HOUSE FINANCE COMMITTEE January 22, 2004 2:26 PM TAPE HFC 04 - 11, Side A CALL TO ORDER Co-Chair Williams called the House Finance Committee meeting to order at 2:26 P.M. MEMBERS PRESENT Representative John Harris, Co-Chair Representative Bill Williams, Co-Chair Representative Kevin Meyer, Vice-Chair Representative Mike Chenault Representative Eric Croft Representative Hugh Fate Representative Richard Foster Representative Mike Hawker Representative Reggie Joule Representative Carl Moses Representative Bill Stoltze MEMBERS ABSENT None ALSO PRESENT Melanie Millhorn, Director, Division of Retirement and Benefits, Department of Administration; Anselm Staack, Chief Financial Officer, Department of Administration; Ray Matiashowski, Deputy Commissioner, Department of Administration. PRESENT VIA TELECONFERENCE Robert Reynolds, Actuarial Consultant, Mercer GENERAL SUBJECT(S): The following overview was taken in log note format. Tapes and handouts will be on file with the House Finance Committee through the 23rd Legislative Session, contact 465- 2156. After the 23rd Legislative Session they will be available through the Legislative Library at 465-3808.       OVERVIEW: Increased Costs of PERS AND TRS  LOG SPEAKER DISCUSSION    TAPE HFC 04 - 11  SIDE A  000 Co-Chair Harris Convened the House Finance Committee meeting at 2:26 p.m.  Increased Costs of PERS and TRS  103 MELANIE MILLHORN, Introduced the other speakers including DIRECTOR, RETIREMENT Mr. Reynolds, an actuarial consultant for and BENEFITS, Mercer. Explained that an actuarial does DEPARTMENT OF projections based on cost.  ADMINISTRATION 205 ROBERT REYNOLDS, Clarified that an actuarial is an ACTUARIAL economic forecaster in specific CONSULTANT, MERCER circumstances.  407 Ms. Millhorn Referred to "Public Employees' Retirement System; Teachers' Retirement System" publication (copy on file.) Explained that the discussion would cover the funding status and the two primary factors driving it: the increase in health costs and the loss of investment earnings. Discussion would also center on FY 01 through FY 05 Employer Rates, and Employer Contribution Rates from FY 98 through FY 04. A subcommittee has been formed to address possible tier redesign: Tier IV for PERS and Tier III for TRS.  0548 Ms. Millhorn Referred to the 8-page White Paper (copy on file) summarizing major concerns. Explained that both PERS and TRS are defined benefit plans for the State.  656 Ms. Millhorn Referred to equation on "Background," page 2.  750 Co-Chair Harris Asked the percentage of administrative expenses.  804 Ms. Millhorn Replied that administrative expenses appear on page 2 of 8.  4059 Co-Chair Harris Asked if there is a maximum that can be spent on administrative costs. Ms. Millhorn replied no. Alaskais currently at 1.2% for PERS and 0.8% for TRS.  830 Representative Croft Asked if those figures are close to the national average.  842 Ms. Millhorn Offered to research the question.  911 Ms. Millhorn Referred to page 3 and explained "over time" is defined as a 25-year amortization schedule for PERS and TRS, which by statute can go up to 40 years. The FY 05 Employer Rates are the result of the most recent evaluation for PERS and TRS on June 30, 2002. The Employer Rate setting is two years ahead based on  evaluation reporting due to the budgeting process. This is standard for most public pension plans.  1003 Representative Croft Noted that there have been dramatic changes in the stock market since 2002 and asked the effect of the Employer Rate being only as current as June 2002.  1018 Ms. Millhorn Responded that the June 30, 2003 rate is expected in March 2004 to set rates for FY 06. The specific time period lags two years. Agreed with Representative Croft that there is "smoothing," and said that Mr. Reynolds could address the actuarial assumption.  1148 ANSELM STAACK, E x p l a i n e d t h a t for FY 03, the amount of CHIEF FINANCIAL earnings was 3.7% for the entire fund, OFFICER, DEPARTMENT compared to the actuarial assumed rate of OF ADMINISTRATION 8.25%.  1321 Representative Croft Referred to page 1, Defined Benefits, that describes an early cash-out with the employee receiving only employee contributions and fixed interest. Observed that employee early cash-outs leave a lot of money in the system.  1407 Mr. Staack Responded that the only way to get an actuarial gain from early cash-outs is if the member doesn't take his benefit. Explained that if a member cashes out their account early and takes the employee contributions and 4.5% interest earnings by statute, it is only 20-30% of the actual value of their benefit.  1507 Representative Croft Asserted that it would be in the fund's interest, not the individual's, though not many people cash out early.  1528 Mr. Reynolds Explained that if a member leaves before vesting, he forfeits the employer contributions made on his behalf during that time period; therefore, the fund becomes more solvent if people leave before becoming vested. Assumptions are made when doing valuations about the rate at which people leave, but for the system to become more solvent, people would need to leave at a greater rate than is currently assumed. In TRS, the assumption is that 10% will leave during the first year. Mr. Reynolds pointed out that the majority of the systems liabilities are not attributable to unvested members, but rather to retired members, surviving  spouses, terminated members who are already vested, and active members who are already vested. He said that even if all non-vested liabilities were eliminated, the systems still wouldn't be 100% funded because non-vested members represent a small portion.  