Legislature(2011 - 2012)SENATE FINANCE 532

02/22/2012 09:00 AM FINANCE

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09:04:11 AM Start
09:05:08 AM Financial Update: Public Employees' Retirement System and the Teachers' Retirement System by the Department of Administration and the Alaska Retirement Management Board
10:04:17 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Financial Update on the Public Employees TELECONFERENCED
Retirement System and the Teachers Retirement
System by the Dept. of Administration and the
Alaska Retirement Management Board
<Bill Hearing Canceled>
+ Bills Previously Heard/Scheduled TELECONFERENCED
                 SENATE FINANCE COMMITTEE                                                                                       
                     February 22, 2012                                                                                          
                         9:04 a.m.                                                                                              
9:04:11 AM                                                                                                                    
CALL TO ORDER                                                                                                                 
Co-Chair  Stedman   called  the  Senate   Finance  Committee                                                                    
meeting to order at 9:04 a.m.                                                                                                   
MEMBERS PRESENT                                                                                                               
Senator Lyman Hoffman, Co-Chair                                                                                                 
Senator Bert Stedman, Co-Chair                                                                                                  
Senator Lesil McGuire, Vice-Chair                                                                                               
Senator Johnny Ellis                                                                                                            
Senator Dennis Egan                                                                                                             
Senator Donny Olson                                                                                                             
Senator Joe Thomas                                                                                                              
MEMBERS ABSENT                                                                                                                
ALSO PRESENT                                                                                                                  
Michael   Barnhill,  Deputy   Commissioner,  Department   of                                                                    
Administration;   Angela    Rodell,   Deputy   Commissioner,                                                                    
Treasury  Division,  Department  of Revenue;  Senator  Cathy                                                                    
^FINANCIAL UPDATE:  PUBLIC EMPLOYEES' RETIREMENT  SYSTEM AND                                                                    
THE  TEACHERS'  RETIREMENT  SYSTEM   BY  THE  DEPARTMENT  OF                                                                    
ADMINISTRATION AND THE ALASKA RETIREMENT MANAGEMENT BOARD                                                                       
9:05:08 AM                                                                                                                    
Co-Chair Stedman  indicated that  the meeting  would include                                                                    
an  update  from the  Department  of  Administration on  the                                                                    
financial   status   of   the  state's   Public   Employees'                                                                    
Retirement  System (PERS)  and  Teachers' Retirement  System                                                                    
(TRS), specifically  related to  asset size,  management and                                                                    
fiduciary  oversight, investment  policy, asset  allocation,                                                                    
and  potential investment  performance. He  shared that  the                                                                    
prior meeting  had included a  presentation from  the Alaska                                                                    
Permanent Fund Corporation and  Callan Associates related to                                                                    
future market  performance expectations.  He added  that the                                                                    
meetings were  meant to  be informative  for the  public and                                                                    
the committee;  public testimony  would not be  taken during                                                                    
the meeting.                                                                                                                    
9:06:14 AM                                                                                                                    
MICHAEL   BARNHILL,  DEPUTY   COMMISSIONER,  DEPARTMENT   OF                                                                    
ADMINISTRATION  (DOA),  provided a  PowerPoint  presentation                                                                    
titled:   "Public   Employees'  Retirement   System   (PERS)                                                                    
Teachers' Retirement  System (TRS)  Update" (copy  on file).                                                                    
The purpose  of the  update was  to give  a snapshot  of the                                                                    
current vital statistics of PERS  and TRS. He noted that the                                                                    
presentation was very  similar to the one  provided the past                                                                    
Mr.  Barnhill  pointed to  statistics  taken  from the  2011                                                                    
Comprehensive  Annual Financial  Report (CAFR)  on slide  5.                                                                    
There were  160 PERS member  employers; the State  of Alaska                                                                    
represented  the   largest  employer  and   others  included                                                                    
municipalities,  school districts  and more.  He noted  that                                                                    
due to the reporting method  the 2011 CAFR used numbers from                                                                    
the  2010  actuarial  evaluation; therefore,  numbers  shown                                                                    
were slightly  out of date. The  report showed approximately                                                                    
26,000 retirees,  but the current  number was  slightly over                                                                    
30,000. Additionally, the report  showed about 26,000 active                                                                    
employees;  however, the  current  number was  approximately                                                                    
35,000. Employees  [in the Defined  Benefit (DB)  plan] were                                                                    
spread between three  benefit tiers (Tiers I,  II, and III).                                                                    
He shared  that beginning  July 1,  2006, all  new employees                                                                    
under  the   160  member  employers  were   in  the  Defined                                                                    
Contribution  (DC)   tier  [Tier   IV);  the   total  active                                                                    
employees in  the DC system  were just over  11,000. Between                                                                    
the  two  plans  there   were  approximately  47,000  active                                                                    
employees; 75  percent in  the DB system  and 25  percent in                                                                    
the DC system.                                                                                                                  
9:08:59 AM                                                                                                                    
Mr. Barnhill addressed TRS on  slide 6. There were 58 member                                                                    
employer school districts. He noted  that many of the school                                                                    
districts  were   also  PERS  members.  The   CAFR  reported                                                                    
approximately 10,600 retirees, but  currently the number was                                                                    
closer  to 11,800;  there were  approximately 10,000  active                                                                    
employees.  There was  one DC  tier that  began for  all new                                                                    
employees starting July 1, 2006;  there were just over 2,700                                                                    
active employees in the DC  system. Approximately 79 percent                                                                    
of  the  active employees  were  in  the  DB system  and  21                                                                    
