Legislature(2015 - 2016)HOUSE FINANCE 519
02/12/2016 01:30 PM House FINANCE
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Department of Revenue Presentation: Pension Obligation Bonds | |
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* first hearing in first committee of referral
+ teleconferenced
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+ teleconferenced
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HOUSE FINANCE COMMITTEE February 12, 2016 1:33 p.m. 1:33:18 PM CALL TO ORDER Co-Chair Neuman called the House Finance Committee meeting to order at 1:33 p.m. MEMBERS PRESENT Representative Mark Neuman, Co-Chair Representative Steve Thompson, Co-Chair Representative Dan Saddler, Vice-Chair Representative Bryce Edgmon Representative Les Gara Representative Lynn Gattis Representative David Guttenberg Representative Scott Kawasaki Representative Cathy Munoz Representative Lance Pruitt Representative Tammie Wilson MEMBERS ABSENT None ALSO PRESENT Jerry Burnett, Deputy Commissioner, Treasury Division, Department of Revenue; Deven Mitchell, Executive Director, Alaska Municipal Bond Bank Authority, Department of Revenue. SUMMARY PRESENTATION: PENSION OBLIGATION BONDS DEPARTMENT OF REVENUE Co-Chair Neuman discussed the meeting agenda. ^DEPARTMENT OF REVENUE PRESENTATION: PENSION OBLIGATION BONDS 1:34:17 PM JERRY BURNETT, DEPUTY COMMISSIONER, TREASURY DIVISION, DEPARTMENT OF REVENUE, provided a PowerPoint presentation titled "Alaska Pension Obligation Bond Corporation" (copy on file). He began on slide 2: Alaska's Major Pension Systems · The State manages 2 major pension systems: Public Employee Retirement System (PERS) and Teachers' Retirement System (TRS) · The PERS and TRS systems provide retirement benefits for most public employees and teachers in the State of Alaska · 160 state and local employers participate in PERS, and 60 state and local education entities and school districts participate in TRS · By statute the State is obligated to consider appropriating amounts to support the PERS and · TRS pension liabilities · Between 1999 and 2001 PERS and TRS went from being overfunded to carrying UAALs Mr. Burnett read from slide 3: How are PERS and TRS Funded · Both are Pre funded, meaning that as retirement benefit liabilities accrue payments intended to satisfy those benefits are deposited into a trust. · The payments are based on actuarial analysis which includes many assumptions including employment patterns, future wages, life expectancy, healthcare costs and an investment return rate of 8% on the pre-payments · The actual experience of the pension systems is reviewed in an annual funded status report. o A debt or "unfunded assumed actuarial liability (UAAL)" occurs when the current pre-funding and its future earnings are projected to be less than the retirement obligations. o This debt is then repaid over time in a fashion comparable to borrowing at the assumed rate of return (8%) o UAALs materialize due to the experience being worse than the assumptions o -An overfunding occurs when t the current pre-funding and its future earnings are projected to be more than the retirement obligations · In 2008 SB 125 capped PERS employer contribution rate at 22% and TRS employer contribution rate at 12.56% and declared that the State shall make up any difference between 22% and the actuarially determined contribution rate. · -This made the State the default funding source for any additional funding requirement due to the experience being worse than the actuarial assumptions for systems Co-Chair Neuman asked whether the fund had earned 8 percent annually. Mr. Burnett answered that in FY 2015 the funds had earned approximately 3.2 percent and in FY 2015 earned well over 8 percent; the funds earned well in excess of 8 percent over the system's life. Co-Chair Neuman pointed to the market downturn. He asked where the markets may be headed. DEVEN MITCHELL, EXECUTIVE DIRECTOR, ALASKA MUNICIPAL BOND BANK AUTHORITY, DEPARTMENT OF REVENUE, replied that he did not usually invest large sums of money; he was responsible for borrowing money that was "somewhat different than fixed income investing." He shared that his views on the equity markets and fixed income markets relative to retirement systems were not as informed and not his area of expertise. He deferred to other professionals within the Department of Revenue (DOR) for details. Co-Chair Neuman noted that the individuals could address the committee at a later time. Representative Munoz asked whether the assumed rate for the defined benefit plans needed to be recalculated due to the declining number of people paying into the plan. Mr. Burnett answered that she was referring to a "closed plan" and noted that the plans were closed in 2007. He explained that as earnings grew more important than deposits into the fund the cash needs exceeded the liquidity that was provided with an asset allocation with an 8 percent return. He referred to an analysis that was done on the issue by Gary Bader, Chief Investment Officer, Treasury Division, Department of Revenue. The analysis concluded that the problem was expected in the early 2020s. However, the estimation was advanced because the issue was analyzed prior to the $3.2 billion infusion the legislature had allocated to the unfunded liability [2014]. He believed the situation was far removed into the future. He shared that the Alaska Retirement Management Board (ARMB) revisited the topic annually. 