Testimony on Alaska House Bill 22

Testimony on Alaska House Bill 22 (HB 22) submitted to the Alaska House State Affairs Committee.

Good morning, my name is Ryan Frost, and I’m a senior policy analyst with the Pension Integrity Project at Reason Foundation. Our team conducts quantitative public pension research and offers pro-bono technical assistance to officials and stakeholders aiming to improve pension resiliency and advance retirement security for public servants in a financially responsible way. We have been involved in around 70 pension reforms over the past seven years, all aimed at bringing down long-term risks and costs to the state and taxpayers. Prior to my current role, I spent seven years as the senior research and policy manager for the Law Enforcement Officers and Firefighters (LEOFF 2) Pension System in Washington state. LEOFF 2 has been one of the top-three best-funded public pension plans since its inception in the mid-1970s, and that has primarily been accomplished by keeping it up to date with best practices in plan design and funding policies.

Reason Foundation has worked on some of the nation’s significant pension reforms of recent years, including Arizona’s public safety plan, Michigan’s public-school employees plan, and Texas’ public employees’ plan. Pension plan design is an extremely complex issue. Much like a house, if the plan designer fails to build the pension system’s foundation properly, it can be incredibly costly to fix those later. Alaska is currently dealing with that issue in the Alaska Public Employees’ Retirement System (PERS) and Teachers’ Retirement System (TRS) plans, which have been closed since 2006 yet remain saddled with billions of dollars in unfunded liabilities.

Speaking to Alaska House Bill 22, the state legislature considered a bill identical to this last session, and Reason presented an analysis of the risks to the state in terms of potential unfunded liabilities and short- and long-term costs. Just like last session, our concern is that far too much risk is built into this proposal to reopen a defined benefit pension plan and retroactively undo the risk-reducing measures that Alaska has enjoyed since 2006. The Pension Integrity Project has never seen a defined public benefit plan proposal anywhere in the country with this much risk in the first few years of the proposed plan’s life.

Surprisingly, such a massive plan design change has yet to receive a long-term actuarial study of the potential impacts on the state budget. The only analysis the legislature received last session was a projected six-year cost figure from the PERS actuarial consultant, Buck, and an analysis performed by an outside actuary hired by the bill’s proponents.

We’ve built an actuarial model, using a certified consulting actuary, that allows us to examine and compare costs through many different scenarios, compare benefit levels of the defined contribution plan versus the proposed defined benefit, and perform an accurate risk assessment of the bill, which last year’s bill unfortunately lacked.

To that end, Reason Foundation’s initial modeling suggests that HB 22 could cost Alaska upwards of $800 million in the coming decades. While the proposed ‘new’ defined benefit (DB) plan does have a few modest improvements relative to the legacy pension tier, HB 22 still lacks sufficient controls to justify the proponent’s assertion that there is no risk to state/local budgets, as there is with the current defined contribution (DC) plan today.

The risk from this proposed bill is threefold:

1.          Allowing all previously earned service in the DC plan to be transferred into the proposed DB plan creates massive unfunded liability risk in year one.

Transferring DC balances to a DB pension fund as if they had been there all along sets up a pension obligation bond-like situation where any downturn in stock market performance or lowering of investment return assumptions would quickly create significant unfunded liabilities in the system. There was a lot of discussion at this bill’s first hearing about last year’s proposal almost passing. Let’s say the bill did pass last year, here’s what would’ve happened (and what we warned about last session): All public safety members hired since 2006 would be assumed to transfer all of their assets from the DC plan into a new tier of the PERS DB plan. This effectively means the state would have seen up to 16 years of liabilities added to the plan on day one, all priced at last year’s overly optimistic discount rate of 7.38%. PERS investment returns were negative last year, earning -6%. Missing the long-term assumption on investment returns by more than 13%, this new tier would have had a huge funding hole immediately in year one. The new PERS tier would have added over $33 million dollars in unfunded liabilities before the plan reached one year old.

2.          The current assumed rate of investment returns being used by PERS, which this new proposed plan falls under, is far too high.

Reviewing the landscape of public pension systems nationally, it would be fair to characterize the situation as a race to get down to a 5.5-6% assumed rate of investment returns for other public pension systems across the country. Alaska has followed this trend, lowering its assumed rate from 8% to 7.25% over the last few years.

These jurisdictions also commit to higher current pension contributions because lowering the assumed rate makes previously promised liabilities more expensive. This bill, for some reason, sets the assumed rate 125-175 basis points above that near-term market outlook. The Alaska Retirement Management Board (ARM) has already lowered its expected annual rate of return this year, going down from 7.38% to 7.25%. When the PERS investment return assumption is reduced again in the future—which it most certainly will—this new tier will have instantly created unfunded liabilities.

3.          While proponents claim there is built-in cost sharing, it is not true.

Employee contribution rates are essentially fixed in statute, meaning any poor plan experience that brings required contributions above the maximum rate that employees are set to pay would be borne by the state.

HB 22 is being proposed due to concerns with recruitment and retention challenges. Proponents claim they are having trouble recruiting and retaining members due to the lack of a defined benefit pension to offer to their members. However, this claim does not hold up to the data as, according to the National Police Foundation, 86% of police departments across the country face a shortage of members. Proponents stated to the prior committee that all other states offer a defined benefit for public safety employees. If all of those states are also having issues with recruitment and retention, the obvious question would be, if a defined benefit plan isn’t keeping public safety workers everywhere else, why would it be any different here? We even have an academic working paper showing that retention rates saw no change when Alaska swapped from a DB to DC in 2006.

Supporters of this bill often mention that states like Washington are stealing firefighters from Alaska. That may be true at some level, but is the pension the reason they transfer to become cops or firefighters in Washington? Recent salary data in Washington shows the average police and fire salary across the state is over $122,000 per year and firefighters alone average over $130,000 yearly. Most out-of-state police and firefighters I spoke with when I worked for that pension system pointed out that they nearly doubled their salary by moving to Washington.

Then there’s the issue that Washington is also struggling to hire new public safety, specifically law enforcement, officers. The city of Seattle is struggling to convince its current officers to work overtime as security for Seattle Seahawks games because their officers say they are burnt out from all the other overtime they have to work. This is not an Alaska-specific issue, and it is a common issue across the country. In fact, from our experience of studying and working on reforms of other public pension plans around the country, Alaska’s stated 6% turnover rate is on par or lower than what most other public safety plans across the country are seeing. For example, there’s been a major pension reform push in North Dakota, and its defined benefit pension plan for public employees has a 15% turnover rate per year.

The national trend since the Great Recession of 2007-2009 has been for states to adopt greater risk controls in their traditional pension systems and to move toward a variety of plan design options to avoid re-exposing state and local budgets to the risks of worsening unfunded liabilities. Texas, Arizona, Michigan, and Colorado are among the states that have recently adopted new, risk-managed retirement plans that provide adequate retirement benefits but also do not disproportionately burden employers with financial risk. Unfortunately, HB 22 does not resemble those types of prudent reforms.

In closing, retirement plans for public workers must meet the benefit needs of its members and must not apply unnecessary costs to government budgets. While Alaska’s current defined contribution plan is not without opportunities for improvement, it stands as a valuable benefit that works well for the modern workforce. It does not burden the state with significant debt and costs. House Bill 22, as currently written, would not fulfill these same requirements and could very realistically expose the state to immediate risks of runaway costs.