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.

The post Testimony on Alaska House Bill 22 appeared first on Reason Foundation.

HB 22/SB 35 costs are dependent on a flawed discount rate: The claim that the proposed changes will not require any additional funding relies on the pension’s current investment return assumption. Alaska PERS would need to achieve overly-optimistic 7.25% annual returns on investments for decades to avoid additional costs to the state.

• Overly-optimistic investment return assumptions were a major contributor to Alaska’s $5.1 billion debt still owed on the legacy pension plan.
• The average assumed return used by public pension systems around the country is now just below 7%, so Alaska PERS’s current assumption is rosier than peers.
• Capital market forecasts suggest returns closer to 6% for the next 10-15 years.

HB 22 and SB 35 could cost the state an additional $800 million: Actuarial analysis of Alaska PERS that anticipates realistic market stress and multiple recessions over the next 30 years shows HB 22/SB 35 likely expose the state to significant potential costs.

Bottom Line: HB 22 and SB 35 could cost Alaska upwards of $800 million in the coming decades. Since public safety employees make up only about 10% of PERS members, this could be a very costly move that only benefits a relatively small group.

The post Pension changes in House Bill 22 and Senate Bill 35 threaten Alaska’s budgets appeared first on Reason Foundation.

• Holds $1.8 billion in unfunded liabilities;
• Is structurally underfunded by legislatively set contribution rates;
• And is expected to become insolvent around the turn of the century even if all its actuarial assumptions are met (faster if they do not).

This backgrounder examines claims the North Dakota Public Employees Retirement System is making about North Dakota House Bill 1040.

Scrutinizing NDPERS’ cost claims on House Bill 1040

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Thank you for inviting me to provide our technical analysis of House Bill 1040 based on our experience evaluating pension solvency and design quality nationally, as well as answer any questions the committee may have. Reason Foundation’s Pension Integrity Project operated as pro-bono technical assistants during the interim committee process that led to this bill, building an actuarial model for the North Dakota Public Employees Retirement System (NDPERS) to help inform the process. We’ve thoroughly examined the details of this legislation, as well as the funding history of NDPERS. I have provided several supplemental materials to the committee that I hope are helpful in your consideration of this bill. 

The context for the current discussion is the looming insolvency of the North Dakota Public Employees Retirement System. Today, NDPERS is estimated to be about $1.8 billion underfunded. Even according to a recent report from the National Conference on Public Employee Retirement Systems, an organization that represents and advocates for defined benefit public pension plans, North Dakota is one of just five states that has an unsustainable public pension debt trajectory. 

Without any changes, the North Dakota Public Employees Retirement System will continue to accrue unfunded liabilities, ultimately exhausting its assets in approximately 80 years. HB 1040 would meaningfully address many of the longstanding challenges facing NDPERS, help turn it away from a path of perpetual underfunding and set it on a course to be fully paid off in the next 20 years. 

First and most importantly, House Bill 1040 fixes the systematic underfunding that the North Dakota Public Employees Retirement System has undergone over the past two decades by swapping from contribution rates set in statute to an “actuarially determined rate,” or ADEC for short. ADEC is a calculation performed during the pension valuation process that shows what plan contribution rates need to be to pay for both benefits and debt service costs. The pension benefits promised to members of NDPERS are ultimately the responsibility of the state, local governments, and taxpayers. Continuing to fall short of fully funding these pension promises unfairly passes on the cost of today’s public services to future generations. Adopting an ADEC funding policy is a crucial first step in getting North Dakota on the path to living up to its pension obligations. 

Second, this bill closes the current structurally underfunded defined benefit plan to all future new hires and instead offers them a defined contribution retirement plan that our analysis finds meets the high standards of best practices in retirement system design. The proposed reform would avoid the accrual of new unfunded liabilities related to future hires and would, in most cases, offer a more generous benefit than the current NDPERS pension. 

Our analysis, along with research from the Teachers Insurance and Annuity Association (TIAA), a Fortune 100 financial services organization, presented to the interim committee, showed that for almost any age an employee begins work, the proposed defined contribution plan’s benefits would be more generous than the current NDPERS defined benefit plan’s benefits. This is due to the extremely low multiplier of 1.75% that the NDPERS defined benefit uses for calculating benefits and the high rate of turnover in the plan. I’m unaware of any other fully defined benefit pension plan with that low of a benefit multiplier. 

While the cost of offering the current defined benefit should be low, it is saddled by years of underpaying contributions and the high-interest rate on the pension system’s accruing debt. Those are the two main factors that have moved NDPERS from being overfunded in 2000 to being $1.8 billion in debt. 

To help you visualize the thought process behind this bill, think of the North Dakota Public Employees Retirement System’s unfunded liabilities as an oil spill. The two most urgent actions are: (1) to cap the spill and (2) to clean up the oil that’s spilled already. The transition to the defined contribution plan for future hires caps the spill because no new hire would ever have the risk of an unfunded liability attached to them in the future. The second course of action is to clean up the oil already spilled, which is what the shift to proper actuarial funding does. Over the next 20 years, the state and, on a smaller scale, its local governments would be able to pay off the pension system’s $1.8 billion in debt by making full actuarial contributions to the NDPERS defined benefit plan. 

To assist that paydown, the state has also put other cash infusions into this bill, beginning with $250 million in year one and another $70 million per biennium until the plan reaches full funding. Our modeling forecasts show that these added funds, coupled with the swap to a proper actuarial funding method, would save North Dakota $1.1 billion dollars over the next 20 years relative to the status quo and finally put NDPERS back on proper financial footing. 

Lastly, I’d like to make it clear to this committee that if you hear discussions about the costs associated with this bill, those costs are not the inevitable consequence of shifting to a defined contribution plan for future hires. Instead, the costs reflect the state needing to make an overdue commitment to fully pay for the retirement benefits it has already promised generations of public workers and retirees of North Dakota, who understandably expect to have the pensions promised to them adequately funded. 

Swapping to a different retirement plan design has a negligible impact on the overall costs of any pension reform bill. No new workers are needed to “fund” previously granted benefits; pensions do not operate as Ponzi schemes and should not be treated as such. The cleanup of years of underfunding is where the costs of this bill—and most pension reform bills across the country—come from.  

The post Testimony: North Dakota’s HB 1040 would address many challenges facing NDPERS appeared first on Reason Foundation.

