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United States Government Accountability Office: 
GAO: 

Report to Congressional Requesters: 

March 2012: 

State and Local Government Pension Plans: 

Economic Downturn Spurs Efforts to Address Costs and Sustainability: 

GAO-12-322: 

GAO Highlights: 

Highlights of GAO-12-322, a report to congressional requesters. 

Why GAO Did This Study: 

Over 27 million employees and beneficiaries are covered by state and 
local government pension plans. However, the recent economic downturn 
and associated budget challenges confronting state and local 
governments pose some questions as to the sustainability of these 
plans, and what changes, if any, state and local governments are 
making to strengthen the financial condition of their pension plans. 
GAO was asked to examine: 

(1) recent trends in the financial condition of state and local 
government pension plans and; 

(2) strategies state and local governments are using to manage pension 
costs and the impacts of these strategies on plans, sponsors, 
employees, and retirees. 

To address these topics, GAO analyzed various measures of sector-wide 
financial condition based on national-level data on pension funding 
from the U.S. Census Bureau and others, and reviewed information on 
recent state legislative changes affecting government pensions from 
annual reports prepared by the National Conference of State 
Legislatures (NCSL). GAO did not assess the soundness of individual 
plans, but did obtain documents and conduct interviews with pension 
and budget officials in eight states and eight localities, selected to 
illustrate the range of strategies being implemented to meet current 
and future pension funding requirement. 

The Internal Revenue Service and Social Security Administration 
provided technical comments, which were incorporated, as appropriate. 

What GAO Found: 

Despite the recent economic downturn, most large state and local 
government pension plans have assets sufficient to cover benefit 
payments to retirees for a decade or more. However, pension plans 
still face challenges over the long term due to the gap between assets 
and liabilities. In the past, some plan sponsors have not made 
adequate plan contributions or have granted unfunded benefit 
increases, and many suffered from investment losses during the 
economic downturn. The resulting gap between asset values and 
projected liabilities has led to steady increases in the actuarially 
required contribution levels needed to help sustain pension plans at 
the same time state and local governments face other fiscal pressures. 

Since 2008, the combination of fiscal pressures and increasing 
contribution requirements has spurred many states and localities to 
take action to strengthen the financial condition of their plans for 
the long term, often packaging multiple changes together. GAO’s 
tabulation of recent state legislative changes reported by NCSL and 
review of reforms in selected sites revealed the following: 

* Reducing benefits: 35 states have reduced pension benefits, mostly 
for future employees due to legal provisions protecting benefits for 
current employees and retirees. A few states, like Colorado, have 
reduced postretirement benefit increases for all members and 
beneficiaries of their pension plans. 

* Increasing member contributions: Half of the states have increased 
member contributions, thereby shifting a larger share of pension costs 
to employees. 

* Switching to a hybrid approach: Georgia, Michigan, and Utah recently 
implemented hybrid approaches, which incorporate a defined 
contribution plan component, shifting some investment risk to 
employees. 

At the same time, some states and localities have also adjusted their 
funding practices to help manage pension contribution requirements in 
the short term by changing actuarial methods, deferring contributions, 
or issuing bonds, actions that may increase future pension costs. 
Going forward, growing budget pressures will continue to challenge 
state and local governments’ abilities to provide adequate 
contributions to help sustain their pension plans. 

Figure: Notable Changes to State-Sponsored Pension Plans (January 2008 
to June 2011): 

[Refer to PDF for image: horizontal bar graph] 

Reduced benefits: 

Adjusted benefit formula: 
Future employees only: 18; 
Future employees and some current employees: 6; 
Total: 24 states. 

Raised age or increased service requirements: 
Future employees only: 23; 
Future employees and some current employees: 6; 
Total: 29 states. 

Reduced or eliminated postretirement increases: 
Future employees only: 5; 
Future employees and some current employees: 5; 
Future, current, and retired employees: 8; 
Total: 18 states. 

35 states reduced benefits in at least on of the three categories 
above. 

Increase employee contributions: 
Future employees only: 5; 
Future employees and some current employees: 20; 
Total: 25 states. 

Switched to a hybrid approach: 
Future employees only: 3; 
Total: 3 states. 

Source: GAO analysis of annual NCSL reports. 

[End of figure] 

View [hyperlink, http://www.gao.gov/products/GAO-12-322]. For more 
information, contact Barbara D. Bovbjerg at (202) 512-7215 or 
bovbjergb@gao.gov, or Stanley J. Czerwinski at (202) 512-6806 or 
czerwinskis@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

Plans Have Sufficient Assets to Pay Near-Term Benefits, but Growing 
Budget Pressures Will Challenge Their Sustainability: 

States and Localities Have Made Changes to Reduce Costs and Improve 
Plan Sustainability: 

Concluding Observations: 

Agency Comments: 

Appendix I: Profiles of Selected State and Local Government Pensions: 

Appendix II: Actuarial Methods and Assumptions for Measuring Funded 
Status for Public Sector Defined Benefit Plans: 

Appendix III: GAO Contacts and Staff Acknowledgments: 

Tables: 

Table 1: State and Local Plans Selected for Review: 

Table 2: Understanding the Financial Condition of a Public Defined 
Benefit Plan: 

Table 3: Median Contribution Rates for Large Plans as a Percentage of 
Payroll: 

Figures: 

Figure 1: State and Local Government Pension Contributions, Fiscal 
Year 2009: 

Figure 2: Investment Returns for State and Local Government Pension 
Plans, Fiscal Years 2005-2009: 

Figure 3: Historical Trends in the Financial Condition of State and 
Local Government Pension Plans--Aggregate Ratio of Market Assets to 
Total Expenditures, 1957-2009: 

Figure 4: Variability in Large Plans' Ratios of Assets to Annual 
Expenditures, Fiscal Year 2009: 

Figure 5: Aggregate Funding Ratio: Trend Data for Large State and 
Local Government Pension Plans, Fiscal Years 2001-2010: 

Figure 6: Distribution of Percentage of ARC Paid for Large Plans, 
Fiscal Year 2010: 

Figure 7: Notable Changes to State-Sponsored Pension Plans, January 
2008-June 2011: 

Figure 8: Pension Obligation Bond Issuances Nationwide, January 2006-
June 2011: 

Abbreviations: 

ARC: annual required contribution: 

ASB: Actuarial Standards Board: 

CAFR: Comprehensive Annual Financial Report: 

COLA: cost-of-living adjustment: 

CPI-W: Consumer Price Index for Urban Wage Earners and Clerical 
Workers: 

ERISA: Employee Retirement Income Security Act of 1974: 

GAAP: generally accepted accounting principles: 

GASB: Governmental Accounting Standards Board: 

NASBO: National Association of State Budget Officers: 

NCSL: National Conference of State Legislatures: 

POB: pension obligation bond: 

[End of section] 

United States Government Accountability Office: 
Washington, DC 20548: 

March 2, 2012: 

The Honorable Herb Kohl: 
Chairman: 
Special Committee on Aging: 
United States Senate: 

The Honorable Michael B. Enzi: 
Ranking Member: 
Committee on Health, Education, Labor, and Pensions: 
United States Senate: 

The recent economic downturn combined with continuing budget 
challenges has heightened concerns about the financial condition of 
state and local pension plans. Pension funding is a long-term 
endeavor, but states and local governments often have annual balanced 
budget requirements that can pit government contributions to pension 
plans against other pressing funding needs. Although state and local 
retiree benefits are not subject, for the most part, to federal laws 
governing private sector retiree benefits, the federal government has 
an interest in ensuring that all Americans have a secure retirement. 
This includes the over 27 million people covered by state and local 
government pension plans.[Footnote 1] The federal government also has 
an interest in the challenging fiscal situation facing the state and 
local sectors because fiscal health presents a national challenge 
shared by all levels of government. In light of these concerns, you 
asked us to examine: 

1. recent trends in the financial condition of state and local 
government pension plans and: 

2. strategies state and local governments are using to manage pension 
costs and the impacts of these strategies on plans, sponsors, 
employees, and retirees. 

To describe trends in the financial condition of state and local 
pension funds, we analyzed various measures of sector-wide financial 
condition based on existing national-level data on pension funding. We 
analyzed data from the U.S. Census Bureau's surveys of state and local 
retirement systems and from the Public Plans Database developed by the 
Boston College Center for Retirement Research, which includes 
financial data on 126 large state and local defined benefit plans 
covering more than 85 percent of total state and local government 
pension assets and members. To better understand the context for these 
trends, we reviewed existing literature on state and local government 
pension plans and interviewed national experts on state and local 
government pension issues. 

To identify the prevalence of various strategies state and local 
governments are using to manage pension costs, we analyzed national-
level data on state legislative changes and use of bonds to finance 
their plans. Specifically, to identify legislative changes, we 
analyzed annual reports prepared by the National Conference of State 
Legislatures (NCSL) summarizing selected state pension and retirement 
legislation enacted from January 1, 2008, through June 30, 2011. 
[Footnote 2] We limited our analysis of these NCSL reports to changes 
affecting broad categories of employees, such as state employees, 
teachers, public safety personnel, and local employees who are members 
of state-administered plans. In some limited instances, to better 
understand a legislative change, we reviewed supplemental documents 
such as pension plan documents and summaries of the legislation 
prepared by plans, state legislative counsel, or state agencies. We 
did not conduct an independent legal analysis to verify the accuracy 
of the information pertaining to recently enacted legislation 
contained in the NCSL reports. To identify bonds issued for the 
purpose of financing public pension plans, we analyzed multiple 
sources of bond data, including Mergent BondViewer and the Electronic 
Municipal Market Access system.[Footnote 3] We supplemented these 
national-level data by interviewing state and local pension and budget 
officials, and reviewing financial and actuarial reports, from a small 
judgmental sample of plans from eight states, and one locality within 
each of these states, that had implemented pension modifications since 
2008 (see table 1). This judgmental sample was selected to provide 
examples of plans experiencing a range of financial conditions and 
types of strategies adopted by their sponsors. We based this selection 
on our analysis of NCSL annual reports on pension legislation and 
suggestions from our interviews with pension experts. We did not 
assess the financial soundness of individual plans. 

Table 1: State and Local Plans Selected for Review: 

State: California; 
State plan: 
* California State Teachers' Retirement System; 
* California Public Employees' Retirement System; 
Locality: Sonoma County; 
Local plan: Sonoma County Employees' Retirement Association. 

State: Colorado; 
State plan: 
* Colorado Public Employees' Retirement Association; 
Locality: City of Denver; 
Local plan: Denver Employees Retirement Plan. 

State: Georgia; 
State plan: 
* Employees' Retirement System of Georgia; 
Locality: Cobb County; 
Local plan: Cobb County Employees' Retirement System Pension Plan. 

State: Illinois; 
State plan: 
* State Employees' Retirement System of Illinois; 
* Teachers' Retirement System of the State of Illinois; 
Locality: City of Chicago; 
Local plan: Policemen's Annuity and Benefit Fund of Chicago. 

State: Missouri; 
State plan: 
* Missouri State Employees' Retirement System; 
* Missouri Department of Transportation and Highway Patrol Employees' 
Retirement System; 
Locality: City of Springfield; 
Local plan: Police Officers' and Firefighters' Retirement Fund. 

State: Pennsylvania; 
State plan: 
* Pennsylvania Public School Employees' Retirement System; 
* Pennsylvania State Employees' Retirement System; 
Locality: City of Philadelphia; 
Local plan: City of Philadelphia Municipal Pension Plan. 

State: Utah; 
State plan: 
* Utah Retirement Systems; 
Locality: City of Bountiful; 
Local plan: Public Safety Retirement System (City of Bountiful)-part 
of the Utah Retirement Systems. 

State: Virginia; 
State plan: 
* Virginia Retirement System; 
Locality: City of Norfolk; 
Local plan: Employees' Retirement System of the City of Norfolk. 

Source: GAO. 

Note: See appendix I for more detailed profiles of each state, 
locality, and plan. 

[End of table] 

We conducted this performance audit from December 2010 to March 2012 
in accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

Background: 

There are over 3,400 state and local pension systems in the United 
States, according to the most recent Census Bureau Survey of State and 
Local Public-Employee Retirement Systems.[Footnote 4] Most large plans 
are state plans, and more state and local employees are covered by 
state-administered plans than by locally-administered plans (about 24 
million members and beneficiaries compared with about 3 million). 
However, there are more local government employees than state 
government employees (about 14 million compared with about 5 million), 
and while local governments sometimes participate in plans 
administered by states, the local governments generally retain 
responsibility for contributing the employer's share of funding to the 
plans for their employees. As a result, local governments contribute 
more to pension plans each state fiscal year, overall, than do state 
governments (see figure 1).[Footnote 5] 

Figure 1: State and Local Government Pension Contributions, Fiscal 
Year 2009: 

[Refer to PDF for image: pie-chart] 

State government contributions: $35.5 billion (41%); 
Local government contributions: $50.6 billion (59%). 

Source: GAO analysis of U.S. Census data. 

[End of figure] 

Pension plans are generally characterized as either defined benefit or 
defined contribution plans. Unlike in the private sector, defined 
benefit plans provide primary pension benefits for most state and 
local government workers. About 78 percent of state and local 
employees participated in defined benefit plans in 2011, compared with 
only 18 percent of private sector employees.[Footnote 6] In a defined 
benefit plan, the amount of the benefit payment is determined by a 
formula (in the public sector, the formula is typically based on the 
retiree's years of service and final average salary, and is most often 
provided as a lifetime annuity). However, unlike private sector 
employees with defined benefit plans, state and local government 
employees generally contribute to their defined benefit plans. A few 
states offer defined contribution or other types of retirement plans 
as the primary retirement plan.[Footnote 7] In a defined contribution 
plan, the key determinants of the benefit amount are the member's and 
employer's contribution rates, and the rate of return achieved on the 
investments in an individual's account over time. Alternatively, some 
states have adopted hybrid approaches that combine components of both 
defined benefit and defined contribution plans. 

Also unlike in the private sector, many state and local employees are 
not covered by Social Security. About 6.4 million, or over one-fourth, 
of state and local government employees are not eligible to receive 
Social Security benefits based on their government earnings and do not 
pay Social Security taxes on earnings from their government 
occupations.[Footnote 8] As a result, employer-provided pension 
benefits for non-covered employees are generally higher than for 
employees covered by Social Security, and employee and employer 
contributions are higher as well. 

The federal government has not imposed the same funding and reporting 
requirements on state and local pensions as it has on private sector 
pension plans.[Footnote 9] State and local government pension plans 
are not covered by most of the substantive requirements under the 
Employee Retirement Income Security Act of 1974 (ERISA)--requirements 
which apply to most private employer benefit plans. Nor are they 
insured by the Pension Benefit Guaranty Corporation as private plans 
are. Federal law generally does not require state and local 
governments to prefund or report on the funded status of pension 
plans. However, in order for participants to receive preferential tax 
treatment (that is, for employee contributions and investment earnings 
to be tax-deferred), state and local pensions must comply with certain 
requirements of the Internal Revenue Code.[Footnote 10] 

State and local governments also follow different standards than the 
private sector for accounting and financial reporting. The 
Governmental Accounting Standards Board (GASB), an independent 
organization, has been recognized by governments, the accounting 
industry, and the capital markets as the official source of generally 
accepted accounting principles (GAAP) for U.S. state and local 
governments. GASB's standards are not federal laws or regulations and 
GASB does not have enforcement authority. However, compliance with its 
standards is enforced through laws of some individual states and the 
audit process, whereby auditors render opinions on the fair 
presentation of state and local governments' financial statements in 
conformity with GAAP. GASB's standards require reporting financial 
information on pensions, such as the annual pension cost, 
contributions actually made to the plan, and the ratio of assets to 
liabilities. In addition, actuarial standards of practice are 
promulgated by the Actuarial Standards Board. These standards are 
designed to provide practicing actuaries with a basis for assuring 
that their work will conform to appropriate practices and to assure 
the public that actuaries are professionally accountable (see appendix 
II for information on recently proposed changes to GASB and Actuarial 
Standards Board standards). 

