Legislature(2019 - 2020)SENATE FINANCE 532
04/02/2019 09:00 AM Senate FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| Presentation: Alaska Retirement Management Board Update | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
SENATE FINANCE COMMITTEE
April 2, 2019
9:00 a.m.
9:00:41 AM
CALL TO ORDER
Co-Chair Stedman called the Senate Finance Committee
meeting to order at 9:00 a.m.
MEMBERS PRESENT
Senator Natasha von Imhof, Co-Chair
Senator Bert Stedman, Co-Chair
Senator Lyman Hoffman
Senator Peter Micciche
Senator Donny Olson
Senator Mike Shower
Senator Bill Wielechowski
Senator David Wilson
MEMBERS ABSENT
Senator Click Bishop
ALSO PRESENT
Senator Cathy Giessel; Bruce Tangeman, Commissioner,
Department of Revenue; Rob Johnson, Trustee, Alaska
Retirement Management Board; Paul Erlendson, Callan
Associates; Steve Center, Callan Associates; Ajay Desai,
Director, Division of Retirement and Benefits, Department
of Administration; Kevin Worley, Chief Financial Officer,
Division of Retirement and Benefits.
PRESENT VIA TELECONFERENCE
David Kershner, Buck Firm
SUMMARY
PRESENTATION: ALASKA RETIREMENT MANAGEMENT BOARD UPDATE
Co-Chair Stedman discussed the order of business for the
meeting. He clarified that the state had been struggling
with unfunded pension liability since the early 2000s. He
thought it would take another decade to address the issue.
He stressed that there was no imminent danger of health and
retirement benefits not being paid.
Co-Chair Stedman summarized that the state was facing a
cashflow issue; and reiterated that there was no need for
fear of missed payments.
^PRESENTATION: ALASKA RETIREMENT MANAGEMENT BOARD UPDATE
9:04:46 AM
BRUCE TANGEMAN, COMMISSIONER, DEPARTMENT OF REVENUE,
informed that the presentation was broken into three parts
with testifiers from the Alaska Retirement Board, Callan
LLC, the Department of Retirement and Benefits, and Buck
Consulting.
9:05:48 AM
ROB JOHNSON, TRUSTEE, ALASKA RETIREMENT MANAGEMENT BOARD,
discussed the presentation "Informal Presentations from:
Alaska Retirement Management Board/Callan LLC/Buck" (copy
on file).
Mr. Johnson looked at Slide 2, "ARMB Overview."
Mr. Johnson turned to Slide 3, " Alaska Retirement
Management Board":
Primary Duties (AS 37.10.210(a))
? Serve as trustee for pension and retiree health
trusts, the State of Alaska Supplemental Annuity
Plan, and Deferred Compensation programs
? Manage and invest assets in a manner that is
sufficient to meet the liabilities and pension
obligations of the systems
Mr. Johnson discussed overarching obligations of the Alaska
Retirement Management (ARM) Board.
9:07:03 AM
Mr. Johnson showed Slide 4, " Alaska Retirement Management
Board":
Summary of Activities
? Establish Investment Policies
? Review Actuarial Earnings Assumptions
? Establish Asset Allocation
? Set Contribution Rates of Employers
? Provide Investment Options
? Monitor Performance
Mr. Johnson asserted that the task of reviewing actuarial
earnings assumptions was a critical feature and specified
that the review of actuarial assumptions took place every
five years. He said that the review of the assumption that
had concluded in 2018 had been adopted and would take
effect in FY 21. He shared that the most critical change to
the assumptions was the earnings assumption, which had been
reduced from 8 percent to 7.38 percent. He relayed that the
assumption consisted of two things; the real investment
earnings of 4.88 percent, which had not changed, and the
inflation assumption, which had been dropped. This
significant factor change had resulted in the creation of
an increasing unfunded liability.
Mr. Johnson discussed the importance of asset allocation.
He said when setting contribution rates, the board
considered actuarial assumptions, actuarial returns, and
setting contribution rates.
9:09:19 AM
Mr. Johnson continued discussing Slide 4. He said that the
board provided investment options for defined contribution
plans and set the investment options for SBS and deferred
compensation programs.
9:10:27 AM
Mr. Johnson displayed Slide 5, "Alaska Retirement
Management Board":
Composition of the Board
Nine members
o Commissioners of administration and revenue
o Seven members appointed by the governor
? Qualify for permanent fund dividend
? Recognized competence in investment
management, finance, banking, economics,
accounting, pension administration or
actuarial analysis
o Two members of the general public
o One member employed as finance officer for a
political subdivision
o Two PERS and two TRS members, each selected
from a list of four nominees submitted from PERS
and TRS bargaining units
o Other than commissioners, members serve
staggered, four-year terms
Mr. Johnson shared that the composition of the board was
defined in AS 37.10.210 and 220.
