The Senate Finance Committee participated Wednesday, January 30, in a history lesson on the State’s public retirement systems, which currently have a $7 billion unfunded liability.

Alaska has two major retirement systems.  The larger Public Employees’ Retirement System (PERS) has 54,000 participants in the pension-style defined benefit plans, according to a presentation by the Division of Retirement and Benefits (DRB).  The remaining 22,000 workers participate in 401(k)-style defined contribution plans.

The Teachers’ Retirement System (TRS) has 24,000 participants, 18,000 of which have defined benefit plans.

DRB also administers three smaller retirement systems, the Judicial Retirement System, the National Guard & Naval Militia Retirement System, and the Elected Public Officers Retirement System.  The last ended in 1976 via citizen referendum ten months after it took effect, but the handful of people who qualified during that window and their beneficiaries are still entitled to benefits.  

In 2017, the most recent year available, PERS had a funding ratio of 77 percent and an unfunded liability of $5.1 billion.  TRS had an unfunded liability of $1.8 billion and funding ratio of 82 percent.

“The source of the income for the system is the employee and employer contributions,” DRB Director Ajay Desai explained in a hearing.  “Unfunded liability is created if the benefits and expenses are higher compared to the contributions and investment earnings.  If the contributions and investment earnings are higher, then the funding ratio goes up.  The fundings are in excess.” 

Desai joined the State in 2017.  He has worked in the pension department of The Walt Disney Company and managed pensions for the Motion Picture Industry Pension & Health Plans.

The Source of the Unfunded Liability

DRB Chief Financial Officer Kevin Worley explained that an actuarial analysis smooths asset value over five years so that there isn’t an overreaction to short-term market volatility.

The State’s contracted actuarial company Mercer reported in 1999 that TRS was overfunded.  PERS had a reported funding ratio over 100 percent as recently as 2001.

Mercer advised over 200 Alaska employers that paid into PERS and TRS to halt their contributions so they wouldn’t have to pay out higher benefits than expected.  Contributions went from about 30 percent of base salary to seven percent, staying there from 2000 through 2004.

But Mercer had made serious actuarial errors, Senate Finance Chair Bert Stedman (R-Sitka) told the committee, reporting the plans as overfunded when they were likely underfunded.

“We ended up with erroneous data from our actuary,” Stedman said.

Stedman, who has served in the Senate since 2003, drew upon his institutional knowledge to educate Finance members, often answering his own questions originally posed to Desai.

Stedman was a member of Senate Finance when then-committee Chair Lyda Green (R-Wasilla) approached him with concerns about the pensions.

“‘They’re giving me these reports, and it looks like it’s going south.  I don’t understand what’s going on,’” Stedman quoted Green.  “She dropped a one-foot stack of papers on my desk and walked out the door.”

“That took us a few months just to figure out what is going on?  Why are we underwater?  Why is this information erroneous, or is it accurate?” he said.

“It was a perfect storm that right after that, in 2001 and ’02, the market went down,” Desai added.

The tech bubble bursting compounded Mercer’s errors.  PERS went from being 101 percent funded to 75 percent in one year.  TRS dropped from 95 percent to 68 percent.

Stedman warned that those statistics are unreliable because they include data from Mercer.  That data has never been corrected.

The Alaska Retirement Management (ARM) Board, trustee of the PERS/TRS assets, eventually sued Mercer, settling for $500 million in 2010.

Buck is the current actuary for DRB.  Callan, the Permanent Fund’s advisor, also advises the ARM Board.

Alaska Still Cleaning Up Mercer’s 20-Year-Old Actuarial Errors

Stedman said the legislature went about fixing the problem after learning of the errors.

“We went through the process in the legislature to try to not only define it, but then to rectify it,” he said.

Article XII, Section 7 of the Alaska Constitution reads, “Membership in employee retirement systems of the State or its political subdivisions shall constitute a contractual relationship.  Accrued benefits of these systems shall not be diminished or impaired.”

“Clearly, any liability that is accumulated through misestimating the future- which is very, very difficult- to, frankly, incompetence is backed up by the State treasury.  It doesn’t make any difference.  The defined benefits are guaranteed, again, by our constitution.  If there’s a problem, it comes in on this table.  It doesn’t go to the beneficiary for funding,” Stedman said.