1:41:23 PM Representative Gara asked for the Public Employees' Retirement System (PERS) and Teachers' Retirement System (TRS) shortfall amount. He asked whether the amount was based on a certain percentage of retired employees and what the percentage was. Mr. Burnett answered that when an actuarial analysis was done on a retirement system it examined the whole universe of the system. He delineated that the goal was to obtain a level of ongoing payments where there were sufficient assets to pay for future liabilities for all employees in the system receiving benefits. Representative Gara surmised that the department was measuring what was needed to pay 100 percent of the entire state work force assuming they just quit and for current retirees. Mr. Burnett replied that the measurement was done on a "point in time" on an annual basis. He added that rate setting was based on the contribution required by the state in excess of the rates paid by employees. Representative Gara stated that many people may believe the assumption may be excessive. He asked what the projected debt was for both systems currently. Mr. Burnett answered that as the latest evaluation that occurred on June 30, 2014, the unfunded liability for PERS was $6.252 billion and $3.822 billion for TRS. He recounted that the amounts did not include the legislative appropriation of $3 billion ($1 billion into PERS and $2 billion into TRS). The actual amounts were different. Representative Gara asked for updated numbers calculated after June 2014. Mr. Burnett answered that draft numbers for June 2015 had been presented to the Department of Administration and DOR. He related that Buck Consultants, the state's standard actuary and Gabriel, Roeder, Smith and Company, the state's review actuary and ARMB needed to review the draft numbers. The departments assumed that the draft numbers were close to being correct, but the actuaries and ARMB had not yet seen the figures. He summarized that the figures were in draft and not fully reviewed. Co-Chair Neuman asked whether the numbers could be presented to the committee in draft form. Mr. Burnett responded that he could speak to an approximate number but until the number was reviewed by the second actuary they would remain an estimate. He shared that Mr. Mitchell was "free" to speak to the estimates and he would release the amounts as soon as possible. Co-Chair Neuman remarked that the department was unable to answer questions regarding stock market projections and state savings. He questioned the presenter's preparedness for the meeting. Representative Gara interjected that the presenters were also not able to tell the committee what the state owed. Mr. Mitchell relayed that the figures were typically not disseminated to anyone until they were reviewed by the ARMB. The department was granted limited access to the draft numbers due to the governor's proposal to use Pension Obligation Bonds (POB). He indicated that the limited access specifically required that the figure could not be divulged to third-parties and was a unique situation. He revealed that the calculations for sizing the POB had been included in the presentation but DOR was not planning to address a draft report. Co-Chair Neuman asked whether the presenters thought they would be asked the question. Mr. Burnett replied that they would get the numbers to the committee. He expected to discuss "the sizing of the deal" without delving into the specific numbers that would change. The numbers in the proposed governor's budget always lagged one year. 1:49:18 PM Representative Pruitt noted his frustration with the lack of specific information and noted that he experienced the situation before. He wondered whether the committee should move into an executive session so some of the figures could be brought forward. He asked what the percentage of funding was. He wondered whether the retirement system was at the level of private funds. Mr. Mitchell remembered that the TRS health care was 100.6 percent funded and the pensions were funded 86 percent. He added that for PERS health care was funded in the high 90 percent range, pensions were funded in the low 70 percent and the blended percentage was in the high 70's. Representative Pruitt ascertained that the state was within the required ranges. He asked how the state's POB levels related to IRS requirements. Mr. Burnett answered that the state was not under the same rules. The POB's were currently in the 90 percent range and the situation "was much improved" and moved the debt to the pension systems at lower costs. 1:53:33 PM Representative Pruitt wanted to hold the state to the same standards as private industry. He surmised that "the weight in the system was shifted to the general fund." Mr. Burnett replied that under Generally Accepted Accounting practices (Governmental Accounting Standards Board (GASB) under which the state operated the unfunded liability of the pension systems and the amount paid in excess of 22 percent (paid by the employer) resided on the states book as a liability similar to borrowing money. The POB strategy did not change the state's liability on a balance sheet but changed "the liability to an investor from a liability to a pension fund," which was operated for the benefit of state and local government employees. Representative Pruitt surmised that strategy was not about the debt, but about the potential risk of borrowing and earning more for the money. Mr. Burnett answered that his statement was "almost" the case. He explained that the state was proposing to refinance debt paid at an 8 percent assumed interest rate because the money the state was replacing was comprised entirely from the General Fund (GF). The pension obligation bonds would be a debt to another party at a much lower interest rate, which resulted in reduced budgetary costs. He stated that the proposal was not "an arbitrage play," but was a refinancing play. The difference between a POB and a retirement system was that it was more difficult for the legislature to miss a payment in a specific year because the results were different. In one the unfunded liability increased and in the other the loan was in default. 1:56:48 PM Co-Chair Neuman reiterated Representative Gara's question. He asked how much was currently in the fund. Mr. Burnett answered that the amount was roughly $15 billion in the PERS fund and $8 billion in the TRS fund. Co-Chair Neuman asked whether the original balance was approximately $10 billion. Mr. Burnett replied in the affirmative. Co-Chair Neuman asked whether Alaska's retirement funds were viewed as one of the best funded retirement system in the nation. Mr. Burnett was not able to answer the question. Co-Chair Neuman referenced the legislature's $3 billion cash infusion into the system. He asked how much the state's payments would have been without the cash injection and how much the state paid currently. Mr. Burnett replied that if the legislature had not infused the $3 billion the payment would be approximately $1 billion in the current year. Co- Chair Neuman was trying to understand why the strategy was currently being proposed and "start out in the hole." He sensed that the markets would probably not increase in the next year. He wondered why the rush to implement POBs and "start out at 4 or 5 percent in the hole" instead of waiting until the percentage increased to 8 percent. 