Legislature(2013 - 2014)HOUSE FINANCE 519
01/27/2014 01:30 PM House FINANCE
| Audio | Topic |
|---|---|
| Start | |
| Presentation: Pers/trs: History and Current Situation: Legislative Finance Division | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
HOUSE FINANCE COMMITTEE
January 27, 2014
1:36 p.m.
1:36:39 PM
CALL TO ORDER
Co-Chair Austerman called the House Finance Committee
meeting to order at 1:36 p.m.
MEMBERS PRESENT
Representative Alan Austerman, Co-Chair
Representative Bill Stoltze, Co-Chair
Representative Mark Neuman, Vice-Chair
Representative Mia Costello
Representative Bryce Edgmon
Representative Les Gara
Representative David Guttenberg
Representative Cathy Munoz
Representative Steve Thompson
Representative Tammie Wilson
MEMBERS ABSENT
Representative Lindsey Holmes
ALSO PRESENT
David Teal, Director, Legislative Finance Division;
Representative Jonathan Kreiss-Tomkins.
SUMMARY
^PRESENTATION: PERS/TRS: HISTORY AND CURRENT SITUATION:
LEGISLATIVE FINANCE DIVISION
1:37:23 PM
Co-Chair Austerman discussed the agenda. He stated that the
goal was to gain a baseline understanding of why the
state's unfunded retirement liability had gotten to its
current level.
DAVID TEAL, DIRECTOR, LEGISLATIVE FINANCE DIVISION,
provided a PowerPoint presentation titled "A discussion of
Retirement Systems in Alaska" (copy on file). He noted that
the slides had been prepared for the Senate Finance
Committee over the prior interim. The focus was on the
health of Alaska's retirement systems; the presentation was
an assessment of the situation aimed at helping people to
decide whether action was necessary. He detailed that the
presentation was the second of a three part series on
retirement issues; the first part related to an in depth
history of the issue and the third part pertained to the
discussion of options. The discussion of options would be
left for a future meeting. He pointed to the complexity of
the issue and recognized that members' understanding of the
issue varied. He explained that much of the later material
built upon the earlier material. He remarked that Pete
Ecklund, staff to Representative Alan Austerman was a
significant benefit to the committee because he had been
involved in changes to the system that had occurred more
than five years earlier.
1:41:04 PM
Mr. Teal pointed to slide 2 and addressed the questions
"Are Alaska's Public Employee Retirement Systems Healthy?"
and "If not, what can be done about it?"
Mr. Teal communicated that the answer to the first question
was no. He shared that the presentation would detail what
had led him to the conclusion. He planned to talk about
actuarial concepts and policy guidelines. The focus was on
the Public Employees' Retirement System (PERS), but much of
the information applied to the Teachers' Retirement System
(TRS), and the Judicial Retirement System (JRS). The
discussion would be limited to the Defined Benefit (DB)
plans.
Representative Edgmon addressed the first question on slide
2 and agreed that the retirement system was unhealthy.
However, he believed it bore comparison to some of the
worst case scenarios around the country (e.g. Illinois,
Detroit, and other) where pension shortfalls were beyond
the reach of the local economies. He remarked on the
state's AAA bond rating. He noted that although the
liability was around $11 billion to $13 billion, it could
be argued that it was still in the state's reach to correct
over time; whereas other states may not have the same
option.
Mr. Teal answered that the assessment was accurate. He
elaborated that some systems throughout the U.S. were
healthier than Alaska's and some were less healthy. The
current liability was quite high; however, it was
advantageous that Alaska had closed its DB system and that
it was no longer accruing unfunded liability on what was
becoming a larger and larger share of the state's payroll.
He detailed that Defined Contribution (DC) employees
currently accounted for approximately 30 percent or one-
third of the payroll.
Mr. Teal addressed slide 3 titled "System health refers to
the likelihood that the promised benefits will be paid when
due" [Note: slide 3 is missing from the presentation's
electronic document]:
· Defined Contribution (DC) Plans
o No promised benefit level
o So not measure of health required
· Defined Benefits (Mr. Boyle) Plans
o Promised benefits (pensions)
o So it is critical to track and maintain
system health
Mr. Teal expounded that under DC plans the employer paid a
percentage of payroll into an individual retirement
account-type setup. The employer made no promises about
what the accounts would be worth in future years; the
employee bore the risk that the account would have the
ability to provide sufficient income for retirement. He
stated that because system health referred to the
likelihood that money would be on hand to pay promised
benefits, it did not make sense to discuss the health of DC
plans, given that there was no risk that the system would
be unable to pay promised benefits.
Mr. Teal relayed that under the DB plan employers typically
contributed a percentage of payroll and often the costs
were similar to the time when contributions were made. He
discussed that the defining attribute of the DB plan was
that the employer promised to pay retirees a pension. The
employer bore the risk and responsibility of ensuring that
benefits could be paid when due.
1:46:37 PM
Mr. Teal addressed slide 4 titled "Measuring the Health of
a Retirement System":
1. Funding Ratio = Assets/Liabilities.
2. Unfunded Liability--just a dollar amount; not a
relative measure.
3. Are employers paying the actuarially required
contribution (ARC)?
4. Are the contributions causing financial stress?
Mr. Teal explained that measuring the health of a
retirement system used to be easy. Employees accrued
pension benefits as they worked and accrued benefits were
an accounting liability to the system. He detailed that
when the funding ratio (assets/liabilities) was 100 percent
or more the system was fully funded, meaning there were
sufficient assets on hand to pay all anticipated future
benefits. The funding ratio was measured at a specific
point in time (typically annually) and was a common way of
measuring health and comparing systems.
