State and Local Government Pension Plans: Current Structure and  
Funded Status (10-JUL-08, GAO-08-983T). 			 
                                                                 
Millions of state and local government employees are promised	 
pension benefits when they retire. Although these benefits are	 
not subject, for the most part, to federal laws governing private
sector benefits, there is a federal interest in ensuring that all
American have a secure retirement, as reflected in the special	 
tax treatment provided for private and public pension funds.	 
Recently, new accounting standards have called for the reporting 
of liabilities for future retiree health benefits. It is unclear 
what actions state and local governments may take once the extent
of these liabilities become clear but such anticipated fiscal and
economic challenges have raised questions about the unfunded	 
liabilities for state and local retiree benefits, including	 
pension benefits. GAO was asked to report on (1) the current	 
structure of state and local government pension plans and how	 
pension benefits are protected and managed, and (2) the current  
funded status of state and local government pension plans. GAO	 
spoke to a wide range of public experts and officials from	 
various federal and nongovernmental entities, made several site  
visits and gathered detailed information about state benefits,	 
and analyzed self-reported data on the funded status of state and
local pension plans from the Public Fund Survey and Public	 
Pension Coordinating Council.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-983T					        
    ACCNO:   A82783						        
  TITLE:     State and Local Government Pension Plans: Current	      
Structure and Funded Status					 
     DATE:   07/10/2008 
  SUBJECT:   Accountability					 
	     Accounting standards				 
	     Contingent liabilities				 
	     Cost analysis					 
	     Employee medical benefits				 
	     Employee retirement plans				 
	     Federal employee retirement programs		 
	     Federal/state relations				 
	     Funds management					 
	     Government retirement benefits			 
	     Health care cost control				 
	     Health care costs					 
	     Health care planning				 
	     Health care programs				 
	     Health care reform 				 
	     Local governments					 
	     Pension plan cost control				 
	     Pensions						 
	     Program management 				 
	     Reporting requirements				 
	     Retirees						 
	     Retirement 					 
	     Retirement benefits				 
	     Retirement income					 
	     State employees					 
	     State governments					 
	     State taxes					 
	     Statistical data					 
	     Strategic planning 				 

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GAO-08-983T

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Testimony: 

Before the Joint Economic Committee: 

United States Government Accountability Office: 
GAO: 

For Release on Delivery: 
Expected at 10:00 a.m. EST:
Thursday, July 10, 2008: 

State And Local Government Pension Plans: 

Current Structure and Funded Status: 

Statement of Barbara D. Bovbjerg, Director: 
Education, Workforce, and Income Security: 

GAO-08-983T: 

GAO Highlights: 

Highlights of GAO-08-983T, a testimony before the Joint Economic 
Committee. 

Why GAO Did This Study: 

Millions of state and local government employees are promised pension 
benefits when they retire. Although these benefits are not subject, for 
the most part, to federal laws governing private sector benefits, there 
is a federal interest in ensuring that all American have a secure 
retirement, as reflected in the special tax treatment provided for 
private and public pension funds. Recently, new accounting standards 
have called for the reporting of liabilities for future retiree health 
benefits. It is unclear what actions state and local governments may 
take once the extent of these liabilities become clear but such 
anticipated fiscal and economic challenges have raised questions about 
the unfunded liabilities for state and local retiree benefits, 
including pension benefits. GAO was asked to report on (1) the current 
structure of state and local government pension plans and how pension 
benefits are protected and managed, and (2) the current funded status 
of state and local government pension plans. GAO spoke to a wide range 
of public experts and officials from various federal and 
nongovernmental entities, made several site visits and gathered 
detailed information about state benefits, and analyzed self-reported 
data on the funded status of state and local pension plans from the 
Public Fund Survey and Public Pension Coordinating Council. 

What GAO Found: 

State and local entities typically provide pension plans with defined 
benefits and a supplemental defined contribution plan for voluntary 
savings. Most states still have traditional defined benefit plans as 
the primary retirement plans for their workers. However, a couple of 
states have adopted defined contribution and other plans as their 
primary plan. State and local entities typically offer tax-deferred 
supplemental voluntary plans to encourage workers to save. State 
statutes and local ordinances protect and manage pension benefit and 
often include explicit protections, such as provisions stating that 
pensions promised to public employees cannot be eliminated or 
diminished. In addition, state constitutions and/or statutes often 
require pension plans to be managed as trust funds and overseen by 
boards of trustees. 

Most state and local government pension plans have enough invested 
resources set aside to fund the benefits they are scheduled to pay over 
the next several decades. Many experts consider a funded ratio 
(actuarial value of assets divided by actuarial accrued liabilities) of 
about 80 percent or better to be sound for government pensions. We 
found that 58 percent of 65 large pension plans were funded to that 
level in 2006, a decrease since 2000 when about 90 percent of plans 
were so funded. Low funded ratios would eventually require the 
government employer to improve funding, for example, by reducing 
benefits or by increasing contributions. However, pension benefits are 
generally not at risk in the near term because current assets and new 
contributions may be sufficient to pay benefits for several years. 
Still, many governments have often contributed less than the amount 
needed to improve or maintain funded ratios. Low contributions raise 
concerns about the future funded status. 

Figure: Percentage of State and Local Government Pension Plans with 
Funded Ratios above or below 80 Percent: 

[See PDF for image] 

This figure is a stacked vertical bar graph depicting the following 
data: 

Fiscal year: 
Funded ratio 80 percent or more: 
Funded ratio less than 80 percent: 

Source: GAO analysis of PFS, PENDAT data. 

[End of figure] 

What GAO Recommends: 

GAO is not making recommendations at this time. 

To view the full product, including the scope and methodology, click on 
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-983T]. For more 
information, contact Barbara Bovbjerg at (202) 512-7215 or 
[email protected]. 

[End of section] 

Mr. Chairman and Members of the Committee: 

I am pleased to be here today as you consider the current structure and 
funded status of state and local government pension plans. Nearly 20 
million employees and 7 million retirees and dependents of state and 
local governments--including school teachers, police, firefighters, and 
other public servants--are promised pensions. Although state and local 
pension plans are not subject, for the most part, to federal laws 
governing private sector pension plans, there is a federal interest in 
ensuring that all Americans have a secure retirement, an interest that 
is reflected in preferential tax treatment for contributions and 
investment earnings associated with qualified pension plans in both the 
public and private sectors. 

Many pension benefits represent actuarial accrued liabilities[Footnote 
1] for state and local governments and ultimately the taxpayer. 
Typically, pension benefits are paid from a fund made up of assets from 
employers' and employees' annual contributions and the investment 
earnings from these contributions. Such a fund has an unfunded 
liability when the actuarial value of assets is less than actuarial 
accrued liabilities. Accounting standards have called for state and 
local governments to report their unfunded pension liabilities since 
1986. Recently, new government accounting standards were issued, 
calling for the reporting of liabilities for future retiree health 
liabilities. The extent of these liabilities nationwide is not yet 
known, but some predict they will be very large, exceeding $1 trillion 
dollars nationwide in present value terms. It is unclear what actions 
state and local governments may take once the future costs of these 
liabilities become clear but such anticipated fiscal and economic 
challenges have raised questions about the unfunded liabilities for 
state and local retiree benefits, including pension plans. 

