Legislature(2003 - 2004)
04/06/2004 09:04 AM Senate FIN
| Audio | Topic |
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
MINUTES
JOINT MEETING
SENATE FINANCE COMMITTEE
SENATE STATE AFFAIRS COMMITTEE
April 06, 2004
9:04 AM
TAPES
SFC-04 # 71, Side A
SFC 04 # 71, Side B
SFC 04 # 72, Side A
CALL TO ORDER
Co-Chair Gary Wilken convened the meeting at approximately 9:04 AM.
PRESENT
Finance Committee Members
Senator Lyda Green, Co-Chair
Senator Gary Wilken, Co-Chair
Senator Con Bunde, Vice Chair
Senator Ben Stevens
Senator Lyman Hoffman
Senator Donny Olson
Senator Fred Dyson
State Affairs Committee Members
Senator Gary Stevens, Chair
Senator John Cowdery
Senator Bert Stedman
Senator Lyman Hoffman
Also Attending: MELANIE MILHORN, Director, Division of Retirement
and Benefits, Department of Administration; BOB REYNOLDS, Mercer
Human Consulting; GEORGE SULLIVAN, Chair, PERS Board; ANSLEM
STAACK, Chief Financial Officer, Division of Retirement and
Benefits, Department of Administration;
Attending via Teleconference: There were no teleconference
participants.
SUMMARY INFORMATION
Actuarial Valuation Report
By Bob Reynolds, Mercer Human Consulting
Co-Chair Wilken introduced former Anchorage Mayor and current Chair
of the Public Employees Retirement (PERS) Board, George Sullivan
MELANIE MILHORN, Director, Division of Retirement and Benefits,
Department of Administration, noted that Mercer Human Consulting
has been advising the Division for approximately 12 years and she
introduced Bob Reynolds.
BOB REYNOLDS, Mercer Human Consulting, testified that each year an
actuarial of systems is undertaken, which is an evaluation of the
Public Employees Retirement System (PERS) and the Teachers
Retirement System (TRS) to determine the amounts necessary to fund
the programs. He noted the consulting firm analyzes the liability
of the systems, but is not involved in investment of the funds, nor
gives advice on the investment of those funds. He stated the Alaska
State Pension Investment Board undertakes the investment
activities.
Mr. Reynolds informed that the actuarial valuation was presented to
the PERS/TRS board with information current as of June 30, 2003. He
referenced a handout prepared by Mercer Human Resource Consulting
for the March 24, 2004 PERS and TRS Board meeting, titled, "State
of Alaska, Public Employees' Retirement System and Teachers'
Retirement System Actuarial Valuations as of June 30, 2003" [copy
on file.]
Page 2
[Flow chart showing that Provisions, Data and Assets, as of
June 30, 2003, and Assumptions and Methods revised in January
2003 are input into the Actuarial Valuation, which produces
Contribution Rate and Funding Ratio.]
Mr. Reynolds defined the data and assets as the "hard data", to
which the assumptions and methods are applied. He qualified that
many unknown factors are involved, including investment returns,
mortality rates, pay raises, etc., and that the consulting firm
makes estimates based on the information available. He expressed
the intent that the program contains adequate funds for each
member's benefits during that member's working lifetime.
Mr. Reynolds stated that the funding ratio is a measure of the
assets compared to the liabilities of the system. The intent is
that the funding ration is 100 percent, i.e. the exact amount of
assets in the system necessary to pay the benefits the membership
has earned. The funding ratio is used to calculate the actuarial
contribution rate.
Mr. Reynolds defined the actuarial contribution rate as the rate
necessary to pay into the system to arrive at a funding ration of
100 percent after a 25-year period. He listed two components of the
contribution rate, one being the rate intended to pay the benefits
that members are currently earning. This is referred to as the
normal cost rate. The second component is the past service cost,
which is related to the funding ratio. If at any time the program
is not 100 percent funded, the unfunded liability is amortized with
the intent to pay off in 25 years, similar to a mortgage.
Mr. Reynolds summarized the cost of benefits currently earned and
catch up rate, which is the amortization of the unfunded liability.
Page 3
PERS Key Results
Average Contribution Rate:
FY 05 24.91%
FY 06 25.63%
Board Adopted Rate:
FY 05 11.77%
FY 06 TBD
Funding Ratio:
Non-Medical Benefits
June 30, 2002 120.9%
June 30, 2003 121.4%
Total Benefits
June 30, 2002 75.2%
June 30, 2003 72.8%
Mr. Reynolds stated that at June 30 2002, assets were approximately
three-quarters of the liability of the system. The PERS and TRS
systems provide both retirement and medical benefits, although many
state systems do not pre-fund for medical benefits; Alaska's system
is one of only eight that do, while approximately 100 systems do
not. Alaska's systems are pre-funded actuarially.