The Arizona State Retirement System is a cost-sharing, multiple-employer plan where participating employer and employee contributions are pooled. All assets, approximately $50 billion, of the plan are shared, pooled for investment, and used to pay for promised pension benefits. Every employer in the state pays the same contribution rate, as a percentage, for each employee. All liabilities are pro rata owned by every employer, who all share in paying for the normal cost and unfunded liabilities of the plan.  

Under this fairly common contribution and liability structure, there is no way for any individual employer to “pay down” or accelerate the payment of their portion of unfunded pension liabilities. Any supplemental contributions from one employer would simply accrue to the entire employer pool.  

What the passage of the contribution prefunding program (CPP) brings is a novel way for government employers to set aside surplus funds to offset future required contributions, essentially allowing them to budget for lower ASRS payments in the future, while continuing to pay the full contributions now.  

The biggest benefit of the CPP is the ability for employer-prefunded contributions to earn the same investment return as the ASRS pension fund. ASRS will grant all pre-funded contributions an earnings rate equal to the actual annual rate of return on the ASRS pension investment portfolio, net of investment expenses. As an example of the return employers could expect to receive on their contributions to the program, ASRS has averaged an annual investment return of just over 9% since plan inception in 1975, although market outlooks in the near term posit a realistic return figure being somewhat lower.  

The growth of individual employers’ funds in the contribution prefunding program will help offset future unfunded accrued liability (UAL) cash requirements and help the employer keep budget stability during poor financial times. Instead of having to cut funding to other programs when pension contribution requirements increase, the employer can simply pull dollars from the CPP to offset that increase.  

The flexibility in this new program is also an important feature. The application of the money in the CPP is up to the employer, with three stipulations. One, for administrative reasons, the minimum prepayment contribution is $100,000. Two, the dollars must eventually be used to offset future pension contributions. And third, once ASRS reaches full funding and therefore has zero unfunded liabilities to be paid down, the plan will no longer accept additional funds into the CPP.  

Apart from that, the employer can choose exactly how and when to use their CPP balances. There is no requirement that the employer must use the funds within a certain time frame, allowing the employer to take advantage of the compounding returns from the ASRS investment portfolio. 

For an example of the possible employer savings from participating in the CPP, we use three hypothetical ASRS employers and assume each plan has a $100 million unfunded liability. For the purposes of this analysis, we assume: 

• Each employer’s payroll begins at $52 million and grows at 3% per year.  
• Employers have a payroll contribution of 8% to pay down the UAL.  
• Two employers choose not to contribute any dollars to the CPP. 
• The other employer chooses to contribute $20 million to the CPP in 2022. 
• The CPP employer wants to amortize (use the dollars in the CPP) over a 10-year period to help offset future contribution requirements.  
• CPP contributions are assumed to grow at ASRS assumed annual rate of 7%.  

For the employers who decided not to join the contribution prefunding program, their 10-year total contributions would be $48,245,443. For the employer who decided to contribute $20 million to the CPP, and use those funds to offset future contributions, their 10-year total contribution would be $40,248,304. The annual contribution amounts are seen in the chart below.  

Contributions for Hypothetical ASRS Employer

Under this scenario, the employers who neglect to join the CPP would pay roughly $8 million more over just that 10-year period. This is due to the compounding interest discussed earlier. The CPP employer’s $20 million, minus the amount used to offset each year’s contributions, is gaining 7% interest compounded annually.  

Senate Bill 1082 is a win for Arizona, the Arizona State Retirement System, government employers, and taxpayers. It is another important step forward in the successful and ongoing process of improving the state’s public retirement systems. With the wave of investment volatility and the costs of the average pension plan rising, these prefunding programs could allow employers some desirable flexibility and budget stability as it relates to pension costs. 

The post Arizona passes prefunding program for state retirement system  appeared first on Reason Foundation.

The hybrid retirement pension plan design, a design that typically combines a guaranteed benefit and 401(k) style individual retirement account, has seen ever-increasing interest from public sector employers in the United States since the market downturns of the late 2000s. Although hybrid retirement plans have been around for decades—notably one of the first adopters being the Federal Employee’s Retirement System—most stakeholders know relatively little about their purpose and possible structure.

A hybrid plan’s goals are no different than any other retirement benefit design’s goals: to provide adequate benefits to workers at an affordable cost to them and their employers. Yet hybrid plans are also beginning to help answer a political question in the wake of the stock market volatility in the last 20 years: What is the appropriate level of risk that employers should shoulder to provide retirement benefits to their employees? The viability of future traditional defined benefit pension plans may depend on a common outlook on this question from both employers and participants.

The recent shift toward offering hybrid plans to newly hired government employees suggests that governmental employers may be changing their perceptions of the balance of financial risk between employees and employers and whether governments should put greater risk of investment returns on employees by distancing from the traditional defined benefit pension. Employee and labor associations on the other hand, often have extreme— whether fair or not—biases against the 401(k)-style defined contribution retirement plans that are typical in the private sector.

The hybrid retirement plan offers policymakers and stakeholders a potential compromise between the two opposing viewpoints, potentially offering a “best of both worlds” blended approach.

As with the design of any pension system, the quality of a hybrid plan comes down to how it is structured. A well-designed hybrid strikes a proper balance of risk between employees and employers while putting career-long employees on a secure path to retirement and granting non-career members the flexibility they need to get the most out of their retirement contributions. Intelligently designing the defined contribution portion of the benefit is crucial, as generally half of the hybrid employee’s retirement benefits will be paid out of their accumulated assets.

When designing the DC, policymakers need to ensure proper contributions are being made by employees (and sometimes employers), grant a wide array of investment options, and offer annuities to guarantee lifetime income.
Although the path to an adequate retirement benefit may look different from a traditional pension, intelligently designed hybrids have nonetheless shown to provide relatively similar pension benefit accruals for employees—at a much lower risk to the states and local governments who provide them.

Full Policy Brief: Best Practices in Hybrid Retirement Plan Design

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This proposed amendment on Georgia’s November 2022 ballot would adjust the state constitution to allow for the suspension of certain public officials’ compensation while the individual is suspended from office for being indicted for a felony. An official who is reinstated to their previous position would receive all pay and benefits that were withheld.

Currently, a public official must be convicted before that suspension of the compensation would take place. This amendment would only apply to the following public positions: 

• Any member of the General Assembly;
• Governor;
• Lieutenant Governor;
• Secretary of State;
• Attorney General;
• State School Superintendent;
• Commissioner of Insurance;
• Commissioner of Agriculture; or
• Commissioner of Labor

Fiscal Impact

This amendment has no immediate fiscal impact on state taxpayers.