Mr. Teal addressed the second measure on slide 4: unfunded
liability. The unfunded liability was the dollar amount
owed; whereas the funding ratio provided the number in a
percentage (the terms were almost interchangeable). He
relayed that the state had an unfunded liability of
approximately $7.5 billion or approximately 61 percent of
the assets required to pay benefits in PERS.
Representative Gara understood that under the Alaska
Constitution the state could not change benefits for DB
retirees. He shared that he was a Tier II employee and
wondered whether there was an option for changing the ratio
for what he and the state paid towards retirement. He asked
if the change would not be allowed because benefits would
be impacted.
Mr. Teal replied that many other states were facing
problems paying their benefits. One solution to the problem
was to change the level of benefits. He relayed that in
most states, including Alaska, the issue was constitutional
and the state was not allowed to reduce benefits
unilaterally. He elaborated that some states had tried
reducing benefits, but most had moved forward with the
implementation of a new tier that applied to employees
hired after a set date. Alaska had switched to a DC plan;
therefore it did not have many options for new tiers for
the DB plans. He reiterated his earlier testimony that the
state was not allowing any additional people into the DB
system; therefore there was no reason to implement a new
tier that would change the benefits people receive.
Representative Costello noted that the unfunded liability
was usually discussed as $12 billion. She asked if the $7.5
billion figure used in the presentation was limited to
PERS. Mr. Teal replied in the affirmative.
Representative Munoz stated that the unfunded liability had
"exploded" since the implementation of the DC plan. She
asked for underlying factors contributing to the dramatic
increase since 2006. Mr. Teal replied that much of his
presentation focused on providing factors contributing to
the liability. He would address the items throughout the
presentation.
1:51:13 PM
Representative Guttenberg asked if anyone was tracking
health care for the new DC system. Mr. Teal replied in the
affirmative. He stated that there was no reason to track an
individual retirement account; however, there was
technically a hybrid plan for health care. He detailed that
the health portion of the DC plan was actually a DB plan;
employees were promised health benefits regardless of the
cost or cost change. The presentation simplified the issue
and referred only to the retirement portion of benefits.
Representative Guttenberg was concerned that a future
legislature may try to look back for information that had
not been tracked.
Co-Chair Stoltze remarked that the Alaska Supreme Court had
interpreted that the Alaska Constitution prohibits a change
to benefits. He stated that that the court ruling was broad
and he could not find a section on pensions and benefits.
He was interested in obtaining more information on the
topic in order to better explain it. He believed the
legislature had relied on the court ruling, but the
legislature could not expect the Alaska Court System to
come explain it. He remarked that the legislature only
heard from the court system once a year. He opined that it
was difficult to have a conversation about how the state
got to the specific place. He did not have a clean
understanding of the court case. He discussed that
Lieutenant Governor Treadwell had tossed out an initiative
related to appropriation on the advice of an assistant
attorney general. He observed that the Alaska Supreme Court
was allowed to appropriate all of the time. He stated that
the constitution was explicit on appropriation powers. He
made a remark about a fishing issue. He believed the courts
had been very aggressive in directing appropriations.
1:55:21 PM
Co-Chair Stoltze noted that it would be much easier talking
to constituents if the legislature had a better
understanding of what the Alaska Supreme Court was
directing.
Mr. Teal agreed that the topic was not simple. He referred
to other states that had tried to reduce benefits on
constitutional grounds; some had won and others had lost.
He discussed Alaska's Supreme Court ruling that made it
clearer but, there were issues related to how much money a
state had and whether it could continue to pay benefits.
Co-Chair Stoltze remarked that he had been told the Alaska
Supreme Court made political decisions occasionally.
Representative Gara pointed to Article 12, Section 7 of the
Alaska Constitution and read that "accrued benefits to
these systems shall not be diminished or impaired."
Co-Chair Austerman asked for the page number.
Representative Gara referred to page 37, Article 12,
Section 7 under Retirement Systems.
Mr. Teal added that the definition of "accrued" was not
provided. He stated that different definitions of the term
would provide for different outcomes; the issue had been
decided differently in various states.
Mr. Teal continued to address slide 4. He relayed that a
funding ratio of 100 percent did not provide a guarantee of
long-term health. He elaborated that most systems had a
funding ratios near, at, or above 100 percent during the
1990s due to a decade of relatively high interest rates
resulting in solid asset growth. He detailed that low
contribution rates played a part in the situation in the
1990s. He elaborated that in many cases when systems were
healthy the response was an expansion of benefits. He
stated that fortunately for the treasury, Alaska did not
expand benefits when it had experienced funding ratios at
100 percent. Alaska had reduced benefits when other states
had been expanding them. He would address the third and
fourth measures of health shown on slide 4 later in the
presentation.
1:59:24 PM
Mr. Teal moved to slide 5 "PERS Assets and Liabilities."
The graph showed assets and liabilities in the funding
ratio beginning in 2002. He noted that the graph's dark
line represented assets, the dotted line represented
liabilities and the blue line represented the funding
ratio. The state had been at a 100 percent funding ratio
for a lengthy period of time; however, a $2.5 billion gap
occurred in 2005. The gap caused the funding ratio to fall
from 100 percent to 75 percent in one year's time. He did
not have concern about the upward trend in liability. He
explained that an upward trend was expected because there
were typically more workers earning more money and
accumulating more health and pension benefits as time
passed. He reiterated that Alaska had not increased
benefits when the funding ratios were high and its benefits
were not extraordinarily generous. He pointed out that
Alaska was one of three states that included health costs
in its unfunded liability funding-ratio calculation. The
state was relatively better off than numbers showed. He
stressed that investments must perform as expected for the
system to function optimally.