Senator Dyson asked the definition of average contribution rate.
Mr. Reynolds answered this is the percentage of payroll of the
system membership for 25 years.
Senator Dyson clarified this is 25 percent of each employee's
paycheck.
Mr. Reynolds affirmed this is necessary to fund the system at 100
percent.
Senator Dyson asked if this amount is paid entirely by the employee
or whether the employer contributes a portion.
Mr. Reynolds responded this pertains to the employer contribution,
as the employee contribution is already taken into account.
Senator Bunde clarified that the Board had adopted an 11.77 percent
increase to the employer contribution, although actuaries
recommended 24.91 percent.
GEORGE SULLIVAN, Chair, PERS Board, replied that the PERS Board is
only authorized to adopt a five percent increase each year. The TRS
Board has no limitation in the amount of authorized increases.
Mr. Reynolds furthered that the Board increased the contribution a
full five percent, although the amount remains below the actuarial
rate.
Co-Chair Green clarified that the five percent limitation is
specified in regulation not in statute. She asked the reason of the
limitation.
Ms. Milhorn affirmed the five percent restriction is contained in
regulation. She was unsure the reason for the limitation, which
only applies to PERS contributions. The Board adopts regulations
for both the PERS and TRS systems.
Mr. Sullivan was new to the Board and requested the Board discuss
this matter at its meeting later in the week.
Co-Chair Green wanted clarification that the limitation is a
regulatory requirement.
Senator Bunde noted the limitation does not apply to TRS members
and that TRS contributions could be increased to any amount.
Page 4
TRS - Key Results
Total Contribution Rate:
FY 05 35.57%
FY 06 38.85%
Board Adopted Rate:
FY 05 16%
FY 06 TBD
Funding Ratio:
Non-Medical Benefits:
June 30, 2002 93.2%
June 30, 2003 89.5%
Total Benefits:
June 30, 2002 68.2%
June 30, 2003 64.3%
Mr. Reynolds outlined this page.
Mr. Reynolds noted the Board considers this information plus other
factors to determine the actual rate.
Page 5
Funding Ratio History
[Bar Graph showing the percentages for PERS and TRS for the
years 1979 through 2003.]
Mr. Reynolds indicated this graph provides a comparison of the two
systems. In many years, the funding has been below 100 percent. The
last two years has had a significant decline for two primary
reasons. One is a market correction as the result of "soft" market
performance for two years that has decreased the value of
investments. Also, the cost of medical care is in significant
excess of the anticipated costs.
Senator Bunde understood the intent that years in which the system
was funded more than 100 percent would "average out" the years in
which funding was less than 100 percent. However, the system has
been fully funded only eight of the previous 25 years.
Page 11
Monthly Blended Premium per Retiree for Health Coverage
[Graph showing comparison of the actual premium amount to the
assumed premium for the years 1995 through 2004.]
Mr. Reynolds explained this graph shows the history of the costs of
medical care provided by the system since 1995. The methodology of
actuarially attempts to mitigate a portion of the volatility. He
noted the amount of volatility of the annual cost of medical care
over time. It has been difficult to therefore calculate liability.
Mr. Reynolds pointed out that during the middle 1990s, the costs of
medical care appeared to be "under control". However, the trend
appeared to reverse itself with an escalating cost of medical care.
In the years 2001 and 2002 actuaries have "fallen behind" in
predicting accurate liability. After three years, it has been
determined this is more than simple routine volatility, and the
consultants and the Board decided to adjust to the abnormal
increases. This is one factor contributing to the funding ratio.
Page 14
Health Cost Trend Assumption
[Bar Graph showing the percentage of the rates, as revised in
2003, would vary in the years FY 03 through FY 18.]
Mr. Reynolds explained this graph shows the current expectation of
costs into the future. Its expected that medical costs would
increase in "double digits" over the next several years, at
approximately 12 percent per year for FY 04 and FY 05, then
gradually decline over time at about one-half percent per year.
Inflation is calculated to be 3.5 percent, which is higher than the
current inflation rate. It is anticipated that medical care costs
would "settle into" a rate higher than inflation, which has been
the trend.
