Legislature(2005 - 2006)SENATE FINANCE 532
04/01/2005 09:00 AM Senate FINANCE
| Audio | Topic |
|---|---|
| Start | |
| SB141 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | SB 141 | TELECONFERENCED | |
| + | TELECONFERENCED | ||
MINUTES
SENATE FINANCE COMMITTEE
April 1, 2005
9:13 a.m.
CALL TO ORDER
Co-Chair Green convened the meeting at approximately 9:13:12 AM.
PRESENT
Senator Lyda Green, Co-Chair
Senator Gary Wilken, Co-Chair
Senator Con Bunde, Vice-Chair
Senator Fred Dyson
Senator Bert Stedman
Senator Lyman Hoffman
Senator Donny Olson
Also Attending: SENATOR GARY STEVENS; SENATOR TOM WAGONER; NEIL
SLOTNICK, Assistant Attorney General, Labor and State Affairs
Section, Civil Division (Juneau), Department of Law; MILES BAKER,
Staff to Senator Bert Stedman
Attending via Teleconference: There were no teleconference
participants.
SUMMARY INFORMATION
SB 141-PUBLIC EMPLOYEE/TEACHER RETIREMENT
The Committee heard a presentation from the Department of Law
regarding the Alaska Resident Cost of Living Adjustment class
action lawsuit and its relationship to this legislation. In
addition, the bill's sponsor discussed the contribution rate
component of the proposed Defined Contribution Plan. The bill was
held in Committee.
SENATE BILL NO. 141
"An Act relating to the teachers' and public employees'
retirement systems and creating defined contribution and
health reimbursement plans for members of the teachers'
retirement system and the public employees' retirement system
who are first hired after July 1, 2005; establishing the
Alaska Retirement Management Board to replace the Alaska State
Pension Investment Board, the Alaska Teachers' Retirement
Board, and the Public Employees' Retirement Board; adding
appeals of the decisions of the administrator of the teachers'
and public employees' retirement systems to the jurisdiction
of the office of administrative hearings; and providing for an
effective date."
This was the eighth hearing for this bill in the Senate Finance
Committee.
Co-Chair Green stated that the Department of Law would be
explaining the A. John Gallant, et.al, Plaintiff, vs. Public
Employees' Retirement System, et.al., Defendant, Case No. 3AN-02-
9748 Civil class action lawsuit regarding the Alaska resident ten-
percent Cost of Living Adjustment (COLA) and its possible impact on
the State of Alaska.
NEIL SLOTNICK, Assistant Attorney General, Labor and State Affairs
Section, Civil Division (Juneau), Department of Law, stated that
the Gallant V. Public Employees Retirement System class action
lawsuit (Lawsuit) is relevant to SB 141, and, in addition, might
require "Legislative attention in the future". The Class referenced
in this Class Action Lawsuit consists of the entirety of the
current members of the Public Employees Retirement System (PERS)
and the Teachers Retirement System (TRS). The Lawsuit challenges
the Constitutionality of the Alaska resident COLA, which, as a
feature of both retirement systems, "adds ten percent to the
retirement income of anyone who" physically resides in the State.
It is not paid to a retiree or disability recipient who resides
outside the State or who is absent from the State for more than a
90-day period. The Lawsuit contends that such withholding of the
ten-percent COLA is unconstitutional under the State's Equal
Protection Clause on the basis "that it burdens their right to
travel" outside the State. Furthermore, the cost of living in many
areas outside of the State is as high or higher than the cost of
living in Alaska, and, therefore, a person moving to those areas is
penalized.
Mr. Slotnick stated that one of the first issues addressed by the
Department in regards to this Lawsuit was "the question of
severability". The Department's argument before the Judge was that,
were the withholding of COLA found unconstitutional, "the right
remedy would be that no one" would receive it. "The Legislature
would never intended there to be an unconstitutional provision
given to retirees, and therefore, what we should do is just strike
it completely, if in fact, it turns out to unconstitutional".
9:16:25 AM
Mr. Slotnick stated that were Superior Court Judge John Suddock to
agree to the Order of Severability argument in advance, the Lawsuit
might not move forward "as there would be no advantage to anyone"
in doing so. However, the Judge did not agree with the State's
argument in this regard. The Alaska Superior Court Summary Judgment
ruling on this issue is depicted on page five of the Department's
information packet titled "A. John Gallant et. al. Plaintiff, vs.
Public Employees' Retirement System, et. al., Defendant" [copy on
file]. The basis for the ruling was Article XII, Section 7 of the
State's Constitution, which reads as follows.
Retirement Systems. Membership in employee retirement systems
of the State or its political subdivisions shall constitute a
contractual relationship. Accrued benefits of these systems
shall not be diminished or impaired.
Mr. Slotnick read the Judge's aforementioned ruling as follows.
Plaintiff's Motion for Partial Summary Judgment, on Article
XII, Section 7 grounds, is styled as a request for a finding
of constitutionally required severability. The Court instead
grants partial summary judgment on the related rationale that
Article XII, Section 7 prohibits reduction of the ten percent
supplement as to class members, while they are Alaska
residents.
Mr. Slotnick stated that, "what the Court held was that we cannot
take away this COLA to Alaskan residents under the Constitution
because it is in fact a vested right in their pension". Were this
ruling upheld by the Alaska Supreme Court, it would "certainly
affect SB 141 and any attempt to do away with the COLA as to
everybody". The Superior Court has ruled that the COLA as "a vested
right for Alaska residents cannot be diminished either
Legislatively or by a Court", even were the residency issue found
to be unconstitutional.
9:18:52 AM
Senator Stedman understood that System retirees "living in high
cost areas relative to Alaska" such as Seattle Washington or
Phoenix Arizona are interested in this issue, even though he
considered it "odd that the intent was to have a cost of living for
living in Alaska. Now it is being twisted around and trying to be
made applicable to golfing in Phoenix".