My comments today are based on findings from our September 2007 report 
entitled State and Local Government Retiree Benefits: Current Status of 
Benefit Structures, Protections, and Fiscal Outlook for Funding Future 
Costs[Footnote 2] and our January 2008 report entitled State and Local 
Government Retiree Benefits: Current Funded Status of Pension and 
Health Benefits.[Footnote 3] My remarks focus on (1) the current 
structure of state and local government pension plans and how pension 
benefits are protected and managed, and (2) the current funded status 
of state and local government pension plans. 

To determine the structure of state and local pension benefits and 
protections, we spoke with experts, advocacy groups, and union 
officials from various national organizations and associations, various 
federal agencies, and nongovernmental entities that analyze government 
data and conduct surveys on these topics. We also conducted site visits 
and gathered detailed information about the benefits provided in three 
states, California, Michigan, and Oregon. To illustrate a wide range of 
retiree benefit system characteristics, in some instances we 
complemented information gathered during our site visits with 
information gathered about retiree benefits provided in other state and 
local jurisdictions. To determine the current funded status of state 
and local government pension plans, we analyzed self-reported data from 
the Public Fund Survey (PFS) as well as surveys by the Public Pension 
Coordinating Council (PPCC).[Footnote 4] We conducted our performance 
audits from July 2006 to January 2008 in accordance with generally 
accepted government auditing standards, which included an assessment of 
data reliability. 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 on our audit objectives. 

In summary, we found that state and local entities typically provide a 
pension plan with defined benefits and a supplemental defined 
contribution plan for voluntary savings. As of 2007, most states still 
have traditional defined benefit plans as the primary retirement plans 
for their workers. Only two states (Alaska and Michigan) and the 
District of Columbia had adopted defined contribution plans as their 
primary plans for general public employees. Two other states (Indiana 
and Oregon) had adopted primary plans with both defined benefit and 
defined contribution components, while one state (Nebraska) had adopted 
a cash balance defined benefit plan as its primary plan. State statutes 
and local ordinances typically protect pension plan benefits, often 
including explicit protections such as provisions stating that pensions 
promised to public employees cannot be eliminated or diminished. State 
constitutions and/or statutes often require pension plans to be managed 
as trust funds and overseen by boards of trustees, which typically 
establish overall policies for the operation and management of the 
pension plans, including adopting actuarial assumptions for calculating 
liabilities, establishing procedures for financial control and 
reporting, and setting investment strategies. We also found that more 
than half of public pension plans reported that they have put enough 
assets aside in advance to pay for benefits over the next several 
decades. Although many experts consider a funded ratio of about 80 
percent or better to be sound for government pensions, the percentage 
of pension plans with funded ratios below 80 percent has increased in 
recent years. Available data show that 58 percent of 65 large pension 
plans were funded to that level in 2006, a decrease since 2000 when 
about 90 percent of plans were so funded. A few plans are persistently 
and significantly underfunded, and although members of these plans may 
not be at risk of losing benefits in the near term, the unfunded 
liabilities will have to be made up in the future. Finally, a number of 
governments reported not contributing enough to reduce unfunded 
liabilities. Low contributions raise concerns about the future funded 
status, and may shift costs to future generations. 

Background: 

Pension plans can generally be characterized as either defined benefit 
or defined contribution plans. In a defined benefit plan, the amount of 
the benefit payment is determined by a formula typically based on the 
retiree's years of service and final average salary, and is most often 
provided as a lifetime annuity. For state and local government 
retirees, postretirement cost-of-living adjustments (COLAs) are 
frequently provided in defined benefit plans. But benefit payments are 
generally reduced for early retirement, and in some cases payments may 
be offset for receipt of Social Security.[Footnote 5] In a defined 
contribution plan, 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. The employee assumes the investment risk; the account balance at 
the time of retirement is the total amount of funds available, and 
unlike with defined benefit plans, there are generally no COLAs. Until 
depleted, however, a defined contribution account balance may continue 
to earn investment returns after retirement, and a retiree could use 
the balance to purchase an inflation-protected annuity. Also, defined 
contribution plans are more portable than defined benefit plans, as 
employees own their accounts individually and can generally take their 
balances with them when they leave government employment. There are no 
reductions based on early retirement or for participation in Social 
Security.[Footnote 6] 

Both government employers and employees generally make contributions to 
fund state and local pension benefits. For plans in which employees are 
covered by Social Security, the median contribution rate in fiscal year 
2006 was 8.5 percent of payroll for employers and 5 percent of pay for 
employees, in addition to 6.2 percent of payroll from both employers 
and employees to Social Security. For plans in which employees are not 
covered by Social Security, the median contribution rate was 11.5 
percent of payroll for employers and 8 percent of pay for employees. 
Actuaries estimate the amount that will be needed to pay future 
benefits. The benefits that are attributable to past service are called 
"actuarial accrued liabilities." (In this report, the actuarial accrued 
liabilities are referred to as "liabilities." Actuaries calculate 
liabilities based on an actuarial cost method and a number of 
assumptions including discount rates and worker and retiree mortality. 
Actuaries also estimate the "actuarial value of assets" that fund a 
plan. (In this report, the actuarial value of assets is referred to 
simply as "assets"). The excess of actuarial accrued liabilities over 
the actuarial value of assets is referred to as the "unfunded actuarial 
accrued liability" or "unfunded liability." Under accounting standards, 
such information is disclosed in financial statements. In contrast, the 
liability that is recognized on the balance sheet is the cumulative 
excess of annual benefit costs over contributions to the plan. Certain 
amounts included in the actuarial accrued liability are not yet 
recognized as annual benefit costs under accounting standards, as they 
are amortized over several years. 

State and local government pension plans are not covered by most of the 
substantive requirements, or the insurance program operated by the 
Pension Benefit Guaranty Corporation (PBGC), under the Employee 
Retirement Income Security Act of 1974 (ERISA), which apply to most 
private employer benefit plans. Federal law generally does not require 
state and local governments to prefund or report on the funded status 
of pension plans. However, in order to receive preferential tax 
treatment, state and local pensions must comply with requirements of 
the Internal Revenue Code. In addition, the retirement income security 
of Americans is an ongoing concern of the federal government. 

Although ERISA imposes participation, vesting, and other requirements 
directly upon employee pension plans offered by private sector 
employers, governmental plans such as those provided by state and local 
governments to their employees are excepted from these requirements. In 
addition, ERISA established an insurance program for defined benefit 
plans under which promised benefits are paid (up to a statutorily set 
amount) if an employer cannot pay them--but this too does not apply to 
governmental plans. However, for participants in governmental pension 
plans to receive preferential tax treatment (that is, for plan 
contributions and investment earnings to be tax-deferred), plans must 
be deemed "qualified" by the Internal Revenue Service.[Footnote 7] 

Since the 1980s, the Governmental Accounting Standards Board (GASB) has 
maintained standards for accounting and financial reporting for state 
and local governments. GASB operates independently and has no authority 
to enforce the use of its standards. Still, many state laws require 
local governments to follow GASB standards, and bond raters do consider 
whether GASB standards are followed. Also, to receive a "clean" audit 
opinion under generally accepted accounting principles, state and local 
governments are required to follow GASB standards. These standards 
require disclosing financial information on pensions, such as the 
amount of contributions and the ratio of assets to liabilities. 

