STATE OF FLORIDA et al v. UNITED STATES DEPARTMENT OF HEALTH AND HUMAN SERVICES et al

Filing 80

MOTION for Summary Judgment by PLAINTIFF STATES. (Internal deadline for referral to judge if response not filed earlier: 11/22/2010). (Attachments: # 1 Memorandum of Law, # 2 Statement of Material Facts, # 3 Exhibits Volume I, # 4 Exhibits Volume II, # 5 Exhibits Volume III, # 6 Exhibits Volume IV) (tdg) (Additional attachment(s) added on 11/4/2010: # 7 Exhibits Volume V.1 (35, 36), # 8 Exhibits Volume V.2 (37,38), # 9 Exhibits Volume V.3 (39,40)) (tdg).

STATE OF FLORIDA et al v. UNITED STATES DEPARTMENT OF HEALTH AND HUMAN SERVICES et al

Doc. 80 Att. 6

IN THE UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF FLORIDA Pensacola Division STATE OF FLORIDA, by and through Bill McCollum, et al., Plaintiffs, v. UNITED STATES DEPARTMENT OF HEALTH AND HUMAN SERVICES, et al., Defendants. ___________________________________________/ Case No.: 3:10-cv-91-RV/EMT

APPENDIX OF EXHIBITS IN SUPPORT OF PLAINTIFFS' MOTION FOR SUMMARY JUDGMENT VOLUME IV (Exhibits 21-34)

Dockets.Justia.com

Plaintiffs hereby submit Volume IV of their Appendix of Exhibits in Support of their Motion for Summary Judgment. Respectfully submitted, BILL MCCOLLUM ATTORNEY GENERAL OF FLORIDA /s/ Blaine H. Winship Blaine H. Winship (Fla. Bar No. 0356913) Special Counsel Joseph W. Jacquot (Fla. Bar No. 189715) Deputy Attorney General Scott D. Makar (Fla. Bar No. 709697) Solicitor General Louis F. Hubener (Fla. Bar No. 0140084) Timothy D. Osterhaus (Fla. Bar No. 0133728) Deputy Solicitors General Office of the Attorney General of Florida The Capitol, Suite PL-01 Tallahassee, Florida 32399-1050 Telephone: [phone] Facsimile: [phone] Email: [e-mail] Attorneys for Plaintiff States David B. Rivkin (D.C. Bar No. 394446) Lee A. Casey (D.C. Bar No. 447443) Baker & Hostetler LLP 1050 Connecticut Avenue, N.W., Ste. 1100 Washington, DC 20036 Telephone: [phone] Facsimile: [phone] Attorneys for Plaintiff States, National Federation of Independent Business, Mary Brown, and Kaj Ahlburg Katherine J. Spohn Special Counsel to the Attorney General Office of the Attorney General of Nebraska 2115 State Capitol Building Lincoln, Nebraska 68508 Telephone: [phone] Facsimile: [phone] Email: [e-mail] 2

Attorneys for Plaintiff the State of Nebraska Karen R. Harned Executive Director National Federation of Independent Business Small Business Legal Center 1201 F Street, N.W., Suite 200 Washington, DC 20004 Telephone: [phone] Facsimile: [phone] Of counsel for Plaintiff National Federation of Independent Business Bill Cobb Deputy Attorney General for Civil Litigation Office of the Attorney General of Texas P.O. Box 12548, Capitol Station Austin, Texas 78711-2548 Telephone: [phone] Facsimile: [phone] Email: [e-mail] Attorneys for Plaintiff the State of Texas

CERTIFICATE OF SERVICE I hereby certify that, on this 4th day of November, 2010, a copy of the foregoing Volume IV of Appendix of Exhibits in Support of Plaintiffs' Motion for Summary Judgment was served on counsel of record for all Defendants through the Court's Notice of Electronic Filing system. /s/ Blaine H. Winship Blaine H. Winship Special Counsel

3

TABLE OF EXHIBITS Exhibit No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Dudek Declaration Lange Declaration Watkins Declaration Leznoff Declaration Robleto Declaration Shier Declaration Ashmore Declaration Battilana Declaration Betlach Declaration Casanova Declaration Damler Declaration Phillips Declaration Anderson Declaration Chaumont Declaration Wells Declaration Willden Declaration Van Camp Declaration

18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

Bowman Declaration Zinter Declaration Millwee Declaration Dial Declaration Kukla Declaration Gooch Declaration Sundwall Declaration Brown Declaration Ahlburg Declaration Danner Declaration Grimes Declaration Klemencic Declaration McClain Declaration Thompson Declaration CMS Letter from Acting Director Barbara K. Richards to Monica Curry, AZ Off. of Intergovernmental Relations, April 1, 2010 Second CMS Letter from Acting Director Barbara K. Richards to Monica Curry, AZ Off. of Intergovernmental Relations, June 24, 2010 Chairman Ben S. Bernanke, Bd. of Governors of the Federal Reserve System, Challenges for the Economy and State Governments, Aug. 2, 2010 Policies for Increasing Economic Growth and Employment in 2010 and 2011, Cong. Budget Off., Jan. 2010

36 37 38

Variation in Analyses of PPACA's Fiscal Impact on States, Cong. Res.Serv., Sept. 8, 2010 State and Local Governments' Fiscal Outlook (GAO-10-358), Gov't Accountability Off, March 2010 State and Local Governments: Fiscal Pressures Could Have Implications for Future Delivery of Intergovernmental Programs (GAO-10-899), Gov't Accountability Off., July 2010 Richard S. Foster, Estimated Financial Effects of the "Patient Protection and Affordable Care Act," Centers for Medicare & Medicaid Service, April 22, 2010 Dubberly Declaration

39

40

ATTCHMENT 1 Philip S. Dial Mr. Dial is a graduate of the University of Texas at Austin with a Bachelor's degree in Business Administration. He also has a Master's degree in Actuarial Science from the University of Michigan. He is a Fellow of the Society of Actuaries and a member of the American Academy of Actuaries. Mr. Dial has been a consulting actuary with Rudd and Wisdom, Inc. since 1971 and is the firm's specialist in the group and health benefits field. He has seven years experience working with public pension plans. He is a Senior Principal and Secretary of the firm. His experience includes:
·

Service as consultant to large group and health benefits programs of large public employers, including that of the State of Texas, the University of Texas System, the Texas Medicaid Program and group benefits programs of several of the largest trade and professional associations in Texas. These consulting activities include:
o o o o o o o o o o o

Health and welfare plan design and financing Risk evaluation Evaluation and selection of insurance, reinsurance, managed care arrangements ,and administrative contracts Valuation of other post employment benefits under GASB 43 and 45 Design of alternate funding mechanisms Actuarial cost projections/statistical modeling Preparation of budgets and legislative appropriation requests Legislative impact evaluation and testimony before legislative committees Provision of technical advise to boards of trustees Assistance with and provision of testimony before legislative committees Communication of complex actuarial and risk-related issues to nontechnical personnel

·

Extensive consulting activities with professional associations in the design, creation, implementation and operation of captive insurance companies designed to meet the individual insurance needs of their members. These consulting services have included strategic planning, financial analysis, policy design, premium rate determination, assistance in regulatory matters, procurement of reinsurance and general advice and counsel to staffs and boards of directors. Extensive consulting activities with large, public retirement systems in Texas including actuarial valuations, special studies and investigations of experience. These services have also included consultation with respect to policy matters, administrative methodology, benefit design and the drafting of legislation.

