HOUSE BILL NO. 278 An Act relating to the Alaska Municipal Bond Bank Authority; permitting the Alaska Municipal Bond Bank Authority or a subsidiary of the authority to assist state and municipal governmental employers by issuing bonds and other commercial paper to enable the governmental employers to prepay all or a portion of the governmental employers' shares of the unfunded accrued actuarial liabilities of retirement systems and authorizing governmental employers to contract with and to issue bonds, notes, or commercial paper to the authority or its subsidiary corporation for that purpose; and providing for an effective date. REPRESENTATIVE MIKE HAWKER, SPONSOR, stated that one of the biggest issues facing the State of Alaska is the unfunded pension liability. It has become a growing issue the last several years; last year, a determination was made on how to best address it. HB 278 recommends a way to address that liability. Representative Hawker stated there is a $6 billion dollar deficit. He knew that the State could not come up with that amount of money, however, the amount could be amortized over time. The issue before the Committee is how to pay it off, understanding the compound growth rate of 8%. HB 278 provides a tool within the financial market to help pay off the obligation with the least possible cost to tax payers. The idea is to borrow from an entity, asking a less amount of interest and the difference would be a net savings over time for the State. 1:50:59 PM Representative Hawker suggested a possible savings close to $1.5 billion dollars over the time of the loan if the debt is bonded out. He reiterated that this savings would be to the taxpayers of the State of Alaska. Representative Hawker acknowledged that borrowing the funds would create a profound constitutional change and that such a mechanism was available within the international markets. The bill was brought forward because it addresses the capital market; municipalities would like to have the consideration of that option and the statutory authority to pursue it. He noted that the Municipality of Anchorage supports the concept. The Alaska Municipal League (AML) has passed a resolution indicating that they would like the statutory authority to consider the option. The bill would provide statutory authority to municipalities to pursue pension obligation bond transactions. 1:55:08 PM Representative Hawker stressed the simplicity of the bill. The most complicated aspect of the legislation is understanding what pension obligation bonds are and the associated benefits and risks. He recommended that staff and legislators carefully read the back up materials regarding the transactions. Two firms interested in pursuing the transactions are on line for testimony & questions. 1:58:31 PM Representative Hawker said pension bonds would be better than the alternatives to solving the pension fund concern. Most municipalities do not have the ability to write a check to solve their pension fund issues. The annual required payment into the Teacher Retirement System (TRS) amounts to 50% of the teacher's gross pay. A pension bond obligation would allow the State to reduce their matching requirement. The local taxpayers end up paying most of the cost for the local school districts. Representative Hawker summarized significant points of opposition: · Too risky - risk that the State would not be able to invest at 8% and borrow at 5%. The spread between what can be borrowed and what can be invested is called arbitrage. Arbitrage has been illegal since 1986. There is a specifically allowed federal provision for pension obligations. Representative Hawker was comfortable that investors would be able to continue the 8% profit on investments. · The mechanism of the bill is to grant the authority to the Alaska Municipal Bond Bank to execute the transactions on behalf of the municipalities, in order to facilitate reaching all capital markets in the country. The risk becomes obligated to the State if that authority faults. There is a moral obligation to the State, if the municipality defaults. · Some say that Wall Street would "frown on the benefit" of issuing obligation to the municipalities. The current pension obligation is a moral obligation to the State of Alaska. · There is fear that the municipalities would not "pay up". Representative Hawker did not agree. Representative Hawker urged support for HB 278, believing that capital markets are extremely self-governing and the investors would not take a high risk with those accounts, given the high degree of self-regulation. 2:09:46 PM Representative Hawker urged that the fiscal note be changed to indeterminate. 2:11:04 PM Co-Chair Meyer pointed out that representatives from Northwest Securities Corporation were present to testify on line. Representative Hawker advised that several firms had taken an interest in the State of Alaska. No one firm is authorizing a transaction, only providing educational backup. 2:12:26 PM Representative Kelly noted support for the legislation and asked if Fairbanks had indicated support for the option. 