Three measures are key to understanding pension plans' funded status: 
contributions, funded ratios, and unfunded liabilities. According to 
experts we interviewed, any single measure at a point in time may give 
a dimension of a plan's funded status, but it does not give a complete 
picture. Instead, the measures should be reviewed collectively over 
time to understand how the funded status is improving or worsening. For 
example, a strong funded status means that, over time, the amount of 
assets, along with future schedule contributions, comes close to 
matching a plan's liabilities.[Footnote 8] 

Under GASB reporting standards, the funded status of different pension 
plans cannot be compared easily because governments use different 
actuarial approaches such as different actuarial cost methods, 
assumptions, amortization periods, and "smoothing" mechanisms. Most 
public pension plans use one of three "actuarial cost methods," out of 
the six GASB approves.[Footnote 9] Actuarial costs methods differ in 
several ways. First, each uses a different approach to calculate the 
"normal cost," the portion of future benefits that the cost method 
allocates to a specific year, resulting in different funding patterns 
for each.[Footnote 10] In addition to the cost methods, differences in 
assumptions used to calculate the funded status can result in 
significant differences among plans that make comparison difficult. 
Also differences in amortization periods make it difficult to compare 
the funded status of different plans. Finally, actuaries for many plans 
calculate the value of current assets based on an average value of past 
years. As a result, if the value of assets fluctuates significantly 
from year to year, the "smoothed" value of assets changes less 
dramatically. Comparing the funded status of plans that use different 
smoothing periods can be confusing because the value of the different 
plans' assets reflects a different number of years.[Footnote 11] 

We reported recently that state and local governments will likely face 
daunting fiscal challenges, driven in large part by the growth in 
health-related costs, such as Medicaid and health insurance for state 
and local employees. Our report was based on simulations for the state 
and local government sector that indicated that in the absence of 
policy changes, large and growing fiscal challenges will likely emerge 
within a decade.[Footnote 12] We found that, as is true for the federal 
sector, the growth in health-related costs is a primary driver of these 
fiscal challenges. 

State And Local Government Pension Plans Typically Include A Defined 
Benefit Plan And A Supplemental Voluntary Savings Plan And Laws Protect 
Benefits: 

State and local governments typically provide their employees with 
retirement benefits that include a defined benefit plan and a 
supplemental defined contribution plan for voluntary savings. However, 
the way each of these components is structured and the level of 
benefits provided varies widely--both across states, and within states 
based on such things as date of hire, employee occupation, and local 
jurisdiction. Statutes and local ordinances protect and manage pension 
plans and are often anchored by provisions in state constitutions and 
local charters. State and local law also typically requires that 
pensions be managed as trust funds and overseen by boards. 

Defined Benefit Plans Provide the Core Benefits for Most Retirees: 

Most state and local government workers are provided traditional 
pension plans with defined benefits. About 90 percent of full-time 
state and local employees participated in defined benefit plans as of 
1998.[Footnote 13] In fiscal year 2006, state and local government 
pension systems covered 18.4 million members and made periodic payments 
to 7.3 million beneficiaries, paying out $151.7 billion in benefits. 
State and local government employees are generally required to 
contribute a percentage of their salaries to their defined benefit 
plans, unlike private sector employees, who generally make no 
contribution when they participate in defined benefit plans. According 
to a 50-state survey conducted by Workplace Economics, Inc., 43 of 48 
states with defined benefit plans reported that general state employees 
were required to make contributions ranging from 1.25 to 10.5 percent 
of their salaries. Nevertheless, these contributions have no influence 
on the amount of benefits paid because benefits are based solely on the 
formula. 

In 1998, all states had defined benefit plans as their primary pension 
plans for their general state workers except for Michigan and Nebraska 
(and the District of Columbia), which had defined contribution plans as 
their primary plans, and Indiana, which combined both defined benefit 
and defined contribution components in its primary plan.[Footnote 14] 
Almost a decade later, we found that as of 2007, only one additional 
state (Alaska) had adopted a defined contribution plan as its primary 
plan; one additional state (Oregon) had adopted a combined plan, and 
Nebraska had replaced its defined contribution plan with a cash balance 
defined benefit plan. (See fig. 1.) Although still providing defined 
benefit plans as their primary plans for general state employees, some 
states also offer defined contribution plans (or hybrid defined 
benefit/defined contribution plans) as optional alternatives to their 
primary plans. These states include Colorado, Florida, Montana, Ohio, 
South Carolina, and Washington. 

Figure 1: Types of Pension Plans in Place for Newly Hired General State 
Employees, as of 2007: 

[See PDF for image] 

This figure is a map of the United States depicting the types of 
pension plans in place for newly hired general state employees, as of 
2007 in the following four categories: 

Traditional defined benefit: 
Alabama; 
Arizona; 
Arkansas; 
California; 
Colorado; 
Connecticut; 
Delaware; 
District of Columbia; 
Florida; 
Georgia; 
Hawaii; 
Idaho; 
Illinois; 
Iowa; 
Kansas; 
Kentucky; 
Louisiana; 
Maine; 
Maryland; 
Massachusetts; 
Minnesota; 
Mississippi; 
Missouri; 
Montana; 
Nevada; 
New Hampshire; 
New Jersey; 
New Mexico; 
New York; 
North Carolina; 
North Dakota; 
Ohio; 
Oklahoma; 
Pennsylvania; 
Rhode Island; 
South Carolina; 
South Dakota; 
Tennessee; 
Texas; 
Utah; 
Vermont; 
Virginia; 
Washington; 
West Virginia; 
Wisconsin; 
Wyoming. 

Cash balance defined benefit: 
Nebraska. 

Combined (with both definite benefit and defined contribution 
components): 
Indiana; 
Oregon. 

Defined contribution: 
Alaska; 
Michigan. 

Note: Plans depicted are those in which newly hired general state 
employees in each state are required to participate as their primary 
pension plan. In some states, employees may opt to participate in 
alternative or supplementary defined contribution plans, but 
participation in these plans is not mandatory. 

[End of figure] 

In states that have adopted defined contribution plans as their primary 
plans, most employees continue to participate in defined benefit plans 
because employees are allowed to continue their participation in their 
previous plans (which is rare in the private sector).[Footnote 15] 
Thus, in contrast to the private sector, which has moved increasingly 
away from defined benefit plans over the past several decades, the 
overwhelming majority of states continue to provide defined benefit 
plans for their general state employees. 

Most states have multiple pension plans providing benefits to different 
groups of state and local government workers based on occupation (such 
as police officer or teacher) and/or local jurisdiction. According to 
the most recent Census data available, in fiscal year 2004-2005 there 
were a total of 2,656 state and local government pension plans. We 
found that defined benefit plans were still prevalent for most of these 
other state and local employees as well. For example, a nationwide 
study conducted by the National Education Association in 2006 found 
that of 99 large pension plans serving teachers and other school 
employees, 79 were defined benefit plans, 3 were defined contribution 
plans, and the remainder offered a range of alternative, optional, or 
combined plan designs with both defined benefit and defined 
contribution features. 

