Legislature(2005 - 2006)SENATE FINANCE 532
01/27/2005 09:30 AM Senate FINANCE
| Audio | Topic |
|---|---|
| Start | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
MINUTES
SENATE FINANCE COMMITTEE
January 27, 2005
9:31 a.m.
CALL TO ORDER
Co-Chair Green convened the meeting at approximately 9:31:59 AM.
PRESENT
Senator Lyda Green, Co-Chair
Senator Gary Wilken, Co-Chair
Senator Con Bunde, Vice-Chair
Senator Bert Stedman
Senator Donny Olson
Senator Fred Dyson
Also Attending: SENATOR GARY STEVENS; BILL CORBUS, Commissioner,
Department of Revenue; TOM BOUTIN, Deputy Commissioner, Department
of Revenue; GARY BADER, Chief Investment Officer, Treasury
Division, Department of Revenue; MELANIE MILLHORN, Director,
Division of Administrative Services, Department of Administration
Attending via Teleconference: From offnet locations: SENATOR LYMAN
HOFFMAN; BOB REYNOLDS, Senior Actuarial Consultant, Mercer Human
Resource Consulting
SUMMARY INFORMATION
Department of Revenue: Roles of ASPIB & Treasury Division
The Committee heard a report from the Department of Revenue
Treasury Division's regarding the Alaska State Pension Investment
Board and the Public Employees Retirement System and the Teachers
Retirement System.
Department of Administration: Tier Redesign Project Report
The Committee heard from the Department of Administration regarding
the Tier Redesign Project.
^
Department of Revenue:
Roles of ASPIB & Treasury Division
Co-Chair Green announced that, in order to allow time for thorough
presentations, Members' questions would be entertained following
the conclusion of today's presentations. Were it deemed necessary,
the hearing would continue tomorrow.
BILL CORBUS, Commissioner, Department of Revenue, stated that the
presentation would address four issues: the structure of the
Department of Revenue Treasury Division; a review of the Division's
investment funds that have "a role in managing" investments; the
relationship of the Alaska State Pension Investment Board's (ASPIB)
investment policy to the Public Employees Retirement System (PERS)
and the Teachers Retirement System (TERS) actuarial assumptions;
and the ASPIB investment process.
Commissioner Corbus stated that the Missions and Measures of the
Treasury Division specify that it is the Division's responsibility
"to collect and invest the State's money." This would include cash
management functions and insuring that established guidelines are
followed. An investment staff of financial analysts conduct the
"most difficult and challenging" responsibility which is that of
investing approximately four billion dollars of State funds as well
as managing the investments of ASPIB. The Commissioner has
fiduciary responsibly for the State's money and, as an ASPIB board
member, has equal responsibility to that of the other seven Board
members.
TOM BOUTIN, Deputy Commissioner, Treasury Division, Department of
Revenue, commented that in 2004, the Treasury Division managed and
invested approximately $20.5 billion of State money as reflected on
the Department's handout titled "Combined Schedule of Invested
Assets at Fair Value December 31, 2004" [copy on file] which
depicts the money "by fiduciary and within those headings, by
beneficiary group or agency." Updated information could be located
on the Division's website each month. The Division manages money on
behalf of "ASPIB for four defined benefits programs and two
participant-directed plans." The Division manages money for four
State agencies and 27 other funds that the Commissioner has
judiciary responsibility for. Cash flows, cash needs, liquidity and
investment restrictions associated with such things as proceeds
from tax exempt bonds that vary by fund.
Mr. Boutin stated that today's presentation would be limited to the
activities of the Treasury Division and ASPIB, which was
established by legislation in 1992. The Treasury Division was
charged with exercising "the investment, custodial and depository
powers or duties, the Fiduciary of a State fund shall apply the
prudent investor rule and exercise a fiduciary duty in the sole
financial best interest of the Fund. Treasury further refines the
prudent investor rule to the standards of: 1) an institutional
investor; 2) a professional; and 3) an investor managing large
investments. While some funds managed by Treasury and entrusted to
the Commissioner of Revenue are Trust funds, such as the Public
School Trust Fund and the Children's Trust, Treasury uses the same
investment process and standards for all funds." In regards to
procedures, "Treasury prepares written investment policies and
documents investment processes. Each fund has missions and
objectives that lead to an appropriate asset allocation strategy
and establishment of specific investment policy. Investment
managers are selected for each fund to implement the investment
policy." Approximately four billion dollars of fixed income
management is conducted internally with the balance of the fund
being conducted by external investment managers. "Performance of
managers is strictly monitored, evaluated, and documented" and
ASPIB and the Commissioner of Revenue hold formal meetings to
monitor performance and asset allocations. Results are reported
quarterly and independent audits are conducted annually.
Mr. Boutin reported that the Division is allowed by State Statute
to establish investment pools and benchmarks. Policies are
maintained and available for viewing on the Department's website.
Formal processes exist for asset allocation and asset classes,
expected returns, risks, time and time horizons, risk tolerance and
liquidity, and "the evaluation and hiring and firing of money
managers". The fiscal year 2004 Rate of Return on Investments for
PERS and TRS was 15.08 percent and 15.09, respectfully. These
returns exceeded the actuarial assumptions as well as the medium
return for public funds, as reported by Callan & Associates. He
referenced the Department's handout titled "Cumulative Performance
Relative to Target" [copy on file] whose "Cumulative Returns Actual
vs Target" chart depicts the Fund's rates of returns experienced
since 1991 to the national actuarial expected returns. The
handout's chart titled "Thirteen Year Annualized Risk vs Return"
portrays the Fund's rate of return to a larger universe of
comparable funds.