Some municipal bond analysts have reported concerns about state and 
local governments' creditworthiness in light of the recent economic 
downturn and continuing pension obligations. In 2008 and 2010, 
respectively, the Securities and Exchange Commission took enforcement 
actions against the city of San Diego and the state of New Jersey for 
misrepresenting the financial condition of their pension funds in 
information provided to investors.[Footnote 11] 

Plans Have Sufficient Assets to Pay Near-Term Benefits, but Growing 
Budget Pressures Will Challenge Their Sustainability: 

Although pension plans suffered significant investment losses from the 
recent economic downturn, which was the most serious since the Great 
Depression, most state and local government plans currently have 
assets sufficient to cover their benefit commitments for a decade or 
more. Nevertheless, most plans have experienced a growing gap between 
actuarial assets and liabilities over the past decade, meaning that 
higher contributions from government sponsors are needed to maintain 
funds on an actuarially based path toward sustainability. In spite of 
budget pressures through the recession, most plans continued to 
receive prerecession contribution levels on an actuarial basis from 
their sponsors, with most plans contributing their full actuarial 
level. However, there were some notable exceptions, and these plans 
continued to receive lower contribution payments. State and local 
governments experienced declining revenues and growing expenses on 
other fronts, and growing budget pressures will continue to challenge 
their ability to provide adequate contributions to help sustain their 
pension funds. 

Despite Investment Losses, Most Plans Hold Sufficient Assets to Pay 
Benefit Obligations for the Near Future: 

The recent economic downturn resulted in state and local pension plans 
suffering significant investment losses. Positive investment returns 
are an important source of funds for pension plans, and have 
historically generated more than half of state and local pension fund 
increases. However, rather than adding to plans' assets, investments 
lost more than $672 billion during fiscal years 2008 and 2009, based 
upon Census Bureau figures for the sector (see figure 2). Since 2009, 
improvements in investment earnings have helped plans recover some of 
these losses, as evidenced by more recent Census Bureau data on large 
plans.[Footnote 12] More importantly, however, public pension plans 
have built up assets over many years through prefunding (that is, 
employer and member contributions) and through the accumulation of 
associated investment returns.[Footnote 13] 

Figure 2: Investment Returns for State and Local Government Pension 
Plans, Fiscal Years 2005-2009: 

[Refer to PDF for image: vertical bar graph] 

Year: 2005; 
Value of investments: $262.69 billion. 

Year: 2006; 
Value of investments: $295.64 billion. 

Year: 2007; 
Value of investments: $472.24 billion. 

Year: 2008; 
Value of investments: -$38.91 billion. 

Year: 2009; 
Value of investments: -$633.41 billion. 

Source: State and local retirement systems data from Census Bureau. 

[End of figure] 

Assessing the financial condition across all plans using actuarially 
determined figures (such as a plan's funded ratio) is challenging, in 
part, because of the various methods and assumptions used by these 
plans (see appendix II). One alternative measure of financial 
condition across pension plans, although not optimal when assessing 
the financial health of a single plan, is the ratio of fund assets to 
annual expenditures.[Footnote 14] Fund assets represent the dollar 
amount a plan has built up, while annual expenditures ultimately 
determine how quickly assets are spent down.[Footnote 15] 
Alternatively, when assessing the financial condition of an individual 
defined benefit plan, various approaches are used, and looking at 
multiple factors is especially useful in providing a more complete 
picture of a plan's financial condition. In addition to the level of 
funding (level of plan assets relative to plan liabilities), 
assessments of a plan's financial viability by rating agencies and 
others may take into consideration the influence of the plan sponsor, 
the plan's underlying methods and assumptions, and efforts to manage 
risk (see table 2). 

Table 2: Understanding the Financial Condition of a Public Defined 
Benefit Plan: 

Influence of plan sponsor: 
Sample questions: 
* Has the government sponsor maintained its actuarial required 
contributions over time? 
* What is the outlook for the government sponsor's economy and budget 
(to afford future contributions)? 
* Is the plan's sponsor able to adjust the plan's design (that is, 
benefit levels), if needed? 

Underlying plan methods and assumptions: 
Sample questions: 
* Are underlying actuarial assumptions reasonable, such as the plan's 
discount rate or assumptions for inflation and salary growth? 
* Do the sponsor's actuarial methods for determining the rapidity of 
prefunding (actuarial cost methods for assigning costs to time 
periods, amortization periods, and any asset smoothing methods) 
produce a responsible path toward funding the obligation? 
* Who ultimately determines a plan's methods and assumptions? 
* Are those making these decisions doing so with sound professional 
judgment? 

Managing risk: 
Sample questions: 
* Is a plan's investment portfolio properly positioned to balance risk 
and returns? 
* Has a risk evaluation, management, and reporting framework been 
identified to help manage plan risk? 
* Has the risk analysis and asset allocation decision taken into 
account relevant risk factors, such as the size of the sponsor's plans 
relative to the size of the plan sponsor's tax base, budget, or other 
measure of economic resources? 
* Do the plan's benefit formulas or governance processes subject the 
plan sponsor to the risk of significant increases in benefit promises? 

Source: GAO analysis. 

[End of table] 

As illustrated in figure 3, an analysis of historical Census Bureau 
data on state and local government pensions shows that the ratio of 
fund assets to annual expenditures fell during the stock market 
downturn related to the oil crisis of the early 1970s, but eventually 
recovered and reached its peak in 2000, driven by strong investment 
results throughout the 1990s. Since that peak, both the market 
downturn in the early 2000s and sustained economic weakness beginning 
in 2008 drove the ratio of sector-wide assets relative to expenditures 
lower. Overall, these data show that the aggregate ratio of fund 
assets to annual expenditures, as of 2009, is lower, but in line with 
historical norms dating back to 1957. 

Figure 3: Historical Trends in the Financial Condition of State and 
Local Government Pension Plans--Aggregate Ratio of Market Assets to 
Total Expenditures, 1957-2009: 

[Refer to PDF for image: vertical bar graph] 

Year: 1957; 
Ratio of plan assets to expenditures: 13.39. 

Year: 1958; 
Ratio of plan assets to expenditures: not available. 

Year: 1959; 
Ratio of plan assets to expenditures: 13.8. 

Year: 1960; 
Ratio of plan assets to expenditures: 14.26. 

Year: 1961; 
Ratio of plan assets to expenditures: 14.78. 

Year: 1962; 
Ratio of plan assets to expenditures: 14.66. 

Year: 1963; 
Ratio of plan assets to expenditures: 14.91. 

Year: 1964; 
Ratio of plan assets to expenditures: 15.53. 

Year: 1965; 
Ratio of plan assets to expenditures: 15.84. 

Year: 1966; 
Ratio of plan assets to expenditures: 15.89. 

Year: 1967; 
Ratio of plan assets to expenditures: 14.63. 

Year: 1968; 
Ratio of plan assets to expenditures: 15.46. 

Year: 1969; 
Ratio of plan assets to expenditures: 15.26. 

Year: 1970; 
Ratio of plan assets to expenditures: 15.1. 

Year: 1971; 
Ratio of plan assets to expenditures: 14.83. 

Year: 1972; 
Ratio of plan assets to expenditures: 13.98. 

Year: 1973; 
Ratio of plan assets to expenditures: 13.49. 

Year: 1974; 
Ratio of plan assets to expenditures: 13.18. 

Year: 1975; 
Ratio of plan assets to expenditures: 13.09. 

Year: 1976; 
Ratio of plan assets to expenditures: 13.24. 

Year: 1977; 
Ratio of plan assets to expenditures: 12.6. 

Year: 1978; 
Ratio of plan assets to expenditures: 13.23. 

Year: 1979; 
Ratio of plan assets to expenditures: 13.17. 

Year: 1980; 
Ratio of plan assets to expenditures: 13.22. 

Year: 1981; 
Ratio of plan assets to expenditures: 13.47. 

Year: 1982; 
Ratio of plan assets to expenditures: 13.4. 

Year: 1983; 
Ratio of plan assets to expenditures: 14.64. 

Year: 1984; 
Ratio of plan assets to expenditures: 14.27. 

Year: 1985; 
Ratio of plan assets to expenditures: 15.16. 

Year: 1986; 
Ratio of plan assets to expenditures: 16.02. 

Year: 1987; 
Ratio of plan assets to expenditures: 16.82. 

Year: 1988; 
Ratio of plan assets to expenditures: 17. 

Year: 1989; 
Ratio of plan assets to expenditures: 17.38. 

Year: 1990; 
Ratio of plan assets to expenditures: 18.13. 

Year: 1991; 
Ratio of plan assets to expenditures: 18.02. 

Year: 1992; 
Ratio of plan assets to expenditures: 17.9. 

Year: 1993; 
Ratio of plan assets to expenditures: 17.3. 

Year: 1994; 
Ratio of plan assets to expenditures: 17.19. 

Year: 1995; 
Ratio of plan assets to expenditures: 17.57. 

Year: 1996; 
Ratio of plan assets to expenditures: 17.93. 

Year: 1997; 
Ratio of plan assets to expenditures: 19.39. 

Year: 1998; 
Ratio of plan assets to expenditures: 20.46. 

Year: 1999; 
Ratio of plan assets to expenditures: 21.17. 

Year: 2000; 
Ratio of plan assets to expenditures: 21.59. 

Year: 2001; 
Ratio of plan assets to expenditures: 19.22. 

Year: 2002; 
Ratio of plan assets to expenditures: 17.58. 

Year: 2003; 
Ratio of plan assets to expenditures: 16.11. 

Year: 2004; 
Ratio of plan assets to expenditures: 17.16. 

Year: 2005; 
Ratio of plan assets to expenditures: 17.14. 

Year: 2006; 
Ratio of plan assets to expenditures: 17.5. 

Year: 2007; 
Ratio of plan assets to expenditures: 18.49. 

Year: 2008; 
Ratio of plan assets to expenditures: 16.46. 

Year: 2009; 
Ratio of plan assets to expenditures: 12.24. 

Source: GAO analysis of nationwide Census data on state and local 
government pension plans. 

[End of figure] 

At the same time, data on individual plans indicate that this measure 
can vary considerably across plans. As illustrated in figure 4, data 
on large plans for fiscal year 2009 show that their fund assets 
relative to annual expenditures varied widely, with ratios ranging 
from less than 5 to greater than 20. 

Figure 4: Variability in Large Plans' Ratios of Assets to Annual 
Expenditures, Fiscal Year 2009: 

[Refer to PDF for image: horizontal bar graph] 

Ration of assets to expenditures: less than 5; 
Number of public plans: 1. 

Ration of assets to expenditures: 5 to 10; 
Number of public plans: 35. 

Ration of assets to expenditures: 10 to 15; 
Number of public plans: 51. 

Ration of assets to expenditures: 15 to 20; 
Number of public plans: 24. 

Ration of assets to expenditures: More than 20; 
Number of public plans: 5. 

Source: GAO analysis of data on 116 large plans for the Center for 
Retirement Research of Boston College. 

[End of figure] 

From the early years of prefunding of pension plans, sector-wide plan 
contributions outpaced plan expenditures, but by the early 1990s, 
expenditures began outpacing contributions.[Footnote 16] This trend 
was predictable. As public plans matured, they began to have greater 
proportions of retirees to active workers. As such, payments to 
retirees increased relative to plan contributions and, as a result, in 
more recent years, sector-wide expenditures have outpaced 
contributions.[Footnote 17] Nevertheless, given the asset levels of 
most state and local government plans and the pace of expenditures 
relative to contributions, most plans can be expected to cover their 
commitments for the near future with their existing assets.[Footnote 
18] For example, even if these plans received no more contributions or 
investment returns, most large plans would not exhaust their assets 
for a decade or longer, since they hold assets at least 10 times their 
annual expenditures. 

Plans Face a Growing Gap between Assets and Liabilities, Leading to 
Higher Contribution Requirements: 

While state and local pension plans have sufficient assets to meet 
their obligations in the near future, an examination of actuarially 
determined funded ratios among large plans shows a growing gap between 
their assets and liabilities.[Footnote 19] This ratio is important 
since, on a plan-by-plan basis, a plan's funded ratio shows the plan's 
funding progress and is part of the basis for determining contribution 
levels necessary for fund sustainability.[Footnote 20] As a result of 
recent market declines and other reasons--such as sponsors' failure to 
keep pace with their actuarially required contributions and benefit 
increases during the early 2000s--funded ratios have trended lower. 
Data compiled on large plans indicate that the funded ratios for these 
plans, in aggregate, have fallen over the past decade from over 100 
percent in fiscal year 2001 to 75.6 percent in fiscal year 2010. 
[Footnote 21] (See figure 5.) 

Figure 5: Aggregate Funding Ratio: Trend Data for Large State and 
Local Government Pension Plans, Fiscal Years 2001-2010: 

[Refer to PDF for image: vertical bar graph] 

Fiscal year: 2001; 
Aggregate funding ratio: 101.3%. 

Fiscal year: 2002; 
Aggregate funding ratio: 97.1%. 

Fiscal year: 2003; 
Aggregate funding ratio: 91.3%. 

Fiscal year: 2004; 
Aggregate funding ratio: 87.9%. 

Fiscal year: 2005; 
Aggregate funding ratio: 86.3%. 

Fiscal year: 2006; 
Aggregate funding ratio: 85.3%. 

Fiscal year: 2007; 
Aggregate funding ratio: 86.1%. 

Fiscal year: 2008; 
Aggregate funding ratio: 85%. 

Fiscal year: 2009; 
Aggregate funding ratio: 79.8%. 

Fiscal year: 2010; 
Aggregate funding ratio: 75.6%. 

Source: GAO analysis of data on large plans from the National 
Association of State Retirement Administrators' Public Fund Survey and 
the Center for Retirement Research of Boston College. 

Note: The number of large plans included in the analysis ranged from 
119 to 126 plans. 

[End of figure] 

Growing Gap between Actuarial Assets and Liabilities: 

Several factors have contributed to the growing gap between plans' 
actuarial assets and liabilities. For example, large pension funds 
generally assumed investment returns ranging from 6 to 9 percent 
throughout the 2000s, including assuming returns of approximately 8 
percent, on average, in 2009, despite the declines in the stock market 
during this time.[Footnote 22] Pension portfolios maintain other 
assets beside equities; however, gains in these other asset classes 
did not make up the amounts lost by negative equity performance over 
this period.[Footnote 23] It is important to note that the period from 
2008 to 2009 was an extraordinary low period for returns on 
investments in the financial history of the United States. 