Mr. Slotnick responded that would be the State's argument when the
State takes "this case to the Alaska Supreme Court and appeals"
Judge Suddock's ruling. "The COLA doesn't penalize someone's right
to travel." People who remain in the State, which has "generally
higher costs that the Lower 48", would receive this supplement to
their retirement income. However, that is not how Judge Suddock
viewed it. His ruling was based on a 1984 Workers Compensation (WC)
case in which a formula calculates the compensation payments based
on the average wage rate of the state in which the injured worker
resided. "The formula that was in effect at the time had a huge
affect on workers who left this State because average pay up here
at the time, during the pipeline, was so much greater than the
average pay down in the Lower 48. The Court found that that was in
fact a burden on the workers right to travel" as some WC
compensation payments were reduced by more than 50 percent. Judge
Suddock deemed the denial of the COLA to be similar to the WC case
as it would reduce someone's retirement income by ten percent, and
the individual might be moving to an area with higher cost of
living than Alaska. The State does not agree with the COLA/WC
comparison because rather than diminishing someone's retirement
income, COLA pays "someone an extra ten percent because they do
live in the State of Alaska which is, in general, more expensive
than the rest of the Lower 48".
SENATOR GARY STEVENS asked whether the COLA would be eliminated for
the entire year or only for the length of time that an individual
is outside of the State for more than 90 days.
Mr. Slotnick responded that the COLA would be withheld only for the
period of time an individual were absent from the State for more
than 90 days. COLA would be reinstated at the time of their return
to the State.
Mr. Slotnick noted that Judge Suddock's order that was issued in
August 2003 "clearly" indicates that eliminating the COLA for all
Alaskans would be unconstitutional. The litigation as it stands
today is in regards to a question that arose to the effect of "if
the cost of living adjustment being limited to Alaska residents is
an unconstitutional residency requirement, what's the remedy?" Were
the State required to provide "the COLA to all retirees, then it
should not be viewed as a Cost of Living Adjustment at all". The
Judge disagreed and stated that the State should find out where the
retirees live, and compute the cost of living for that area, "and
if it is in fact as high or higher than the cost of living" in
Alaska, then the State would be required to pay the COLA. The State
has argued that this should be done on a state-by-state average
rather than individual areas' averages. The Judge ruled otherwise:
the cost of living must be conducted by the metropolitan service
area (MSA) in which the person resides. Were the MSA study not
conducted, the Judge stated that all retirees, regardless of place
of residence, must receive the ten percent COLA. Furthermore, were
the Supreme Court to uphold Judge Suddock's ruling, the State would
be required to develop a new formula for a Constitutional cost of
living adjustment formula within one Legislative session plus six
months for regulations, after that ruling.
9:24:31 AM
Mr. Slotnick warned the Committee that the subsequent ruling on the
COLA might occur within the next two Legislative sessions, and
could result in another unfunded liability the size of which is
unknown. A "worst case scenario", which would include both payments
going forward, and, as specified in the class action lawsuit, "past
damages going back at least six years to make everyone whole for
this unconstitutional act" could amount to approximately $33
million per year. The reply to the State's argument that, "you
don't get payment for unconstitutional statutes." was that "It's a
contract." The State then argued, "No, there was no contract to pay
retirees who don't live in the State ten percent, there was no
offer and acceptance. The offer that was always made was ten
percent more if you lived in the State of Alaska. That was the
contractual provision. The Judge agreed with us". He said "no
contract damages, no looking backward damages, only going forward
would there have to be an increase in payment and that would
depend" on whether the State develops a formula to determine the
cost of living in the different MSAs.
Mr. Slotnick reiterated that the $33 million per year figure was a
worst-case scenario. Accurate costs are difficult to determine at
this time.
Senator Hoffman asked the percentage of retirees who live in State.
Mr. Slotnick estimated that 68-percent of PERS retirees and 65-
percent of TRS retirees reside in the State.
9:27:33 AM
Co-Chair Green asked for further information regarding the
individuals who initiated the Lawsuit.
Mr. Slotnick explained that it is a class action lawsuit and all
current and retired PERS/TRS employees have been certified as
participants. The basis being that any Alaska resident member's
right to travel would be burdened because, were they to leave, they
would loose the ten percent COLA.
Co-Chair Green asked for further information regarding the
individual(s) who originally filed the Lawsuit.
Mr. Slotnick replied that the named plaintiffs are a retired
Department of Corrections officer who lives in Hawaii, and two
teachers who lived in Kenai and wanted to leave the State but had
not left at the time the case was filed.
9:28:32 AM
Senator Stedman theorized therefore that an out-of-state retiree
could move from a low cost of living area to one with a high cost
of living and receive what could be likened to a ten percent raise.
There is a problem.
Co-Chair Green asked how often the MSA comparison must be
conducted. She suggested that the retirement payment should be
reduced were the area deemed to have a lower cost of living.
SENATOR TOM WAGONER echoed Co-Chair Green's suggestion that a
reduction in the retirement payment could be considered were the
out-of-state retiree to reside in an area with a lower cost of
living. He disclosed being a recipient of the ten-percent COLA, and
stated that it was a factor in his decision to retire early and
remain in the State. The COLA allows other retirees to remain in
the State and, as such, has an economic impact.
Senator Wagoner asked what solution to the issue is being
considered and whether it might require a Constitutional amendment
that specifies that anyone who retires and remains in the State
would be entitled to a ten-percent cost of living adjustment.
9:30:12 AM
Mr. Slotnick recommended that no further action on the part of the
State occur until after the Supreme Court ruling is made. There is
"already a Constitutional amendment that tells us that any
residency preference granted by the Legislature to residents of the
State of Alaska shall be treated the same under Alaska
Constitutional standards as under federal Constitutional standards
… Under federal standards, this kind of COLA would not be viewed as
a burden on anyone's right to travel". One argument presented to
the Superior Court was that the people of the State, through their
action of adopting the Constitutional amendment, have approved
treating this type of "preference for Alaska residents as leniently
as possible under all Constitutional standards. The Court did not
agree that that Constitutional amendment applied here, and viewed
this "not as a preference as meant under that amendment". Therefore
the Court applied Alaska law.