Page 26
Market Return versus Actuarial Return on Assets
[Graph listing the percentages of: Market Return, Actuarial
Return PERS, and Actuarial Return TRS, for the fiscal years
ending 1995 through 2003.]
Mr. Reynolds pointed out that investment performance in the middle
and late 1990s was very good, then poor in the years 2002 and 2003.
One assumption was that investments would earn 8.25 percent per
year. However, the earnings were negative eight percent for the
past three years. This translated to a 33 percent loss to the cost
to the system.
Page 23
PERS Reconciliation of Average Contribution Rate for Fiscal
Year 2006
[Bar graph listing the following:
Contribution rate FY 05 24.91%
Elimination of 102% 0.90%
Resetting assumed medical
Premium 0.00%
Health cost trend 0.00%
System benefit changes
(including PRPA) 0.00%
Salary increases -0.19%
Contribution shortfall 1.10%
Demographic experience 0.40%
Investment experience 0.31%
Contribution rate FY 06 25.63%]
Mr. Reynolds informed this exercise is undertaken each year.
Mr. Reynolds noted the contribution shortfall of 1.1 percent of the
24.91 percent originally calculated as the amount necessary to
contribute to the system. Shortfalls result in future liabilities
Page 24
[Bar graph indicating the following:
Contribution rate FY 05 35.57%
Resetting assumed medical
Premium 0.00%
Health cost trend 0.00%
System benefit changes
(including PRPA) 0.00%
Salary increases 0.10%
Contribution shortfall 1.40%
Demographic experience 1.35%
Investment experience 0.43%
Contribution rate FY 06 38.85%]
Mr. Reynolds overviewed this graph.
Senator Bunde noted that shortfalls are amortized over 25 years. He
asked if the significant shortfalls of the last two years would
remain apparent over 25 years.
Mr. Reynolds replied that the information presented so far, is an
evaluation of the situation as of June 30, 2003, and that he would
begin to address the projection of the system in the future.
Page 28
Projections at Calculated Rate - Key Assumptions
· Three active populations scenarios:
Π0% growth
Π1% growth
Π2% growth
· New entrants brought in to replace members assumed to
die, terminate, retire, or become disabled
· New entrant profiles based on average new entrant
profiles from the prior 3 years
· Future liabilities and asset returns are calculated at
8.25%, except
o 17% investment return for FY 04
· Actuarially calculated contribution rate is adopted
each year, beginning in FY 06, but rate cannot
increase by more than 5% per year for PERS.
Mr. Reynolds defined growth as membership.
Mr. Reynolds noted the 17 percent investment return for FY 04
reflects the actual rate of return and have exceeded assumptions.
Senator Hoffman asked if the 8.25 percent return on assets
calculation is realistic over the long term.
Mr. Reynolds answered yes based on analysis of capital market
returns and the asset allocation. He told of an investment-
consulting group that assisted in making this calculation. The
State Pension Investment Board undertakes a similar calculation of
expected returns, although those calculations utilize a shorter
timeframe of five years. The projections presented at this hearing
extend 30 to 40 years into the future to determine an average over
a long period of time.
Page 33
PERS Projections at Calculated Rate - Observations
· Calculated rates increase under all population scenarios
· Calculated rates begin to decline towards end of the
projection period under the 1% and 2% scenarios
· Over the past 9 years, the average annual population
increase for the PERS has been 1.1%
· Calculated rates increase to above 30% under the 1%
population increase scenario
· Factors contributing to the projected rate increases are:
o Contributions are less than the actuarially
calculated rate for the first 5 years of the
projection
o New entrants enter the System at lower pay levels
than the exiting members they are replacing,
generating losses and diluting the pay-off of
unfunded liabilities
· Funding ratios are at least 96% by the end of the 25-year
period, under all 3 population scenarios
Mr. Reynolds qualified that the calculated 1.1 percent growth is an
estimate and the actual rate is unknown.
Mr. Reynolds explained that contributions into the system for new
employees hired at a lower pay are less than the contributions for
current employees because contributions are calculated as a
percentage of payroll. Contributions therefore decline over time.
Senator Bunde commented that proposals for early retirement are
marketed as positive actions because payroll would be lower;
however, the retirement benefit costs are not reduced because a
certain level of contributions must be maintained.
Mr. Reynolds agreed.
