Episode 54 – Pension plan funding with the WA state actuary
Episode transcript:
[music intro]
Seth
Welcome back to Fund Your Future with DRS. Today we have the Washington State Actuary, Matt Smith, with us here to talk about the recent actuarial valuation report that his office released in August. Actuarial valuations are technical reports providing full disclosure of the financial and funding status of public retirement systems administered by DRS and Matt is here to help us learn what can be found in this report. So welcome, Matt.
Matt
Great to be here. Thank you.
Seth
Thank you. So, to remind our listeners, we had Mitch from your office, the state actuary on episode 33 of this podcast to talk a little bit about what an actuary is and how pensions are funded in Washington. So, if longtime listeners may remember and for new time listeners, they may want to go back and listen to that episode with Mitch.
But Matt, as the actual state actuary, can you just give us the elevator speech for what your team does in relationship to state pensions?
Matt
Of course. You know, for me, the beauty of a pension plan is the promise of lifetime income when you retire. So, my team provides professional services and analysis to support that promise. So, for example, we calculate required contribution rates based on funding policies that support that goal. We select various demographic assumptions and recommend economic assumptions that we use to perform our calculations.
We evaluate how proposed law changes would impact the pension systems if they were enacted by the legislature. You know, in the end, we hope our analysis supports informed decision making and the soundness of the state pension system.
Seth
And we’ll get a little more into the soundness of the pension systems and everything that is included in this report. So, I mentioned the actuarial valuation for the plan recently came out in August. And could you just give us kind of what your two key takeaways or highlights might be from this report each year? That kind of the general audience might find interesting?
Matt
Certainly, they’re page-turners as you know, for sure. [laughs] But seriously, I think there’s really two key measurements that I suggest a general reader track. I think we’ll talk later, maybe specifically about the results of this valuation. But in terms of just for general information, there’s two things. There’s the calculation of the required contribution rates and two, the funded status, for the plan or the plans of interest for the reader.
Let me just start with the area of contribution rates. The evaluation reports that we publish, I mean, in even numbered years, they’re audited by an outside actuarial firm. And if those contribution rates from that report are adopted, they become the contribution rates that will be applied for the ensuing biennium. So, for example, the valuation report that we just published, this year was audited. The results were replicated by an outside firm within small and acceptable differences that you would see in any kind of audit.
And the contribution rates from that report, they were adopted for the 25-27 biennium, subject to revision by the legislature next session. So, to bring this down to the member level, if, for example, you’re a member of PERS Plan 2 and you’re curious about how your member contribution rate might change in the future, this report can be a helpful resource. And also, the Department of Retirement Systems, as you know, provides really helpful communications in this area as well.
Seth
I think that’s really helpful context as well. I know I oftentimes get questions of: “the stock market went up last month, are my contribution rates going to go down?” And part of why we want to have this discussion is to talk about how these things are evaluated on a yearly cycle or a every other year cycle. And so those immediate short-term shocks in an economy or something like that don’t have an immediate necessary impact on the pension.
So, you mentioned funded status as well as one of the other takeaways out of this report. So, could you give us an overview of what funded status means for a retirement system and how someone might interpret that?
Matt
Yeah, I’m glad you asked this question. And this is probably the most used, actuarial metric, if you will, but it also say it might be the most misunderstood or potentially misinterpreted metric that we have, in our reports. And I think that’s common to all public plans, not just Washington. So, maybe I’ll start in general by saying what it is not.
In most cases, the funded status was not a measure of whether the plan requires future contributions. So, this is kind of one of the more common misconceptions I see. For example, if you see in a report that a plan has a funded status of 105% at a given measurement, in general, that does not mean the plan is overfunded by 5% or it does not require future contributions because of that status.
The funded status measure, provides information on whether a plan is on track with this ongoing financing plan. And just kind of put some of this in context, generally speaking, say you had a plan with a funded status of exactly 100%. That would indicate the plan is on track at the latest measurement date and the continuation of current required contribution rates are expected to keep that plan on track.