Proponents’ Arguments

Proponents argue that public officials should be good stewards of taxpayer dollars, and should not be paid if they are not currently doing their jobs. They also argue that taxpayers’ funds being used to pay for these suspended public officials could be used to hire public workers in other needed fields. 

Opponents’ Arguments

There is no formal opposition to this amendment. The proposed amendment was placed on the ballot by the state legislature with a vote of 51-1 in the State Senate and 169-0 in the House. 

Discussion

This amendment was introduced as a response to former Georgia Insurance Commissioner Jim Beck receiving $343,000 during the period between his suspension from office and his conviction on numerous fraud charges.

All 50 states will suspend the compensation of public officials if they are convicted of a crime related to their duties. Few, if any, states will withhold that compensation before the official is convicted, but there has been a similar proposal in Michigan to do so. Georgia is also one of 30 states that allow for either the garnishment or forfeiture of public employees’ earned retirement benefits if they are convicted of crimes related to their public duties. 

The principle behind this garnishment/forfeiture policy is that taxpayers should not be paying for a corrupt public official’s salary and benefits. This amendment does track with that principle by suspending the official’s compensation until they are cleared of wrongdoing, and in cases where a formal indictment and trial take years to reach a conclusion, could save taxpayers hundreds of thousands of dollars. 

However, this amendment goes against the “presumption of innocence” principle, whose legal basis is typically argued for under the 5^th, 6^th, and 14^th Amendments. Suspending an official’s salary, before they are convicted of a crime, could harm their ability to mount a defense against the charges brought upon them and cause them and their family to suffer while guilt is not yet proven. Removing an official’s livelihood before any crime has been proven to have taken place is a potentially dangerous action in a hyper-politicized environment. 

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Through legislation and supplementary contributions over the past two years, state and local employers in Arizona dedicated an extra $2.67 billion in supplemental contributions to reduce the significant unfunded pension liabilities within state pension systems.

Similarly, Michigan policymakers have provided around $2.5 billion in relief payments for several of their underfunded pension plans in the recently enacted 2022 budget.  

These major payments mark a dedication to fulfilling promised retirement benefits, and they signal to taxpayers and public workers that these states are confident in the risk-reducing reforms enacted in recent years. 

Arizona 

Arizona lawmakers took their first meaningful leap into pension reform in 2016 by enacting major changes to the pension system for public safety workers. The bipartisan reform established a new risk-managed tier of benefits for new workers and more stable inflation protection for retirees. This comprehensive approach reduced the chances of the state facing unpredictable costs on promised benefits for incoming police and firefighters. In 2017, a parallel reform accomplished the same for the state’s corrections officer pension system. 

Now, with several years of results demonstrating the improved outlook of these systems, lawmakers are taking the next crucial step by making significant payments into the retirement funds to accelerate the paydown of unfunded obligations. Governor Doug Ducey’s 2021 state budget included $1 billion in extra appropriations dedicated to the public safety and corrections officer plans as part of a budget focused on tax cuts and debt reduction. Additional contributions totaling $500 million from local and state employers were also included.  

In 2022, three separate pieces of legislation passed in the Arizona Legislature and were signed into law by Gov. Ducey, instantly eliminating another $1.17 billion in unfunded pension liabilities for the state’s public safety systems. House Bill 2862 made a supplemental payment of $1.07 billion, Senate Bill 1086 secured $40.8 million, and Senate Bill 1002 added another $60 million to be applied to unfunded pension liability.  

These significant payments reinforce the state’s commitment to the retirement promises made to public safety workers while reducing long-term costs to future taxpayers. Much like any other debt, paying down Arizona’s unfunded pension obligations faster will save tremendous amounts down the road. For some perspective on how much savings will be generated from these supplemental payments, the Pension Integrity Project estimated a $1 billion payment would save the state as much as $564 million over the next 30 years. 

Michigan 

Michigan’s pension systems have gone through numerous reforms over the past 25 years and it was the first state to institute a defined contribution plan for its public workers in 1997. After the Great Recession, the state reformed its underfunded public school and state police employee plans, ultimately passing a series of bills that have put the state’s pension funding outlook on solid ground. Most notably, a 2017 reform of the public school pension system established a hybrid plan for all new members that balances risks and costs equally between employees and the state, slowing the growth of runaway debts and costs. 

The 2022 Michigan legislative session included a wave of supplemental pension payments in its final 2022-23 budget (HB 5783), totaling around $2.5 billion, into three of its underfunded pension systems. Just over $1.7 billion of those funds were allocated to the public school employees’ pension system (MPSERS). The seven university employers in MPSERS received $300 million to pay down their unfunded liabilities, $425 million was allocated to the broader MPSERS plan to offset the costs associated with reducing the plan’s payroll growth assumption to 0%, and $1 billion was earmarked for distribution into the plan’s asset pool. Of note is that this payment is not to be used for any debt or normal cost payments.  

The municipal employee’s retirement system was also given $750 million to start a grant program that will award dollars to qualified local governments, with the goal of reaching a 60% funded ratio. $170 million of those funds, the largest individual chunk for any one governmental unit, will make its way to Flint where the city’s pension system is facing over $400 million in unfunded liabilities. The third system receiving funds is the state police pension system, which will have the plan’s entire unfunded liability paid off through a $100 million supplemental payment.  

Arizona and Michigan’s recent treatment of funding for pension systems is an example of the value of comprehensive pension reform. Other state and local governments should note their success in tackling the challenge of reducing pension debt. The clearest lesson to be learned from these successes is that when real risk-reducing reform is adopted, it makes it much easier for policymakers to work and reduce unfunded obligations. If lawmakers see that a plan has addressed the problems that created the funding shortfall, it can alleviate their reluctance to dedicate the necessary share of the budget to resolve the legacy costs of those problems.  

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But in the 2021-22 legislative session, HB55 and HB220 both advanced through the state House of Representatives policy and fiscal committees with strong political support despite no apparent scrutiny and actuarial analysis. These bills would have opened new and financially risky tiers of the now-closed legacy pension systems for all new government workers. A Pension Integrity Project analysis found that implementing HB55 alone could have easily exposed the state to over $200 million in new unfunded liabilities by allowing current DC plan participants to switch to the proposed plan. 

There were two major arguments for the swap to a DC plan in 2005. First, the pension funds’ unfunded liabilities had already started ramping up to unsustainable levels, meaning the paydown of those debts were starting to eat too much into the state budget. Second, the state greatly feared another revenue shortage like it had in the 80s and 90s, impacting the legislature’s ability to fund already accrued and future benefits.  

