Legislature(2007 - 2008)SENATE FINANCE 532
02/08/2008 09:00 AM Senate FINANCE
| Audio | Topic |
|---|---|
| Start | |
| SB119 | |
| SB57 | |
| HB13 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | SB 57 | TELECONFERENCED | |
| + | HB 13 | TELECONFERENCED | |
| + | TELECONFERENCED | ||
| += | SB 119 | TELECONFERENCED | |
CS FOR HOUSE BILL NO. 13(FIN)
"An Act relating to prepayments of accrued actuarial
liabilities of government retirement systems; relating
to the Alaska Municipal Bond Bank Authority, the Alaska
Housing Finance Corporation, and the state bond
committee; establishing the Alaska Pension Obligation
Bond Corporation; permitting the Alaska Municipal Bond
Bank Authority or a subsidiary of the authority, a
subsidiary of the Alaska Housing Finance Corporation,
the state bond committee, and the Alaska Pension
Obligation Bond Corporation to assist state and
municipal governmental employers by issuing bonds,
notes, commercial paper, or other obligations 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;
authorizing a governmental employer to issue
obligations to prepay all or a portion of the
governmental employer's shares of the unfunded accrued
actuarial liabilities of retirement systems and to
enter into a lease or other contractual agreement with
a trustee, the Alaska Municipal Bond Bank Authority or
a subsidiary of the authority, a subsidiary of the
Alaska Housing Finance Corporation, the state bond
committee, or the Alaska Pension Obligation Bond
Corporation in connection with the issuance of
obligations for that purpose, and relating to those
obligations; relating to revision of the employer
contribution rate in connection with financed
prepayment of unfunded accrued actuarial liabilities of
government retirement systems; and providing for an
effective date."
Co-Chair Stedman commented that the bill has an immense
magnitude in dollars and is one of the tools to facilitate
cash flow for the unfunded liability. He referred to a book
called "Pension Obligation Bonds and Other Post-Employment
Benefits" by Roger Davis. He referred to the presentation
by the Department of Revenue (DOR). He also referred to
documents from the PEW Center on the States, "Promises with
a Price", and a fact sheet regarding other states' retiree
benefit obligations. There is also a handout from Standard
and Poor's RatingsDirect, "Time May Be Ripe For A POB
Revival". (All copies are on file.)
10:05:49 AM
REPRESENTATIVE MIKE HAWKER, SPONSOR, explained that HB 13
deals with the unfunded liability related to the Public
Employee Retirement System (PERS) and the Teacher Retirement
System (TRS), due to insufficient assets to cover
liabilities. About $8.5 billion is needed to cover the
unfunded liabilities. The retirement obligation to those
trusts is a requirement fixed in the state constitution. HB
13 provides a mechanism by which to pay off the liability
through the use of the capital markets financial leverage.
Representative Hawker compared the debt to a mortgage on a
house, which accrues interest. The pension liabilities also
accrue interest, of sorts. The device offered in the bill
would empower the political subdivision to refinance these
pension funds by going into the international capital
markets, borrowing money at a low rate of interest, and
investing it. He explained how the state saves on the
arbitrage. There are many federal restrictions, but this
method is federally sanctioned.
10:11:03 AM
Representative Hawker emphasized that the bill is an
empowerment bill. It allows the municipal authorities to
engage in Pension Obligation Bonds (POBs) to help reduce
debt. He pointed out that the state has qualified financial
advisors. He highly recommended the Orrick (Roger Davis)
book.
10:14:09 AM
BRIAN ANDREWS, DEPUTY COMMISSIONER, TREASURY DIVISION,
DEPARTMENT OF REVENUE, testified on HB 13 using a handout
entitled "Pension Obligation Bonds" (copy on file.) He
referred to page one of the handout to define what Pension
Obligation Bonds (POBs) are. He explained that POBs
replaces one form of debt with another form of debt that
carries a lower interest rate cost, similar to refinancing
the mortgage on a house. They are issued by a state or
local government. The greater the investment arbitrage, the
better off the state will be in achieving a lower
contribution rate to the state's pension plans. POBs have
been a increasingly popular and successful way for state and
local governments to accomplish financial goals. Since
1955, six states and over 234 local governments have issued
POBs totaling in excess of $40 billion. In the mid-90's
Anchorage issued a POB.
Mr. Andrews turned to page 2, a map of the U.S. which
depicts states that have issued POBs. Illinois holds the
record for the largest POB, in 2003, worth $10 billion. He
noted that Connecticut would be issuing a POB in the next
couple weeks.
10:17:55 AM
Mr. Andrews addressed the question, "Why Should We Consider
Issuing POBs?" found on page 3. Some of the benefits of
POBs are interest rate savings, a positive arbitrage
potential, and the fact that they are not generally viewed
as adding to the debt burden of the state government issuer.