In addition to primary pension plans (whether defined benefit or 
defined contribution), data we gathered from various national 
organizations show that each of the 50 states has also established a 
defined contribution plan as a supplementary, voluntary option for tax- 
deferred retirement savings for their general state employees. Such 
plans appear to be common among other employee groups as well.[Footnote 
16] These supplementary defined contribution plans are typically 
voluntary deferred compensation plans under section 457(b) of the 
federal tax code.[Footnote 17] 

While these defined contribution plans are fairly universally 
available, state and local worker participation in the plans has been 
modest. In a 2006 nationwide survey conducted by the National 
Association of Government Defined Contribution Administrators, the 
average participation rate for all defined contribution plans was 21.6 
percent. 

One reason cited for low participation rates in these supplementary 
plans is that, unlike in the private sector, it has been relatively 
rare for employers to match workers' contributions to these plans, but 
the number of states offering a match has been increasing. According to 
a state employee benefit survey of all 50 states conducted by Workplace 
Economics, Inc., in 2006 12 states matched the employee's contribution 
up to a specified percent or dollar amount.[Footnote 18] Among our site 
visit states, none made contributions to the supplementary savings 
plans for their general state employees, and employee participation 
rates generally ranged between 20 to 50 percent. In San Francisco, 
however, despite the lack of an employer match, 75 percent of employees 
had established 457(b) accounts. The executive director of the city's 
retirement system attributed this success to several factors, including 
(1) that the plan had been in place for over 25 years, (2) that the 
plan offers good investment options for employees to choose from, and 
(3) that plan administrators have a strong outreach program. In the 
private sector, a growing number of employers are attempting to 
increase participation rates and retirement savings in defined 
contribution plans by automatically enrolling workers and offering new 
types of investment funds.[Footnote 19] 

Laws Protecting Pensions Are often Anchored in State Constitutions and 
Local Charters: 

State and local laws generally provide the most direct source of any 
specific legal protections for the pensions of state and local workers. 
Provisions in state constitutions often protect pensions from being 
eliminated or diminished. In addition, constitutional provisions often 
specify how pension funds are to be managed, such as by mandating 
certain funding requirements and/or requiring that the funds be 
overseen by boards of trustees.[Footnote 20] Moreover, we found that at 
the sites we visited, locally administered plans were generally 
governed by local laws. However, state employees, as well as the vast 
majority of local employees, are covered by state-administered plans. 

Protections for pensions in state constitutions are the strongest form 
of legal protection states can provide because constitutions--which set 
out the system of fundamental laws for the governance of each state-- 
preempt state statutes and are difficult to change. Furthermore, 
changing a state constitution usually requires broad public support. 
For example, often a supermajority (such as three-fifths) of a state's 
legislature may need to first approve proposed constitutional changes 
and typically if a change passes the legislature, voters must also 
approve it. 

The majority of states have some form of constitutional protection for 
their pensions. According to AARP data compiled in 2000, 31 states have 
a total of 93 constitutional provisions explicitly protecting pensions. 
[Footnote 21] (The other 19 states all have pension protections in 
their statutes or recognize legal protections under common law.) These 
constitutional pension provisions prescribe some combination of how 
pension trusts are to be funded, protected, managed, or governed. (See 
table 1.) 

Table 1: Constitutional Protections for Pension Benefits: 

Constitutional provisions requiring: Certain standards are to be in 
place for how the retirement system should be funded; 
States: Arizona, Florida, Georgia, Louisiana, Maine, Michigan, 
Mississippi, Montana, New Hampshire, New Mexico, North Dakota, South 
Carolina, Texas, and Virginia; 
Number of states: 14. 

Constitutional provisions requiring: Assets in a trust fund are to be 
for the exclusive purpose of the retirement system; 
States: Alabama, Arizona, California, Louisiana, Maine, Mississippi, 
Montana, New Hampshire, New Mexico, North Carolina, Oklahoma, Texas, 
Virginia, and Wyoming; 
Number of states: 14. 

Constitutional provisions requiring: Trust fund assets are not to be 
diverted for nonretirement uses; 
States: Alabama, Louisiana, Maine, Mississippi, Montana, Nevada, New 
Hampshire, New Mexico, North Carolina, Oklahoma, South Carolina, Texas, 
and Virginia; 
Number of states: 13. 

Constitutional provisions requiring: Retirement system boards of 
trustees are to be off limits to the legislature; 
States: California, Montana, Nevada, New Mexico, and Texas; 
Number of states: 5. 

Constitutional provisions requiring: Participants in a retirement 
system have a guaranteed right to a benefit, and that accrued financial 
benefits cannot be eliminated or diminished; 
States: Alaska, Arizona, Hawaii, Illinois, Louisiana, Michigan, 
Missouri, New Mexico, and New York; 
Number of states: 9. 

Constitutional provisions requiring: States have investment authority 
for their retirement systems; 
States: Indiana, Michigan, Montana, Nebraska, South Carolina, 
Washington, and West Virginia; 
Number of states: 7. 

Constitutional provisions requiring: Retirement system money is to be 
held in a separate trust fund; 
States: Arizona, California, Nevada, New Mexico, and Virginia; 
Number of states: 5. 

Constitutional provisions requiring: Retirement benefits may be 
increased; 
States: Georgia, Nebraska, Pennsylvania, Washington, and Wisconsin; 
Number of states: 5. 

Constitutional provisions requiring: A retirement system is required; 
States: Louisiana, Texas, and Virginia; 
Number of states: 3. 

Constitutional provisions requiring: The payment of retirement benefits 
is authorized; 
States: Georgia and Oklahoma; 
Number of states: 2. 

Constitutional provisions requiring: Other protections are in place, 
such as prohibiting constitutional changes to the retirement system 
through the initiative process; 
States: Mississippi, Missouri, Nebraska, and Nevada; 
Number of states: 4. 

Source: AARP, 2000. 

[End of table] 

Pensions Benefits, Once Accrued, Are Generally Protected: 

In nine states, constitutional provisions take the form of a specific 
guarantee of the right to a benefit. In two of the states we visited, 
the state constitution provided protection for pension benefits. In 
California, for example, the state constitution provides that public 
plan assets are trust funds to be used only for providing pension 
benefits to plan participants.[Footnote 22] In Michigan, the state 
constitution provides that public pension benefits are contractual 
obligations that cannot be diminished or impaired and must be funded 
annually.[Footnote 23] 

The basic features of pension plans--such as eligibility, 
contributions, and types of benefits--are often spelled out in state or 
local statute. State-administered plans are generally governed by state 
laws. For example, in California, the formulas used to calculate 
pension benefit levels for employees participating in the California 
Public Employees' Retirement System (CalPERS) are provided in state 
law.[Footnote 24] Similarly, in Oregon, pension benefit formulas for 
state and local employees participating in the Oregon Public Employees 
Retirement System (OPERS) plans are provided in state statute.[Footnote 
25] In addition, we found that at the sites we visited locally 
administered plans were generally governed by local laws. For example, 
in San Francisco, contribution rates for employees participating in the 
San Francisco City and County Employees' Retirement System are spelled 
out in the city charter.[Footnote 26] 

Legal protections usually apply to benefits for existing workers or 
benefits that have already accrued; thus, state and local governments 
generally can change the benefits for new hires by creating a series of 
new tiers or plans that apply to employees hired only after the date of 
the change. For example, the Oregon legislature changed the pension 
benefit for employees hired on or after January 1, 1996, and again for 
employees hired on or after August 29, 2003, each time increasing the 
retirement age for the new group of employees. 