GARY BADER, Chief Investment Officer, Alaska State Pension
Investment Board and Treasury Division, Department of Revenue,
pointed out that State Statutes specify that the PERS and TRS Board
would establish their actuarial rates of return after the receipt
of advice from the Division of Retirement and Benefits and the
Actuary. The Actuary, whose investment horizon is approximately 25
to 30 years, determines the assumptions and then applies the
assumption and develops "the estimated contribution rates required
of the employers in the system." The Actuarial information is
presented annually, in a joint meeting, to the Boards. The ASPIB
Board is "acutely aware" that PERS/TRS are anticipating "an 8.25
percent rate of return over a long period of time." Following the
Actuarial presentation and the PERS/TRS adoption of their actuarial
rates of return, ASPIB would establish "its target earnings for the
coming year."
Mr. Bader continued that the process leading up to the point of how
ASPIB establishes its earning assumptions each year, including how
to deploy the assets, is further explained in the Department's
packet titled "Alaska State Pension Investment Board Presentation
to the Senate Finance Committee: The Role of ASPIB and the Treasury
Division" [copy on file], dated January 27, 2005. This packet
contains an abbreviated version of what the Board considers in the
process "of setting its asset allocations."
Mr. Bader reviewed the packet's presentation as follows.
Page two
Agenda
* Present reasoning behind capital market projection process
- economic background
- specific projections
* Discuss implications generally
* Outline next steps
Mr. Bader stated that page two outlines the process undertaken by
the Division's financial consultant, Callan Associates Inc.
regarding capital market assumptions as to how the stock market
would perform over the next five years for such things as fixed
income and other asset allocation classes.
Page four
Callan's Capital Market Projection Process
Economic Outlook Drives Our Projections
* Evaluate the current environment and economic outlook for
the U.S. and other major industrial countries:
- Business cycles, relative growth, inflation.
* Examine the relationships between the economy and asset
class performance patterns.
* Examine recent and long-run trends in asset class
performance.
*Apply market insight:
- Consultant experience - Plan Sponsor, Manager Search,
Specialty
-Industry consensus
-Client Policy Review Committee
* Test the projections for reasonable results.
Mr. Bader stated that page four is the first of several pages that
demonstrate the types of evaluations Callan considers in developing
their assumptions.
Page five
2004 Capital Market Projections
Guiding Objectives
*Our best thinking regarding the 5-year outlook, recognizing
our median projections represent the midpoint of a range,
rather than a specific number.
*Results that are readily defensible both for individual asset
classes and for total portfolios.
*Conscious of the level of change suggested in strategic
allocations for DB, DC and foundation/endowment clients.
*Reflect common sense and recent market developments.
*Balance conflicting goals and conflicting opinions.
Mr. Bader read the information on page five. The information on
page six is a reflection on recent years' asset returns. In the
year 2000, the Russell 3000's return of a negative 7.46 percent is
an indicator of how the stock market performed in general. In
contrast, the Leman Brothers Aggregate reflected a positive 11.63
percent that year. "This demonstrates one of the basic tenants of
investment management," which is that of having "a number of asset
classes that have rates of return that are not necessarily
correlated with one another." When possible, asset allocations
should be made according to those principals.
Mr. Bader stated that page seven depicts global perspectives
considered by Callan Associates. Page eight considers information
regarding the United States economy. He highlighted information on
page eight regarding interest rates as follows.
* Interest rates are still extraordinarily low:
- Treasury bonds yields were at their lowest in 40-years, duet
to
*Aggressive Fed action to lower interest rates
*Investors, afraid of equity, favoring bonds and driving
yields lower.
Mr. Bader stated that this information is being factored into the
assumptions about "how committed we should be regarding fixed
income in the coming time period."
Mr. Bader continued that page nine addresses expectations. He
highlighted the section on that page as follows.
*Callan's outlook in a nutshell: expect a low inflation, low
interest rate, single digit return environment.
Mr. Bader noted that the graph on page ten depicts the historical
relationship between earnings to price and the Standard & Poor
(S&P) 500 returns.
Mr. Bader expressed that the graph on page eleven depicts the
historical relationship between the S&P 500 Earnings Yield and the
10-Year Treasury Bond Yield from 1981 through 2003.
Mr. Bader stated that in regard to Domestic Fixed Income, the graph
on page 12 reflects that current yield is an indicator of the
future returns of bonds. "There is relatively close tracking
between the return on bonds fives years out and what their yield to
worst is today."
Mr. Bader stated that page 13 is a thumbnail explanation of the
rationale for the 2004 capital market assumptions, presented on
page fourteen, that Callan Associates presented to ASPIB. The
Projected Standard Deviation (Risk) factor is a measure of "how
likely that return might vary from the prediction."
Mr. Bader noted that page 15 depicts the 2004 Correlation
Coefficient Matrix. He reiterated that the investment policy
supports holding a variety of different assets classes, studying
their variations, and then determining how they move in relation to
one another. Were something "to move in step" with another asset
class, the correlation factor would be one; were it to move in the
exact opposite direction, such as stocks going up and bonds going
down "in exactly the same proportions to one another" the
correlation factor would be minus one. The correlation factor would
be zero were there no correlation at all.