Mr. Teal relayed that slightly over one-third of the
state's unfunded liability was due to health costs. He
advised against making a comparison to other systems. He
communicated that the health costs should be included in
computations if the state expected to pay them. The purpose
of measuring system health was to obtain an honest
assessment of the situation, not to make a system look
better in comparison to others. Alaska did include the
health costs in the calculation. He reiterated that the
state should not be concerned with the upward trend of the
liability curve. The problem was that assets were supposed
to keep pace with the liability curve; however, that had
not been occurring. He shared that it could be read as the
funding ratio declining or as an increasing gap. He relayed
that issue was not typically a problem because as payroll
and benefit accrual increased so did contributions (with
little or no change in rates). He emphasized that
everything was fine in a DB system as long as investments
performed as expected. He stated that the pertinent
question related to how the systems in Alaska and most
other states had become so unhealthy in such a short time
period.
2:03:41 PM
Mr. Teal shared that the answer was that unfunded liability
was the consequence of assumptions that failed to
materialize (slide 6). He referred to the defining
attribute of a DB plan that employers bore the risk of
system health. He detailed that unfunded liability was a
consequence of risk becoming reality. There was trouble
when earnings did not meet assumptions. He reiterated that
in one year the state had gone from a funding ratio of 100
percent down to 75 percent and a $2.5 billion unfunded
liability. There were two sides to the risk. First,
liability was a moving target. If any circumstance
increased benefits to a greater than expected value (e.g.
life expectancy or health care costs), the funding ratio
declined and unfunded liability appeared. He noted that the
state's legal case against its former actuary Mercer
represented an example of utilizing outdated assumptions
that had understated the state's accrued liability. With
the adoption of better assumptions, the accrued liability
increased.
Mr. Teal moved to a chart on slide 7 that showed a sudden
increase in accrued liability. He explained that
approximately half of the gap was due to an understatement
of the state's accrued liability. The state had sued Mercer
and had received a $0.5 million settlement; consequently
the assumptions had been fixed. He stressed that assets
could fail to keep pace with liabilities even if benefits
followed assumptions; this had occurred at the same time
that benefit assumptions were revised. Half of the $2.5
billion gap was due to incorrect assumptions and half was
due to investment losses.
2:06:55 PM
Representative Gara mentioned how the system had been
designed. He pointed to skyrocketing healthcare cost
increases and wondered if the state would be close to fully
funded in the absence of such significant healthcare costs.
Mr. Teal answered that healthcare costs accounted for
approximately one-third of the unfunded liability because
assumptions had been inaccurate. However, it was difficult
to separate healthcare costs from life expectancy and other
assumptions that had understated liability. He agreed that
the unfunded liability would have been lower if healthcare
costs had not increased; however, DB systems were designed
to automatically fill the gap over an amortization period.
The gap was filled by making small adjustments to rates;
the strategy had always worked in the past. He explained
that actuaries calculated health care costs, the amount of
benefits expected to be earned, and the total expected to
be paid in benefits for the upcoming year. He expounded
that assuming the goal was to remain at a funding ratio of
100 percent, assets would need to increase by the same
amount as the change in accrued liability.
2:10:01 PM
Mr. Teal moved to an Excel spreadsheet shown on slide 8,
related to how volatility of investment returns affects
unfunded liability. The spreadsheet included a simplified
actuarial model that assumed beginning assets of $12
billion and $12 billion in liabilities, which meant a
funding ratio of 100 percent (the retirement funding ratio
had been at 100 percent in 2004). He walked through the
scenario and discussed how accrued benefits liabilities,
earnings, and employee contributions impacted the assets
and liabilities. The trouble is that contributions were
determined based on an earnings estimate that was assumed
in advance. He provided another example with lower earnings
and the same contribution rate, which resulted in an
unfunded liability. He elaborated that the liability was
not a significant problem if returns were higher some years
and lower others. He pointed to the normal contributions
rate that generated sufficient assets provided that
assumptions come true; unfunded liability was generated
when the assumptions did not come true. He shared that an
unfunded liability could be covered through past service
costs; a sum was recovered during an amortization period of
25 years. He added that the liability did not necessarily
need to be recovered over the 25-year period because the
unfunded liability could go away if a higher return was
earned; as long as there was a fairly narrow band of
earnings the system recovered on its own with small changes
in contribution rates.
2:15:06 PM
Mr. Teal continued with slide 8. He discussed the impact of
volatility on interest rates. He discussed years with
interest earnings of 6 percent and years of earnings at 10
percent, with an average rate of 8 percent. Under the years
earning 6 percent the unfunded liability increased;
however, the years earning 10 percent mostly recovered the
lost earnings. He stated that increased volatility could
generate greater unfunded liability and an inability to pay
the amount off in the following year.
Mr. Teal looked at a historical chart showing interest
earnings on slide 9. Some years had seen returns at 15
percent or more and others had seen losses of up to 20
percent. The average rate of return over the past five
years had been 1.4 percent. Losing 21 percent was lost
would create a huge unfunded liability; if the average rate
of return was kept at 8 percent it would be necessary to
earn 37 percent the following year, but there would still
be an unfunded liability. He explained that it would be
necessary to earn over 50 percent to offset the one year of
a 21 percent loss. He communicated that the system never
anticipated such significant earnings volatility; it was
designed to look at stable bond returns where contribution
rates would remain fairly stable and the unfunded liability
would take care of itself. He relayed that the system could
take care of itself if volatility was small; however,
volatility had not been small.