Mr. Johnson discussed the PERS and TRS members. The seven
governor appointees served on staggering terms and were
subject to reappointment.
9:12:58 AM
Mr. Johnson showed Slide 6, "Alaska Retirement Management
Board":
Composition of the Board (cont.)
? Rob Johnson, Chair, represents PERS bargaining
units
? Gayle Harbo, Secretary, represents TRS
bargaining units
? Lorne Bretz, finance officer
? Tom Brice, represents PERS bargaining units
? Allen Hippler, member of general public
? Bruce Tangeman, Commissioner of Revenue
Designee
? Kelly Tshibaka, Commissioner of Administration
Designee
? Norman West, member of general public
? Bob Williams, represents TRS bargaining units
Mr. Johnson thought the board was a talented group that
worked well together. He thought the statutory construct in
the state prevented schisms and cliques and allowed the
board to function well. He reiterated that the statutory
constructs provided workable solutions and were a model for
problem solving. He encouraged people to attend board
meetings.
9:16:52 AM
Co-Chair Stedman commented that on the defined benefit
side, the responsibility for paying the benefit lie with
the state, rather than the employee. He cautioned that if a
mistake was made that resulted in unfunded liability, the
onus fell on the legislature for funding. He noted that the
previous board had not included a state representative,
which had led to a restructuring of the board.
9:18:21 AM
Senator Hoffman asked Mr. Johnson to review the
renumerations received by the board.
Mr. Johnson stated that law entitled the board to per diem
when traveling and an honorarium of $400 per day for days
of meetings, and one travel day associated with meetings.
All travel was reimbursed.
9:19:04 AM
PAUL ERLENDSON, CALLAN ASSOCIATES, relayed that Callan and
Associates had been in business since 1973, and had worked
with several state pension funds and sovereign wealth
funds. He relayed that the group helped in four main areas:
asset allocation, implementation of policy, ascertain
objectives, and ongoing education.
STEVE CENTER, CALLAN ASSOCIATES, introduced himself.
9:21:35 AM
Co-Chair von Imhof looked ahead to Slide 10, "25 Years of
Capital Market Return History," which constrained a table
entitled 'Returns for Periods ended December 31, 2018."
Co-Chair Stedman interjected that the testifiers would be
speaking to the current performance of the board after
discussion the board's history.
9:22:31 AM
Mr. Erlendson looked at Slide 10, which was divided by
asset classes. He continued later slides would address
policy setting and asset allocation. He thought there might
be questions about the Permanent Fund, which would be
addressed later in the presentation. He said that any
information that was not presented today would be given in
a follow up presentation.
9:23:37 AM
Co-Chair Stedman thought there may be requests for
additional information for the committee.
9:23:49 AM
Mr. Erlandson noted that the figures on the table on slide
10 represented cumulative rates of return as of December
31, 2019. He pointed to the far-left column, which listed
groups of asset classes. He noted the "risky assets": U.S
Equity, Non-U.S. Equity, Fixed Income, and Real Estate. He
said that "Alternatives" was a category and not an asset
class, as they could not be indexed or bought passively. He
said that the returns in the last three-month of last year
reflected that equity markets had been down significantly.
He stated that the highest returning strategies were
equity-oriented strategies; fixed income returns were in
the mixed single digits, real estate was the most stable,
and the goal was to select the right combination in order
to achieve long-term objectives.
9:25:31 AM
Mr. Erlandson showed reviewed Slide 11, "Stock Market
Returns by Calendar Year," which showed a graph entitled
'2018 Performance in Perspective: History of the U.S. Stock
Market (230 Years of Returns).' He directed attention to
the tallest column and noted that the most frequently
occurring annual return was from 0 to 10 percent. He
pointed out that the graph depicted a classic bell curve
distribution. The extreme outcomes were rare, but he
pointed to 2008 as an example. He noted that the market had
been relatively benign over the last few years.
9:27:05 AM
Co-Chair Stedman thought the previous two years had robust
returns. He asked whether there was an expectation that the
market would stay robust.