Mr. Bader stated that pages 16 and 17 provide additional
information that ASPIB would be considering at the upcoming March
meeting at which the asset allocation would be established. He
noted that ASPIB and its consultant, Callan Associates, do not work
independently in setting asset allocations, as Statutes require
that ASPIB have an Investment Advisory Committee (IAC), with a
minimum of three members. He reviewed the current membership and
shared that IAC, during a recent telephonically conducted meeting,
proposed to ASPIB and Callan Associates that the asset allocation
target rate of return be 7.84 percent as reflected in the gray
column depicted on the Efficient Frontier Segment chart on page 19,
with a standard deviation of 11.81 percent over time.
Mr. Bader stated that page 20 presents the previous page's
Efficient Frontier information in graph form. "The basic tenant is
that the higher return you expect to get, the more volatility of
returns" might be experienced in achieving it. "Volatility is
considered a measure of risk." He noted that Callan's capital
market target rate of return was 7.60 percent based on a five-year
projection, whereas PERS/TRS were seeking a target return of 8.25
percent. He pointed out that the actuarial assumptions for PERS/TRS
are based on a thirty-year horizon, whereas Callan Associates
utilizes a five-year projection. "The difference between the two is
what is assumed in the inflation adjustment between the two
assumptions. Callan had an inflation assumption of 2.6 percent. The
attempt here is to get a five percent real rate of return. If you
put into 2.6 percent inflation, that brings the ASPIB to 7.6
percent. Mercer is also trying in their assumptions to get a five
percent real rate of return. Their inflation assumption over a 30-
year period is greater than Callan's is over the five. That is why
there is a disconnect between the earnings assumption of PERS/TRS
and the target rate of return for ASPIB."
Mr. Bader continued that pages 22 through 24 depict "graphical
representations of the probability of return." The expected
likelihood of getting the target rate of return is approximately
"50/50" on the chart titled "1-Year Range of Return Comparison" on
page 22. The likelihood of exceeding the target rate of return is
depicted in the column titled "Proposed". For example there is a
ten-percent probability of earning 23.94 percent or greater. Were
the ten-year Range of Return chart of page 24 compared to the one-
year chart on page 22, "the likelihood of obtaining the targeted
range of return" is the relatively the same, the likelihood of
differing from that rate of return is diminished as exampled by
there being only a ten-percent probability of earning 12.69 percent
or higher over the ten-year period. Therefore, the longer something
is invested, the more likely the possibility of obtaining the
target.
Mr. Bader informed that, with the exception of pages 25 and 27, the
information in the packet was provided by Callan Associates. The
information on page 25 was provided by Mercer Human Resource
Consulting in response to the question, "how have the funds
impacted the funding ratios of the retirement system." As depicted,
the "rate of return exceeded what the actuarial rate of return
actually turned out to be", as reflected on the chart. "There were
a number of years in which the ASPIB and PERS/TRS funds earned
higher rates of returns" than expected. He noted that the aggregate
of all the investment returns impacted the 2003 funding ratio for
PERS, as depicted in the chart on page 25, but only accounted for a
negative 3.8 percent decline in the funding ratio. Were the 2004
investment returns, which were in the 15.1 percentage, taken into
consideration, the funds would reflect a positive investment return
over the period since 1993.
Mr. Bader stated that the "Cumulative Returns Actual vs. Target"
chart on page 26 depicts the Actuarial Assumption and the returns
of the PERS/TRS funds as provided by Callan Associates.
Mr. Bader stated that page 27 contains a copy of the January 3,
2005 letter from Mercer Human Resource Consulting to Melanie
Millhorn, Director of the Department of Administration, that
presents that the change in the funded status of the funds, "while
slightly impacted by investment returns … is the result of changes
in the liabilities of the funds."
Mr. Bader concluded the Division of Treasury's ASPIB presentation.
AT EASE 9:59:58 AM / 10:00:22 AM
Co-Chair Green noted that, in addition to this meeting being
teleconferenced with the Anchorage and Fairbanks Legislative
Information Offices (LIO), the Kenai LIO is also participating.
^
TIER REDESIGN PROJECT REPORT
DEPARTMENT OF ADMINISTRATION
MELANIE MILLHORN, Director, Division of Retirement & Benefits,
Department of Administration, explained that "the catalyst behind"
the tier redesign project that began in January 2004, was the
Commissioner of the Department of Administration who tasked members
of the PERS/TRS Board with developing new tier redesigns to address
two areas: the short-funded status for the systems and rising
employer contribution rates. The information being presented today
includes information that was discussed during the Tier Redesign
Project meetings conducted in Anchorage and Fairbanks over a nine-
month period. The "State of Alaska PERS & TRS Tier Proposals Senate
Finance" Report [copy on file] was prepared by the actuarial firm,
Mercer Human Resource Consulting, and is a compilation of the
information discussed during those meetings. The meetings were
advertised and numerous employers and interested parties
participated in the discussions. In November 2004 the Tier Project
Review Subcommittee, which consisted of two PERS and two TRS Board
members, finalized their work on this project and presented two
alternative tier proposals, referred to as Alternative 1 and
Alternative 2, to the full PERS/TRS Boards. While the Subcommittee
favored Alternative 1, the full PERS/TRS Boards did not approve
either of the Tier Redesign alternatives, and as a result, no
recommendation was furthered to the Department of Administration
Commissioner, Ray Matiashowski. The Tier Review Subcommittee is no
longer active as their task has been completed. She noted that
there was "significant participation" by the employers, who are the
stakeholders of this system," at the November 2004 PERS/TRS Board
meeting. It should also be noted that "all of the employers who
testified and participated in that meeting which was the
culmination of all of that analysis, benchmarking," and survey
results, "advocated for new tier alternatives."