For some state and local workers whose benefit provisions are not laid 
out in detail in state or local statutes, specific provisions are left 
to be negotiated between employers and unions.[Footnote 27] For 
example, in California, according to state officials, various benefit 
formula options for local employees are laid out in state statutes, but 
the specific provisions adopted are generally determined through 
collective bargaining between the more than 1,500 different local 
public employers and rank-and-file bargaining units. In all three 
states we visited, unions also lobby the state legislature on behalf of 
their members. For example, in Michigan, according to officials from 
the Department of Management and Budget, unions marshal support for or 
against a proposal by taking such actions as initiating letter-writing 
campaigns to support or oppose legislative measures. 

Pensions Are Typically Managed as Trust Funds with Board Oversight: 

In accordance with state constitution and/or statute, the assets of 
state and local government pension plans are typically managed as 
trusts and overseen by boards of trustees to ensure that the assets are 
used for the sole purpose of meeting retirement system obligations and 
that the plans are in compliance with the federal tax code.[Footnote 
28] Boards of trustees, of varying size and composition, often serve 
the purpose of establishing the overall policies for the operation and 
management of the pension plans, which can include adopting actuarial 
assumptions, establishing procedures for financial control and 
reporting, and setting investment strategy. On the basis of our 
analysis of data from the National Education Association, the National 
Association of State Retirement Administrators (NASRA), and reports and 
publications from selected states, we found that 46 states had boards 
overseeing the administration of their pension plans for general state 
employees.[Footnote 29] These boards ranged in size from 5 to 19 
members, with various combinations of those elected by plan members, 
those appointed by a state official, and those who serve automatically 
based on their office in state government (known as ex officio 
members). (See fig. 2.) 

Figure 2: Various Interests Represented on Boards of Each State's 
Pension Plan for General State Employees: 

[See PDF for image] 

This figure is a pie-chart depicting the following data: 

Appointed: 43 of 50 plans have appointed board members representing 
various groups or areas of expertise, such as an investment specialist: 
51.7%. 

Elected: 24 of 50 plans have board members elected by various groups, 
such as retired or active plan members: 29.1%. 

Ex officio: 36 of 50 plans have ex officio board members who serve 
automatically based on their office, such as the treasurer from the 
state or local jurisdiction: 19.1%. 

Source: GAO analysis of board membership for the primary pension plans 
for general state employees in each state, based on data from various 
national organizations and from individual states' reports and 
publications. 

Note: Percentages do not total 100 because of rounding. 

[End of figure] 

Different types of members bring different perspectives to bear, and 
can help to balance competing demands on retirement system resources. 
For example, board members who are elected by active and retired 
members of the retirement system, or who are union members, generally 
help to ensure that members' benefits are protected. Board members who 
are appointed sometimes are required to have some type of technical 
knowledge, such as investment expertise. Finally, ex officio board 
members generally represent the financial concerns of the state 
government. 

Some pension boards do not have each of these perspectives represented. 
For example, boards governing the primary public employee pension plans 
in all three states we visited had various compositions and 
responsibilities. (See table 2.) At the local level, in Detroit, 
Michigan, a majority of the board of Detroit's General Retirement 
System is composed of members of the system. According to officials 
from the General Retirement System, this is thought to protect pension 
plan assets from being used for purposes other than providing benefits 
to members of the retirement system. Regarding responsibilities, the 
board administers the General Retirement System and, as specified in 
local city ordinances, is responsible for the system's proper operation 
and investment strategy. 

Table 2: Composition and Responsibilities of Boards of Primary Public 
Employee Pension Plans in California, Michigan, and Oregon: 

State: California; 
Pension plan: California Public Employees' Retirement System (CalPERS); 
Number of board members: 13; 
Composition of board members: 3 appointed; 6 elected; 4 ex officio[A]; 
Board responsible for: Management and control of CalPERS, including the 
exclusive control of the administration and investment of the 
retirement fund.[B]. 

State: Michigan; 
Pension plan: Michigan State Employees' Retirement System (MSERS); 
Number of board members: 9; 
Composition of board members: 4 appointed; 5 ex officio[C]; 
Board responsible for: Administering and managing the defined benefit 
plan by making investment decisions and arranging for an actuarial 
valuation.[D]. 

State: Oregon; 
Pension plan: Oregon Public Employees' Retirement System (OPERS); 
Number of board members: 5; 
Composition of board members: 5 appointed[E]; 
Board responsible for: Managing the retirement system, including 
responsibilities such as arranging for actuarial services and 
publishing an annual report on the retirement system. 

Source: Statutes, as cited below. 

[A] Cal. Govt. Code ï¿½ 20090 (Deering, 2007). 

[B] Cal. Gov't. Code ï¿½ 20120 (Deering, 2007). 

[C] Mich. Comp. Laws ï¿½ 38.3 (2007). 

[D] Mich. Comp. Laws ï¿½ 38.2 (2007). The defined contribution plan is 
administered and its assets invested by the state treasurer. Mich. 
Comp. Laws ï¿½ 38.9 (2007). 

[E] Or. Rev. Stat. ï¿½ 238.660 (2005). 

[End of table] 

Pension boards of trustees typically serve as pension plan fiduciaries, 
and as fiduciaries, they usually have significant independence in terms 
of how they manage the funds. Boards make policy decisions within the 
framework of the plan's enabling statutes, which may include adopting 
actuarial assumptions,[Footnote 30] establishing procedures for 
financial control and reporting, and setting investment policy. In the 
course of managing pension trusts, boards generally obtain the services 
of independent advisors, actuaries, or investment professionals. 

Also, some states' pension plans have investment boards in addition to, 
or instead of, general oversight boards. For example, three of the four 
states without general oversight boards have investment boards 
responsible for setting investment policy. While public employees may 
have a broad mandate to serve all citizens, board members generally 
have a fiduciary duty to act solely in the interests of plan 
participants and beneficiaries. One study of approximately 250 pension 
plans at the state and local level found that plans with boards 
overseeing them were associated with greater funding than those without 
boards.[Footnote 31] 

When state pension plans do not have a general oversight board, these 
responsibilities tend to be handled directly by legislators and/or 
senior executive officials. For example, in the state of Washington, 
the pension plan for general state employees is overseen by the Pension 
Funding Council--a six-member body whose membership, by statute, 
includes four state legislators.[Footnote 32] The council adopts 
changes to economic assumptions and contribution rates for state 
retirement systems by majority vote. In Florida, the Florida Retirement 
System is not overseen by a separate independent board; instead, the 
pension plan is the responsibility of the State Board of 
Administration, composed of the governor, the chief financial officer 
of the state, and the state attorney general.[Footnote 37] In New York, 
the state comptroller, an elected official, serves as sole trustee and 
administrative head of the New York State and Local Employees' 
Retirement System.[Footnote 33] 

Most Public Pensions Have Assets To Pay Benefits Over Several Decades, 
But Contributions Vary: 

Currently, most state and local government pension plans have enough 
invested resources set aside to pay for the benefits they are scheduled 
to pay over the next several decades. Many experts consider a funded 
ratio of about 80 percent or better to be sound for state and local 
government pensions. While most plans' funding may be sound, a few 
plans have persistently reported low funded ratios, which will 
eventually require the government employer to improve funding, for 
example, by reducing benefits or by increasing contributions. Even for 
many plans with lower funded ratios, benefits are generally not at risk 
in the near term because current assets and new contributions may be 
sufficient to pay benefits for several years. Still, many governments 
have often contributed less than the amount need to improve or maintain 
funded ratios. Low contributions raise concerns about the future funded 
status, and may shift costs to future generations. 