percent fell under the DC system.                                                                                               
Mr.  Barnhill  spoke  to  slide  7  titled  "Basic  Facts  -                                                                    
Organization."  He stated  that  the  structure of  Alaska's                                                                    
retirement system  was different from other  states' because                                                                    
responsibility  for  various  aspects   of  the  system  was                                                                    
divided among  three different organizations.  He elaborated                                                                    
that   under   CalPERS    in   California,   the   benefits,                                                                    
investments, and  management of staff were  all consolidated                                                                    
into one  organization; whereas,  in Alaska,  the Department                                                                    
of Revenue  handled the  investments, the  Alaska Retirement                                                                    
Management  Board  was the  fiduciary  of  the assets  under                                                                    
management, and  DOA was  responsible for  administering the                                                                    
plan  of  benefits  (ensuring  benefits  were  disseminated,                                                                    
paying medical bills, and contracting with the actuary).                                                                        
Mr.  Barnhill directed  attention to  slide 8  titled "Basic                                                                    
Facts  -  Balance Sheet."  He  believed  that a  significant                                                                    
amount  of time  would be  spent on  the unfunded  liability                                                                    
shown  on the  slide.  To determine  unfunded liability  the                                                                    
actuary  computed the  difference between  the value  of the                                                                    
assets  and the  accrued liabilities  (a form  of discounted                                                                    
net present value of all  liabilities the systems would have                                                                    
to  pay between  present-day  and when  the  last DB  member                                                                    
9:11:46 AM                                                                                                                    
Co-Chair  Stedman  asked  for   a  definition  of  the  term                                                                    
"actuarial value." He requested an  estimate of the June 30,                                                                    
2011 market value. Mr. Barnhill  replied that actuaries used                                                                    
a variety  of techniques to smooth  short-term volatility in                                                                    
investment markets. He  detailed that a gain or  loss at the                                                                    
end of the  year was divided by five in  order to smooth the                                                                    
gain over a  five-year period. He shared  that the actuarial                                                                    
value of assets and the  fair value of assets (market value)                                                                    
were  almost  the  same  for June  30,  2011.  The  unfunded                                                                    
liability  was essentially  the  same when  it was  computed                                                                    
based  on actuarial  value of  assets and  on fair  value of                                                                    
Co-Chair Stedman  asked for the  market value.  Mr. Barnhill                                                                    
responded  that as  of June  30,  2011 the  market value  of                                                                    
assets  was  approximately  $11.3 billion;  the  number  was                                                                    
closer to the actuarial value of  assets than it had been in                                                                    
a  long time.  He added  that  the number  had continued  to                                                                    
decline;  Department of  Revenue Deputy  Commissioner Angela                                                                    
Rodell  would   share  data  for   December  31,   2011.  He                                                                    
elaborated that the numbers had  gone down because the third                                                                    
quarter in the calendar year of  2011 was a loss quarter for                                                                    
the plans.                                                                                                                      
9:13:40 AM                                                                                                                    
Mr.  Barnhill communicated  that  as of  June  30, 2011  the                                                                    
unfunded liability  on an actuarial basis  was $6.9 billion;                                                                    
the number was slightly higher  on a market value basis. The                                                                    
TRS actuarial value  of assets was $4.9  billion; the market                                                                    
value  was slightly  lower. The  difference between  the TRS                                                                    
actuarial  value  of  assets of  $4.9  billion  and  accrued                                                                    
liabilities  of   $9.1  billion  equaled  an   unfunded  TRS                                                                    
liability   of  $4.19   billion.  The   funding  ratio   was                                                                    
calculated by dividing assets by  liabilities; the ratio was                                                                    
63 percent  for PERS  and 54 percent  for TRS.  He explained                                                                    
that  funding   ratios  were  used  to   gauge  the  overall                                                                    
financial  health   of  the   system  (whether   there  were                                                                    
sufficient assets  on hand that  would meet  the liabilities                                                                    
as they  came due over the  next 60 years). He  relayed that                                                                    
actuaries  liked to  see a  funding ratio  of 80  percent or                                                                    
higher for  a healthy plan.  He shared that  actuaries would                                                                    
indicate  that the  plans needed  more  funding, given  that                                                                    
they were not close to 80 percent.                                                                                              
Mr.  Barnhill referenced  a  Callan Associates  presentation                                                                    
related to  short-term and  long-term forecasts  on expected                                                                    
investment returns  that had been provided  to the committee                                                                    
the prior day.  The presentation had also been  given to the                                                                    
Alaska  Retirement  Management  Board  (ARMB)  the  previous                                                                    
week. He  referred to discussion related  to Callan's 5-year                                                                    
to 10-year forecast  that an 8 percent  return (the expected                                                                    
earnings  return  assumption  adopted   by  ARMB)  would  be                                                                    
difficult  to impossible  to  meet and  a  7 percent  return                                                                    
would be a challenge.  The systems' actuary Buck Consultants                                                                    
projected  that the  unfunded  liability  would continue  to                                                                    
rise as losses  from FY 09 were smoothed  in. Buck projected                                                                    
that  under  an 8  percent  return  scenario  by FY  21  the                                                                    
unfunded liability  (measured on  an actuarial  value basis)                                                                    
would be  approximately $10.5 billion; the  projected number                                                                    
was  closer  to $12  billion  with  a  7 percent  return  (a                                                                    