2:18:44 PM
Mr. Teal turned to slide 10 titled "Take-away Points
Regarding Earnings":
1. Earnings are volatile and unpredictable
2. Small variations can be addressed by smoothing,
amortization and good fortune
3. When variations are small unfunded liability is a
soft liability that can be repaid with earnings
(rather than contributions).
4. The road to recovery from large losses can be very
long - so long that the system may appear to be
broken
Mr. Teal expounded that earnings were volatile and
unpredictable; small variations could be addressed by
smoothing (a 5-year moving average), amortization, and good
fortune; and when variations are small there may not be
need to fund an unfunded liability through contributions.
Many states had mistakenly assumed that the unfunded
liability gap was soft and that raising contribution rates
was unnecessary. He relayed that states were in trouble
because the soft liability continued to grow and became
firmer and firmer. He stated that Alaska could no longer
count on high earnings to close the gap; it had turned into
a debt that the state needed to pay.
Representative Costello asked for verification that the
state paid above 22.5 percent for PERS and above 12.5
percent for TRS. She surmised that raising rates in the
past would have resulted in increased cost to the state
anyway. Mr. Teal answered that because employer rates were
capped any increase in the rate showed up as additional
state assistance.
2:21:03 PM
Representative Costello stated that the CBR had one account
that was more aggressively invested and one account that
had a more conservative long-term approach. She wondered
whether investment philosophies were the same.
Mr. Teal replied in the negative. He relayed that time
horizon and investment objectives definitely influenced the
rate of return. The 8 percent rate of return was based on
the idea that assets were invested for the long-term.
Annual contributions provided the state with cash flow to
pay benefits, which meant the state did not need to worry
about spinning off cash flow to make benefit payments; as
long as this was true perhaps 8 percent earnings were
attainable. He relayed that the Permanent Fund had lowered
its earnings target. The aggressive CBR account earned
close to 8 percent and the shorter-term main account earned
half the amount. He stressed that as the state's system
changed he did not believe it was possible to continue to
make 8 percent because of liquidity concerns. He wondered
where the cash would come from to make benefit payments
when contributions went away. He would discuss the issue
further at a future meeting.
Mr. Teal continued to address slide 10:
5. The system is unlikely to stay broken in the long-
run
6. If you pay what you owe, the system will fix itself
7. As time passes, assumptions are replaced with
reality
Mr. Teal elaborated on slide 10. He addressed that
investment losses could be so large that there were not
enough assets on hand to recover even with very high
interest rates; however, the system was unlikely to stay
broken in the long-term. The system would fix itself if the
debt was paid. He stressed that investment projection
models were helpful, but they were only models; as time
passed model assumptions would be replaced with actual
earnings. Unfunded liability would result if a model's
earning rate was too high; subsequently contribution rates
would increase. Employers would not pay the additional
contribution rate, but the state would. He communicated
that paying debt exhibits to credit raters the willingness
to pay other liabilities including bonds. The debt
calculation was complex and controversial because
determining what was owed was a matter of choice to some
degree. Different interest and amortization rates would
provide great differences in the unfunded liability and
required contribution rate. Credit raters had discovered
that models used by various states were not useful due to
the multitude of assumptions used; therefore, raters had
developed a common set of assumptions they could use to
compare systems.
2:27:23 PM
Mr. Teal continued to discuss measuring the health of a
retirement system on slide 11. He opined that the state
ought to focus on its own unfunded liability rather than
compare itself to other states with similar issues. He
relayed that the cost of paying benefits was identical
under any option as long as a model's assumptions were
accepted and benefits did not change. He did not believe
the state was looking at changing benefits. He compared the
options to those facing a person buying a home; the goal
was to find the most affordable option.
Mr. Teal turned to slide 12 and addressed the fourth
measure of a retirement system health: "Are contributions
causing financial stress?" The measure was the least
technical and played a significant role in discussions that
had resulted in the adoption of a DC plan. He communicated
that losses in 2005 opened many legislators' eyes to the
financial risk of the DB plan. Subsequently, the
legislature adopted the DC plan for PERS and TRS; the
change had not been made for JRS. He noted that the
legislature may want to consider making the change to JRS.
The DB plan was the ultimate pay as you go plan; money was
put money in and would never be owed. The DC plan affected
only new employees; therefore; it was necessary to
determine what to do with the existing DB plans and the
massive debt that had been incurred. He informed the
committee that amortizing the unfunded liability over 25
years would have resulted in some employers paying
extremely high contribution rates. He recalled a Fairbanks
rate at 180 percent of payroll; a rate that high would not
be feasible for an employer.
2:31:00 PM
Mr. Teal continued providing a historical perspective. He
relayed that many employers faced rates they could not pay
prior to 2008 (before more money was lost in 2008 and
2009). He noted that the state had accounting difficulties
during the time. He provided a hypothetical example of a
person who had worked for the school board for ten years at
$150 per month and transitioned to two other positions that
paid more for 10 years each. With 30 years of service the
employee would retire with about two-thirds of their pay
earned at the last position; each employer would be
responsible for one-third of the amount. The school
district had reserved funds to pay its portion of the
employee's retirement at the $150 per month rate; however,
they were not able to pay one-third of the rate earned at
the last high paying position. When the issue occurred it
created an accounting problem that had resulted in
individual employer rates with significant variability. He
detailed that some lawsuits had been threatened. He noted
that the new law made the issue moot as it offered a shared
cost proposal; liabilities were pooled and employers paid
the same blended rate.