Mr. Slotnick stated that the discussion of adopting "yet another
amendment to the Alaska Constitutional saying that this time we
mean it … would only work if in fact the decision is under Alaska
law. If it's a federal equal protection standard that says this
COLA were unconstitutional, that type of amendment wouldn't work".
To date, there is no indication "that the federal Constitution
would require this result; it is only under Alaska Constitutional
law". The Legislature and the people of the State have already
provided the Department of Law "the weapons we need to defend it".
The Department would do its "best to defend it in the Supreme
Court".
9:32:36 AM
Senator G. Stevens asked whether this situation could be likened to
someone being refused a Permanent Fund Dividend (PFD) due to their
being out of state.
9:33:08 AM
Mr. Slotnick noted that the State has argued that there is a
connection. The issue of denying a PFD to someone who did not meet
the residency requirements has been addressed by the Alaska Supreme
Court "and the Court has held that when you leave the State you are
not eligible for a PFD even if in fact you are an Alaskan resident"
which is defined by the 180-day requirement. The Court decision
"upheld that as not being violative of someone's right to travel
even though they're as every bit an Alaska resident on the one
hundredth and eighty-first day as on the one hundredth and seventy
ninth … doesn't matter … it's a benefit, it's not a burden". The
State likes this connection. However the Superior Court Judge did
not recognize this connection; he did not view his decision in the
COLA case as overturning the PFD ruling.
Senator Bunde suggested that, were the State to not prevail in this
case, one options would be to reduce everyone's retirement by ten
percent rather than increasing everyone's retirement by that
amount. Were that to occur, the names of the persons who filed this
suit should be released to PERS/TRS members.
9:34:31 AM
Senator Dyson recounted that numerous class action suits have been
filed in the past few years, and, he himself, "had ended up being a
part of" two cases. He shared that, in those instances, those in
the "class" had been provided an opportunity to opt out of the
suit. Therefore, he asked whether an opt-out clause could be
included in this case.
Mr. Slotnick expressed that, "there are such things as non opt-out
class actions". Research would be conducted to clarify the
mechanics of the law in regard to this case. Typically the opt-out
ability is provided when damage claims are a component, as is the
case here.
9:36:02 AM
Co-Chair Green asked whether the upholding of the Superior Court
Judge's decision by the Supreme Court would eliminate the
possibility of repealing the COLA benefit "for all members of the
existing retirement system", both active and retired.
Mr. Slotnick affirmed that it would. Were the Superior Court's
ruling to hold, repealing the existing COLA "would be a difficult
task, given our Supreme Court precedence".
Co-Chair Green understood that that ruling would apply to members
of Tiers 1, 11, and 111 of PERS and Tiers I and II of TRS.
Mr. Slotnick agreed.
Co-Chair Green stated that the interpretation of the COLA provision
is "clearly not what was intended by anyone. It was the incentive
to stay here …". There are financial implications that are of
concern to this Committee. The Committee should be made aware of
any action that might be required on its part to assist the State's
legal staff in this issue.
Mr. Slotnick acknowledged the request. He reiterated that, "the
Constitution has a provision that says you cannot diminish or
impair the accrued rights of members of the State Retirement
Systems. The Courts take a very liberal interpretation of that
provision. I think it would be very difficult to defend repealing
the COLA for existing employees, regardless of whether they've
retired already or not because once they have accepted employment
with the State or with the member employers, then part of their
contractual rights includes that COLA upon retirement should they
choose to stay in the State".
Co-Chair Green commented that, "the key issue is whether the
employee stays within the State".
Senator Bunde surmised therefore that his earlier suggestion to
eliminate COLA would not an option.
Senator Bunde asked regarding the financial impact of the Lawsuit
were the State not to prevail.
Co-Chair Green stated that the worst-case scenario could be
approximately $33 million annually.
Mr. Slotnick clarified that the $33 million amount would include
back damages, as there is the possibility that the Supreme Court
could reverse the decision made in the State's favor in that
regard. While the State is hopeful that the Supreme Court would
reverse the Superior Court Judge's ruling, the claimants are
hopeful that the Supreme Court might reverse the back damages
ruling. Were that to occur, the State would face an unfunded
liability of $33 million per year. The financial impact of the
Supreme Court's ruling would be "very difficult to compute until we
have done a lot more research on the cost of living in the MSAs;
where people are living; who would be eligible for what."
Co-Chair Green pointed out that the process involved in the MSA
study and the gathering of information "would be costly".
Additional expenses would be incurred were someone to move to
another MSA. She viewed this as "an unreasonable burden".
Mr. Slotnick responded that the cost of conducting studies was
argued in Court. The Judge "just shook his head and said, 'No, its
not going to be the sky is falling, Mr. Slotnick'". Twenty-five to
thirty-five high-cost MSAs could be identified and surveyed. It
would be "Constitutionally permissible for you to make an
assumption that its lower costs than Alaska until proven
otherwise". "Even that burden though is not insignificant". There
would be an additional burden related to the tracking procedures.
Co-Chair Green concurred that the "targets are ever-changing".
Mr. Slotnick concluded his remarks.
9:42:13 AM
Senator Stedman, the sponsor of SB 141, stated that today's hearing
would concentrate on the Contribution Rate component of the
proposed Defined Contribution Plan (DCP). A seven-page handout,
titled "Contribution Rates for New Defined Contribution (DC) Plan",
dated April 1, 2005, along with a fourteen-page handout titled
"Comparison of the States Normal Retirement by Age/Service" [copies
on file] were distributed to complement the presentation. The 14-
page handout provided examples of retirement benefit levels as
influenced by retiree age and length of service.
Senator Stedman voiced appreciation for the laborious work being
conducted by his Finance Aide, Miles Baker, in developing the bill
and the handout materials.
Senator Stedman reviewed the "Contribution Rates for New Defined
Contribution (DC) Plan" handout as follows.