The arguments from bill supporters centered around a desire to recruit and retain more public employees. Yet there is little, if any, evidence that a defined benefit pension is a relevant factor that helps drive employee recruitment and retention. A Reason Foundation working paper examining teacher retention in Alaska finds that retention rates did not change when the state swapped from a DB to DC in 2005. In addition, 86% of police stations across the country are facing a shortage of members and every one of those stations, outside of Alaska, has a pension with some defined benefit component. 

While the fiscal note analysis performed by Alaska’s pension system actuaries presented only a five-year cost projection, based on the assumption that the proposed pension tier would meet all of its actuarial assumptions, even that analysis raised some major concerns for state policymakers. It stated: “Adverse plan experience (due to poor asset returns and/or unexpected growth in liabilities) or changes to more conservative assumptions will increase the PERS DB (defined benefit) unfunded liabilities, resulting in higher contribution rates.”  

Lacking any meaningful actuarial or fiscal analyses, legislators and staff uncertain about the impacts of these bills sought an independent evaluation of potential outcomes, prompting several organizations—including the Pension Integrity Project at Reason Foundation, Americans for Prosperity, Alaska Policy Forum, Americans for Tax Reform, the American Legislative Exchange Council, and the Heritage Foundation—to provide technical assistance, policy analysis, and legislative testimony. 

Reintroducing Risk Via New Pension Tiers 

Pension Integrity Project’s analysis found that while the pension designs proposed under HB55 and HB220 did include a few modest improvements relative to the original legacy pension tiers, the designs still left far too much financial risk on the table.  

A key problem is the proposals’ use of a 7.38% assumed rate of return on investments, far higher than the national median—and higher than previous iterations of these proposals put forth by public employee stakeholders. This assumption is vital to get correct. Soon after the proposed inception of this new tier, the pension systems would have up to 15 years of liabilities already on their books because the bills stipulated that, for any member who chooses to enter the new tier, all their previously earned service in the DC plan will be transferred into the new defined benefit pension at the current 7.38% discount rate. This sets up a pension obligation bond-like situation where any downturn in market performance or lowering of investment return assumptions—both situations being almost a certainty based on 10-15 year market forecasts—would immediately create unfunded liabilities in the pension system. 

So why would a new pension proposal go the opposite direction on investment risk when all other public pension systems are rapidly dropping their assumed rates of investment return, and market forecasts predict returns more than 1% lower than the Alaska bills envisioned? The only possible explanation is that the use of a lower assumption would raise the cost of these proposals to a level that would make the supporters’ arguments of these bills being “cost neutral” an impossibility. The supposed “cost neutrality” argument from supporters is especially important due to the way Alaska funds its pension systems. Alaska has, for all intents and purposes, capped its employer contribution at 22% of pay. This new proposal, using faulty assumptions that hide the actual cost of the plan, would have eaten into the portion of that 22% that’s used to pay down legacy pension debt. If the plan was properly priced, even less would go toward paying down Alaska’s pension debt which would introduce significant risk to the promises the state has made on accrued benefits. 

Additionally, the pension systems’ actuaries noted a critical point—the current DC plan (DCR) offers nearly the same retirement benefit as proposed under HB 55 (PERS DB). Increasing employer contributions in the current DC plan and adding more annuity purchase options could yield an equivalent benefit and provide lifetime income options. In the fiscal analysis of HB55, the plan actuaries found, “On average, approximately 94% of DCR service as of June 30, 2021 was credited to PERS DB.”  

Evaluation of Alaska’s Current Retirement Offerings 

An actual state-by-state comparison of the retirement benefits earned by Alaska employees versus other statewide public employees would be prudent, because they have possibly the most generous post-employment benefits in the country. Not only does the state offer a solid contribution rate to its DC members, a Social Security replacement plan, the Supplemental Annuity Plan (SBS-AP), that puts the amount that would have gone into Social Security instead into a 401(a) account is also offered. Anyone relatively familiar with Social Security knows the poor benefit it offers for the dollars contributed into it, meaning Alaska’s employees will almost certainly earn more through the SBS-AP, if they are eligible, than they would have if they were paying into Social Security.  

Between the 12.26% of pay going into the SBS-AP (6.13% each from employee and employer) and the 13-15% of pay going into a member’s DC account (split depending on employee classification), an employee of Alaska has between 25.26% and 27.26% of pay going toward their retirement benefits each year. 

The Future for Alaska Retirement Policy 

While HB55 and HB220 fell short this legislative session, efforts to upend the state’s previous reforms will likely arise again in future legislative sessions. Recruiting and retaining public employees continues to be challenging for all states, not just Alaska. Despite misguided reasoning, there will be pressure to address these challenges with concessions in public retirement benefits. But reopening the doors to the beleaguered pension plan will resurrect major unacceptable risks while doing little to improve the state’s retention issues. Alaska policymakers will need to look elsewhere to address these challenges. 

That is not to say that there are no reforms Alaska lawmakers could consider to improve the state’s retirement systems. The legacy $7.4 billion in unfunded pension liabilities are still generating major costs in state budgets, and accounting of these debts is suboptimal, understating their magnitude with outdated market assumptions that need to be brought in line with broader industry trends. Policymakers should direct their attention to eliminating this debt as quickly as possible. Several other states have recently committed supplemental payments to address pension funding shortfalls, and Alaska would be wise to do the same.  

In 2005, Alaska policymakers made the prudent decision to recalibrate their retirement systems in a way that better served the mobility of the modern workforce and ceased any future exposure of unexpected costs for state budgets, blazing a trail for the rest of the country. Since Alaska’s landmark reform, several other states have adopted similar risk reducing measures. Instead of unraveling the state’s progress from the last 17 years, policymakers should seek to bolster the policies that brought resiliency and reliability to the retirement benefits of public workers. 

The post Alaska avoids attempt to roll back 2005 pension reform   appeared first on Reason Foundation.

A version of this testimony was given to the Louisiana Senate Committee on Retirement on April 25, 2022.

Thank you for the opportunity to share our project’s perspective on Senate Bill 438 (SB 438) and the proposed new hybrid retirement benefit under the Louisiana State Employees’ Retirement System (LASERS). 

My name is Ryan Frost, and I serve as a policy analyst for the Pension Integrity Project at Reason Foundation. Prior to joining Reason, I spent seven years as the research and policy manager for the Law Enforcement Officers and Firefighters Pension System in Washington state. Our team has engaged stakeholders in Louisiana dating back to 2016, offering quantitative research and pro-bono technical assistance to advance retirement security for public servants in a financially responsible way.  