1712 Representative Croft Asked what would happen if a vested member cashed out his contributions.  1727 Mr. Staack Replied that the vested member would receive only the contributions and the earnings on those contributions; the fund retains the rest. Mr. Staack stated that cashing out happens more often than one might think.  1834 Representative Croft Asked if there has ever been an incentive encouraging members to cash out before becoming vested.  1901 Mr. Reynolds Replied that there has not, and added that there would be legal constraints. In single employer corporate plans, for example, the employer can't discriminate or take an action in order to prevent an employee from becoming vested.  1947 Representative Croft Commented that another way to make the fund solvent would be to create a bigger pool of people.  2010 Ms. Millhorn Explained that the fund looks at a 25- year period, with stock market performance playing a large role. The objective over time is to regain the funding status at the targeted rate.  2114 Ms. Millhorn Noted that the next valuation report will be completed by the end of March 2004. The PERS, TRS, and Alaska State Pension Investment Board will discuss the results of the valuation report of June 30, 2003 and adopt the actuarial assumptions underlying the Employer Rates. In April 2004, PERS and TRS will meet separately to determine the Employer Rates for FY 06.  2215 Ms. Millhorn Referred to page 4, "System Funding Goals," and discussed the four points.  2325 Vice-Chair Meyer Asked how Alaska compares to other state pension systems and targeted funding ratios.  2402 Mr. Reynolds Responded that it is difficult to compare PERS and TRS with other systems because PERS and TRS fund to a much higher target, including pre-funding retiree medical benefits whereas most systems treat medical benefits as a pay-as-you-go  expense. The funding ratios of Alaska compare well with other states, as neither the highest nor the lowest.  2500 Representative Asked Mr. Reynolds the risks of setting a Hawker funding ratio of less than 100% with a covered employee base that is stable or declining over time.  2557 Mr. Reynolds Explained that with a less than 100% funding target over a 25-year median period, the funding of the systems would pass beyond the current workforce to a future generation. With a declining workforce, the state would accept the risk of not being able to ever fully fund the systems.  2812 Ms. Millhorn Referred to page 5, "Data, Assumptions and Methods" and pointed out that all reports are available online with the Division of Retirement & Benefits. The current issues challenging the systems are the financial market performance and the rising cost of medical care, page 6.  2930 Ms. Millhorn Referred to pages 6-7, Employer Rates in FY 04 and FY 05 and reviewed the average employer contribution rate.  3129 Representative Croft Asked if it is a unified pool with every employer having a different rate.  3141 Ms. Millhorn Responded that is correct.  3150 Representative Croft Asked about the advantage and legality of pooling.  3221 Mr. Reynolds Replied that in the TRS system each employer shares in the experience of the whole system. By not pooling the employer rates, the employer assumes the liability for granted past service.  3327 Representative Asked if there was a change in methods or Hawker actuarial assumptions between FY 04 and FY 05.  3423 Mr. Reynolds Responded that the primary drivers for the change in the rates for PERS and TRS were the investment performance and the increases in healthcare costs. These led to revising some assumptions and methods.  3634 Mr. Reynolds Continued, that it takes several years to recognize a trend and draw conclusions, and it's normal for investment experience to be down in any one year.  3736 Representative Asked if Mr. Reynolds could offer any Stoltze cautionary advice on the retirement legislation.  3758 RAY MATIASHOWSKI, Stated that the department would evaluate DEPUTY COMMISSIONER, bills on a case- by- case basis. He DEPARTMENT OF observed that they are in an "under ADMINISTRATION funding" status. He anticipated that the market would return to the pre-1990 rates. Alaska is one of the few states that pre-funds medical liabilities.  3950 Representative Croft Asked the result of funding a target of less than 100%, for example a target of 98%.  4012 Mr. Reynolds Responded that the target of 98% would not have a large effect on calculating the contribution rate. He cautioned that, over time, 100% should be the target; he advised to avoid adopting rates significantly below the calculated contribution rates for extended periods of time.  4209 Representative Croft Noted that the up market was smoothed but now the down market is not, and he questioned the result.  4245 Mr. Reynolds Disagreed with Representative Croft's conclusion. He pointed out that there were three significant down years, where it made sense not to continue to smooth. He maintained that they would smooth down years in the future. He clarified that for the FY 05 evaluation based on FY 02, market results were not smoothed because it was felt that it was better to recognize what had occurred.  4416 Representative Croft Noted that big market years were smoothed, but that the FY 05 was taken straight. He questioned what would have occurred if it were smoothed.  4526 Mr. Reynolds Observed that the first two years were good and the next three were extremely bad; if they had smoothed, the valuation would have been low. The expectation is that with an absence of poor performance the rates would be higher.  4633 Representative Croft Referred to smoothing assumptions.    TAPE CHANGE HFC 04- 11, SIDE B  4551 Ms. Millhorn Spoke to the result of early retirement in education.  