9:43:51 AM
Page three
Defined Benefit Plan Defined Contribution Plan
*Benefit level is fixed *Contribution level is fixed
*Benefit is based on a *Benefit is based on the amount
formula involving salary, of money invested and earned in
years of service, age, etc. employee's account
* Benefit is paid for life *Benefit is paid until account
and to qualified survivors runs out
*Future benefit payments are *Future benefit payments are
NOT driven by investment driven by investment
performance. performance
Senator Stedman discussed the side-by-side comparison of a Defined
Benefit Plan (DBP) and a Defined Contribution Plan (DCP). As
discussed during Mr. Slotnick's presentation, there are certain
legal obligations that must be considered when endeavoring to
modify the State's current DBP retirement plan.
Senator Stedman noted that while the contribution level would be
fixed in a DCP, the level could be increased or decreased "in the
future if need be". Rather than being a pooled investment, each DCP
employee would have their own account and would receive the benefit
until either the account is empty; or there were "a separation of
service and the employee decides to transfer the funds to his new
employer"; or, were the employee to die, the funds were transferred
to the heirs.
Co-Chair Green concluded therefore that this portability factor is
"the distinction between" a DBP and a DCP.
Senator Stedman concurred and stated that in today's working
environment, it would not be unusual for an employee to have three
or four different careers throughout their life. A DCP with its
portability component would allow an employee, with multiple
careers, to move his/her funds from one employer's retirement plan
to another. A DCP would therefore, not penalize an employee "at the
end when they want to retire".
Senator Stedman stated that the State's current Supplemental
Benefit System (SBS) and the Deferred Compensation Plan are
examples of future benefit payments driven by investment
performance.
Senator Stedman explained that page four compares the differences
between the investment accounts of a DCP and a DBP: a DBP pools
employee and employer contributions and the benefits are paid out
as determined by a set formula; a DCP establishes individual
employee accounts with the retirement money being a combination of
employee and employer contributions during his/her working years
and the cumulative investment earnings.
Senator Stedman further explained that, in a DBP, the "cumulative
benefit payout over a member's retired lifetime is not necessarily
representative of what they deposited during their active career".
A "classic example" is someone who works in a "system for five or
ten years" and "gets health care for life" at age 60. "There is no
way" the employee could have contributed enough to cover the cost
of health care for life. Therefore "the obligation to meet the
payments … is borne by the employer".
Senator Stedman noted that in a DCP, both the employee and the
employer contribute into an individual account. Whatever amount of
money that is accumulated in that account by the time the employee
retires, is dispersed.
9:49:44 AM
Senator Bunde asked whether the "Constitutional prohibitions"
afforded the DBC would allow a current employee's contribution to
be adjusted upward in order to support the increased liabilities
the plan would experience due to increased life expectancy.
Senator Stedman replied that when a new actuarial assumption table
is brought forward that indicates that life expectancy has
increased the increased cost of that liability is borne solely by
the employer. No mechanism is included in the DBP that would allow
working or retired employee contributions to be increased to offset
the increased costs. It was difficult in 1960, 1970, and 1980 to
forecast the expenses associated with health care costs in the year
2004.
Senator Bunde stated that, considering the Constitutional
prohibitions, Senator Stedman's response that current employees
could not be asked to increase their contribution was not
unexpected. While understanding the difficulty in forecasting but
given the fact that for the past fifty years life-spans have been
steadily increasing, he asked whether new employee contributions
could be increased, or "hedged", regardless of current figures, in
anticipation of future liabilities resulting from their longer life
expectancies.
Senator Stedman responded that the most recently adopted actuarial
tables, which are supported by actuarial reports, did reflect an
increase in liabilities. While he was unsure of the extent, he
hoped that some "migration" is built into the actuarial table.
Asking the actuaries how they incorporate, from the adoption of the
table, the slow migration to whatever the table might be in the
future would be a good question. To that point, he recalled TRS
Board member, Richard Solie's, March 31, 2005 testimony before the
Committee in which he voiced concern that the actuarial assumptions
regarding the growth of health care were low. The Board is
discussing the issue and asking the actuarial consultant for
further information. Were that assumption found to be low, it would
increase the Fund's liabilities.
9:54:07 AM
Senator Bunde asked whether there is any legal prohibition to
hedging calculations going forward two or three years, in
anticipation of assumption increases, rather than using today's
figures.
Senator Stedman voiced being unaware of any.
Senator Stedman stated that, as described on page four, the funds
invested by both the employee and the employer in a DCP and the
rate of return on those investments, would be available for
retirement. In a DCP, the employee would choose his/her investment
strategy from a selection of options similar to the current process
for SBS. There is a difference between the current DBP pooled
investment account and the individual accounts proposed in the DCP.
Page five
Normal Cost Comparisons - TRS Tier II & PERS Tier III
Vs. Proposed DC Plan
FY 06 Normal Cost Rates
TRS II PERS III DC Plan
Medical normal cost rate 7.93% 7.23% 3.75%
Defined contribution rate 12.43% 10.32% 11.50%
HRA contribution rate 0.0 % 0.0% 1.0%
Gross normal cost rate 20.36% 17.55% 16.25%
Member contribution rate (8.65)% (6.81)% (8.00)%
Employer normal cost rate 12.71% 10.74% 8.25%
Senator Stedman stated that in order to simplify the variety of
concepts and the volumes of information, "a blended rate", which is
an average of the PERS Tiers I, II, and III and TRS Tiers I and II,
was used. In order to compare the current tiers, PERS Tier III and
TRS Tier II, to the proposed plan, the table on page five was
developed. The medical cost rate in the current tiers ranges from
7.23% to 7.93% as compared to 3.75% in the proposed DCP.
Senator Stedman stated that the Health Reimbursement Account (HRA)
currently does not exist under the current plan; therefore, it is
reflected as zero in the PERS/TRS table and as one percent in the
DCP. The total of the three cost elements, or the Gross normal cost
rate, is 20.36% for TRS Tier II, 17.55% for PERS Tier III, and
16.25% for the DCP. The amount that the employee pays as the Member
Contribution Rate must be subtracted from this amount. Therefore
the Employer normal cost rate equates to 12.71% for TRS, 10.74% for
PERS and 8.25% for the DCP, even though there is no employer normal
cost component in the DCP as "there is no past service cost for the
retirement side", since the DCP "is technically not a pension
plan".