Mr. Andrews emphasized that POBs are not a golden bullet,
but rather a financial tool - page 4.
Mr. Andrews discussed page 5, "Alaska Pension Bill/Unfunded
Actuarial Accrued Liability (UAAL) in 2006". The unfunded
liability is a bill that the pension systems are giving to
the state and local governments, which totals $8.6 billion.
Co-Chair Stedman asked for a definition of PERS and TRS.
Mr. Andrews defined those terms.
Mr. Andrews continued to explain page 6, "Paying the
Bill/UAAL". One of the options is to pay with cash; another
option is to pay with a loan at 8.25 percent over 25 years.
The question is whether a POB can reduce the cost to less
than 8.25 percent.
10:20:27 AM
Mr. Andrews reported on the "Funding Status Overview" on
page 7. He reviewed the funding status for PERS and TRS as
of June 30, 2006, according to the actuarial report.
Mr. Andrews discussed "Interest Rate Savings" - page 8. IF
a bond transaction was issued this week, it would be at
about 5.25 percent. He cautioned that credit markets are in
an unstable state. The difference between 8.25 and 5.25
over twenty-five years is $323 million in savings on $1
billion, or $23 million annually.
Mr. Andrews explained the "Interest Rate History" on page 9.
The interest rate is very low, the lowest since the mid-
60's. Page 10 deals with "Treasury Rates Still Historically
Attractive".
10:23:44 AM
Mr. Andrews turned to the topic of arbitrage and the
"Historical Investment Returns of State Pension Plans
(PERS)" on page 11 and 12. The average return from 1992 to
2007 is 9.67 percent. The numbers from 2003 and up have
been very attractive. He discussed the risk, which is
usually measured by volatility, a measurement of standard
deviation. The level of volatility is low. The numbers are
very similar for TRS because the portfolio is similar.
Mr. Andrews turned to page 13, "Long Term Target Asset
Allocation". The ARM Board reviews the asset allocations
each year with the help of the financial advisor, Callan
Associates, Inc. The median return is 8.05 percent with a
standard deviation of 12.27 percent.
10:26:05 AM
Mr. Andrews discussed the third reason for going to POBs,
credit neutrality. He explained "Credit Rating
Consideration" on page 14. He summarized that POBs are not
considered new debt. Rating agencies like to talk about
unfunded liabilities as being a soft liability, which allows
for some flexibility. A POB transaction turns a soft
liability into a hard liability. He argued that unfunded
liabilities are really hard liabilities because they are set
in constitution. He recalled a case, the State v. Duncan
that agreed with the interpretation that unfunded
liabilities are hard liabilities. He opined that treating
the unfunded liabilities as hard liabilities brings fiscal
stability to the process.
10:28:07 AM
Mr. Andrews turned to page 15, "Prudently Structured, POBs
are Ratings Neutral". He pointed out that the funding level
rating agencies like to look at is around 80 percent.
Overfunding above 80 percent is somewhat risky. Ratios
below 80 percent are a potential negative.
Mr. Andrews explained, on page 16, the three types of risks:
investment, political, and market. He turned to page 17 -
"Investment Risk Analysis". As long as those bond-funded
assets earn more than 5.25 percent, there is a positive
effect; anything under that percentage fails to cover the
cost of the bond. Page 18 depicts "Investment Risks
(PERS)". The graph shows the various scenarios by year
since 1992 if POBs had been issued. For 14 out of 16 years
the issuance of POBs would have resulted in a gain to the
pension plan. It highlights one of the risks of having a
negative scenario, such as in 2000 and in 2001.
10:31:37 AM
Co-Chair Stedman asked for more information about cash flow
impacts in various environments. The 90's had a very strong
equity market. 2002 and 2001 were negative environments.
Mr. Andrews agreed to provide more information. He spoke of
bull markets and bear markets as examples.
10:33:14 AM
Mr. Andrews addressed page 20, "UAAL vs. POB Financial
Success". He summarized that as long as the bond-funded
assets make more than 5.25 percent, the state is better off
for having borrowed. If the assets earn less than 8.25
percent, the unfunded liability goes up. Even if those
assets earn more than 8.25 percent, the unfunded liability
can increase due to actuarial and/or accounting changes.
Senator Thomas asked about the charts on pages 18 and 19 and
the change in the estimated cost of borrowing column. He
wondered if the percentages are actuals. Mr. Andrews
replied that each year stands by itself. He gave examples
from various years. Co-Chair Stedman asked if that was
before or after transaction costs. Mr. Andrews said that
included transaction fees. In 2007, the rate would have
been around 5.75 percent. He noted that these figures are
for fiscal years.