Most Public Pension Plans Have Enough Funds to Pay for Benefits over 
the Long-Term: 

Most public pension plans report having sufficient assets to pay for 
retiree benefits over the next several decades. Many experts and 
officials to whom we spoke consider a funded ratio of 80 percent to be 
sufficient for public plans for a couple of reasons.[Footnote 34] 
First, it is unlikely that public entities will go out of business or 
cease operations as can happen with private sector employers, and state 
and local governments can spread the costs of unfunded liabilities over 
a period of up to 30 years under current GASB standards. In addition, 
several commented that it can be politically unwise for a plan to be 
overfunded; that is, to have a funded ratio over 100 percent. The 
contributions made to funds with "excess" assets can become a target 
for lawmakers with other priorities or for those wishing to increase 
retiree benefits. 

More than half of state and local governments' plans reviewed by the 
Public Fund Survey (PFS) had a funded ratio of 80 percent or better in 
fiscal year 2006, but the percentage of plans with a funded ratio of 80 
percent or better has decreased since 2000, as shown in figure 
3.[Footnote 35] Our analysis of the PFS data on 65 self-reported state 
and local government pension plans showed that 38 (58 percent) had a 
funded ratio of 80 percent or more, while 27 (42 percent) had a funded 
ratio of less than 80 percent. In the early 2000s, according to one 
study, the funded ratio of 114 state and local government pension plans 
together reached about 100 percent; it has since declined. [Footnote 
36] In fiscal year 2006, the aggregate funded ratio was about 86 
percent. Some officials attribute the decline in funded ratios since 
the late 1990s to the decline of the stock market, which reduced the 
value of assets. This sharp decline would likely affect funded ratios 
for several years because most plans use smoothing techniques to 
average out the value of assets over several years. Our analysis of 
several factors affecting the funded ratio showed that changes in 
investment returns had the most significant impact on the funded ratio 
between 1988 and 2005, followed by changes in liabilities.[Footnote 37] 

Figure 3: Percentage of State and Local Government Pension Plans with 
Funded Ratios above or below 80 Percent, by Fiscal Year: 

[See PDF for image] 

This figure is a stacked vertical bar graph depicting the following 
data: 

Fiscal year: 1994; 
Funding ratio less than 80 percent: 40%; 
Funding ratio 80 percent or more: 60%. 

Fiscal year: 1996; 
Funding ratio less than 80 percent: 31.25%; 
Funding ratio 80 percent or more: 68.75%. 

Fiscal year: 2000; 
Funding ratio less than 80 percent: 8.9%; 
Funding ratio 80 percent or more: 91.1%. 

Fiscal year: 2001; 
Funding ratio less than 80 percent: 10.6%; 
Funding ratio 80 percent or more: 89.4%. 

Fiscal year: 2002; 
Funding ratio less than 80 percent: 16.7%; 
Funding ratio 80 percent or more: 83.3%. 

Fiscal year: 2003; 
Funding ratio less than 80 percent: 22.7%; 
Funding ratio 80 percent or more: 77.3%. 

Fiscal year: 2004; 
Funding ratio less than 80 percent: 25.8%; 
Funding ratio 80 percent or more: 74.2%. 
; "	33.8462	66.1538
Funding ratio less than 80 percent: 33.8%; 
Funding ratio 80 percent or more: 66.2%. 

Fiscal year: 2006; 
Funding ratio less than 80 percent: 41.5%; 
Funding ratio 80 percent or more: 58.5%. 

Source: GAO analysis of PFS, PENDAT data. 

[End of figure] 

Although most plans report being soundly funded in 2006, a few have 
been persistently underfunded, and some plans have seen funded ratio 
declines in recent years.[Footnote 38] We found that several plans in 
our data set had funded ratios below 80 percent in each of the years 
for which data is available. Of 70 plans in our data set, 6 had funded 
ratios below 80 percent for 9 years between 1994 and 2006. Two plans 
had funded ratios below 50 percent for the same time period. In 
addition, of the 27 plans that had funded ratios below 80 percent in 
2006, 15 had lower funded ratios in 2006 than in 1994. The sponsors of 
these plans may be at risk in the future of increased budget pressures. 

By themselves, lower funded ratios and unfunded liabilities do not 
necessarily indicate that benefits for current plan members are at 
risk, according to experts we interviewed. Unfunded liabilities are 
generally not paid off in a single year, so it can be misleading to 
review total unfunded liabilities without knowing the length of the 
period over which the government plans to pay them off. Large unfunded 
liabilities may represent a fiscal challenge, particularly if the 
period to pay them off is short. But all unfunded liabilities shift the 
responsibility for paying for benefits accrued in past years to the 
future. 

Unfunded liabilities will eventually require the government employer to 
increase revenue, reduce benefits or other government spending, or do 
some combination of these. Revenue increase could include higher taxes, 
returns on investments, or employee contributions. Nevertheless, we 
found that unfunded liabilities do not necessarily imply that pension 
benefits are at risk in the near term. Current funds and new 
contributions may be sufficient to pay benefits for several years, even 
when funded rations are relatively low. 

Some Pension Sponsors Do Not Contribute Enough to Improve Funding 
Status: 

A number of governments reported not contributing enough to keep up 
with yearly costs. Governments need to contribute the full annual 
required contribution (ARC) yearly to maintain the funded ratio of a 
fully funded plan or improve the funded ratio of a plan with unfunded 
liabilities.[Footnote 39] In fiscal year 2006, the sponsors of 46 
percent of the 70 plans in our data set contributed less than 100 
percent of the ARC, as shown in figure 4, including 39 percent that 
contributed less than 90 percent of the ARC. In fact, the percentage of 
governments contributing less than the full ARC has risen in recent 
years. This continues a trend in recent years of about half of 
governments making full contributions. 

Figure 4: Percentage of State and Local Government Pension Plans for 
which Governments Contributed More or Less Than 100 Percent of the ARC, 
by Fiscal Year: 

[See PDF for image] 

This figure is a stacked vertical bar graph depicting the following 
data: 

Fiscal year: 1994; 
Funding ratio Less than 100 percent of the ARC: 89.2%; 
Funding ratio 100 percent or more of the ARC: 10.8%. 

Fiscal year: 1996; 
Funding ratio Less than 100 percent of the ARC: 16.9%; 
Funding ratio 100 percent or more of the ARC: 83.1%. 