You very rarely see a plan exactly at 100%. These measurements move. Now let’s look at a couple of other scenarios. Let’s say the funded status is below 100%. And what does that indicate? That indicates that your plan is behind schedule again at a given measurement date. And it also suggests that increases in contribution rates for a period of time may be required to increase the funded status to 100% overtime.
The other sort of obvious scenario would be what if the funded status is above 100%? Well, that indicates that your plan is ahead of schedule, and there could be a period where a decrease in contribution rates are required to lower the funded status to 100%, because really that is the goal of our state’s funding policy is to have plans that are 100% funded.
But I mentioned this earlier, but I think it’s really important to remember that the funded status changes each time we measure it. So, the assumptions we use can change. The laws that determine the pension benefits can change. Experience can be better or worse than what we assumed. For example, you mentioned earlier, what if there’s a big shock on the stock market or the economy?
A plan can be on track, and fall behind from one year to the next. One favorable year of experience could move a plan from being behind to ahead of schedule in a single year.
Seth
I think that’s also a really good point. You mentioned this a couple of times, but I want to just highlight it again, is that that funded status is one point in time. It’s on a certain date. And that really on some level it might make more sense. Maybe to be more well-informed is to look at the trend line of that funded status.
Is that, as you said, is it staying at 100%, is it moving up from 80% to 85% to 90%? Is it moving down? So, could you tell us your team did this report, what was the key finding for what is the funded status of Washington plans as of the most recent valuation?
Matt
Yeah, the funded status varies by plan. So, we calculate for each, retirement plan in each retirement system. But, they do stand on their own. So, I’d refer folks to the report for those for the specific kind of status of their plan. But I wanted to provide some examples. So, our three largest plans, PERS the Public Employees’ Plan 2, 3, the Teachers’ Retirement Plan 2, 3.
And the School Employees’ SERS 2, 3. They had funded status as of 97%, 92 and 93, respectively, as of our most recent report. These are all very good numbers that are expected to trend toward 100% over the next five years.
Seth
I know a question I have received over time. We have some plans in the state that are over 100% funded, and I think sometimes there is a perception that it would be best to be 105% funded across all of our plans, or to have a plan that’s overfunded. This is a little bit off our script, but could you talk a little bit about what some of the downsides are to having a plan that’s overfunded, or why that might not be an ultimate goal of policymakers?
Matt
Yeah. Another great question, Seth. I think, from a risk management perspective, it’s easy to say, that you would you’d like to have a little bit more, right, a little cushion, right? Because if we have cushion and maybe it’s 105% fund or it’s 110% funded. Yeah. There’s, margin there to manage any adverse experience that should arise, so there isn’t necessarily an immediate shock to the contribution rates, but that’s like insurance, right? And insurance has a cost.
So, I think, some [people] in the public finance area would say: ‘is that the best use of funds?’ And once they’re in a pension system, it can also be very difficult and almost impossible, right, to take that money out and use it for other purposes. Right? Because it goes into a trust fund, trust fund dedicated to be used for the pension system, the pension beneficiaries. So, it’s kind of my initial reaction. I yeah, I certainly wouldn’t lose any sleep personally, if a plan had a little bit of margin. But if that margin starts to really, really grow, I think it can be it can be problematic. And it may not be the best use of taxpayer dollars.
Seth
Yeah. I actually think about this in terms of personal finances as well, that there’s this idea that you always need to save more for retirement. You always personally want to save more for retirement, but at some point, there’s sort of diminishing returns as well. If you’re saving 80% of your income to go save for some future retirement, you’re forgoing some current opportunity with those funds that you could use to go on vacation or take some other use for that money that might provide you more value or overall joy.
Matt
I think it’s a great comment, and it makes me think about, the priorities of government; setting a budget and pension systems are important, but they’re one aspect of a large government operation, right? And yeah, there’s limited resources available to fund all the required services. So yeah, it’s a tricky balance. So again, we want to make sure that we’re able to deliver on these promises. And do it in the most cost-effective way.
Seth
Yeah. So, you mentioned that our big retirement plans are somewhere in the low 90s to mid 90s as far as funded status. Could you just comment a little bit on how that compares historically in Washington, and maybe how it compares more on the national level as well?
