Florida retirement system project

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Florida retirement system project

  1. 1. US State of Florida Retirement System Ricardo A. VanEgas, Ulrich Bogner, Oluwatayo Joseph Ogunleye, Antonia María Sánchez, Mash Zahid (resident of Florida) 01 December 2013 Prepared for ‘The Finance of Retirement & Pensions’ with Professor Joshua Rauh, Stanford GSB
  2. 2. US State of Florida’s Retirement System • The Florida State Retirement System (FRS) is the 4th largest public pension plan in the U.S. and offers a traditional defined benefit pension plan for 84% of members as well as a defined contribution/investment plan for the remaining 16% of members. • Our analysis finds that FRS’s funding is based on overly optimistic assumptions— currently assuming 7.75% rate of return per year yet since 2000 is actually averaging 3.3% per year. • The State of Florida currently contributes $5.5 billion per year to the FRS but needs to contribute $11 billion per year to remain solid—without pension reform this would equate to $765 in additional taxes per household per year, from research published by Professor Rauh (2011). 1
  3. 3. Exhibit: Florida Retirement System Analysis 1. Recalculating the AAL under 12, 15 and 20 year durations, using selected Treasury and municipal rates: 2 Current AAL of the Pension system YEARS FV at actuarial 7.75% (7/1/2013)(thousands of USD) 12 15 20 $127,891,781 313,220,357.79 391,833,729.48 569,099,510.39 ① Muni Rate % 2.719 3.94 4.256 ② Treasury Rate % 2.97 3.24 3.5 (after a short rate interpolation) AAL (PV as of 7/1/2013) 227,007,699.83 219,462,908.49 247,267,504.67 MUNI RATE 220,455,748.83 242,874,477.74 286,009,998.77 TREASURY RATE ① http://florida.municipalbonds.com/bonds/yield_curve ② http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
  4. 4. Exhibit: Florida Retirement System Analysis (cont.) 2. If plan is frozen today, how long can the assets pay pensions: Using formula AssetsMV = deductions/(r-CPI)*(1-(1+r/1+CPI)^-NPER) 3 Assets Avalaible for Benefit ($ in Thousands) Market Value $122,921,388 Total deductions $10,485,750 Actuarial Value $127,891,781 CPI correction adding 3% Actuarial Liabilities Value $147,193,166 ABO $122,432,331 YEARS 8% 18.61 6% 15.09 4% 12.91 2% 11.36 0% 10.19
  5. 5. Exhibit: Florida Retirement System Analysis (cont.) 3. If plan continues on an ongoing basis without additions to assets, how long can the assets pay pensions: Using formula AssetsMV = NETCASHFLOW/r*(1-(1+r)^-NPER) 4 Given current market value of assets is $122,921,388, and during the last fiscal year's report the cash flow was ($6,183,665) (this net flow is assumed to be constant) discounted at … assets will last for... 8% infinite 6% infinite 4% 40.42 years 2% 25.59 years 0% 19.88 years 3% CPI correction included through inflows and outflows. No other adjustments.
  6. 6. Policy Recommendations 1. Some general questions 1.1. Good features of this system: Defined Contribution, Contributions Refunded if leaving office. 1.2. Bad features of this system: portfolio losses charged to you, no guarantee of a minimum benefit for newcomers 1.3. Does the system provide adequate benefits for its members: You need to contribute to social security and other corporate plans or personal investments 1.4. Is the system fiscally stable: No, have too high fluctuations in the normal cost. 2. Some questions about recent history for you to answer using Internet searches 2.1. Have reforms been proposed to this system? Yes 2.2 Have reforms been actually implemented to this system? Yes. Defined Benefit Programs is no longer available. "DROP" was setup. 2.3. How have these reforms impacted the adequacy of the benefits and the solvency of the system? You can no longer rely 100% on the allowances after retirement since there is no a minimum benefit 2.4. If reforms were proposed but not implemented, what happened? N/A 3. Propose a program of reforms to improve the system. The reform program should be: 3.1. Based on the economics of the situation: Given the sensitivity of the actuarial value of pensions currently representing 60.6% of the AAL, and the fall in interest rates would be the right time to establish a policy of insurance or asset portfolios assigned to different groups , to guarantee a more stable value of the assets in time. 3.2. Have a goal of improving the solvency of the system without excessively impacting benefit adequacy: In this case we should separate the collective assets and maintain UAAL for active members, while for retirement and DROP members should compare the present value of liabilities with a valuation of assets, valued at maturity (or duration matching matching assets). And using the interest rate resulting from that allocation. Or see the cost of an insurance coverage to those liabilities, and limit the fluctuations of interest rate and mortality deviations. 5