Benefit increases were another important reason for the growing gap 
between assets and liabilities over the past decade. These increases 
were enacted early in the decade when the funded status of plans was 
strong. For example, 11 states increased pension benefits in 2001 
according to reports from the National Conference of State 
Legislatures.[Footnote 24] Among the sites included in our review, 
Pennsylvania enacted legislation in 2001 that increased the pension 
benefit multiplier from 2 to 2.5 percent--an increase of 25 
percent.[Footnote 25] This higher benefit formula applied to both new 
and currently employed pension plan members (covering state employees 
and local public school employees). This was also the case in 
California and Colorado where pension benefit increases in the late 
1990s and early in the 2000s helped drive liabilities higher. 

Actuarially Determined Contribution Rates Trending Higher: 

Lower funded ratios generally mean higher annual contribution rates 
are necessary to help sustain pension plans. Thus, as funded ratios 
trended lower over the past decade, sponsor contribution rates trended 
higher. For example, from 2002 to 2009, the median government sponsor 
contribution rates among large plans rose as a percentage of payroll, 
while employee contribution levels remained the same through this same 
period (see table 3). 

Table 3: Median Contribution Rates for Large Plans as a Percentage of 
Payroll: 

Plans not participating in Social Security: 

Employer: 
2002: 10.3%; 
2009: 12.7%. 

Employee: 
2002: 8%; 
2009: 8%. 

Plans participating in Social Security: 

Employer:
2002: 6%; 
2009: 9.4%. 

Employee:
2002: 2002: 5%; 
2009: 2009: 5%. 

Source: National Association of State Retirement Administrators. 

[End of table] 

In spite of budget pressures through the 2007-2009 recession, most 
government sponsors of large plans continued to contribute about the 
same percentage of their annual required contribution (ARC) levels 
determined to be needed to help sustain their fund assets.[Footnote 
26] From 2005 until 2009, just under two-thirds of large plan sponsors 
continued to pay at least 90 percent of their ARC payments.[Footnote 
27] However, the gap in dollars between what large plans would have 
received, in aggregate, if they received their full ARC payments is 
significant. For example, in 2009, large plans sponsors contributed 
approximately $63.9 billion in aggregate, $10.7 billion less than if 
they had made their full ARC payments. 

In addition, the distribution of plan sponsor contribution levels in 
2010, illustrated in figure 6, shows that about half the sponsors of 
large plans contributed their full 100 percent or more of ARC 
payments, while others contributed much less. 

Figure 6: Distribution of Percentage of ARC Paid for Large Plans, 
Fiscal Year 2010: 

[Refer to PDF for image: vertical bar graph] 

Percentage of ARC: less than 50%; 
Number of plans: 9. 

Percentage of ARC: 50-60%; 
Number of plans: 6. 

Percentage of ARC: 60-70%; 
Number of plans: 14. 

Percentage of ARC: 70-80%; 
Number of plans: 7. 

Percentage of ARC: 80-90%; 
Number of plans: 17. 

Percentage of ARC: 90-100; 
Number of plans: 9. 

Percentage of ARC: 100-110; 
Number of plans: 57. 

Percentage of ARC: More than 110; 
Number of plans: 7. 

Source: GAO analysis of data from the Public Plans Database of the 
Center for Retirement Research at Boston College. 

[End of figure] 

Going forward, among the eight selected states and eight selected 
local jurisdictions we reviewed, several officials told us that they 
expected significant increases in their employer contribution rates as 
a percentage of payroll. For instance, officials from the Employees' 
Retirement System of Georgia expect their contribution rates to nearly 
double over the next 5 years (from 10.5 to 20 percent of payroll) to 
help maintain a sustainable path for their defined benefit plans. 
Officials from the Utah Retirement Systems expect rates to increase 
from approximately 13 to 20 percent of payroll. 

Plans Are Vulnerable to Pressures on State and Local Budgets: 

Fiscal pressures on state and local governments' budgets add to the 
challenges faced by plan sponsors and their ability to make adequate 
contributions to their pension plans. The economic downturn and slow 
recovery led to budget shortfalls in the state and local sectors 
because of declining tax revenues and increased spending on economic 
safety net programs such as health care and social services. According 
to survey data from the National Association of State Budget Officers 
(NASBO), from fiscal years 2009 through 2011, states reported solving 
nearly $230 billion in gaps between projected spending and revenue 
levels.[Footnote 28] Local governments have also struggled with their 
budgets. For example, the National League of Cities reported that if 
all city budgets were totaled together, they would likely face a 
combined estimated shortfall of anywhere from $56 billion to $83 
billion from 2010 to 2012.[Footnote 29] 

As a result, higher pension contributions have been needed at the same 
time state and local governments have faced added pressures to balance 
their budgets. Even in normal economic times, state and local 
governments seek consistency in program spending areas, meaning that 
large year-to-year increases in pension contribution levels can strain 
budgets. Since some of these governments are subject to balanced 
budget requirements, annual pension contributions, which averaged 
around 4 percent of state and local budgets in fiscal year 2008, must 
compete with other pressing needs, even though pension costs are 
obligations that governments must eventually pay.[Footnote 30] 

Although tax revenues are slowly recovering to pre-2008 levels, going 
forward, long-term budget issues will likely continue to stress state 
and local governments and their ability to fund their pension 
programs. GAO has reported that state and local governments face 
fiscal challenges that will grow over time, and with current policies 
in place, the sector's fiscal health is projected to decline steadily 
through 2060.[Footnote 31] The primary factor driving this decline is 
the projected growth in health-related costs. For example, GAO 
simulations show that the sector's health-related costs will be about 
3.7 percent of gross domestic product in 2010, but grow to 8.3 percent 
by 2060.[Footnote 32] These fiscal pressures, combined with growing 
pension contribution rates, have spurred many states and localities to 
take action to reduce pension costs and improve the future 
sustainability of their plans. 

States and Localities Have Made Changes to Reduce Costs and Improve 
Plan Sustainability: 

States and localities have implemented various changes to their 
pension systems since the 2008 economic downturn--changes that, 
according to officials, were intended to help manage costs and improve 
plan sustainability long term (see figure 7). Based on our tabulation 
of state legislative changes reported annually by NCSL, we found that 
the majority of states have modified their existing defined benefit 
systems to reduce member benefits, lowering future liabilities. Half 
of states have increased required member (that is, employee) 
contributions, shifting costs to employees. Only a few states have 
adopted primary plans with defined contribution components, which 
reduce plan sponsors' investment risk by shifting it to employees. 
Some states and localities have also taken action to lower pension 
contributions in the short term by changing actuarial methods, and a 
few have issued pension bonds to finance their contributions or to 
lower their costs by reducing the gap between plan assets and 
liabilities. In general, we found that states and localities often 
package several of these different pension changes together. These 
packaged changes can have varying effects on employer contributions, 
plan sustainability, and employees' retirement security.[Footnote 33] 

Figure 7: Notable Changes to State-Sponsored Pension Plans, January 
2008-June 2011: 

[Refer to PDF for image: horizontal bar graph] 

Reduced benefits: 

Adjusted benefit formula: 
Future employees only: 18; 
Future employees and some current employees: 6; 
Total: 24 states. 

Raised age or increased service requirements: 
Future employees only: 23; 
Future employees and some current employees: 6; 
Total: 29 states. 

Reduced or eliminated postretirement increases: 
Future employees only: 5; 
Future employees and some current employees: 5; 
Future, current, and retired employees: 8; 
Total: 18 states. 

35 states reduced benefits in at least on of the three categories 
above. 

Increase employee contributions: 
Future employees only: 5; 
Future employees and some current employees: 20; 
Total: 25 states. 

Switched to a hybrid approach: 
Future employees only: 3; 
Total: 3 states. 

Source: GAO analysis of annual NCSL reports. 

[End of figure] 

Majority of States Have Reduced Benefits since 2008, Reducing Future 
Liabilities: 

Since the economic downturn in 2008, 35 states have modified at least 
one state-sponsored defined benefit system to reduce member benefits 
and lower future pension liabilities, according to our analysis of 
NCSL annual reports on recent pension legislation.[Footnote 34] States 
and localities have used various strategies to reduce benefits for 
plan participants, such as adjusting the benefit formula, raising 
eligibility requirements, and limiting postretirement benefit 
increases: 

* Adjusting pension benefit formula. Since 2008, 24 states have 
adjusted the defined benefit formulas to reduce benefits by expanding 
the time period for calculating final average salary or lowering the 
percentage of final average salary multiplied by years of service for 
determining benefits.[Footnote 35] For example, California recently 
lowered the benefit multiplier for new state safety employees, many of 
whom are not covered by Social Security, from 2.5 to 2 percent. In 
addition, two localities we reviewed made similar changes. For 
example, Denver, Colorado, increased the period used for calculating 
final average salary from 3 to 5 years for new members of the Denver 
Employees Retirement Plan. 

* Raising eligibility requirements. Since 2008, 29 states have 
increased retirement age or vesting requirements for plan 
participants.[Footnote 36] For example, Missouri raised the normal 
retirement age for general employees from 62 to 67 and lengthened the 
vesting period from 5 to 10 years for new members of the State 
Employees' Retirement System and the Missouri Department of 
Transportation and Highway Patrol Employees' Retirement System. In 
addition, two localities we reviewed made similar changes. For 
example, the normal retirement age for new members of the Policemen's 
Annuity and Benefit Fund of Chicago was raised from 50 to 55 years. 

* Limiting postretirement benefits. Since 2008, 18 states have reduced 
or eliminated annual postretirement cost-of-living adjustments (COLA). 
Some states have even applied these changes to current retirees. In 
the case of Colorado, the state recently reduced postretirement COLAs 
for future, current, and retired members. According to plan documents, 
most plan members, who are not covered by Social Security, had 
previously been guaranteed an annual postretirement COLA of 3.5 
percent, but the recent legislation eliminated the COLA for 2010 and 
capped future COLAs at 2 percent.[Footnote 37] 

The majority of these benefit changes have been limited to new 
employees, slowing the future growth of pension liabilities, but 
usually not significantly reducing systems' existing unfunded 
liabilities, which are based on the benefits promised to current 
employees and retirees.[Footnote 38] As we have reported previously, 
provisions in state constitutions, statutes, or recognized legal 
protections under common law often protect pensions from being 
eliminated or diminished for current or retired members.[Footnote 39] 
Thus, some state and local governments change benefits by creating a 
new tier or plan that applies to new employees hired only after the 
date of the change, and sometimes also to newer employees who are not 
yet vested. It takes time for these new employees with less expensive 
pension benefits to become a significant portion of the workforce, 
delaying for a decade or more any significant reductions in plan 
liabilities.[Footnote 40] Over the long term, however, these benefit 
reductions can reduce pension liabilities and consequently lower 
actuarially required sponsor contributions. From the employee 
perspective, these changes can mean that those in the new tier or plan 
will realize lower future benefits than their coworkers who continue 
to participate in the old plan. This could affect employee recruitment 
and retention over the long term, but some pension officials we spoke 
with expected any short-term impacts to be minimal. 

Among the pension plans included in our review, we found that six 
states and two localities had reduced the benefits in some of their 
largest defined benefit plans. For example, in 2011, Denver, Colorado, 
reduced retirement benefits for new members of the Denver Employees 
Retirement Plan hired after July 1, 2011. Denver reversed previous 
benefit enhancements enacted over prior decades by increasing the 
period used for calculating final average salary (the basis for 
benefit calculations) and raising the minimum retirement age from 55 
to 60, among other changes. Over the next 30 years, these changes are 
expected to reduce the city's pension contributions by 1.65 percent of 
payroll. According to plan documents, the changes enacted are expected 
to reduce pension benefits for new employees and will require some 
members to work longer to receive full pension benefits. Nevertheless, 
city officials do not expect any of the recent changes to 
significantly affect employee recruitment and retention. 

Half the States Have Raised Member Contributions, Shifting Costs to 
Plan Members: 

Twenty-five states have taken action since 2008 to increase member 
contributions, shifting pension costs to employees, according to NCSL 
reports. States generally have more leeway to adjust member 
contribution rates as compared with pension benefits for existing 
members. As a result, more states have increased contributions for 
some active employees rather than limiting the increases to future 
employees. Some states are also requiring members to contribute to 
their pensions for the first time. Among the states we reviewed, 
Virginia and Missouri recently required some new plan members to 
contribute to the retirement plan (5 percent in Virginia and 4 percent 
in Missouri), whereas members did not previously contribute. 

Increases in member contributions reduce the actuarially required 
amounts plan sponsors need to contribute to their pension systems. As 
a result, these changes often do not affect the amount of revenue 
flowing into pension systems, but rather represent a shifting of 
pension cost from employers to plan members. Member contributions are 
a relatively stable source of pension revenue, since they are less 
susceptible to market conditions than investment returns, and less 
susceptible to budgetary and political pressures than employer 
contributions. However, member contributions are susceptible to 
declines in the size of the workforce and are often refunded to 
employees if they separate from their employer before becoming 
eligible to receive benefits. 

Among the jurisdictions included in our review, we found that four 
states and one locality had increased the member contributions in some 
of their largest defined benefit plans. For example, in the case of 
Norfolk, Virginia, the city began requiring new members to contribute 
5 percent to the Employees' Retirement System in 2010, whereas current 
members do not contribute. As a result of this change, the city's 
employer contributions will decline as more contributing members join 
the system. City officials said that new employees had already 
contributed over $140,000 to the system in the first year. This 
increase in member contributions will reduce employee compensation and 
could affect recruitment and retention, particularly since the change 
will be immediately reflected in lower paychecks. However, city 
officials did not expect the changes to have a significant impact on 
employee recruitment and retention, since the Virginia Retirement 
System had recently implemented similar changes for state employees. 

Three States Recently Adopted Hybrid Approaches, Reducing Risk for 
Plan Sponsors: 

Although a majority of states have continued to use traditional 
defined benefit plans as their primary pension system, our analysis of 
NCSL annual reports on recent pension legislation found that, since 
2008, three states--Georgia, Michigan,[Footnote 41] and Utah--have 
implemented hybrid approaches as primary plans for large groups of 
employees,[Footnote 42] shifting some investment risk to new 
employees.[Footnote 43] Two of the eight localities we reviewed have 
also switched to hybrid approaches since 2008: Cobb County, Georgia, 
and Bountiful, Utah (which participates in Utah's state-administered 
retirement system). Unlike in a defined benefit plan, which provides 
benefits based on a set formula,[Footnote 44] in a defined 
contribution component of a hybrid approach, the key determinants of 
the benefit amount are the employee's and employer's contribution 
rates, and the rate of return achieved on the amounts contributed to 
an individual's account over time. 

