TO:	Honorable Joan Huffman, Chair, Senate Committee on State Affairs
FROM:	Ursula Parks, Director, Legislative Budget Board
IN RE:	HB3158 by Flynn (Relating to the retirement systems for and the provision of other benefits to police and fire fighters in certain municipalities; creating a criminal offense.), As Engrossed

The following information was supplied by Agency 338 - Pension Review Board:

HB 3158, as engrossed, would make significant changes to Article 6243a-1, Title 109 Revised Civil Statutes (affecting the Dallas Police and Fire Pension System (DPFPS)) to increase both employee and City of Dallas (City) contributions; modify future benefit accruals; provide a retroactive multiplier increase for certain members; modify DROP participation and cost of living adjustments; make changes to the composition and governance structure of the DPFPS board (board); and require the establishment of an investment advisory committee. Article 6243a-1 establishes the basic governing structure of the DPFPS. While changes to the benefit structure can be made by the Legislature or members of the system, the employee contributions may only be modified by the Legislature, whereas City contributions can be modified by the Legislature or a majority vote of the City voters.

 

The proposed changes to the bill, if enacted, would significantly improve the actuarial soundness of the system. Under the existing plan structure, the plan is expected to become insolvent within the next 10 years. While the bill does not immediately bring the amortization period down to 40 years, which is the maximum recommended amortization period according to PRB Guidelines for Actuarial Soundness currently in effect, it sets the system on a path to full funding within a finite period.

 

The following table outlines the changes between the current plan and HB 3158, as engrossed:

 

* Amount is a percentage of total pay for the Current Plan scenario and a percentage of computation pay for the If Bill Enacted scenario. The If Bill Enacted scenario does not include additional $11 million annual contributions.

** Based on estimated 2017 computation pay of $392 Million as provided by the City.

*** Takes into account the additional $11 million annual contribution for the period October 1, 2017 - September 30, 2019 under the If Bill Enacted scenario, but assumes the $11 million will not be contributed in future years when the amortization period falls below 35 years.

 

ACTUARIAL EFFECTS

The actuarial analysis provided by the plan's actuary states that although the retirement system is not projected to reach 100% funding within 30 years, it is projected to eventually become fully funded.  The plan's actuary further states that currently the System is projected to become insolvent within the next 10 years. PRB's actuarial review states that the bill would make the retirement system less unsound and would set it on a path to full funding within a finite period.

 

The actuarial review notes that as part of raising the City's contribution requirement, the bill establishes a contribution policy for the City that is worth noting. The bill would increase the City's contribution rate to 34.5% of aggregate computation pay paid to members and an additional annual contribution equal to $11 million, but only for the period of October 1, 2017 through September 30, 2019. For periods beginning October 1, 2019, the $11 million additional annual contribution would only be required when the amortization period is less than or equal to 35 years. This means that the City contribution would be a fixed percentage of pay plus a flat dollar amount per year. However, after the first two years, the City's flat dollar contribution is only required when the system has an amortization period under 35 years and is not required if the amortization period is over 35 years. In other words, the additional contribution is not made when there is a greater need for it.

 

The retirement system's actuarial analysis notes that effective October 1, 2019, the system is projected to have an amortization period above 35 years and therefore the additional $11 million annual contribution would no longer be required. Also, the actuarial analysis notes that if this contribution were made every year regardless of the calculated amortization period for that year, the amortization period reported as of January 1, 2017 would be 48 years.

 

Even though the bill indicates the additional $11 million annual contribution is required again once the amortization period is less than or equal to 35 years, the analysis assumes this contribution will not resume in the future. Based on the PRB's estimates, stopping the additional $11 million contribution effective September 1, 2019 and restarting it when the calculated amortization period decreases to 35 years (projected for 2036) would likely lower the estimated January 1, 2017 amortization period from 58 to 55 years.

 

The benefit and DROP distribution changes proposed in the bill would also improve the funded ratio of the plan from approx. 37% to 49%.