BOB REYNOLDS, Senior Actuarial Consultant, Mercer Human Resource
Consulting, testified via teleconference from an offnet site and
stated that Mercer is the actuary for the State of Alaska's
retirement systems, the PERS/TRS systems in particular. Mercer's
role with the Tier Redesign Project subcommittee was to facilitate,
gather information, and provide cost alternatives for tier
alternatives being considered.
Mr. Reynolds turned his remarks to the aforementioned handout and
stated that Slide One on page one indicates that the Retirement
Program Financial Management is influenced by how the Benefit
Policies, Funding Policies, and the Investment Policy interact.
Mr. Reynolds reviewed the contents of the Report as follows.
Slide 2, page 1
Financial Summary
Employer Contribution Rates - PERS
FY05 FY06
Normal Cost Rate: 13.31% 13.24%
Average Past Service Rate: 11.60% 12.39%
Average Contribution Rate: 24.91% 25.63%
Board Adopted Rate: 11.77% 16.77%
*The normal cost rate provides for benefits expected to be
earned by active members during the fiscal year
*The past service rate is the part of the contribution that
is intended to pay the unfunded liability (over 25 years)
Slide 3, page 2
Financial Summary
Employer Contribution Rates - TRS
FY05 FY06
Normal Cost Rate: 14.76% 14.28%
Past Service Rate: 20.81% 24.57%
Total Contribution Rate: 35.57% 38.85%
Board Adopted Rate: 16.00% 21.00%
*The normal cost rate provides for benefits expected to be
earned by active members during the fiscal year
*The past service rate is the part of the contribution that
is intended to pay off the unfunded liability (over 25
years)
Mr. Reynolds stated that the intention of Slide 2 regarding the
PERS system and Slide 3 regarding the TRS system, is to provide
background information pertinent to the "financial implications of
the new tiers." Mercer's FY 06 actuarial calculated rate for the
PERS system is 25.63 percent as denoted as the Average Contribution
Rate on Slide 2 and 38.85 percent as denoted by the Total
Contribution Rate for TRS on Slide 3. While both of these rates are
comprised of the same two components, the Normal Cost Rate and the
Past Service Rate, they are labeled differently because the PERS
system employers "are each charged their own separate rate
calculation relative to their own circumstances." Therefore the
rate reflects the "average contribution system" for PERS "as a
whole." The TRS employer contribution rate is referred to as the
Total Contribution Rate because a single calculation rate would
apply to all employers in the system. The definitions of normal
cost rate and past service rate are depicted at the bottom of
Slides 2 and 3. "The normal cost rate is the cost of the benefits
that the members who are actively employed within the system are
earning during that year." "In any situation where the funding is
less than 100 percent" according to Mercer's calculations, in that
there are less assets than there is "accrued liability in the
system, that deficit is called the unfunded liability and it is
amortized over 25 years, similar to a mortgage, except that it is
amortized as a level percentage of payroll."
Mr. Reynolds continued that for FY 06, the PERS Average Past
Service Rate of 12.39 percent is the amount that would be required
to pay off the unfunded liability over 25 years. The Normal Cost
Rate for FY 06 is 13.24 percent. Therefore the Average Contribution
Rate is 25.63 percent.
Mr. Reynolds declared that, by regulation, the PERS employer
contribution could only decrease or increase by five percent per
year. Thus, while the FY 06 Average Contribution Rate is 25.63
percent, the Board Adopted Rate is 16.77 percent.
Mr. Reynolds noted that the FY 06 Normal Cost Rate is 14.28 percent
and the Past Service Rate is 24.57 percent, for a Total
Contribution Rate of 38.85 percent. "The largest portion of the
Total Contribution Rate is actually the part that is required to
pay off the unfunded liability." The TRS Board has "recommended" a
rate of 21.00 percent for FY 06.
Mr. Reynolds pointed out that absent any unfunded liability, "if
the systems were 100 percent funded," the calculated rate for the
PERS system would be 13.24 percent and the calculated rate for the
TRS would be 14.28 percent. Therefore, "were the systems fully
funded at this time", the systems' rates would range between 13 and
14 percent.
Slide 4, page 2
*Rising contribution levels
*Volatile investment returns
=investment uncertainty
*Rising medical costs
Mr. Reynolds stated that Slide 4 further describes some of the
financial concerns of the Tier study.
Slide 5, page 3
Overview
Key Information
Key information gathered and analyzed
* Employer survey
* Member focus groups
* Benchmarking
* Benefit levels
* Demographic projections
* Implications of Medicare changes
* Trends, issues and alternatives
* Cost analysis and projections
Mr. Reynolds stated that Slide 5 depicts some of the key
information utilized by the subcommittee in determining its Tier
alternatives. "An extensive body of information was gathered,
discussed, and analyzed over the course of the ten to eleven month
period." Much of this information is available on the Department of
Administration website. "One key finding of the benchmarking
activity that was conducted was that the medical program through
the PERS/TRS systems was considerably richer than programs offered
in similar states."
Ms. Millhorn informed the Committee that the PERS and TRS
employers' survey results are located on pages 30 through 57 of the
Report. The survey was very important as it set the framework for
gathering information. Employers' input alerted the subcommittee as
to which benefits are valued. 89 PERS employers responded and ten
others replied that they choose not to participate. 36 of 57 TRS
employers responded. Surveys were also distributed to 11 collective
bargaining unions; only one responded. Employer input was a valued
component of this process.