Page 34
TRS Projections at Calculated Rate - Observations
· Calculated rates increase under all population scenarios
· Calculated rates begin to decline towards the end of the
projection period under the 1% and 2% scenarios
· Calculated rates increase to 42% even under the 2%
population increase scenario
· Factors contribution to the projected rate increases are:
o Contributions are less than the actuarially
calculated rated for the first 2 years of the
projection
o After the first 2 years, there is still a 2-year
lag before calculated rates actually enter the
System
o New entrants enter the System at lower pay levels
than the exiting members they are replacing,
generating losses and diluting the pay-off of
unfunded liabilities
· Funding ratios are at least 96% by the end of the 25-year
period, under all 3 population scenarios
Mr. Reynolds pointed out that the TRS calculated increase is higher
than that for PERS. He stated that the TRS Board does not have same
constraint in increasing the contribution percentage.
Senator Dyson questioned the 1.1 percent growth rate cited on page
33, noting the State population is only projected to increase one-
percent.
Mr. Reynolds clarified the 1.1 percent figure is rounded from the
1.06 estimate projected for the State.
SFC 04 # 71, Side B 09:51 AM
Mr. Reynolds added that the growth rate for TRS was approximately
0.6 percent, which is actually lower than the PERS growth rate over
the last nine years.
Mr. Reynolds continued that the factors that contributed to rate
increases for TRS is similar to the factors influencing the PERS
rate increases. The funding ratios for the two systems would both
be approximately 96 percent at the end of the 25-year projection
period.
Senator Bunde asked why the funding ratio over the next 25 years
would not reach 100 percent.
Mr. Reynolds replied that contributions into the system are less
because new employees entering the system are earning lower pay
levels than those employees leaving the system.
Mr. Sullivan furthered that retired TRS teachers returning to work
under contract are not paying into the TRS system.
Mr. Reynolds specified this is an influence on what has happened in
the past, and is not included in the calculations.
Page 35
PERS Projections at Calculated Rates
Contribution Rates
[Bar graph projecting the Contribution Rate percentage for the
fiscal years 2004 through 2028 for Population Increase 2%,
Population Increase 1%, and Population Increase 0%.]
Page 36
TRS Projections at Calculated Rate
Contribution Rates
[Bar graph projecting the Contribution Rate percentage for the
fiscal years 2004 through 2028 for Population Increase 2%,
Population Increase 1%, and Population Increase 0%.]
Mr. Reynolds stated these graphs demonstrate the previous point in
detail.
Page 37
PERS Projections at Calculated Rate
Funding Ratios
[Bar graph projecting the Funding Ratio percentage on June 30
of the years 2003 through 2028 for Population Increase 0%,
Population Increase 1%, and Population Increase 2%.]
Page 38
TRS Projections at Calculated Rate
Funding Ratios
[Bar graph projecting the Funding Ratio percentage on June 30
of the years 2003 through 2028 for Population Increase 0%,
Population Increase 1%, and Population Increase 2%.]
Mr. Reynolds pointed out these graphs indicate the funding ratios
would increase to almost 100 percent at end of the projection
period.
Mr. Reynolds stressed the "most powerful influence" on these
assumptions is the assumption that the boards are adopting the
calculated rate, to the best of their ability, to the maximum
amount possible. He explained that this assumption assumes that
the actuarial calculated rates are the rates that the boards would
be adopting. According to this assumption, the funding ratio
reaches almost 100 percent at the end of the 25-year period.
However, the rates currently entering the system are not the
actuarial calculated rates.
Page 39
Projections at Current Rate - Key Assumptions
· Three active population scenarios:
Π0% growth
Π1% growth
Π2% growth
· New entrants brought in to replace members assumed to
die, terminate, retire, or become disabled
· New entrant profiles based on average new entrant
profiles from the prior 3 years
· Future liabilities and asset returns are calculated at
8.25%, except:
Π17% investment return for FY 04
· Adopted contribution rate is maintained at the FY 05
level for all future years
Mr. Reynolds explained the results if current contribution rates
were maintained and not increased.
Page 40
Projections at Current Rate - Observations
PERS Observations
· System funding deteriorates under all three population
scenarios
· Actuarially calculated rates escalate under all
population scenarios
· Assuming 1% population growth, actuarially calculated
rates increase to more than 75%, while funding ratio
decreases to 20% by the end of the projection period.
TRS Observations
· System funding deteriorates under all three population
scenarios
· Actuarially calculated rates escalate to 90% or more,
depending upon the population scenario
· Assuming 1% population growth, actuarially calculated
rates increase to more than 100%, while the funding ratio
decreases to 0% by the end of the projection period.
Mr. Reynolds outlined this page.