·

ATTACHMENT 2

ATTACHMENT 3

S

Legislative Appropriations Request
FISCAL YEARS 2012 - 2013

ubmitted to The Governor's Office of Budget, Planning and Policy and the Legislative Budget Board
by

The Employees Retirement System of Texas
August 30, 2010

Employees Retirement System of Texas Legislative Appropriation Request For Fiscal Years 2012 and 2013

TABLE OF CONTENTS

Description

Page

Administrator 's Statement ..................................................................................................................................................................................................... 1 Organizational Chart.............................................................................................................................................................................................................. 9 Summary of Base Request by Strategy ............................................................................................................................................................................. 2.A Summary of Base Request by Method of Finance ............................................................................................................................................................. 2.B Summary of Base Request by Object of Expense .............................................................................................................................................................2.C Summary of Base Request Objective Outcomes ...............................................................................................................................................................2.D Summary of Exceptional Items Request ............................................................................................................................................................................ 2.E Summary of Total Request by Strategy .............................................................................................................................................................................. 2.F Summary of Total Request Objective Outcomes ................................................................................................................................................................2.G Strategy Request ................................................................................................................................................................................................................ 3.A Rider Revisions and Additions Request ............................................................................................................................................................................. 3.B Exceptional Item Request Schedule................................................................................................................................................................................... 4.A Exceptional Items Strategy Allocation Schedule ................................................................................................................................................................ 4.B Exceptional Items Strategy Request ..................................................................................................................................................................................4.C Historically Underutilized Business Supporting Schedule .................................................................................................................................................. 6.A Federal Funds Supporting Schedule ..................................................................................................................................................................................6.C Estimated Total of All Funds Outside the General Appropriations Act Bill Pattern Schedule..............................................................................................6.H Budgetary Impacts Related to Federal Health Care Reform ...............................................................................................................................................6.J

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Administrator's Statement 82nd Regular Session, Fiscal Years 2012-2013

Agency Code: 327 Agency Name: Employees Retirement System of Texas Ann S. Fuelberg, Executive Director I am pleased to present the Legislative Appropriations Request (LAR) for the Employees Retirement System of Texas. The LAR requests funding to provide retirement and insurance benefits to more than 500,000 State of Texas employees, retirees and their eligible family members. These benefits support the State's goal to recruit, retain, and reward the high-quality workforce Texas needs to make government work for all of its citizens. The programs provide financial security for more than 76,000 retired Texans and health care for one of every 46 Texans, including 118,387 children under the age of 18. The programs benefit Texas through the impact of pension payments spent in Texas and medical claim payments to Texas doctors, hospitals, and pharmacies. This request supports: Four retirement plans: service retirement for state employees (ERS); elected state officials and district attorneys (ESO), law enforcement and custodial officers (LECOS), and two judicial plans including state district and appellate judges (JRS I and JRS II). Disability retirement benefits -- occupational and non-occupational -- are a part of each plan. Two death benefit programs: $5,000 lump sum death benefit paid to survivors of state retirees; $250,000 special death benefit paid to the survivors of certain Texas public safety officers killed in the line of duty. Three insurance programs: employee and retiree health insurance, the State Kids Insurance Program (SKIP)and employee and retiree basic life insurance. Accomplishments The continued commitment and careful stewardship of the State, combined with active contract and investment management by ERS, have built a model benefits program. Over 200 employers rely on these benefits to attract the employees they need. Texas is a large and growing state, with diverse workforce needs ranging from professors to prison guards. The benefits program must compete with the private sector and other governmental entities, at a cost that Texas taxpayers can reasonably support. To earn that support, ERS manages the programs to lower costs without sacrificing quality or value. This past biennium, ERS worked with the Legislature to modify both the retirement and insurance programs to address rising costs. House Bill 2559 addressed the sustainability of the state pension program by modifying key components of the program, such as retirement eligibility, benefit calculations, contribution rates, and return to work employment rules. The new provisions, which went into effect for all employees hired on or after September 1, 2009, are similar to provisions now being considered by states across the country. Texas already prohibits many other pension plan cost drivers, such as automatic retiree cost of living adjustments and increasing or "spiking" retirement benefits by manipulating final salary figures. All employees contribute to their own retirement security. In the insurance plan, ERS took a multi-pronged approach to address a funding shortfall accelerated by higher than expected hospital costs. Negotiated Page 1