10:36:59 AM
Mr. Andrews turned to page 21, "Investment Return Forecast",
a Monte Carlo simulation that takes historical returns and
scrambles them and tries to determine what the return of a
portfolio would be. In a conservative scenario - 70/30 -
the return was greater than 5.25 percent, but included a
risk.
Co-Chair Stedman referred to page 18 and a reference to if
POBs had been implemented last year on June 30. He
requested more information. Mr. Andrews corrected that it
would have been in June of 2006, with a return of 18.9
percent.
Representative Hawker spoke of this proposed transaction as
having a high degree of confidence that, over the life of
the transaction, works to the state's benefit. He explained
how the Monte Carlo simulation documents the possibilities.
He said this POB proposal has a high degree of confidence
due to the fortuitous time of low interest rates. He
cautioned not to try to time a transaction with the market.
10:40:56 AM
Senator Elton referred to page 21 and noted it was a 25-year
investment period. He assumed there was a 5.25 percent cost
over that time, based upon assumptions in the market place
at the time over the life of the bonds. Mr. Andrews
explained how the Monte Carlo model worked by scrambling
iterations. Senator Elton said he is assuming if the bill
passes, the interest rate will be predicated over the full
life of the term of the bond. Mr. Andrews said that is
correct.
10:43:21 AM
Co-Chair Stedman requested information about the probability
of the outcome using various time periods, not just 25
years. Mr. Andrews replied that the life of the bonds is 25
years, and the shorter the time period, the more volatility
there is. Over time, that is lessened and the return
averages out. If the time frame is shortened to 5 or 10
years, the confidence level decreases.
Co-Chair Stedman offered to provide more data to the
committee. He asked where Mr. Andrews got his data. Mr.
Andrews replied that it came from the S & P 500 index. Co-
Chair Stedman asked if allocations were used. Mr. Andrews
reported that the 70/30, 80/20, and 90/10 allocations were
used. Co-Chair Stedman said the 70 percent was from the S &
P 500. He asked where the 30 percent was from. Mr. Andrews
replied Lehman aggregate, an index that is used for fixed
income securities with a duration of about 7 years. Mr.
Andrews explained that the average maturity of the Lehman
aggregate or fixed income portfolio is approximately 10
years. Co-Chair Stedman added that it is a weighted average
of cash flows.
10:47:36 AM
Mr. Andrews turned to page 22, "Political Risk - Key Driver
of UAAL". He explained that the unfunded liability, as
reported by the state's actuary, was really created by
increased health benefit costs in 2001-2003. There were
also some pension plan changes that contributed to the
expense. It was not the result of poor investment returns.
Mr. Andrews discussed political risk on page 23. High
amounts of POB proceeds may cause the pension system to be
over-funded, which could lead to political pressure calling
for benefit increases that would incur new liabilities in
the future.
Mr. Andrews spoke of "Market Risk" on page 24. POB proceeds
cause a large amount of capital infusion into the pension
system at once, and how the ARM Board invests those proceeds
is critical. The success of the POB plan relies on a low
cost and a positive arbitrage. When the issuance of the
bonds have proceeds, it's very important that they achieve
at least 5.25 percent during the first couple of years. He
provided an example: If a $100 investment drops to $50, the
loss is 50 percent; however, to go from $50 back to $100
requires a 100 percent gain.
Representative Hawker related a strategy by the ARM Board to
invest more conservatively in the first couple of years.
10:51:33 AM
Mr. Andrews turned to three types of public debt, page 25,
"Security": general obligation bonds, obligations imposed by
law, and annual appropriation bonds. HB 13 calls for annual
appropriation bonds.
He explained potential savings, page 27, "Case Study
(PERS)". The upper left matrix, "Employer Contribution
Rates", shows a figure of 35.22 percent, which is the
contribution rate that the ARM Board adopted for the
unfunded liability. The matrices show the potential savings
of issuing POBs or using cash to pay down the unfunded
liability. He gave an example from the first matrix of a $2
billion POB transaction moving the annual contribution rate
down to 32.91 percent. That equals a savings of 2.31
percent on the annual contribution rate as depicted in the
lower left column. That equates to dollars in the upper
right column, which is a savings of $38.62 million annually.
Over the life of the bonds, or 25 years, that is a
cumulative rate of $544.28 million in savings, discounted
out at 35 percent. That final tally is shown in the lower
right column.
10:54:15 AM
Mr. Andrews summarized the "Take-aways" on page 31. He read
the 4 points:
If we can earn more than the cost of POB, we are better
off for issuing it.
We are in a very favorable interest rate environment -
take advantage of it!
Risks associated with POB issuance are quantifiable and
statistically justified by the rewards.
Doing nothing is not a viable option.
Mr. Andrews concluded that the Administration is in favor of
HB 13.
CSHB 13(FIN) was heard and HELD in Committee for further
consideration.
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