Matt
Yeah, maybe start with the National. We have some of the best funded public plans in the country. When you combine all of our plans into one for reporting and comparison purposes, that’s most commonly done. Even though they do stand on their own. We often fall in the top five of all states when you measure it that way.
In recent years. And we’ve been moving up, I wouldn’t be surprised if we’re getting up there to be, the top three or the top two. All plans took a big hit during the Great Recession. But they have since recovered. And I’m really pleased to see that our open plans, the plans that are open to new members, our Plans 2 and our Plans 3 generally, but throughout their history been very, very well funded.
There were some periods where they took some hits, but during my tenure, those plans have always been, really near the top of public pension plans.
Seth
I think I would be remiss if I didn’t ask, about PERS 1 and TRS 1, the Public Employees’ Plan 1 and the Teachers’ Employees Plan 1. I think one of the things when I go out and speak to the public, or public employees about the retirement plans in general, there’s just a lot of negative news about pensions.
You see a lot of negative news nationally about pensions. And I think it’s easy for folks in Washington state to point to those Plan 1s that were closed in the in the 70’s and say, “oh, those are underfunded. This is a pension liability the state’s got a problem with.” And I don’t want to put you on the spot too much, though you are the state actuary and you do, I think, professionally opine on this. But could you just talk to our listeners a little bit about the funding of the closed plans and plan to bring them up to fully funded status?
Matt
Yeah, happy to. You know, you mentioned, the Public Employees, PERS 1 and the Teachers’ Retirement System Plan 1. Those two, have had legacy, unfunded liabilities. Really, going back to the inception of those plans, I don’t remember the exact year that they were created, but I’m sure it’s [probably] things that go back to the 1930’s or perhaps the 1940’s.
So, they’re very old plans, but didn’t really have a good financing plan to begin with. But from what I understand and what I’ve been able to research, I don’t think accurate contributions were made to those plans, and it really starts to snowball, when you get behind. So, we talked about earlier about staying on track, right?
And the funded status being one of those measures that you assess regularly and monitor to see if you’re on track. Those plans are off track from nearly the get go. And I think the legislature struggled with coming up with a funding policy that was really going to catch that up, over time and without it being too expensive, perhaps selected some plans that were, a little bit too inexpensive and didn’t accomplish the goal for many decades.
But I’m happy to report that based on a funding policy change that was made in, I think, 2009, the funded status of those plans is approved markedly. And they’re approaching 100%. And our latest projections suggest that those plans will be fully funded, probably within the next five years if our assumptions are realized. That’s a big, powerful thing to share, something I’ve been working on for my entire career in the state, actually. So, I’d be very pleased to see those projections come to fruition. And to have those plans finally attain100% funded ratio.
Seth
Yeah, that ties back to what we were talking about earlier, about what funded status means and maybe the closed Plan 1s are the best example to describe it. There are still a few people continuing to work in those plans, but they’re pretty close to being done as far as active employees and people contributing into the plan.
Let me say this and you can correct me where I’m wrong on this, but my understanding would be then, if the plans are valued at being 100% fully funded, that the and there’s no more people contributing the plan, that is a projection that there is enough funds in the plan to pay out all future benefits, assuming that everything happens as the assumptions of the plan currently are laid out. Is that a fair description of what being 100% funded would mean for those closed plans?
Matt
Yeah, I think I think you nailed it. And I think the one little nuance when you think about a plan like that and you and you alluded to this earlier, a population that’s nearly 100% retired, right? So almost very few remaining. And at some point, there will be no active members working. So, you’re not getting any contributions from those individuals.
And in a plan like that, the terminology would be the plan is closed, closed to new members, you ideally would have 100% funded status. And then yep, if your assumptions realized, you wouldn’t need future contributions. So I mentioned earlier, in an open plan you can have various levels of funded status, which give you an indication of whether or not contribution rates need to go up or down to keep you on track at 100%.
In a closed plan, it’s a little bit different, right? It you’re not having any, continuing active members or ones retired. You want to be able to retain that 100% funded status. So, there’s no contributions from anyone, the employer or the members required to keep that plan on track and deliver on the promise.
