Austin, Texas
April 29, 2015

Honorable Joan Huffman, Chair, Senate Committee on State Affairs
Ursula Parks, Director, Legislative Budget Board
HB9 by Flynn (Relating to member contributions to the Employees Retirement System of Texas.), As Engrossed

The increased contribution rate under the bill would have a material positive impact on the actuarial soundness of ERS, changing its amortization period from infinite (never) to 34 years, based on the mid-year valuation as of February 28, 2015.


                                                     Employees' Retirement System of Texas
                                                    Projected for Fiscal Year 2016 and Beyond
  Current (Projected 08/31/2015 Valuation) Proposed Difference
State Contribution 7.50% 9.50% 2.00%
Employee Contribution 7.20% 9.50% 2.30%
State Agency Contribution 0.50% 0.50% 0.00%
Total Contribution* 15.20% 19.50% 4.30%
Normal Cost (% of payroll)** 11.58% 12.26% 0.68%
Unfunded Actuarial Accrued Liability (millions)** $8,078.90 $8,029.60 ($49.30)
Amortization Period (years) Infinite (Never) 34 NA
Funded Ratio 76.40% 76.50% 0.10%
Projected Estimated Fund Exhaustion Date Yes No NA
*The actuarial analysis assumes that the member (employee class and elected class, including members of the legislature) contribution rate increase to 9.50 percent proposed by the bill would be accompanied by an increase in the combined State and state agency contribution rate of 10.00 percent (9.50 percent State, 0.50 percent state agency) for fiscal year 2016 and beyond. 
**The increase in the normal cost rate and the slight decrease in the unfunded actuarial accrued liability (UAAL) are based on the assumption that a greater proportion of employee class members would terminate and elect to get a refund of their accumulated employee contributions instead of a deferred pension. The actuarial analysis projects that the bill would increase the normal cost rate due to the increase in future refunds of employee contributions.

The Employees Retirement System (ERS) total contribution rate for fiscal year 2016 is 15.20 percent. Based on the February 28, 2015 update of the August 31, 2014 valuation, the UAAL will never be amortized (infinite amortization period) with a 15.20 percent contribution rate. As of the projected August 31, 2015 valuation results, the total contribution rate necessary for ERS to fund the normal cost and achieve a 31-year amortization period is 19.11 percent of payroll. Assuming the State contributes 9.50 percent for fiscal year 2016 and thereafter, the bill would increase the total contribution rate to 19.50 percent in fiscal year 2016 and beyond, and significantly improve the amortization period for the retirement system, as of the February 28, 2015 valuation, to 34 years. The actuarial analysis states that an amortization period of 34 years is a significant improvement from the current infinite (never) amortization period. Further, an amortization period of 34 years indicates that ERS would be expected to meet the 31-year amortization limit set in its statute within three years. 

The actuarial review also states that ERS is currently actuarially unsound. The increased contribution rate would make ERS actuarially sound with a 34 year amortization period. Under the current Pension Review Board (PRB) Guidelines for Actuarial Soundness, funding should be adequate to amortize the UAAL over a period which should not exceed 40 years, with 15-25 years being a more preferable target. The PRB projects that the total contribution rate of 19.50 percent would make ERS's amortization period meet the PRB Guidelines.

The bill would amend Government Code to increase the employee contribution rate for ERS members who are not legislators from 7.2 percent to 9.5 percent and for legislators from 8.0 percent to 9.5 percent of the member's compensation for service after August 31, 2015. The contribution rate increase applies to both the employee class and the elected class, including members of the legislature. Additionally, for service rendered on or after September 1, 2017, the employee contribution rate of 9.5 percent for ERS members who are not legislators would be reduced by one-tenth of a percent for each corresponding one-tenth of a percent reduction in the State contribution. This bill would become effective September 1, 2015.
Although not part of the bill, the actuarial analysis was prepared based on the understanding that the State and agency contribution would be increased to 10.0 percent (9.5 percent from the State, and 0.5 percent from state agency appropriations), also for service after August 31, 2015.
According to the actuarial analysis, the bill would increase, by 0.68 percent of payroll, the total normal cost rate of ERS from 11.58 percent to 12.26 percent. This increase in the normal cost rate would cause the actuarially sound contribution rate to increase from 19.11 percent to 19.75 percent of payroll. The proposal would slightly improve the funded ratio of the system from 76.40 percent to 76.50 percent.

Additionally, the actuarial analysis discusses the cost-of-living adjustment (COLA) under Texas Government Code Section 814.604. This COLA is required to be made to certain retiree benefits when ERS's amortization period is less than 31 years. At that time, the increase in liability associated with the COLA will increase the plan's amortization period by approximately one year.

The actuarial review states that any proposed increase in pay for ERS active members coinciding with the increase in member contribution rate could slightly increase ERS's amortization period. The actuarial review also notes that the bill increases the plan funding security for all ERS members.

Although not discussed in the actuarial analysis, the passage of the bill (together with an increase in the State plus agency contribution rate to 10 percent) would have a positive impact on ERS and the State under the new Governmental Accounting Standards Board (GASB) reporting standards (GASB 67 & 68). The increase in the total contribution rate to 19.50 percent may have the effect of reducing the 8/31/2015 ERS Net Pension Liability (NPL) from its $14.5 billion (as of 8/31/14) level. The PRB believes that for GASB purposes, the State will be able to project future State, member and agency funding at the contribution rates put into effect for fiscal year 2016. The likely result, if the total contribution rate is increased to 19.50 percent, is that no fund exhaustion date or blended discount rate (lower than the assumed rate of return) will be used. In that case, the ERS NPL will be lower than the $14.5 billion (as of 8/31/2014) level and will be equal to the Entry Age Normal unfunded actuarial accrued liability on a market value of assets basis.

The analysis assumes no further changes are made to ERS and cautions that the combined economic impact of several proposals can exceed the effect of each proposal considered individually.  The ERS analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the ERS actuarial valuation for August 31, 2014 and mid-year valuation as of February 28, 2015. According to the PRB actuary, the actuarial assumptions, methods and procedures used in the analysis appears 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. 
Actuarial Analysis by Mr. R. Ryan Falls, FSA, EA, MAAA and Mr. Joseph P. Newton, FSA, EA, MAAA; Senior Consulting Actuaries, Gabriel Roeder Smith & Company, April 21, 2015.
Actuarial Review by Robert M. May, FSA, EA, MAAA, Board Actuary; and Mr. Daniel P. Moore, FSA, EA, MAAA, Staff Actuary, Pension Review Board, April 28, 2015.
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 Payments - The yearly payments made to reduce the Unfunded Actuarial Accrued Liability (UAAL).
Amortization Period - The number of years required to pay off the unfunded actuarial accrued liability. The State Pension Review Board recommends that funding should be adequate to amortize the UAAL over a period which should not exceed 40 years, with 15-25 years being a more preferable target. 
Actuarial Cost Method - A method used by actuaries to divide the Present Value of Future Beneits (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 actuarial assets to the actuarial accrued liabilities.
GASB 68 and related terminology - A statement of the Governmental Accounting Standards Board (GASB) concerning accounting for pension by governmental employers effective for FYE 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 and 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 (NC) - The portion of the PVFB that is attributed to the current year of service. ERS uses the Ultimate Entry Age Normal Cost Method for funding.  
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 Actuarial Accrued Liability (AAL) less the Actuarial Value of Assets (AVA).

Source Agencies:
338 Pension Review Board
LBB Staff:
UP, EP, EMo, KFa