Senate Finance’s immediate response was to introduce SB 141 in 2005, ending access to the defined benefit plans for new State employees and switching to defined contribution plans.

The legislature had already created tiers in PERS/TRS with reduced benefits prior to the passage of SB 141.

In 2008, the legislature passed SB 125, introduced by Gov. Sarah Palin, capping employer contribution rates at 22 percent of base salary for PERS and 12.56 percent for TRS.

Prior to SB 125, Stedman said employers like municipalities and hospitals were seriously in danger of bankruptcy dealing with the unfunded liability in the wake of Mercer.

“It was a negotiated rate high enough that the legislature thought that it would get the municipalities’ attention, but not high enough to put them over the edge to insolvency and give them the ability to adjust their budgets to feed that rate,” Stedman explained of the 22 percent.

The lower rate for TRS was in recognition of the constitutional obligation to provide an education, Stedman said.

The State picks up the difference between the employer contribution rate and the 28-30 percent total contribution.

For defined contribution participants in PERS, employers still provide matching funds and benefits equal to 22 percent of base salary.  Any surplus paid by the employer goes toward reducing the unfunded liability.

Most recently, the legislature passed Gov. Sean Parnell’s HB 385, extending the ARM Board’s amortization schedule and switching them from the level dollar method to the level-percent of pay method to liquidate unfunded liabilities.

The University of Alaska Anchorage (UAA) Institute of Social and Economic Research (ISER) explains, “The level dollar method costs employers more up front, but provides significant savings later.”

Hence, extending the amortization schedule and switching to the level-percent of pay method will cause employers, like municipalities, to pay significantly more money over time.

Senate Finance introduced a series of bills at the end of the 2016 legislative session that would have shifted more costs onto municipalities, but the bills were extremely unpopular and didn’t make it out of committee.

HB 385 also infused PERS and TRS with $3 billion, $2.3 billion beyond the State’s annual obligation.

“That $3 billion have helped the system at a huge level to keep it close to 80 percent, which is the healthy funded ratio,” Desai told the committee.

Sen. Click Bishop (R-Fairbanks) suggested the legislature may want to make another large deposit to reduce the unfunded liability.

Stedman responded that the legislature should consult Callan to gauge the impacts.

“Is there any ability or interest or benefit if we did another equity infusion?  Just as a decision-making point, we should understand that in the event that we ever want to pull that trigger this year or five years from now,” he said.

DRB Director Says PERS/TRS Very Near Healthy Funding Ratios

Given that Desai recommended 80 percent as a healthy funding ratio, Sen. Peter Micciche (R-Soldotna) asked if there is cause for alarm that PERS sits at 77 percent and TRS is just over the mark at 82 percent.

Desai suggested that 90 percent is a comfortable funding ratio, but 80 percent is healthy.  Below 80 percent, the State should consider strategies to address it.

HB 385 set a goal of eliminating the unfunded liability by 2040.  To do so, the State will have to pay $9.2 billion beyond its standard contributions.

DRB reported the State has already paid an additional $7.2 billion, including the $3 billion in HB 385.

The $9.2 billion payoff number has increased since 2017 because Buck has adjusted the expected investment return from eight percent to 7.38 percent.  It has also lowered anticipated payroll growth.

Stedman noted that the committee should consider the impact of potential budget cuts on the unfunded liability.

In addition to the actuarial adjustments above, Worley said beneficiaries are expected to live longer, 84 years as opposed to 82.

The last PERS/TRS beneficiary is expected to live until 2116.

Desai said if the State pays more up front, as Bishop suggested, it would reduce the $9.2 billion total.  Changing the funding ratio goal from 100 percent to 80 percent or 90 percent would also substantially reduce the amount.

The PERS/TRS funding ratios commonly reported are a combination of pension and health care funding.  Health care funding ratios are around 95 percent, while pension ratios are 67 percent for PERS and 76 percent for TRS.

Worley explained that previous administrations directed funding toward health care to reduce costs.

“We believe if we are looking at something to fund better, definitely the pension side,” he recommended.

Stedman noted that all the legislature’s efforts to reduce the unfunded liability have brought it in line with 2005 levels.

That means the unfunded liability is back to the size it was when Mercer’s errors were first discovered

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