Mr. Erlandson stated that historically, lower returns would
be expected in the future. He relayed that interest rates
had dropped year after year, and the challenge to investors
was to find the safest return on investment, which was
cash; with equities on could suffer a 30 percent loss. He
said that the hope for an investor was that longer the
capital could work, the more risk that was taken, the
higher the return would be achieved over a longer time
period. He said that if the time period was short then
risks could not be taken, which resulted in a portfolio
with less risky assets and a lower return assumption. He
stated that as interest rates went up there was no need to
take as much risk with higher returning assets and the
challenge became finding the right investment mix. He
asserted that, based on history, returns would be lower
than historical averages but would rise to equilibrium
rates. He referred to Slide 10. He said that as interest
rates increased, stable income could be achieved without
taking riskier assets.
9:30:50 AM
Co-Chair Stedman looked at Slide 11. He was under the
impression that active markets started in the mid 1920's.
He wondered how the presenters had found data to include
from a time prior to the 1920's, when there were no active
markets.
Mr. Erlandson replied that the slide measured the riskiness
of opportunity sets that were available at that point in
time. He said that the information on the chart that
related to the last decade, and not the last 100 years, was
the relevant information.
9:32:41 AM
Co-Chair Stedman thought information from the 1800s did not
have relevancy and the ability to measure that information
was questionable.
9:32:58 AM
Mr. Erlandson spoke to Slide 12, "Historical Public Fund
Asset Allocation and Returns," which showed a line graph
showing rolling 10-year returns, as well as a grouping of
pie charts and a data table. He drew attention to the first
pie chart, which showed that in 1985 the average pension
fund was almost equally invested in domestic equity and
domestic fixed income. He said that the 10-year return for
the average pension fund in 1985 was over 10 percent. From
left to right the pie charts indicated that public pension
funds have become progressively more complex investment
structures. He said that from the late 80s until the market
crash in the early 2000s, the average public pension had
returns in the low double digits. He said that once
inflation was brought under control in the late 80s, money
was plentiful for institutional investors, increasing
appetites for risk. He noted that every additional asset
class that was brought in was typically done at a higher
management fee; the costs of the programs went up and the
returns were robust. Over the 43-year history charted on
the slide - the average 10-year return was over 9 percent
per year. He noted the vertical line on the graph that
charted the market and pointed to 2009, when the global
financial crisis ebbed, and the market began to correct
itself. He said that before that time the average pension
fund had a return of approximately 10 percent, since that
time the average return had been less than 6 percent. He
reiterated that the asset allocation of the average pension
fund had grown progressively more complex in order to find
assets that will deliver higher expected returns.
9:36:34 AM
Co-Chair Stedman looked at 2010 and 2015 and asked what the
10-year trail was for the board's administrable assets.
Mr. Erlandson offered to provide the information later.
Co-Chair Stedman recalled at that from 2007 to 2010, Callan
had given several presentations that had indicated that the
target rate should be 8.5 percent. He said that the
committee had repeatedly expressed concerns about the rate
of expected return being too high and was unachievable. He
wanted to see the target rates for the time periods
relative to the returns on the slide. He was concerned that
year after year the aggregate dollar value of the portfolio
was missing the target. He worried that the state could
never catch up and wanted to know if the state was meeting
the projections. He thought it was nice to see the
historical public trust asset allocations but stressed that
it was more important to see the returns on the state's
current portfolio.
9:39:54 AM
Co-Chair von Imhof added to Co-Chair Stedman's comments.
She thought the basic material of the presentation was fine
but suggested that the committee had expected a more
sophisticated presentation that revealed specific
information, rather than general trends. She said that when
the state dropped form an 8 percent return estimate to 7.3
percent, payments increased. She thought it could be
helpful to look at 10-year, or 5-year, return. She
suggested examining the past 25-years in 5-year increments.
She thought this would provide different perspectives on
volatility. She felt that charting the volatility of the
market would be helpful in knowing how the board payments
would be affected. She requested a ratio of what the actual
returns were and what future proforma payments could be.
9:41:32 AM
Mr. Erlandson advanced to Slide 15, "Historical Return
Projections: Major Asset Classes," which showed a line
graph depicting return projections from 1989 to 2019. He
noted that the first observation was in 1989. He drew
attention to the 'Private Equity' line and observed that
back then it had been assumed that private equity would
return 15 percent per year over the decade. He summarized
that return assumptions had been coming down and had
influenced work with the board when deciding how to achieve
long-term goals.
