Based on the August 31, 2012 TRS Actuarial Valuation:

* The current total contribution rate of 12.80 is insufficient to amortize the unfunded liabilities over a 30-year period. Currently, the total contribution rate necessary to maintain a 30-year funding period is 15.02% of payroll. Under the proposal, the required 30-year amortization rate would increase by 1.19% of payroll to 16.21%. If the provisions of this bill are enacted, it is anticipated that state's contributions for TRS will need to increase by 3.41% of payroll for fiscal year 2013 to achieve a 30-year funding for TRS under the requirements of Section 821.006 of Texas Government Code.

A Glossary of Actuarial Terms is provided at the end of this impact statement.

ACTUARIAL EFFECTS:

The actuarial analysis is based on the August 31, 2012 Teacher Retirement System actuarial valuations. According to the analysis, HB 103 would increase the normal cost of the plan by 0.60% of payroll, from 10.60% to 11.20%. HB 103 would also increase the unfunded actuarial accrued liability (UAAL) by $4.313 billion, an increase from $26.101 billion to $30.414 billion and would increase the actuarially sound state contribution rate from 8.62% of payroll to 9.81% of payroll, an increase of 1.19% of payroll.

The bill would only authorize a one-time supplemental payment which would cost approximately $425 million and would therefore directly add $425 million to the unfunded liability. However the analysis assumes that the passage of this bill would lead to similar bills in the future and assumes that contingent supplemental payments would become permanent.

The actuarial analysis notes that the proposal would attempt to use earnings in excess of the 8.0% investment return assumption as a funding source for the supplemental payment. The assumed rate of return on investments represents an expected rate of return over a long-term period, not the rate is to be realized in any given year. The TRS actuary states, "over the past 10 years, the 8.0% target has been exceeded in 7 of the 10 years, meaning a supplemental payment would have been made under HB 103. However, the average return over that same period of time was less than the 8.0% assumption." The use of excess future earnings to provide funding for supplemental payments would mean that future earnings available to meet current obligations would be decreased and thus the investment return assumption used by TRS would need to be decreased, from 8.0% to 7.75%.

SYNOPSIS OF PROVISIONS:

HB 103, to be effective September 1, 2013, would provide the following changes:

-        Provide a supplemental payment to eligible annuitants in an amount equal to the lower of their monthly benefit or $2,400. The supplemental payment is to be made at the end of any fiscal year if the investment earnings of the fund exceed 8.0% during the preceding fiscal year by an amount large enough to pay the supplemental payment.

-        Includes a provision that the supplemental payment can occur even if the amortization period for the UAAL exceeds 30 years as long as the retirement system preserves an 80% funded ratio.

-       Provides that the provisions of the bill expire on January 1, 2016.

FINDINGS AND CONCLUSIONS:

HB 103 provides for a one-time supplemental payment to eligible annuitants in an amount equal to the lower of their monthly benefit or $2,400. The supplemental payment would be made at the end of a fiscal year if the investment earnings of the fund exceed 8.0% during the preceding fiscal year by an amount large enough to pay the supplemental payment. The bill includes a provision that the supplemental payment could occur even if the amortization period for the UAAL exceeds 30 years as long as the retirement system preserves an 80% funded ratio. The provisions of the bill would expire on January 1, 2016.

According to the actuarial analysis, based on current projections from the 8/31/2012 valuation, including the State continuing to contribute less than the actuarially determined contributions rate, the TRS is expected to be marginally above 80% funded as of August 31, 2013 but below 80% funded on all valuation dates thereafter. The cost of the supplemental payment as described by HB 103 would be approximately $425 to $430 million in fiscal year 2014. Since the bill does not provide for increases in the contribution levels nor provide for decreases in the benefits during years when the contingent trigger is not met, the bill would only provide possible unfunded increases in the benefit streams; therefore, the bill cannot be defined as cost neutral.

According to the PRB actuary, the proposed bill would have the effect of increasing the TRS Net Pension Liability (NPL) as of August 31, 2015 (assuming the state follows the reporting standards required by GASB 68. The benefit provisions of the bill increase the plan's Actuarial Accrued Liability (AAL), thus directly increasing the August 31, 2015 Total Pension Liability (TPL) and NPL. Also, the closer projected asset exhaustion date would require a lower discount rate for calculating the Total Pension Liability, and thus a higher NPL. Note that increases in unfunded liabilities from benefit increases for retirees increase the NPL immediately, instead of being smoothed over a period of years. The full increase in liabilities is also added to the annual pension cost in the year of the increase.

METHODOLOGY AND STANDARDS:

The analysis and calculations are based on the member data of TRS as of August 31, 2012, the actuarial value of assets as of August 31, 2012, and the actuarial assumptions and methods in use as of August 31, 2012 for valuing the actuarial condition of TRS. Note that the analysis does not reflect the deferred asset losses of $7 billion that have yet to be recognized in the actuarial value of assets as of August 31, 2012. Nor does it include the results of the February 28, 2013 update to the 2012 actuarial valuation. The analysis assumes no further changes are made to TRS except for implementing permanent contingent supplemental payments and cautions that the combined economic impact of several proposals can exceed the effect of each proposal considered individually. According to the PRB actuary, the actuarial assumptions, methods and procedures 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.

SOURCES:  

Actuarial Analysis by, Linna Ye, A.S.A., Lewis Ward, Consultant, and Joseph P. Newton, F.S.A., Gabriel Roeder Smith & Company, February 11, 2013.

Actuarial Review by Mr. Dan P. Moore, Staff Actuary, Pension Review Board, April, 19, 2013.

Actuarial Accrued Liability (AAL) � the portion of the PVFB that is attributed to past service.

Actuarial Value of Assets (AVA) � the smoothed value of system's assets.

Amortization� the payment on the Unfunded Actuarial Accrued Liability (UAAL).

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 II benefits or state contribution rates if the result is an amortization period exceeding 30.9 years.

Cost Method � a method to divide the Present Value of Future Benefits (PVFB) into the Actuarial Accrued Liability (AAL), the Present Value of Future Normal Costs (PVFNC), and the Normal Cost (NC).

Funded Ratio (FR) � the ratio of the assets to the liabilities.

GASB 68 and related terminology� a statement of the Governmental Accounting Standards Board (GASB) concerning accounting for pension by governmental employers effective 6/30/2015 and later:

-       Net Pension Liability (NPL): The liability of employers and non-employer contributing entities for pension benefits shown on the entity's balance sheet for FYE 6/30/2015 and later. The NPL equals the TPL minus the market value of plan assets. (If plan assets exceed the TPL, there is a Net Pension Asset.)

-       Total Pension Liability (TPL): the portion of the actuarial present value of projected benefit payments attributed to past periods of employee service under the Entry Age Normal valuation method.

-       Discount Rate: A single rate used to discount the calculate the TPL which is equivalent to discounting future payments reflected in the TPL at the long-term expected rate of return until plan assets are projected to be exhausted, and discounting at the municipal bond rate for subsequent payments reflected in the TPL.

Market Value of Assets (MVA) � the fair market value of the system's assets

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.

Present Value of Future Benefits (PVFB) � the present value of all benefits expected to be paid from the plan to current plan participants.

Present Value of Future Normal Costs (PVFNC) � the portion of the PVFB that will be attributed to future years of service.

Unfunded Actuarial Accrued Liability (UAAL) � 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.