  7. 7. Policy Recommendations (cont.) 3.3. As fair as possible to the different parties : Public Pension Systems are strangled mainly because of affording pension allowances of expensive bureaucrats. Regardless of managerial tastes and portfolio techniques....Defined Benefit is feasible if final benefit ranges between 1 and 2 minimum monthly wages 3.4. Make tactics politically feasible, which means that you could envision a scenario in which the necessary parties would agree to it • Public Pension Systems should be managed by the national central bank. Central banks might create future money • if one buys reserve rights today and 40 years later one will collect a pension after an exchange rate against all of the reserve rights I bought... • No Ponzi Game, No Madoff Scheme Situations • No further burden against official budgets nor taxpayers' pockets • New money is created after reserve rights are redeemed....The bank is NOT printing money out if thin air… • Less market pressures and frictions against market economy due to portfolios of public pensions • No illiquid trap, no risk of underfunded paid benefits • Workers may contribute by buying rights in terms that your final Defined Benefit will be between one and two minimum monthly wages 6
  8. 8. Recommended Strategy RECOMMENDATION IMPLEMENTATION STRATEGY (1) The UAAL methodology compare variables that are not homogeneous. The present value of the liabilities has no market value, and is based on approximations. We believe they have not applied a next interest rate market value of these liabilities, while the asset portfolio if you follow an approximate market valuation rating. In this case, we should separate the collective assets and maintain UAAL for active members, while for retirement and DROP members should compare the present value of liabilities with a valuation of assets, valued at maturity (or duration matching matching assets). And using the interest rate resulting from that allocation. Or see the cost of an insurance coverage to those liabilities, this cost will be a market value estimated fair value. External consultants/actuaries such as Milliman, among others, work on behalf of Florida’s Department of Management Services. These consulting firms may be approached directly with our analysis and insights to influence this thinking to pervade to the Florida State-employed pension plan managers. 7
  9. 9. Recommended Strategy (cont.) RECOMMENDATION IMPLEMENTATION STRATEGY (2) Public Pension Systems should be managed by the national central bank. Central banks might create future money if one buys reserve rights today and 40 years later one will collect a pension after an exchange rate against all of the reserve rights bought into it. • No Ponzi Game, No Madoff scheme situations • No further burden against official budgets nor additional taxpayer liabilities • New money is created after reserve rights are redeemed....The central bank is NOT printing money out of thin air • Less market pressures and frictions against market economy due to portfolios of public pensions • No illiquid trap, no risk of underfunded paid benefits • Workers may contribute by buying rights in terms that your final Defined Benefit will be between one and two minimum monthly wages 1. Make the defined contribution/investment plan the default option for new hires who don’t express a preference. 2. Limit employees switching between plans to the first year of employment (in order to prevent gaming the system and to allow for more accurate predictions/assumptions.) 3. Lengthen the defined benefit/pension plan vesting period to 10 years from 8. 4. Increase the employee contribution rate to 4% from 3%. (This would still be below the National average of 5%.) 5. Apply the above reforms to municipalities. (Currently 130 municipal pension plans in Florida are less than 80% funded.) 8

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