Adjusting public pension benefits in Colorado: a fiduciary process.

• Author: Smith, Gregory W.

[ILLUSTRATION OMITTED]

From late 2007 into 2009, the United States and countries around the world experienced the worst financial collapse since the Great Depression. The U.S. economy was officially in a recession for 18 months from December 2007 until June 2009. The Dow Jones Industrial average sank from 14,279 in October 2007 to 8,776 on December 31, 2008 (a 39 percent decrease), and bottomed out at 6,440 in March 2009 (a 55 percent decrease). The severe market downturn in 2008 caused substantial investment losses for all investors around the world, including the Colorado Public Employees' Retirement Association (PERA), which administers a defined benefit (DB) plan in which all teachers, K-12 staff, state employees, state court judges, and employees of 143 local government units in Colorado participate. While faring better than many of its peers and the market indexes, PERA's assets decreased by 26.2 percent, amounting to approximately $11 billion in investment losses, with assets falling from approximately $41 billion to approximately $30 billion.

For the first time in its history of more than 75 years, PERA's long-term viability was imperiled. The pension system could no longer guarantee that its members would receive a benefit for their lifetime. In fact, PERA's financial projections indicated that the trust funds would be exhausted within 30 years. This reality was a call to action for the PERA Board of Trustees, and the question became, what is the proper fiduciary response to such a crisis? This article will focus on the process undertaken by the PERA Board of Trustees in response to the economic crisis of 2008, a process that ultimately resulted in the country's first reduction in a fixed, statutory cost-of-living adjustment (COLA), applicable to existing retirees.

GETTING THE NUMBERS RIGHT

Across the country there are many governance structures for public DB plans, but the feature common to all of them is the existence of a plan fiduciary. In the case of Colorado PERA, a statutorily created board of trustees serves as the fiduciary responsible for overseeing the investment program and benefit administration, while the Colorado General Assembly (with approval of the governor) is responsible for setting the benefit formula as well as the contribution rates for both employers and employees. In the last days of the 2009 Legislative session, the General Assembly charged the PERA Board of Trustees with making a comprehensive recommendation by November 1, 2009, to return the DB plan to long-term sustainability, with all unfunded liabilities paid off within 30 years.

The board's first step in developing a comprehensive response to PERA's funding crisis was to ensure that the numbers were right. To that end, the board undertook several studies to ensure that it knew exactly what the impact of 2008 was on the system. The process began with an independent financial audit to verify the 2008 investment results and market value of all DB plan assets. Next, the board retained an independent national actuarial firm to conduct the annual actuarial valuation. (The actuarial valuation determines the funded ratio of the plan--assets versus net present value of accrued benefits--and the amount of employer and employee contributions necessary to bring the plan to 100 percent funding within 30 years--referred to as the actuarially required contribution, or ARC).

To accurately determine the funded ratio and ARC, the actuaries must use assumptions regarding important future events, such as how long members will live on average, how much salaries will increase, how long members will work before retiring, and many others. To...