Slide 6, page 3
Employer Survey - PERS
Important Conclusions
* Employers want the retirement program to continue to provide
medical coverage
* Many employers open to the possibility of providing
differing levels of medical coverage based on service or
having members share in the cost of coverage
* Other potential cost savings areas that some employers seem
open to:
- Lowering the post-retirement cost-of-living adjustment
- Not providing medical coverage to vested terminated
members
* Some responses seem to favor continuing a defined benefit
approach
- Reward long service
* However, responses leaned towards shifting investment risk
to members
Slide 7, page 4
Employer Survey - TRS
Important Conclusions
*Employers want the retirement program to continue to
provide medical coverage
* Many employers, particularly the largest employers, open
to the possibility of providing differing levels of medical
coverage based on
service or having members share in the cost of coverage
* Other potential cost savings areas that some employers
seem open to:
- Lowering the post-retirement cost-of-living
adjustment
- Not providing medical coverage to vested terminated
members
* Some responses seem to favor continuing a defined benefit
approach
- Reward long service
* However, responses leaned towards shifting investment risk
to members
Mr. Reynolds stated that Slides 6 and 7 depict "the important
conclusions that were drawn from the Employers' surveys. Slide 6
reflects the conclusions for PERS employers and Slide 7 depicts the
conclusions for TRS employers. "The conclusions were essentially
identical". He reviewed the conclusions and noted that "vested
terminated members are members who leave the system prior to
reaching eligibility for retirement, but who are entitled
nevertheless to receive a benefit from the State once they reach
retirement age." The benchmarking activity that was undertaken in
the Tier Review revealed that, "very few, if any, other system
provides medical coverage to vested terminated members."
Slide 8, page 4
Overview
System Objectives and Constraints
Based on information gathered and stakeholder feedback, the
Tier Committee drafted the following objectives:
* The System should provide medical benefits to retirees
- Members should bear a greater share of the cost
- Members should have to retire from the System to be
eligible
* Benefits should favor longer-service members
* Employer contributions should be more predictable and
stable
* Investment risk should be shared by employers and members
* Healthcare inflation risk should be shared by employers
and members
Slide 9, page 5
Overview
System Objectives and Constraints
Based on information gathered and stakeholder feedback, the
Tier Committee drafted the following constraints:
* Non-medical benefits must be sufficient to satisfy minimum
requirements for employers who do not participate in Social
Security
* Benefit changes must take the form of new "tiers"
* Annual cost of benefits should be less than the current
Systems' normal cost rates
Mr. Reynolds stated that the employers' survey combined with other
information gathered by the subcommittee "led to the drafting
objectives and constraints for the retirement system that are
reflected on Slides 8 and 9. The information on Slides 8 and 9
provide the framework for what the subcommittee "was aiming at in
arriving at the proposed alternatives."
Slide 10, page 5
Trends and Alternatives
Defined Benefit Observations
* Plans have experienced higher cost levels and greater cost
volatility
* Funded status has declined in last 3 years
* Advantages (to employer) of defined benefit plans
- Retention incentives, lower turnover cost
- Workforce management
- Cost allocated to longer-service employees
Slide 11, page 6
Trends and Alternatives
Defined Benefit Observations (continued)
* Advantages (to employee) of defined benefit plans
- Pooling of longevity risk
- In most cases, employer bears investment risk
- Predictable, stable retirement income
* Challenges (for employer) of defined benefit plans
- Investment risk
- Cost volatility
Slide 12, page 6
Trends and Alternatives
Defined Contribution Observations
* Advantages (to employer) of defined contribution plans
- Predictable cost
- Stable cost
- Employee assumes investment risk
- No long-term administrative commitment
- Contribution equity among employees
* Advantages (to employee) of defined contribution plans
- Portability
- Ability to direct investments
- Contribution equity among employees
Slide 13, page 7
Trends and Alternatives
Defined Contribution Observations (continued)
* Challenges for defined contribution plans
- More difficult to manage workforce
- Employee directed money often earns less
- Amount needed at retirement is often underestimated
- Employees need to contribute in excess of 10 percent,
but most do not
- Retirees generally not equipped to transform lump sum
into monthly payments that last for a lifetime
(difficult to manage longevity risk)
Mr. Reynolds stated that Slides 10 through 13 describe trends and
alternatives in retirement programs nationwide. He read the
information on the slides and stated that one outcome of this
benchmarking activity was the realization that retirement systems
around the country "have experienced or would experience changes to
their programs." Therefore, comparing Alaska's retirement programs
to others is difficult as programs nationwide are in a state of
flux. An alternative retirement program is a defined contribution
retirement plan such as a 401K plan, which is the type of program
being proposed for the federal Social Security program. "A Defined
contribution plan is an account that is typically invested at the
employee's discretion in the marketplace… in mutual funds or stock
funds." The advantages of a defined contribution plan to an
employer and an employee are depicted on Slide 12. The challenges
of these plans are depicted on Slide 13.
Slide 15, page 8
Proposed Alternatives
Overview
* Two alternatives are being presented to the PERS and TRS
Boards, with the
Tier Committee recommending Alternative 1
* Components of Alternative 1
- defined benefit
- defined contribution
- medical
- health reimbursement account (HRA)
* Components of Alternative 2
- defined contribution
- medical
- health reimbursement account (HRA)
* Member contributions under both alternatives are higher
than the current tiers
* Contribution rates for the defined contribution component
are higher for Alternative 2
* Post-retirement medical program is the same for both
alternatives
Mr. Reynolds stated that the Subcommittee proposed two
alternatives, Alternative 1 and Alternative 2, as described on
Slide 15. The health reimbursement account (HRA) which is the
medical component being proposed for both alternatives "is a
vehicle similar to a defined contribution account but with the
purpose of setting aside and building a fund to pay for medical
expenses in retirement." Therefore, the HRA plan would be different
from the current plan.