Senator Bunde asked if the contribution rate were 100 percent,
contributions to the retirement system would be equal to the amount
of the employee's salary.
Co-Chair Wilken clarified this would occur if the current
contribution rate were maintained.
Mr. Reynolds compared this to credit card debt, explaining that if
monthly payments were less than the interest rate, the debt would
increase over time.
Page 41
PERS Projections at Current Rate
Contribution Rates
[Bar graph estimating the Contribution Rate percentages for
the fiscal years ending 2004 through 2028 for Population
Increase 2%, Population Increase 1%, and Population Increase
0%.]
Mr. Reynolds noted this graph assumes that the contribution rate
increases for FY 05 then remains the same for 25 years.
Page 4
TRS Projections at Current Rate
Contribution Rates
[Bar graph estimating the Contribution Rate percentages for
the fiscal years ending 2004 through 2028 for Population
Increase 2%, Population Increase 1%, and Population Increase
0%.]
Mr. Reynolds pointed out the situation is the same for the TRS
system.
Page 43
PERS Projections at Current Rate
Funding Ratios
[Bar graph estimating the Funding Ratio percentages for the
fiscal years ending 2004 through 2028 for Population Increase
0%, Population Increase 1%, and Population Increase 2%.]
Page 44
TRS Projections at Current Rate
Funding Ratios
[Bar graph estimating the Funding Ratio percentages for the
fiscal years ending 2004 through 2028 for Population Increase
0%, Population Increase 1%, and Population Increase 2%.]
Mr. Reynolds noted that the decline occurs much sooner, and with no
funds to pay benefits monies must be appropriated from general
revenues.
Page 45
Projections Under Different Economic Scenarios - Key
Assumptions
· All assumptions and methods are the same as Section
1.5(a) except:
ΠResults are shown only under the 1% population
growth scenario
ΠThe actuarially calculated contribution rate is
adopted in each year, beginning in FY 06
ΠInvestment returns are assumed as follows:
[Table indicating the Total Portfolio Investment
Return Under Each Scenario of each of the fiscal
years 2004 through 2010 and beyond, showing the
Base Case, Growth, and Prolonged Recession
percentages.]
Mr. Reynolds outlined this page.
Mr. Reynolds noted this demonstrates prolonged unfunded liability,
"a.k.a. double-dipped".
Page 46
PERS Economic Scenarios - Projected Contribution Rates
Annual Population Increase 1%
[Line Graph showing the Contribution Rate percentages of the
fiscal years 1004 through 2028 for Prolonged Recession, Base
Case, and Growth.]
Page 47
TRS Economic Scenarios - Projected Contribution Rates
Annual Population Increase 1%
[Line graph showing the projected Contribution Rate
percentages of the fiscal years 1004 through 2028 for
Prolonged Recession, Base Case, and Growth.]
Mr. Reynolds explained these results for calculated rates.
Page 48
PERS Economic Scenarios - Projected Funding Ratios
Annual Population Increase 1%
[Line graph showing the projected Funding Ratio percentages of
the fiscal years 2003 through 2028 for Prolonged Recession,
Base Case and Growth.]
Page 49
TRS Economic Scenarios - Projected Funding Ratios
Annual Population Increase 1%
[Line graph showing the projected Funding Ratio percentages of
the fiscal years 2003 through 2028 for Prolonged Recession,
Base Case and Growth.]
Mr. Reynolds noted this indicates the results for funding ratios.
Mr. Reynolds informed that a prolonged recession would result in
contribution rates significantly higher than current calculations.
This is an optimistic scenario, but would realize modest benefits.
Mr. Reynolds stated the results for the TRS System are similar in
that the projections assume calculated rates enter the System and
the Boards adopt the full rate increase.
Mr. Sullivan commented that at the request of employers, the five-
percent annual increase limit was adopted to prevent large
increases in any one year.
Senator Bunde noted that in FY 05 the legislature would appropriate
$41 million to the education foundation funding formula to address
the TRS deficit. He asked if a similar deficit should be expected
for the next 25 years.
Mr. Reynolds clarified the $40 million is necessary to account for
the rate increase from 12 to 16 percent. The 16 percent rate is
still 22 percent less than the 38 percent necessary to fully fund
the system. Five times the $40 million amount is required to
eliminate the unfunded liability.
Co-Chair Green stressed the importance that the five percent limit
is not statutory, but rather a regulation the Board adopted for
itself.
Co-Chair Wilken reiterated this was done at the request of
municipalities.