Defined contribution and hybrid approaches reduce the impact of market 
volatility on plan funding and employer contributions, but are riskier 
for plan members. Whereas under a defined benefit system, employer 
contributions generally rise and fall depending in part on investment 
returns, plan sponsors of a defined contribution system contribute a 
set amount regardless of investment returns. This reduces the risk 
facing the pension system as well as the state or locality sponsoring 
the plan. However, switching to a defined contribution plan can 
involve additional short-term costs for plan sponsors, since 
contributions from new employees go toward their own private accounts 
rather than paying off existing unfunded liabilities of the defined 
benefit plan once it is closed to new employees. From the member's 
perspective, building up retirement savings in defined contribution 
plans rests on factors that are, to some degree, outside of the 
control of the individual worker. Most notable among these is the 
market return on plan assets, which, among other factors, determines 
future retirement benefits. On the one hand, this exposure to market 
risk increases members' financial uncertainty, since retirement 
benefits rise and fall based on investment returns. On the other hand, 
defined contribution plans are often viewed as more portable than 
defined benefit plans, as employees own their accounts individually 
and can generally take their balances with them--including both member 
and employer contributions--when they leave government employment, as 
long as they are vested. In contrast, employees in defined benefit 
plans can generally take their member contributions, if any, with them 
if they leave government employment, but not the employer's 
contributions.[Footnote 45] 

In the case of Georgia, the state replaced its defined benefit plan 
with a hybrid approach for all new employees hired after January 1, 
2009. This new hybrid approach is composed of a smaller defined 
benefit relative to the previous plan (1 percent of highest average 
salary multiplied by years of service compared with 2 percent 
previously) and automatic enrollment in the state's 401(k) plan with 
the state matching up to 3 percent of the employee's contributions. 
[Footnote 46] Plan officials said it is difficult to calculate how 
much the state will save as a result of the change, but it is expected 
to be financially advantageous for the state in the long run. In 2011, 
employer contributions for the defined benefit portion of the hybrid 
approach were 6.54 percent of payroll, compared with 10.41 percent for 
employees covered under the old plan. However, since the changes are 
limited to new employees, it will take time for the state to realize 
significant savings from the change. According to plan officials, one 
of the motivating factors behind the switch to the hybrid approach was 
the desire to attract new employees to the state by providing them 
with more portable retirement benefits that mirrored those in the 
private sector. However, as is common with defined contribution plans 
in the private sector, some participants in the hybrid approach may 
not be saving enough for a secure retirement. As of December 31, 2011, 
80 percent of employees participating in the 401(k) component of the 
hybrid approach were contributing only the default 1 percent, 
according to plan officials. At this level, employees may struggle to 
build adequate retirement savings. Plan officials said they have tried 
to encourage members to contribute more to their 401(k) plans, but 
these efforts have not been successful. 

Some States and Localities Have Adjusted Pension Funding Practices, 
Potentially Increasing Future Costs: 

To address rising actuarially required pension contribution levels and 
budget pressures, some states and localities have taken actions to 
limit employer contributions in the short term or refinance their 
contributions.[Footnote 47] These strategies included changing 
actuarial methods or issuing pension bonds to supplement other sources 
of financing for pension plans. Such strategies help plan sponsors 
manage their contributions in the near term, but may increase their 
future costs. Fewer nationwide data are available on the use of these 
strategies; however, we were able to document their use across several 
of our selected pension plans.[Footnote 48] 

Adjusting Actuarial Methods: 

Some state and local governments have limited or deferred their 
pension contributions in the short term by making actuarial changes. 
It is difficult to determine the recent prevalence of these changes 
nationwide; however, five of the eight states and one of the 
localities we reviewed had implemented actuarial changes to reduce 
their pension contributions since 2008.[Footnote 49] The changes 
included expanding amortization periods (the number of years allotted 
to pay off unfunded liabilities) and adjusting smoothing techniques 
(methods for reducing the effect of market volatility on pension 
contributions by averaging asset values over multiple years).[Footnote 
50] For example, Utah reported that it increased the amortization for 
the state's retirement system from 20 years to 25 years to extend the 
length of time for paying down unfunded pension liabilities.[Footnote 
51] Alternatively, Illinois reported that it recently required all 
Illinois state retirement systems to switch from a market valuation 
with no smoothing to a 5-year smoothing method for calculating 
actuarial assets and employer contributions to lessen the immediate 
impact of fiscal year 2009 investment losses on contributions. 

Capping or Postponing Employer Contributions: 

Some state and local governments, while not formally changing their 
underlying actuarial methods, have simply deferred or capped their 
pension contributions. Two states and one locality we reviewed limited 
contributions in the short term by capping increases in employer 
contributions or by simply postponing otherwise scheduled 
contributions. Capping increases in contributions allowed these states 
and this locality to temporarily suppress the increases that would 
otherwise have been required given 2008 investment losses and other 
factors. In the case of the Pennsylvania, the state addressed an 
expected 19 percent increase in actuarially required contributions to 
the State Employees' Retirement System by capping annual increases at 
3 percent for 2012, 3.5 percent for 2013, and 4.5 percent thereafter. 
Similarly, the Illinois Municipal Retirement Fund allowed local plan 
sponsors to cap contribution increases at 10 percent starting in 2010. 

Although adjusting plan funding produced some short-term savings for 
state and local budgets, it also increased the unfunded liabilities of 
the pension system and will necessitate larger contributions in the 
future. In the case of Philadelphia, the city used its authority under 
state law to partially defer pension payments by $150 million in 
fiscal year 2010 and $90 million in 2011. While these deferrals helped 
the city reduce its contributions in the short term, state law 
requires that the money be repaid with interest by fiscal year 2014. 
The city has adopted a temporary 1 percent increase in the sales tax 
to help cover these future costs.[Footnote 52] 

Issuing Pension Obligation Bonds: 

Issuing pension obligation bonds (POB) is another funding strategy, 
although relatively few states and localities have used it, as it can 
expose plan sponsors to additional market risk. POBs are taxable 
general obligation bonds that provide a one-time cash infusion into 
the pension system. They convert a current pension obligation into a 
long-term, fixed obligation of the government issuing the bond. POBs 
are issued for generally one of two purposes: either to provide 
temporary budget relief by financing a plan sponsor's actuarially 
required contribution for a single year, or as part of a longer-term 
strategy for paying off a plan's unfunded liability. Using POBs to pay 
off all or a portion of a plan's unfunded liability potentially 
reduces future actuarially required pension contributions, but 
requires plan sponsors to make annual debt service payments on the 
POBs instead.[Footnote 53] 

We analyzed data on state and local government bond issuances 
nationwide and found that other than the states of Illinois and 
Connecticut, and the Chicago Transit Authority, most state and local 
governments have not issued sizable POBs over the past 6 years (see 
figure 8). This type of pension funding has been limited, with only 25 
or fewer POB issuances in each of the last 6 years. The total amount 
of POBs issued in a single year has not exceeded more than 1 percent 
of total assets in state and local pension plans. 

Figure 8: Pension Obligation Bond Issuances Nationwide, January 2006-
June 2011: 

[Refer to PDF for image: horizontal bar graph] 

Year: 2006; 
Number of bond issuance: 25; 
Value on bonds: 
All other issuers: $0.4 billion. 

Year: 2007; 
Number of bond issuance: 16; 
Value on bonds: 
All other issuers: $1.0 billion. 

Year: 2008; 
Number of bond issuance: 15; 
Value on bonds: 
All other issuers: $0.6 billion; 
State of Connecticut: $2.3 billion;
Chicago Transit Authority: $1.3 billion. 

Year: 2009; 
Number of bond issuance: 13; 
Value on bonds: 
All other issuers: $1.0 billion. 

Year: 2010; 
Number of bond issuance: 23; 
Value on bonds: 
All other issuers: $0.6 billion; 
State of Illinois: $3.5 billion. 

Year: 2011; 
Number of bond issuance: 3; 
Value on bonds: 
State of Illinois: $3.7 billion. 

Source: GAO analysis of Mergent BondViewer data. 

[End of figure] 

These transactions involve significant risks for government entities 
because investment returns on the bond proceeds can be volatile and 
lower than the interest rate on the bonds. In these cases, POBs can 
leave plan sponsors worse off than they were before, juggling debt 
service payments on the POBs in addition to their annual pension 
contributions. In a recent brief, the Center for State and Local 
Government Excellence reported that by mid-2009, most POBs issued 
since 1992 were a net drain on government revenues.[Footnote 54] In 
light of these concerns, officials in Pennsylvania noted that the 
state had enacted legislation in 2010 prohibiting the use of POBs. 
[Footnote 55] 

Two of the pension systems included in our review--Illinois and Sonoma 
County, California--have issued POBs since 2008. Illinois, which is 
discussed at length below, has been the largest single issuer in 
recent years, issuing over $7 billion in POBs since 2010. In the case 
of Sonoma County, California, the county issued $289 million of POBs 
in 2010 with maturities ranging up to 19 years. County officials 
explained that the POBs were financially advantageous because they had 
an average interest rate of just under 6 percent, which is lower than 
the 8 percent expected return on the pension fund investments at the 
time the bonds were issued. The difference between the POB interest 
rates and the assumed rate of return is projected to save the county 
$93 million in contributions over the life of the bonds.[Footnote 56] 
However, results could vary significantly. The POBs could increase the 
county's future expenses if actual investment returns fall below 6 
percent. Over the prior 10-year period ending in 2010, the retirement 
system's average investment rate of return was 4.1 percent, but 
returns over the prior 20-year period have been significantly higher 
at 8.4 percent. 

States and Localities Often Combine Strategies: 

States and localities often packaged multiple pension changes 
together. For example, our analysis of the NCSL reports revealed that 
23 states have both increased employee contributions and reduced 
member benefits. Each change made, and the interplay among the 
changes, contributes to various impacts on plan sponsors, pension 
sustainability, and plan members. The following examples demonstrate 
some of the ways states have packaged these changes, and the varying 
impacts that are expected as a result. 

Reducing Benefits and Increasing Contributions for New Members: 

Missouri is an example of a state that packaged increases in member 
contributions with reductions in benefits to narrow the gap between 
plan assets and liabilities. For new general members of the Missouri 
State Employees Retirement System and the Missouri Department of 
Transportation and Highway Patrol Employees' Retirement System, the 
state increased the normal retirement age from 62 to 67, expanded the 
vesting period from 5 to 10 years, and required members to contribute 
4 percent of pay to the pension system, although current members do 
not contribute. These changes are expected to lower the state's 
contributions to the system over the long run by more than 5 percent 
of payroll, but the initial savings are much smaller. In fiscal year 
2012, the benefit and contribution changes are expected to reduce the 
state's contribution to its largest plan by less than 1 percent of 
payroll, since there will be only a small number of newly hired 
members in the system. However, by fiscal year 2018, employees covered 
under the reduced benefit structure are expected to account for over 
half of payroll, further reducing the state's annual contributions. 
Plan officials said these changes could pose issues for recruitment 
and retention, although the influence of retirement plan details will 
vary based on individual circumstances. They also noted that the 
changes could affect employee morale, since new employees will have to 
work longer to qualify for benefits and the required pension 
contributions will reduce their compensation. 

Combining Short-Term Funding Adjustments with Longer-Term Benefit 
Reductions: 

In the case of Pennsylvania, the state passed a package of pension 
changes in 2010 that offset a short-term funding cap with long-term 
benefit reductions to limit the impact on the plan's funded status. 
For the State Employees' Retirement System, the most significant 
funding change was a statutory cap on employer contribution rate 
increases. The legislation addressed an expected 19 percent increase 
in actuarially required contributions by capping any increases at 3 
percent for fiscal year 2011/2012, 3.5 percent for fiscal year 
2012/2013, and 4.5 percent thereafter. In the short term, the caps 
effectively reduced the state's expected contributions over the next 4 
years by $2.5 billion. But in the long term, the caps, along with 
other actuarial changes, are expected to increase the state's pension 
contributions to the system by $7 billion over the next 32 years. To 
help offset the additional long-term costs, Pennsylvania enacted 
pension legislation calling for various benefit reductions for future 
employees. For example, the state reduced the benefit multiplier for 
future employees from 2.5 to 2 percent (with an option for members to 
maintain the 2.5 multiplier by paying a higher member contribution 
rate); increased the normal retirement age from 60 to 65; and expanded 
the vesting period from 5 to 10 years. These benefit reductions will 
reduce future liabilities and are expected to lower the state's 
pension costs by almost $8.5 billion over the next 32 years, for an 
estimated net savings of $1.5 billion over the cost of the caps and 
other funding adjustments. Both pension and budget officials said 
these changes will help the state better manage rising pension 
contributions in the short term, but the overall savings from the 
legislative package are relatively modest over the long term. 
Meanwhile, the changes will require new employees to work longer for 
lower benefits and will leave more employees with no benefit at all. 
Plan officials said it is too early to tell if this will affect 
employee recruitment and retention[Footnote 57]. : 

Managing Funding through POBs, Actuarial Changes, and Benefit 
Reductions: 

In the case of Illinois, the state combined use of POBs, actuarial 
changes, and benefit reductions to manage the state's pension costs. 
The state issued $3.5 billion of POBs in 2010 and $3.7 billion in 2011 
with maturities up to 8 years and used the proceeds to fund the 
state's annual contributions to various pension systems. An Illinois 
budget official explained that issuing the POBs helped the state avoid 
making additional spending cuts to other portions of the state's 
budget. Alternatively, given the state's budgetary challenges, some 
pension officials said that if the state had not issued the POBs, it 
is more likely that it would have not paid its full required pension 
contributions. 

Use of POBs will be costly to Illinois, since the state will face 
annual debt service payments of about $1 billion over the next 9 
years. However, the state increased individual and corporate taxes in 
2010 and state budget officials told us the state plans to use the 
additional revenue to fund these debt service payments as well as 
other budgetary priorities. Whether the state's statutorily required 
contributions are funded through POBs or general revenue does not 
directly affect the financial condition of the pension system. 
However, some pension officials were concerned that the debt service 
payments on the POBs would reduce available funding for future pension 
contributions. 

Illinois has also lowered employer contributions to the state's 
pension systems in the short term by adjusting actuarial methods. In 
2009, the state required its pension systems to switch from a market 
value (no smoothing) to a 5-year smoothing method for calculating 
actuarial assets and employer contributions. Plan officials explained 
that the change was intended to reduce the state's contributions and 
dampen the impact of fiscal year 2009 market losses for the short 
term. As a result of the change, the state's actuarially calculated 
contribution to the State Employees' Retirement System of Illinois was 
reduced by $100 million in the first year, according to plan 
officials. However, plan actuaries noted that this strategy only 
defers contributions when plan assets experience a loss, as they did 
in fiscal year 2009. Future contributions will be higher than they 
would have been previously once the fiscal year 2009 market losses are 
fully recognized. 

In addition to the use of POBs and actuarial changes, Illinois also 
reduced benefits for new employees and applied the future savings to 
reduce employer contributions in the short term. For example, the 
state raised new employees' normal retirement age to 67, capped final 
average salaries used for pension purposes, and reduced annual COLAs. 
[Footnote 58] According to plan officials, these changes are expected 
to reduce the State Employees' Retirement System's future liabilities 
by a third. State budget officials said the projected total estimated 
savings for the state over the next 35 years will be about $220 
billion. Since the changes apply only to new employees, the savings 
will slowly accrue over the next 35 years. Nevertheless, the state 
took advanced credit for these future benefit reductions, further 
reducing contributions in the short term. According to plan actuaries, 
by taking this advance credit, the state also increased unfunded 
liabilities in the short term, adversely affecting its retirement 
systems. 