Mr. Reynolds stated that the difference in the two Alternatives is
that the defined benefit portion of the retirement program was
eliminated in Alternative 2, "and the costs that would have been
directed to the defined benefit program in Alternative 1 were
instead directed to the defined contribution part of Alternative 2
so that Alternative 2 has a larger defined contribution component
than Alternative 1 does and no defined benefits portion." The
Member contribution in both Alternatives would be higher than
current tiers' levels. While the Subcommittee supported Alternative
1, the overall PERS/TRS Boards did not approve it.
Slide 16, page 8
Proposed Alternatives
Defined Benefit Alternative
Key features of Alternative 1 defined benefit program
* 1 percent of career average pay
* Pay is indexed from year received to year preceding
retirement (or termination) based on the Anchorage CPI
- for example, 1997 pay for a member retiring on December 31,
2009 would be increased at Anchorage CPI for 12 years
* Base pay only
* Normal retirement at the earlier of
- (1) age 60 with 5 years of service (8 years for TRS),
or
- (2) 25 years of service (30 years for PERS "others")
* Post-retirement pension adjustments similar to current
tiers
* No 10 percent Alaska cost-of-living adjustment (COLA)
Slide 17, page 9
Defined Contribution Alternatives
Key features of defined contribution components
* Individual accounts are maintained for each member
* Contributions are a percentage of base pay
* Various investment options (member-directed)
* 100% vested
* Terminating or retiring member takes account (eligible for
rollover)
Mr. Reynolds stated that Slides 16 through 19, on pages eight and
ten, provide details of the defined benefit and defined
contribution components of the programs. The graph on Slide 18, on
page nine, compares the value of the TRS Non-Medical benefits of
the current plan at various ages to the projected values of the two
proposed Alternatives. The graph on Slide 19 reflects these values
for PERS. The TRS chart depicted on Slide 18 indicates that Tier 2
members who retire from the current system at age 60 would receive
higher benefit levels than either Alternative; however, the
proposed Alternatives would provide that person higher benefits
were they to retire at an earlier age. On average, the benefit
levels of the Alternatives would provide similar values to those of
current Tier 2 employees. A PERS Tier 2 60-year old retiree's
current benefit levels would be similar to those of Alternative 1.
Prior to that age, Alternative 1's value exceeds that of
Alternative 2 or the current PERS Tier program.
Mr. Reynolds characterized the proposed Alternatives' Non-medical
benefit components as being "risk-shifting" rather than being a
cost-reduction. The benefit levels were designed to be roughly
similar to the current programs with some of the investment risks
shifting from the employer to the employee. The level of shifting
is what differs in the two proposed alternatives. "Alternative 1
shifts some of the risks from employers to members and Alternative
2 shifts" the entirety of the investment risk from the employer to
the members in regards to non-medical benefits.
Mr. Reynolds stated that key aspects of the proposed Medical
programs are described on Slides 20 through 28, pages ten through
14.
Slide 20, page 10
Proposed Medical Program
Key Features
Key features of post-retirement medical program
* Members must retire directly from the System to be eligible
* System sponsored health plan with varying levels of subsidy
or cost to members
* Early retirees get "access only" prior to normal retirement
eligibility
* Defined dollar benefit from normal retirement to Medicare
eligibility (currently age 65)
* Defined health benefit after Medicare eligibility, similar
to the current program with the following key exceptions:
- Method of coordination with Medicare
- Retired members will share in the cost through premium
contributions
Slide 21, page 11
Proposed Medical Program
System Sponsored Health Care Plan
* System sponsored health plan available to all eligible
retirees, but with varying levels of subsidy
* Basic plan design elements
Current Plan Alternate Plan
Medical
*Coordination with Maintenance of
Medicare Total Allowance Benefits
*Deductible $150/person, $250/person,
$450/family $750/family
*Out of Pocket $800 $2,500
*Outpatient Surgery 100% 80%
Coinsurance
Prescription Drug
*Retail 90 day supply 30 day supply
-Generic $4 $5
-Brand Formulary $8 $15
-Brand Non-Formulary $8 $30
*Mail Order 90 day supply 90 day supply
-Generic $0 $5
-Brand Formulary $0 $15
-Brand Non-Formulary $0 $30
Dental, Vision, Audio No change
Slide 22, page 11
Proposed Medical Program
Eligibility
*Normal retirement eligibility for medical benefits will be
defined as the earlier of
- (1) age 60 with 10 years of service
- (2) 25 years of service (30 years for PERS "others"
retirees).