Page six
Factors that drive the contribution rate discussion
· Investment Return Assumptions
· Cost/Benefit Balance for the Employer
· Total Acceptance Normal Cost
· Keeping Competitive in Northwest Region
Senator Stedman stressed that the discussion should focus on these
four elements; specifically what might be a reasonable rate of
return range and keeping the State competitive in recruitment and
retention of employees, particularly in regards to teachers.
Senator Bunde asked, were the DCP in effect, whether the process
might be similar to Amerada Hess, in that the employee money might
be managed and invested as a subset of the Permanent Fund
Corporation.
10:00:26 AM
Senator Stedman imagined that the investment strategy would be
crafted along the lines of the State's Supplemental Benefit System.
The question about the management of monies has been raised several
times during the discussion, and the Finance Committee should delve
into the issue of whether the Permanent Fund Corporation should
manage the existing systems' pooled accounts rather than the
accounts being managed by the Department of Revenue.
10:01:27 AM
Senator Bunde reasoned that consolidating the accounts under the
Permanent Fund Corporation management would result in cost savings
resulting from opportunities such as volume purchasing.
Page seven
Normal Cost Comparisons - Proposed DC Plan vs. Existing
TRS/PERS (all Tiers)
FY 06 Normal Cost Rates
TRS PERS DC Plan
Medical normal cost rate 9.07% 8.68% 3.75%
Defined contribution rate 13.90% 11.37% 11.50%
HRA contribution rate 0.0 % 0.0% 1.0%
Gross normal cost rate 22.97% 20.05% 16.25%
Member contribution rate (8.69)% (6.81)% (8.00)%
Employer normal cost rate 14.28% 13.24% 8.25%
Senator Stedman reiterated that even though the desire is to
develop a DCP plan that would be comparable with PERS Tier III and
TRS Tier II, blended rates consisting of both TRS I and II and PERS
Tier I, II, and III are used in this table comparison to provide
consistency.
10:02:42 AM
Page five
Normal Cost Comparisons - TRS Tier II & PERS Tier III
Vs. Proposed DC Plan
FY 06 Normal Cost Rates
TRS II PERS III DC Plan
Medical normal cost rate 7.93% 7.23% 3.75%
Defined contribution rate 12.43% 10.32% 11.50%
HRA contribution rate 0.0 % 0.0% 1.0%
Gross normal cost rate 20.36% 17.55% 16.25%
Member contribution rate (8.65)% (6.81)% (8.00)%
Employer normal cost rate 12.71% 10.74% 8.25%
Senator Stedman revisited the table presented on page five, and
noted that the DCP's Normal Cost Rate of 3.75% "includes some pre-
65 health care costs", as provided by the actuary. Since the
medical component in a DCP becomes effective at age 65, the pre-65
health care costs amounting to approximately two-percent, should be
removed. Therefore, when determining the Defined Contribution
amount as a percentage of payroll, "there is roughly two percent to
work with", without changing the potential contribution rate of the
employer or the employee. Therefore, the Defined Contribution rate
could be increased from 11.5% to 13.5% or a portion of the two
percent could be factored into the HRA component. This two-percent
flexibility would provide options that could be undertaken before
the targeted rate structure were changed.
Senator Stedman referred the Committee to the aforementioned 14-
page handout titled "Comparison of PERS Tier III & TRS Tier II
Pension Benefits vs Defined Contribution Investment Account". He
noted that TRS Board Member, Richard Solie, had spent a significant
amount of time discussing the proposed legislation with his staff
person, Miles Baker, and the modeling forecast tool Mr. Solie had
developed when he was a member of the PERS/TRS Tier Review
Subcommittee was incorporated into these comparison tables.
10:05:44 AM
Senator Stedman stated that definitions of the headings and
language included in the handout are depicted on page two.
"Samplings" of retirement variables including such things as age,
years of service, and defined contribution amounts has been
developed and included in the handout. Other age and variable
samplings could be provided as desired by the Committee.
Senator Stedman explained that the page three retirement sampling
examples a PERS employee who was hired at the age of 25 and retired
at the age of 55 with ten years of service. This individual has an
expected life expectancy of 23.8 years beyond his retirement age of
55. His salary was $39,128. There is an inflation factor, based on
the Anchorage Consumer Price Index (CPI) of 3.50-pecent. Another
factor in this retirement scenario is "the high five salary years"
component equating to $55,397. Other than the "High Five" variable,
the criteria listed at the top of the pages could vary.
Senator Stedman continued that the sampling tables depict a variety
of scenarios based upon the combination of such things as a
Contribution Levels column that utilizes retirement contribution
levels ranging from 11.50-percent to 14.5 percent; a Total Return
column reflecting total returns on the selected investments ranging
from 4.5-percent to 8.75-percent; a Real Return column indicating
the real return on the investment after inflation ranging from
1.00-percent to 5.25-percent; a Final Salary column; an Account
Balance at Termination column; a Beginning Annuity column; an
Annuity as percent of Final Salary column; the Existing PERS
Pension Benefit; and the DC verses DB column. As an aside, he noted
that the Alaska State Pension Investment Board (ASPIB) and the
Permanent Fund Board utilize a five-percent real rate of return.
10:11:36 AM
Senator Stedman noted that the difference between the retirement
sampling table his staff had developed and that of Mr. Solie was
that Mr. Solie had incorporated an Annuity, developed at the point
of retirement, into his model in order to compare that amount to
the current system. Currently, the DBP system incorporates
inflation into the money being drawn in retirement. It should be
noted that one of the challenges with annuities is that they
provide a fixed payment until one dies and are not inflation-
proofed. To that point, were one to exceed the life expectancy of
the annuity, inflation would erode its purchasing power. This would
be detrimental over the long run. While such an annuity is not
available, inflation is factored into the annuity in Mr. Solie's
table in order to provide a better comparison between TRS II/PERS
III and the proposed DCP. This would serve to more realistically
compare "apples to apples".
Senator Stedman mentioned that a number higher than 100.00 percent
in the "DC vs DB" column on the sampling table would indicate that
the DCP would be more beneficial to the retiree. A number less than
100.00 percent would indicate that the current DBP structure would
be more beneficial.