difference of approximately  $1.5 billion). Callan projected                                                                    
that 8  percent returns  over the next  30 years  were still                                                                    
9:17:21 AM                                                                                                                    
Co-Chair  Hoffman noted  that the  numbers were  staggering,                                                                    
but asked for verification that  retirees did not need to be                                                                    
frightened by them. Mr. Barnhill  did not disagree; the good                                                                    
news  was   that  the  legislature  had   historically  been                                                                    
committed to  providing responsible support to  the systems.                                                                    
He detailed  that on an  annual basis,  actuaries calculated                                                                    
their  required contribution  (he likened  it to  a mortgage                                                                    
payment). If the actuarially  required contribution was made                                                                    
for the term  of the "mortgage" (ARMB had adopted  a 25 year                                                                    
amortization term) the unfunded  liability would be paid off                                                                    
in  that time.  He stated  that it  was very  promising that                                                                    
that  the legislature  had  made the  payment  on an  annual                                                                    
basis since ARMB's origination  in 2006; therefore, retirees                                                                    
should not be afraid. He  relayed that some legislatures did                                                                    
not  make  their  actuarially required  contribution,  which                                                                    
caused the funding  ratio to decline over time and  led to a                                                                    
threatened fiscal status.                                                                                                       
Co-Chair   Stedman   pointed   out  that   the   state   had                                                                    
approximately $16.7 billion  in assets as of  June 30, 2011,                                                                    
which did not include the  state's liquid savings or the $40                                                                    
billion in  the permanent fund that  constitutionally backed                                                                    
up the liability.  He observed that the state  would have to                                                                    
exhaust its  savings and  the permanent  fund before  it was                                                                    
not able  to meet its  obligations. Mr. Barnhill  agreed and                                                                    
remarked that the  state was blessed with  assets. He shared                                                                    
that the conversation  around the table continued  to be how                                                                    
to  responsibly   continue  to  address  the   issues  while                                                                    
maintaining  the state's  commitments to  other items  (e.g.                                                                    
education,   public   safety,   infrastructure,   government                                                                    
services, etc.).                                                                                                                
9:19:47 AM                                                                                                                    
Mr. Barnhill moved  to slide 9 titled "Basic  Facts - Health                                                                    
Cost  Trends."  The  slide  showed  the  change  in  retiree                                                                    
premium  in  the PERS  and  TRS  healthcare plan  from  1978                                                                    
through 2012 and illustrated the  story of rising healthcare                                                                    
costs in  Alaska, which were the  same as those in  the rest                                                                    
of the country. Premiums had started  at $57 in 1978 and had                                                                    
risen  to $1,200  in 2012;  reflecting  an average  compound                                                                    
growth  of 9  percent  per  year. He  relayed  that DOA  was                                                                    
working to determine  how to change the trend  as the growth                                                                    
was not sustainable.                                                                                                            
Mr. Barnhill  stated that the department  was taking efforts                                                                    
to  implement patient  wellness programs  within the  active                                                                    
plan  in FY  13.  If successful,  the  initiatives would  be                                                                    
rolled out to other parts of  the population, with a goal to                                                                    
ultimately cover the entire population  that would roll into                                                                    
the retiree plans. He stated  that many employers around the                                                                    
county  had  experienced  some success  in  reducing  the  9                                                                    
percent annual  cost growth with  the method.  He elaborated                                                                    
that the state needed  to have conversations with physicians                                                                    
about the  unsustainable nature of  the cost growth  and how                                                                    
they  could develop  a partnership  to make  healthcare cost                                                                    
growth  sustainable for  the state  without bankrupting  the                                                                    
healthcare  industry. The  department was  pleased that  the                                                                    
premium had  only risen  from $1,176 to  $1,200 in  the past                                                                    
year.  The 2  percent increase  reflected efforts  underway;                                                                    
additionally,  historically there  had  been  years of  flat                                                                    
growth followed  by years of double-digit  growth. He shared                                                                    
that  the  challenge  was  to convert  the  flat  growth  to                                                                    
sustainable modest growth.                                                                                                      
9:22:45 AM                                                                                                                    
Mr.  Barnhill turned  to slide  10: "Basic  Facts -  Funding                                                                    
Ratio  History -  PERS/TRS," which  showed  the PERS  funded                                                                    
status  over time.  He  referenced discussions  specifically                                                                    
regarding  2001 to  2002 when  the system  went from  a full                                                                    
funded status down  to less than 80 percent;  the change had                                                                    
prompted litigation  against the state's former  actuary. He                                                                    
explained  that  the funding  ratio  had  remained below  80                                                                    
percent for  some time due to  a number of reasons  and that                                                                    
the  risks were  endemic to  any DB  system. Risks  included                                                                    
investment loss;  there had been four  investment loss years                                                                    
between 2001  and 2012.  He furthered  that during  the time                                                                    
period  ARMB's investment  return assumption  had been  8.25                                                                    
percent  (it  had  recently  been  reduced  to  8  percent);                                                                    
whenever  the return  was below  the  assumption the  system                                                                    
fell  further behind.  He cited  Callan's presentation  from                                                                    
the prior  day and observed  that systems would  continue to                                                                    