2:34:26 PM
Mr. Teal continued that most employers had paid a higher
rate than the state in earlier years; therefore, going to a
blended rate was advantageous to them. Those municipalities
without higher rates were held harmless and the new blended
rate was phased in. He elaborated that even the blended
rates had been problematic; the recommended rate for FY 08
was close to 40 percent of payroll and was expected to
increase for several years even under the best
circumstances. Municipalities had requested rates that were
stable, predictable and affordable. The 22 percent PERS and
12.5 percent TRS employer contribution caps were a solution
the state and municipalities agreed upon because the state
understood that municipalities could not pay 40 percent
rates without going bankrupt. He had recently reviewed a
presentation he had made in April 2007; his conclusion at
the time was that the rate caps were stable and
predictable.
Mr. Teal relayed that the 22 percent cap was intended to go
through the early to mid-2030s until the last DB employee
retired. The model prepared by the actuary at the time
showed that the state would pay approximately $50 million
on behalf of employers in 2008; the amount would peak at
approximately $70 million in 2010 and would steadily
decline below $30 million in 2017. There had been a state
surplus at the time. The solution had looked affordable for
the long-term; particularly when recognizing that the state
was also an employer capped at 22 percent and had about 60
percent of the payroll. Approximately 40 percent of the
state assistance went to municipalities; whereas the
remainder went to the state's own bill.
2:37:34 PM
Mr. Teal advised that perhaps the lesson was to take
actuarial models with a grain of salt. Instead of fading
away, state assistance had grown to $700 million in the
current year; it was heading for over $1 billion annually.
Addressing the issue had not been critical when there had
been a budget surplus.
Co-Chair Austerman pointed to the 22 percent cap versus a
40 percent that had been proposed in the past. Over the
years the state continued to provide revenue sharing to
municipalities to cover the cost of their employees'
retirements. He asked for verification that the above 22
percent paid by the state was the same 22 percent that
began in 2007.
Mr. Teal replied in the affirmative. The 22 percent rate
had been set in statute; however, the state's share
(everything above 22 percent) had continued to increase. He
reminded the committee that 20 percent of the state's
retirement portfolio had been lost. He pointed to the
expectation that funds would earn 8 percent annually or
$800 million on a $10 billion portfolio. He elaborated that
a 20 percent loss equated to a loss of $20 million, putting
the state $2.8 million behind its expected earnings. The
losses need to be recovered, but the employers continue to
pay the same 22 percent; the state picked up all of the
additional unfunded liability.
Mr. Teal discussed the thinking behind the failure to
address the issue earlier on slide 13 titled "What is
Fiscal Stress???":
· The state may be paying too much into retirement
plans, but it is better to choose to pay when we can
afford it than be forced to pay when we cannot
afford it.
· When budget surpluses turn into deficits, we can
work to reduce state costs.
· Until then, state contributions reduce the magnitude
of the future fiscal problem.
Mr. Teal elaborated that two years earlier concern had
developed about the state's ability to pay the current and
projected level of state assistance. He relayed that in
response SB 187 had been introduced, calling for a cash
infusion and reduced state assistance in the future; both
the governor and the Alaska Retirement Management Board
(ARMB) had opposed the legislation and it did not move
forward. The concern about a deficit had become a reality;
the state was now concerned about fiscal stress or
affordability. He relayed that it had become evident at a
recent National Conference of State Legislatures (NCSL)
Pension Task Force meeting that he was not alone in
thinking that fiscal stress was an important measure of
system health. He noted that there were a multitude of
things happening with retirement systems nationally
including revised Governmental Accounting Standards Board
(GASB) rules. The board had changed pension accounting
rules; there were new computations by Moody's and other
bond raters. He elaborated that there was now a separation
between pension accounting and pension funding. The task
force had been concerned that the standards and
calculations would be confusing to the public and
legislators. Until the present year, GASB standards had
been used for accounting, for bond rating, and for funding
decisions made by legislators; there were now separate
calculations for each.
2:43:46 PM
Mr. Teal turned to slide 14 titled "Books, Bonds, and
Budgets." Accountants now had to report net pension
liability on balance sheets. He explained that previously
if a debt was paid on time it was not reported on a balance
sheet. He compared the prior method to not factoring in
money owed on a mortgage when determining a person's net
worth. Ratings agencies used common set of assumptions in
order to make system health comparable, which had resulted
in some downgrades in bond ratings. He had spoken with a
Moody's rater who had shared that Alaska had not been
downgraded because it had closed its retirement system,
which was a fiscally responsible step. The state was paying
what it was supposed to pay and pensions only accounted for
a portion of the rating agency's model. Additionally, the
state had large financial reserves.
Mr. Teal addressed that GASB no longer provided guidance to
legislators. He shared that previously there had been a
model showing that states were required to pay the
actuarially required contributions. He did not know why
GASB had discontinued funding guidance. The state no longer
had any rules that it was required to follow when paying
off its unfunded liability.
2:46:48 PM
Representative Gara had a couple of questions related to
the governor's proposal. Mr. Teal replied that he would
hold off on a discussion of options until the following
week.