9:43:16 AM
Mr. Erlandson turned to Slide 16, " Historical Risk
Projections: Major Asset Classes," which showed a line
graph depicting risk projections from 1989 to 2019. He said
that the slide showed that risk levels declined a bit but
not as much as the returns. He stated that this meant the
if the targeted rate of return was at 1989 levels more
money would need to be deployed into risker assets. He
stressed that the challenge of asset allocation was how to
balance the amount of variability on returns on the short-
term basis, with the goal of achieving the long-term
assumption.
9:44:50 AM
Senator Shower was concerned with inflation. He asked where
the presenter expected inflation to be currently, in
relation to past levels.
Mr. Erlandson stated that the long-term average going back
to the 1950s was about 4 percent per year, but much of the
inflation occurred during the 70s and 80s. He thought the
inflation average was more misleading than informative. He
said that over the last 20 years inflation had been at less
than 3 percent, closer to 2 over the past decade. He
related that his assumption going forward was 2.25 percent.
Co-Chair Stedman asked about what the rate of inflation was
over the previous century.
Mr. Erlandson said he did not know.
9:46:16 AM
Co-Chair von Imhof considered an overlay of actual returns
from 1989 to now.
Mr. Center returned to Slide 15 and noted that the chart
represented Callan's capital market projections for each
calendar year. He relayed that the only thing that could be
promised about the projections was that they would be
wrong. He thought guessing what the next 10-year return was
an art rather than a science. He stated that the only
scientific fact that could be considered would be the
current interest rates and their impact on historical
returns. He offered to send a chart that showed the
information.
Co-Chair von Imhof thought it would be interesting to see
some volatility overlaid on the chart. She spoke of the
permanent fund and mentioned the percent of market value
(POMV) draw, which was a five-year lookback. She noted that
volatility materially affected the draw. She thought it
would be helpful to see the variations in the potential
market scenarios.
9:48:59 AM
Mr. Center stated that one reason a five-year lookback was
used was to minimize the impact of volatility. He stated
that volatility in the market could result in substantial
variations in the draw amount. He stated that in the most
previous study he had done, there was less than a 10
percent chance that the ERA would be depleted due to a
multiple year period of negative returns. He said that
further finding would be presented by June 30, 2019.
9:50:13 AM
Co-Chair von Imhof thought while the ERA balance was
important, it was less so than the what the potential
budget number could be with the POMV draw. In a true pure
POMV, there was no distinction between the corpus of the
fund and the ERA. She considered that the amount of the
POMV was more important that what was in the ERA.
9:51:09 AM
Co-Chair Stedman asked about correlations as shown on Slide
16. He asked for further explanation of the correlations.
Mr. Erlandson reminded that Slide 15 showed projected
returns and Slide 16 showed projected risk. Because of the
way models were built, a single number was plugged into the
equation, which was rarely accurate. He relayed that
correlation calculations used numbers rarely used in the
modeling. The model was meant to demonstrate trends and
were only tools used to examine knowable facts and ranges
in outcomes. He thought that the narrowing of the probables
was the best that could be done.
9:53:46 AM
Mr. Erlandson displayed Slide 17, "Projected Allocations
required to Achieve 7.5% Expected Return: Increasing Levels
of Risk Required to Obtain the Same Expected Rate of
Return," which showed a flow chart including three pie
charts. The charts illustrated asset mixes that would have
been suggested to investors in 1989, 2004, and 2019, to
achieve a 7.5 percent return. He said that using the
assumptions in 1989, risky assets would have been
unnecessary to reach the 7.5 percent return. He noted that
in 2004, achieving 7.5 percent would have required a
movement to riskier assets, tripling the level of risk to
achieve the wanted return. The slide detailed the
progression:
• In 1989, our expectations for cash and broad U.S.
fixed income were 6.80 percent and 9.35 percent,
respectively.
• 15 years later, and investor would have needed half
of the portfolio in public equities to achieve 7.5
percent, nearly tripling the portfolio volatility of
1989.
• Today an investor is required to include 96 percent
in return-seeking assets to earn 7.5 percent at
almost 6 times the volatility compared to 1989.
Mr. Erlandson questioned whether it was more important to
achieve the 7.5 percent return or, was it more important to
avoid and 18 percent risk level.
9:55:57 AM
Co-Chair Stedman suggested that if Mr. Erlandson provided a
bugle chart it could help the committee to visualize future
performance expectations.
Mr. Center stated that he was currently working through an
asset allocation study and an asset liability analysis
which would inform future overall asset allocation for PERS
and TRS. He agreed to provide the requested information in
a bugle chart format.
Co-Chair Stedman recalled that the committee had great
difficulty in the past getting the similar charts produced.
He believed that the cart would be useful in examining the
magnitude of potential outcomes.