Proposing an alternative benefit design to offer new public employees is commendable because even after the historic investment returns in 2021, LASERS is still only 66% funded with $6.8 billion in unfunded pension obligations. Although current amortization schedules are set to retire some of that debt, market forecasters also expect returns to be less than what LASERS actuaries assume across all asset classes. Lower returns would increase the probability of more unfunded liabilities in the near future.  

LASERS’ financial health aside, the plan’s current benefit structure is grossly inadequate for most public employees. Only 2.5% of new hires joining LASERS at age 35 will stay in the system long enough to accrue a full retirement benefit. Seventy percent of LASERS members leave with only their employee contributions to return to them (without interest). The current LASERS benefit is simply not designed for the modern public employee. These increasingly mobile employees are being penalized in Louisiana when leaving public employment. 

While previous attempts to implement a hybrid LASERS benefit—most notably back in 2018 under Senate Bill 14—would have addressed these issues, this current proposal includes changes that would likely prevent the state and taxpayers from seeing any meaningful cost reduction or financial risk reduction. 

Reason Foundation found that the use of a 1.8% multiplier (as outlined under the guaranteed benefit portion of the bill) would make LASERS an extreme outlier among hybrid plans. For example, the State Teachers Retirement System of Ohio whose members, like LASERS members, do not pay into Social Security operates using a 1% multiplier. Hybrid defined benefit (DB) and defined contribution (DC) designs typically use a 1.0%-1.25% multiplier for the guaranteed benefit and a more prominent defined contribution portion to broaden the number of members served by the plan. 

Another feature of this proposed plan that would be less than ideal for employees is the stipulation that hybrid members must annuitize their DC balances within LASERS. If a member separates from service for any reason (including retirement) and they want to withdraw their DC money in a lump sum, they are forced to also withdraw their DB contributions and forfeit any accrued pension benefit. They forfeit that benefit and all employer contributions made to the DB as well while gaining zero interest on any contributions made to the DB. 

No other hybrid plan has this stipulation. For a typical hybrid plan, if a member separates mid-career, they can take their DC money with them and leave their DB account alone. If a member separates at retirement–no matter what they choose to do with their DC balance–they may either receive their accrued pension or take a refund of all DB contributions (both employer and employee contributions plus interest). 

Adding this anomalous stipulation unduly jeopardizes members’ retirement security. Employees should be allowed to keep their DB benefit intact even if they withdraw their defined contribution benefit. In the end, the guaranteed benefit portion of the proposed hybrid plan slightly increases benefits for new hires while maintaining the same cost and risk challenges that led to LASERS’ current funding issues.  

While a new hybrid design for LASERS members could be a prudent step forward, Senate Bill 438, as currently drafted, lacks the risk and cost-saving mechanisms of other better-designed hybrid plans.  We commend legislators, members, and stakeholders willing to examine these important public pension issues and thank you again for the opportunity to share our perspective. 

The post Testimony: Louisiana Senate Bill 438 could cause public pension woes appeared first on Reason Foundation.

Good afternoon, my name is Ryan Frost, and I’m a policy analyst with the Pension Integrity Project at Reason Foundation. I’ve been with Reason since 2019, and prior to that, I spent seven years as the Research and Policy Manager for the Law Enforcement Officers and Firefighters Pension System in Washington state, or LEOFF 2 for short. LEOFF 2 has been one of the top-three best-funded pension plans since its inception in the mid-1970s, and that’s primarily been accomplished by keeping up to date with best practices in pension plans and funding design.
Reason Foundation’s pension team has played a key pro-bono technical assistance role on 55 pension reforms over the past six years, including the two largest being the public safety plan in Arizona and the Texas employee’s retirement system. Those reforms include new defined benefit pension tiers, new hybrid design tiers, new cash balance pension tiers, and new defined contribution plan tiers.

Accordingly, our team is agnostic on plan design. We are not ‘defined contribution or bust’ zealots; in fact, most of the reforms we’ve worked on have included a defined-benefit pension component. But each of those reforms has at its very foundation a way of paying for the pension system that ensures costs do not eat into state and local budgets and that these important benefits earned by employees are fully funded for their retirement.

House Bill 55, which would open a new defined benefit tier for public safety officers and firefighters hired since 2006, does far too little to prevent growing unfunded pension liabilities. Supporters of HB 55 claim that certain tweaks to the “new” pension would eliminate the financial risk to the state. However, these tweaks have faced minimal actuarial scrutiny to support proponents’ claims, and there is no publicly available long-term actuarial forecasting or stress testing to justify such a financially profound policy decision.

While it does have a few modest improvements relative to the legacy pension tier, HB 55 is a weak pension design and still lacks sufficient controls to justify the assertion that there is no risk to state/local budgets, as there is with the current defined-contribution plan.

Recognizing the need for a long-term perspective on funding and costs, the Pension Integrity Project has prepared preliminary modeling of the proposed new House Bill 55 tier. It is important to note that these results do not include potential impacts on the legacy Alaska Public Employees’ Retirement System tier and its current $4.6 billion in unfunded liabilities.

The results of our analysis indicate that HB 55 would very likely expose the state to new and growing unfunded liabilities. Instead of the $743 million paid in employer contributions over the observed 30-year window if all current actuarial and demographic assumptions are met, Alaska would be responsible for paying $887 million instead due to the need to service growing unfunded liabilities. That analysis is available on our website.

Public pension systems operate over generations, but state legislators have only been presented with minimal five-year cost projections based on an assumption that the proposed pension tier would do the impossible: hit all its actuarial assumptions. In short, HB 55 only works as intended if Alaska PERS does something it has never once accomplished in its entire history—get 100% of its assumptions 100% right, 100% of the time.

Despite practically flying blind to the risks and long-term trajectory of the new pension tier, the Alaska House passed it out of its chamber.

The updated fiscal note from Buck is basically a carbon copy of its previous fiscal note, only being updated for results of the latest actuarial valuation. A proper actuarial analysis of the proposal still has not been conducted.
Take, for example, a bill recently passed in Washington State for its police and fire pension system. That system has been overfunded since its inception in the mid-1970s through prudent risk analysis and funding design. Due to decades of hard work, the plan managed to create a side account to pay (in full) for any future benefit increases. The first benefit increase was passed this year: a multiplier increase.