Co-Chair Stoltze wondered how critical the premise of an 8
percent investment return was. He asked about the
sensitivity of dependence and dangers of relying on the 8
percent. Mr. Teal answered the issue was "absolutely
critical" to the system. He detailed that billions would be
added to the unfunded liability if 8 percent was not earned
and the interest rate assumption was changed by a full
percentage point.
Co-Chair Stoltze remarked that the payout would not need to
be the same as a trust, which was indefinite by nature. He
observed that at some point the system would run out of
beneficiaries. He wondered if that was the reason for using
a higher investment return target instead of a more
sustainable target. He expressed confusion on the issue.
Mr. Teal believed it would be easier to answer the
questions later. He believed the issue addressed by Co-
Chair Stoltze represented what was wrong with the current
way the state was approaching the problem: trying to build
up a significant balance and coast.
Co-Chair Stoltze asked for verification about the premise
the state was operating under. Mr. Teal replied that the
premise was that the state would build up enough money in
the fund so that contributions would fall to zero in the
mid-2030s and that from that point on the state would rely
on earnings from assets to pay benefits for the following
40 years. He relayed that there was a major problem with
the premise if the state was not going to earn 8 percent;
without any contributions if the state did not earn the 8
percent return it would mean a difference of billions of
dollars over a 40-year period.
2:51:45 PM
Mr. Teal continued to address a question by Co-Chair
Stoltze. He believed the state would be responsible for
paying the difference if 8 percent was not earned.
Co-Chair Austerman agreed that the state would be
responsible. He believed the entire legislature needed to
have an in depth discussion on the issue. He remarked that
the state could use its entire savings to pay off the
unfunded liability and in the future it could be right back
in the same situation if there were years that experienced
significant losses. He stated that the whole system was off
kilter.
Co-Chair Stoltze believed the legislature needed to be
cautious and to be better educated on the subject prior to
making a decision on how to proceed.
Representative Gara was concerned that the state could not
make the [investment] returns that individuals could
because it had to be more cautious with the money. He
discussed that paying a cash infusion would limit the risk
exposure. He remarked that he and Representative Guttenberg
had proposed a similar solution in the past. He compared
the issue to paying down a mortgage to reduce the amount of
money owed over the long-term. He recognized that there
would be large swings in the stock market, but if the
amount owed was minimized the large swings would hurt less.
2:56:00 PM
Mr. Teal turned to slide 15 that included advice from the
National Pension Funding Task Force:
· Put funding guidelines in statute. Describe
computation of the Annual Required Contribution.
Show the plan to bring the system to full funding
· The numeric approach offers sound guidance, but the
funding ratio and other actuarial measures are not
the most important measure of system health. What
really matters is what is affordable.
Mr. Teal elaborated that two years earlier there had been
large budget surpluses and state assistance had represented
just one more large appropriation; there had been
sufficient funds to cover the appropriation and the state
had still been saving money. He explained that the funding
ratio had not changed since that time. He stated that two
years earlier the systems had been healthy by definition.
Currently with a funding ratio at the same level, the
health of the systems had deteriorated substantially
because the state treasury could no longer afford the
current path or a path with increased payments.
Mr. Teal moved to slide 16. The slide showed a graph
comparing three cost drivers of available revenue. Cost
drivers including K-12, Medicaid, and retirement assistance
required over 62 percent of the state's available revenue.
He expounded that if revenue forecasts and growth
assumptions in the three cost drivers both held true the
drivers would take 99 percent of the state's available
revenue by FY 22. The mismatch between revenue and
expenditure was unsustainable. He surmised the legislature
may want to know how to address the issue if it was
accepted that the state could not afford the projected
retirement payments under the current path.
He turned to slide 17 titled "What Other States Have Done
to Improve Retirement System Health":
· Increase assets
o Increase employee contributions
· Reduce benefits
o Raise the retirement age
o Increase service requirements
o Reduce post-retirement adjustments
o Adopt hybrid plans
Mr. Teal elaborated on slide 17. States were trying to
change the path of the liability curve. He stated that
states could try to increase assets, but the only way to
increase assets was to increase earnings. He noted that
earnings assumptions were already fairly high. Other states
wanted to increase employer contributions, but employers
could not afford it; therefore, they were turning to
employees. He elaborated that sometimes it related to
future employees and sometimes it also included current
employees. He relayed none of the forms of benefit
reductions made by other states made much more than a small
but growing change over a long period of time. He
acknowledged that the changes could amount to billions of
dollars over a long time period and that states had few
other options. He had not heard of any proposals to tweak
Alaska's benefits system; Alaska was still ahead of other
states because it had acted early.
Mr. Teal looked at how reducing future benefits would
impact the state's liability curve in a graph on slide 18.
A reduction in benefits resulted in a small change to the
liability curve that would continue to trend upward. He
moved to slide 19 related to PERS accrued liability.
Alaska's closure of the DB system to new entrants resulted
in a radical [downward] change in the benefit curve shown
on slide 19. The state would continue to accrue more
benefits while DB employees continued working; however, by
FY 30 benefits would peak and begin to decline through FY
70 or FY 80. He noted that the downward trend allowed the
state to move away from the standard actuarial approach in
which assets had to chase the liability curve upward. He
asked how else the liability gap would be closed when
liabilities were set by statute.
3:02:59 PM
Mr. Teal continued to discuss slide 19. The state had
approximately $15 billion in assets; the current plan gave
the state 25 years to close the gap. The goal should be to
pay all benefits when due and to end up with no money left
when the curve reached zero. He addressed why the state
wanted to build its assets up until it reached the
liability curve at its peak and why it could not go
straight across or head straight for the bottom of the
curve. He noted that a large balance was not needed; the
only reason for a large balance was so contributions could
go to zero and the state could coast on interest earnings.