struggle with  the issue. Another  reason for  the continued                                                                    
struggle with funded ratio was  that assumptions do not play                                                                    
out as expected; the actuary  projects that healthcare costs                                                                    
would decrease  over time,  but costs  do not  decrease. The                                                                    
actuarial  projection  curve  for cost  growth  had  started                                                                    
close to 9  percent and had declined to 6  percent, where it                                                                    
would remain  for the next  several decades.  The department                                                                    
hoped that  efforts to increase overall  wellness would help                                                                    
the  state reach  the 6  percent  figure in  the future.  He                                                                    
shared  that  mistakes  had  been made  by  the  actuary  in                                                                    
projecting  and  computing  healthcare calculations  in  the                                                                    
1990s;  therefore,  the  state  had under  collected  for  a                                                                    
considerable period  of time and  subsequently it  was still                                                                    
making up for  the under collection. He stated  that the TRS                                                                    
chart was  similar (slide 11),  but the funding  ratios were                                                                    
slightly worse.                                                                                                                 
9:25:37 AM                                                                                                                    
Mr. Barnhill directed attention to  slide 12: "Basic Facts -                                                                    
Contribution  Rates."  He  relayed that  contribution  rates                                                                    
rose  when  funding ratios  declined.  He  discussed how  DB                                                                    
systems  were   funded  and   explained  that   the  actuary                                                                    
discounted  benefits  to  present value  and  computed  what                                                                    
would need  to be collected  at present (from  employees and                                                                    
employers) if  all of the  actuarial assumptions  came true.                                                                    
Historically rates  for PERS and  TRS ranged from  8 percent                                                                    
to 12 percent, but  rates had climbed dramatically beginning                                                                    
in the  early 2000s;  rates had peaked  at above  50 percent                                                                    
for TRS and  above 30 percent for PERS in  2008. As a result                                                                    
the  legislature  had enacted  SB  125  in 2008  to  provide                                                                    
pension  relief  to  municipalities  and  school  districts;                                                                    
additionally,  the TRS  and PERS  rates had  been capped  at                                                                    
12.56  percent and  22 percent  respectively. The  actuarial                                                                    
rate in FY 13  was back up at peak levels  of 54 percent for                                                                    
TRS and 35 percent for PERS.                                                                                                    
Mr.   Barnhill   addressed   slide  13   titled   "Projected                                                                    
Retirement  Population Growth."  The chart  showed that  the                                                                    
ongoing  baby boomer  population retirement  would increase.                                                                    
In 2012  there were  just over  40,000 retirees;  the number                                                                    
would increase  to approximately 60,000 in  the next several                                                                    
years and would subsequently begin to decline.                                                                                  
9:27:57 AM                                                                                                                    
Mr. Barnhill turned  to slide 14 titled  "Big Picture Budget                                                                    
Issues PERS and TRS promises  made." The slide addressed the                                                                    
crux of  the issue  and showed the  benefits that  the state                                                                    
was  constitutionally required  to  pay between  present-day                                                                    
and when  the last DB  member dies (between 2070  and 2080).                                                                    
Beginning  in  2012 the  systems  would  be responsible  for                                                                    
slightly over $1  billion per year; at the end  of the 2020s                                                                    
the systems  would be responsible  for just over  $3 billion                                                                    
per year;  the payment would  cap out at slightly  over $3.5                                                                    
billion in  the 2040s.  The payment would  not dip  below $3                                                                    
billion per  year until  the late  2040s. The  total benefit                                                                    
payments  over  the next  70  years  were $141  billion.  He                                                                    
believed  that although  the amount  was extraordinary,  the                                                                    
systems  were  capable  of  handling  it  when  all  of  the                                                                    
resources   were   considered   (i.e.   contributions   from                                                                    
employees  and employers,  investment  returns, and  general                                                                    
fund assistance).  He acknowledged that issue  was large and                                                                    
one that the state was committed to.                                                                                            
9:29:13 AM                                                                                                                    
Co-Chair  Hoffman asked  if there  was a  chart that  showed                                                                    
what benefit  payment assistance would be  required from the                                                                    
general fund from 2012 to 2080.                                                                                                 
Mr. Barnhill directed the committee  to a chart on slide 21.                                                                    
The chart showed  the different ways the  general fund could                                                                    
be   called  upon   to  provide   necessary  assistance   in                                                                    
fulfilling benefit payments. The  chart encompassed the time                                                                    
period that  it would take  to pay  off the entirety  of the                                                                    
unfunded  liability  assuming  an amortization  term  of  25                                                                    
years.  There  were  two  methodologies  of  amortizing  the                                                                    
unfunded liability.  The first was called  "level percentage                                                                    
of  pay"; one  of  the actuarial  assumptions  was that  pay                                                                    
would increase  by 3 percent  to 4  percent per year  and if                                                                    
payment increased  at about the  same amount the  payment on                                                                    
the unfunded  liability would  increase (represented  by the                                                                    
blue bar  on the chart).  The second form was  called "level                                                                    
dollar";  he equated  the  method to  a  house mortgage  and                                                                    
explained that payments  were equal on a  monthly basis over                                                                    
the course of the 30-year  loan term (represented by the red                                                                    
bar, which  declined slightly due  to movement  of actuarial                                                                    