2:00:12 PM Mr. Burnett answered that currently the system would likely be fully funded, if the system had been funded in 2009 when the market was down. He indicated that the market was down and it was a better time to buy. In 2008, when the legislature created the Alaska Pension Obligation Bond Corporation interest rates were in the 6 percent range. Currently interest rates were in the 4 to 5 percent range. He stated that the current situation favored potential savings. He referred to the collapse of the market in 2008 and the inability to borrow money. He mentioned the tax exempt financing rate of 5.9 percent in 2008 (for the Goose Creek Prison) was the highest rate the state had paid since the 1980s. He revealed that the law required the state to borrow below a 6.5 percent interest rate with an 8 percent return expectation; therefore, the state was not able to borrow at the time. The commissioner and ARMB was constantly monitoring the market and did not want to implement POB's when the market was peaking or rapidly falling. The department retained timing discretion for a sale. Representative Wilson asked who managed the retirement funds. Mr. Burnett answered that the ARMB managed the funds and was manned by the Treasury Division investment staff. Representative Wilson asked why the Alaska Permanent Fund Corporation (APFC) was not managing the money. Mr. Burnett answered that there were different mandates for the various funds. He shared that DOR and ARMB had better returns than the Permanent Fund 21 out of the last 31 years. Representative Wilson requested more information. Mr. Burnett detailed that the Treasury Division and ARMB had approximately 40 separate asset allocations and mandates for investments and each contained different results over time compared to APFC that had only one mandate. He voiced that the funds were managed "completely differently." Representative Wilson asked how the 22 percent state employer contribution rate for PERS and the 12.5 percent for TRS had been decided and how the legislature could amend the rates. 2:05:26 PM Representative Gara was concerned over a statement by Mr. Burnett regarding proposing the bond sale when the market was lower and not peaking. He voiced that the department had proposed the strategy when the market was peaking. Mr. Burnett replied that when the department had begun considering the idea the prior August there was a market "correction." The department did not time the market, but they could control the interest rate. Mr. Burnett continued and read the portion of slide 3: · The actual experience of the pension systems is reviewed in an annual funded status report. o A debt or "unfunded assumed actuarial liability (UAAL)" occurs when the current pre-funding and its future earnings are projected to be less than the retirement obligations. Æ’ This debt is then repaid over time in a fashion comparable to borrowing at the assumed rate of return (8%) Æ’ UAALs materialize due to the experience being worse than the assumptions o An overfunding occurs when the current pre- funding and its future earnings are projected to be more than the retirement obligations · In 2008 SB 125 capped PERS employer contribution rate at 22% and TRS employer contribution rate at 12.56% and declared that the State shall make up any difference between 22% and the actuarially determined contribution rate. o This made the State the default funding source for any additional funding requirement due to the experience being worse than the actuarial assumptions for systems Mr. Burnett related that prior to 2008, PERS was an agent multi-employer system where each employer had its own unfunded liability and rate. He delineated that some "political subdivisions" could have had rates higher than 100 percent of its payroll if actuarial results had not been updated. Co-Chair Neuman noted that Representative Louise Stutes was present in the room. Mr. Burnett addressed slide 4 titled "Alaska has Actively Addressed its UAAL with Several Reforms": · 2005: SB 141 closed PERS and TRS to new employees · 2007: SB 123 created Alaska Retiree Health Care Trusts · 2008: SB 125 capped PERS employer contribution rate at 22% and TRS employer contribution rate at 12.56% · 2008: HB 13 created Alaska Pension Obligation Bond Corporation (APOBC) and authorized issuance of $5 billion of Pension Obligation Bonds (POBs) · 2014: Deposited $1 billion in PERS and $2 billion in TRS from Constitutional Budget Reserve · Fund · 2016: Planned implementation of POB strategy to diminish growth of the annual increase of the · State's appropriation to the systems 2:10:39 PM Mr. Burnett delineated that the state had always prefunded health care for retirees and had the "best funded retiree healthcare of any state." Accounting requirements for retiree healthcare was impending under GASB rule 72. Representative Pruitt asked if the POBs had been issued in 2008. Mr. Burnett replied in the negative. Representative Pruitt asked whether the department had the authority to issue POBs without the legislature's authority. Mr. Burnett answered in the affirmative. He detailed that the APOBC was comprised of the commissioners of the Department of Administration (DOA), Department of Commerce, Community and Economic Development (DCCED), and DOR and was analogous to the state bond committee. He voiced that the APOBC did not want to market bonds without legislative approval because investors needed the assurance that legislative bodies were supportive. Vice-Chair Saddler referred to a document titled "Pension Obligation Bonds - Are They a Good Move for Alaska?" (Copy on file). He asked whether the administration would issue the bonds "absent committed indication" by the legislature that annual repayment appropriations would be a made. Mr. Burnett related that he was DOR's commissioner designee for the APOBC and he would be "incredibly reluctant" to issue POB's without legislative support and thought the action would be irresponsible. Vice-Chair Saddler asked what the corporation's mechanism for making the decision was. Mr. Burnett answered that the corporation would meet, seek presentations from staff (including Mr. Mitchell) and take action on a resolution. Vice-Chair Saddler asked if there would be a vote. Mr. Burnett answered in the affirmative. He added that signatures would be required. 