He intended to address the questions the following week.
Mr. Teal directed attention to slide 20 titled "A National
Task Force Recommends that Pension Funding Policies":
1. Be based on actuarially determined contribution
rates - and the calculation of rates should be in
statue so the plan is clear to employees, retirees,
administrators, boards, and legislators
2. Collect a consistent percentage of payroll - use the
Level Percent of Pay amortization method
3. Be disciplined - to ensure that promised benefits
can be paid (i.e., pay the ARC)
4. Maintain intergenerational equity (i.e. the cost of
benefits should be paid by the generation of
taxpayers that were served by the employees who
earned those benefits)
5. Require clear reporting to show how and when plans
will be fully funded and the progress toward that
goal
Mr. Teal expounded on slide 20. He believed item number one
was doable once a plan was agreed upon. He remarked that a
slight conflict existed with item two because ARMB
recommended changing amortization methods. He did not
believe it was necessary to discuss amortization methods
because the board had supported the governor's proposal;
therefore he did not believe the level dollar would be
discussed as an option any longer. He continued that the
method for setting the actuarial contribution rate was
designed for open systems where new entrants were joining
regularly; the system required the percent of pay method.
He addressed item number 3, which entailed putting a plan
in statute and following it. He believed the item was
achievable if the plan was affordable. The fourth
recommendation stipulated that debt should not be moved
forward to be paid by the next generation. The fifth item
recommended that clear reporting should be required to show
how and when plans would be fully funded and progress
towards the goal. He did not include unfunded liability in
the normal cost category that he defined as what it took to
pay an employee's benefits supposing all assumptions came
true.
3:07:54 PM
Mr. Teal agreed with intergenerational equity when it came
to paying the pension what a model projected would be owed;
however, unfunded liability was not a normal cost and it
could not be paid in a way that maintained
intergenerational equity. He provided an example of a
person who retired in 2004 when the unfunded liability was
zero; expected benefits were all paid for by his generation
and money was on hand to pay all of the expected benefits.
However, unanticipated losses occurred in 2005 and an
unfunded liability was created; contribution rates had to
rise in order to fill the gap, which meant that the next
generation would pay. Under a DB system the employer took
the risk and had to pay when an unfunded liability gap
opened; it did not matter who the liability was attributed
to.
Mr. Teal relayed that the Buck Consultants' (the state's
actuary) actuarial model showed that unfunded liability was
fully paid by the 2030s because existing unfunded liability
was fully amortized by that time and the model never
developed any new unfunded liability; the reason was
because earnings assumptions were always met under the
actuarial model.
Mr. Teal turned to a chart on slide 21 titled "PERS Assets
and Accrued Liability." The actuarial projection was shown
in black and depicted liabilities as increasing, peaking,
and slowly decreasing. The model showed that contributions
would be necessary until a trust fund of $25 billion was
reached; when the $25 billion was reached the plan was 100
percent funded and contributions would stop. However, if
earnings ever fell below 8 percent, new unfunded liability
would occur. He concluded that costs could and probably
would continue long after the last DB plan employee retired
and that the state would pay for any costs that may open
up. He believed obsession with intergenerational equity
could lead to overly restrictive policy decisions. The
concept did not apply to unfunded liability and a DC plan
would be required if intergenerational equity was desired.
3:12:07 PM
Mr. Teal communicated that the ARMB sideboards regarding
intergenerational equity and shifting costs from the state
to the municipalities could not be followed by ARMB
proposals. He did not believe the legislature should be
held to the ARMB sideboards if the entity's models could
not comply.
Mr. Teal did not object to a cash infusion; he noted he had
worked on a cash infusion model over two years earlier. He
addressed the questions "What is the Goal?" and "What
Options Might Achieve it?" on slide 22:
Goal: a healthy system-meaning a system with a plan to
eliminate unfunded liability in a reasonable time at
an affordable cost.
Mr. Teal elaborated that the goal was also to pay benefits
when due. He relayed that several things could be done. The
state could re-amortize its unfunded liability, which would
reduce state assistance in the short-term, but would not
save money. He compared the option to refinancing a home
longer-term without a change in interest rates. Another
option would be to change the model assumptions, but it was
reality that mattered; if the model was not the best
reflection of expectations it would not have value. A third
option would be to eliminate healthcare from the unfunded
liability calculation; however, those costs were real and
if the state was going to continue to pay them they should
be included. The state could also look for more workable
options that did not rely on the assumptions that no
additional unfunded liability would open up or that the
state would continue to earn 8 percent returns.
3:15:12 PM
Mr. Teal provided a wrap up. He stressed that action on
funding was not imperative. The state was on a track to
reach full funding; the primary issue was the affordability
of staying on the present track. He provided concluding
advice on slide 23:
· Outline your plan in statute.
· Avoid paying less than the plan.
· Avoid paying more than we can afford.
Mr. Teal expounded that the plan should be outlined in
statute and the state should not merely appropriate money
annually. The state should also avoid paying less than the
plan or more than it could afford.
Co-Chair Austerman requested information showing the
different potential liabilities for municipalities. He
stated that if the state's real share was 60 percent it
left 40 percent for other employers. He noted that the
state had been paying over 22 percent since 2007.
Additionally, he wondered what the state's total bill had
been since 2007 for costs that would have been paid by the
municipalities if a 22 percent cap had not been
implemented.