Mr. Barnhill  furthered that level  percentage of pay  was a                                                                    
more  back-loaded amortization  methodology; payments  would                                                                    
be lower in the beginning  and higher later on. Level dollar                                                                    
was  a  more  front-loaded methodology;  payments  would  be                                                                    
higher  initially   and  lower   later  on.  The   blue  bar                                                                    
(representing the  status quo)  called for  an appropriation                                                                    
from the  general fund under SB  125 of $610 million  for FY                                                                    
13;  the  amount was  included  in  the governor's  proposed                                                                    
budget.  The number  would  increase  to approximately  $870                                                                    
million in  FY 13  (or more  in future  years) if  the level                                                                    
dollar method was adopted.                                                                                                      
9:32:25 AM                                                                                                                    
ANGELA  RODELL,  DEPUTY   COMMISSIONER,  TREASURY  DIVISION,                                                                    
DEPARTMENT  OF  REVENUE,  began  a  review  of  the  current                                                                    
investment  status  in  the   retirement  trust  funds.  She                                                                    
pointed  to  slide  16: "Investments  -  ARMB  Assets  Under                                                                    
Management," which  showed the plan balances  as of December                                                                    
31, 2011. There was approximately  $11.1 billion in the PERS                                                                    
plan; $5.9 billion was in  the Retirement Trust and $4.9 was                                                                    
in  the Retirement  Health  Care Trust.  There  was a  total                                                                    
balance of approximately $4.6 billion  in the TRS plan, with                                                                    
close to $3  billion in the Retirement  Trust. The remainder                                                                    
of the  $19 billion  in total  assets under  management fell                                                                    
under the  Judicial Retirement System,  National Guard/Naval                                                                    
Militia  Retirement System,  Supplemental Annuity  Plan, and                                                                    
the Deferred Compensation Plan.                                                                                                 
Ms. Rodell  moved to  slide 17  titled "Investments  - Asset                                                                    
Allocation." The  slide included two pie  charts showing the                                                                    
actual asset allocation  as of December 31,  2011 versus the                                                                    
target asset  allocation. She detailed that  the majority of                                                                    
the assets  continued to be in  equities (approximately 50.6                                                                    
percent  in domestic  and global  equities); the  number was                                                                    
slightly  higher  than  the  target  allocation,  which  was                                                                    
partially due to manager selections  and timing of purchases                                                                    
and  settlements. She  communicated  that there  was also  a                                                                    
large portion  of assets invested  in fixed income  and real                                                                    
9:34:12 AM                                                                                                                    
Ms. Rodell explained that slide  18 titled "Investments - US                                                                    
Stock   Market  Historical   Returns"  provided   historical                                                                    
returns and  highlighted comparisons between the  years 2008                                                                    
through  2011. She  added  that losses  and  gains would  be                                                                    
smoothed  out  over  a five-year  period.  Slide  19  titled                                                                    
"PERS/TRS  Annualized  Returns"  showed  annualized  returns                                                                    
through  June 30,  2011. She  communicated  that the  1-year                                                                    
annualized  return  was  21.1  percent  for  PERS  and  21.3                                                                    
percent for  TRS, with an  average return of  21.27 percent;                                                                    
the  target  return was  21.62  percent  (slightly over  the                                                                    
realized returns).  She shared  that the  10-year annualized                                                                    
return  was 5.43  percent for  PERS, with  a target  of 5.67                                                                    
Co-Chair  Stedman  requested  a historical  10-year  rolling                                                                    
projection of returns recommended  by Callan compared to the                                                                    
market value.  He observed  that targeted  returns continued                                                                    
to be  unattainable over time.  He referred to  a discussion                                                                    
from the prior day that  market returns would potentially be                                                                    
around 7 percent;  whereas, the target return  was 8 percent                                                                    
(reduced  from   8.25  percent,  which  the   committee  had                                                                    
expressed  concern about  for the  past several  years). Ms.                                                                    
Rodell  responded that  the requested  information would  be                                                                    
provided to the committee.                                                                                                      
9:37:02 AM                                                                                                                    
Mr.  Barnhill   referred  to  Callan's  7   percent  10-year                                                                    
projection  and  explained  that   Callan  had  an  imbedded                                                                    
inflation  assumption   of  2.5  percent;   however,  ARMB's                                                                    
imbedded  inflation  assumption  was 3.12  percent  (not  as                                                                    
bullish). When Buck had run  the numbers it had not adjusted                                                                    
the inflation  assumption down  to Callan's;  its projection                                                                    
had only  included a  7 percent market  return (versus  an 8                                                                    
percent  scenario), which  would  result in  a $1.5  billion                                                                    
liability  in  FY  21. He  communicated  that  the  unfunded                                                                    
liability would be adjusted down  if inflation was less than                                                                    
3.12 percent. He  was reluctant to suggest  that the actuary                                                                    
should  reduce  its   inflation  assumption  because  Callan                                                                    
expected  inflation to  rise at  some  point. He  elaborated                                                                    
that Callan had indicated that  given the amount of economic                                                                    
stimulus funds  spent in the  U.S. and  worldwide, logically                                                                    
inflation  would   rise.  He  concluded  that   2.5  percent                                                                    
inflation seemed more  bullish than was wise  in a long-term                                                                    
9:38:59 AM                                                                                                                    
Co-Chair Stedman  believed it would be  helpful to calculate                                                                    
