TO:	Honorable Joan Huffman, Chair, Senate Committee on State Affairs
FROM:	Ursula Parks, Director, Legislative Budget Board
IN RE:	SB2190 by Huffman (Relating to the public retirement systems of certain municipalities.), Committee Report 1st House, Substituted

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

CSSB 2190 would make significant changes to Articles 6243e.2(1) (affecting the Houston Firefighters' Relief & Retirement Fund (HFRRF)), 6243g-4 (affecting the Houston Police Officer's Retirement System (HPOPS)), and 6243h (affecting the Houston Municipal Employees Retirement System (HMEPS)), Revised Civil Statues, to immediately reduce benefits,increase employee contributions, outline funding policies, codify certain actuarial assumptions and methods for purposes of valuing benefits, and detail an approach to making modifications to the assumptions, methods and benefits under certain economic scenarios with the intent of minimizing the volatility of future contribution requirements for the affected retirement systems. Currently,the City of Houston's (the "City") contribution structure for HFRRF is outlined in its governing statute, and for HMEPS and HPOPS the contributions are established through the most recent meet and confer agreements with the City.

 

The proposed changes of the bill, if enacted, would help strengthen the long-term sustainability and improve the actuarial soundness of the affected retirement systems by lowering the current and future liabilities.

 

Background on Actuarial Analyses

It is our understanding that the actuarial analyses relating to CSSB 2190 provided for HPOPS and HMEPS have been completed based on the language developed during negotiations between the City and the respective system. The actuarial analysis provided by HFRRF relies on assumptions,methods, and plan provisions outlined in the July 1, 2016 valuation report which has not been provided to the PRB. In accordance with Texas Government Code Section 802.302(h), the PRB is also including the actuarial analysis prepared by Retirement Horizons Incorporated (RHI) at the direction of the City. In some cases, the plan provisions used in the analyses differ from the language included in CSSB 2190. The PRB has noted in the Synopsis of Provisions section these differences and have provided commentary in the Findings and Conclusions section regarding the potential impact of these differences.

Baseline and If Bill Enacted Scenarios

The following tables provide the key financial impact on HFRRF, HPOPS and HMEPS as provided in the actuarial analyses. The Baseline scenario utilizes assumptions, methods, and plan provisions described in the latest valuation reports from the systems (July 1, 2015 valuation reports for HFRRF (prepared by RHI for the City) and HMEPS and July 1, 2016 valuation report for HPOPS), with modifications, including a lowered 7.0% discount rate; the change from an open to a closed 30-year amortization period; and marking the assets to market.

 

Also, the Baseline scenario for HFRRF (prepared by Conduent) utilizes the assumptions, methods,and plan provisions described in the July 1, 2016 Valuation Report with smoothed value of assets as of July 1, 2016. The PRB has not been provided with a copy of this report, but has been informed that this valuation uses a 7.00%assumed rate of return and calculates the City contribution based on a 30-year closed amortization period beginning July 1, 2015 (i.e. a 29-year amortization period as of July 1, 2016).

 

 

The If Bill Enacted scenario shows the effect of the additional changes to assumptions, methods, increased employee contributions, and the decreased benefit provisions as contained in the bill.

 

The following tables outline the previously mentioned scenarios.

 

*The provision for administrative expenses expressed here exceeds the maximum allowable under the bill, which is 1.25%.

**The definition of payroll would be changed under the bill to exclude overtime. The City contribution has been calculated as a percentage of pensionable pay, excluding overtime for both the Baseline and If Bill Enacted scenarios.

***For comparison purposes, the total employer contribution has also been calculated as a percentage of gross pay (including overtime).

 

 

*Smoothed value of assets for the Baseline scenario and market value of assets for the If Bill Enacted scenario.

**The actuarial analysis does not indicate if there is an explicit assumption for administrative expenses under the Baseline scenario.

***The amortization payment for the Baseline scenario has been calculated using a 29-year amortization period as of July 1, 2016.

****The total employer contribution has been calculated as a percentage of gross pay(including overtime).

 

 

Both scenarios include the discounted value of expected POB proceeds ($750 million).

If Bill Enactedscenario includes the discounted value of expected POB proceeds ($250 million).

 

ACTUARIAL EFFECTS

PRB's actuarial review states that the affected retirement systems are currently identified as being actuarially sound under the PRB Guidelines for Actuarial Soundness. However, the City has stated that its pension liabilities for the three retirement systems have risen to $8.1 billion and it is facing the prospect of increasing costs that have the potential to outpace its ability to pay. The proposed changes help strengthen the long-term sustainability and improve the actuarial soundness of the affected retirement systems.

Also, the PRB actuarial review states that the differences in the bill provisions versus the provisions valued in the actuarial analyses would have no material impact on the conclusions regarding actuarial soundness. Further, while the bill requires voter approval for the issuance of POBs, the HPOPS and HMEPS actuarial analyses do not address the impact on future costs if the proceeds of the POBs are not received. However,if the POBs are not issued, the bill provides that the amortization schedule established for the initial liability layer should be adjusted beginning with the annual required contribution for the fiscal year ending June 30, 2019.Since the bill requires an automatic adjustment of the required contributions for HPOPS and HMEPS should the systems not receive the planned POB proceeds;the bill would still serve to improve the actuarial soundness of these two systems.

Corridor Midpoint

The bill establishes a unique funding policy that establishes a "target" contribution rate for the City, develops a minimum and maximum corridor around the City's target contribution rate, and defines steps that must be taken should the annual calculated contribution move outside this corridor. The following tables outline the projected corridor midpoint for the three systems.