provider discounts shaved $2.7 billion from provider-billed charges. When hospitals requested unreasonable price increases, ERS terminated them from the provider network. Unlike many plan sponsors, ERS enforced a court settlement in the pharmacy program, holding our pharmacy benefit manager to honor contractual discounts based on a court ordered price rollback, saving the program an estimated $15 million a year. Despite these cost-cutting successes, the health insurance plan faced a funding gap. Working with insurance plan participants, ERS developed proposals to share costs with participants. The plan, which goes into effect on September 1, 2010, targets high cost services, while allowing people to manage their budgets. The new benefit design is sensitive to members' preferences and feedback, which ERS received through a series of statewide listening sessions and a survey that drew a 26 percent response rate. Following these changes, participants will be responsible for about 21% of the health care costs of the program. External Challenges Among the many external challenges ERS faced during the past biennium, the most significant was the downturn in the U.S. economy and its effect on the investment market. While ERS was not immune to the market decline, the trust fund's long-term horizon, conservative approach, and diversified investment portfolio makes it well suited to withstand such short-term market volatility. Another challenge will be the impact and implementation of federal health care reform. While some provisions could have a positive effect, others will certainly increase some short-term costs. Having depleted the insurance contingency reserve fund to cover previous funding shortfalls, the program does not have reserves to deal with these cost increases. A continuing challenge for the health care program is the rising costs associated with health care delivery. The costs continue to climb at rates well above inflation. Rising costs are due to continuing increases in the price and utilization of health care services because of several factors, including an aging population, an increase in chronic health conditions, the introduction of costly new procedures and medications, and cost shifting to insured patients. External budget pressure could also affect the retirement program. If Texas reduces the workforce through layoffs or retirement incentives, retirement rates could skyrocket. Currently 13% of the state workforce is eligible to retire. Even employment practices such as furloughs or salary freezes could increase the number of retirements. Retirement rates that exceed current assumptions and experience increase the cost of providing benefits. The last retirement incentive was a significant factor in increasing system costs by accelerating retirement rates above the system's funding assumptions. Retirement Appropriation Request The state starts funding retirement benefits as soon as a worker enters the system. This funds the benefits throughout an employee's working career. The normal cost is calculated by determining the current rate of employer and employee contributions needed to pay for future retirement benefits, assuming that retirement rates and investment earnings match expectations. The current normal cost is 12.38%. System members contribute 6.5% of that cost. The unfunded liability of a system is adversely affected when the system does not consistently receive enough contributions to pay the normal cost of providing benefits and pay down any unfunded liability. To cover this unfunded liability, contributions must increase to an actuarially sound contribution rate. The current actuarially sound contribution rate for the ERS employee retirement trust fund is 15.84% based on the valuation as of August 31, 2009. Both the normal and the actuarially sound contribution rate will change based on the fiscal year end actuarial valuation of the trust fund. In addition to the fiscal year update, a special mid-year actuarial updated valuation of the fund will be done as of February 28, 2011 in order to provide the Legislature with the most current estimates. Page 2

Baseline requests for the retirement program: Employee and elected class retirement $814 million to fund the state retirement contribution at the base line of 6.95%. The member contribution is assumed to remain at 6.5% for the biennium. This baseline request (13.45%) slightly exceeds the current normal cost of 12.38%. This amount does not equal the actuarially sound contribution rate as set by state law and accounting standards. That means it is not enough to amortize the unfunded accrued liability, or even pay the interest on the liability. Law Enforcement and Custodial Officer Supplemental Retirement Trust Fund (LECOS) $47.7 million to fund the LECOS program at the base line of 1.59%. LECOS members began contributing to the LECOS retirement fund on September 1, 2009. The LECOS member contribution is assumed to remain at 0.5% of payroll for the biennium. This baseline request (2.09%) slightly exceeds the current normal cost of 2.07%, but it is not sufficient to amortize the unfunded accrued liability over a measurable period. JRS Plan I $54.5 million to fund the Judicial Retirement Plan I at current levels. JRS I is a closed plan that receives appropriations equal to benefit payments. JRS Plan II $22.7 million to fund the Judicial Retirement Plan II at the base line of 16.83%. Plan II judges contribute 6% of payroll to the plan. The JRS II member contribution is assumed to remain at 6% of payroll for the biennium. At these contribution levels, the plan is considered actuarially sound. Chapter 615 $12.1 million to fund public safety officer death benefits at current levels. Retiree death benefit $16.2 million to fund retiree lump sum death benefits at current levels. Exceptional item requests for the retirement program: Current Actuarially Sound Contribution for Retirement Trust Fund Page 3

$282.3 million to provide the actuarially sound contribution rate as required in Sec. 811.006 of the Texas Government Code. The current actuarially sound contribution rate is 15.84%, requiring an employer contribution of 9.34%, in addition to the member contribution of 6.5%. The actuarially sound contribution rate is made up of the normal cost of 12.38%, and the contributions needed to erase the unfunded liability over 31 years. The current difference is 3.46% between the normal cost and the actuarially sound contribution rate. The system reported an unfunded liability in 2003, following years of below normal cost contributions, the impact of retirement incentives and two years of negative investment returns. The liability has continued to grow because the fund has not received enough contributions to cover the normal cost and pay down the unfunded debt. Current Actuarially Required Contribution for Law Enforcement and Custodial Officers Supplemental Fund $14.9 million for the LECOS fund to provide the actuarially sound contribution rate as required in Sec. 811.006 of the Texas Government Code. The current actuarially sound contribution rate is 2.58%, requiring an employer contribution of 2.08%, in addition to the member contribution of 0.5%. Group Benefits (Insurance) Program Appropriations Request Baseline requests for the Group Benefits Program: $2.5 billion to fund the program at the prescribed base level, below the current spending levels The baseline request for the FY2012-2013 biennium provides slightly more funding than the estimated and appropriated state funding for the FY20102011 biennium. Current GBP expenditures are much higher than that appropriated amount. Those higher costs were covered by using funds from the GBP contingency reserve fund as supplemental funding; i.e., the contingency reserve fund is being used to supplement state contributions. ERS expects the contingency reserve fund to be almost fully depleted by August 31, 2011, and unavailable to supplement state contributions in the FY2012-2013 biennium. Funding the program at this baseline level would require GBP spending cuts of about 17%. This level of cuts cannot be achieved through standard cost-shifting strategies. This level of cuts would drastically alter the current benefit design and cost sharing structure of the plan. In order to meet this lower funding level, the state would not be able to maintain the current contribution strategy. Since at least 1993, the State has paid 100% of the cost of member coverage and 50% of the cost of dependent coverage. At this baseline funding level, it would be necessary for members (employees and retirees) to pay 20% of the cost of member only coverage and 60% of the dependent coverage cost. For employees covering their families, this would be a 41% increase to their premium contributions. Alternatively, the State could choose to restructure the plan design, shifting to a high deductible health plan with an associated health savings account for employees, or a catastrophic health plan. Exceptional item requests for the Group Benefits Program: Funding to maintain health plan benefits at FY2011 levels In addition to the baseline funding request, the program needs $575.6 million to fund the program at a level sufficient to cover GBP costs for the FY2012-2013 biennium, including projected increases in health plan costs. The baseline funding level is based on an average of the FY2010-2011 program costs and not the actual costs as of August 31, 2011. This lower figure was then reduced by 5%. To make up for this deficit, and to cover Page 4

any cost increases, this exceptional item, together with the baseline, requests annual increases in per capita funding of 15.58% for FY2012 and 8.89% for FY2013. ERS expects the contingency reserve fund to be almost fully depleted at the start of the biennium and not available to supplement program funding. Per capita health plan benefit costs are projected to increase based on a number of factors including: how many and what type of health care services and medications will be used by program participants, how much service and drug costs are expected to increase, how much plan costs will be lowered through cost containment and members' cost share and behavior, and the impact of legislative changes, such as expanded coverage required by federal health care reform.