Seth
Yeah, I appreciate the additional, nuance and clarification. So, I’ve got one last meaty question for you. What are the risks, I guess, to a pension plan or how could it be negatively impacted that could change that future funded status?
Matt
Yeah. One of the bigger risks is investment returns and investment returns falling below our long-term expectations. And just for context, you know how important this is, over the past 20 to 25 years, investment returns have covered about 70 to 75% of pension costs. So, I mean, that’s really powerful. That means that about three quarters of pensions are paid from investments and the rest being from contributions, if that were to change in the future, would have a huge impact on funded status.
So, not surprisingly, the level of contributions to the plans will impact the funded status as well. So, for example, if the legislature adopts contribution rates that are below what we would call an actual required level, we would expect the funded status to weaken, law changes, right? Another kind of, seems odd to think of it as a risk.
But, law changes that enhance future benefits could be something that’s very welcomed by a member of the system to a larger benefit. But if it’s beyond the level that’s defined in law, that’s beyond the level that’s been funded under current law, that’s going to decrease the funded status in the short term and typically requires higher contributions.
And lastly, I think it’s really important to remember that the funded status calculation, as you alluded to earlier, is the result of actuarial projection based on a lot of assumptions. So actual costs could be higher than what we assume. But fortunately, we monitor this, annually we adjust our assumptions. We have the opportunity to adjust contribution rates over time. But I want to just be really clear that poor experience can lead to periods where the funded status can decline.
Seth
Yeah, I appreciate that. And I appreciate everyone in your office that I’ve ever talked to about this is very clear that there are lots of assumptions that you’re all making about the future, and it’s very likely that you’re not going to be exactly right about any of them. And you kind of hope that they offset, when, when you’re looking at the future of the plan.
But I think one of the great things about what we’ve been talking about today with this valuation report, and I know your team does a lot of other studies is that you’re constantly monitoring this as well. It’s not just a, you know, ‘set it, forget it, let it sit for 30 years and then come back and see where you’re at.’
It’s really constantly being tweaked and adjusted. And for our listeners, people who are in the retirement plans, this might sometimes feel a little bit frustrating when they see their contribution rates go up or down a little bit, or the employer community every two years could see their contribution rates go up or down. But that’s really to ensure that we have fully funded pension plans 20, 30, 40 years in the future when you actually retire.
So, I think we will certainly have to have you back or somebody from your office back to talk about all the other studies your office does and how it plays into the overall pension systems. But if our listeners are interested in learning more about the actuarial valuation report that just came out or any of the other work that your office does, where should they go to find more information?
Matt
Yeah, I typically would share our web address. But, the legislature, which we’re a part of recently updated their website. And the web address is a lot more complicated than it used to be. So, I think the easiest thing to do is just search for, ‘Office of the State Actuary’ in a browser and our report is on our main page.
And I think it’s titled ‘Final 2023 Actuarial Evaluation Report.’ So just go into your browser, search for our Office State Actuary on our homepage you’ll find this report. If you have any trouble finding it or navigating the new website, please email us. The email address is state.actuary@leg.wa.gov.
Seth
I appreciate your reports a lot in that there’s oftentimes a summary: what are the takeaways; what are the things that have changed or the exciting points. And then if you want to dive deeper, there’s, as you said, oftentimes hundreds of pages that you can find more information on about the work that your team has done. So, Matt, really appreciate that you took the time to talk to us today.
Matt
My pleasure. Thank you.
Seth
All right.
[music outro]
Disclaimer
Thanks for listening. And now we’d love to hear from you. What topics would you like to hear about? What questions do you have for us? Send an email to drs.podcasts@drs.wa.gov that’s drs.podcasts@drs.wa.gov. The Department of Retirement Systems provides this podcast as a public service, but it’s neither a legal interpretation nor a statement of DRS policy. References to any specific product or entity do not constitute an endorsement or recommendation. The views expressed by guests are their own, and their appearance on the program does not imply an endorsement of them or any entity they represent. Views and opinions expressed by DRS employees are those of the employees and do not necessarily reflect the view of DRS or any of its officials