10:13:33 AM
Senator Dyson asked for further information regarding the "Existing
PERS Pension Benefit" column; specifically whether the amount
depicted was a monthly or annual pension benefit.
MILES BAKER, Staff to Senator Bert Stedman, responded that the
amount depicted in that column is the annual pension benefit
amount.
Senator Dyson questioned the fact that this person's annual pension
would only amount to approximately $6,000.
Mr. Baker explained that in this scenario the person was hired at
the age of 25 and retired at the age of 55 with "only ten-years of
service". The term of service and the individual's salary levels
would affect the annual pension amount. It should be noted that
under the existing DBP, this person would be guaranteed the pension
for life.
Senator Dyson acknowledged.
Co-Chair Green interjected that the pension amount is based on a
standard formula that calculates the number of years of service
multiplied by two percent, multiplied by the high three-year
salary.
Mr. Baker pointed out that the pension amount calculation formula
for the PERS/TRS pensions are detailed in Item #10 at the bottom of
the definitions page, page two.
10:15:19 AM
In response to a question from Co-Chair Wilken, Mr. Baker stated
that the individual in the aforementioned scenario would receive an
annual pension of $6,625 per year under the current DBP, were the
Contribution Level 13.00 percent with an 8.25 percent Total Return
rate, and a $95,312 Account Balance at Termination. Were the
proposed DCP in effect, the individual would receive $5,780 per
year.
Co-Chair Wilken calculated that, under the DCP, the individual
would receive $5,780 annually for 16-years: the $95,312 account
balance divided by $5,780 equates to sixteen.
Mr. Baker responded that in this scenario the DCP pension
calculation was based on a life expectancy is 23.8 years.
Co-Chair Wilken understood therefore that the $5,780 payment would
be received until either the account was depleted or the individual
died.
Mr. Baker expressed that in order to compare the DBP and the DCP,
the projected life expectancy rather than an actual age of death is
utilized. The "Account Balance at Termination" amount is divided by
the number of years of life expectancy after retirement to
determine the annual pension amount under the DCP.
Co-Chair Green concluded therefore, that "for the purposes of the
formula", the life expectancy of 23.8 years is used in the
calculations.
Mr. Baker noted that the life expectancy numeral is based on the
male mortality table, and as such, "is a dynamic number depending
on the scenario" being run.
Senator Hoffman asked regarding the formula for determining the "DC
vs DB" percentage calculation.
Mr. Baker pointed out that in this particular scenario, the percent
in the "DC vs DB" column was calculated incorrectly.
Mr. Baker stated that to determine which plan would be more
beneficial to the individual, one should compare the amount in the
"PV 2004" subheading under the "Beginning Annuity" column to the
Existing PERS Pension Benefit. In this case, those numbers would be
$5,780 and $6,625, respectively.
Senator Hoffman acknowledged and voiced that, in this scenario, the
118.90 percent reflected in the "DC vs DB" column is incorrect.
Mr. Baker agreed and reiterated that the percent calculation was
inadvertently reversed in this scenario.
Senator Hoffman concluded therefore that under the given scenario,
the individual would not achieve 100-percent until the Total Return
was greater than 8.75 percent.
Mr. Baker agreed.
[NOTE: Further clarification regarding the correct methodology for
the "DC vs DB" ratio is located at Time Stamp 10:26:59 am.]
Co-Chair Green suggested that the amount in the termination year,
or "Term Yr.", column might be the number applicable to the "DC vs
DB" column calculation. The columns could have been inadvertently
reversed.
Mr. Baker stated that, as depicted in the "Final Salary Term Yr."
column, the value of the final salary in the year the individual
terminated was $59,825. That amount would be the equivalent of
$22,060 today, as depicted in the Present Value (PV) column. He
reminded the Committee that this individual was only employed for
ten years.
Co-Chair Green furthered her previous suggestion by stating that,
at the 12.50% Contribution Level with a 8.75% Total Return, the
$8,116 amount in the "Term Yr." subheading under the "Beginning
Annuity" column, is 122.49% of the $6,625 Existing PERS Pension
Benefit, depicted in the "DC vs DB" column. That column might be
the proper one to be used in the calculation. Perhaps those columns
were inadvertently reversed.
Mr. Baker stated that he would revisit the information presented in
the tables as he might have inadvertently used incorrect
information. The correct methodology would have been to use a ratio
of the amount in the "PV 2004" subheading under the "Beginning
Annuity" heading to the Existing PERS Pension Benefit" column.
Co-Chair Green acknowledged.
[NOTE: Co-Chair Green was correct in suggesting that the "DC vs DB"
ratio should be that of comparing the "Beginning Annuity Term Yr."
to the "Existing PERS Pension Benefit". This clarification occurs
at Time Stamp 10:26:59 am.]
10:20:56 AM
Senator Dyson, continuing the line of questioning begun by Co-Chair
Wilken, asked whether, under a DCP, a retiree would receive monies
based on the balance of their account plus the money earned
annually on the investment and their life expectancy. He questioned
what would occur were the individual to live longer than their life
expectancy and the balance of their account to reach zero.
10:21:56 AM
Mr. Baker replied that "there is a finite amount of money" in the
account under the DCP concept. As argued by Richard Solie in his
presentation, that "would be one of the risks" the employee would
bear under the DCP. Individuals must plan for such things or face
the possibility of deleting the funds in their retirement account.
This is the reason that Mr. Solie "argued for the floor". This
would not be an issue for someone in a DBP.
Senator Dyson asked whether a person with a life expectancy of 78,
as projected in this scenario, could have their payment amount
readjusted when they reached, for example, the age of 73.
Mr. Baker replied that under the conditions of the current DBP, the
person would continue to receive the benefit until their death. At
that time, the spouse and dependents would continue to receive the
benefit. Upon termination of an employee under the DCP, the
individual would receive a lump sum amount of which he/she could
choose how to disperse it. There is no mechanism through which to
provide an individual more money were their life expectancy to
increase.
Co-Chair Green emphasized that a person who works for only ten
years should not have the expectation of receiving a lifetime
pension.