historic  projections  without  the  inflation  numbers.  He                                                                    
understood  the purpose  of the  inflation assumptions,  but                                                                    
the  committee was  primarily  concerned  about the  targets                                                                    
that  were not  met.  He asked  for  historical real  return                                                                    
expectations   for  the   asset  allocation.   Mr.  Barnhill                                                                    
acknowledged the request.                                                                                                       
Mr.  Barnhill   turned  back  to  slide   21  titled  "State                                                                    
Assistance (SB  125)" and reiterated that  the legislature's                                                                    
commitment  to  either  method of  amortizing  the  unfunded                                                                    
liability (shown  with red  and blue  bars) was  critical to                                                                    
health of the PERS and TRS systems.                                                                                             
Co-Chair Hoffman shared concern  that without a major change                                                                    
in  the  state's  revenue stream  it  could  potentially  be                                                                    
facing  a  deficit and  subsequently  a  major reduction  in                                                                    
services  by  2020. He  pointed  out  that state  assistance                                                                    
continued  to rise  in the  status quo  method (blue  bar on                                                                    
slide 21). Mr. Barnhill agreed.                                                                                                 
9:41:23 AM                                                                                                                    
Mr. Barnhill shared  that the dynamic of the  demands on the                                                                    
general fund  increasing to above  $1 billion over  time had                                                                    
been a grave concern  to executive and legislative branches.                                                                    
In the  fall of  2010 the  Legislative Finance  Division had                                                                    
asked ARMB to  look at the issue and  to provide information                                                                    
and  options for  consideration. As  a result  ARMB compiled                                                                    
40-plus   unfunded  liability   scenarios   (slide  23)   by                                                                    
adjusting  five different  "levers." He  expounded that  the                                                                    
unfunded liability was  a "soft" liability and  there were a                                                                    
variety of ways to  pay it off (it could be  paid off all at                                                                    
once  or  over  time).  The first  lever  was  "amortization                                                                    
methodology"; the  two principal  forms of  methodology were                                                                    
level  dollar (front  loaded) and  level  percentage of  pay                                                                    
(back loaded). The second lever  was "amortization term." He                                                                    
relayed  that ARMB  was  currently  amortizing the  unfunded                                                                    
liability over a  25-year period; it had also  looked at 30-                                                                    
year  and 40-year  amortization schedules.  The third  lever                                                                    
was "cash infusion,"  which had been a  topic of significant                                                                    
discussion in  the legislature; the scenario  addressed what                                                                    
would happen  to the liability if  a lump sum was  paid down                                                                    
(e.g. $2 billion).                                                                                                              
Mr.  Barnhill looked  at the  fourth lever  "continuation or                                                                    
discontinuation   of   state   assistance."   The   scenario                                                                    
addressed  what  would  happen if  the  annual  payment  was                                                                    
discontinued.  The  fifth  lever was  "additional  municipal                                                                    
participation,"  which  looked  at increasing  the  employer                                                                    
rate cap from 22 percent to  24 percent. The actuary had run                                                                    
the  40-plus  scenarios  and had  measured  the  outputs  in                                                                    
various ways.                                                                                                                   
9:44:34 AM                                                                                                                    
Mr.  Barnhill continued  that primary  measurements included                                                                    
how much it would cost  participants to pay off the unfunded                                                                    
liability,  the payoff  date, amount  the  state would  pay,                                                                    
amount  the  municipalities  would pay,  and  the  near-term                                                                    
burden  (in  percentage  terms)  on  the  general  fund.  He                                                                    
referenced  a spreadsheet  [State of  Alaska PERS  Financial                                                                    
Projections   (in   thousands)]    showing   the   actuarial                                                                    
measurements  from  FY  11  to  FY 71  (copy  on  file).  He                                                                    
believed the exercise was useful  and showed that there were                                                                    
a variety of  responsible ways that the status  quo could be                                                                    
adjusted.  In   December  2011  ARMB  passed   a  resolution                                                                    
recommending the  legislature to consider  certain scenarios                                                                    
and discard  others (the recommendation did  not prevent the                                                                    
legislative  or   executive  branches  from   continuing  to                                                                    
consider  the  scenarios).  He   noted  that  the  work  had                                                                    
culminated in pending legislation that  would be taken up by                                                                    
the committee at a later date.                                                                                                  
9:46:38 AM                                                                                                                    
Senator  Thomas asked  about  the  relationship between  the                                                                    
actuarial  assumption,  annualized   returns,  and  unfunded                                                                    
liability. He referenced issues  associated with all pension                                                                    
plans  (e.g. recessions  caused  all plans  to decline).  He                                                                    
referred to  the current situation  of many  ERISA [Employee                                                                    
Retirement Income Security Act]/  Taft Hartley plans; he was                                                                    
not aware of any that were  underfunded to the extent of the                                                                    
Alaska plans.  He wondered why  the state would  continue to                                                                    
have an  actuarial assumption; Taft Hartley  plans actuarial                                                                    
assumptions were directed by the  federal government. He was                                                                    
skeptical that  projections would  be realized based  on the                                                                    
historical returns  that were 3 percent  less than actuarial                                                                    
Mr. Barnhill  responded that he  did not have  any expertise                                                                    
in  Taft Hartley  plans. He  was aware  that the  assumption                                                                    