 

Below is a table of the total projected contribution amounts (City plus employee contributions) under the current plan and HB 3158, as engrossed:

 

 

 

Actuarial Assumptions and Methods

The actuarial review states that while the PRB believes a 2.25% assumed COLA would be more appropriate given the bill language, the use of a 2.0% assumed COLA is not unreasonable for the If Bill Enacted scenario the actuarial analysis uses a 2.0% COLA assumption for the If Bill Enacted scenario. Otherwise, the PRB actuaries noted in their review that the assumptions and methods used in the actuarial analysis are reasonable.

 

The assumptions and methods are the same as used in the January 1, 2016 actuarial valuation report except as noted in the following table.

 

Summary of Changes in Assumptions

 

Discount Rate

7.25% - same as the January 1, 2016 actuarial valuation

 

Investment Return

Market value returns assumed to be 5.00% in 2016, -1.74% in 2017, 5.00% in 2018, 6.50% in 2019, 7.00% in 2020, and 7.25% thereafter. Assumed rates of return were provided by the System.

 

Actuarial Value of Assets

Set equal to market value of assets

 

DROP Utilization

It is assumed that there will be no future entrants into DROP

 

Salary Increases

Select rates added for years 2016 - 2018.

 

2016 and 2018 - 10% if 0 - 10 years, 7% if 11 - 12 years, and 2% if 12 years

2017 - 5% if 0 - 10 years, 2% for all others

 

Current salary scale applies in 2019 and beyond

 

Payroll Growth Rate

4.25% in 2018; 2.75% in all other years

 

Overtime

The City is no longer assumed to contribute an amount 11% greater than computation pay for overtime work. This assumption does not impact benefits or liabilities.

 

Cost of Living Adjustment (COLA)

Two percent simple COLA assumed to be paid starting in 2047 and every year thereafter, based on the System's benchmark that the Plan must be at least 70% funded on a market value basis prior to and after a COLA is paid. Market returns must meet a certain level over a five-year period before COLA payments can be enacted; it is assumed these levels are met for purposes of these calculations.

 

Retirement Rates

Retirements are assumed to occur on January 1st.

 

In 2016, rates are increased by 5 percentage points for those participants who have been in DROP for six years or more.

 

Beginning in 2017, the current valuation retirement rates apply, with the following exception:

 

Current Active DROP Participants

-          If at least 8 years in DROP as of 1/1/2017, 100% retirement rate in 2018

-          If less than 8 years in DROP as of 1/1/2017, 50% retirement rate in 2018

 

Retirement Rates Beginning in 2018 for those not in DROP

 

Age	Tiers 1 & 2, <20 YOS as of 9/1/2017	Tier 1, at least 20 YOS as of 9/1/2017	Tier 3
<50	1%	1%	1%
50	10%	20%	5%
51	5%	10%	5%
52	5%	10%	5%
53	5%	10%	5%
54	5%	20%	10%
55	15%	40%	20%
56	10%	50%	30%
57	5%	50%	40%
58	60%	60%	50%
59	50%	60%	50%
60	50%	60%	50%
61	50%	60%	50%
62	100%	100%	100%

 

100% retirement assumed once total of benefit multipliers reach 90%.

 

Current terminated vested participants are assumed to retire at age 50.

 

Future terminated vested participants are assumed to retire at age 58.

 

DROP Distribution

Current retirees - For those who were retirees as of January 1, 2016, 57.50% of the January 1, 2016 balance was assumed to be paid out in 2016 and 10% of the January 1, 2017 account balance is assumed to be paid out in 2017. Beginning January 1, 2018, the remainder of the DROP accounts are assumed to be paid out over the expected lifetime of the participant upon their retirement based on the mortality tables in effect at the time of their retirement; the expected lifetime is currently assumed to be 23 years. It is understood that the actual date of the change in DROP account distributions may occur prior to January 1, 2018.

 

Current actives - 10% of the January 1, 2017 account balances are assumed to be paid out in 2017 for participants that retire in 2017. Beginning January 1, 2018, DROP accounts are assumed to be paid out over the expected lifetime of the participant upon their retirement, based on the mortality tables in effect at the time of their retirement; the expected lifetime is currently assumed to be 21 years if the Normal Retirement Age is 58. It is understood that the actual date of the change in DROP account distributions may occur prior to January 1, 2018.