Fiscal year: 2000; 
Funding ratio Less than 100 percent of the ARC: 25.8%; 
Funding ratio 100 percent or more of the ARC: 74.2%. 

Fiscal year: 2001; 
Funding ratio Less than 100 percent of the ARC: 19.7%; 
Funding ratio 100 percent or more of the ARC: 80.3%. 

Fiscal year: 2002; 
Funding ratio Less than 100 percent of the ARC: 35.2%; 
Funding ratio 100 percent or more of the ARC: 64.8%. 

Fiscal year: 2003; 
Funding ratio Less than 100 percent of the ARC: 43.7%; 
Funding ratio 100 percent or more of the ARC: 56.3%. 

Fiscal year: 2004; 
Funding ratio Less than 100 percent of the ARC: 49.3%; 
Funding ratio 100 percent or more of the ARC: 50.7%. 

Fiscal year: 2005; 
Funding ratio Less than 100 percent of the ARC: 48.6%; 
Funding ratio 100 percent or more of the ARC: 51.4%. 

Fiscal year: 2006; 
Funding ratio Less than 100 percent of the ARC: 45.7%; 
Funding ratio 100 percent or more of the ARC: 54.3%. 

Source: GAO analysis of PFS, PENDAT data. 

[End of figure] 

In particular, some of the governments that did not contribute the full 
ARC in multiple years were sponsors of plans with lower funded ratios. 
In 2006, almost two-thirds of plans with funded ratios below 80 percent 
in 2006 did not contribute the full ARC in multiple years. Of the 32 
plans that in 2006 had funded ratios below 80 percent, 20 did not 
contribute the full ARC in more than half of the 9 years for which data 
is available. In addition, 17 of these governments did not contribute 
more than 90 percent of the full ARC in more than half the years. 

State and local government pension representatives told us that 
governments may not contribute the full ARC each year for a number of 
reasons. First, when state and local governments are under fiscal 
pressure, they may have to make difficult choices about paying for 
competing interests. State and local governments will likely face 
increasing fiscal challenges in the next several years as the cost of 
health care continues to rise. In light of this stress, the ability of 
some governments to continue to pay the ARC may be questioned. Second, 
changes in the value of assets can affect governments' expectations 
about how much they will have to contribute. Moreover, some plans have 
contribution rates that are fixed by constitution, statute, or practice 
and do not change in response to changes in the ARC. Even when the 
contribution rate is not fixed, the political process may take time to 
recognize and act on the need for increased contributions. Nonetheless, 
many states have been increasing their contribution rates in recent 
years, according to information compiled by the National Conference of 
State Legislatures. Third, some governments may not contribute the full 
ARC because they are not committed to prefunding their pension plans 
and instead have other priorities. 

When a government contributes less than the full ARC, the funded ratio 
can decline and unfunded liabilities can rise, if all other assumptions 
are met about the change in assets and liabilities.[Footnote 40] 
Increased unfunded liabilities will require larger contributions in the 
future to keep pace with the liabilities that accrue each year and to 
make up for liabilities that accrued in the past. As a result, costs 
are shifted from current to future generations. 

Conclusions: 

The funded status of state and local government pensions overall is 
reasonably sound, though recent deterioration underscores the 
importance of keeping up with contributions. Since the stock market 
downturn in the early 2000s, the funded ratios of some governments have 
declined. Although governments can gradually recover from these losses, 
the failure of some to consistently make the annual required 
contributions undermines that progress and is cause for concern. This 
is especially important as state and local governments face increasing 
fiscal pressure in the coming decades. 

The ability to maintain current levels of public sector retiree 
benefits will depend, in large part, on the nature and extent of the 
fiscal challenges these governments face in the years ahead. As state 
and local governments begin to comply with GASB accounting and 
reporting standards, information about the future costs of retiree 
health benefits will become more transparent. In light of the initial 
estimates of the cost of future retiree health benefits, state and 
local governments will likely have to find new strategies for dealing 
with their unfunded liabilities. Although public sector workers have 
thus far been relatively shielded from many of the changes that have 
occurred in private sector defined benefit commitments, these 
protections could undergo revision under the pressure of overall future 
fiscal commitments. 

We are continuing our work on state and local government retiree 
benefits. We have two engagements underway; the first study will 
examine the various approaches these governments are taking to address 
their retiree health care liabilities, while the second examines the 
ways state and local governments allocate the assets in their pension 
and retiree health care funds. We are pleased that this committee is 
interested in our work and look forward to working with you in the 
future. 

That concludes my testimony: I would be pleased to respond to any 
questions the committee has. 

Contacts and Acknowledgments: 

For further information regarding this testimony, please contact 
Barbara D. Bovbjerg, Director, Education, Workforce, and Income 
Security Issues at (202) 512-7215 or [email protected]. Contact points 
for our Offices of Congressional Relations and Public Affairs may be 
found on the last page of this statement. Individuals making key 
contributions to this testimony include Tamara Cross (Assistant 
Director), Bill Keller (Assistant Director), Anna Bonelli, Margie 
Shields, Joe Applebaum, and Craig Winslow. 

[End of section] 

Footnotes: 

[1] Actuarial accrued liabilities, referred to in this testimony as 
"liabilities," are the portion of the present value of future benefits 
that is attributable to employee services in past periods, under the 
actuarial cost method utilized. 

[2] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-1156] 
(Washington, D.C.: Sept. 24, 2007). 

[3] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-223] 
(Washington, D.C.: Jan. 29, 2008). 

[4] The PFS is sponsored by the National Association of State 
Retirement Administrators and the National Council on Teacher 
Retirement. In 2005, the PFS data we used represented 58 percent of 
total assets invested in public pension plans nationwide, and 72 
percent of total members. PFS data covered years beginning with 2001. 
PPCC data covered years 1994, 1996, and 2000. 

[5] Unlike in the private sector, there are large groups of state and 
local government workers who are not covered by Social Security. 
According to data from the Social Security Administration, about 30 
percent of all state and local government workers nationwide are not 
covered, although the extent of coverage varies widely by state and by 
occupation. 

[6] There could, however, be federal tax penalties if funds are 
withdrawn before the employee reaches a certain age. 26 U.S.C. ï¿½ 72(t). 

[7] Contributions to qualified pension plans that meet certain 
requirements--whether defined benefit or defined contribution--are 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. 

[8] For more extensive information on the three key measures see State 
and Local Government Retiree Benefits: Current Funded Status of Pension 
and Health Benefits, [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-
08-223] (Washington, D.C.: Jan. 29, 2008). 

[9] The three most commonly used actuarial cost methods are the 
projected unit credit (projected benefits of each employee covered by 
the plan are allocated by a consistent formula to valuation years); 
entry age normal (the current value of future benefits of each employee 
is allocated on a level basis over the earnings or service of the 
employee between entry age and assumed exit age); and aggregate (the 
excess of the value of future benefits of all employees over the 
current value of assets is allocated on a level basis over the earnings 
or service of the group between the valuation date and assumed exit. 
This allocation is performed for the group as a whole, not as a sum of 
individual allocations). 