regarding  investment  return  for   ERISA  plans  was  more                                                                    
tightly controlled;  it was  similar to  a riskless  rate of                                                                    
return in the  4 percent to 5 percent range.  He stated that                                                                    
ARMB could adopt  a comparable riskless rate  of return; the                                                                    
topic had  been a subject  of debate around the  country. He                                                                    
relayed  that  a Chicago  professor  named  Joshua Rauh  was                                                                    
calling on  public pension  plans to  reduce their  rates of                                                                    
return from  8 percent down  to the  4 percent to  5 percent                                                                    
range. He  reminded the  committee that  a reduction  to the                                                                    
rate  of  return  assumption  would  increase  the  unfunded                                                                    
liability;  if the  number was  dropped  to 4  percent or  5                                                                    
percent  the  unfunded  liability would  essentially  double                                                                    
from $11  billion up  to $22 billion.  He furthered  that if                                                                    
the  liability increased  to  $22  billion the  contribution                                                                    
rate would double;  it would be over 100  percent of payroll                                                                    
for TRS  and around  60 percent of  payroll for  PERS. Rates                                                                    
had been capped; therefore, pressure  would not be placed on                                                                    
municipalities and  school districts (rates would  remain at                                                                    
22 percent and 12.5 percent  respectively), but it would put                                                                    
a huge  demand on the  general fund  under SB 125.  The $610                                                                    
million figure would increase sharply.                                                                                          
Senator  Thomas  understood,  but  reiterated  his  concerns                                                                    
about going forward  with unrealistic actuarial assumptions.                                                                    
He  speculated  that  the unrealistic  assumptions  probably                                                                    
existed 20 years earlier.                                                                                                       
9:50:59 AM                                                                                                                    
Co-Chair Stedman  asked the department  to have  the actuary                                                                    
run  scenarios  using  4  percent up  to  8  percent  return                                                                    
assumptions. Mr.  Barnhill agreed. He relayed  that Buck had                                                                    
recently  begun  running  a   sensitivity  analysis  in  its                                                                    
valuations  using 7  percent and  9 percent  assumptions. He                                                                    
noted that Senator Thomas's point  was well taken; the state                                                                    
was between  a rock and  a hard place  and the time  to have                                                                    
adopted lower  return assumptions would  have been 25  to 30                                                                    
years earlier.                                                                                                                  
Senator McGuire stated that it  would be difficult to double                                                                    
the unfunded liability from a  political standpoint, but she                                                                    
believed  it was  related  to  how the  state  got into  the                                                                    
"mess" to  begin with. She  recalled when the  situation had                                                                    
begun unfolding in the past;  part of the problem had arisen                                                                    
from  bad advice,  but there  had also  been some  political                                                                    
sensitivity  related  to  the size  of  the  liability.  She                                                                    
furthered that the returns were  4.3 percent and 5.4 percent                                                                    
and  were  not  close  to  the  8  percent  assumption.  She                                                                    
believed it was incumbent upon  the state to lay the current                                                                    
facts  out,  which  she  hoped   would  lead  to  thoughtful                                                                    
solutions.  The  committee  had  proposed  a  cash  infusion                                                                    
methodology and other  solutions included pension obligation                                                                    
bonds. She stressed  the importance of laying  out the facts                                                                    
in order to reach the  needed solution. She asked Ms. Rodell                                                                    
to  provide  her opinion  on  the  status quo  versus  level                                                                    
dollar methods shown on slide  21. Ms. Rodell replied it was                                                                    
important to recognize that the  state had continued to fund                                                                    
the arc.  She preferred the  level dollar method  that would                                                                    
allow the state to pay  down liabilities while the resources                                                                    
existed  versus  later  when it  could  be  more  difficult.                                                                    
Additionally,  the state  would receive  more credit  in the                                                                    
national market for taking care of its liabilities quicker.                                                                     
9:54:41 AM                                                                                                                    
Co-Chair Hoffman  discussed that the state  paid costs above                                                                    
22 percent  for PERS and  12.5 percent for TRS.  He wondered                                                                    
whether  other  states  provided  financial  assistance  for                                                                    
their retirement  programs. Mr. Barnhill was  unsure, but he                                                                    
was  aware  of   other  states  that  did   not  make  their                                                                    
actuarially required  contribution. He sensed  that Alaska's                                                                    
magnitude  of  general  fund   assistance  was  unusual.  He                                                                    
communicated  that a  number of  states were  included in  a                                                                    
disturbing trend  that involved cutting benefits  to current                                                                    
retirees in  order to  fully fund  their systems.  He shared                                                                    
that in Colorado and Minnesota  the courts had sustained the                                                                    
benefit  cut, which  involved  a reduction  in  the cost  of                                                                    
living adjustment.                                                                                                              
Co-Chair  Hoffman  queried  why  the state  had  elected  to                                                                    
provide  the  assistance.  Mr. Barnhill  answered  that  the                                                                    
state chose  to provide  the assistance in  order to  do the                                                                    
responsible  thing.  Additionally,  under  the  Diminishment                                                                    
Clause of  the Alaska  Constitution, the state  was required                                                                    
to pay all of the benefits when due.                                                                                            
Co-Chair  Hoffman  agreed  that  state  assistance  was  the                                                                    