Concluding Observations: 

State and local governments continue to experience the lingering 
effects of investment losses and budget pressures in the wake of the 
recent economic downturn. Although most large state and local 
government pension plans still maintain substantial assets, sufficient 
to cover their pension obligations for a decade or more, heightened 
concerns over the long-term sustainability of the plans has spurred 
many states and localities to implement a variety of reforms, 
including reductions in benefits and increases in member contributions. 

Despite these efforts, continued vigilance is needed to help ensure 
that states and localities can continue to meet their pension 
obligations. Several factors will ultimately affect the sustainability 
of state and local pension plans over the long term. Important among 
them are whether government sponsors maintain adequate contributions 
toward these plans, and whether investment returns meet sponsors' long-
term assumptions. Going forward, growing budget pressures will 
continue to challenge state and local governments' abilities to 
provide adequate contributions to help sustain their pension plans and 
ensure a secure retirement for current and future employees. 

Agency Comments: 

We provided officials from the Internal Revenue Service and the Social 
Security Administration with a draft of this report. They provided 
technical comments that we incorporated, as appropriate. In addition, 
we provided officials from the states and cities we reviewed with 
portions of the draft report that addressed aspects of the pension 
funds in their jurisdictions. We incorporated their technical 
comments, as appropriate, as well. 

We are sending copies of this report to relevant congressional 
committees, the Commissioners of the Internal Revenue Service and the 
Social Security Administration, and other interested parties. In 
addition, this report will be available at no charge on GAO's website 
at [hyperlink, http://www.gao.gov]. 

If you have any questions concerning this report, please contact 
Barbara D. Bovbjerg at (202) 512-7215 or Stanley J. Czerwinski at 
(202) 512-6806. Contact points for our Office of Congressional 
Relations and Public Affairs may be found on the last page of this 
report. GAO staff who made major contributions to this report are 
listed in appendix III. 

Signed by: 

Barbara D. Bovbjerg Managing: 
Director, Education, Workforce, and Income Security Issues: 

Signed by: 

Stanley J. Czerwinski: 
Director, Strategic Issues: 

[End of section] 

Appendix I: Profiles of Selected State and Local Government Pensions: 

United States: 

Overview of nationwide state and local retirement systems (FY 2009): 

Number of plans: 3,418: 
* State plans: 222; 
* Local plans: 3,196. 

Active members: 14,829,943: 
* State plans: 13,112,318; 
* Local plans: 1,717,625. 

Beneficiaries: 7,990,405; 
* State plans: 6,751,285; 
* Local plans: 1,239,120. 

Percentage of members covered by Social Security: 73%. 

Assets (thousands): $2,465,959,589; 
* State plans: $2,029,509,728; 
* Local plans: $436,449,861. 

Contributions (thousands): 
* Employees: $39,511,586; 
* State government: $35,509,035; 
* Local government:$50,611,000. 

Source: GAO analysis of most recent Census and Social Security data. 

Note: Census categorizes plans as state or local based on their level 
of administration, not sponsorship. 

Methodology: 

We reviewed a small judgmental sample of plans from eight states, and 
one locality within each of these states, that have implemented pension 
modifications since 2008. This judgmental sample was selected to 
provide examples of plans experiencing a range of financial conditions 
and types of strategies adopted by their sponsors. The profiles on the 
following pages are based on information from the U.S. Census Bureau, 
Social Security Administration, pension plan documents (including 
Comprehensive Annual Financial Reports (CAFR)), and interviews with 
state and local government officials. At each location, we interviewed 
budget officials and pension plan administrators, and obtained 
documents describing recent changes to their plans. The descriptions of 
recent pension reforms included here highlight notable changes given 
the scope of our review; they are not intended to provide a 
comprehensive list of every change implemented by each state or 
locality. We did not conduct an independent legal review of any state 
or local laws in compiling this appendix. 

State and Local Jurisdictions Selected for Review: 
* California and Sonoma County; 
* Colorado and the City of Denver; 
* Georgia and Cobb County; 
* Illinois and the City of Chicago; 
* Missouri and the City of Springfield; 
* Pennsylvania and the City of Philadelphia; 
* Utah and the City of Bountiful; 
* Virginia and the City of Norfolk. 

[End of profile] 

California and Sonoma County: 

Overview of California state and local retirement systems (FY 2009): 

Number of plans: 62: 
* State plans: 5; 
* Local plans: 57. 

Active members: 1,767,618: 
* State plans: 1,396,440; 
* Local plans: 371,178. 

Beneficiaries: 1,017,122: 
* State plans: 779,637; 
* Local plans: 237,485. 

Percentage of members covered by Social Security: 44%. 

Assets (thousands): $470,140,330; 
* State plans: $340,161,617; 
* Local plans: $129,978,713. 

Contributions (thousands): 
* Employees: $18,217,580; 
* State government: $4,426,716; 
* Local government:$10,785,868. 

Source: GAO analysis of most recent Census and Social Security data. 

Note: Census categorizes plans as state or local based on their level 
of administration, not sponsorship. 

Table: Selected state-sponsored plans: 

As of June 30, 2011: 

Plan basics: Active members; 
California Public Employees’ Retirement System (CalPERS): 791,219; 
California State Teachers’ Retirement System: 429,600; 

Plan basics: Beneficiaries; 
California Public Employees’ Retirement System (CalPERS): 536,234; 
California State Teachers’ Retirement System: 253,041. 

Plan basics: Members covered by Social Security? 
California Public Employees’ Retirement System (CalPERS): Varies by 
plan; 
California State Teachers’ Retirement System: No. 

Plan basics: Net assets (thousands); 
California Public Employees’ Retirement System (CalPERS): $241,761,791; 
California State Teachers’ Retirement System: $155,345,815. 

Plan basics: Contributions: Employees; 
California Public Employees’ Retirement System (CalPERS): $3,600,089; 
California State Teachers’ Retirement System: $7,465,397. 

Plan basics: (thousands) Employers; 
California Public Employees’ Retirement System (CalPERS): $2,355,909; 
California State Teachers’ Retirement System: $3,503,615[A]. 

Source: GAO analysis of most recent plan CAFRs. 

[A] This also includes government contributions 

[End of table] 

Benefit reductions: The state reduced benefits for new members of 
CalPERS hired on or after January 15, 2011, including 

* raising the normal retirement age from 55 to 60 for general state 
employees and from age 50 to 55 for members of the state highway 
patrol, 
* reducing the benefit multiplier from 2.5 to 2 percent for state 
safety employees, and, 
* increasing the period for calculating final average salary from 
1 year to 3 years. 

Member contributions: In fiscal year 2010-2011, most CalPERS 
member contributions increased by between 2 and 5 percent of 
compensation, depending on the type of employee. 

Funding changes: The CalPERS board temporarily adjusted the 
actuarial smoothing methods for the system’s plans from 2009 to 2011 to 
reduce the effects of investment losses. 

Selected locally-sponsored plan: 

As of December 31, 2010: 

Plan basics: Active members; 
Sonoma County Employees’ Retirement Association: 3,780. 

Plan basics: Beneficiaries; 
Sonoma County Employees’ Retirement Association: 3,780. 

Plan basics: Members covered by Social Security? 
Sonoma County Employees’ Retirement Association: Yes. 

Plan basics: Net assets (thousands); 
Sonoma County Employees’ Retirement Association: $1,752,819. 

Plan basics: Contributions: Employees; 
Sonoma County Employees’ Retirement Association: $37,322. 

Plan basics: (thousands) Employers; 
Sonoma County Employees’ Retirement Association: $337,761[A]. 

Source: GAO analysis of most recent financial report. 

[A] This includes $289.3 million in pension obligation bond proceeds. 

[End of table] 

Funding changes: The county issued $289 million of pension obligation 
bonds (POB) in September 2010 at an interest rate of 5.51 percent to 
pay down the plan’s unfunded liability. 

[End of profile] 

Colorado and the City of Denver: 

Overview of Colorado state and local retirement systems (2009): 

Number of plans: 67; 
* State plans: 2; 
* Local plans: 65. 

Active members: 223,636; 
* State plans: 201,524; 
* Local plans: 22,112. 

Beneficiaries: 103,134; 
* State plans: 87,174; 
* Local plans: 15,960. 

Percentage of members covered by Social Security: 30%. 

Assets (thousands): $37,072,374; 
* State plans: $31,969,762; 
* Local plans: $5,102,612. 

Contributions (thousands): 
* Employees: $658,087; 
* State government: $313,999; 
* Local government: $1,121,023. 

Source: GAO analysis of most recent Census and Social Security data. 

Note: Census categorizes plans as state or local based on their level 
of administration, not sponsorship. 

Selected state-sponsored plans: 

As of December 31, 2010 

Plan basics: Active members; 
Colorado Public Employees’ Retirement Association: 201,095. 

Plan basics: Beneficiaries; 
Colorado Public Employees’ Retirement Association: 94,017. 

Plan basics: Members covered by Social Security? 
Colorado Public Employees’ Retirement Association: No. 

Plan basics: Net assets (thousands); 
Colorado Public Employees’ Retirement Association: $38,405,701. 

Plan basics: Contributions: Employees; 
Colorado Public Employees’ Retirement Association: $668,131. 

Plan basics: (thousands) Employers; 
Colorado Public Employees’ Retirement Association: $908,330. 

Source: GAO analysis of most recent plan CAFRs. 

[End of table] 

Benefit reductions: In 2010, the state reduced postretirement cost-of-
living adjustments (COLA) for future, current, and retired members. The 
COLA was set to zero for 2010, and future COLAs were set at 2 percent, 
unless the plan has a negative investment return year, in which case 
the COLA will be the lesser of 2 percent or the Consumer Price Index 
for Urban Wage Earners and Clerical Workers (CPI-W) for the next 3 
years. Prior to the change, most plan members had been guaranteed an 
annual postretirement COLA of 3.5 percent. 

Member contributions: For fiscal years 2011 and 2012, the state 
temporarily increased member contributions by 2.5 percent of 
compensation and reduced employer contributions by the same amount. 

Selected locally-sponsored plan: 

As of December 31, 2010: 

Plan basics: Active members; 
Denver Employees Retirement Plan: 8,403. 

Plan basics: Beneficiaries; 
Denver Employees Retirement Plan: 7,606. 

Plan basics: Members covered by Social Security? 
Denver Employees Retirement Plan: Yes. 

Plan basics: Net assets (thousands); 
Denver Employees Retirement Plan: $1,802,143. 

Plan basics: Contributions: Employees; 
Denver Employees Retirement Plan: $23,090. 

Plan basics: (thousands) Employers; 
Denver Employees Retirement Plan: $45,153. 

Source: GAO analysis of most recent financial report. 

[End of table] 

Benefit reductions: In 2011, the city adopted several benefit 
reductions for new employees hired on or after July 1, 2011, including 

* increasing the minimum retirement age from 55 to 60, 
* increasing the age and service requirements needed to qualify for 
an unreduced early retirement, and, 
* increasing the period used for calculating final average salary 
from 3 to 5 years. 

[End of profile] 

Georgia and Cobb County: 

Overview of Georgia state and local retirement systems (FY 2009): 

Number of plans: 34; 
* State plans: 9; 
* Local plans: 25. 

Active members: 392,668; 
* State plans: 365,274; 
* Local plans: 27,394. 

Beneficiaries: 155,462; 
* State plans: 140,046; 
* Local plans: 15,416. 

Percentage of members covered by Social Security: 74%. 

Assets (thousands): $60,462,340; 
* State plans: $54,830,465; 
* Local plans: $5,631,875. 

Contributions (thousands); 
* Employees: $680,508; 
* State government: $1,061,525; 
* Local government: $579,042. 

Source: GAO analysis of most recent Census and Social Security data. 

Note: Census categorizes plans as state or local based on their level 
of administration, not sponsorship. 

Selected state-sponsored plans: 

As of June 30, 2011: 

Plan basics: Active members; 
Employees’ Retirement System of Georgia: 134,487. 

Plan basics: Beneficiaries; 
Employees’ Retirement System of Georgia: 55,929. 

Plan basics: Members covered by Social Security? 
Employees’ Retirement System of Georgia: Most (varies by plan). 

Plan basics: Net assets (thousands); 
Employees’ Retirement System of Georgia: 15,479,714. 

Plan basics: Contributions: Employees; 
Employees’ Retirement System of Georgia: $121,742. 

Plan basics: (thousands) Employers; 
Employees’ Retirement System of Georgia: 297,763. 

Source: GAO analysis of most recent plan CAFRs. 

[End of table] 

Hybrid approach: In 2008, the state adopted a hybrid approach for new 
employees hired after January 1, 2009, that combines defined benefit 
and defined contribution components. 

* Defined benefit portion: The plan has a 10-year vesting period 
with a benefit formula based on 1 percent of highest average 
salary multiplied by years of service. 

* Defined contribution portion: Members receive a 1 percent 
contribution match from state on the first 1 percent they contribute 
to the 401(k) plan. The state then matches half of each additional 
percent contributed by members up to a total maximum state 
match of 3 percent (based on an employee contribution of 5 
percent). However, as of December 31, 2011, about 10 percent of 
new members have opted not to participate in this part of the 
plan. 

Selected locally-sponsored plan: 

As of September 30, 2010: 

Plan basics: Active members; 
Cobb County Employees’ Retirement System Pension Plan: 4,242[A]. 

Plan basics: Beneficiaries; 
Cobb County Employees’ Retirement System Pension Plan: 1,490[A]. 

Plan basics: Members covered by Social Security? 
Cobb County Employees’ Retirement System Pension Plan: Yes. 

Plan basics: Net assets (thousands); 
Cobb County Employees’ Retirement System Pension Plan: $356,696. 

Plan basics: Contributions: Employees; 
Cobb County Employees’ Retirement System Pension Plan: $10,896. 

Plan basics: (thousands) Employers; 
Cobb County Employees’ Retirement System Pension Plan: $27,068. 

Source: GAO analysis of most recent financial report. 

[A] As of January 1, 2010. 

[End of table] 

Hybrid approach: In 2009, the county adopted a hybrid approach for 
new employees hired on or after January 1, 2010, and for nonvested 
employees who elect to join the plan. Similar to the state’s new hybrid 
plan, the defined benefit portion of the plan has a 10-year vesting 
period with a benefit formula based on 1 percent of highest average 
salary multiplied by years of service. The defined contribution 
component of the plan is voluntary, but the county matches half of the 
member’s contribution up to 2 percent. 

[End of profile] 

Illinois and the City of Chicago: 

Overview of Illinois state and local retirement systems (FY 2009): 

Number of plans: 457; 
* State plans: 6; 
* Local plans: 451. 

Active members: 633,233; 
* State plans: 491,283; 
* Local plans: 141,950. 

Beneficiaries: 404,194; 
* State plans: 292,907; 
* Local plans: 111,287. 

Percentage of members covered by Social Security: 55%. 

Assets (thousands): $100,765,313; 
* State plans: $67,472,265; 
* Local plans: $33,293,048. 

Contributions (thousands): 
* Employees: $2,497,390; 
* State government: $2,765,993; 
* Local government: $3,150,048. 

Source: GAO analysis of most recent Census and Social Security data. 

Note: Census categorizes plans as state or local based on their level 
of administration, not sponsorship. 