2:14:18 PM Representative Guttenberg stated that the department had the authorization since 2008. He asked whether this was the first time the department had requested further authorization. Mr. Burnett responded in the affirmative. Representative Guttenberg asked whether in the ensuing years since 2008, opportunities existed to issue POB bonds. Mr. Burnett answered that discussions had taken place. He furthered that there were several administration changes since 2008 and the relative health of the state had changed. Mr. Mitchell expounded that the interest rate environment on the borrowing side was not favorable during the time period. The taxable rates for most of that interim was close to the 6 to 6.5 percent rate; at the level from a historical perspective, there was still "a double digit probability of not beating" 6.5 percent. At a 5 percent interest rate the success rate was in the high 90th percentile. Representative Munoz deduced that if the rate was 5 percent the rate of failure was close to 10 percent. She asked for clarification. Mr. Mitchell answered that the failure rate was closer to 1 percent. He elaborated that in 2008, former DOR deputy commissioner Brian Andrews performed historical analytical analysis to provide the statistical probabilities, which created confidence and contributed to passage of the legislation. He clarified that the current prefunded system assumed an earnings rate of 8 percent and if the rated dropped to 7.5 percent the unfunded liability nearly doubled. The state had already made an investment in the state's future. Representative Munoz referred to her earlier question about the assumed rate of 8 percent. She asked whether he thought the rate was "generous" since the plans were closed and future contributions became more limited over time. Mr. Burnett restated that the issue was a concern at some point out in the future and reminded her that ARMB and actuaries regularly reviewed the assumed rate and determined it was reasonable. He did not know what the future would bring over a long period of time. He indicated that whether or not the state did POBs, the unfunded liability significantly increases under any scenario where the earnings were less than 8 percent. Representative Munoz asked whether POBs carried a risk that if they do not perform as anticipated the unfunded liability grew. Mr. Burnett responded that "under almost any scenario," unless the funds was losing money, selling POBs would not make the unfunded liability or the payments towards the unfunded liability any worse. He explained that underperformance would shift part of the unfunded liability payment onto the investor and the other part onto the fund. The point of POVs were to "smooth out and reduce" the payment on the 8 percent debt. Representative Munoz observed that the liability would go from a "soft to a hard commitment… to transferring to a commitment that is real." Mr. Burnett answered that the commitment was just as real either way. The distinction lied in repayment and "what the consequences for making payments" were. 2:23:07 PM Co-Chair Neuman referred to Mr. Burnett's statement that the payments would not change. He discussed a scenario where only 3 or 4 percent was earned and not the expected 8 percent return. He asked whether the difference in the year end payments would be paid in GF dollars. Mr. Burnett answered that either way the shortfall would have to be made up with GF. The unfunded liability would still grow between the difference of 8 and 3 percent. The retirement system required annual actuarial analysis. Co-Chair Neuman restated his question regarding reconciling the difference in GF dollars. Mr. Burnett replied in the affirmative. He expounded that the shortfall would be filled with GF whether POBs were used or not. He stated that POB investing was fundamentally different than if the "pension fund itself was borrowing money for leverage;" "the state was borrowing money and changing the nature of who the liability was owed to and did not extinguish the liability but it put the money in a different place." Co-Chair Thompson asked whether issuing POBs could be viewed as an act of desperation by the state. He wondered whether the action could contribute to a rating downgrade. Mr. Burnett responded that if the POBs were issued to address the current year's payment; converting short-term debt to long-term debt, under a certain scenario did not look good. However, converting long-term 8 percent debt to a long-term debt of 5 percent was considered positive. He reported that the state discussed POBs with the rating agencies. 2:27:05 PM Co-Chair Neuman asked whether POBs would negatively impact the state's ability to bond for other projects. Mr. Burnett replied in the negative and stated that it would actually help. Representative Wilson asked why the state did not issue bonds in 2008 "instead of" the $3 billion payment. Mr. Burnett restated that the legislature made the choice and that the payment occurred in 2014. Representative Wilson asked that if POBs were such a good idea why was in not chosen as an option in 2014. Mr. Burnett answered that there were a number of different options in 2014 and the state chose cash. In 2014, the two consecutive prior years the price of oil was $110 per barrel and the payment was not perceived as a problem. Representative Wilson thought the reasoning was nonsensical. She believed the concept of POVs was a sound option and reasoned that it was a good option in any year. She voiced that "if we can make more money than what we are borrowing off it that should always have been something that would have made more sense at the time, unless we are not getting the whole story." Mr. Burnett reiterated that the interest rates had not been as favorable in 2008. Representative Wilson asked what the interest rates had been in 2008. Mr. Mitchell reiterated that interest rates were roughly 6 to 6.5 percent. It was impossible to "sell bonds like these in the market for a period of time" subsequent to the market's collapse. A "hard cap" was built into the legislation and the state could not borrow unless a return greater than 6.5 percent was realized. He restated that all the department could do was control interest rates and attempt to make informed decisions on the reinvestment of the money to ensure that the state did not engage in unnecessary risk. He remarked that after a 20 year time period the state would reevaluate whether the choice was correct or the trust would be underfunded. 