Mr. Baker acknowledged that the ratio in the "DC vs DB" column
should be that of the value of the "Term Yr" under the "Beginning
Annuity" column as compared to the "Existing PERS Pension Benefit"
as earlier suggested by Co-Chair Green. An 11.50% "Contribution
Level" with an 8.25% "Total Return" with a Beginning Annuity Term
Yr." of $6,969 and an Existing PERS Pension Benefit of $6,625 would
equate to a 105.18% "DC vs DB" ratio. This indicates that the DCP
plan payments would exceed the DBP pension benefit by five percent.
AT EASE 10:25:26 AM /10:26:59 AM
Senator Stedman stated that while the equation is correct in the
"DC vs DB" column, the chart would be revised before the next
Committee hearing on this bill in order to more clearly reflect
that the "Beginning Annuity Term Yr." Column amount is being
compared to the Existing PERS Pension Payment amount. He apologized
for the confusion.
Co-Chair Green voiced that this discussion clearly reflects the
reason that the current DBP "is quickly under-funded and will
always be as long as this system is in place". Under the current
DBP, retirees "receive an infinite amount of return for a limited
amount of investment during the service years".
Senator Stedman continued that the table depicted on page four
reflects the DCP/DBP scenario for a PERS person who was hired at
the age of 25, retired at age 55, and who worked for 20 years. This
scenario is one in which the person took "Early Retirement" at the
age of 55 rather than at the age of 60, as denoted on the top right
hand side of the page. The Early Retirement scenario would provide
"a more conservative comparison" as, in this case, a penalty in the
formula that would result in a slightly lower pension. He noted
that "the retirement age concept" would dissipate under the DCP.
Senator Stedman stated that in the page four scenario, the DCP
would be more beneficial to the employee than the DBP at the 12.5
percent Contribution Level and a Total Return level of 7.00% or
higher. The DBP would be more beneficial at a Contribution Level of
14.00% and a lower Total Return level of 6.50%.
Senator Stedman stated that page five depicts a scenario in which a
PERS employee was hired at the age of 25 and retired at age 55
after 30 years of service. Being able to retire at age 55 is still
ten earlier than the normal retirement age of 65.
Mr. Baker explained that under the current PERS DBP, anyone with 30
years of service could retire at any age without penalty. The
individual in the page five scenario would, upon retirement, be
able to immediately draw his full retirement pension benefit
without penalty.
Senator Stedman stated that in the page five scenario, the DCP
would be equivalent to the benefits of the DBP at the 11.50%
Contribution Rate with an 8.75% Total Return. As reflected in the
"DC vs DB" column, the ratio is basically "dead even" at 100.76%.
Another example would be the 13.00% Contribution Level where the
"DC vs DB" ratio is 100.28% at the 8.25% Total Return level.
Senator Stedman pointed out that these tables example how the plans
are affected by such factors as age, life expectancy, and years of
service.
Mr. Baker commented that the page five scenario is a good example
of how the DBP system favors a long-term employee, even at a 14.50%
Contribution Level. Even at the "optimistic" Total Return rate of
8.25%, "it would be hard to beat" the current benefit being
provided.
Co-Chair Green asked whether the major factor in the level of
benefits paid to a 30-year employee is due to including in the
pension calculation formula, the employee's highest five salary
years.
Mr. Baker expressed that the "high-five" salary and the fact that a
person who retires at the age of 55 has a life expectancy of
another 23.8 years, enhance the benefit. They could receive the
pension benefit for approximately 24 years after retirement.
Co-Chair Green asked whether the five-year salary consideration
would be included in the DCP.
Mr. Baker responded that, in the DCP, nothing except the annual
employee/employer contributions and their earnings would fund the
plan.
Senator Hoffman asked whether the outcome of the 8.00% Member
contribution rate being proposed in the DCP plan when compared to
the current TRS/PERS Member contribution rates, as depicted on page
five of the "Contribution Rates for New Defined Contribution (DC)
Plan" handout would be that TRS II employees would receive a .65
percent salary increase and PERS III employees' would experience a
slight salary decrease.
Senator Stedman asked for further clarification.
Senator Hoffman understood that under the proposed DCP, the PERS
III Member Contribution Rate would be higher than their current
contribution rate and the TRS Member contribution rate would be
lower than the current contribution rate.
Co-Chair Green asked for further clarification of the question.
Senator Hoffman stated that his desire was to better understand how
the proposed DCP would affect the Member Contribution Rates of both
TRS and PERS employees and the subsequent affect on their
paychecks.
10:35:21 AM
Senator Stedman replied that Senator Hoffman was correct, in that
were salaries and other factors equal, the DCP Member contribution
rate for a PERS III employee would be more than being paid under
the current plan and less than the rate currently paid by a TRS II
employee.
Senator Hoffman acknowledged the information.
Senator Stedman stated that the table on page six of the
"Comparison of PERS Tier III & TRS Tier II Pension Benefits vs
Defined Contribution Investment Account" handout depicts the
scenario for a PERS employee who was hired at the age of 30, worked
20 years and took early retirement at the age of 55. The 100% DCP
and DBP break even point for this individual would be at the 12.50%
Contribution Level with a 7.00% Total Return level. This point
would equate, under the DCP to "a 3.50% Real Return which is
substantially less than the five-percent … that would be the target
for the pooled investor".
Senator Stedman continued that the table depicted on page eight
reflects a TRS Tier II employee, hired at the age of 25, who works
for 15 years and takes Early Retirement at the age of 55. As
denoted by the "ASD Teacher BA Step I" notation at the top of the
page, there would be a base salary increase tied into the salary
schedule. The breakeven point would be at the 12.50% Contribution
Level with a 6.75% Total Return rate. A 14.00% Contribution Level
would allow the breakeven point to drop to a 6.00% Total Return
rate. "They are all inter-related".
Senator Stedman stated that the Police and Fire Employees tables
are separated from other PERS/TRS employees because their Normal
Retirement age and other factors differ.
Senator Stedman commented that while the repetition of the tables
might appear to be "redundant", the objective of the various
examples is to provide Legislators sufficient information from
which they could formulate their own thoughts about how a plan
should be developed.