The Washington state actuary’s fiscal note for that multiplier increase—a relatively minuscule task when compared to a complete pension design overhaul—is a shining example of the level of detail that must be considered when adjusting a pension benefit. A few things that Washington state’s fiscal note includes that the Buck fiscal note does not:

• 25-year costs to the state of Alaska;
• Stochastic modeling to assess the effect of unexpected experiences under thousands of potential outcomes;
• The expected chance that contribution rates will exceed 10%;
• Sensitivity analysis on retirement rates due to the effects of bill passage;
• And, funded status trajectory going out 30 years.

Even with the limited scope and rigor of the updated fiscal note, Buck’s analysis still raises some major concerns for state policymakers, stating, “Adverse plan experience (due to poor asset returns and/or unexpected growth in liabilities) or changes to more conservative assumptions will increase the PERS DB [defined benefit] unfunded liabilities, resulting in higher contribution rates.”

On day one of this new tier being opened, the plan will have up to 15 years of liabilities already on its books because House Bill 55 stipulates that, for any member who chooses to enter the new tier, all their previously earned service in the DCR will be transferred using an unrealistically high discount rate of 7.38%. This number is completely out of step with national trends, where the national median is now dropping under 7%. This sets up a ‘pension obligation bond-like situation where any downturn in market performance or lowering of investment return assumptions would quickly create unfunded liabilities in the pension system.

Previous proposals to put public safety into a defined benefit plan, specifically House Bill 79 (2020), set the plan’s assumed rate of return at 7%. HB 79 is nearly identical to HB 55, apart from a few changes to assumptions and minimum employee contribution rates.

Why is this proposal going the opposite direction on investment risk than previous iterations by using a higher rate, 7.38%, than the previous proposal? Our hypothesis is that the 7% assumption would raise the normal cost too high for a cost-neutral argument to hold any water because even fewer dollars would be going to legacy debt. Additionally, Buck Global notes a critical point—the current defined contribution (DC) benefit offers nearly the same retirement benefit as proposed under HB 55, suggesting that simply increasing the employer contribution in the current DC plan and adding more annuity purchase options in the current plan could yield an equivalent benefit and provide lifetime income options. Buck finds, “On average, approximately 94% of DCR service as of June 30, 2021 was credited to PERS DB.”

This means that the assets in the current DC plan holdings would cover nearly all the equivalent liabilities in the proposed new HB 55 pension tier, suggesting that the current retirement offering could potentially be improved to achieve the same policy goals. It’s also another potential explanation for why the supporters decided to use a 7.38% discount rate. Using a 7% rate would make the service-credit purchase more expensive at the time of transfer, meaning that members entering the pension tier would be effectively taking a benefit cut.

What would it take to push the actuarially determined rate over the 9% employer contribution floor? This is the first question that should have been asked in the first committee hearing on this bill. We have provided a list of other questions that should have been asked in a document accompanying this testimony.

There is a strong likelihood—and you don’t know how much until you get a real actuarial analysis beyond the minimal Buck fiscal note analysis—that the arbitrarily high 7.38% discount rate will need to be lowered within the first five years of the new tier’s life to keep up with the larger pension system trends. When that happens, costs will necessarily increase.

House Bill 55 is being proposed by public safety associations concerned with recruitment and retention challenges. Proponents claim they are having trouble recruiting and retaining members due to the lack of a defined benefit pension for their members. However, this claim does not hold up to the data as 86% of police stations across the country are facing a shortage of members. Every one of those stations, outside of Alaska, has a pension with some defined benefit component. In fact, we have an academic working paper that shows retention rates did not change when Alaska swapped from a DB to DC in 2005.

The national trend since the Great Recession of 2007-2009 has been for states to adopt greater risk controls in their traditional public pension systems and move towards a variety of plan design options with the goal of avoiding re-exposing state and local budgets to the risks of worsening unfunded liabilities over the long-term. Texas, Arizona, Michigan, and Colorado are among the states that have recently adopted new, risk-managed pension-like guaranteed retirement plans that also do not disproportionately burden employers with financial risk.

Unfortunately, HB 55 does not resemble those types of prudent pension reforms but it could be redesigned to do so if given sufficient time and if informed by robust actuarial modeling and stress testing analysis.

In conclusion, there is a way forward that can meet whatever needs this legislative body and stakeholders desire, but House Bill 55, as currently written, would not put this new tier on a successful path. We’d be happy to work with the committee and stakeholders to help draft a design that best meets those needs and follows current best practices in pension design.

Thank you for your time today, and I’d be happy to answer any questions.

The post Testimony on Alaska House Bill 55 and Buck’s updated fiscal analysis appeared first on Reason Foundation.

• Pension systems operate over generations, but legislators have only been presented with minimal 5-year cost projections based on an assumption that the proposed pension tier would do the impossible: get 100% of its assumptions 100% right, 100% of the time.
• Major retirement plan design changes necessitate long-term actuarial analysis and stress testing to ensure financial risks to governments are transparent and clearly understood beforehand.

Despite these limitations, Buck Global—the PERS consulting actuary— gives policymakers an idea of the limited information available on the long-term impacts of HB 55. In a March 2022 Fiscal Note on House Bill 55, Buck Global concluded that Alaska taxpayers would see increases in Alaska Public Employees’ Retirement System contributions as a result of opening a new defined benefit tier. Buck Global wrote:

• “Adverse plan experience (due to poor asset returns and/or unexpected growth in liabilities) or changes to more conservative assumptions will increase the PERS DB unfunded liabilities, resulting in higher contribution rates.”
• “The impact of HB 55 on projected contribution rates depends on how large the PERS DB unfunded liabilities become.”
• “Since HB 55 will increase PERS DB liabilities and actuarial contribution rates, the State-as-an-Employer contributions increase.”
• “By shifting active P/F members (and all future P/F hires) from DCR to DB, the State will be taking on greater risk of higher contributions in future years.”

Bottom Line: Changes of the magnitude being proposed in House Bill 55 should receive rigorous actuarial and risk analyses that have not yet been conducted.

Questions Alaska Policymakers Should Ask About House Bill 55

• Given the high discount rate used by PERS (7.38%) what is the risk of underfunding in the new tier created by allowing all current DC plan participants to immediately transfer assets to the new pension system?
• Under HB 55, what happens if PERS only achieves a 7%, 6%, or 5% long-term average investment return?
• Does the timing of returns matter to the cost borne by employers?
• What happens if PERS only achieves a 5-6% average return over the next 10 years—at what point do unfunded liabilities start growing again?
• What happens if we have another pandemic?
• What happens if HB 55 doesn’t solve Alaska’s retention issues?
• What happens if there is an unforeseen major geopolitical challenge in the next several years that results in a major investment underperformance early in the new tier, increasing unfunded liabilities in the legacy plan at the same time costs start rising on the new pension plan?
• Why does HB 55 set the all-important investment return assumption at 7.38% (38 basis points higher than the national median) when Alaska Retirement Management Board advisors project 6.6% for the next decade?
• What does it take to push the actuarially-determined employer contribution over the 9% employer contribution floor?
• Why was the discount rate not adjusted in HB 55 as it was in House Bill 79 from 2020?