Ms. Milhorn explained the process in which the Board made the
determination of the five percent annual limit. She indicated the
matter would be brought back before the Board for reconsideration.
Co-Chair Green recommended this be done.
Senator Stedman identified two issues: "Where we are today and how
to get out of it", and policy failure. He recommended the 3.5
percent inflation rate must be modified to determine a positive
affect on the under-funding. He furthered that the Board made
several policy decision, most of which escalated the under funding
status. One of those decisions relates to the market loss and
adjustments to account for that loss. He requested future
explanation of these policy decisions. He indicated less concern
with policy decisions relating to liability, as the actuaries could
only provide estimates. The policies relating to management of
assets should be examined. The risk levels of the State and
municipalities may not be accurately reflected in the actions of
the Board. He intended to review the Board's interactions with
consultant actuaries. The comparisons with other states are not
accurate because most other states do no pre-fund medical benefits.
He supported pre-funding medical benefits. The issue of the asset
strategy recommended by the consultant, and that implemented by the
Board, as well as the levels of risk within those different
strategies is a concern.
Mr. Reynolds stressed that inflation is only one aspect affecting
actuarial assumptions; other factors include investment returns,
salary increases and medical cost increases. If inflation were less
than 3.5 percent, other assumptions would also be reduced by one
percent. Salaries less than expected and lower medical expenses
would benefit the systems, but poor investment returns would
increase the liability of the systems.
Senator Stedman argued that inflation has historically been 3.1
percent and he predicted that over the next 30 to 40 years,
inflation would average three to 3.1 percent. He noted the cost of
health care should be calculated separately.
Mr. Reynolds replied that this is considered in the assumptions.
Senator Stedman commented that if inflation averages 3.5 percent in
the future, the liability of the systems would be greater than
anticipated and the problem would be more serious than currently
estimated.
Mr. Reynolds responded that 3.5 percent was intended to be the best
estimate at the time of the latest actuarial assumption. The
consulting group formally reviews the assumptions every five years
and results are audited by an independent actuarial firm. When last
preformed and "layered", the expectations arrived at a rate of
return on investments of approximately 8.6 percent. It is common to
factor in conservatives, which was done in this instance and the
resulting rate of return prediction was 8.25 percent. The amounts
are factored conservatively, partly in the event inflation is lower
than anticipated.
Senator Stedman asked the percentage of error.
Mr. Reynolds did not have the information immediately available,
although the data does exist.
Senator B. Stevens asked how long Mercer Human Consulting has been
the State's advisor.
Mr. Reynolds answered 12 years.
Senator B. Stevens asked how the contribution is based.
Mr. Reynolds replied the fiscal year contribution is based on
calculations of the two previous years.
Senator B. Stevens wanted justification of why the Board chose
reductions from 12.8 percent to six percent. He asked if this was
because the projections indicated the system would be fully funded
into the future. He asked why the calculations would decrease.
Mr. Reynolds explained how projections appear at each point in
time. Projections start with the amount available. The contribution
rate is two parts: the amount required to meet the current need and
the amount necessary to pay debt. At that time the debt was very
low. The risk factor is borne by the employer and includes
investment of assets. The largest contributor to the system is the
financial market, which is volatile. This is the starting point for
determining necessary contribution rates.
Senator B. Stevens cited information provided by the Department
indicates a projected reduction. He asked if that reduction was
approved at a meeting after the original rate had been approved.
ANSLEM STAACK, Chief Financial Officer, Division of Retirement and
Benefits, Department of Administration, testified that the Board
has always followed the recommendations of the actuary in setting
rates. The Board has never taken independent actions in this,
except in 1997 when adjustments were made to offset the first drop
of four percent; however the recommendation was made two years
prior.
Senator B. Stevens remarked on the matter that if emergency action
could be taken to reduce the contribution rate, is there ability to
take immediate action to increase the rate.
Mr. Staak assumed this could be done if regulation did not prevent
such increases.
Senator B. Stevens asked if any pending legislation was before the
legislature that would enhance the State's ability to manage
pensions.
Mr. Reynolds responded that this situation is not unique and is due
to national and international factors, investment returns and cost
of medical care. The funding status of all systems has declined
dramatically over the last few years. Several other public employee
retirement systems are attempting to address the unfunded
liabilities. In some states, like Alaska, the invest risk resides
with employers. Other programs are defined as a contribution
program, commonly known as a 401k in the private sector, where the
employee assumes the risks. Some states have adopted an employee
risk method or a hybrid of both.