Mr. Teal replied that he would follow up with the
information. He used Anchorage as an example and shared
that its payroll was $25 million annually. He addressed the
first portion with an Excel spreadsheet titled "December
2013 Retirement Assistance by Employer" (copy not on file)
and relayed that the Anchorage municipality's percentage of
payroll was 8.2 percent; its share of the unfunded
liability was $650 million. He remarked that the state
could choose to pay its share in a lump sum and to ask
municipalities to do the same or to pay the amount over a
period of time; he did not think it was a serious option.
He explained that the idea would not work because
Anchorage's bill would be $60 million per year or 32
percent of its payroll on top of the normal contributions
if it opted to make the payment over a 25-year period.
3:19:29 PM
Co-Chair Austerman reiterated his request for information
showing the different potential liabilities for
municipalities. He wanted an apples-to-apples conversation,
which he did not believe was occurring at present.
Representative Munoz asked for verification that the state
paid 100 percent of past obligations prior to 2007. Mr.
Teal replied in the negative. He communicated that the
obligation was recomputed annually.
Representative Munoz asked what the breakdown had been for
local governments and the state prior to 2007.
Mr. Teal replied that the payment portions had all been
even; everyone had paid a rate and there had been no state
assistance. He elaborated that because it had not been a
shared system that communities had different rates. For
example, rates may have been 17 percent for Juneau, 12
percent for Anchorage, and 21 percent for North Slope. When
the system became shared it meant that all communities paid
the same blended rate based on the shared liability of the
system and payroll. The rate had been about 40 percent, but
it had been determined that municipalities could not pay
that amount, as a result the cap had been set at 22
percent.
Representative Costello observed that the unfunded
liability was not the only problem facing the state. The
committee had learned earlier in the day that by 2022 the
state would have a $7 billion Medicaid bill. She surmised
that if the state was going to consider all of its problems
that it was important to factor in when cash would be
needed the most. She saw it as a delicate timing issue that
was not isolated to the pension problems. She believed that
the state wanted to reduce its annual payment in order to
free up money to fund state services.
3:23:08 PM
Mr. Teal had not meant to imply that addressing retirement
issues would take care of the other issues. He believed all
of the issues were related and it was important to think
about them together. He detailed that in 2007 education,
retirement, and revenue sharing had all been tied together
and solved as a common solution. He agreed that under the
current plan the savings to employers did not occur until
20 years in the future, but the state was facing fiscal
problems much sooner than 20 years out. However, if the
state was to address retirement it would free up a
substantial amount of money to focus on health, education,
and municipal revenue sharing issues. He added that the gap
would not be filled, but it would help.
Representative Costello remarked that earlier in his
testimony Mr. Teal had been somewhat dismissive of the bond
raters' view on how Alaska should handle the issue. She
asked for comment on the value of the state's bond rating
and how the legislature's action or inaction could impact
it.
Mr. Teal answered that he had not meant to dismiss the bond
raters. He believed the rating was important and allowed
the state to borrow money at a lower rate. He clarified
that he had been dismissing the role of pension debt in
determining the bond rating. The bond rater had
communicated that Alaska had large reserves and that it
could choose to pay off the debt. There were many factors
included in bond ratings and he did not believe the pension
debt was a critical component. Raters also factored in that
the state had closed its DB system. He relayed that bonds
were rated for 20 years in the future, not for the next
year.
3:27:14 PM
Representative Guttenberg referred to shared plans and
blended rates. He wondered whether it was still possible to
break out the different rates by community. Mr. Teal
answered that he was not able to calculate the data. He
thought that the Division of Retirement and Benefits may
have the information that would allow for a computation of
the data. He did not know if the division had the data in a
format that would allow for the computation currently; the
whole point of going to a shared cost system was that the
breakout did not need to occur any longer.
Representative Guttenberg referred to Mr. Teal's earlier
testimony that used Anchorage as an example. He thought the
example had provided a breakout of information for the
municipality.
Mr. Teal replied in the negative and explained that the
issues were separate. One of the issues pertained to the
way individual employers used to be responsible for
individual employees' benefits. The state had moved away
from the format and currently the system was blended; no
matter where an employee worked they received the same
benefits depending on pay and time of service. Employees
were paid out of one large pool. The second issue pertained
to taking the unfunded liability and breaking out a
municipality's share of the debt. He explained that if
money was spent on a capital project paid for with
municipal bonds there would be something to show for it.
There was nothing to show for unfunded liability, the money
was just lost.
3:30:44 PM
Representative Guttenberg agreed; however, he provided a
scenario in which an employee worked for the City of Saint
Paul and had subsequently worked in Anchorage and
Petersburg. He surmised that all of the communities would
claim that the liability was not theirs. He stated that
municipalities could no longer calculate the portion of the
money they owed. He believed the issue would be a sticking
point.
Mr. Teal stressed that the state did not care where anyone
worked anymore. The assignment of liability had nothing to
do with the time served or money made by employees. He
elaborated that the assignment to employers had nothing to
do with the employees. Money had been lost and
municipalities were all responsible for their share.
Co-Chair Austerman remarked that the question had been
raised in 2006 and 2007, which had prompted moving to a
shared system. He added that the state had been unable to
answer the question at that time as well.
ADJOURNMENT
3:33:25 PM
The meeting was adjourned at 3:33 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| 1 27 14 Retirement Health (HFC).pdf |
HFIN 1/27/2014 1:30:00 PM |
PERS/TERS HFIN |