Selected state-sponsored plans: 

Plan basics: Active members; 
State Employees’ Retirement System of Illinois; As of June 30, 2010: 
64,143;
Teachers’ Retirement System of the State of Illinois; As of June 30, 
2011: 166,013. 

Plan basics: Beneficiaries; 
State Employees’ Retirement System of Illinois; As of June 30, 2010: 
58,392;
Teachers’ Retirement System of the State of Illinois; As of June 30, 
2011: 101,288. 

Plan basics: Members covered by Social Security? 
State Employees’ Retirement System of Illinois; As of June 30, 2010: 
Yes; 
Teachers’ Retirement System of the State of Illinois; As of June 30, 
2011: No. 

Plan basics: Net assets (thousands); 
State Employees’ Retirement System of Illinois; As of June 30, 2010: 
$9,201,831;
Teachers’ Retirement System of the State of Illinois; As of June 30, 
2011: $37,471,267. 

Plan basics: Contributions: Employees; 
State Employees’ Retirement System of Illinois; As of June 30, 2010: 
$246,173;
Teachers’ Retirement System of the State of Illinois; As of June 30, 
2011: $1,095,546[A]. 

Plan basics: (thousands) Employers; 
State Employees’ Retirement System of Illinois; As of June 30, 2010: 
$909,577; 
Teachers’ Retirement System of the State of Illinois; As of June 30, 
2011: $2,326,029[A]. 

Source: GAO analysis of most recent plan CAFRs. 

[A] Includes state appropriations. 

[End of table] 

Benefit reductions: In 2010, the state adopted several benefit changes 
for new members of state plans effective January 1, 2011, including 

* raising the normal retirement age from 62 to 67, 
* reducing COLAs to the lesser of 3 percent or half of the annual 
change in the CPI and made them noncompounding, and, 
* capping salaries used for benefit calculations and for determining 
contributions at $106,800 (indexed to the lesser of 3 percent or 
half of the annual change in the CPI). 

Funding changes: The state issued $3.5 billion of POBs in 2010 and 
$3.7 billion in 2011 to fund the state’s annual contributions to 
various pension systems. Previously, in 2009, the state required its 
pension systems to switch from a market value (no smoothing) to a 5-
year smoothing method for calculating actuarial assets and 
contributions. 

Selected locally-sponsored plan: 

As of September 30, 2010: 

Plan basics: Active members; 
Policemen’s Annuity and Benefit Fund of Chicago: 12,737. 

Plan basics: Beneficiaries; 
Policemen’s Annuity and Benefit Fund of Chicago: 12,380. 

Plan basics: Members covered by Social Security? 
Policemen’s Annuity and Benefit Fund of Chicago: No. 

Plan basics: Net assets (thousands); 
Policemen’s Annuity and Benefit Fund of Chicago: $3,439,669. 

Plan basics: Contributions: Employees; 
Policemen’s Annuity and Benefit Fund of Chicago: $108,402. 

Plan basics: (thousands) Employers; 
Policemen’s Annuity and Benefit Fund of Chicago: $183,835. 

Source: GAO analysis of most recent financial report. 

[End of table] 

Benefit reductions: In 2010, the state also adopted similar benefit 
changes for local government employees, including the members of this 
local policemen’s pension plan—except the normal retirement age for 
policemen was raised from 50 to 55. 

Funding changes: The state enacted legislation in 2010 requiring the 
plan to move to an actuarially based funding method in 2015. 

[End of profile] 

Missouri and the City of Springfield: 

Overview of Missouri state and local retirement systems (2009): 

Number of plans: 66; 
* State plans: 10; 
* Local plans: 56. 

Active members: 265,049; 
* State plans: 229,472; 
* Local plans: 35,577. 

Beneficiaries: 148,249; 
* State plans: 123,832; 
* Local plans: 24,417. 

Percentage of members covered by Social Security: 73%. 

Assets (thousands): $42,604,597; 
* State plans: $36,489,230; 
* Local plans: $6,115,367. 

Contributions (thousands) 
* Employees: $780,248; 
* State government: $486,439; 
* Local government: $1,045,550. 

Source: GAO analysis of most recent Census and Social Security data. 

Note: Census categorizes plans as state or local based on their level 
of administration, not sponsorship. 

Selected state-sponsored plans: 

As of June 30, 2011: 

Plan basics: Active members; 
Missouri State Employees’ Retirement System: 51,660;
Missouri Department of Transportation and Highway Patrol Employees’ 
Retirement System: 8,160. 

Plan basics: Beneficiaries; 
Missouri State Employees’ Retirement System: 35,315;
Missouri Department of Transportation and Highway Patrol Employees’ 
Retirement System: 7,792. 

Plan basics: Members covered by Social Security? 
Missouri State Employees’ Retirement System: Yes;
Missouri Department of Transportation and Highway Patrol Employees’ 
Retirement System: Yes. 

Plan basics: Net assets (thousands); 
Missouri State Employees’ Retirement System: $7,866,917;
Missouri Department of Transportation and Highway Patrol Employees’ 
Retirement System: $1,555,681. 

Plan basics: Contributions: Employees; 
Missouri State Employees’ Retirement System: $660;
Missouri Department of Transportation and Highway Patrol Employees’ 
Retirement System: $291,121. 

Plan basics: (thousands) Employers; 
Missouri State Employees’ Retirement System: $45;
Missouri Department of Transportation and Highway Patrol Employees’ 
Retirement System: $150,022. 

Source: GAO analysis of most recent plan CAFRs. 

[End of table] 

Benefit reductions: In 2010, the state adopted several benefit changes 
for new employees of both these plans, effective January 1, 2011, 
including: 

* raising the normal retirement age from 62 to 67 for most 
employees and. 

* increasing the vesting period from 5 to 10 years. 

Member contributions: The state also adopted changes requiring new 
employees to contribute 4 percent of compensation (current members do 
not contribute). 

Funding changes: The board of the State Employees’ Retirement 
System temporarily adjusted its actuarial smoothing methods from fiscal 
year 2009 to 2011 to reduce the effects of market volatility. 

Selected locally-sponsored plan: 

As of June 30, 2011: 

Plan basics: Active members; 
City of Springfield, Missouri Police Officers’ and Fire Fighters’ 
Retirement Fund: 394. 

Plan basics: Beneficiaries; 
City of Springfield, Missouri Police Officers’ and Fire Fighters’ 
Retirement Fund: 497. 

Plan basics: Members covered by Social Security? 
City of Springfield, Missouri Police Officers’ and Fire Fighters’ 
Retirement Fund: No. 

Plan basics: Net assets (thousands); 
City of Springfield, Missouri Police Officers’ and Fire Fighters’ 
Retirement Fund: $191,168. 

Plan basics: Contributions: Employees; 
City of Springfield, Missouri Police Officers’ and Fire Fighters’ 
Retirement Fund: $2,991. 

Plan basics: (thousands) Employers; 
City of Springfield, Missouri Police Officers’ and Fire Fighters’ 
Retirement Fund: $7,859. 

Source: GAO analysis of most recent financial report. 

[End of table] 

Funding changes: In 2009, the city approved a 0.75-cent sales tax, all 
of which will go toward funding the city’s Police Officers' and Fire 
Fighters' Retirement Fund System. The city subsequently closed this 
plan to new members on January 31, 2010, so police and firefighters 
hired after this date participate in the statewide Local Government 
Employees Retirement System, which is less expensive for the city. 

[End of profile] 

Pennsylvania and the City of Philadelphia: 

Overview of Pennsylvania state and local retirement systems (FY 2009): 

Number of plans: 1,425; 
* State plans: 3; 
* Local plans: 1,422. 

Active members: 519,496; 
* State plans: 392,889; 
* Local plans: 126,607. 

Beneficiaries: 385,355; 
* State plans: 285,831; 
* Local plans: 99,524. 

Percentage of members covered by Social Security: 93%. 

Assets (thousands): $86,418,676; 
* State plans: $68,671,589; 
* Local plans: $17,747,087. 

Contributions (thousands) 
* Employees: $1,560,757; 
* State government: $731,634; 
* Local government: $1,292,358. 

Source: GAO analysis of most recent Census and Social Security data. 

Note: Census categorizes plans as state or local based on their level 
of administration, not sponsorship. 

Selected state-sponsored plans: 

As of December 31, 2010: 

Plan basics: Active members; 
Pennsylvania State Employees’ Retirement System (SERS): 109,255;
Pennsylvania Public School Employees’ Retirement System (PSERS): 
279,152. 

Plan basics: Beneficiaries; 
Pennsylvania State Employees’ Retirement System (SERS): 111,713;
Pennsylvania Public School Employees’ Retirement System (PSERS): 
194,622. 

Plan basics: Members covered by Social Security? 
Pennsylvania State Employees’ Retirement System (SERS): Most (varies 
by plan);
Pennsylvania Public School Employees’ Retirement System (PSERS): Yes. 

Plan basics: Net assets (thousands); 
Pennsylvania State Employees’ Retirement System (SERS): $25,886,102;
Pennsylvania Public School Employees’ Retirement System (PSERS): 
$51,311,252. 

Plan basics: Contributions: Employees; 
Pennsylvania State Employees’ Retirement System (SERS): $349,049;
Pennsylvania Public School Employees’ Retirement System (PSERS): 
$273,083. 

Plan basics: (thousands) Employers; 
Pennsylvania State Employees’ Retirement System (SERS): $1,042,707; 
Pennsylvania Public School Employees’ Retirement System (PSERS): 
$747,753. 

Source: GAO analysis of most recent plan CAFRs. 

[End of table] 

Benefit reductions: In 2010, the state adopted several changes for new 
employees of both these plans, effective January 1, 2011 for SERS and 
July 1, 2011 for PSERS, including 

* lowering the benefit multiplier from 2.5 percent to 2 percent (with 
an option to maintain the 2.5 percent multiplier if the member 
contributes at a higher rate), 
* increasing the vesting period from 5 to 10 years, and, 
* increasing the normal retirement age for general employees from 
60 to 65. 

Funding changes: In 2010, the state also capped increases in employer 
contribution rates to both systems at 3 percent for fiscal year 
2011/2012, 3.5 percent for fiscal year 2012/2013, and 4.5 percent 
thereafter. The state also adjusted the actuarial methods for both 
systems, re-amortizing State Employees’ Retirement System liabilities 
over 30 years and re-amortizing Public School Employees’ Retirement 
System liabilities over 24 years using a different actuarial method. 

Selected locally-sponsored plan: 

As of June 30, 2010: 

Plan basics: Active members; 
City of Philadelphia Municipal Pension Plan: 28,632[A]. 

Plan basics: Beneficiaries; 
City of Philadelphia Municipal Pension Plan: 35,694[A]. 

Plan basics: Members covered by Social Security? 
City of Philadelphia Municipal Pension Plan: Yes (except police and 
fire). 

Plan basics: Net assets (thousands); 
City of Philadelphia Municipal Pension Plan: $3,501,602. 

Plan basics: Contributions: Employees; 
City of Philadelphia Municipal Pension Plan: $51,570. 

Plan basics: (thousands) Employers; 
City of Philadelphia Municipal Pension Plan: $312,556. 

Source: GAO analysis of most recent financial report. 

[A] As of July 1, 2009. 

[End of table] 

Funding changes: The city partially deferred its pension payments in 
fiscal year 2010 and 2011 by $150 and $90 million respectively, but 
must pay these amounts in addition to its future annual required 
amounts by 2014. The city also re-amortized its liabilities over 30 
years. 

[End of profile] 

Utah and the City of Bountiful: 

Overview of Utah state and local retirement systems (FY 2009): 

Number of plans: 7; 
* State plans: 6; 
* Local plans: 1. 

Active members: 108,016; 
* State plans: 106,261; 
* Local plans: 1,755. 

Beneficiaries: 42,390; 
* State plans: 42,138; 
* Local plans: 252. 

Percentage of members covered by Social Security: 92%. 

Assets (thousands): $17,641,058; 
* State plans: $17,568,156; 
* Local plans: $72,902. 

Contributions (thousands) 
* Employees: $36,471; 
* State government: $641,690; 
* Local government: $7,680. 

Source: GAO analysis of most recent Census and Social Security data. 

Note: Census categorizes plans as state or local based on their level 
of administration, not sponsorship. 

Selected state-sponsored plans: 

As of December 31, 2010: 

Plan basics: Active members; 
Utah Retirement Systems: 104,467. 

Plan basics: Beneficiaries; 
Utah Retirement Systems: 46,399. 

Plan basics: Members covered by Social Security? 
Utah Retirement Systems: Most (varies by plan). 

Plan basics: Net assets (thousands); 
Utah Retirement Systems: $19,756,106. 

Plan basics: Contributions: Employees; 
Utah Retirement Systems: $59,652. 

Plan basics: (thousands) Employers; 
Utah Retirement Systems: $682,600. 

Source: GAO analysis of most recent plan CAFRs. 

[End of table] 

Hybrid approach: In 2010, the state adopted a new retirement plan for 
all government employees (except judges) hired on or after July 1, 
2011, providing the option of joining a defined contribution plan or a 
hybrid approach. The employer contribution rate is set at 10 percent of 
compensation for both options (12 percent for public safety employees). 
For the defined contribution option, the employer contributes the full 
10 percent to a 401(k), in addition to any voluntary employee 
contributions. For the hybrid approach, members receive a defined 
benefit based on 1.5 percent of highest average salary multiplied by 
years of service. If the actuarial calculated contribution rate for 
the defined benefit component is less than 10 percent, the employer 
deposits the difference into a 401(k) plan. If the actuarial rate 
exceeds 10 percent, members are required to make any additional 
contributions to the defined benefit component. 

Funding changes: In 2009, the system’s board expanded the 
amortization period for unfunded liabilities from an open 20 year 
period to a closed 25 year period and adjusted the actuarial smoothing 
methods to reduce the effects of market volatility. 

Selected locally-sponsored plan: 

As of December 31, 2010: 

Plan basics: Active members; 
Public Safety Retirement System (Bountiful City): 36. 

Plan basics: Beneficiaries; 
Public Safety Retirement System (Bountiful City): not available. 

Plan basics: Members covered by Social Security? 
Public Safety Retirement System (Bountiful City): Yes. 

Plan basics: Net assets (thousands); 
Public Safety Retirement System (Bountiful City): $14,998. 

Plan basics: Contributions: Employees; 
Public Safety Retirement System (Bountiful City): [Empty]. 

Plan basics: (thousands) Employers; 
Public Safety Retirement System (Bountiful City): $485. 

Source: GAO analysis of most recent financial report. 

[End of table] 

Hybrid approach: The city contributes to several pension plans that are 
administered by the Utah Retirement Systems, including the Public 
Safety Retirement System. The changes adopted by the state’s system, 
described above, apply to local government employees and employers 
as well. Thus, new city employees hired on or after July 1, 2011, have 
the same option of joining a defined contribution or a hybrid approach 
plan, and the city’s required contributions to these plans are 
comparable. 

[End of profile] 

Virginia and the City of Norfolk: 

Overview of Virginia state and local retirement systems (FY 2009): 

Number of plans: 18; 
* State plans: 1; 
* Local plans: 17; 

Active members: 408,196; 
* State plans: 346,929; 
* Local plans: 61,267. 

Beneficiaries: 176,737; 
* State plans: 141,746; 
* Local plans: 34,991. 