 

DROP Account Interest

Current retirees - 2.75%;

 

Current actives - 2.75%; only the DROP account balance as of September 1, 2017 receives interest upon retirement. DROP contributions into existing DROP accounts after September 1, 2017 and future DROP participants receive 0% interest during the DROP and upon retirement.

 

SYNOPSIS OF PROVISIONS

HB 3158, as engrossed, would amend and add sections to Title 109, Revised Civil Statutes Article 6243a-1 to reduce benefits (summarized in the table below), increase both employee and City contributions, change the board's composition and governance structure, and require the creation of an investment advisory committee.

 

Board Composition

The bill would change the board composition by establishing new requirements for trustee positions.   The changes to the board are to be executed on the effective date of the bill.

 

Board Governance

The bill would clarify that the executive director is a fiduciary of the pension system, whereas currently the statute states that the “administrator” of the plan is not a fiduciary. The bill would require a two-thirds vote of the board to implement any rule change concerning board governance.

 

Also, the bill would require the PRB to review any board rule to determine that the implementation of the rule would not cause the amortization period to exceed 35 years. The PRB would also be entitled to all documents and other information provided by DPFPS to the public, which would then be subject to an independent review by the PRB. Any employee or other agent acting on behalf of DPFPS commits a Class B misdemeanor offense if the person knowingly provides false information to the PRB.

 

The bill would also require the board to adopt a code of ethics and require the board members to take pension-related training from a manual created by the DPFPS executive director.

 

City Contributions

The bill would require the City to make biweekly contributions to the system of 34.5% of aggregate computation pay paid to members with additional biweekly payments of 1/26 of $11 million between September 2017 and September 2019. The additional $11 million contribution would not be made if the unfunded actuarial accrued liability is not projected to be paid off within 35 years while including the $11 million contribution.

 

Investment Advisory Committee

The bill would require the board to establish an investment advisory committee. The committee would be composed of a majority of outside investment professionals, as well as sitting board members. The committee would review investment-related matters and make recommendations to the board. In addition, the bill would require a two-thirds vote by the board to approve each alternative investment.

 

Equitable Adjustments to Benefits

The bill would require the board to consider and adopt rules requiring the equitable return of funds paid or credited to the benefit of a member or a pensioner before 9/1/17, including the return of excessive interest credited to a member's DROP account and excessive adjustments made as disability or COLA benefits. The bill also outlines the adjudication process for any judicial challenges to the equitable return of funds as required by the board.

 

DROP Payment Options

A member who terminated service before 9/1/2017 shall have their DROP account annuitized in either monthly or yearly distributions based on the member's election. Additionally, a member who has a financial hardship that was not reasonably foreseeable may obtain a lump-sum distribution from the member's DROP account resulting in a corresponding reduction in the total number or amount of annuity payments. The board shall adopt rules regarding what constitutes an unforeseeable emergency or hardship, and in adopting the rules, the board shall provide flexibility to members.

 

Effective Date

Except as otherwise provided by the Act, the Act takes effect on September 1, 2017.

 

The following table outlines the primary changes to benefit provisions included in the bill.

 

Summary of Plan Changes

Normal Retirement Benefit

Eligibility

  Current          Tier 3: Age 55 and 10 Years of Service

  Proposed        Tier 3: Age 58 and 5 Years of Service

 

Amount

 Current          Tiers 1 & 2: 3.0% x Years of Service x Final Average Salary, no more than 96% x Final Average Salary or less than $2,200 per month (minimum is prorated for periods of service less than 20)

Tier 3: [Years of Service (up to 20) x 2.0% Years of Service (>20, <=25) x 2.5% Years of Service (>25) x 3.0%] x Final Average Salary, not less than $110 x Years of Service (up to 20)

 Proposed        Tiers 1 & 2: [3.0% x Years of Service (prior to September 1, 2017) Percent Multiplier (in table below) x Years of Service (after September 1, 2017)] x Final Average Salary, max is the greater of i. 90% or ii. the vested accrued benefit as of August 31, 2017