The FY2012 percentage increase is larger than the FY2013 percentage increase. The FY2012 request includes replacing the contingency fund spend down (4.89%), plus the projected costs related to health care reform (1.74%) in addition to the plan cost trend of 8.95%. In FY2013, the per capita funding increase is equal to the per capita increase in GBP cost. Note that this item does not re-establish the contingency reserve fund. Reestablishment of the contingency reserve fund is in a separate exceptional item request. State appropriations are only part of the GBP funding. Other funding comes from: Member contributions for dependent premiums, Contributions from higher education institutions, and other employers, and Supplemental funding from the contingency reserve fund (when available).

Funding to meet statutory requirement for the GBP contingency reserve fund: $311.2 million to re-establish the contingency reserve fund as required under Section 1551.211 of the Texas Insurance Code. The statute requires ERS to request funding necessary to maintain a contingency reserve fund adequate to cover self-funded expenditures for an average 60-day period in the next biennium, or a balance of about $569 million as of August 31, 2013. This funding request, together with additional funding from (a) higher education institutions, (b) other employers participating in the program, and (c) members who elect dependent coverage, is expected to be sufficient to meet the statutory minimum.

Estimated Budgetary Impacts Related to Federal Health Care Reform This LAR includes an estimate of the budgetary impact to the Group Benefits Program (GBP) of the federal HR 3590, Patient Protection and Affordable Care Act of 2010 (PPACA), and HR 4872, the Health Care and Education Reconciliation Act of 2010, collectively referred to as federal health care reform. We appreciate the recognition that there is considerable uncertainty surrounding state implementation. The PPACA, as amended, includes many changes to existing statutes, regulations, and to other provisions of the PPACA itself, and many requirements and references are not clearly stated, organized, or cross-referenced and/or are vague and ambiguous. It is unclear whether some of the provisions will apply to the GBP, as noted throughout the Part 6.J. schedule. ERS anticipates that legislative guidance will be issued that will affect these estimated costs. Some regulations are not yet published; others were only recently issued, without sufficient opportunity for ERS to consider all of the possible impacts and costs. ERS is prepared to revise this estimate as Page 5

additional information, such as newly issued or revised statutes, regulations, interpretations or other guidance and/or any court rulings become available. There is the possibility that the GBP could qualify for revenue from the Early Retiree Reinsurance Program. The ERRP provides reimbursement to plan sponsors providing health insurance coverage to retirees who are over age 55 and who are not yet eligible for Medicare. Plan sponsors may be reimbursed for 80 percent of claims between $15,000 and $90,000 for eligible retirees and their spouses and dependent children. ERS has applied for participation in the ERRP on behalf of the GBP. If the application is accepted, ERS will submit periodic requests for the GBP's share of the $5 billion appropriation for the program. However, it is unclear if the funding is sufficient to respond to all applications, if the GBP application will be approved, and if the State would agree to accept any funding provided to the program. With all of these variables, any possible cost savings are too uncertain to include on the Part 6.J. schedule. GASB standards relating to Other Post Employment Benefits (OPEB) As reported in the last LAR, the Governmental Accounting Standards Board (GASB) now requires governmental employers to value and report the projected cost of providing current and future retirees with other post-employment benefits (OPEB), primarily health care benefits. Texas funds OPEB on a pay-as-you-go basis and does not have a continuing, or constitutional, obligation to provide insurance benefits to employees or retirees beyond each fiscal year. ERS reports the information required under GASB Statement No. 43, Financial Reporting for Postemployment Benefit Plans Other than Pension Plans, to the Texas Comptroller of Public Accounts. This LAR requests funding for the cost of providing life and health benefits to retirees during FY20122013, as detailed in the request, but does not request funding for any future costs associated with OPEB. GASB is also considering changing the reporting method for pension liabilities that would change how the unfunded liability is reported. The proposal would report the unfunded liability (or net pension liability) on the State's balance sheet. This shifts the reporting to a total obligation and makes it harder to determine if an employer is meeting its short-term obligations to the plan. If approved, these proposed accounting standards could go into effect as early as 2012. The standards would initially be implemented for pension plan reporting and then could affect OPEB calculations. GASB clearly states that the proposed standards are for accounting and financial reporting only and are separate from funding standards. Agency Authority and Policy on Criminal Background Checks In accordance with Texas Government Code, Chapter 411.1402, ERS may obtain criminal history record information maintained by the Texas Department of Public Safety (DPS) for all job applicants. The criminal history information may be used to evaluate an applicant for employment. All ERS job postings will state that the agency conducts a criminal history check on the primary and secondary candidate(s) recommended for the position. Criminal history checks may also be conducted on current or former employees when circumstances necessitate such checks. Only the Executive Director or designee may approve a request for a criminal history check on current or former employees. ERS will conduct an FBI fingerprint check on all applicants, including internal candidates, selected to fill "covered person" positions. Covered persons are defined in the ERS Investments Policy as all ERS Investments staff, Investment Accounting staff, the Investment Compliance Auditor, the Chief Operating Officer, and Executive Director. A conviction is not an automatic cause for an adverse personnel action. However, failure to report a conviction may result in corrective action up to and including termination of employment.

Page 6

The ERS will review all criminal convictions on a case-by-case basis based on several factors including: The nature and seriousness of each offense and its relationship to the duties of the position. The number of offenses committed by the individual. The length of time since the offense, The individual's work performance and/or history, The accuracy of the information on the individual's employment application, and The explanation the candidate provides in the event of a criminal conviction.

Page 7

Employees Retirement System of Texas

Board Members
I. Craig Hester, Chair Cydney Donnell, Vice-Chair Yolanda "Yoly" Griego Owen Whitworth Donald Wood Cheryl MacBride

Dates of Terms
November 1, 2005 ­ June 20, 2007 August 31, 2009 January 8, 2009 October 19, 2009 ­ ­ ­ ­ August 31, 2010 August 31, 2012 August 31, 2015 August 31, 2011 August 31, 2014 August 31, 2013

Hometown
Austin, Texas Fredricksburg, Texas El Paso, Texas Austin, Texas Odessa, Texas Austin, Texas

