Legislature(2005 - 2006)BELTZ 211
04/28/2006 01:30 PM Senate COMMUNITY & REGIONAL AFFAIRS
| Audio | Topic |
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| Start | |
| HB278 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | HB 278 | TELECONFERENCED | |
| + | TELECONFERENCED |
CSHB 278(RLS)-RETIREMENT SYSTEM LIABILITY/BONDS
1:34:26 PM
SENATOR BERT STEDMAN announced HB 278 to be up for
consideration. He asked the record to reflect that there was not
a quorum, but that Representative Hawker would introduce HB 278
and public testimony would be taken.
REPRESENTATIVE MIKE HAWKER, Sponsor of HB 278, informed members
that the bill addresses the issue of the unfunded pension
obligation for past service costs. Describing HB 278 as an
empowering bill, he said it doesn't authorize transactions it
simply grants power to the Municipal Bond Bank to work with
municipalities to see if they can structure such transactions.
He added that the bill also clarifies that municipalities have
the right to conduct such transactions.
A pension obligation bonding transaction is simply an arbitrage
transaction. In such a transaction an entity with a pension
liability would issue debt the proceeds of which would be
invested with the plan assets and would yield a return that is
the same as the rest of the plan assets. In the case of the
State of Alaska and its government employers that's been
demonstrated to be a bit better than 8 percent. Representative
Hawker described it as borrowing for cheap, investing for
expensive, and benefiting from the differential and suggested
that even in today's markets the spread would be better than 5
percent.
REPRESENTATIVE HAWKER outlined the risks and the points of
opposition: too much inherent investment risk; constitutional
limitations regarding the ability for municipalities to general
obligation debt for the purpose of capital projects; issuing
such debt transactions could impair the State's or the
municipalities' credit ratings; municipalities might refuse to
pay after entering into one of these transactions.
He asserted his belief that, "... there are very rational
analyses that would lead one to the conclusion that while those
risks all do exist, that they are adequately mitigated and
protected by the forces within the market - that we would not be
subjecting anyone or ourselves assuming too much risk in
pursuing one of these transactions.
REPRESENTATIVE HAWKER noted that the packets included comments
from Standard and Poor's rating agency and an educational primer
from a securities law firm both of which provided supporting
comments and information related to POBs. In particular the
primer points out that agencies actually endorse these
transactions.
With regard to the concern about constitutional limits, he said
the key is how the transaction is structured, which is why the
vehicles that are used aren't, by definition, general obligation
bonds. Although, he opined, if that authority were available a
transaction could be executed at an even lower cost to the
borrower.
The issue of investment risk and market timing is legitimate
when the window is short, but over time that risk is mitigated.
The transactions contemplated here extend from 25 to 28 years
and it's been proven time and again that over time, markets
perform consistently. For example, in the past ten years the
State's PERS and TRS programs have returned more than 8 percent.
To address the concern that relates to municipalities not paying
up he pointed out that the Municipal Bond Bank screens and
guides municipalities that are entering into these transactions.
Language in the bill makes it clear that a community won't be
put into debt circumstances beyond its means.
He advised that the bill has been specifically crafted to exempt
POBs from any of the debt ceiling limits placed on the Municipal
Bond Bank. He asked the committee to give particular attention
to that provision and decide whether or not it is appropriate.
1:45:45 PM
CHAIR STEDMAN asked for a layman's explanation of: how the
mechanism would work; why municipalities would borrow; and what
municipalities would do with the money.
REPRESENTATIVE HAWKER explained that the Municipal Bond Bank
exists to help government employers in the state that may not
have the financial standing to enter international capital
markets. In this instance, the bill would authorize the
Municipal Bond Band to issue debt on behalf of communities. The
municipalities would be the ultimate obligators for repaying the
debt and the money that's raised would go to the individual
municipalities for the specific purpose of being deposited into
the state's retirement investment trust. That money would be
invested on behalf of the particular community or group of
communities. The bill says that if a community wants to put
money into its PERS or TRS account(s) then as the money is
invested it is earmarked and accounted for separately so that
the benefit of the investment would go to the benefit of the
specific community that made the initial deposit.