                                                                    

                                                                     Age at            Percent

                                                 Retirement       Multiplier

                                     57                2.40%

                                     56                2.30%

                                     55                2.20%

                                     54                2.10%

                           53 and younger     2.00%

 

                        Tier 3: Years of Service x 2.5% x Final Average Salary, max 90%

Final Average Salary

  Current          Tiers 1 & 2: Highest 36 month period

  Proposed        Tiers 1 & 2: Highest 36 month period for service prior to September 1, 2017 and highest 60 month period for service after September 1, 2017

Early Retirement Benefit

Eligibility

  Current          Tiers 1 & 2: Age 45 and 5 Years of Service or 20 Years of Service

                        Tier 3: N/A

Proposed        Tiers 1 & 2: Age 45 and 5 Years of Service, if 45 years or older as of September 1, 2017, age 53 and 5 Years of Service otherwise, or 20 Years of Service

Tier 3: Age 53 and 5 Years of Service or 20 Years of Service

Amount

 Current          Tiers 1 & 2 with 20 Years of Service - replace 3% multiplier with the following based on age at retirement:

                                    Age at

                                    Retirement       Multiplier

                                    48 & 49           2.75%

                                    47                    2.50%

                                    46                    2.25%

                                    45 or younger  2.00%

Tiers 1 & 2 with less than 20 Years of Service: Reduction equal to 2/3 of 1% per month retirement date precedes age 50.

  Proposed        Tiers 1 & 2 with 20 Years of Service accrued as of September 1, 2017 - replace 3% multiplier with the following based on age at retirement:

                       

Age at

                                    Retirement       Multiplier

                                    48 & 49           2.75%

                                    47                    2.50%

                                    46                    2.25%

                                    45 and younger            2.00%

All others with 20 Years of Service - replace 2.5% multiplier with the following based on age at retirement:

                                    Age at

                                    Retirement       Multiplier

                                    57                    2.40%

                                    56                    2.30%

                                    55                    2.20%

                                    54                    2.10%

                                    53 and younger            2.00%

 

With less than 20 Years of Service: Reduction equal to 2/3 of 1% per month retirement date precedes age 45 if 45 years or older as of September 1, 2017, age 53 otherwise.

            Unreduced at any retirement age if a member's pension is equal to 90% of Final Average Salary.

 

Supplemental Retirement Benefit

 Current          The greater of $75 per month or 3% of their Normal or Early Retirement Benefit, payable beginning at age 55

Proposed        Payable only to those receiving the supplement as of September 1, 2017

 

Vesting

  Current          Tier 3: 10 Year Cliff

  Proposed        Tier 3: 5 Year Cliff

 

Cost of Living Adjustment

  Current          Tier 1: 4.0% simple

  Proposed        If the plan is at least 70% funded after taking into account the COLA, a simple crediting rate on October 1 equal to 100% of the average annual rate of actual investment return for the five-year period ending on the preceding December 31 minus 5%, and not to exceed 4%, beginning at the earlier of age 62 or 3 years after retirement. (The actuarial analysis indicates the COLA is ad-hoc, however, it assumes a COLA is paid every year once the plan reaches the necessary funding target.)

 

Deferred Retirement Option Plan

Active

  Current          Interest credited is 6% effective October 1, 2016 dropping to 5% effective October 1, 2017 and variable based on the plans funded ratio thereafter.

                        Funded Ratio   Crediting Rate

                        >=95%             7.0%

                        90%-94%        6.5%

                        85%-89%        6.0%

                        65%-84%        5.0%

                        60%-64%        4.0%

                        55%-59%        3.0%

                        <55%               0.0%

COLA credited to account

No maximum participation period

May elect a lump sum distribution or leave up to 100% of account balance in plan at separation of service and continue to accrue interest credit

  Proposed       No interest credited to account

No COLA credited to account

10 year maximum participation period

DROP balance distributed over the life expectancy at separation of service,

DROP account balance as of September 1, 2017 will be annuitized using a rate on a United States Treasury or other federal treasury note with a reasonable duration, as determined by the Board.