* Disabled participants will be eligible
* Terminated vested participants are not eligible. A member
must retire directly from active service in order to receive
coverage
Slide 23, page 12
Proposed Medical Program
Early Retirement
* Early retirees who have not reached normal retirement
eligibility
- Receive "access only" plan
- Will not be eligible for subsidized retiree health plan
costs
- Pay 100% of the pre-Medicare eligible (currently pre-
age 65) per member per year (PMPY) claim costs
* Dependent spouses of early retirees will pay 100% of the
appropriate pre-Medicare or Medicare eligible PMPY claim cost
Slide 24, page 12
Proposed Medical Program
Normal Retirement to Medicare Eligibility
* Members who retire directly from the Systems will be
eligible for a "defined dollar" benefit upon reaching
eligibility for normal retirement
* Fixed dollar subsidy toward system sponsored health coverage
* Access to system sponsored retiree medical plan as outlined
above
* Subsidy amount is based on length of service
* Subsidy amount indexed each year by healthcare inflation up
to a maximum of 5 percent (with a "catch-up" provision based
on years when healthcare inflation is less than 5%)
Slide 25, page 13
Proposed Medical Program
Normal Retirement to Medicare Eligibility
* Upon becoming eligible for Medicare, such members will
become eligible for the "defined health" benefit
* Pre-Medicare dependent spouse is eligible for the same
subsidy as retiree
* Medicare eligible dependent spouse is eligible for the
Medicare eligible benefit level, with contribution percentage
based on retiree length of service
Slide 26, page 13
Proposed Medical Program
Normal Retirement to Medicare Eligibility
* Apply percentages to the applicable subsidy base to arrive
at the appropriate subsidy amount.
* Defined Dollar Subsidy Base Annual PMPY for fiscal year
2004:
Pre Medicare $5,962*
* Subsidy Percentage
Service (yrs) Subsidy %
10-14 30%
15-19 45%
20-24 60%
25-29 75%
30+ 90%
* Member contributions are determined by subtracting the
annual subsidy amount from the annual claims cost for a given
year.
*Equivalent to FY2004 pre-Medicare projected claim cost.
Slide 27, page 14
Proposed Medical Program
After Medicare Eligibility
* Defined health benefit similar to current program
* Retirees who were previously eligible for 100% subsidy of
retiree health plan costs will now participate in the premium
cost.
* Contributions are per covered individual
* Pre-Medicare dependent spouses are eligible to receive a
defined dollar subsidy with percentage based on retiree length
of service
* Medicare eligible dependent spouses are eligible to receive
the same defined health benefits as the retiree and pay the
same contributions
Slide 28, page 14
Proposed Medical Program
After Medicare Eligibility
*Contribution Base PMPY for fiscal year 2004:
Medicare Eligible $2,667
* Contribution Percentage
Service (yrs) Contribution %
10-14 30%
15-19 25%
20-24 20%
25-29 15%
30+ 10%
* Apply percentages to the contribution base to arrive at the
applicable contribution
Mr. Reynolds stated that Slides 20 through Slide 28 describe the
key aspects of the proposed medical program. He communicated that
under the proposed alternatives, terminated vested members who
leave prior to retirement would not be eligible for medical
benefits. The components of Slide 20 were reviewed. The System
sponsored health plan would provide varying levels of subsidy or
costs to the members. The medical benefits program would be divided
into three phases over a member's retirement including: Phase 1 is
early retirement in which a member who retires prior to normal
retirement "would get access to the program but would need
essentially to pay their own way"; Phase 2 would be from a member's
normal retirement age to reaching eligibility age for Medicare
which is currently age 65; and Phase 3 which is once a member
reaches Medicare eligibility. Phase 2"S Defined Dollar Benefit
means that "the system would provide money that the member would
use to help pay for medical care but the member would be
responsible for the difference between what the system provides and
the actual cost of the medical care. Phase 3 would be similar to
the current program with the exception being the method through
which "the program coordinates with Medicare and a greater degree
of cost sharing with the members through premium contributions."
The Health Reimbursement Account (HRA) is intended to assist
members with setting aside money "to help pay for some of the cost
sharing elements in the proposed program." He recommended that the
Committee Members independently review the Medical component
Slides.
Mr. Reynolds informed the Committee that more information regarding
the HRA account is provided on Slides 29 through 38, pages 15
through 19. HRA have been in existence for several years and recent
federal legislation "is making them more common and more
attractive." While HRA accounts are similar to defined contribution
plans, the key point here is that HRA "is simply an account that
helps accumulate money toward health expenses in retirement."
Mr. Reynolds stated that the financial implications of the
alternatives are depicted beginning with Slide 39 on page 20. It
provides the normal cost rates of Alternative 1 as compared to the
current system for both PERS and TRS. He reminded that the current
system's normal cost rates were depicted in Slides 2 and 3. "The
normal cost rate is the cost of the benefit that the members are
expected to earn in any given year. It does not consider any
unfunded liability that might need to be paid off. It's a fresh
start look at the cost of the retirement system." It would be
"expected that on average the Alternative 1 program would cost
18.75 percent." The numbers in parenthesis reflect the comparable
cost for the current TRS system. The current projected cost would
total 22.97 percent. Alternative 1 would result in approximately a
four-percent savings. One of the Tier Redesign subcommittee's
objections was to reduce costs of the system. Currently, members'
share of the program cost is 8.69 percent; under the new system
members' share would increase to 10.0 percent. Employers' costs
would be reduced by approximately 5.5 percent. The PERS cost rates
are also depicted on Slide 39.
Mr. Reynolds explained that Slide 40 on page ten depicts similar
information regarding Alternative 2. The overall costs of
Alternative 2 were designed to be similar to Alternative 1. The
difference is that the defined benefit program is eliminated and
the defined contribution rate is higher. He reviewed the PERS and
TRS normal cost rates for members and employers as proposed by
Alternative 2.
Mr. Reynolds concluded that both Alternatives "were designed to
have similar overall long term cost implications both to members
and employers." The differences "include the levels of cost
volatility that could be expected from year to year." Alternative 1
has more volatility because it has retained the defined benefit
component". Alternative 2 would have "considerably less volatility
but would continue to have some cost volatility associated with the
medical component."
