits were present for approximately half of the plans.

In order to protect plan members from benefit reductions, some states have placed constitutional or statutory restrictions against reductions in earned benefits. The analysis shows that 19 percent of the respondent plans indicated that their state constitutions prohibited reductions in earned benefits, 21 percent indicated state statutory prohibitions and 3 percent indicated other prohibitions. In addition, 41 percent of the respondent plans indicated that there were no prohibitions against benefit reductions.

Actuarial Valuations

In establishing a retirement plan, a public employer is promising to pay benefits that will come due in the future. Generally these benefits can be paid in one of two ways: either "pay-as-you-go" or through some form of reserve funding. Exhibit 3 shows that the majority of respondents accumulated the monies necessary to pay retirement benefits through a reserve funding method which, in most cases, was based on the entry age cost method. Actuarial valuations were carried out frequently, usually on an annual basis, and more than 90 percent of the respondents performed actuarial valuations at least every two years.

The assumptions used by actuaries to calculate the funding requirements of the PERS play an important role in determining the amount of the computed contributions. Because it is impossible to know the future, a variety of assumptions must be made concerning rates of investment return, pay increases, withdrawal from employment and mortality. Of these, the assumptions regarding investment return and salary increase are especially critical, since even small changes in these assumptions can result in large changes to computed contributions. (1)

The mean actuarial assumption regarding the investment rate of return for all systems was 7.76 percent. On average, systems with assets of less than $100 million assumed annual returns of 7.64 percent while systems with $10 billion or more assumed returns of 7.91 percent. It is interesting to note that, while these differences are statistically significant, they are also very narrow, amounting to only 27 basis points on average between the larger and smaller systems.

In addition to assumptions about the long-term rates of return on investments, systems also must establish assumptions about the long-term rate of growth in employees' salaries. These assumptions usually include estimates of increases due to merit and seniority as well as inflation, although the survey respondents often did not show these components separately. Assumed salary increases (including both merit and inflationary increases) ranged over a wide scale, with two-thirds of the respondents reporting values between 5.0 and 7.0 percent. Assumed salary increases averaged 5.93 percent for all systems. As with investment return, the values for the smaller systems were lower than for the larger systems. On average, respondent systems with less than 1,000 members assumed rates of salary increase of 5.89 percent, while systems with 100,000 members or more assumed salary increases of 6.46 percent.

It should be noted that these figures include both inflation and merit/step increases. Although not all systems disagregated their salary assumptions into these various subcomponents, among those that did the assumptions about inflation averated 5.01 percent.

Liabilities and Assets

An actuarial valuation is a mathematical process the actuary uses to determine the pension contribution that the employer must make for a particular year. One of the steps in this process is the calculation of the actuarial accrued liability (AAL), which is a measure of the employer's obligation to pay benefits for services rendered by former and present employees. The AAL has been a topic of interest in the literature surrounding public pensions, and questions are frequently asked regarding the amount of the actuarial accrued liability and the extent to which this liability is offset by accumulated plan assets. The AAL for the PPCC respondents totaled $487.5 billion and averaged $2.7 billion per plan.

Different actuarial methods provide different treatments of the benefits that have accrued to employees as a result of past, present and possible future service. As a result, actuarial accrued liabilities per se are not directly comparable among different plans. Consistent reporting of a standard measure of the pension obligation began in 1987, when the Governmental Accounting Standards Board (GASB) mandated the disclosure of the pension benefit obligation (PBO) in the footnotes to financial statements. (2) The PBO is the actuarial accrued liability calculated using one specific actuarial valuation technique, the projected unit credit method. The PBO totaled $536.7 billion and averaged $2.5 billion per plan.

The apparent difference between the total PBO and AAL is largely due to the fact that more respondents reported the PBO than the AAL. When plans reporting both were compared, the PBO amounted to 92.4 percent of the AAL (determined using the entry age normal method).

The plans have accumulated substantial assets to cover the pension obligations and generally demonstrate strong financial health. The actuarial value of assets totaled $469.9 billion, and averaged $2.0 billion per plan. Although the unfunded actuarial accrued liability was sizeable, totaling $115.9 billion for the respondent plans, the average period for its amortization averaged 24 years. In addition, the value of assets as a percent of the pension benefit obligation averaged 85 percent.

Employer and Employee Contributions

One of the actuary's central tasks is to compute the annual contribution that the employer must make to fund the retirement plan on a systematic basis. In most instances, this contribution includes an amount representing the benefits which will accrue to members during the next plan year (referred to as the "normal cost") and an amount that amortizes the unfunded actuarially accrued liability over a period ranging from 20 to 40 years.

