Honorable Dan Flynn, Chair, House Committee on Pensions
FROM:
Ursula Parks, Director, Legislative Budget Board
IN RE:
HB260 by Martinez, "Mando" (Relating to a cost-of-living increase applicable to benefits paid by the Teacher Retirement System of Texas.), As Introduced
ACTUARIAL EFFECTS According to the actuarial review, the bill would establish a permanent triggering mechanism for implementing a cost of living adjustment (COLA) which is difficult to value, and if enacted, could make TRS actuarially unsound. Under the current PRB Pension Funding Guidelines, funding should be adequate to amortize the unfunded actuarial accrued liability (UAAL) over a period which should not exceed 30 years, with 10 - 25 years being a more preferable target.
The actuarial analysis presents the cost of granting a COLA equivalent to the automatic cost-of-living adjustment made by the U.S. Social Security Administration, which is assumed in the analysis to be equal to the valuation inflation assumption, or 2.5% per annum, as having the following impact: the UAAL would increase from $36.6 billion to $83.0 billion, the funded ratio would decrease from 79.5% to 63.1%, the amortization period would return to infinite, and the State's portion of the actuarially sound contribution rate would increase from the current 7.7% (the 7.7% includes the State's 6.8% plus the additional contributions made by employers that do not provide social security coverage which is assumed to be approximately 0.9% of total payroll) to 17.25%.
Therefore, the COLA provisions must have some value and any reasonable COLA assumption would increase the funding period above 30 by one or more years and passage of the bill would not be allowed under TRS funding statute, Texas Government Code Section 821.006.
SYNOPSIS OF PROVISIONS 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 could be granted on January 1, 2018 and subsequent COLAs could be granted each year on January 1st. Additionally, the bill specifies that 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 on the 91st day after the last day of the legislative session.
FINDINGS AND CONCLUSIONS The PRB actuarial review states that the bill attempts to create an ad-hoc COLA, but with a defined trigger and the likely result is the plan's amortization period would perpetually be adjusted 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. 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 states that this circular logic makes the type of COLA provision created by the bill difficult to measure. The actuarial analysis further 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 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.
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.
METHODOLOGY AND STANDARDS The TRS analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the TRS actuarial valuations for August 31, 2016, except the actuarial value of assets is calculated as of February 28, 2017.
According to the PRB actuaries, 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.
SOURCES Actuarial Analysis by Lewis Ward and Joseph P. Newton, FSA, Gabriel Roeder Smith & Company, 4/26/2017.
Actuarial Review by Kenneth J. Herbold, ASA, EA, MAAA, Staff Actuary, Pension Review Board, 8/2/2017.
GLOSSARY 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 30 years, with 10-25 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).
Funded Ratio (FR) - The ratio of actuarial assets to the actuarial accrued liabilities.
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).