Legislature(2013 - 2014)HOUSE FINANCE 519

01/27/2014 01:30 PM FINANCE


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01:36:39 PM Start
01:37:23 PM Presentation: Pers/trs: History and Current Situation: Legislative Finance Division
03:33:25 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Presentation: "PERS/TRS: History & Current TELECONFERENCED
Situation" by David Teal, Director, Legislative
Finance Division
                  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