9:57:43 AM
Co-Chair von Imhof thought Slide 17 was very telling. She
noted that in 1989, the portfolio assumed less risk, but
inflation was more significant. She thought it would be
helpful for a national and global analysis of what affected
different asset choices, with recommendations.
Mr. Center stated that the process was ongoing.
9:58:57 AM
Senator Micciche asked whether 1989 represented an
extremely unusual case. He asked whether the state had ever
been in the same situation at another point in time. He
wondered how the 1989 numbers for risk could be compared
with those of 2004 and forward.
Mr. Erlandson stated that there had been shorter times when
the cash return had been relatively high; he noted that in
2007, the return on cash investment was nearly 5 percent.
He thought it was unusual and inexplicable that interest
rates had been down while there was so much capital in the
market. He said that inflation was not viewed as a
potential issue and that interest rates were predicted to
rise. He discussed the investment climate in 1989 and how
it informed decisions at that point in time.
10:01:08 AM
Mr. Erlandson referenced Slide 19, "2019 Callan Capital
Market Projections," which showed a data table entitled '
Expected risk and return (20192028).' He pointed out the
Asset Class column on the left. He noted the Index column
and explained the column reflected if one were to buy a
passive exposure, which index would be purchased. He said
that the capital market projections were net of fee, index
returns; without active management, except for
"alternatives" that could not be passively bought. He
continued to discuss the thought process for an investor as
they sought return on their investment. He stated that the
policy assumed passive implementation and if a return was
hoped for that exceeded the target, active manager
opportunities needed to be explored.
10:02:53 AM
Co-Chair Stedman thought it was possible to measure
statistically the stock selection and timing ability within
the portfolio.
Mr. Erlandson confirmed that on the Callan website there
was a quarterly exhibit that measured the net of fee
effectiveness of managers.
Co-Chair Stedman asked for an explanation of the difference
between the 1-year arithmetic and 10-year annualized
projected return.
10:03:33 AM
Mr. Erlandson stated that the arithmetic return was from
the beginning, day zero, to the end of the 10-year period,
without variability. The geometric return assumed
variability of return.
Co-Chair Stedman thought the easy way to consider the
difference was that the arithmetic was a 1-year return, the
geometric was a 10-year compounding return that took risk
level into account.
Co-Chair Stedman asked for an explanation of 'duration'.
Mr. Center stated that for fixed income investments
"duration" had to do with the length of time that the bond
had to maturity. Shorter duration maturity could be 3 years
or less, longer duration dated securities, or market
duration, could take 5 or 6 years to maturity.
Co-Chair Stedman thought the duration time would indicate
the timing of the cash flows.
Mr. Center added that shorter duration securities tended to
have lower risk because the likelihood of the default was
lower than that of a longer duration bond.
10:06:16 AM
Mr. Erlandson discussed Slide 20, " Expanding the Length of
the Forecast Horizon":
10-Year vs. Equilibrium Capital Market Expectations
?As the time horizon grows beyond 10 years, our
capital market expectations increasingly incorporate
"equilibrium returns". Equilibrium returns reference
long-term historical mean results, with an overlay of
informed judgment. Key elements to consider:
Nominal returns
Inflation
Real returns
Risk premium bonds over cash, stocks over
bonds, long duration over short
Long-term underlying economic growth (real GDP)
? 10-Year expectations:
Large Cap Stocks: 7.0% nominal, 4.75% real,
3.25% premium over bonds
Bonds: 3.75% nominal, 1.50% real, 1.25% premium
over cash
Cash: 2.50% nominal, 0.25% real
Inflation: 2.25%
Underlying economic growth (real GDP) 2 to
2.5% per year
?Equilibrium expectations:
Large Cap Stocks: 8.25% nominal, 6.0% real,
3.25% premium over bonds
Bonds: 5% nominal, 2.75% real, 1.75% premium
over cash
Cash: 3.25% nominal, 1.0% real
Inflation: 2.25%
Underlying economic growth (real GDP) 3% per
year
Mr. Erlandson said that the slide put into narrative format
the assumption that lower returns were being assumed for
the next decade but, 15, 25, 30 years out, returns would
gradually increase. He said that everything was priced off
the risk-free rate and anything that was purchased would be
scrutinized for cash return and risk. He argued that longer
time horizons should assume higher rates of return but, if
the return horizon was shorter then lower return
expectations should be made for the same asset allocation.
10:09:12 AM
Mr. Erlandson turned to Slide 21, "Comparison of 10-year
Returns with Equilibrium Returns," which showed a data
table that compared the returns.
