Employees' Retirement System (ERS): The irrevocable election of an optional defined contribution (DC) plan by employees under HB 951 will not initially increase the actuarial accrued liability or the normal cost for current members of ERS. However, this change will affect the benefit costs for future employees. Since the actual normal cost is significantly less for young members than for members hired at older ages, as young new hires elect the optional plan while older new hires elect the defined benefit plan, the normal cost will increase over time. As a result, the normal cost will gradually increase by 0.62% of covered payroll from 12.709% currently to approximately 13.33% over time. The total normal cost of 13.33% of the remaining covered payroll would exceed the current total State contribution rate of 12% to the ERS fund, requiring a parallel increase in the optional DC plan.

Further anti-selection is possible because current and future members terminating and being rehired could change their elections. Also, anti-selection is possible between genders - the optional DC plan may be financially advantageous for men, while the defined benefit plan may be financially advantageous for women because of longer life expectancy.

Optional DC plan members and the state contribute to the DC plan based on contribution rates that members and the state make to the existing ERS defined benefit (DB) plan. Contribution rate increases for the state could be required. A higher required DB plan state contribution rate would trigger a corresponding higher contribution rate by the state to the DC plan.

Under current law, the net asset balance is expected to drop from a net asset balance of $459.6 million on September 1, 2002 to a net liability balance of $533.7 million on September 1, 2005. This projection assumes an 8% return on assets at market and the absence of net gains from sources other investments. Under the proposal the net liability balance is projected at $531.7 million on September 1, 2005.

Law Enforcement and Custodial Officers' Supplemental Retirement Fund (LECOSRF): The normal cost is higher for law enforcement and custodial officers and elected officials. If this population selects the defined benefit plan while regular state employees are more likely to choose the optional plan, costs will increase for the ERS fund above the amounts identified above.

SYNOPSIS OF PROVISIONS:

This bill, to be effective September 1, 2003, would provide the following changes:

• Provides an optional DC plan to members, allowing them to participate in either ERS or the optional DC plan with an irrevocable election to be made within 90 days of employment or rehire.
• Members terminating employment with fewer than five years of service will forfeit a portion of their optional DC account derived from State contributions.

HB 951 will not be cost neutral from the perspective of the state. As demonstrated by the analysis, the combined state contribution to the DB and DC components will eventually exceed the state contribution rate required to support ERS as presently structured. In the absence of net gains, the current 6% ERS State contribution rate will not be adequate starting September 1, 2003 under the current structure. As long as a benefit change does not increase ERS obligations, additional State contributions to ERS in excess of 6% are not required under the law. The ERS/LECOSRF actuary states that ERS will remain actuarially sound only if the state contribution is increased to 6.828% of payroll for fiscal year 2004 and to 7.618% of payroll for fiscal year 2005.

Anti-selection is the tendency of an individual in a financial security program like ERS to select the choice that is most financially beneficial to that individual, thereby creating a higher cost to the sponsor of the financial security program, which is the State in this circumstance. The ERS/LECOSRF actuary states that although the law would appear to be cost-neutral, there will be increased costs because of anti-selection. Since law enforcement and custodial officers receive the 2.8% multiplier and early retirement features, they would generally benefit from remaining in the defined benefit plan. Because the ERS actuary assumed that these members would elect to remain in the defined benefit plan, there would be no significant actuarial effect on the Law Enforcement and Custodial Officers' Supplemental Retirement System.

The ERS actuary notes that as of the August 31, 2002 actuarial valuation, the ERS actuarial value of assets exceeded the actuarial accrued liability and the contribution rate was less than the normal cost. The actuarial value of asset method smoothes unexpected asset gains and losses at a rate of 20% per year. As a result, the asset losses that have not been recognized in the August 31, 2002 valuation will be smoothed in over the next five years. As these losses are recognized, in the absence of outstanding market gains, the plan will cease to be self-sufficient, even if no benefit improvements are granted.

To attempt to quantify the effect of anti-selection due to HB 951, the ERS actuary assumed that all future regular state employees who are hired before age 40 will elect the optional DC plan, that all future regular state employees who are hired after age 40 will elect the current ERS defined benefit plan, and that elected class members and law enforcement and custodial officers will elect the defined benefit plan.

The analysis has considered only the effect on the defined benefit portion of the ERS program. In addition, because there will be fewer members in the defined benefit plan, as some new state employees elect the optional DC plan, the ERS actuary has decreased the assumed rate of payroll growth from 4% to 0% beginning in 2004. The ERS actuary assumes current ERS members will not be eligible for this DC plan unless employment is terminated with the State and rehired later

The analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the August 31, 2002 actuarial valuations of ERS and LECOSRF. According to the PRB actuary, the actuarial assumptions and methods, as well as the plan level conclusions, appear to be reasonable. All actuarial projections have a degree of uncertainty because they are based on the probability of occurrence of future contingent events. Accordingly, actual results will be different from the results contained in the analysis to the extent actual future experience varies from the experience implied by the assumptions. The analysis considers only those changes contained in the proposal and cautions that the combined economic impact of several proposals currently under consideration could exceed the economic impact of each such proposal considered individually.

The numbers provided above may change after the results of the February 28, 2003 ERS Actuarial Valuation update are available.

Actuarial Analysis by Steven R. Rusher, Actuary, Towers Perrin, March 20, 2003

Actuarial Review by Mr. Richard E. White, Actuary, Milliman USA, Inc., March 20, 2003

Normal Cost-- the current cost as a percentage of payroll that is necessary to pre-fund pension benefits adequately during the course of an employee's career.

Unfunded Liability-- the amount of total liabilities that are not covered by the total assets of a retirement system. Both liabilities and assets are measured on an actuarial basis using certain assumptions including average annual salary increases, the investment return of the retirement fund, and the demographics of retirement system members.

Amortization Period-- the number of years required to pay-off the unfunded liability. Public retirement systems have found that amortization periods ranging from 20 to 40 years are acceptable. State law prohibits changes in TRS, ERS, or JRS-2 benefits or state contribution rates if the result is an amortization period exceeding 30.9 years.