2:31:31 PM Representative Wilson viewed the situation as "déjà vu from 2014." Representative Edgmon asked whether the administration was modeling the sovereign wealth concept along with the POV "risk adjusted rate of return for the state." Mr. Burnett replied in the affirmative. He revealed that there was a very robust model for the sovereign wealth fund and "a lot of modeling by investment banks" were performed for POBs. Representative Edgmon asked whether Alaska would be the one sovereign entity with so much connection and wealth tied to the equity markets if both plans were enacted. Mr. Burnett was not certain but surmised that the state would "certainly" have large exposure relative to "most places given the size of the state's population." Representative Munoz discussed the state struggling to bring the unfunded retirement costs down in 2014 due to the growth of the unfunded liability in relation to the state's budget. She wondered what would happen to the amount the state owed annually if the POB option was exercised. Mr. Burnett replied that they would address the issue later in the presentation. He read from slide 5: · Fund TRS to 90% - approximately $675 Million · Fund PRS to eliminate state contributions required when actuarially determined rate goes above 22% · of payroll - $1.1 Billion to $1.8 billion · Don't use the 23 years of savings to avoid short term payments · This is how Illinois or New Jersey used POBs · Use savings to reduce the projected increases in future payments · Otherwise we are leaving even more for a future generation to fund · Take advantage of low interest rates. Current taxable interest rates are historically low - over · 1.5% lower than when the POBC Legislation was approved. · The lower the cost of capital the higher the probability of success · The stock market has undergone a correction · Strategies may be implemented on the reinvestment side to dollar cost average or otherwise limit risk of buying into an overvalued market 2:36:47 PM Mr. Mitchell turned to slide 6 titled "How Would Pension Obligation Bonds Authorized in 2008 Work?" The narrative on slide 6 follows: Taxable municipal bonds are issued to refinance all or a portion of the Pension Plans' UAAL · The State borrows at a rate of 6.5% or lower (currently 5%) to "refinance" the existing liability being amortized at an 8% rate · Proceeds of the APOBC bonds are deposited in Pension Funds; funds will be invested according to pension fund policy · The State's periodic UAAL amortization payments (or a portion thereof) are replaced with principal and interest payments to bondholders secured by State appropriations · Just like the other pre-paid benefits, the actual experience of the transaction will be determined when the future investment performance of the pension trusts is realized Mr. Mitchell mentioned a graphic on slide 6 that depicted the narrative. He turned to slide 7 titled "TRS - Current Unfunded Liability Breakdown - Buck Consultants have provided draft 2015 Actuarial Valuation results displaying the projected TRS UAAL payments by contributor at an assumed 8.0 percent actuarial rate." He referred to the chart that portrayed TRS UAAL contributions. He explained that the non-state employer contribution was approximately $22 million in 2016, increased to over $25 million in 2038 and began to decline in 2039. He indicated that the state's TRS contribution was "relatively small" because the state was not a large TRS employer. He pointed to the blue column that depicted the state's contribution on behalf of the system that held the employers harmless at 11.56 percent. The amount grew from $130.1 million in 2016 to over $265 million in 2039, which was the focus of the POBs. Co-Chair Neuman spoke to the 8 percent actuarial rate and asked whether the state had averaged 8 percent for the previous 25 years. Mr. Burnett replied in the affirmative and noted that the average was higher than 8 percent. Vice-Chair Saddler what the employer rate percentage was. Mr. Burnett answered that the rate was 12.56 percent (TRS). Representative Wilson asked whether the only risk was whether the money earned 8 percent. Mr. Mitchell reiterated that if 8 percent was not reached the state would pay more in either scenario. He elaborated that the idea encompassed in POBs was savings. The amount of the TRS fund balance was deficient by $1.4 billion for employees' benefits that had already accrued; i.e., the unfunded liability amortized over 23 years at 8 percent was a much larger figure than at 5 percent. The state would realize savings over 23 years paying at 5 percent instead of 8 percent. 2:41:01 PM Representative Wilson asked whether the risk was realizing returns under 5 percent. Mr. Mitchell answered in the affirmative. Mr. Mitchell moved to slide 8 titled "PERS - Current Unfunded Liability Breakdown - Buck Consultants have provided draft 2015 Actuarial Valuation results displaying the projected TRS UAAL payments by contributor at an assumed 8.0 percent actuarial rate." He explained that the non-state employer contribution was approximately $118.8 million in 2016 and increased to over $272.3 million in 2039. He reported that the state employer rate was over $132 million in 2016 and $302.9 million in 2039. He pointed to the blue column depicting the state's contribution on behalf of the system that held the employers harmless at 22 percent and reported that the state's contribution was $126.5 million in 2016. He noted that the reduced payments beginning in 2017 were partly due to the large deposit in 2014 and complex actuarial calculations. The contributions did eventually grow to $283 million by 2039, which was the reason for the POBs; attempting to flatten the growth in the annual payment. Co-Chair Neuman asked about slide 8 related to the PERS state contribution. Under the current system, the state's contribution would be $99.1 million in 2017 and decreased [through 2025] in the current system. He asked whether the figures in the column were "expected." Mr. Mitchell responded that the information in the presentation was not available when the budget was developed. The information was not typically distributed until after the legislative session. Co-Chair Neuman noted that the legislature was trying to develop its budget. He asked whether the estimates were reliable. Mr. Burnett believed that the numbers were a likely outcome in 2017. Co-Chair Neuman stated that the estimates were "good information for the committee." Representative Pruitt referred to the numbers on slide 8. He thought that the infusion of cash in 2014 would level the state's payments to approximately $500 million per year for the "entirety of the rest of the time" and the results did not "pan out." He noted that the legislature was experiencing "shell shock" and just wanted to figure out a solution. He wondered what would happen if the 8 percent was not realized in a particular year. He asked whether "the state would have to cover what should have been made" or would the state engage in "yet another discussion" about increased costs in retirement because POVs did not perform as intended. 