Senator Stedman communicated that page twelve reflects a police or
fire employee who is hired at the age of 25 and who retires with
full benefits at age 50 after twenty years of service. The normal
retirement age for police/fire is 45 years of age.
Mr. Baker reminded the Committee that police and fire employees
could retire, with full benefits, at any age after 20 years of
service.
Senator Dyson pointed out that the life expectancy information has
not changed from one Normal Age retirement scenario to another.
Mr. Baker stated that this element would be revisited.
Co-Chair Green asked whether any discrepancy in the tables might be
experienced due to this life expectancy component.
Mr. Baker responded that because the life expectancy factor is not
a component of the pension benefit calculation formula, it should
not affect the table. It is included on the page for general
information purposes only.
Senator Stedman communicated that a master template was used to
develop the spreadsheets in this presentation. While such things as
age, length of service, and life expectancy are included in the
model heading, they are for presentation purposes and do not affect
the numbers in the table. The numbers in the table are correct.
Senator Stedman and Mr. Baker assured the Committee that this would
be rechecked. Were their understanding proven differently, the
information would be modified. He noted that the multitude of
information related to this legislation is immense and, during the
next few bill hearings, it would become evident that, due to time
constraints, it would be difficult to modify all the various
components.
Senator Stedman, referencing the Police/Fire table on page twelve,
commented that it would "be difficult" for the DCP to match the
benefits currently provided to police and fire employees under the
DBP. The current plan is "pretty attractive" to the employee, but
"expensive to the employer".
Co-Chair Green concurred and commented that, "it's no wonder it's
vastly under-funded".
Senator Stedman reiterated that models could be developed to
reflect any scenario a Legislator might want to review. The
influence of the life expectancy factor would be rechecked.
Senator Stedman stated that the current version of the bill
"targets" an 11.50% Defined Contribution rate. The Committee might
wish to revisit that component, as there is a range of numbers that
could be incorporated. In addition, as mentioned earlier in this
hearing, there is a two-percent buffer that could absorb some of
the need to change the dollar contributions for either the employer
or the employee.
Co-Chair Wilken observed that as long as the TRS employee who was
hired at the age of 25, and took Early Retirement at the age of 55
with 20 years of service, as depicted on page nine, received a
minimum of 7.50% Total Return at the 11.50% Contribution Level, the
DCP would be "roughly equivalent" to the current DBP. The plans
would also be equivalent at a Contribution Level of 13.00% with a
6.50% Total Return. A DCP with a Total Return at or exceeding 7.00%
would be a better plan for this teacher.
Senator Stedman affirmed. He shared that the Finance Committee had
approved the purchase of a historical data book depicting the
United States financial market return data since 1925. This book,
which was used as a resource in the development of this
legislation, includes information on such things as blended
formulas of 50 percent stocks/50 percent bonds and 70 percent
stocks/30 percents bonds. The 70/30 stock/bond split resembles the
Alaska Balance Fund, which is the most commonly selected fund
option, offered in the SBS program. The book provided rolling
averages for five, ten, 15, and 20 years since 1926. He noted that,
nationwide, individuals managing their own retirement portfolios
"don't have the risk tolerance that the pooled investments" such as
the DBP, have. Therefore, "there is the tendency for the individual
investments to under-perform the pooled investment". Pooled
investments currently have a targeted return of 8.25 percent. Thus
the reason that most of the return range is below 8.25 percent.
Therefore, it is a reasonable assumption that the average
participant would not get "too fancy" and would pick a balanced
fund. The expectation would be that the performance numbers over
time would be in the upper end rather than the lower end of the
range, were the forward financial markets to continue the trends
existing from 1925.
Co-Chair Wilken understood therefore that the generalization of
page nine is that, if returns had followed the historical trend of
the last 70 years, the DCP is better. The downside is that that
money would be depleted "because it is a finite amount of money".
The DBP would provide money until the individual died.
Senator Hoffman opined that the DCP money would run out at the end
of the person's life expectancy timeframe.
Co-Chair Wilken commented that he was attempting to compare the
issues in generalities.
Senator Stedman asked that the life expectancy issue not be focused
upon as he wished to further investigate whether the "life
expectancy link would change the numbers. Nonetheless, he voiced
certainty that the numbers in the table were correct.
Senator Stedman, responding to Co-Chair Wilken's comment, stated
that a person experiencing a short life span would be
"disadvantaged" in a DBP; however, a person with a long life
expectancy would be advantaged because they would receive pension
payments for a long time. Therefore, in a DCP, a person with a long
life expectancy would strive to achieve a rate of return that would
exceed the 100.00% DBC/DCP equivalency point.
10:51:23 AM
Senator Bunde commented that contrary to the conditions of a DBP,
the retirement funds of a person in a DCP who dies at an early age
would belong to the person's estate and have transportability to
heirs or other survivors. Unless the person in the DCP had chosen
survivor benefits, their funds would not be transferable.
Senator Stedman expanded on Senator Bunde's remarks by theorizing
that were a person in a DCP, to retire knowing that he would have a
shortened life span, he could roll his retirement into an IRA and
upon his death, that IRA could be rolled into his child's IRA. This
would provide "generational portability". The DCP could provide a
mechanism through which the funds could be transferred to a spouse
or to children.
Senator Bunde interjected that his point was that there are two
sides to the equation.
Co-Chair Green commented that at retirement, were a person to
withdraw the entirety of their benefits, the person with a DBP
would be entitled only to the amount of money that had been
contributed. The person in the DCP would be able to take all the
money that had been contributed along with any investment growth on
that money. The person in the DCP would experience much "greater
flexibility".
AT EASE 10:54:59 AM / 10:55:28 AM
Co-Chair Green reviewed the week's hearing schedule for the bill.
10:56:56 AM
Senator Bunde noted that a handout titled "Comparison of the States
Normal Retirement by Age/Service" [copy on file] that compares
other states' retirement policies has also been provided to
Members.
ADJOURNMENT
Co-Chair Green adjourned the meeting at 10:57 AM.
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