2:13:39 PM Representative Hawker replied that the bill does not address specific concerns. 2:14:28 PM CAROL SAMUELS, (TESTIFIED VIA TELECONFERENCE), NORTHWEST SECURITIES CORPORATION, SEATTLE WASHINGTON, provided an overview of a power point presentation included in the file. (Copy on File). She testified in favor of the bill. 2:16:46 PM Ms. Samuels referred to Page 1, the pension obligation bond description. A pension obligation bond is a financing used to defray unfunded pension costs. It is a replacement financing rather than a new obligation. Many jurisdictions have used pension obligation bonds to refinance the system loans at rates lower than the amortization rate. Ms. Samuels referred to Page 2, addressing why pension obligation bonds might be useful in Alaska. · According to the recently released 2004 valuation, assuming above average growth in population, Public Employees Retirement System (PERS) rates rise to 32% of payroll beginning in 2011 and do not decline until 2029 and the Teachers Retirement System (TRS) rates rise to 50% of payroll in 2011 and continue increasing to 56% by 2028 before declining. · Pension obligation bonds can be an effective tool for immediately reducing payroll rates and producing long-term savings for jurisdiction. · In Oregon, jurisdictions are projected to save over $1.3 billion dollars from use of that technique. Ms. Samuels continued, Page 3 provides a graph indicating the Alaska Pension system, asset base, covered employees, *average employer rate, funded ratio and the Unfunded Accrued Actuarial Liability (UAAL) as of 2003 valuation. 2:23:11 PM Page 4 provides a graph of the bonding used as a popular tool. Many jurisdictions throughout the country have chosen to finance their PERS liability with bonds. In Oregon: · A total of 133 school districts, cities, counties and the State have issued $5.4 billion dollars of pension bonds. · Savings projected at $1.3 billion overall, assuming an 8% rate of return. · Original statutory authority provided to local governments and school districts in 2001 for issuance of "full faith and credit obligations". · School districts also granted authority to enter into an intercept agreement with the State, whereby, operating funds were additionally pledged. The approach resulted in "State" credit rating. · State constitutional amendment approved by voters in 2003 authorizing the State to issue General Obligation (GO) bonds for its share of the liability. Voter approval margin was 55.25%. 2:25:05 PM Page 5 highlights the arbitrage issue. Issuing a pension bond is not like refinancing a mortgage. The success from borrowing depends on the market returning more than the cost of the bond. 2:27:47 PM Ms. Samuels continued, Page 6 indicates the Alaska Public Retirement System (PERS) history of investment results. She pointed out that in Oregon, PERS has a long history of strong investment performance: · 10 year average: 12.38% · 15 year average: 12.69% · 56 year average: 10.84% 2:29:44 PM Page 9 demonstrates the Alaska PERS system-wide refinancing analysis. A refinancing of the $3.4 billion PERS could result in net present value savings of over $1 billion dollars. 2:31:40 PM Page 10 examines the savings available in refinancing the Teachers Retirement System (TRS). She estimated a $37 million dollar savings, which might be redirected back into the classroom. 2:32:15 PM Page 11 summarizes the lessons learned over the past. 1. Payment to PERS does not guarantee UAAL will be paid off in full. 2. What happens if UAAL is subsequently reduced or increased - reduction and lump sum payment would put jurisdiction in surplus. Funds would not be returned to jurisdiction, but surplus would be used to reduce payroll rates further. 3. Structure of the financing matters - inappropriate to use unrealistic assumptions about rates of return; amortization structure of bonds should match amortization of UAAL that the PERS system uses; it is not prudent to have back weighted structures where all savings are produced in early years. 2:34:04 PM Ms. Samuels noted several examples of debt financing, which had been accomplished in inappropriate ways. She noted that 8% was used as a reasonable rate of return, whereas 9% was not appropriate in their opinion. 2:34:58 PM Page 12 continues outlining the "house keeping" issues. She noted that regulations would need to be drafted to ensure that funds were accounted for and payroll rates were reduced in a rational manner. She opined that work would need to be done on the system to ensure funds were protected. 2:38:19 PM Ms. Samuels noted Page 13 summarizes the intent of HB 278. The bill authorizes access to capital markets for the purpose of financing pension liabilities. It provides express authorization for all types of jurisdictions to issue obligations for that purpose either individually or thorough another entity. It also provides authorization for individual jurisdictions to pool together through a state entity such as Bond Bank to achieve economics of scale. Additionally, it will allow for credit support to enhance access to the market such as, intercept of funding, bond reserves and bond insurance. 