September 1, 2005 ­

Page 8

Employees Retirement System of Texas Agency Organization Chart

Page 9

Employees Retirement System of Texas Organizational Chart Supplementary Information
1) Board of Trustees The board is composed of six members and headed by the Chairperson. It is responsible for formulating the basic policies, rules and regulations consistent with the purposes, policies, principles and standards stated in the statutes. The board members serve as fiduciaries of all trust funds administered by the ERS. The Executive Director and Internal Audit report to the Board of Trustees. 2) Executive Director The Executive Director, who manages a staff of four, is appointed by the Board of Trustees. The Executive Director advises and recommends to the board what will be needed to transact the business of the ERS. The Executive Director is responsible for the preparation of an annual operating budget indicating the amount needed to pay the retirement system's expenses for the following fiscal year. This budget is submitted to the board for review and adoption. Governmental Relations, Investments, Communications and Research, and Legal Services staff report to the Executive Director. 3) Internal Audit The Director of Internal Audit directs a staff of four. Internal Audit provides independent, objective assurance and advisory services to the agency. 4) Legal Services The General Counsel directs a staff of 15. The Legal Services division advises the Board of Trustees, the Executive Director and Division Directors regarding all legal matters affecting ERS and the programs it administers. Division staff represents ERS and the Board of Trustees in administrative appeals related to members and retirees claims for insurance benefits and disability retirement. 5) Governmental Relations The Director of Governmental Relations directs a staff of two. Governmental Relations serves as the key contact and liaison for requests and inquiries from the Governor's office, Legislature, and legislative agencies, and external communications with the media. It monitors and reports on ERS related legislation, legislative studies, and studies or reports conducted by other state agencies. 6) Communications and Research The Director of Communications and Research directs a staff of 14. The Division manages communications with ERS members and participants including employees, retirees and human resources staff of the employers served by ERS. Writers, graphic designers, trainers, and speakers educate these audiences through print publications, the ERS website, face-to-face presentations, webcasts and benefits fairs.

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7)

Investments The Deputy Executive Director of Investments directs a staff of 58. The Investments Division is responsible for managing fund assets in order to earn a sufficient return on investments to insure the payments due to members of the retirement plan.

8)

Chief Operating Officer The Chief Operating Officer, who directs a staff of six, is responsible for the daily operations of the ERS. Benefit Contracts, Finance, Customer Benefits, Human Resources, Information Systems, and Operations Support staff report to the Chief Operating Officer.

9)

Human Resources The Human Resources Manager directs a staff of three. Human Resources is responsible for administering the personnel program for ERS. It is responsible for hiring and retaining a competent, quality work force.

10)

Benefit Contracts The Director of Benefit Contracts directs a staff of 20. The Benefit Contracts division is responsible for the administration of contracts with vendors that provide benefits related products and services to ERS customers.

11)

Finance The Chief Financial Officer directs a staff of 35. The Finance division includes Budget, General Accounting, Purchasing, Investment Accounting and Revenue Processing. Finance performs the accounting and budgeting functions for the agency.

12)

Customer Benefits The Director of Customer Benefits directs a staff of 97. The Customer Benefits division communicates, counsels and responds to benefit related inquiries from ERS customers. Division staff calculates and pays annuity and survivor benefits, processes insurance transactions, and oversees the flexible benefits and deferred compensation program.

13)

Information Systems The Chief Technology Officer directs a staff of 63. The Information Systems division is responsible for the development and operation of all automated systems in support of the agency's mission.

14)

Operations Support The Operations Support Manager directs a staff of 15. The Operations Support division provides support services such as records management, printing, mail and building maintenance.

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3.B. Rider Revisions and Additions Request Agency Code: 327 Current Rider Number
4

Agency Name: Employees Retirement System Page Number in 2010-2011 GAA
I-33

Prepared By: Michael C. Wheeler

Date: August 30, 2010

Request Level: Base

State Contribution to Employees Retirement Program. The amount specified above in A.1.1, Retirement Contributions, is based on a state contribution of 6.45 6.95 percent of payroll, including annual membership fees of $3 for contributing members for each fiscal year. State Contribution to Group Insurance for General State Employees. Funds identified above for group insurance are intended to fund: a. b. c. d. the total cost of the basic life and health coverage for all active and retired employees; fifty percent of the total cost of health coverage for the spouses and dependent children of all active and retired employees who enroll in coverage categories which include a spouse and/or dependent children; the additional cost of providing a premium structure comparable to the Children's Health Insurance Program (CHIP) for dependent children of state employees enrolled in the State Kids Insurance Program (SKIP); and the incentive program to waive participation in the Group Benefit Plan (Opt-Out).

Proposed Rider Language

6

I 3233

In no event shall the total amount of state contributions allocated to fund coverage in an optional health plan exceed the actuarially determined total amount of state contributions that would be required to fund basic health coverage for those active employees and retirees who have elected to participate in that optional health plan. During each fiscal year, the state's monthly contribution shall be determined by multiplying (1) the per capita monthly contribution as certified herein by (2) the total number of full-time active and retired employees enrolled for coverage during that month.

3.B. Page 1 of 2

3.B. Rider Revisions and Additions Request Agency Code: 327 Current Rider Number Agency Name: Employees Retirement System Page Number in 2010-2011 GAA Prepared By: Michael C. Wheeler Date: August 30, 2010 Request Level: Base

For each employee or retiree that waives participation in the Group Benefit Plan and enrolls in allowable optional coverage, the Employees Retirement System shall receive $60 per month in lieu of the "employeeonly" state contribution amount. The waived participant may apply up to $60 per month towards the cost of the optional coverage. Each year, upon adoption of group insurance rates by the Board of Trustees, the Employees Retirement System must notify the Comptroller, the Legislative Budget Board, and the Governor of the per capita monthly contribution required in accordance with this rider for each full-time active and retired employee enrolled for coverage during the fiscal year. It is the intent of the Legislature that the Employees Retirement System control the cost of the group insurance program by not providing rate increases to health care providers participating in HealthSelect during the 2010 11 2012-13 biennium. Online Health Risk Assessment. Out of funds appropriated above in Strategy B.1.1, the Employee Retirement System shall use an amount not to exceed $100,000 in fiscal year 2010 for the purpose of purchasing access to an online health risk assessment for state employees that do not already have access to one. Appropriation for the Deferred Compensation Trust Fund and the TexaSaver Trust Fund. All money deposited into the Deferred Compensation Trust Fund, Employees Retirement System No. 0945 and the TexaSaver Trust Fund No. 0946 pursuant to § 609.512 Government Code are hereby appropriated to the system for the 2010 11 2012-2013 biennium for the purposes authorized by law.

Proposed Rider Language

12

I 34

13

I-34

3.B. Page 2 of 2

6.H. Estimated Total of All Agency Funds Outside the GAA Bill Pattern Employees Retirement System of Texas
ESTIMATED GRAND TOTAL OF AGENCY FUNDS OUTSIDE THE 2012-13 GAA BILL PATTERN

$

31,982,414,589

Retirement Trust Fund (0955) Estimated Beginning Balance in FY 2010 Estimated Revenues FY 2010 Estimated Revenues FY 2011 $ 19,097,775,053 $ 1,385,387,056 $ 2,692,929,633 FY 2010-11 Total $ 23,176,091,742 $ 20,002,387,404 $ 2,523,630,658 $ 2,667,739,696 FY 2012-13 Total $ 25,193,757,758

Estimated Beginning Balance in FY 2012 Estimated Revenues FY 2012 Estimated Revenues FY 2013

Constitutional or Statutory Creation and Use of Funds:
The ERS Retirement Trust Fund is created by Government Code, Section 815.310. Funds in the account are used to pay retirement annuities and to operate the retirement system.