           

Contributions

 Employee

   Current         8.5% for non-DROP active participants & 4.0% for DROP active participants

   Proposed       13.5% as of the effective date

 

 Employer

   Current         27.5% of pay

   Proposed       34.5% of computation pay plus $11,000,000 per year, subject to certain restrictions (34.5% of pay shall not be less than $5,173,000 for each of the bi-weekly pay periods ending during September 1, 2017 - December 31, 2017; $5,344,000 for each of the bi-weekly pay periods ending during January 1, 2018 - December 31, 2018; $5,571,000 for each of the bi-weekly pay periods ending during January 1, 2019 - December 31, 2019; and $5,571,000 increased by 2.75%, compounded annually, for each bi-weekly pay period ending during the calendar years thereafter.  Beginning September 1, 2019, for any year in which the 34.5% of pay plus $11 million is not sufficient to amortize the existing UAAL within a 35 year period, the city is not required to make the $11 million contribution.)

The contributions outlined above will remain in force as long as the system has a UAAL. If the plan is fully funded, contributions will be split equally between the city and members.

 

FINDINGS AND CONCLUSIONS

Given that the bill provisions for DPFPS would increase the total contribution rate and reduce current liabilities, it would increase the long-term funding security for all members of the affected retirement systems. It would impact all current and future active members because it increases the employee contributions for all groups of members. In addition, certain classes of active and inactive members are impacted by changes in plan provisions. Current active members would see changes to their prospective and retroactive benefit multiplier, as well as changes to retirement eligibility requirements and contribution requirements. Limits would be placed on the total DROP participation period and future interest accruals for current and future DROP participants. The bill would also make changes to future cost of living adjustments (COLA) that will impact current and future retirees and beneficiaries.

The actuarial analysis assumes a COLA of 2.0%, although given an assumed rate of return of 7.25%; the actuarial review determined that a 2.25% assumed COLA would be more appropriate. The PRB's actuaries do not have sufficient data to determine the magnitude of the impact of using a 2.25% assumed COLA, but this change would increase the projected liabilities and increase the calculated amortization period. However, the impact of an additional 0.25% simple COLA is likely to be small, given that the bill also requires the plan to be at least 70% funded prior to providing a COLA, and the actuarial analysis projects the plan will not be 70% funded until the year 2047.

 

The actuarial review states that the actuarial assumptions and methods are the same as used by Segal for the January 1, 2016 actuarial valuation, except as noted in the Summary of Changes in Assumptions table above. The assumptions and methods used by Segal are reasonable. Also, in the actuarial analysis, Segal uses a 2.0% COLA for the If Bill Enacted scenario. While the PRB actuaries believe a 2.25% COLA would be more appropriate given the bill language, the impact of this difference is expected to be small, and therefore, the use of a 2.0% assumed COLA is not unreasonable.

 

Finally, based on the results outlined in the actuarial analysis, DPFPS is likely to be subject to the Funding Soundness Restoration Plan (FSRP) requirements, as outlined in Texas Government Code Section 802.2015, once the January 1, 2017 actuarial valuation is finalized and will therefore need to make additional adjustments to contributions and/or benefits to further reduce their amortization period.

 

METHODOLOGY AND STANDARDS

 

According to the PRB actuaries, to the best of their knowledge, no material biases exist with respect to the data, methods or assumptions used to develop the analysis other than those specifically identified above and in the actuarial review. The PRB did not audit the information provided but has reviewed the information for reasonableness and consistency with other information provided by or for the affected retirement systems. The PRB is not responsible for the accuracy or completeness of the information provided to the agency. 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 DPFPS 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 Jeffery S. Williams, FCA, ASA, MAAA, EA, Vice President and Consulting Actuary, Segal Consulting, March, 31, 2017.

Actuarial Review by Robert M. May, FSA, EA, MAAA, Board Actuary; and Kenneth J. Herbold, ASA, EA, MAAA, Staff Actuary, Pension Review Board, April 13, 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 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).

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).