CHAIR STEDMAN posed the hypothetical situation of a community
with a $25 million liability that wanted to use this mechanism
for all of its unfunded liability and asked Representative
Hawker to explain that process.
REPRESENTATIVE HAWKER explained that the bond authority, on
behalf of the community, would issue $25 million in debt. In the
open market that debt would be payable at somewhere between 5
and 6 percent. When the money goes into the pension plan(s) it
would reduce the employer's unfunded past service cost. As a
result, when the actuarial valuation is performed on the plan
the employer's obligation for past service cost would be
reduced. The community would no longer have an unfunded past
service cost. Instead of having an obligation to the pension
plan, it would be substituting a fixed debt to the capital
markets at a little more than 5 percent.
He advised when he first began looking at these vehicles he
asked national investment firms to review the state's overall
financial picture and its $6 billion unfunded pension liability.
Two firms modeled what would happen if the state were to go to
the capital markets and bond out the entire $6 billion liability
and then pay off the debt with a 25 year amortization. Both
indicated that the approximate net present value or real dollar
savings to the pension plan would be in the range of $1.5
billion.
REPRESENTATIVE HAWKER acknowledged that the scenario was just a
model, but it clarifies that there is the potential for saving
the public significant amounts of money in satisfying the
pension obligations.
CHAIR STEDMAN asked for assurance that municipalities have this
option and it is in no way mandatory.
REPRESENTATIVE HAWKER agreed that the bill is strictly
permissive and the decision to pursue such transactions would be
made on a community-by-community basis.
CHAIR STEDMAN questioned whether there have been failures.
REPRESENTATIVE HAWKER responded there have been spectacular
failures, but if the transactions are approached responsibly and
the expectations for returns are realistic this is a reasonable
alternative. The permanent fund is a good solid investment
benchmark that shows that a long-term average return of 8
percent isn't unreasonable. On the other hand, some states have
entered into transactions in order to leverage their pension
plans to remove money from the plans and place it in the general
fund to meet ongoing governmental obligations. He said he would
argue that that is clearly wrong and that action positioned
those states for spectacular failure.
He asserted that it's important to look at successes as well as
failures to make certain that, as the bill is crafted, the
appropriate sidebars are in place to ensure that the
transactions are approached responsibly.
CHAIR STEDMAN referenced the hypothetical instance of an 8
percent return for bonds that are issued and pay between 5 and 6
percent and asked for clarification as to how the money would be
generated.
REPRESENTATIVE HAWKER replied the proceeds of the bond issuance
would be deposited into the pension retirement trusts and would
be invested along with the rest of the pension assets. As has
been demonstrated here in Alaska, the return over time would be
in excess of 8 percent.
1:55:35 PM
CHAIR STEDMAN questioned where the risk lay.
REPRESENTATIVE HAWKER replied the investment risk is that the
state pensions, under the auspices of the ARM Board, could fail
to earn a return that is greater than the cost of the bonds over
the life of the bond issue.
CHAIR STEDMAN asked if success or failure is dependent on swings
in the financial market.
REPRESENTATIVE HAWKER responded market timing is important, but
the value of these transactions is that there is a demonstrated
ability to achieve an 8 percent return over time. Also, the
bonds are contractual obligations so the rate is fixed over the
term of the obligation.
CHAIR STEDMAN noted that he and most others agree that
municipalities are responsible for their own liabilities even
though the state might have to step in at some point if the
liabilities become unmanageable at the local level. He
questioned how municipalities might deal with transactions that
"turn upside down" and how the state treasury might be
obligated.
REPRESENTATIVE HAWKER said he couldn't speak for municipalities,
but many are already turned upside down in terms of ability to
meet their current obligations. He said he does agree that the
PERS liability is an obligation of the municipalities. HB 278
provides a tool for municipalities to help themselves without
increasing risk to the state treasury. Certainly there would be
no more risk than there is now since the retirement plans are
state sponsored and have constitutionally mandated benefits.