SFC 04 # 72, Side A 10:39 AM
Mr. Reynolds continued that some states allow the employee to make
a selection between programs. These are policy issues. Many systems
are experiencing these risk challenges for the first time as a
result of poor investment market returns of the last couple of
years. During the 1990s risk was actually a "reward" because
investment returns were so high.
Senator B. Stevens repeated his question regarding any pending
legislation to address this matter.
Mr. Sullivan replied that HB 329 and HB 321, would significantly
impact the retirements systems.
Mr. Reynolds clarified this legislation would enhance benefits for
certain members of the system. The consulting group has commented
on these bills and the boards have appointed committees to explore
the issue and make recommendations.
Ms. Milhorn detailed memberships of the boards and the active
pursuit of this matter to obtain information, perform analysis and
make recommendations for a tier "redesign". This would include
recruitment and retention issues as well.
Co-Chair Wilken asked when this report would be complete.
Ms. Milhorn replied the report is due to be submitted to the
legislature in February 2005.
Senator B. Stevens asked for clarification that the pending
legislation would have a three-percent impact across the entire
payroll or just the payrolls that involve those individuals.
Mr. Staak explained that the provisions of HB 91 would change
benefits to police and fire employees. It would incur an additional
cost per year of approximately $5 million per year to be paid over
time. HB 329 relates to early retirement incentives and would cost
an estimated $5 billion if every employee who qualified for the
early retirement chose to retire.
Co-Chair Wilken interjected these bills would have negative impacts
to the PERS and TRS systems.
Senator B. Stevens furthered the legislation would affect a certain
employee base, but would impact all members of the system.
Mr. Reynolds affirmed that a segment of the members would be
affected.
Senator Dyson appreciated that the Murkowski Administration is
making an effort to define clear missions and goals. He assumed
that the mission of the benefits and retirements system is to be
viable and not encounter these issues in the future. When the
matter was brought before the Senate Finance budget subcommittee,
the subcommittee was told, "we only manage the fund and others do
[the] actuarial [assessments]" He suggested the functions should be
combined.
Senator Dyson also wanted discussion of options to implement at
times the system is under-funded, including which portion of the
risk or burden is incurred by the employees' direct contribution.
He wanted to know the benefits and limitations of this.
Ms. Milhorn assured that the Division is dedicated to finding ways
to ensure the solvency of the System. The TRS committee is
investigating employee contributions.
AT EASE 10:49 AM / 10:49 AM
Senator Bunde requested the actuarial information relating to HB
91. He then expressed concern about information released by the
Department of Labor and Workforce Development indicating that the
majority of the current population is of a "working age", but that
in about ten years, the working age segment would decrease by as
much as 50 percent. This would impact the PERS/TRS system. He asked
if this has been factored into the consultant's assessments. He
also asked if the variables could be altered and employment
increased.
Mr. Reynolds replied that the Group has periodically studied the
retirement patterns of the system membership. A large number of
employees in the PERS/TRS system would likely retire in ten to 15
years. Replacement employees would hired be at lower pay levels.
This has been factored into the assessments.
Senator Bunde surmised that fewer PERS and TRS employees would
increase the "burden" on taxpayers, and that a smaller percentage
of the population would be taxpayers carrying that burden.
Senator Stedman remarked, "Portfolios refer to strategy". An active
management strategy is not the only option available. This is a
policy issue with the Board setting the policy for those carrying
the liability. He asked the level of interaction between the
consultant and the Board, as he ascertained the two entities
assessed different funding levels and risk levels.
Mr. Reynolds responded that expectation of higher earnings through
an equity portfolio over longer term has a tradeoff of greater
volatility. The alternative is a more conservative investment
policy in bonds, which has less volatility, but incurs a higher
long-term cost, because of the lower returns.
Mr. Reynolds agreed the concern regarding the "mismatch of assets
and liabilities" is common within the private sector, because of
the requirement that corporations values their liability at current
income investment rates. As a result, the liabilities have been
driven upward dramatically by decreases in the rates available
while the value of the assets backing those liabilities have been
reduced because those assets are invested in the stock market. This
is a worldwide issue. Some European companies are currently
invested exclusively in bonds to ensure that assets match
liabilities; this has not been done in the United States because
the accounting rules are different.
Mr. Staak furthered that the PERS and TRS boards meet on a regular
basis with the Alaska State Pension Investment Board (ASPIB), and
are aware of the information input to the actuarial valuation.