10:09:31 AM
Mr. Erlandson referenced Slide 22, "2019 Capital Market
Projections versus Other Firms," which showed a data table
listing the 11 organizations that had made projections like
Callan. He noted that the return projects did not all use
the same asset classes and the time horizons differed. He
gleaned that the longer the time horizon, generally the
higher return the organization listed were predicting. He
pointed out the four columns on the far right that showed
the high and the low returns, with the Callan assumptions
highlighted in yellow.
10:10:49 AM
Mr. Center displayed Slide 23, "PERS and TRS Asset
Allocation Over Time":
? Table shows asset allocations for PERS (solid line)
and TRS (dashed line) over time. Dashes are only
visible when differences arise.
? Through much of the1990's, PERS and TRS had slightly
different asset allocations
? PERS had a moderately higher Fixed Income allocation
? TRS had a slightly higher allocation to Domestic and
Non-US Equities
? Asset Allocations have been effectively similar
since 2000
Mr. Center stated that the slide was in response to a
question from the committee after a presentation that had
showed historical returns for PERS and TRS; a return
difference had been observed for the two plans over the
long term. He noted that there were two sets of lines for
each asset class. The slide showed asset allocations for
PERS (solid line) and TRS (dashed line) over time; dashed
were only visible when differenced arose. Through much of
the 1990s, PERS and TRS had slightly different asset
allocations, PERS had a moderately higher fixed income
allocation, while TRS had a slightly higher allocation to
domestic and non-US equities. The slide concluded that
asset allocations had been effectively similar since 2000.
10:13:04 AM
Co-Chair Stedman thank the presenters and invited the next
set of speakers to the table.
10:13:50 AM
AJAY DESAI, DIRECTOR, DIVISION OF RETIREMENT AND BENEFITS,
DEPARTMENT OF ADMINISTRATION, introduced himself.
KEVIN WORLEY, CHIEF FINANCIAL OFFICER, DIVISION OF
RETIREMENT AND BENEFITS, introduced Mr. Kershner and showed
slide 24, "Buck Analysis."
DAVID KERSHNER, BUCK FIRM (via teleconference), relayed
that the primary function of Buck had been to help the
board assess the funded status of the plans each year based
on the annual evaluations. The evaluations were used to set
the contribution rates for the various employers and the
state.
10:15:24 AM
Mr. Kershner referenced Slide 25, "Impact of Actuarial
Assumption Changes," which showed a data table the
illustrated actuarial accrued liability for PERS and TRS.
He explained that contributions for the plan came from
three sources: active participants, participating
employers, and the additional state contribution. He
discussed the statutorily set contribution rates for each
source.
Mr. Kershner continued to address Slide 25. He informed
that Buck was in the process of the 2018 evaluation, which
would be presented to the board in May 2019. Over the
previous year, the firm had performed an experience study
to assess the reasonableness of the actuarial assumptions
and whether changes were warranted. He continued that the
firm made a series of assumptions in order to project
benefits for participants decades into the future.
Demographic assumptions were used to project the plan
population each year into the future.
Mr. Kershner discussed economic assumptions used to devise
an investment return rate, which was composed of an
inflation rate assumption and a real rate of return. He
continued that the inflation assumption was common to other
economic assumptions, i.e.; the assumption regarding future
pay increases for active members because pension benefits
are a function of average pay of retirement. Merit and
productivity were also considered. He spoke to healthcare
and said that the liabilities were a function of the
medical and prescription drug claims generated by retirees
and their covered dependents. He stated that assumptions
were made as to how those expenses were expected to
increase in the future due to inflation, changes in
utilization, changes in technology, and new programs that
were implemented to control healthcare costs.
10:19:40 AM
Mr. Kershner shared that the board had adopted a study in
January, and 2018 valuations would be used to set
contribution rates for FY 21.
Mr. Kershner noted that Slide 25, as well as the following
slide would address the overall impact on PERS and TRS of
the newly adopted assumption changes. He relayed that the
top half of slide 25, showed the actuarial accrued
liability from the most recent valuation prior to the new
assumption being reflected in the 2018 evaluations.
Mr. Kershner pointed to line 1, which showed PERS liability
for pension and healthcare at approximately $22 billion and
$10.1 billion for TRS. The actuarial accrued liability was
the present value of future benefits, based on assumptions,
attributable to service earned as of the evaluation date of
June 30, 2017. He said that this was the denominator of the
funded status of the plan and was used to set the
contribution rate.