2:47:40 PM Mr. Burnett replied that the actuaries used a "smoothing formula" which captured the results of investments over a period of years. He offered that the results would be variable over the years due to a time lag but would result in a "smoothing of assets." He reminded the committee that the legislature, in relation to the $3 billion infusion into the unfunded retirement liability, directed ARMB to remove the "smoothing out" for one year to allow the cash infusion to "catch up' and "reset rather than averaging the $3 billion over several years." The delay in asset smoothing was reflected in the rapid reduction in payments depicted on the slide. The increased contribution out in the future over time happened for a number of reasons. He explained that the main reason was that actuaries assumed payroll growth. Mr. Mitchell discussed slide 9 titled "TRS - 8.0% Actuarial Rate - Comparison of State Payment - Refunded UAAL vs POB Debt Service" which depicted a chart and graphs illustrating the estimated total state obligation after a POB transaction. He indicated that the plan was to fund the PRS system up to the 90 percent level. He pointed to the column labeled "prior state obligation" and noted that in 2017 the state would pay $116.7 million and a POB issue would refinance $75.9 million of the amount. The remainder of $40.8 million was the unfunded actuarially assumed liability payment. The $48.3 million payment in the middle white column reflected the "hard liability" or POB debt service payment, which remained relatively "static" for the 23 year life of the bond. He referred to the first dark blue column which reflected the total state payment after the transaction that was $89 million and 17.88 percent of the total contribution rate (second dark blue column). Finally, the last white column showed the cash flow difference of $27.6 million. The cash flow diminished in the first year and increased in years 2, 3, and 4. The "backend loading" was very apparent and built to $45 million in 2039, which was intentional resulting in flattening the payment curve. He referred to a small bar graph on the upper right portion of the slide. The rising black line on the top of the bars reflected the current system. The dark blue bars presented the POB option and represented savings or a "diminishment of payment." The department attempted to "push the savings out" over the years to diminish the growth. The POB debt service was reflected in the bottom light blue layer of bars and remained steady. The orange line that rose slightly through the amortized years above the light blue bars reflected the amount of refinanced liability. He shared that another cash payment would "chop off the blue line and diminish" each column bars by $48.3 million which would show the impact of a cash repayment versus borrowing the money. The impact on the total system was depicted in the bottom bar graph and was very similar in the case of TRS. He stated that the benefit accrued to the state due to the 12.56 percent contribution rate. He referred back to the second dark blue column on the chart reflecting the rate and pointed to the low of 17.88 percent in FY 17 that increased to 24.39 percent in 2019. He commented that the state would always provide the shock absorber function as the "deep pocket" whenever a deficiency existed. The state's contribution would diminish if for instance, the returns were greater than 8 percent. 2:55:36 PM Co-Chair Neuman deduced that in 5 or 6 years the state's payments would be higher. Mr. Mitchell responded in the affirmative. Co-Chair Neuman wondered where the chart depicted the estimated difference in money. Mr. Mitchell answered the difference was shown in column F labeled "cash flow difference," which totaled $417.5 million. Co-Chair Neuman was concerned about 2017 through 2021. Mr. Mitchell answered that by design POBs pushed the savings into the future. Co-Chair Neuman remarked on the current budget crisis. He determined that it was not advantageous to pay more in TRS/PERS payments under a system that was 80 percent funded. He wondered whether delaying POBs until the state was on better financial footing was a better strategy. Mr. Mitchell answered that the $27.8 million reduction in 2017 would offset the next three year's underperformance. He communicated that the underperformance years could be eliminated. The goal of refinancing was to get the growth in the annual state contribution as level as possible to benefit the future rather than in the present. Co-Chair Neuman stated that the legislature was concerned about the present day. He surmised that the bond rating agencies would view the debt negatively. Mr. Mitchell responded that the proposed debt restructuring was the most "conservative way of structuring" the type of transaction. The option was not banking on savings to bail the state out. The transaction would be banking on savings to bail the state out in the long-term. Co-Chair Neuman emphasized his concern about the next couple of years and thought the proposal would place "more burden" on the state in the short-term. 2:59:34 PM Representative Munoz asked how the non-state employers contributed to their share of the debt service. Mr. Mitchell replied that the non-state employers would not be paying any of the debt service. He referred to the 12.564 percent contribution rate and explained that the POB obligation would not reach the level of impacting the other employer's contribution rate. The lowest employer contribution rate [in 2017} was 17.88 percent; still