Ms. Millhorn explained that page 21 depicts the historical PERS and
TRS Normal Cost Rates as compared to the Actuarial Computed Rates
for the years FY 1983 through FY 2006. She noted that the benefits
from higher investment earnings are reflected in the lower cost
rates for the years 1999 through 2002.
Mr. Reynolds stated that pages 22 through 25 portray the Key
Assumptions utilized for the Actuarial Projections into the future
for the current PERS and TRS systems. The assumptions on page 22
project that there would be a population growth rate of one
percent; the PERS Board would adopt the Actuarial recommended rate
with the provision that, as established in State Regulation, the
rate could not increase by more than five-percent per year; and the
utilization of "three different possible economic futures"
including one labeled "Base Rate" in which it is anticipated that
the fund would earn on average 8.25 percent per year; one labeled
"Growth" which "is a little more optimistic with higher returns in
the next few years, leveling out to the Actuarial assumption in the
future"; and a "pessimistic economic scenario labeled Prolonged
Recession with very poor investment returns for the first few years
rebounding to a higher level but a level that is still lower than
the 8.25 percent assumption." The known actual returns for the year
2004 have been factored in. These three scenarios and their
projected contributions rates are depicted, in graph form, on page
23. He stated that the graph depicts that the unfunded liability
would be paid off in 25 years. The contribution rates could
increase to as much as 30-percent under the Base Case scenario
before declining.
Co-Chair Green understood that this information was provided in the
Department's January 26 presentation.
Mr. Reynolds affirmed, and noted that this information continues
for the TRS system on pages 24 and 25. The TRS system's
contributions could increase to approximately 55-percent before the
unfunded liability is paid off. He reiterated that the TRS Board is
not bound by the five-percent constraint.
Mr. Reynolds stated that the PERS/TRS scenarios for the new tiers,
as compared to the current program are depicted on Slides 41 and 42
on page 26, respectfully. He clarified that because no one in the
current system would be subject to the new tier provisions, a few
years would pass before the savings affects of the new tier would
be realized. It is anticipated that "significant cost savings"
amounting to approximately six or seven percent could result at the
end of the 25-year period for the PERS system, as reflected on
Slide 41. Similar savings are projected for the TRS system as
depicted on Slide 42.
Mr. Reynolds and Ms. Millhorn concluded their remarks.
Senator Bunde understood that a significant number of employees
would be retiring from the PERS/TRS systems over the next few
years. Therefore, implementation of a new tier within the next four
or five years would be the most effective action.
Ms. Millhorn deferred to Mr. Reynolds, as her Division had not
conducted an analysis in this regard.
Mr. Reynolds responded that while he could not provide "a numerical
answer to the question", during the initial stages of the tier
redesign project, Mercer had conducted population projections for
both the PERS and TRS systems for the next five to ten years. The
projections included expected retirements and the areas of the
system that would require personnel replacements. This information
is available on the Department of Administration's website. The
projections portrayed on page 26 of the Report reflect "the affect
of the new tier were it to be implemented in the very near future,"
either today or in the next one to two years. Projections were not
undertaken that would reflect the affects of a new tier occurring
five years out. While those projections are unavailable, "clearly
it does defer by five years any savings that a new tier might bring
into the system." He agreed that were "a bubble of people" retiring
over the next few years, delaying the implementation of a new tier
could be characterized as "some opportunity lost in terms of
replacing current membership with new tier members."
Co-Chair Wilken chaired the following portion of the meeting.
Senator Bunde stated that he would defer the decision to the Co-
chairs as to whether development of a chart depicting the
forecasted retirement scenario might be helpful to the discussions.
Continuing, he asked for further information regarding the
projected one-percent population growth.
Mr. Reynolds clarified that, based on "recent historical analyses,"
a one-percent population growth is forecast in regards to the
growth of members in the two systems: active membership in PERS has
grown 1.1 percent per year on average over the past five years as
compared to .6 percent per year growth for TRS. He clarified
however, that "it is not Mercer's attempt to predict" what might
occur in the State.
Senator Bunde stated that it would be interesting to compare this
information to the projections developed by the Department of Labor
and Workforce Development.
Senator Bunde asked regarding "the cost of money" in that would the
State be able to save a substantial amount of money were it able to
pay off the outstanding debt early, similar to how an individual
might save money were their 30-year loan paid off prior to its
termination date.
Senator Green assumed Chair of the meeting.
Mr. Reynolds responded, "that the time value of money is factored
into all these calculations." Paying off a mortgage early would
save nominal dollars. However, were that money invested at the
mortgage interest rate, it would not result in significant savings
as tax incentives and other elements would not be applicable. The
Department has requested Mercer to determine the affect of paying
off a portion of the unfunded liability early. This information is
being compiled. He referred the Committee to the right hand column
of figures on aforementioned Slides 2 and 3 which indicate that,
were each systems' entire unfunded balance paid off, the cost rate
would decrease from 25.63 percent to 13.24 percent and from 38.85
percent to 14.28 percent for PERS and TRS respectfully. "That would
be the savings realized from paying off the entire unfunded
portions of the unfunded…." Were half of it paid off, "the past
service rate would decrease by half."
Co-Chair Green announced that, due to time constraints, Members'
questions pertinent to these issues would continue during the
Friday, January 28, 2005 meeting.
ADJOURNMENT
Co-Chair Green adjourned the meeting at 11:01 AM
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