The total actuarially determined contribution reported by the survey respondents amounted to $19.8 billion, and averaged $90 million per plan. When expressed as a percent of covered members' payroll, the actuarially determined contribution averaged 14.36 percent per respondent plan. Interestingly, actuarially required contributions as a percent of payroll were significantly larger for the smaller plans. The average actuarially determined contribution was 17.07 percent of payroll for plans with less than 1,000 members, 13.61 percent for plans with 1,000 to 49,000 members, 11.37 percent for plans with 50,000 to 99,999 members and 10.37 percent for plans with 100,000 or more members.

Governmental contributions to public retirement plans are generally subject to the appropriation process within the employing government. Consequently, the plans compete with other governmental programs for funds. The actual annual employer's contribution for the PPCC respondents totaled $17.3 billion, and averaged $80 million per plan, somewhat less than the total actuarially determined contribution. When expressed as a percent of covered member payroll, actual employers' contributions averaged 12 percent per respondent plan. As was the case with acturially determined contributions above, actual employer's contributions as a percent of payroll were higher for smaller plans. Actual employer's contributions averaged 14.35 percent of payroll for plans with less than 1,000 members, 11.13 percent for plans with between 1,000 and 49,999 members, 9.16 percent for plans with between 50,000 and 99,999 member and 8.88 percent for plans with 100,000 members or more.

The above statistics suggest, in aggregate, that employers are making approximately 87 percent of their actuarially determined contributions. This statistic is somewhat misleading, however, since the majority of employers actually make all of their actuarially determined contribution. Exhibit 4 presents the distribution of respondent plans by the percent of the actuarially determined contribution actually made by the employer. Approximately 60 percent of the respondents indicated that the employer made the full actuarially determined contribution, and approximately 80 percent indicated that the employer made at least three-quarters of the contribution.

In addition, the PPCC respondents were generally contributory systems, requiring contributions from their members. Member contributions amounted to an additional $9.6 billion, or 6.16 percent of payroll.

Investments

The investment of plan asset is an issue of immense consequence to plan participants, to taxpayers and to the economy as a whole. If the assets invested by the retirement system earn low yields, then the sponsoring government must contribute additional funds to pay retirement benefits that have been promised to plan members. This places an additional strain on the sponsoring government and may require tax increases.

Public employee retirement system investments are made within a framework of state and local statutes that regulate investment decisions. For the majority of the survey respondents, investment restrictions took the form of the "prudent person" standard, requiring that investments be made with the "care, skill and diligence" of a prudent standard was supplemented with "legal lists," specifying the maximum percent of assets that could be invested in certain types of securities.

Empirical research suggests that investment returns over time are largely attributable to the basic "asset allocation" of the portfolio. Asset allocation refers to the distribution of assets among the traditional asset classes (e.g., stocks, bonds, cash, etc.). Studies suggest that public investors will obtain most of their returns as a result of their asset allocation, rather than as a result of the individual securities selected or the time that they are purchased. (3)

On average, the respondent systems held 8 percent of their assets in short-term securities, 33 percent in domestic equities, 47 percent in domestic fixed-income securities, 4 percent in real estate mortgages and equities (excluding government guaranteed mortgages), 1 percent in international equities and fixed-income securities, and the remaining 7 percent in various other types of investments.

Smaller systems tended to hold less of their assets in domestic equities than did the larger systems. Systems with assets of less than $100 million held 26 percent in domestic equities, compared with 41 percent for the systems with assets of $10 billion or more. Smaller systems also held less of their assets in real estate than did the larger systems.

The annualized rate of return earned by the systems over time has been falling. After earning annualized returns averaging 11.98 percent over the past five years, average annual returns fell to 9.55 percent over the past three years and 6.85 percent during the most recent year. The rapid reduction in investment return for 1990 presumably reflects the recession for that year.

The PPCC disks containing the survey data are available from the Government Finance Officers Association, 180 N. Michigan, Avenue, Suite 800, Chicago Il 60601.

NOTES

(1) Committee on Education and Labor, U.S. House of Representatives, Pension Task Force Report on Public Employee Retirement Systems, Washington, DC: U.S. Government Printing Office, 1978, p. 161.

(2) Governmental Accounting Standards Board, Statement No. 5, Disclosure of Information by Public Employee Retirement Systems and State and Local Governmental Employers, Stamford, CT: Governmental Accounting Standards Board, 1986.

(3) Miller, Girard, Pension Fund Investing, Chicago, IL: Government Finance Officers Association, 1987, p. 9. Miller reports on a study by Jeffrey Diermeier, which found a close correlation between the basic allocation of assets and investment return. Diermeier reported that the basic allocation of assets among traditional asset classes was correlated with 86 percent of total variation in investment returns.

PAUL ZORN, consultant to GFOA's Government Finance Research Center, has done extensive work in the area of public pension analysis. CATHIE EITELBERG, director of GFOA's Pension and Benefits Program in Washington, D.C., was project coordinator for this survey.
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Author:Zorn, Paul
Publication:Government Finance Review
Date:Feb 1, 1992
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