CHAIR STEDMAN asked if there has been discussion about including
schools, the university, and the state in addition to
municipalities.
REPRESENTATIVE HAWKER acknowledged, for the record, that the
current administration does not believe that these transactions
are in the state's best interest so it won't be a participant.
On the other hand, individual municipalities have asked about
participation and that is an individual decision as to whether
or not to pursue this in relation to the PERS/TRS liability. The
University of Alaska requested specific authority to be
included, but at Representative Weyhrauch's request, that
authority was removed from the bill in the House Finance
Committee.
He reiterated that this is just one tool that has proven to be
adequately successful in markets outside Alaska and that it's
important to put as many tools as is responsibly possible in
municipal employers' hands.
2:05:27 PM
CHAIR STEDMAN asked if the proceeds from a bond issuance are
turned over to the ARM Board for management.
REPRESENTATIVE HAWKER replied yes; the proceeds would be
invested under the auspices of the investment managers that are
currently managing the state pension investment trusts.
CHAIR STEDMAN asked if the ARM Board would assume increased
risk.
REPRESENTATIVE HAWKER said he couldn't speak for the ARM Board,
but its current investment management structure would be
affected. Simply put, HB 278 would provide additional assets to
invest according to current investment guidelines and policies.
CHAIR STEDMAN questioned whether the ARM Board wouldn't be
doubling its liability if it were paying the bonds off over 20
to 25 years.
REPRESENTATIVE HAWKER admitted he was a bit confused by the
question because the debt to the bond investors would ultimately
be an obligation of the government employer and not an
obligation of the pension trust.
CHAIR STEDMAN agreed and added that everything flows back to the
employer.
REPRESENTATIVE HAWKER said he couldn't see how the obligation to
the capital markets from a municipality would affect the
operation of the trustee that was investing the proceeds.
CHAIR STEDMAN responded the trustee investing the proceeds would
have to deal with asset allocation and the underlying debt
service requirements to pay the bonds off.
REPRESENTATIVE HAWKER respectfully pointed out that the money to
pay off the bonds wouldn't come from the pension trust. The only
cash flow the pension trustees have to manage is the cash flow
required to meet the benefits and obligations under the pension
plans. A municipality's obligation wouldn't be transferred to
anyone; it would remain an obligation of that municipality. The
only obligation the pension trust would have would be to meet
the benefit payments that are part of the pension and retirement
structure.
2:09:05 PM
CAROL SAMUELS, Vice President with Seattle-Northwest Securities
Corporation, testified in support of HB 278 and reported that in
Oregon over 130 municipalities have entered the capital markets
for the purpose of refinancing pension liability.
Responding to Chair Stedman she clarified that this isn't a new
financing; it is a replacement. From a cash flow standpoint, the
bond proceeds would be sent to the system and the obligation to
the system would be satisfied by those bond proceeds. The
municipality would use general fund resources - which it would
otherwise use to pay off the obligation to PERS - to pay off the
bonds. If everything is successful from a reinvestment point of
view, the overall cost to the municipality should go down.
In Oregon the various jurisdictions issued about $5 billion in
POBs over the last four years and the projection is that it will
save more than $1 billion or about 25 percent of the amount that
was borrowed. The projection assumed a reinvestment rate of 8
percent.
She directed attention to page 8 of a PowerPoint presentation
and said it indicates the actual experience of the various
jurisdictions since 2002. Column 2 shows the true interest cost
(TIC) and it indicates that the jurisdictions borrowed from a
low of 4.77 percent in late 2005 to a high of 7 percent in 2002.
The average is between 5 and 5.5 percent. The column at the far
right shows the rate of return for each entity since they
deposited the proceeds. She noted that even the highest
borrowing rate has earned more than the cost of funds, which is
the break even. To the extent that the municipalities earn, on
average, more than 7 percent over the 25-year borrowing period
they will reduce the amount that they would otherwise pay to
PERS.
She summarized that when properly structured POBs can be a
useful tool to municipalities that are faced with significant
cost increases in order to payoff a liability.