Method of Calculation and Revenue Assumptions:
Revenues to the trust fund include member contributions, state contributions, investment income, and other revenues. Investment income can vary widely from year to year. State contributions are dependent upon legislative action. For this document, other revenue is assumed to remain constant at the FY 2010 level for FY 2011-13. Investment Income is calculated using the 8% return assumption used in the ERS actuarial valuation report for August 31, 2009. State contributions are estimated at the LAR Base Level of 6.95%. Zero payroll growth is assumed for FY 2012-13.

6.H. Page 1 of 4

6.H. Estimated Total of All Agency Funds Outside the GAA Bill Pattern Employees Retirement System of Texas

Insurance Fund (0973) Estimated Beginning Balance in FY 2010 Estimated Revenues FY 2010 Estimated Revenues FY 2011 $ $ $ FY 2010-11 Total $ $ $ $ FY 2012-13 Total $ 282,483,838 2,180,927,771 2,329,215,694 4,792,627,303 20,855,627 2,692,107,499 2,931,435,856 5,644,398,982

Estimated Beginning Balance in FY 2012 Estimated Revenues FY 2012 Estimated Revenues FY 2013 Constitutional or Statutory Creation and Use of Funds:

The Insurance Fund is created by Insurance Code, Section 1551.401. Funds in the account are used for all payments of any coverages provided for under the Group Benefits Program and for payment of expenses of administering the program.

Method of Calculation and Revenue Assumptions:
Revenues to the trust fund include member contributions, state contributions, investment income, and other revenues. It is assumed that contributions from the state and the members for FY 2012 and FY 2013 will be established at the actuarial assumption levels of 15.58% in FY 2012 and 8.89% for FY 2013. Contribution increases are estimated at 6.5 and 6.8% for FY 2010-11.

6.H. Page 2 of 4

6.H. Estimated Total of All Agency Funds Outside the GAA Bill Pattern Employees Retirement System of Texas

LECOS Trust Fund (0977) Estimated Beginning Balance in FY 2010 Estimated Revenues FY 2010 Estimated Revenues FY 2011 $ $ $ FY 2010-11 Total $ $ $ $ FY 2012-13 Total $ 634,778,749 52,483,738 62,402,787 749,665,274 665,201,845 76,554,626 80,785,024 822,541,494

Estimated Beginning Balance in FY 2012 Estimated Revenues FY 2012 Estimated Revenues FY 2013 Constitutional or Statutory Creation and Use of Funds:

The LECOS Trust Fund is created by Government Code, Section 815.317. Funds in the account are used to pay law enforcement and custodial officer supplemental retirement and death benefits to law enforcement and custodial officers and to pay for the administration of the fund.

Method of Calculation and Revenue Assumptions:
Revenues to the trust fund include member contributions, state contributions, investment income, and other revenues. Investment income can vary widely from year to year. It is assumed that contributions from the state for FY 2012 and FY 2013 will be established at the current level of 1.59%. Investment income is calculated using the 8% return assumption used in the ERS actuarial valuation report for August 31, 2009. Enrollment is assumed to remain at the FY 2010 level with no payroll growth for FY 2012-13.

6.H. Page 3 of 4

6.H. Estimated Total of All Agency Funds Outside the GAA Bill Pattern Employees Retirement System of Texas

JRS II Trust Fund (0993) Estimated Beginning Balance in FY 2010 Estimated Revenues FY 2010 Estimated Revenues FY 2011 $ $ $ FY 2010-11 Total $ $ $ $ FY 2012-13 Total $ 205,730,088 22,096,866 36,855,554 264,682,508 245,417,073 36,456,353 39,842,929 321,716,355

Estimated Beginning Balance in FY 2012 Estimated Revenues FY 2012 Estimated Revenues FY 2013 Constitutional or Statutory Creation and Use of Funds:

The JRS II Trust Fund is created by Government Code, Section 840.305. Funds in the account are used to pay judicial retirement benefits and administrative expenses.

Method of Calculation and Revenue Assumptions:
Revenues to the trust fund include member contributions, state contributions, investment income, and other revenues. Investment income can vary widely from year to year. State contributions are dependent upon legislative action. Investment income is calculated using the 8% return assumption used in the ERS actuarial valuation report for August 31, 2009. State contributions are estimated at the LAR baseline request level of 16.83%. Enrollment is assumed to remain at the FY 2010 level with no payroll growth for FY 2012-13.

6.H. Page 4 of 4

6.J PART A BUDGETARY IMPACTS RELATED TO FEDERAL HEALTH CARE REFORM SCHEDULE 82nd Regular Session, Agency Submission, Version 1 Automated Budget and Evaluation System of Texas (ABEST)

DATE: TIME:

9/30/2010 11:38:47AM

Agency code: 327

Agency name: Employees Retirement System

CODE

DESCRIPTION Item Name: Expand Coverage to Dep up to Age 26

Est 2010

Bud 2011

BL 2012

BL 2013

Excp 2012

Excp 2013

Item Number: 1

Includes Funding for the following Strategy or Strategies: 0002-0001-0001 Provide Basic Insurance Program to General State Employees. Estimated OBJECTS OF EXPENSE

2009 OTHER OPERATING EXPENSE
TOTAL, OBJECT OF EXPENSE METHOD OF FINANCING

$0
$0

$0
$0

$0
$0

$0
$0

$7,693,000
$7,693,000

$8,389,000
$8,389,000

1 General Revenue Fund
SUBTOTAL, GENERAL REVENUE FUNDS

$0
$0

$0
$0

$0
$0

$0
$0

$4,471,941
$4,471,941

$4,876,526
$4,876,526

994 GR Dedicated Accounts
SUBTOTAL, GR DEDICATED

$0
$0

$0
$0

$0
$0

$0
$0

$279,256
$279,256

$304,521
$304,521

6 State Highway Fund 998 Other Special State Funds
SUBTOTAL, OTHER FUNDS

$0 $0
$0

$0 $0
$0

$0 $0
$0

$0 $0
$0

$1,383,971 $41,542
$1,425,513

$1,509,181 $45,300
$1,554,481

555 Federal Funds 00.327.002 ERS Insurance
SUBTOTAL, FEDERAL FUNDS TOTAL, METHOD OF FINANCING FULL-TIME-EQUIVALENT POSITIONS (FTE):