Percentage of members covered by Social Security: 94%. 

Assets (thousands): $50,599,215; 
* State plans: $41,975,141; 
* Local plans: $8,624,074. 

Contributions (thousands) 
* Employees: $139,892; 
* State government: $574,911; 
* Local government: $1,813,973. 

Source: GAO analysis of most recent Census and Social Security data. 

Note: Census categorizes plans as state or local based on their level 
of administration, not sponsorship. 

Selected state-sponsored plans: 

As of June 30, 2010: 

Plan basics: Active members; 
Virginia Retirement System: 339,740. 

Plan basics: Beneficiaries; 
Virginia Retirement System: 156,165. 

Plan basics: Members covered by Social Security? 
Virginia Retirement System: Yes. 

Plan basics: Net assets (thousands); 
Virginia Retirement System: $53,151,088. 

Plan basics: Contributions: Employees; 
Virginia Retirement System: $27,623. 

Plan basics: (thousands) Employers; 
Virginia Retirement System: $1,520,403[A]. 

Source: GAO analysis of most recent plan CAFRs. 

[A] Includes member contributions paid by employers 

[End of table] 

Benefit reductions: In 2010, the state adopted several changes for new 
employees hired on or after July 1, 2010, including: 

* increasing the period for calculating final average salary from 3 to 
5 years, 
* raising the normal retirement age for general employees from age 
65 to the normal Social Security retirement age (age 67 for 
people born since 1960), 
* increasing the age and service requirements needed to qualify for 
an unreduced retirement benefit, and, 
* raising early retirement eligibility from age 50 to age 60. 

Member contributions: The state also adopted changes requiring new 
state employees hired on or after July 1, 2010 to contribute 5 percent 
of compensation (current members’ contributions are paid by employers). 
In 2011, the state passed additional changes that as of July 1, 2011 
require all state employees to pay the 5 percent member contribution, 
not just new plan members. 

Selected locally-sponsored plan: 

As of June 30, 2010: 

Plan basics: Active members; 
Employees’ Retirement System of the City of Norfolk: 3,950. 

Plan basics: Beneficiaries; 
Employees’ Retirement System of the City of Norfolk: 3,271. 

Plan basics: Members covered by Social Security? 
Employees’ Retirement System of the City of Norfolk: Yes (except 
public safety). 

Plan basics: Net assets (thousands); 
Employees’ Retirement System of the City of Norfolk: $779,404. 

Plan basics: Contributions: Employees; 
Employees’ Retirement System of the City of Norfolk: [Empty]. 

Plan basics: (thousands) Employers; 
Employees’ Retirement System of the City of Norfolk: $35,515. 

Source: GAO analysis of most recent financial report. 

[End of table] 

Member contributions: In 2010, the city adopted changes requiring new 
city employees hired on or after October 5, 2010, to contribute 5 
percent of compensation (current members do not contribute). 

[End of profile] 

[End of section] 

Appendix II: Actuarial Methods and Assumptions for Measuring Funded 
Status for Public Sector Defined Benefit Plans: 

Assessments of a plan's funded status are complicated by the fact that 
there are different ways to measure plan assets and plan liabilities 
for different purposes, and the methods used can vary from plan to 
plan.[Footnote 59] Plan assets could be valued at either market value 
or at a "smoothed" value; smoothed values are often used with the goal 
of producing a pattern of employer contributions to the plan that does 
not fluctuate as much as the financial markets. Plan liabilities can 
be measured under a variety of different "actuarial cost methods." An 
actuarial cost method is a means of assigning the costs of projected 
future benefits to time periods in advance of those payments. It 
determines what portion of the cost of an active worker's future 
benefits is included in the plan's liability (also sometimes called 
the actuarial accrued liability or the accrued liability) at any point 
in time.[Footnote 60] Plan liabilities also vary with the actuarial 
assumptions used.[Footnote 61] One assumption in particular, the 
discount rate, has been a matter of considerable controversy. 

The Discount Rate Controversy: 

Over the past decade, there has been a growing controversy over how 
the value of a plan's liabilities should be determined, and in 
particular, over what discount rate should be used. The discount rate 
determines some measure of "current value" (or "present value") for 
pension benefits that are not payable until various points in the 
future. The higher the assumed discount rate, the lower the present 
value; conversely, the lower the assumed discount rate, the higher the 
present value. Thus, for example, a pension liability based on a 4 
percent discount rate will be higher than the same liability based on 
an 8 percent discount rate. Because pension obligations extend far 
into the future, the discount rate is applied over a long period of 
time. As a result, the effect of the discount rate on pension 
liability measures can be substantial. 

The discount rate controversy is an argument over two basic approaches 
to setting a plan's discount rate: (1) basing the discount rate on the 
expected long-term return on plan assets (which, in recent years, 
often would produce discount rates between 7 and 8 percent), or (2) 
basing the discount rate on relevant interest rates in the bond market 
(which, in recent years, often would produce discount rates around 4 
percent). The controversy is over which of these two approaches is the 
appropriate one for measuring the present value of the obligations of 
public sector pension plans.[Footnote 62] 

(1) Basing the discount rate on the expected long-term return on plan 
assets. In this approach, the higher expected market returns on risky 
assets such as stocks is incorporated into the discount rate. As such, 
the discount rate varies with the characteristics of the plan's asset 
allocation, so that adopting a riskier investment policy can increase 
the discount rate and thereby lower liabilities and contributions. 

* Those advocating for this approach argue that this rate provides the 
best estimate of the likely cost to finance the plan's pension 
obligation. They say that assuming a discount rate lower than a plan's 
expected rate of return would lead to higher contributions and thus 
overcharge the current generation. 

* Those critical of this approach contend that using the expected rate 
of return takes credit for anticipated returns on risky investments 
before such returns actually occur, and passes on the associated risk 
to future generations. As such, using expected rates of return could 
understate the cost of pension benefits and potentially lead to 
excessive benefit promises. In addition, it may create an incentive to 
adopt riskier investment policies. 

(2) Basing the discount rate on relevant interest rates in the bond 
market. In this approach, pension promises are viewed as "bond-like," 
and so are valued similarly to how the financial markets value fixed 
income instruments of similar duration and credit quality. 

* Those advocating for this approach contend that the value of a 
plan's liability should be based on the characteristics of that 
liability, and not on the characteristics of any assets put aside to 
finance the liability. They say that while financial markets are 
volatile and not necessarily always rational, there is no better, 
objective way to measure the value of a pension promise than how the 
market currently values an obligation with similar characteristics: 

* Those critical of this approach hold that a "market" measure of plan 
promises is not relevant and thus should not be used in an ongoing 
pension plan. They contend that this approach would severely overstate 
pension costs and could lead to distorted funding, investment, and 
benefits policies. 

Changes Currently Being Proposed: 

Both the Governmental Accounting Standards Board (GASB) and the 
Actuarial Standards Board (ASB) have issued exposure drafts proposing 
comprehensive revisions to their standards regarding measuring and 
reporting pension obligations. [Footnote 63] Under current GASB 
accounting standards, the discount rate must be the expected return on 
plan assets. The GASB proposals, if enacted, would set the overall 
discount rate equal to a composite of (1) the expected return on plan 
assets to the extent that the plan is funded or projected to be 
funded, and (2) a high-quality municipal bond rate to the extent that 
some plan benefits are not expected to be funded in advance. In 
practice, this blended discount rate is expected to be close to the 
current basis--that is, the expected return on plan assets--for most 
plans. The GASB proposals would also require the use of a single, 
uniform actuarial cost method; [Footnote 64] and they would use the 
current market value of plan assets, rather than a smoothed value, in 
determining a plan's deficit or surplus, which would be reported on 
the government entity's balance sheet. 

In this report we use the term "hybrid approach" to refer to public 
pension systems that combine defined benefit and defined contribution 
components. In the private sector, a hybrid plan most often refers to 
a cash balance plan, which is legally a defined benefit plan that 
expresses benefits as a hypothetical individual account balance that 
is based on pay credits (percentage of salary or compensation) and 
interest credits. For additional information on private sector cash 
balance plans, see GAO, Private Pensions: Information on Cash Balance 
Pension Plans, GAO-06-42 (Washington, D.C.: Nov. 3, 2005). 

Among other things, the ASB proposals, if enacted, would add 
additional disclosure requirements regarding funded status, including 
a requirement that whenever a funded status is disclosed using a 
smoothed value of assets, the corresponding statistic based on the 
market value of assets would also have to be disclosed; they would 
also require new disclosures regarding the type of liability measure 
used and the rationale for and reasonableness of the underlying 
actuarial assumptions. In addition, they would clarify that either 
approach to the discount rate is acceptable, with appropriate 
disclosure. 

[End of section] 

Appendix III: GAO Contacts and Staff Acknowledgments: 

GAO Contact: 

Barbara D. Bovbjerg, (202) 512-7215 or bovbjergb@gao.gov, or Stanley 
J. Czerwinski, (202) 512-6806 or czerwinskis@gao.gov. 

Staff Acknowledgments: 

In addition to the contacts named above, Margie K. Shields, Assistant 
Director; Thomas James, Assistant Director; William Colvin, Analyst-in-
Charge; Robert Yetvin; and Andrea Yohe made significant contributions 
to this report. Susan Bernstein; James Bennett; Kathy Leslie; Frank 
Todisco; Walter Vance; Roger Thomas; and Sheila McCoy also made 
important contributions. 

[End of section] 

Footnotes: 

[1] This total is based on the U.S. Census Bureau's 2009 Survey of 
State and Local Public-Employee Retirement Systems and includes active 
members, inactive members, and beneficiaries. 

[2] Ronald K. Snell, NCSL, Pensions and Retirement Plan Enactments, 
annual reports for 2008-2010 and 2011 report as of June 30, 2011. For 
additional information about the state legislative changes described 
in this report, refer to the NCSL reports. 

[3] Mergent BondViewer is an online database of bond data. The 
Electronic Municipal Market Access system, maintained by the Municipal 
Securities Rulemaking Board, is an online database of municipal 
disclosures and data on the municipal securities market 

[4] U.S. Census, 2009 Survey of State and Local Public-Employee 
Retirement Systems (Washington, D.C. 2011). 

[5] Throughout this report, the term "fiscal year" refers to state 
fiscal year (as opposed to federal fiscal year). State fiscal years 
vary, but most run from July 1 to June 30, according to the Census 
Bureau. 

[6] U.S. Department of Labor, Bureau of Labor Statistics, National 
Compensation Survey: Employee Benefits in the United States, March 
2011 (Washington, D.C.: 2011). 

[7] As we have previously reported, all states also offer a voluntary, 
supplemental defined contribution option in addition to their primary 
defined benefit plan. See GAO, State and Local Government Retiree 
Benefits: Current Status of Benefit Structures, Protections, and 
Fiscal Outlook for Funding Future Costs, [hyperlink, 
http://www.gao.gov/products/GAO-07-1156] (Washington, D.C.: Sept. 24, 
2007). 

[8] 42 U.S.C. § 410(a)(7). Historically, Social Security did not 
require coverage of government employment. In 1950, Congress enacted 
legislation allowing voluntary coverage to state and local government 
employees not covered by public pension plans, and in 1955, extended 
voluntary coverage to those already covered by plans as well. Social 
Security Act Amendments of 1950, Pub. L. No. 809, § 106, 64 Stat. 477 
(1950), codified at 42 U.S.C. § 218(a) &(d); Social Security 
Amendments of 1956, Pub. L. No. 880, § 211 (e), 70 Stat. 807 (1956), 
codified at 42 U.S.C. § 218(d)(6). 

[9] To further clarify the difference between government and private 
sector pension plans, the Internal Revenue Service issued an advance 
notice of proposed rulemaking in November 2011 relating to the 
definition of the term "governmental plan." The guidance under 
consideration is intended to establish coordinated criteria for 
determining whether a plan is a governmental plan and address current 
uncertainty regarding entities with organizational, regulatory, and 
contractual connections with states or political subdivisions of 
states. Determination of Governmental Plan Status, 76 Fed. Reg. 69,172 
(Nov. 8, 2011), to be codified at 26 C.F.R. § 1.414(d)-1. 

[10] Contributions to qualified pension plans that meet certain 
requirements--whether defined benefit or defined contribution--are 
generally not counted as taxable income to employees when the 
contributions are made. However, when pension benefits are paid, 
amounts not previously taxed are subject to federal and perhaps state 
tax. This also applies to the interest income such contributions 
generate. As an alternative, some state and local qualified pension 
plans provide an option for designated Roth contributions to Roth 
accounts, and such contributions to Roth accounts are made after 
taxation. The interest income earned on such contributions is 
generally not subject to tax upon distribution, provided that the 
requirements and restrictions applicable to such accounts under the 
Internal Revenue Code have been satisfied. 

[11] GAO is conducting work under Section 976 of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, enacted in 2010, to study 
the information that state and local governments provide investors in 
municipal securities, including the advantages and disadvantages of 
providing additional financial information. The report is scheduled 
for issuance in summer 2012. 

[12] Based on Census quarterly data on 100 large retirement systems, 
investment returns have been mostly positive since the second quarter 
of 2009. See Census, Finances of Selected State and Local Government 
Employee Retirement Systems. 

[13] A prefunded plan means a plan has set aside funds for pension 
obligations made for current employees as opposed to pay-as-you go 
plan, which does not set aside funds to pay for future obligations to 
current employees. 

[14] Expenditures include both annual benefit payments and any 
expenses paid out of plan assets. 

[15] However, using nonactuarial figures is a simplification because 
it does not consider the unique demographic profile--especially, the 
relative proportions of retired and active workers in the plan's 
actuarial liability--and related data associated with each plan. 

[16] This trend is consistent with actuarial practices of pension 
plans that have increasing proportions of retirees (that is, maturing 
plans). 

[17] Whether pension funds grow or diminish depends on whether 
positive investment returns and contributions stay ahead of pension 
fund expenditures. 

[18] A study by the Center for Retirement Research at Boston College 
analyzing plan assets relative to benefit payments and projecting 
these figures forward, assuming investment return rates of 6 and 8 
percent respectively, showed that most large plans have enough 
prefunded resources to cover their benefit payments for at least 30 
years, with a few notable exceptions. Plans included in this study 
were chosen from the largest plans from each state as well as a 
judgmental sample of locally administered plans. The study was based 
upon 2009 data that did not reflect investment return gains over 2010 
or recent state and local government efforts to increase employee 
contributions and reduce benefits for new employees, See Alicia H. 
Munnell, Jean-Pierre Aubry, Josh Hurwitz, and Laura Quinby, Can State 
and Local Pensions Muddle Through?(March 2011). Also, just prior to 
the economic crisis, we reported that most state and local government 
pension plans had enough invested resources to keep up with benefits 
they were scheduled to pay for several decades. See GAO, State and 
Local Government Retiree Benefits: Current Funded Status of Pension 
and Health Benefits, [hyperlink, 
http://www.gao.gov/products/GAO-08-223] (Washington, D.C.: Jan. 29, 
2008). There have been other studies projecting the longevity of state 
and local pension plans; notably a study by Joshua Rauh, see Joshua D. 
Rauh, Are State Public Pensions Sustainable? Why the Federal 
Government Should Worry About State Pension Liabilities, (May 15, 
2010). The study projected some notably early fund exhaustion dates, 
including some funds running out of money this decade. However, the 
study was based on the assumption that benefits earned to date would 
only be financed out of current plan assets and not from any future 
contributions. The projected exhaustion dates are thus not realistic 
estimates of when the funds might actually run out of money. 