more than 5 percent above the employer contribution rate floor. Co-Chair Thompson asked whether the POBs addressed the "on behalf payments" the state made for municipalities. Mr. Mitchell responded that POBs addressed a portion of the on behalf payments and the amount above the 12.56 percent was reflected in column A. He referred to slide 7 that depicted the non-state employer contribution of $26.7 million in 2017 versus the state's $116.7 million on behalf of the employers in TRS and in PERS the numbers corresponded to $132.4 million and $99.1 million in 2017. Co-Chair Neuman asked whether the TRS payments were "outside of the formula." Mr. Burnett answered that the state's contribution "on behalf" was outside the formula. Representative Edgmon referred to the employment patterns and the actuarial analysis. He wondered what employment figure the actuaries were modeling. Mr. Burnett explained that the actuaries were using the actual employment numbers. He noted that if there were a reduction in employees the non-state employer contribution amount would decrease and the amount paid by the state "on behalf" would increase. He expected that the liabilities would be reduced over time but in the short-term less employees would shift costs on to the state's "on behalf" payment. Representative Edgmon asked whether Mr. Burnett could order an analysis based on a reduced number of employees. Mr. Burnett indicated the actuarial analysis could be ordered but it would cost additional money and "was not quick." Co-Chair Neuman asked whether an estimate by the department was possible. Mr. Burnett replied in the affirmative. 3:04:28 PM Representative Gara did not understand why the state was paying so much more in the out years after the cash infusion in 2014. Mr. Burnett replied that the actual direction to ARMB was to use the level percentage of payroll, which caused the increase rather than level dollar amortization. He offered that level dollar amortization produced more money in the current year and fewer in the out years and could be level on an amortization. Co-Chair Neuman asked who made the decision. Mr. Burnett answered that the provision was in statute. Representative Gara opined that the POB option was a difficult concept for the committee because the members thought that the $3 billion cash payment was going to level out the payments over the amortization period. Mr. Burnett responded that the final version of the bill in 2014 did not match earlier presentations on the bill. Representative Gara wondered whether anyone was aware of the change at the time. 3:07:58 PM Representative Munoz clarified that the payment schedule was roughly $250 million for the first 10 to 15 years and increased to $500 million in the final years. She noted that the numbers at the time were very similar to the amounts in the presentation. Representative Gara believed that the payments were much less than $250 million in the first two years and then increasing much higher. Representative Munoz relayed that the combined PERS and TRS figure was approximately $250 million. Co-Chair Neuman asked how a statute change in the other direction would affect payments and if the question was worth examining. Mr. Burnett responded that the action required a significant increase in the contribution in the current years but would level the payments out "significantly more" in the future. Co-Chair Neuman requested the information form DOR. Representative Wilson remembered that the Senate had switched the contribution amounts between PRS and TRS and she had not caught the change before she voted for the bill. 3:10:24 PM Co-Chair Neuman remembered that the Senate had the legislation first. Representative Wilson clarified that the Senate had changed the bill "at the last minute" and returned it to the House. Mr. Mitchell moved to slide 10 titled "TRS -Level Debt Service / Blended Fixed-Variable Rate. - Provided below is a summary of a preliminary TRS pension obligation bond transaction and the potential payment reductions to the State at an actuarial rate of 8.0%." He related that the charts portrayed the summary of structuring scenarios. He requested that the committee clearly indicate "on the record" what structure the committee was proposing. Co- Chair Neuman wanted all of the information on all of the options. Mr. Mitchell continued with the slide. The scenario assumed a total borrowing amount of $675.9 million to reach the targeted 90 percent funding level. The amount of $506.9 million would be in fixed rate bonds and a variable rate bond amount of $168.9 million which represented 25 percent of the total. The deposit totaled $672.5 million in refinancing the UAAL and the true interest cost of roughly 4.4 percent with an "all in" interest cost of 4.5 percent. The average annual payment reduction was $18.1 million. The total [2039] gross cash flow difference of $417.5 million was shown at the bottom left of the chart. The present value would be $223 million. He noted the total percentage difference was reflected at 33 percent and the cash flow differences were shown on the right hand column. Representative Pruitt asked about the thought process behind the variable rate. Mr. Mitchell responded that the states debt policy allowed up to 25 percent of a portfolio in variable rates. Currently, the variable portfolio would have an extraordinarily low interest rate of 1 percent. He indicated that there was a risk which was why a variable rate bond was a smaller component. The states analysis assumed the variable rate would increase every year by .05 percent until it reached 4 percent and became static. He offered that 4 percent would be a historically high variable rate for the state. 