$0
$0 $0

$0
$0 $0

$0
$0 $0

$0
$0 $0

$1,516,290
$1,516,290 $7,693,000

$1,653,472
$1,653,472 $8,389,000

0.0

0.0

0.0

0.0

0.0

0.0

6.J. Page 1 of 8

For release on delivery 10:15 a.m. EDT August 2, 2010

Challenges for the Economy and State Governments

Remarks by Ben S. Bernanke Chairman Board of Governors of the Federal Reserve System at the Annual Meeting of the Southern Legislative Conference of the Council of State Governments Charleston, South Carolina

August 2, 2010

It is a pleasure to be able to address this conference of southern leaders and legislators. As some of you may know, I was raised only about 150 miles from here in Dillon, South Carolina, and remain connected to this area through family ties. Our nation has endured a deep recession that in turn was triggered by the most severe financial crisis since the Great Depression. Today, the financial crisis appears to be mostly behind us, and the economy seems to have stabilized and is expanding again. But we have a considerable way to go to achieve a full recovery in our economy, and many Americans are still grappling with unemployment, foreclosure, and lost savings. The recession--as all of you know too well--has also battered the budgets of state and local governments, primarily because tax revenues have declined sharply. Many states and localities continue to face difficulties in maintaining essential services and have significantly cut their programs and work forces. These cuts have imposed hardships in local jurisdictions around the country and are also part of the reason for the sluggishness of the national recovery. Today, I will touch on current economic and financial conditions and then turn to some near-term and longer-term challenges--fiscal and otherwise--facing state governments. The Economic Outlook After a precipitous decline in late 2008 and early 2009, the U.S. economy stabilized in the middle of last year and is now expanding at a moderate pace. While the support to economic activity from stimulative fiscal policies and firms' restocking of their inventories will diminish over time, rising demand from households and businesses should help sustain growth. In particular, in the household sector, growth in real

-2consumer spending seems likely to pick up in coming quarters from its recent modest pace, supported by gains in income and improving credit conditions. In the business sector, investment in equipment and software has been increasing rapidly, in part as a result of the deferral of capital outlays during the downturn and the need of many businesses to replace aging equipment. At the same time, rising U.S. exports, reflecting the expansion of the global economy and the recovery of world trade, have helped foster growth in the U.S. manufacturing sector. To be sure, notable restraints on the recovery persist. The housing market has remained weak, with the overhang of vacant or foreclosed houses weighing on home prices and new construction. Similarly, poor economic fundamentals and tight credit are holding back investment in nonresidential structures, such as office buildings, hotels, and shopping malls. Importantly, the slow recovery in the labor market and the attendant uncertainty about job prospects are weighing on household confidence and spending. After two years of job losses, private payrolls expanded at an average of about 100,000 per month during the first half of this year, an improvement but still a pace insufficient to reduce the unemployment rate materially. In all likelihood, significant time will be required to restore the nearly 8-1/2 million jobs that were lost over 2008 and 2009. Moreover, nearly half of the unemployed have been out of work for longer than six months. Long-term unemployment not only imposes exceptional near-term hardships on workers and their families, it also erodes skills and may have long-lasting effects on workers' employment and earnings prospects.

-3Financial conditions--though much improved since the depth of the financial crisis--have become somewhat less supportive of economic growth in recent months. Notably, concerns about the ability of Greece and a number of other euro-area countries to manage their sizable budget deficits and high levels of public debt roiled global financial markets in the spring, including our own. In response to these fiscal pressures, European leaders put in place a number of strong measures, including an assistance package for Greece and backstop financing for euro-area countries. And, recently, European banking supervisors released the results of comprehensive stress tests of their banks. 1 On net, these measures appear to have reduced concerns in financial markets about European prospects. Like financial conditions generally, the state of the U.S. banking system has also improved significantly since the worst of the crisis. Loss rates on most types of loans seem to be peaking, and, in the aggregate, bank capital ratios have risen to new highs. However, many banks continue to have a large volume of troubled loans, and bank lending standards remain tight. With credit demand weak and with banks writing down problem credits, bank loans outstanding have continued to decline. Small businesses, which depend importantly on bank credit, have been particularly hard hit by restrictive lending standards. At the Federal Reserve, we have been working to facilitate the flow of funds to creditworthy small businesses. Along with the other banking supervisors, we have emphasized to banks and examiners that lenders should do all they can to meet the needs of creditworthy borrowers, including small businesses. 2 We also have conducted

1

For information on the 2010 European Union stress testing, see the Committee on European Banking Supervisors' website at www.c-ebs.org/EuWideStressTesting.aspx. 2 See Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, Office of Thrift Supervision, and

-4extensive training of our bank examiners, with the message that lending to viable small businesses is good for the safety and soundness of our banking system as well as for our economy. We will continue to monitor bank lending and to seek feedback from banks and borrowers. Inflation has been low, with consumer prices rising at an average annual rate of about 1 percent in the first half of this year, and we anticipate it will remain subdued over the next couple of years. 3 Slack in labor and product markets has damped wage and price pressures, and rapid productivity increases have helped firms control their production costs. Meanwhile, measures of expected inflation generally have remained stable. Fiscal Challenges for State Governments Cuts in state and local programs and employment are also weighing on economic activity. These cuts principally reflect the historically large decreases in state tax revenues during the recession. Sales tax revenues have declined with household and business spending, and income tax revenues have been hit by drops in wages and salaries, capital gains, and corporate profits. In contrast, property tax revenues collected by local governments generally held up well through the beginning of this year, although reappraisals of the values of homes and commercial properties may affect those collections in the future. For the 15 states represented in the Southern Legislative

Conference of State Bank Supervisors (2010), "Regulators Issue Statement on Lending to Creditworthy Small Businesses," joint press release, February 5, www.federalreserve.gov/newsevents/press/bcreg/20100205a htm. 3 The discussion in the text refers to inflation as measured by the price index for personal consumption expenditures.