The post Actuary highlights House Bill 55’s costs and risks to the Alaska Public Employees’ Retirement System appeared first on Reason Foundation.

A deferred retirement option plan is a mechanism that allows a retirement-eligible member to begin receiving his or her pension benefit while still working. However, instead of this benefit being paid out like a typical pension, a DROP participant’s pension is placed into a separate account available for a lump-sum withdrawal when the member stops working for the employer. This separate account also earns interest, typically at the pension plan’s assumed rate of return. 

When looking into pension plans that offer a DROP, a clear trend emerges: poorly funded plans and a swamp of unfunded liabilities. The most extreme example is the Dallas Police and Fire Pension System. Dallas’ deferred retirement option plan single-handedly brought the pension system to its knees, with 56% of all assets in the system earmarked to pay for DROP withdrawals. As a result, the fund had relatively few other assets to invest, leaving it little option to take on longer-term and higher-yielding investments. The fund eventually had to stop DROP withdrawals altogether because it lacked the liquid assets needed to pay for the DROP benefits.

The actuarial standard of practice (ASOP) No. 51 addresses this type of cash flow risk. It warns that public pension plans thinking of offering a deferred retirement option plan while they are already struggling with unfunded liabilities could find DROP lump sum payments to be a particularly difficult issue.

A deferred retirement option plan changes the way a pension system can invest its assets. As more pension systems chase illiquid assets to hit lofty assumed rates of return, a DROP puts more pressure on liquidity needs. The rosy assumptions of many public pension systems, especially when looking at muted 10–to-15-year market outlooks, add more volatility and risk of underfunding if more assets must be held back to pay for large DROP lump-sums.

Accruing additional pension liability at a time when capital market assumptions aren’t in line with pension plans’ assumptions is a move that exposes public employers—and thus taxpayers—to more risk at a time when they should be seeking ways to reduce risk.

A deferred retirement option plan also adds further underfunding risk due to the way interest is paid into the members’ DROP accounts. Pension systems generally have a 30-year investment outlook, assuming that the good years and bad years will average out and get the plan to a certain investment percentage over the long run. This percentage is the plan’s assumed rate of return. Most pension systems that offer DROP options set the interest paid on a member’s DROP account at the plan’s assumed rate of return. If the plan misses its assumed rate of return over the period, it still must pay that higher guaranteed interest rate into the member’s DROP account. Thus, instead of having years to make up for these losses, those losses are compounded. 

Apart from the cash flow issues that deferred options introduce, a DROP also drastically changes the way a public pension plan must fund its benefits. Pension plans regularly run studies to align their assumptions with actual experience to ensure that they are neither underfunding nor overfunding the system. One of the most important assumptions a plan studies is the expected retirement age of its members.

For example, a pension plan may have a normal retirement age of 55, but research may show the average member actually retires around age 60. Therefore, the pension plan may fund benefits with the expectation that the average member will begin drawing his or her pension at age 60.

However, a deferred retirement option plan completely negates that funding design, as there is no reason for a member to not enter DROP at the earliest possible time he or she can. The pension plan must then revise downward its assumed retirement age, resulting in higher required contributions to keep the pension plan properly funded. This issue is exacerbated further for any pension system that offers an early-retirement option, especially for public safety plans specifically, due to their already lower retirement ages. 

A deferred retirement option plan does not solve the root cause of some agencies experiencing police officer retention problems. Employee engagement and recruitment surveys of law enforcement officers show they believe it is more difficult to be a police officer than it used to be. Pushes for criminal justice reform and transparency, changes in the public perception of police officers, rising violent crime rates in some areas, and other issues are all factors.  Throwing additional retirement benefits into the mix is unlikely to solve the retention problems governments are having with police, especially for already strained city, county, and state pension systems and budgets.

Other potential solutions like offering increased salaries or “retention bonuses” might more effectively address retention challenges, and if they don’t, at least they won’t do long-term harm to pension funds that millions of public workers across America are relying on. 

The post Deferred retirement option plans expose public pensions to unique risks appeared first on Reason Foundation.

Good afternoon, my name is Ryan Frost and I’m a policy analyst with the Pension Integrity Project at Reason Foundation. I’ve been with Reason since 2019, but prior to that, I spent seven years as the research and policy manager for the Law Enforcement Officers and Firefighters Pension System in Washington State, or LEOFF 2 for short. LEOFF 2 has been one of the top-three best funded public pension plans since its inception in the mid 1970’s, and that’s primarily been accomplished by keeping up to date with best practices in plan and funding design.

Reason Foundation’s pension team has been a key pro-bono technical consultant on 55 pension reforms over the past six years, the two largest plan’s being the public safety plan in Arizona and the Texas Employee’s Retirement System. Those pension reforms included new defined benefit tiers, new hybrid design tiers, new cash balance tiers, and new defined contribution tiers. Each of those reforms has at its very foundation, a way of paying for the public pension system that ensures costs do not eat into state and local budgets, and that these important benefits earned by employees are fully funded for their retirements.

If it’s the legislature’s desire to open a guaranteed-benefit design to the public safety employees of Alaska, that can most certainly be done, but it must be done in a way that protects the state from financial risk. House Bill 55 would attach new public safety employees to a plan that has had trouble with funding spanning back two decades, only sitting at 76% funded even after it benefited from the largest one-year stock market return in recent history. I’d like to lay out a few public pension best practices for the committee to consider, and where HB 55 falls short.

A successful public pension plan pays the full actuarially determined rate using a full 50/50 cost-sharing method. For a defined benefit plan, this means that when underperformance happens in the market, or any of the other dozens of economic and demographic assumptions aren’t met, employees and employers equally share the paydown of that added debt to the pension system.

This bill has been sold as being “risk-shared,” but neither pays the actual cost of earned pension benefits, as determined by the plan’s actuary, nor equally shares those costs between all stakeholders. Setting contribution rates in statute, and capping those rates for employees, is a flawed funding design from yesteryear that no longer follows the best practices in today’s public pension design.

