Austin, Texas
May 4, 2015

Honorable Dan Flynn, Chair, House Committee on Pensions
Ursula Parks, Director, Legislative Budget Board
HB45 by Martinez, "Mando" (Relating to a cost-of-living increase applicable to benefits paid by the Teacher Retirement System of Texas.), As Introduced

According to the Pension Review Board (PRB) actuarial review, the Teacher Retirement System of Texas (TRS) is currently actuarially sound. However, the bill would establish a permanent triggering mechanism for implementing a COLA which is difficult to value, and if enacted, could make TRS actuarially unsound. Under the current PRB Guidelines for Actuarial Soundness, funding should be adequate to amortize the unfunded actuarial accrued liability over a period which should not exceed 40 years, with 15 - 25 years being a more preferable target (TRS has a 31-year amortization-limit set in statute applicable to benefit or funding changes.) Additionally, the PRB Guidelines state that benefit increases should not be adopted if all plan changes being considered cause a material increase in the amortization period and if the resulting amortization period exceeds 25 years. The current TRS amortization period is already above 25 years.

As a point of reference, the actuarial analysis presents the cost of granting a COLA indexed to 100 percent of CPI (assumed to represent 3 percent annual inflation) resulting in an increase in the unfunded actuarial accrued liability (UAAL) of $52.7 million, a drop in the funded ratio from 80.4 percent to 60.8 percent, and a return in the amortization period to infinite. A State contribution rate of 17.41 percent of payroll would be required to fund an actuarially sound contribution rate in order to return to a 30-year funding period.

As the bill provides only possible benefit increases and no decreases, it is not cost neutral. As any reasonable COLA assumption would increase the funding period (currently 29.3 years) to 31 or more years, the actuarial analysis concludes that the statutory restriction on benefit increases applies, and passage of the bill is not allowed under Government Code Section 821.006.

The bill provides for an annual COLA for current and future retirees equal to the automatic COLA made by the U.S. Social Security Administration. The first COLA increase would be granted on January 1, 2016, and subsequent COLAs could be granted each year on January 1. Additionally, the bill specifies that the COLA for a specific year would only be paid if the TRS Board finds the retirement system to be actuarially sound and that it has enough money to increase benefits that year. The bill provides for a partial COLA if the full COLA is unavailable. The bill would take effect immediately upon receiving two-thirds majority vote in each house. Otherwise, the bill would take effect September 1, 2015.

If future COLAs are assumed, then the funding period is in excess of 30 years by one or more years and thus no COLAs would be paid. However, if there are no COLAs assumed to be paid then the funding period reverts back to a number that would meet the actuarially sound requirement, and thus COLAs could be paid. The actuarial analysis states that this type of circular logic makes the type of COLA provision created by the bill difficult to measure.

The TRS actuarial analysis notes that other states and municipalities have used this type of COLA provision to avoid pre-funding them. These types of COLAs are considered 'ad-hoc' COLAs (because they are not guaranteed to be paid), even though there is an automatic trigger to pay them. The actuarial analysis states that this type of provision is one of the largest contributing factors toward the poor funding of many public funds across the country.

The PRB actuarial review states that the bill is essentially designed to move the plan's amortization period to 30.9 years by adjusting monthly benefits upward by a full or partial percentage of the CPI COLA every year when the plan's amortization period (calculated without that year's COLA) is less than 31 years, assuming that the COLA is valued as an ad hoc adjustment (not assumed to ever be repeated). In years when the amortization period (calculated without that year's COLA) equals or exceeds 31 years, no COLA would be implemented. The actuarial analysis takes the approach that the effect of this bill should not be valued on an ad hoc basis, but rather on a permanent basis (described in the Actuarial Standards of Practice as 'difficult to value'). The PRB agrees that this approach is reasonable. The bill would establish a permanent triggering mechanism for implementing a COLA. As a result of not ignoring subsequent future COLAs to be triggered under the bill, the actuarial analysis concludes that on any reasonable basis, the bill has a material (negative) effect on the actuarial soundness of TRS, and the amortization period would exceed 31 years. Hence, the statutory restriction on benefit increases would apply, and passage of the bill would not be allowed.

In addition, the PRB actuarial review states that, under GASB 68, once the COLA was paid out with sufficient frequency to be considered 'substantially automatic', estimated future COLAs would have to be reflected in the accounting liabilities (Total Pension Liability and Net Pension Liability) of the State. Therefore, the COLA would have to be assumed to be a permanent part of the plan and the liability for the COLA would have to be disclosed for accounting purposes. This bill would impact current retirees (as of December 31, 2015) and future retirees.

The TRS actuarial analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the TRS actuarial valuation for August 31, 2014 and their mid-year valuation as of February 28, 2015. 

According to the PRB actuary, the actuarial assumptions, methods and procedures used in the analysis 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. This analysis is based on the assumption that no other legislative changes affecting the funding or benefits of TRS will be adopted. It should be noted that when several proposals are adopted, the effect of each may be compounded, resulting in a cost that is greater (or less) than the sum of each proposal considered independently.

Actuarial Analysis by Actuary, Lewis Ward and Joseph P. Newton, FSA, Gabriel Roeder Smith & Company, April 28, 2015.
Actuarial Review by Daniel P. Moore, FSA, EA, MAAA, Staff Actuary, Pension Review Board, May 1, 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 Liabiliy (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. An amortization period of 0-15 years is also a more preferable target. 
Actuarial Cost Method • A method used by actuaries 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).
COLA • Cost-of-Living Adjustment. 
Funded Ratio (FR) • The ratio of 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.
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, AM, PFe, KFa