[19] The funded ratio is calculated by dividing plan actuarial assets 
by plan actuarial liabilities. See appendix II for additional 
information on actuarial methods and measures. 

[20] Current GASB standards include a measure known as the annual 
required contribution, or ARC, which is not necessarily the same 
amount as the contribution actually made by the employer to the plan. 
Conceptually, the ARC is an amount that would cover the employer's 
share of costs attributable to the current year of employee service 
(the "normal cost"), plus an amount to eliminate the plan's unfunded 
liability over an amortization period, all determined in accordance 
with an actuarially sound funding method selected for the plan (of 
which there are multiple choices). The accounting cost--that is, the 
cost for the year recognized in the employer's financial statements--
is based on this ARC. In this sense, the accounting is based on the 
stated funding method selected by the employer. But the employer may 
or may not actually contribute the ARC in any given year, so that the 
accounting cost may differ from the funding cost. See appendix II for 
information on proposed changes to GASB standards. 

[21] Analyzing the aggregate level of large plans minimizes the 
difficulties in making comparisons across plans with actuarially based 
data, since these data include the same group of plans over time. Most 
plans keep their key actuarial methods fairly steady over time, with 
some significant exceptions. For example, any given plan will 
typically use a similar cost method, smoothing, and amortization 
period over time. 

[22] Plans typically perform "experience studies" as one factor to 
guide them in making adjustments to their underlying actuarial 
assumptions such as adjusting expected employee salary levels or 
retiree life expectancies. 

[23] See National Association of State Retirement Administrators, 
Public Fund Survey Summary of Findings for FY2009, (November 2010). 

[24] See Ronald Snell, NCSL, Pensions and Retirement Plan Enactments 
in 2001 State Legislatures (2001). 

[25] Soon after Pennsylvania increased benefits, the state also 
changed its actuarial methods to amortize gains more quickly than 
losses, effectively suppressing the employer contribution rate over 
the subsequent 10-year period, according to plan officials. 

[26] A government sponsor may provide a lower percentage of the ARC 
from one year to the next, yet its contribution, in dollars, may be 
higher than the previous year's amount. This is significant from a 
budgeting perspective because of the year-to-year increase. 

[27] This level had fallen since 2001, when 9 of every 10 large plan 
sponsors were paying at least 90 percent of their ARCs. 

[28] NASBO, Fiscal Survey of States: Spring 2011 (Washington, D.C.: 
2011). In addition, NASBO notes that one of the clearest signs of 
fiscal stress is the need for states to make midyear budget cuts to 
help balance their budgets. Survey responses indicate that 43 states 
made such reductions in fiscal year 2009, and 39 states did so in 
fiscal year 2010. 

[29] As an indication of extreme fiscal stress among local 
governments, a small number have filed for bankruptcy: 4 filed in 
2008, 10 in 2009, 6 in 2010, and 4 as of June 2011. Since 1937, when 
the municipal bankruptcy code was instituted, there have been 624 
filings as of June 30, 2011, according to an expert's analysis of 
municipal bankruptcy filings. See James E. Spiotto, "The Myth and 
Reality of State and Local Governments Debt Financing in the U.S.A. in 
Times of Financial Emergency," (July 25, 2011). Available on the U.S. 
Securities and Exchange Commission website. 

[30] Provisions in state constitutions, statutes, or recognized legal 
protections under common law often protect pensions from being 
eliminated or diminished for current or retired members. In a few rare 
exceptions, some jurisdictions have avoided paying promised benefits. 
This can happen in cases of government bankruptcy or when legislative 
changes to reduce benefits are made retroactively and survive any 
legal challenges. 

[31] GAO, State and Local Governments' Fiscal Outlook: April 2011 
Update, [hyperlink, http://www.gao.gov/products/GAO-11-495SP] 
(Washington, D.C.: Apr. 6, 2011). 

[32] To provide more flexibility in addressing the growing cost of 
government employee' retiree health care, state and local 
jurisdictions have begun to prefund these costs. With prefunding, 
governments can reduce the unfunded liability reported in their 
financial statements, take advantage of the compounding effects of 
investment returns on plan assets, and provide greater benefit 
stability for employees and retirees. In addition, by setting aside 
funds for this purpose in advance, government contributions can be 
reduced when fiscal pressures are great. However, prefunding retiree 
health benefits requires higher contributions in the short term than 
pay-as-you-go financing requires. For further discussion of this 
topic, see GAO, State and Local Government Retiree Health Benefits: 
Liabilities Are Largely Unfunded, but Some Governments Are Taking 
Action, [hyperlink, http://www.gao.gov/products/GAO-10-61], 
(Washington, D.C.: Nov. 30, 2009). 

[33] See appendix I for a summary of the recent pension changes 
implemented in the eight states and eight localities we reviewed. 

[34] This analysis is based on our review of annual NCSL reports for 
the years 2008-2010 and a 2011 report that covered changes adopted by 
June of that year. 

[35] Expanding the time period for calculating final average salaries 
generally reduces pension benefits by averaging in lower employee 
salaries. 

[36] The vesting period is the employees' required years of service 
before they earn the right to future pension benefits. 

[37] Prior to the 2010 legislation, the amount of postretirement COLAs 
depended on when employees joined the system, according to plan 
documents. The COLA amount was 3.5 percent for members who joined on 
or before June 30, 2005, and the lower of 3 percent or the Consumer 
Price Index for Urban Wage Earners and Clerical Workers (CPI-W) for 
members who joined on or after July 1, 2005. The 2010 legislation 
lowered the COLA for all future, current, and retired members. For 
members who joined before January 1, 2007, the COLA was reduced to 2 
percent unless the plan has a negative investment return year, in 
which case the COLA will be the lesser of 2 percent or the CPI-W for 
the next three years. A separate reserve fund was created for members 
who joined on or after January 1, 2007. For these members, the COLA 
will be the lesser of 2 percent or the CPI-W as long as payments do 
not exceed 10 percent of the COLA reserve fund. The legislation also 
allows for the maximum COLA to be increased when the plan's overall 
funded status is at or above 103 percent and lowered if it 
subsequently drops below 90 percent. 

[38] As discussed later, Illinois took the more unusual step of taking 
advance credit for benefit reductions that apply only to new employees. 

[39] GAO, State and Local Government Retiree Benefits: Current Status 
of Benefit Structures, Protections, and Fiscal Outlook for Funding 
Future Costs, [hyperlink, http://www.gao.gov/products/GAO-07-1156] 
(Washington, D.C.: Sept. 24, 2007). 

[40] Employers with higher rates of employee turnover will recognize 
savings from pension benefit reductions sooner than those employers 
with less employee turnover. 

[41] Michigan has operated a defined contribution plan for general 
employees since 1997, but adopted a new hybrid system for public 
school employees in 2010. 

[42] Prior to 2008, three states, Alaska, Indiana, and Oregon, and the 
District of Columbia had already adopted defined contribution or 
hybrid approaches as their primary plans for general public employees. 
Indiana has operated a hybrid system since 1997, but adopted a defined 
contribution option for new employees in 2011. In addition, Nebraska 
maintains a cash balance defined benefit plan as its primary plan. 
Although still providing defined benefit plans as their primary plans 
for general state employees, some states also offer defined 
contribution plans or hybrid approaches as optional alternatives to 
their primary plans. These states include Colorado, Florida, Montana, 
Ohio, South Carolina, and Washington. 

[43] In this report we use the term “hybrid approach” to refer to 
public pension systems that combine defined benefit and defined 
contribution components. In the private sector, a hybrid plan most 
often refers to a cash balance plan, which is legally a defined 
benefit plan that expresses benefits as a hypothetical individual 
account balance that is based on pay credits (percentage of salary or 
compensation) and interest credits. For additional information on 
private sector cash balance plans, see GAO, Private Pensions: 
Information on Cash Balance Pension Plans, [hyperlink, 
http://www.gao.gov/products/GAO-06-42] (Washington, D.C.: Nov. 3, 
2005). 

[44] In a public sector defined benefit plan, the amount of the 
benefit is determined by a formula typically based on the retiree's 
years of service and final average salary. 

[45] Once an employee is vested, both defined contribution and defined 
benefit plans could be regarded as "portable." In the case of a 
defined benefit plan, the departing employee takes with him or her the 
right to a future benefit, wherever he or she goes. However, the 
benefit formulas of defined benefit plans are often weighted toward 
employees that retire after many years of service with a single 
employer, so workers changing jobs may incur future lifetime benefit 
losses. The perception of defined contribution plans as more portable 
reflects the greater liquidity and employee discretion over the 
management of these benefits, such as the ability to cash them out 
upon leaving employment, or to roll them over into another plan or an 
individual retirement account. For additional information, see GAO, 
Private Pensions: Alternative Approaches Could Address Retirement 
Risks Faced by Workers but Pose Trade-offs, [hyperlink, 
http://www.gao.gov/products/GAO-09-642] (Washington D.C.: July 24, 
2009). 

[46] A 401(k) plan is a type of defined contribution plan that permits 
employees to defer a portion of their pay to a qualified tax-deferred 
plan. State and local government defined contribution plans are 
typically 457(b) plans. The Tax Reform Act of 1986 prohibited state 
and local governments from establishing any new 401(k) plans after May 
6, 1986, but existing plans were allowed to continue. Pub. L. No. 99-
514, § 1116(b)(3), 100 Stat. 2085, 2455. 

[47] State and local plan sponsors can also address their pension 
finance challenges by adjusting their investment policy, particularly 
plan asset allocation, which is the third key mechanism, besides 
benefit policy and funding policy, that plan sponsors have in 
attempting to manage the amount, riskiness, and sustainability of 
their pension costs. A less risky asset allocation can raise estimated 
costs but also make them less volatile; a more risky allocation can 
lower estimated costs but at the price of greater risk. We have 
previously reported that state and local plans have gradually changed 
their asset portfolios over many years by increasing their allocations 
in higher- risk investments partly in pursuit of higher returns. See 
GAO, State and Local Government Pension Plans: Governance Practices 
and Long-Term Investment Strategies Have Evolved Gradually as Plans 
Take On Increased Investment Risk, [hyperlink, 
http://www.gao.gov/products/GAO-10-754], (Washington, D.C.: Aug. 24, 
2010). 

[48] Since implementation of actuarial changes sometimes does not 
require a legislative change, use of such strategies is not reflected 
in the NCSL annual reports of state legislative changes. As a result, 
our analysis of such changes is based on reviews of our selected 
states and localities rather than NCSL reports. 

[49] In the states we reviewed, actuarial changes were implemented 
either by state legislation or by the pension plan boards. 

[50] Other actuarial changes, such as reducing the assumed rate of 
investment returns, can increase actuarially required pension 
contributions. 

[51] Utah moved from an open 20-year amortization period (meaning that 
the amortization was frozen at 20 years) to a closed 25-year 
amortization period ( meaning that the amortization period will 
decrease annually by one year). As a result, Utah is currently at a 23-
year amortization period, and the period will continue to decrease 
annually unless its board takes action to change the amortization 
policy. 

[52] Philadelphia was not the only locality we reviewed that used a 
temporary tax increase to cover pension contributions. In 2009, 
Springfield, Missouri approved a 0.75 cent sales tax, all of which 
will go toward funding the city's Police Officers' and Firefighters' 
Retirement Fund. 

[53] Issuing POBs can be a leveraging strategy, since funds are 
borrowed at a fixed interest rate and then invested in the stock 
market in an attempt to achieve a higher rate of return (arbitrage). 

[54] Center for State and Local Government Excellence, Issue Brief: 
Pension Obligation Bonds: Financial Crisis Exposes Risks (Washington, 
D.C., January 2010). 

[55] The provisions of Pennsylvania's pension reform legislation (Act 
2010-120), enacted in November 2010, are summarized in Commonwealth of 
Pennsylvania State Employees' Retirement System, Comprehensive Annual 
Financial Report for the year ended December 31, 2010 (Harrisburg, PA: 
May 2011). The report describes the act's provisions for reducing 
benefits for future plan members and for changing funding methods, and 
notes that the act also prohibits the use of pension obligation bonds 
for funding liabilities. 24 Pa. C.S.A. § 8308 (2010). 

[56] The county pension system subsequently lowered its assumed rate 
of return to 7.75 percent. This action, along with any future 
actuarial changes, would affect the expected savings from the POBs. 

[57] The expanded vesting requirement, from 5 years to 10, would mean 
that more employees would leave service with no benefit at all, except 
for a return of member contributions. In the private sector, 5-year 
vesting has been the standard for defined benefit plans since 1986. 

[58] According to plan officials, capping salaries used for benefit 
calculations and for determining contributions decreases the 
anticipated amount of future payroll and employee contributions, which 
affects future state contributions. 

[59] Funded status is a comparison of plan assets to plan liabilities. 
One measure of funded status is the "funded ratio," which is 
calculated by dividing plan assets by plan liabilities. Another 
measure of funded status is the difference between plan assets and 
plan liabilities, that is, the dollar amount of surplus or deficit. 
For example, if assets are greater than liabilities, the funded ratio 
is greater than 100 percent and the plan has a surplus (overfunding) 
equal to the excess of assets over liabilities; if liabilities are 
greater than assets, the funded ratio is less than 100 percent and the 
plan has a deficit (underfunding, or unfunded liability) equal to the 
excess of liabilities over assets. 

[60] As examples, three such cost methods, as they would apply to 
common final-average-salary benefit formulas, are 1. "unit credit"--
The accrued liability is based on the worker's service to date and 
current average salary--2. "projected unit credit"--The accrued 
liability is based on the worker's service to date and projected 
average salary at retirement--3. "entry age normal"--The worker's 
service and salary are both projected to retirement to estimate a 
projected benefit. The cost of this benefit is allocated over the 
worker's entire service (both past and projected future) as a level 
percentage of his or her salary. The accrued liability is the value of 
these allocated costs accumulated up to the point of the worker's 
service to date. 

[61] Actuarial assumptions are needed to project the amount, 
likelihood, and timing of future benefits and to determine their 
present value, and include both economic and demographic assumptions. 
Economic assumptions typically include those for inflation, future 
salary increases, and the discount rate. Demographic assumptions 
typically include those for the likelihood of termination of 
employment, age of retirement, form of benefit elected, and longevity. 

[62] For some, the appropriate choice of discount rate will depend on 
the purpose for which the resulting liability measure will be used. 
For example, some would argue that an expected return on plan assets 
is the appropriate discount rate for funding purposes, while a bond-
like interest rate is the appropriate discount rate for accounting 
purposes. Others might argue for one or the other for both purposes. 

[63] GASB exposure draft of revisions to Statement 27 issued June 
2011; ASB exposure drafts of revisions to ASOP 4 and to ASOP 27 issued 
January 2012. 

[64] The uniform actuarial cost method would be the "entry age normal" 
method, which is the method already used by most public sector plans. 
See prior footnote for a further description of actuarial cost methods. 

[End of section] 

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