2:13:53 PM
SENATOR THOMAS WAGONER asked what would keep a municipality from
getting into the same difficulty again.
MS. SAMUELS replied Oregon had similar difficulties and in 2003
that Legislature approved a rewrite of the system. Originally
the liability was projected to be $17 billion and now it is
projected to be between $5 billion and $6 billion. Certainly the
strong returns in the last few years have helped, but most of
the reduction came through reforms. The system was a defined
benefit system and is now a combination of defined benefit and
defined contribution.
SENATOR WAGONER said Alaska has taken similar steps with its
pension plans, but the real problem is skyrocketing medical
costs here in Alaska compared to other states. The problem here
in Alaska isn't a lack of money it's a problem of ignoring a
solution, he asserted.
2:16:55 PM
REPRESENTATIVE HAWKER agreed that the greatest challenge to the
pension plan, to Medicaid and to workers' compensation is the
explosive unsustainable growth in medical costs. He asked that
this be viewed on its own merit as just one of the many tools
needed to approach the problem.
LARRY SEMMENS, Finance Director for the City of Kenai, stated
support for the work the Legislature has done to address pension
issues. He said he would like to go on record as being in
personal support of HB 278 because it gives municipalities a
tool to deal with an unfunded liability. He emphasized that each
municipality would analyze risk before making the decision to
enter into these transactions and if the borrowing market is at
7.5 percent it's unlikely that any POBs would be issued because
the benefit wouldn't justify the risk.
He said it's unlikely that the moral obligation of the state
would be affected if a municipality were to default on the debt.
It's more likely, he said, that a struggling municipality
wouldn't be able to meet the terms of the issuance in the first
place. Looking at it from the reverse he said he wonders if
there might be an impact on the state if municipalities began
having financial problems due to the dramatic increase in PERS
rates. That is likely because if a municipality were to default
on its PERS obligation the rest of the system would have to
assume that obligation and the State constitutes about two-
thirds of the PERS system.
He urged the committee to give municipalities tools to deal with
their unfunded pension obligations. This is just one of those
tools, he said.
2:21:12 PM
CHAIR STEDMAN asked him to comment as a member of the ARM Board.
MR. SEMMENS reported that the ARM Board has stated that it would
continue to evaluate POBs, but it has not made a recommendation.
CHAIR STEDMAN asked if the ARM Board would return to the
Legislature in January 2007 with a list of recommendations.
MR. SEMMENS replied the ARM Board issued its report on April 18
with recommendations that were identified by three priorities.
One recommendation is embodied in HB 278 and as far as he is
aware, that's the only action the Legislature has taken on those
recommendations. SB 141 tasked the ARM Board with managing the
assets such that they would meet liabilities. He interprets that
to mean that there must be enough assets in the system.
2:24:08 PM
GREGG SUNDBERG, Managing Director with Merrill Lynch, spoke in
support of the bill. He reinforced the notion that this is just
one important tool and in no way is it a fix for the systemic
problem that caused the unfunded liability. Depending on market
conditions this tool can be used beneficially to help reduce the
cost of the unfunded liability that remains after the systemic
problem is addressed.
He cautioned that using POBs would not be appropriate for all
entities because the use of bonds exchanges a soft liability for
a hard liability and some entities aren't in a position to
manage exposure to a hard liability. Clearly some municipalities
in Alaska will benefit more than others and it's likely that the
larger municipalities will benefit more frequently.
In response to questions about prior use of POBs, he advised
that about 160 pension financings have been done in the last
three years and virtually all could be viewed as successes
retrospectively. One measure of success is how the rating
agencies view the risk exposure of these transactions.
Generally, he said, the existing ratings are maintained and
sometimes the rating agency comment is positive relating to use
of POBs. As long as the pension bonds are structured
conservatively so the employer savings is about constant over
time; and as long as conservative actuarial assumptions are used
in the savings calculations; and ask long as POBs are just one
tool of a larger comprehensive pension plan there is every
reason to believe that there would be no impact on ratings.