-5Conference (SLC), state tax revenues fell roughly 10 percent in 2009, similar to the average of all states. 4 Medicaid spending is another source of pressure on state budgets. The recession and the weak job market have swelled the rolls of Medicaid participants. In 2009, caseloads were 11 percent above their 2007 level in the region represented by the SLC, again similar to the average in all states. With revenues down and Medicaid spending up, other categories of spending by state governments have been tightly squeezed. Over the past year, numerous state governments have laid off or furloughed employees, decreased capital spending, and reduced aid to local governments. Indeed, state and local payrolls have fallen by more than 200,000 jobs from their peak near the end of 2008. Some states have also raised taxes, but the weak economy has made it difficult to find significant new revenues. Assistance from the federal government, especially through the fiscal stimulus package, has eased, but certainly not eliminated, the budget difficulties faced by states. Although states and localities will continue to receive significant aid this year, that source of help will be winding down next year. On a more positive note, state and local tax revenues seem set to increase as economic activity expands. Indeed, 11 of the 15 states of the SLC reported earlier this year that they expect fiscal year 2011 revenues to be at least somewhat higher than the previous fiscal year. 5 And improvements in the job market should gradually ease some

4

The Southern Legislative Conference comprises the states of Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Mississippi, Missouri, North Carolina, Oklahoma, South Carolina, Tennessee, Texas, Virginia, and West Virginia. 5 See Southern Legislative Conference (2010), "What Are the Revenue Estimates for Fiscal Years 2010 and 2011 in the SLC States?" Question of the Month, February, www.slcatlanta.org/QoM/2010/QuesFeb10 html.

-6of the demands on Medicaid and other social services. Moreover, the municipal bond market has remained reasonably receptive this year to most borrowers, with rates low and new issuance relatively solid, despite the concerns about the fiscal positions of many state and local governments. All that being said, with economic conditions still far from normal, state budgets will probably remain under substantial pressure for a while, leaving governors and legislatures a difficult juggling act as they try to maintain essential services while meeting their budgetary obligations. A question for the longer run is whether the vulnerability of state budgets to business-cycle downturns can be ameliorated. The pressures that states face during and after a recession are the result, in part, of balanced-budget rules in state constitutions that prohibit the use of long-term borrowing to cover operating budget shortfalls, a constraint not faced by the federal government, as you know. I do not advocate changing the balanced-budget rules followed by 49 of the 50 states; they provide important discipline and are a key reason that states have not built up long-term debt burdens comparable to those of many national governments. However, as is the case today, these rules may force significant state cutbacks in bad economic times when services are most needed. Moreover, many government programs--in areas such as education or health care, for example--are likely to be most effective when funding sources are stable and predictable, allowing for longer-term planning. Tools exist to help mitigate the effects of the business cycle on state budgets. Many states deal with revenue fluctuations by building up reserve--or "rainy day"--funds during good economic times. Measured as a percent of general fund expenditures, the aggregate reserve fund balances for all state governments stood at a record of about

-712 percent at the end of 2006; the states represented by the SLC had accumulated aboveaverage reserves of around 16 percent. These high reserve-fund balances were helpful in lessening the severity of spending cuts or tax increases in many states. Nevertheless, given the depth of the recent recession, even these historically high reserve-fund balances proved insufficient to buffer fully the budgets of most states. Thus, state governments may wish to revisit their criteria for accumulating fiscal reserves. Building a rainy-day fund during good times may not be politically popular, but it can pay off during the bad times. In principle, some smoothing of state government expenditures over time could take place through the capital budget. Maintaining or even increasing the pace of infrastructure construction when the economy is weak fosters economic development and provides local jobs, and it may even allow the state to get more bang for the buck because of increased competition among private contractors when demand is slack. However, voters and policymakers may understandably be reluctant to approve new bond issues and take on additional costs for debt payments in a period of fiscal and economic stress. Beyond balanced-budget rules, state government finances also fluctuate because of the increasing sensitivity of their revenues to changes in economic conditions. For example, capital income, which tends to vary substantially more than wage and salary income, has over time become a relatively more important source of state personal income taxes. 6 Also, sales taxes that understandably exempt certain necessities may also lead to more cyclicality in collections. As state legislatures review their tax systems, they
See Richard Mattoon and Leslie McGranahan (2008), "Revenue Bubbles and Structural Deficits: What's a State to Do?" Working Paper No. 2008-15 (Chicago: Federal Reserve Bank of Chicago, July), available at www.chicagofed.org/webpages/publications/working_papers/2008/wp_15.cfm; and David L. Sjoquist and Sally Wallace (2003), "Capital Gains: Its Recent, Varied, and Growing (?) Impact on State Revenues," State Tax Notes, August 18, available at www.taxpolicycenter.org/publications/url.cfm?ID=1000613.
6

-8may wish to consider revenue stability along with other critical features of the tax code such as fairness, support for economic growth, and administrative costs. Of course, healthy economic growth can ease state and local fiscal problems--and federal fiscal problems, for that matter. Notwithstanding the very difficult near-term budget issues you face, I urge you not to take your eye off the important goal of promoting growth. A basic economic principle is that growth requires investment. Investment includes physical investment such as infrastructure development; surely, adequate transportation networks and the like are necessary for economic growth. But for sustained economic development, investment in people--in their knowledge and skills--is even more important. No economy can succeed without a high-quality workforce, particularly in an age of globalization and technical change. I think this is a lesson that the South, as a region, has learned quite well. When I attended public schools in South Carolina in the 1960s, measures of per-pupil spending, years of schooling, and student achievement in the South lagged significantly behind other parts of the country. Since then, those indicators have changed, very much for the better. Because of the concerted efforts of state and local governments, high school completion rates in the South have gradually converged to the national average. Southern colleges and universities have become more prominent nationally and internationally, and we have seen the emergence of leading centers of education and innovation, such as the Research Triangle Park area in North Carolina and the high-tech area around Austin, Texas. Economic progress and a high quality of life have in turn attracted educated workers and new industries.

-9Doubtless, investment in education and training has been a key source of the remarkable economic gains that the South has achieved over the past 50 years or so. I am confident that, in light of this experience, your efforts to improve education and workforce skills will continue. As you do that, please keep in mind that formal K-12 and post-secondary education, as important as they are, do not alone build better workforces. Research increasingly has shown the importance for both individuals and the economy as a whole of both early childhood education as well as efforts to promote the lifelong acquisition of skills. The payoffs of early childhood programs can be especially high. 7 For instance, investment in preschool programs for disadvantaged children has been shown to increase high school graduation rates. Because high school graduates have higher earnings, pay more taxes, and are less likely to need to use public health programs, such investments can pay off even from the narrow perspective of state budgets; of course, the returns to the overall economy and to the individuals themselves are much greater. 8 Additionally, in a dynamic economy in which job requirements are constantly changing, individuals already in the workforce need opportunities to improve their skills throughout their lives. There are many ways to provide such opportunities. For example, community colleges and vocational schools play essential roles in training and retraining workers, especially if they do so in close collaboration with private employers, and they do so at a relatively low cost. State governments can facilitate public-private

For example, see the work of the Human Capital Research Collaborative, a joint project of the University of Minnesota and the Federal Reserve Bank of Minneapolis, at www.humancapitalrc.org. 8 See, for example,