2:38:59 PM Vice Chair Stoltze questioned the number of agencies that sell this type of bond. Ms. Samuels replied that there are multiple firms eager to help with selling the bonds. Representative Hawker added that any capital market would be available to pursue such a transaction. 2:39:54 PM Representative Kelly referred to the mechanism used to determine a credit rating, inquiring if that would be available and/or useful. Representative Hawker commented that was being researched and there would be a forthcoming amendment. Representative Kelly followed up with queries about the taxation structure of bonds. Representative Hawker responded that in a 1986 federal statutory change, in order to take advantage of arbitrage, the bonds become executed on a taxable basis. ERIC WHALEY, (TESTIFIED VIA TELECONFERENCE), MERRIL LYNCH, noted questions that many municipalities raised regarding how the legislation would impact either the municipality or the State's bond rating. Mr. Whaley pointed out that an unfunded liability already exists. One unfunded liability would be replaced by another. A question was asked if the risk was not positive over a 20- 30 year time period, would the State have been better off if the pension bond had not been issued. Mr. Whaley provided historical examples since 1926 of when portfolios had a return less than the bond rates and the only time that happened was just before the Great Depression. He acknowledged risk, commenting it is minimal. Mr. Whaley offered to answer questions of the Committee. 2:45:04 PM KEVIN RITCHIE, EXECUTIVE DIRECTOR, ALASKA MUNICIPAL LEAGUE (AML), JUNEAU, testified in favor of the legislation. AML supports the State to allow employers the option of refinancing the PERS & TRS debt to avoid the 8.25% rate imposed by the system. He emphasized that it would be a tool for only some municipalities; it is not a fix for all. He added that the relationship between the State and the schools are important. 2:46:58 PM Mr. Ritchie pointed out that the municipalities currently are asking, given the funding provided last year to reduce the 5% increase, questioning what that meant for the long- term health of the system. He maintained that these are important policy questions that must be addressed. Representative Kelly referred to previous discussion regarding the refinancing a portion of the fund. Mr. Ritchie deferred to the finance specialists to better answer that question. 2:48:30 PM Mr. Ritchie reiterated that the municipalities do support the legislation. 2:48:58 PM Representative Hawker concurred that the legislation would be more beneficial if it refinanced the entire fund, however, knew that some municipalities might not be comfortable with that risk. It would be best to let them each decide. 2:49:53 PM Vice Chair Stoltze asked if each municipality's level of debt would affect their ability to participate. Representative Hawker responded that indeed, municipalities would have to consider their own debt load and rating circumstances. It represents a substantial obligation and noted that each circumstance would need to be considered on an individual basis. Vice Chair Stoltze thought that net-caps for the municipalities could be considered and wondered if that potential exists. Representative Hawker acknowledged that caps could affect the municipality's ability to participate or prohibit financing options. 2:51:56 PM Representative Kerttula asked how a municipality could go about obtaining authorization for financing. Representative Hawker responded, it would happen through the same process used for current financial obligations incurred by municipalities. He referred to AS 29, regarding authority of municipal debt and outlined the methods to obtain authorization for municipal debt. 2:53:35 PM CARL ROSE, ALASKA ASSOCIATION OF ALASKA SCHOOL BOARDS, th JUNEAU, noted that on February 12, 2006, Ms. Samuels had addressed their Board. He advised that the numbers impressing him was the projected 50% anticipated increase rate in payroll by 2011; increasing again to 56% by 2028. AASB supports the option for municipalities to refinance to reduce the high rates affecting payroll. He noted appreciation for all the work done on the bill. 2:56:17 PM BILL BYORK, PRESIDENT, NATIONAL EDUCATION ASSOCIATION (NEA), ALASKA, expressed the organization's desire to explore the proposed refinancing options. It is a critical tool for addressing the State's unfunded liability and that HB 278 is essential. 2:57:30 PM Representative Hawker summarized, noting that both the financial and educational communities view the bill as a viable tool but not supported by the Administration. Amendments will be forthcoming to address concerns. He disagreed that the risks outweigh the benefit. Co-Chair Meyer stated that the Administration could testify when the bill incorporated the amendments, making it more supportable. 2:58:55 PM HB 278 was HELD in Committee for further consideration. 3:00:22 PM