Identifying the problem, making a systemic fix and implementing
a POB program to lower the cost of the remaining liability is
often viewed as credit positive, he concluded.
2:27:39 PM
SENATOR WAGONER announced that he had a statement to make and he
meant no disrespect to Representative Hawker or others who had
testified. He continued to say that:
As long as ANWAR maintains the current status and as
long as people in Washington and Oregon continue to be
against opening up of ANWAR, I'm going to do
everything in my power, legislatively and personally
to dissuade anybody in Alaska from doing any business
at all with people from Washington, Oregon, and
California.
CHAIR STEDMAN remarked Senator Wagoner isn't alone in that
sentiment.
REPRESENTATIVE HAWKER said he was not unfamiliar with such
comments and he had probably expressed similar opinions in the
past. However, a U.S. Senator once counseled him to be cautious
in taking that approach.
2:30:16 PM
CHAIR STEDMAN announced he would like to hear from the Alaska
Municipal League.
KEVIN RITCHIE, Executive Director of the Alaska Municipal League
(AML), spoke in support of HB 278 and advised that AML passed a
resolution supporting the option to use pension obligation bonds
as a tool.
He agreed that the larger more sophisticated municipalities
would be more likely to use this tool than the smaller
municipalities, but a reason for having the bond bank is to help
smaller less financially sophisticated municipalities. That's an
advantage of the bond bank; it puts packages together for small
communities that go to the bond market.
MR. RITCHIE likened the proposal to refinancing a home mortgage.
The original loan is paid off, a new loan is taken out, and
payments are made to that new debt instrument. The state would
be paid off and with the resulting reduction in liability the
PERS rate would go down. There would be another obligation, but
the idea is that it would be smaller than the obligation to the
state.
Before anyone uses this tool it is important to have the entire
plan outlined by the state regarding how it can address the
issue. The bottom line is that on the local level all citizens
are double constituents. They are city and borough constituents
as well as state constituents and the goal is for the state and
municipalities to work together to get the best deal for
constituents. For some communities, he said, this might be part
of the solution. Some large communities might not make this
choice and some of the smaller communities might have to band
together with other small municipalities to evaluate the use of
this tool.
CHAIR STEDMAN asked if AML and the ARM Board have had
conversations on the unfunded liability issue.
MR. RITCHIE replied they have been working together closely and
although the ARM Board hasn't taken a stand on whether POBs are
a good idea or not, AML looks forward to continuing the working
relationship.
2:36:20 PM
CARL ROSE, Executive Director of the Association of Alaska
School Boards (AASB), stated that AASB is on record as being in
support of the option to use pension obligation bonds. He opined
that the decision to take advantage of this opportunity or not
is a policy call that should be made at the local level. This
would be a partnership at the local level with municipalities
and with the state as well. We'd like the opportunity to take
advantage of this if it serves us well at the local level, he
said.
CHAIR STEDMAN asked if AASB believes this would be a good
mechanism for dealing with the PERS/TRS liability issue.
MR. ROSE replied it could be in some school districts. Clearly,
a school district couldn't act alone; it would be in conjunction
with the local municipalities, but it's at the local level that
the feasibility discussion should take place.
CHAIR STEDMAN remarked that would be a discussion for another
day. because the state shares in the cost of education.
MR. ROSE agreed.
2:39:24 PM
CHAIR STEDMAN suggested that the issue of greater return on the
portfolio would be explored when the bill moved on to the
Finance Committee. Everyone should be comfortable with the risk
inherent and there should be an action plan in the event that
this turns upside down for some municipality.
He told Representative Hawker that he appreciated his comment
that the municipal level PERS/TRS liability is a municipal
obligation.
REPRESENTATIVE HAWKER said if a municipality should avail itself
of this opportunity it would be signing on the line
acknowledging that liability.
CHAIR STEDMAN closed public testimony and noted that he didn't
have a quorum and so he could not take action on HB 278. He
announced that the committee would do so at the next meeting and
further discussion could take place in the Finance Committee.
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