10:22:47 AM
Mr. Kershner related that lowering the interest rate
assumption from 8 percent to 7.38 percent had been the
primary driver of the increase in the actuarial accrued
liability. He said that the reason that the accrued
liability increased, while the interest rate assumption
decreased rate, was because more needed to be set aside in
the present in order to provide the same benefits into the
future.
Mr. Kershner emphasized that the overall cost of the plans
over time would be whatever the benefits were,
administrative expenses, and whatever invested assets
earned over time. All the actuarial assumptions did was
help allocate the assets over time and determine a pattern
of contributions. He stressed that the goal was to provide
as much stability over time as possible, while recognizing
that there was no control over what happened to invested
assets, and little control over liability due to changes in
assumptions.
10:24:59 AM
Mr. Kershner pointed out that the second line on Slide 25
reflected the increase in the actuarial accrued liability
due to the new assumptions in dollar amounts, the next line
reflected the percentage basis. For PERS there was
approximately a 6 percent increase in the actual accrued
liability, under 1 percent for TRS.
10:25:28 AM
Mr. Kershner noted that line 3 introduced another change
that would be reflected in the 2018 evaluations, the
adoption of the Employer Group Waiver Plus program (EGWP).
This was a program offered by the federal government that
provided incentives to employers to cover prescription
drugs for their participants that were covered under
Medicare. Until EGWP was implemented, there was a Retiree
Drug Subsidy (RDS) program that the state had decided to
stop because EGWP provided a greater subsidy. The EGWP
program reduced the liability of the plan. He pointed out
that the third line on slide showed that showed a decrease
in healthcare liabilities for PERS and TRS. He reiterated
that the slide reflected estimations as of July 30, 2017
and were currently being refined to include the new
program.
10:27:56 AM
Mr. Kershner continued to discuss Slide 25. He discussed
additional state contributions as shown on the slide. He
noted that there were two components to the contribution
rate: the cost of benefits occurring in the current year
and the funding of the unfunded liability. Beginning in
2014, stature required that the unfunded liability for PERS
and TRS be funded over a closed, 25-year period, starting
in 2014, through 2039. He said that the state had 21 years
left to amortize the unfunded liability. He said that work
was being done with the board to modify the way the
unfunded liability would be amortized, with an emphasis on
minimizing the potential volatility in those additional
state contributions. He offered a hypothetical using the
current method of funding the unfunded liability that would
result in an increase in state contribution. He said that
the amortization modification method of 25-year layering
would help to determine projected state contributions into
the future.
10:32:47 AM
Mr. Kershner continued to address slide 25 and noted that
the projections assumed that all the assumptions over time
would be realized. He considered current assumptions
projected for FY 21 - FY 39; $4.1 billion for PERS and $3.7
billion for TRS. He discussed the changes under the new
assumptions before recognizing EGWP and the 25-year
layering.
10:36:33 AM
Co-Chair Stedman asked Mr. Kershner to clarify why the
burden fell to the employer and not the state.
Mr. Kershner clarified that the first use of 25-year
layering would start in 2018, and projected contribution
rates would be less than the 22 percent employer
contribution for PERS, and 12.56 for TRS. The additional
state contributions only kicked in when the contribution
rates exceeded the employer limits.
10:38:08 AM
Co-Chair von Imhof thought EGWP had a tremendous positive
effect on the unfunded liability balance. She wondered
whether Mr. Kershner knew of any other factors such as
pooling mechanisms that could aid in reducing liability.
Mr. Kershner confirmed that he was not a healthcare actuary
and offered to follow up later.
10:39:16 AM
Senator Hoffman also saw the benefits of the EGWP program.
He asked what authority the board had to implement EGWP.
He asked what other states had implemented the program.
Mr. Desai stated that the process of EGWP began in 2017.
Initially the study with a health consulted had shown
potential savings. When it was realized that the savings
would be achieved through the program - it was implemented.
Mr. Desai offered to provide information later regarding
the question of authority to implement the program.
10:41:24 AM
Senator Hoffman wanted a list of other states participating
in the program. He asked what impact the program had on
prescription drug prices for health trusts and end users.
Co-Chair Stedman asked the testifiers to provide the
information later.
10:41:56 AM
Senator Micciche asked why excluding and including EGWP
were stacked in the assumptions on the second half of the
slide.
Mr. Kershner stated that the changes were listed separately
to provide more information on the impact of the three
significant changes being implemented for the current
valuations.
10:42:53 AM
Senator Micciche looked at the net increase and decrease on
unfunded liability. He thought that both influenced the
actuarial calculation.