[10] Actuarial cost methods are used to allocate the current value of 
future benefits into amounts attributable to the past, to the current 
year, and to future years. The cost of future benefits that are 
attributable to past years under the actuarial cost method is called 
the actuarial accrued liability (AAL), while the cost of benefits 
accrued under the cost method in the current year is known as the 
normal cost. 

[11] For more extensive information on the actuarial cost methods and 
comparisons see State and Local Government Retiree Benefits: Current 
Funded Status of Pension and Health Benefits, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-08-223] (Washington, D.C.: Jan. 
29, 2008). 

[12] GAO, State and Local Governments: Persistent Fiscal Challenges 
Will Likely Emerge within the Next Decade, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-07-1080SP] (Washington, D.C.: 
July 18, 2007). 

[13] The last year for which the Bureau of Labor Statistics published 
these data was 1998. U.S. Department of Labor, Bureau of Labor 
Statistics, Employee Benefits in State and Local Governments, 1998 
(Washington, D.C.: 2000). 

[14] See GAO, State and Pension Plans: Similarities and Differences 
Between Federal and State Designs, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO/GGD-99-45] (Washington, D.C.:Mar. 19, 1999). Also, as of 
1998, across all state and local employees nationwide, Bureau of Labor 
Statistics survey data indicate that 90 percent were covered by defined 
benefit plans. 

[15] In the private sector, when a new plan is adopted, the previous 
plan is often frozen. Existing employees keep the benefits they have 
accrued to date, but cannot continue to participate in the previous 
plan from that point forward. In the public sector, when a new plan is 
adopted, existing employees generally are allowed to continue to 
participate in the previous plan. Generally only new employees, hired 
after adoption of the new plan, are required to participate in the new 
plan from that point forward. 

[16] In addition, over the past 10 years, many public sector employers 
have established deferred retirement options plans (DROP). DROPs were 
created to retain experienced employees by permitting those eligible to 
retire to stay on the job and earn a lump-sum payment at retirement in 
addition to their defined benefit annuity. 

[17] 26 U.S.C. ï¿½ 457(b). 

[18] The Workplace Economics, Inc. 2006 survey instructed states to 
provide information on benefits that cover the largest number of 
employees, or that were otherwise deemed representative. 

[19] GAO, Employer-Sponsored Health and Retirement Benefits: Efforts to 
Control Employer Costs and the Implications for Workers, [hyperlink, 
http://www.gao.gov/cgi-bin/getrpt?GAO-07-355] (Washington, D.C.: Mar. 
30, 2007). 

[20] Given the ways in which defined contribution plans differ from 
defined benefit plans, these types of provisions may be less readily 
applicable or relevant to them. 

[21] Although the AARP study focused on pension plans for a particular 
group of public employees (retired educators), our analysis revealed 
that the provisions identified in all but two states were applicable to 
pension plans for all state employees. In addition, we learned that 
subsequent to this study, Oregon adopted a constitutional provision in 
2003 to authorize the issuance of pension obligation bonds. 

[22] Cal. Const., art. XVI ï¿½ 17. 

[23] Mich. Const., art. IX ï¿½19 and 24. 

[24] For example, see Cal. Gov't. Code ï¿½ 21353 (Deering 2007). 

[25] Or. Rev. Stat. ï¿½ 238.300 (2005). 

[26] San Francisco City Charter A8.525. 

[27] The influence of unions on public employees benefits is stronger 
than in the private sector. Over 40 percent of public sector workers-- 
including federal, state, and local government--are covered by union 
agreements, compared with about 10 percent of private sector workers. 

[28] A trust established by an employer for the exclusive benefit of 
its employees, and any income it generates, is exempt from federal 
income tax. 26 U.S.C. ï¿½ 501(a). 

[29] The four states that do not have boards overseeing the operation 
and management of their pension plans for general state employees are 
Florida, Iowa, New York, and Washington. (In addition, the District of 
Columbia does not have a board overseeing its pension plan for its 
general employees.) 

[30] Actuarial assumptions are assumptions as to the occurrence of 
future events affecting pension costs, such as mortality, retirement, 
and rates of investment earnings. 

[31] Marquerite Schneider and Fariborz Damanpour, "Public Choice 
Economics and Public Pension Plan Funding: An Empirical Test," 
Administration and Society, vol. 34, no. 1 (2002). 

[32] Wash. Rev. Code ï¿½41.45.100 (2007). 

[33] Fla. Stat. ï¿½ 215.44 (2007). 

[34] The Pension Protection Act of 2006 provided that large private 
sector pension plans will be considered at risk of defaulting on their 
liabilities if they have less than 80 percent funded ratios under 
standard actuarial assumptions and less than 70 percent funded ratios 
under certain additional "worst-case" actuarial assumptions. When 
private sector plans default on their liabilities, PBGC becomes liable 
for benefits. These funding standards will be phased in, becoming fully 
effective in 2011, and at-risk plans are required to use stricter 
actuarial assumptions that will result in them having to make larger 
plan contributions. Pub. L. No. 109-280, sec. 112(a), ï¿½ 430(i), 120 
Stat. 780, 839-42. 

[35] In this section, we refer to our analysis of the PFS and PENDAT 
database. The PFS is sponsored by the National Association of State 
Retirement Administrators and the National Council on Teacher 
Retirement. These sources contain self-reported data on state and local 
government pension plans in years 1994, 1996, and 2000 to 2006. Each 
year, between 62 and 72 plans were represented in our dataset. In 2005, 
the 70 plans represented 58 percent of total assets invested in public 
pension plans nationwide in 2005, and 72 percent of total members 

[36] K. Brainard, Public Fund Survey Summary of Findings for FY 2006, 
National Association of State Retirement Administrators (Georgetown, 
Tex.: October 2007). 

[37] These findings may be unique to the time period examined (1988- 
2005). In other periods, other factors, such as changes to benefits, 
may account for more of the change in the funded ratio than the rates 
of return on the investment portfolio. 

[38] Reports estimate total unfunded liabilities for public pension 
plans nationwide between $307 and $385 billion, but the estimates do 
not cover all state and local government plans. One study by the 
National Association of State Retirement Administrators reviewed the 
funding status of 125 of the nation's large public pension plans in 
fiscal year 2006 and found total unfunded liabilities to be more than 
$385 billion. Another study reviewed state-only pension plans and found 
that in 2005, the most recent year for which substantially complete 
data was available, total unfunded liabilities for 108 plans were about 
$307 billion. Neither study is a random sample of state and local 
government pension plans that represents all public plans nationwide. 
NASRA Public Fund Survey (2006). This estimate represents 85 percent of 
public plan assets nationwide. Wilshire Consulting, 2007 Wilshire 
Report on State Retirement Systems: Funding Levels and Asset Allocation 
(2007). This study includes only state plans, not local plans. 

[39] The ARC is made up of the amount of future benefits promised to 
plan participants that accumulated in the current year, plus a portion 
of any unfunded liabilities. Although the ARC refers to the annual 
required contribution, the use of the word "required" can be misleading 
because governments can choose to pay more or less than this amount. 

[40] When a government does not contribute at least the normal cost 
plus interest on the unfunded liability (which is an amount less than 
the full ARC), unfunded liabilities will increase. 

[End of section] 

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