The best funded plans also don’t look to past investment experience when setting future assumed rates of return. The median rate of investment return for public pension systems across the country sits at 7%. House Bill 55 would put all employees into a plan assuming a 7.38% rate of return. Not only does that number fail to track with past investment experience in Alaska, but it also severely overestimates the 10–15-year market assumptions being used by most other public pension systems and institutional investors.

For example, over the past year, two of the largest three public pension plans in the country, the California Public Employees Retirement System and the New York State and Local System, have both stated that they only assume to earn 6% over the next 10 years. Both pension systems made immediate and prudent changes by lowering their assumed rates of return, with New York dropping its assumed rate all the way down to 5.9%.

House Bill 55 has been sold as being “cost neutral” due to having the same contribution rate as the defined contribution plan, but if this new tier earns even an optimistic 6.5% rate of return, while assuming 7.38% returns, the plan’s costs—and debt—will rapidly begin to spike. Quite quickly, the cap on the employee rate will be hit, and the government’s employer rate will continue to climb higher and higher to pay for those missed investment return expectations and the added interest, at 7.38%, that each year of missed returns adds to the plan’s unfunded liabilities.

In conclusion, there is a way forward on reform that can meet whatever needs this legislative body and stakeholders desire, but HB 55, as currently written, would not put this new tier on a successful path. Reason Foundation’s Pension Integrity Project would be happy to work with the committee to help draft a design that best meets those needs and follows best practices in pension design. Thank you for your time today, and I’d be happy to answer any questions.“

The post Testimony: Reviewing proposed changes to Alaska’s Public Employees’ Retirement System appeared first on Reason Foundation.

The post Expanding prefunding programs for the Arizona State Retirement System appeared first on Reason Foundation.

The scope of CalPERS findings was broad. Three of the four employees were found to have received a full-time salary as an active employee, while also receiving their full retirement benefits. While some states have rules allowing “independent contractors” to temporarily work in a position that would otherwise be filled with a member in the retirement system, the duties and hours the Broadmoor members worked fell far outside the scope of that description. Two of the four employees also received random, large, lump-sum payments while they were employees of the Broadmoor Police Department.

One of the police chiefs – who retired from Broadmoor in 2007 only to be reinstated for one year in 2012 while he was double-dipping (collection a pension and full-time paycheck from a CalPERS-covered position) – saw his annual pension grow from $93,000 per year to $152,000 per year based on his higher salary in 2012 and incorrect salary reporting from Broadmoor P.D. for almost the entire 10-year audit period. That extra $60,000 annual pension benefit was never prefunded through employee or employer contributions to the pension system, pushing that employer’s benefit obligations further and further into the red.

Another one of the chiefs applied for a duty disability in 2009, which was accepted by CalPERS. To receive a duty disability benefit from a pension system, generally, the employee must show that they are incapacitated from continuing to work in that position. This employee, however, continued to work as a full-time police chief for another three years.

Issues surrounding the Broadmoor P.D. have begun to surface the past 8 months through reporting from a local media outlet. These reports, according to a new media release from Broadmoor P.D. “initiated an internal investigation into misconduct by former top employees who allegedly abused their positions to pay themselves bonuses and inflated hourly rates while defrauding the public employees retirement system.” Those internal investigation findings were passed to CalPERS, who performed a further investigation and audit, who then notified outside law enforcement agencies. According to the San Mateo District Attorney, their office continues to work on the case through their public corruption prosecutor. The Broadmoor Police Commission had a special meeting on 12/14/21, beginning with public comments before going into closed session to discuss this issue with legal counsel. Representatives from CalPERS have recently stated that they plan to “seek appropriate remedies, including restitution.”

Taxpayers, who have no choice but to put their trust in their elected officials, don’t deserve to have their own senior police officials commit crimes against them. That’s especially true as CalPERS continues to build in more realistic assumptions to the pension plan, adding more costs to taxpayers to help fund these pension benefits.

The post CalPERS audit finds history of pension spiking in Broadmoor police department appeared first on Reason Foundation.

These increased contributions point to a shift in funding philosophy, from an employer-funded obligation to more of a shared-funding philosophy between public employees and government employers.

The brief shows 40 states raised contribution rates on employees after the Great Recession. Key holdouts include Wisconsin and South Dakota, two states with very well-funded public pension plans that adjust benefit levels rather than raise and lower contribution rates during periods of exceptional or poor investment performance.

Other holdouts are Kentucky, Oklahoma, and Alaska— three states with alternate retirement designs. Kentucky has had a cash balance plan since 2014, while Oklahoma and Alaska have had new employees in defined contribution plans since 2014 and 2006 respectively.

The remaining five states that did not raise employee contributions were Illinois, Indiana, North Carolina, Massachusetts, and Rhode Island. Indiana’s public employee plan has had employer pick-ups of employee contributions since its inception, while Illinois, North Carolina, Massachusetts, and Rhode Island set their employment rates in statute, therefore not sharing the risks of down markets with taxpayers.

The National Association of State Retirement Administrators found median employee contributions remained relatively flat, at around 5% of pay from 2001-2011. After the dust settled after the Great Recession ended in 2009 and state legislatures had a better idea of their public pension plans’ finances, required contributions from employees began to steadily rise throughout the 2010s, settling at a median of 6.25% of pay in 2020.

The average pension plan became increasingly more expensive through the 2010s due to the shift in market experience revealing a more accurate accounting of public pension costs. This necessitated the adoption of more conservative actuarial assumptions, namely the assumed rate of return on investments. When a pension plan assumes it will earn less on its investments while keeping the same benefit structure in place, the only lever left to fill the gap in funding is through increasing its employee and/or employer contributions.

During the last decade, state legislatures and retirement boards also began to implement risk sharing in their public pension plans, which had historically put the burden of investment risk on taxpayers. Risk-sharing articulates that employee contribution rates may change depending on plan investment returns or other actuarial and demographic factors. (For more information on risk-sharing, read our Best Practices in Incorporating Risk Sharing into Defined Benefit Pension Plans paper here.)

Contributions from employees are important to keep the funded status of statewide pension plans on an upward trajectory. The past 10 years have shown that pension boards and state legislatures are starting to see the importance of this concept as well. Some states which did not require contributions before the 2009 recession, now do. Most other states have raised employee and employer contribution rates to keep up with the funding demands of the average statewide defined benefit pension system. Continuing to advance these policies, alongside forward-thinking shifts in plan choice and continuing to draw down outdated investment return assumptions, will put public pension systems on a better foundation moving into the future.

The post Most public pension plans raised employee contribution rates in the last decade, report shows appeared first on Reason Foundation.