4521 Vice-Chair Meyer Questioned if the stock market is the best place to invest.  4452 Ms. Millhorn Could not respond to the issue.  4432 Vice-Chair Meyer Stressed the difficulty of budgeting for school districts when funding levels are unknown.  4400 Ms. Millhorn Spoke to the PERS results and noted that without the medical portion, 143.7% was funded in FY 04. The PERS is funded at 120.9% in FY 05 without medical expenses. She continued to review the TRS rates over time. For FY 05, Mercer's recommendation was that the employer rate be at 35.57%. The Board adopted a 16 % rate. There is not a cap on TRS.  4153 Ms. Millhorn For FY 05, TRS is at 68.2% with total benefits.  4113 Ms. Millhorn Reviewed employer rates and savings contained in "Employer Savings FY 98-FY 04." The rate was 12.8% in FY 98. There was almost $360 million in savings from FY 96 - FY 05.  3923 Ms. Millhorn Reviewed the estimated change in employer contributions for FY 05 (copy on file.)  3757 Ms. Millhorn Discussed retiree medical insurance cost increases. The monthly premium in 1977 was $34.75. In December 2003, the cost of the monthly premium was $720.00. There has been a large amount of volatility. Health costs for PERS are approximately 30%; TRS is approximately 20%.  3631 Ms. Millhorn Noted that the investment experience is a major factor. The total investment loss was 5.25% in FY 01; FY 03 was a 3.67% gain.  3634 Ms. Millhorn If the investment earnings are less than the 8.25% actuarial earning rate, the plan's targeted funding ratio is significantly impacted.  3454 Ms. Millhorn Reviewed the PERS employer rate change for the last five years. She observed that there are a number of variables that impact the recommendations (copy on file.)  3406 Ms. Millhorn Reviewed the TRS employer rate change for the last five years. The TRS rate has been more stable than has PERS.  3332 Mr. Reynolds In response to a question by Representative Croft, Mr. Reynolds explained that the assumption is that the premium will increase at the assumed rate. The previous years are compared to the assumed rate. Adjustments are only made if there is a significant deviation. In FY 02, the decision was made to use the actual premium due to the amount of variation.  3133 Representative Croft Concluded that the rate had settled down to 10%.  3111 Mr. Reynolds Agreed, but added that recent experience shows greater than 10%. Increases escalated in the late 1990's and beyond. He emphasized the difficulty of estimating health care costs. The assumption is that health care will increase at a rate of about 12% over the next three years.  2943 Representative Observed that changes have manifested in Hawker the most recent evaluation process. He questioned where the decision to reflect changes is made.  2855 Mr. Reynolds Explained that actuaries have professional standards, but that the TRS and PERS Boards have the authority to adopt the recommendations. The Board can modify the recommendations during two steps in the process.  2738 Representative Noted that contributions numbers were Hawker stable until the last year. He questioned if recommendations were not followed this past year.  2698 Mr. Reynolds Explained that calculated rates were not substantially different from the adopted rates.  2622 Representative Observed the change made between FY 01 Hawker and FY 02 from 6.77 to 24.9.  2533 Mr. Reynolds Clarified that the medical and investment experiences occurred in FY 02.  2455 Mr. Reynolds Reviewed a summary of benefits paid by PERS, page 13 (copy on file.) The COLA was collapsed into the service area in 1997. There was $451 million paid out in PERS benefits. She gave examples of payout ratios.  2234 Ms. Millhorn Continued to review the PERS chart (copy on file.) She noted that there was an early retirement option (RIP) from 1997 - 1999.  2137 Ms. Millhorn Observed that a newsletter would be sent to members to solicit input regarding tier redesign.  1951 Representative Questioned if input would be solicited Hawker from non-state employees.  1816 Ms. Millhorn Stated that they would be open to more input; however, there is no intent to actively solicit recommendations outside of the employee base.  1725 Ms. Millhorn Observed that there are only 8 of 123 health care pension plans that pre-fund health care. Many plans only report liabilities on a one-year plan.  1554 Representative Croft Questioned the effect of not pre-funding.  1528 Mr. Reynolds Observed that the calculated contribution rate would be reduced from 25% to 10% - 12% if pre-funding of medical benefit were eliminated for PERS. The same effect would occur in TRS. If medical benefits had not been pre-funded there would be fewer assets in the system. The system is where it is today due to the practice of pre-funding medical benefits in the past.  1315 Mr. Matiashowski In response to a question by Representative Stoltze, noted that there have been two committees formed to look at redesigning the TRS and PERS systems.  1212 Ms. Millhorn Noted that the survey was created to start a dialog about the variables involved in redesigning the tiers.  1142 Mr. Reynolds In response to a question by Representative Hawker, observed that states that do not pre-fund are paying for medical expenses as they occur, from general revenues. These states are not looking very far into the future to assess their ability to meet that obligation.  954 Representative Observed that the risk is exposure to a Hawker more volatile situation.  929 Mr. Reynolds Agreed, and added that large-scale demographic changes, such as the retiring "baby boomer" population, could result in exposure.   ADJOURNMENT The meeting was adjourned at 3:54 PM.