3:14:56 PM Co-Chair Thompson asked where the state was with its bonding capacity and whether or not the POBs would affect the state's ability to bond for $11 billion in reference to AKLNG. Mr. Mitchell answered that the state had a debt affordability analysis performed annually. He relayed that the state's capacity was $175 million of General Obligation Bonds (GO) and other state supported debt capacity was $225 million using historical metrics of unrestricted revenue and not more than 5 percent of unrestricted revenue on GO bonds and for all state supported debt no more than 8 percent of unrestricted revenue. He shared that changes in how the state counted unrestricted revenue would result in a change in the methodology for the affordability analysis. The percentages were based on the fact that the primary source of revenue was based on a volatile commodity; therefore, "were lower than they otherwise could be." He stated that the question was difficult to answer. In essence, the state was refinancing an existing debt with POBs but the method should be carefully approached. He cautioned that any debt that was issued in the current environment should be carefully considered. He voiced that the natural gas pipeline potential financing was a "heavy lift" for the state based on current revenue projections. The enormous amount of outstanding debt would negatively impact the state's credit rating. Co-Chair Neuman asked whether every step that the state took to achieve the gas pipeline that provided a secure source of revenue and 20 percent equity in a $60 billion project was a definite advantage to the state. Mr. Mitchell replied that in the long-term it was a benefit, but in the short-term it was a liability. Co-Chair Neuman asked whether the steps taken to reduce the budget and level out the amount of income coming into the state was beneficial. Mr. Mitchell replied in the affirmative. 3:19:16 PM Mr. Mitchell discussed slide 11 titled "PERS -8.0% Actuarial Rate -Partial Refund - Comparison of State Payment -Refunded UAAL vs POB Debt Service." He noted that the information was presented the same as for TRS. He elaborated that the POB debt service was $72.9 million and the state's payments "on behalf of" were eliminated through 2029. He pointed out that the total contribution rate in the dark blue column went from 22 percent in 2017 to 20.56 percent in 2018 resulting in a benefit for the state's budget and the employers' budget. He stated that the department had discussions with Buck Consultants regarding their view that they cannot hold the contribution rate for the employers at 22 percent if the state made a deposit that drove the contribution rate below 22 percent. In 2017, the state benefited by $27.1 million. The cash flow difference numbers were negative from 2018 through 2025. In 2025 through amortization the state benefit totaled over $505 million with a $221 million present value. He shared that he struggled with the issue. He ascertained that if the state could hold the employer contribution rate at 22 percent the "on behalf" contribution could be reduced or "potentially eliminated." He believed the matter required a statutory change. He pointed to a small graph on the upper right of the slide portraying that the majority of the savings was pushed to the out years. The small bottom graph representing the total system was shown in a small graph on the bottom. 3:23:25 PM Mr. Mitchell skipped to slide 13 titled "PERS -Level Debt Service / Blended Fixed-Variable Rate." He pointed to the first column and pointed to the Summary Statistics line totaling $21.986 million representing the average annual payment reduction for the state only that amounted to $28.593 million in total system benefit. He indicated that $6.5 million of the benefit was accruing to the municipalities or other employers in the PERS system each year for the life of the partial refund for the state's contribution. The full refund column on the right was a negative number for the state and the benefit was accruing for the other employers. Representative Gara spoke to potential savings. He understood the TRS charts but did not understand PERS. He wondered how much extra the state would save for the first five years under PERS if the proposal was adopted. He pointed to the slide titled "PERS -8.0% Actuarial Rate - Partial Refund" and deduced that the state was in the negative over the first 5 years. He ascertained that the combined PERS and TRS payments would cost more than the current system and he wondered how the state could afford the increase costs. Mr. Mitchell replied that the payment structure was by design. The department had been given instructions to make the system as level as possible. The structure kept payments more static over time. He restated that if the legislature's direction was to retain short- term savings the system could be restructured to accomplish the outcome. 3:28:49 PM Representative Gara cited that under the TRS system the life of savings amounted to $417 million. He asked about the PERS savings over the amortized years. Mr. Mitchell answered that the savings were $505.7 million. In relation to his previous question, he explained that the percentage of payroll decreased when the funding level increased and was not held static at 22 percent, the state paid more in the long run because the other employers were not contributing as much to the system so the state had to contribute more at the back end. Representative Gara asked whether the $505.7 million in savings scenario was unlikely. Mr. Mitchell replied in the negative. The scenario saved the state that amount. He offered that he was referring to the "on behalf of" payment that was only eliminated through 2029. He pointed to the column labeled total contribution rate (second dark blue column)on slide 11 and noted that the rate dropped below 22 percent and the municipalities paid less than 22 percent from 2018 through 2029. Mr. Burnett added the state as an employer also paid less than 22 percent but it was not a benefit to the state in the long run because the state's employer contribution were being paid through fund sources other than GF in some instances. Co-Chair Neuman asked about the combined TRS/PERS additional cost to the state if the plan was implemented. Mr. Mitchell replied that it would not cost the state any additional funds. He furthered that the committee could direct DOR to structure the payments in a way that did not increase costs. Co-Chair Neuman asked whether the projections were factored into Governor Walker's current budget. Mr. Mitchell answered in the negative because the actuarial analysis was not available at the time the budget was introduced. Co-Chair Thompson discussed the schedule for the following week. ADJOURNMENT 3:33:03 PM The meeting was adjourned at 3:32 p.m.
Document Name | Date/Time | Subjects |
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DOR Pension Obligation Bonds 2-12-15 HFIN.pdf |
HFIN 2/12/2016 1:30:00 PM |
|
LFD Info Paper Pension Obligation Bonds HFIN.pdf |
HFIN 2/12/2016 1:30:00 PM |