Regarding the structuring of some investments, he noted that over
the past ten years, both boards have not done as well as a single
investment category of the State Supplemental Benefits (SBS) plan.
The SBS plan has outperformed both the Alaska Permanent Fund and
the ASPIB. This is not a fair comparison because each of the
entities has a different "stream" of assets and liabilities it is
trying to match. Matching the assets and liabilities of a pension
plan is difficult, because of the regular "stream of expenditures"
for pensions and health care costs, and given the smaller fund
amount. A pension plan always is expected to earn over 8.25
percent. A single negative year has a dramatic affect because of
the additional loss of the expected earnings as well as the actual
loss. For example a year with a loss of five percent results in an
actual loss of 13 percent because of the anticipated 8 percent
earnings that were not realized but accounted for.
Senator Stedman agreed with the comments on the difficulty of
matching assets and liabilities 100 percent given the ongoing
expenditures. However, he wanted to know why policy decisions did
not control the risk.
Senator Stedman questioned the policy call of lowering the funding
from 12 percent to less than seven percent. He understood the
political pressures and the municipalities' and the State's efforts
to reduce expenses from the general funds. However, most employees
understand the necessity to save at least ten percent of their
salary for retirement. The reduction therefore appeared to be
contrary to general retirement savings plans. This is without
considering actuarial assumptions.
Mr. Reynolds responded that the calculated contribution rates are
based on payment of benefits that the active members are earning,
and payment on the unfunded liability. The payment required for
payment of benefits for each of the systems is approximately 13 to
14 percent for the employer portion. Including the employee
contribution, the rate is approximately 22 percent of each member's
annual salary.
Co-Chair Green pointed out that many of the decisions were made
through regulations. In the event that other changes are deemed
necessary, the boards or the Department must request statutory
changes. No such statutory changes have been recommended to the
legislation. She asked how this situation could be remedied.
Mr. Reynolds listed one option is to deposit the calculated rate
into the systems for the next 25 years. If 39 percent of pay is
contributed to the TRS system for the next 25 years, the
contributions could revert to the payment for the active
memberships' benefits, which would be approximately 14 percent.
This ignores any future volatility within the system, which is
projected to be neutral over time. A second option, which ignores
any potential constraints, is to contribute $5 billion to both
funds immediately. This is the amount the two systems are currently
underfunded. The contribution rates could then be decreased to 12
percent. Another option would be a reduction in the benefits
provided to members. However, courts have ruled that benefits are
contractual and therefore could only be reduced for future
employees. Any benefits from this option would not be realized
until the future.
Page 26
Market Return versus Actuarial Return on Assets
[Line chart showing the percentages of Market Return,
Actuarial Return PERS, and Actuarial Return TRS for the fiscal
years 1995 through 2003.]
Co-Chair Wilken understood that the impact of two to three years of
low performance has resulted in this situation.
Mr. Staak affirmed the implications have been cumulative, because
instead of realizing earnings during those years, earnings went
down. Although earnings increased somewhat, only one-third of the
loss has been recovered. The difference must be made up.
Mr. Reynolds gave an example of a beginning balance of $10 billion
three years prior with an expected annual earning of 8.25 percent.
The projected rate of return after three years would increase the
fund to $12.5 billion. If instead, the fund lost eight percent, the
balance of the fund would be $9.2 billion and the fund would be
underfunded $3.3 billion.
Co-Chair Wilken asked why the System is in the current situation
given that earnings were higher than expected for 1995 though 1999.
Mr. Reynolds replied that the PERS system was funded more than 100
percent, but not much more. Some savings were passed on to
employers during that time and also enhancements were made to the
program since that time.
Page 46
PERS Economic Scenarios - Projected Contribution Rates
Annual Population Increase 1%
[Line Graph showing the Contribution Rate percentages of the
fiscal years 1004 through 2028 for Prolonged Recession, Base
Case, and Growth.]
Page 47
TRS Economic Scenarios - Projected Contribution Rates
Annual Population Increase 1%
[Line graph showing the projected Contribution Rate
percentages of the fiscal years 1004 through 2028 for
Prolonged Recession, Base Case, and Growth.]
Co-Chair Wilken asked if rates must increase from approximately
eight percent for PERS and 11 percent for TRS to 30 and 40 percent
for the next 25 years.
Mr. Reynolds affirmed.
Co-Chair Wilken requested a compilation of the savings returned to
employers. And an accounting of the amount the State would be
expected to fund each year.
ADJOURNMENT
Co-Chair Gary Wilken adjourned the meeting at 11:17 AM
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