responsible  action. He  surmised  that some  municipalities                                                                    
would  have gone  bankrupt if  assistance was  not provided.                                                                    
Mr. Barnhill agreed.                                                                                                            
Co-Chair  Hoffman  asked whether  the  state  had the  legal                                                                    
responsibility  to  provide   the  benefit  assistance.  Mr.                                                                    
Barnhill stated that there were  a variety of ways to handle                                                                    
the situation. Following SB 125  was one responsible way and                                                                    
there  were  a  number  of others.  He  observed  that  some                                                                    
municipalities  may  be  at their  contribution  limit,  but                                                                    
there were others that could probably contribute more.                                                                          
9:57:48 AM                                                                                                                    
Co-Chair  Stedman recalled  that there  had been  discussion                                                                    
regarding   the   department's   inability   to   accurately                                                                    
calculate  potential  liability  sharing  between  different                                                                    
municipalities; therefore,  to avoid lengthy  litigation and                                                                    
significant insolvencies  in various communities,  the state                                                                    
had stepped in and had  taken responsibility for costs above                                                                    
22 percent.  He shared  that 22  percent had  been set  as a                                                                    
negotiated amount in order make  municipalities aware of the                                                                    
problem,  but  to avoid  pushing  them  into insolvency.  He                                                                    
believed it  was incumbent  on the committee  to use  all of                                                                    
the  resources that  the  state had  available  in order  to                                                                    
protect  communities and  retirement plan  participants from                                                                    
diminished benefits.                                                                                                            
Co-Chair Hoffman  asked how much the  assistance was costing                                                                    
the state  and whether it would  increase substantially. Mr.                                                                    
Barnhill responded that to date,  under SB 125 the state had                                                                    
paid approximately  $2 billion  between 2007 and  2012 split                                                                    
evenly between  PERS and  TRS. He  shared that  within state                                                                    
assistance provided  to PERS, the state  and university paid                                                                    
approximately 60 percent of  payroll and municipalities paid                                                                    
40 percent. He  elaborated that the state,  as the employer,                                                                    
was responsible  for $600 million  out of $1  billion; about                                                                    
$400 million had  been paid on behalf  of municipalities and                                                                    
about  $1 billion  paid on  behalf of  school districts.  He                                                                    
pointed  to the  blue  bars  [status quo]  on  slide 21  and                                                                    
relayed  that  the  state  would  be  responsible  for  $610                                                                    
million in FY 13, peaking at  $1 billion in 2025 (the figure                                                                    
would be divided  in half between PERS and TRS  and the same                                                                    
60/40 percent split was used for PERS).                                                                                         
10:00:27 AM                                                                                                                   
Senator Egan  asked for  detail on  assumptions used  in the                                                                    
projections.  For example,  he wondered  whether assumptions                                                                    
included an  annual 10 percent healthcare  increase into the                                                                    
future. Co-Chair  Stedman asked  for a brief  response, with                                                                    
follow up at  a later time. Mr. Barnhill  explained that the                                                                    
assumptions  had  been  adopted   by  ARMB.  The  board  was                                                                    
required  to do  an experience  study every  four years;  at                                                                    
that  time  the  actuary  and secondary  actuary  looked  at                                                                    
assumptions and  made recommendations  to the board.  He was                                                                    
unsure where the 10 percent  inflation figure had come from.                                                                    
He explained  that the  health cost  trend graded  down over                                                                    
the  course of  100  years; the  actuarial assumption  going                                                                    
forward was 6  percent growth for the  next several decades.                                                                    
The  actual  premium  growth  in recent  years  had  been  9                                                                    
percent  (shown on  slide 9);  there had  been a  flattening                                                                    
down to 2 percent in the  past year (the past 3-year average                                                                    
was  around 8  percent). The  change was  promising, but  he                                                                    
believed it  was premature to  say that the growth  had flat                                                                    
lined at 6 percent.                                                                                                             
Co-Chair Stedman felt the 0  percent change in 2007 and 2008                                                                    
was optimistic  (slide 9). Mr.  Barnhill responded  that the                                                                    
figures were based on the  claims experience. He shared that                                                                    
in  the  early  1990s  there  had  been  talk  of  federally                                                                    
regulated  healthcare (the  "Hilary Clinton"  plan); he  had                                                                    
heard  (but  did not  know)  that  the health  industry  had                                                                    
unilaterally  flat lined  its cost  growth during  that time                                                                    
period. The  department was  focused on  sustainable trends;                                                                    
the  current trend  continued  to be  9  percent. The  state                                                                    
would like to  get to the actuarial trend of  6 percent, but                                                                    
it was not there yet.                                                                                                           
10:03:37 AM                                                                                                                   
Co-Chair  Stedman stated  that conversations  would continue                                                                    
as  the state  worked to  find  a solution  to the  unfunded                                                                    
retirement  liability.  He  reviewed   the  agenda  for  the                                                                    
following day.                                                                                                                  
10:04:17 AM                                                                                                                   
The meeting was adjourned at 10:04 a.m.                                                                                         

Document Name Date/Time Subjects
2011 AK Proj PERS TRS Callan 7%.pdf SFIN 2/22/2012 9:00:00 AM
Retirement System Presentation to Senate Finance (Feb22-2012).pdf SFIN 2/22/2012 9:00:00 AM
Rodell to SFC 3-1-2012.pdf SFIN 2/22/2012 9:00:00 AM
Overview: PERS and TERS