Mr. Kershner stated that the new assumptions and the 25-
year layering of the unfunded liability were separate
decisions. The board could have approved the new
assumptions, and kept the current, closed 25-year
amortization, without introducing layering. The
implementation of EGWP was a decision made by DOA and was
independent of the assumptions or the method used to
amortize the unfunded liability.
10:44:28 AM
Senator Micciche considered the decisions that were made,
and understood that the actuarial accrued liability, with
new assumptions, was $22.585 billion.
Mr. Kershner answered in the affirmative.
Senator Micciche asked whether the unfunded liability was
$8.83 billion.
Mr. Kershner stated that that unfunded liability would be
the difference between the actuarial accrued liability and
the asset values, which were not on the slide.
Co-Chair Stedman remarked that the presentation had been
nearly two hours long, and he could not say that he felt
better informed on the matter. He expressed the desire for
a frank conversation on the money available and how the
problem was going to be resolved. He was concerned about
the increase in unfunded liability under the new
calculation.
Mr. Kershner stated that the 2018 valuation would reflect
the 6/30/18 liability, assets, and unfunded amounts. He
admitted that the slide did not reflect the unfunded
liability.
10:46:51 AM
Co-Chair Stedman queried the assets and liability and what
was expected in the report to the board.
Mr. Worley stated that actuarial valuation process was
still underway, the results of which still needed review by
actuaries.
Co-Chair Stedman asked for market value of the portfolio on
June 30, 2018.
Mr. Worley agreed to provide to provide the information.
Co-Chair Stedman expected to see a $1 billion increase. He
thought it was clear that there was a potential increase of
$1 billion in liability to the state. He stressed that the
committee was very concerned about the impact on the next
budget cycle. He lamented that the committee struggled with
the delay of information.
10:49:49 AM
Commissioner Tangeman recalled a presentation at the
January ARM Board meeting, at which time the liability
prior to recent action was $6.9 billion, or 78 percent
funded. The estimate after the experience study (without
EGWP) was about $2 billion. With the EGWP the total was
$7.2 billion. The numbers would be trued up in the coming
month.
Co-Chair Stedman understood that without EGWP and other
modifications the numbers would be higher.
Commissioner Tangeman answered in the affirmative.
Co-Chair Stedman summarized that the state had a $7.2
billion liability. He reiterated his request for a bugle
chart of the analysis over the last decade. He noted that a
similar chart had been done in the past and believed that
it would give the committee a better idea of the state's
exposure to risk. He felt that the committee needed more
information to understand what needed to be done going
forward.
10:53:50 AM
Senator Micciche questioned the sources for the numbers
being used by Commissioner Tangeman.
Co-Chair Stedman said that the information would be made
available to the committee.
10:54:40 AM
Mr. Kershner discussed Slide 26, "Percentage Impact of New
Assumptions/Methods on Actuarial Accrued Liability as of
June 30, 2017," which showed a data table showing the
impact of new assumptions on the 6/30/17 liabilities. He
noted there was four categories of changes: demographic
assumptions, salary increase rates, inflation rate (impact
on COLA-related benefits only), and investment return. He
discussed the two types of COLAs - the residency adjustment
and benefits tied to inflation. He highlighted the dropping
of the investment return from 8 percent to 7.38 percent and
the impact of PERS and TRS pension and healthcare.
10:57:01 AM
Mr. Kershner turned to Slide 27, which showed a data table.
He emphasized that the numbers were hypothetical and
illustrated how the 25-year layering would affect numbers
over time. Layer one was the unfunded liability that would
continue to be amortized over what was left of the 25-year
period, or through FY 39. The columns represented
subsequent layering hypotheticals through 2046.
Co-Chair Stedman thanked the presenters. He noted that the
subject matter could be frustrating. He believed that the
working with presenters to gather information for future
discussions could be fruitful. He highlighted the magnitude
of the issue and the importance that the state meets its
obligations.
11:01:48 AM
Co-Chair Stedman stated the co-chairs would work with the
presenters and the Commissioner of Revenue on the issue.
ADJOURNMENT
11:03:12 AM
The meeting was adjourned at 11:03 a.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| 040219 Summary of Current and Proposed Assumptions and Methods from 2017 Experience Study_121218 AC meeting.pdf |
SFIN 4/2/2019 9:00:00 AM |
Retirement and Benefits |
| 040219 ARMB_Callan_Buck S FIN 4.02.19.pdf |
SFIN 4/2/2019 9:00:00 AM |
Retirement and Benefits |