 

 

 

 

 

Actuarial Assumptions and Methods

The PRB actuaries have also noted in their review that the non-prescribed assumptions and methods used in the other three actuarial analyses are reasonable. The bill mandates the use of the Ultimate Entry Age Normal (UEAN) cost method and a 7.00% assumed rate of investment return, rather than what the systems used in the most recently published actuarial valuations.

The PRB actuarial review noted that the HFRRF analysis prepared by Conduent relies on assumptions,methods, and plan provisions outlined in the July 1, 2016 actuarial valuation report and the changes proposed in the bill. The PRB has not received a copy of this report. Since the PRB actuaries have not had the opportunity to review the majority of the assumptions, methods, or plan provisions underlying the actuarial analysis, they are unable to speak to its reasonableness.

The Entry Age Normal (EAN) level percent of payroll cost method is a mathematical construct designed to spread the costs of a participant's total benefit as a level amount over their entire career. This is done by calculating an annual amount that will remain relatively constant when expressed as a percentage of pay, and be sufficient to fully fund the anticipated benefits when the participant separates service. This results in a relatively stable normal cost contribution requirement from year to year.

 

The PRB actuarial review further states that the UEAN cost method is a variation of the Entry Age Normal (EAN) cost method. The UEAN cost method calculates the total anticipated benefits, or Present Value of Future Benefits (PVFB), based on a member's actual benefit provisions, but calculates the future accruals or Present Value of Future Normal Costs (PVFFNC)using the benefit provisions for new hires. The Actuarial Accrued Liability(AAL) is the difference between the PVFB and PVFNC. The purpose of this approach is to produce a stable normal cost calculation over the anticipated careers of the entire population, not just over the individual participant's career. When comparing results between these two variations, the UEAN cost method will result in a higher AAL than EAN. However, this is offset by lower expected future normal costs. Both cost methods converge to the same values at the time the participant is expected to separate service.

 

The following tables show the changes to assumptions and methods for each system.

 

 

 

 

 

 

 

SYNOPSIS OF PROVISIONS

CSSB 2190 would amend and add sections to Title 109, Revised Civil Statutes Articles 6243e.2(1), 6243g-4, and 6243h to reduce benefits (summarized in tables below), increase employee contributions (summarized in tables below), outline funding policies, codify certain actuarial assumptions and methods for purposes of valuing benefits, and detail an approach to making modifications to the assumptions, methods and benefits under certain economic scenarios with the intent of minimizing the volatility of future contributions requirements for the affected retirement systems. The bill would also require the city to make contributions as outlined by the risk sharing sections.

 

Risk Sharing Corridor

The bill would set baseline assumptions in statute to implement the risk sharing corridor. The corridor sets a minimum and maximum city contribution rate. In a falling-cost environment, gains are used to accelerate the payoff of unfunded liabilities or reduce the interest rate. In arising-cost environment, adjustments are made to the amortization period,employee contributions, or benefits to reduce the city contribution rate.

 

Additional Reporting Requirements

The bill would add reporting requirements for the three systems, including the requirement to conduct actuarial experience studies at least once every four years with the first experience study for HPOPS and HMEPS published no later than September 30, 2022. The systems must also contract with an investment consultant to perform an audit on investments at least once every three years.

 

City Approval of POBs

The bill would amend Chapter 107, Local Government Code to require voter approval for POBs issued to fund the Houston pension systems.

 

Effective Date

Except as otherwise provided by the Act, the Act takes effect July 1, 2017 if it receives a vote of two-thirds of all the members elected to each house, or September 1, 2017.

 

It is our understanding the actuarial analyses provided for HPOPS and HMEPS have been completed based on the language developed during negotiations between the City and the respective system. The actuarial analysis provided by HFRRF relies on assumptions, methods, and plan provisions outlined in the July 1, 2016 actuarial valuation and the proposed legislation.In accordance with Texas Government Code Section 802.302(h), the actuarial analysis prepared by RHI is also included at the direction of the City. In some cases, the plan provisions uses in the analyses differ from the language included in the bill. We have noted the differences in the following tables, which outline the primary changes to benefit provisions.

 

 

 

FINDINGS AND CONCLUSIONS

Given that the bill provisions for the three retirement systems would strengthen the funding policy and reduce current liabilities, it increases the long-term funding security for all members of the affected retirement systems. It impacts all current and future active members because it increases the employee contributions for all three affected systems. In addition, certain classes of active and inactive members are impacted by changes in plan provisions.

 

As noted elsewhere, the benefit provisions valued under the actuarial analyses differ in various ways from the bill language. The PRB's impact statement reviews the benefit provisions evaluated by the actuarial analyses and does not review the additional bill provisions not reviewed in the actuarial analyses received by the PRB.  The differences are briefly noted below.

 

For the actuarial analysis of HFRRF prepared by RHI, we note four specific differences between the bill provisions and the actuarial analysis.  We do not have sufficient data to determine the direction or magnitude of the impact of these differences, but believe it would be small.

 

For HPOPS, we note three specific differences between the bill provisions and the actuarial analysis. We do not have sufficient data to determine the direction or magnitude of the impact of these differences, but believe it would be small.

 

In addition to these changes, there are additional considerations to note for both HFRRF actuarial analyses. The HFRRF analysis prepared by RHI relies on grouped census data for retirees, disabled members,beneficiaries, and members with deferred benefits, as well as aggregate DROP balances for inactive members as of from the July 1, 2015, provided by the HFRRF actuary. RHI also did not receive a formal actuarial communication from the HFRRF actuary to confirm the plan provisions or actuarial assumptions and methods being used. Given these issues, the actual costs and savings could be materially different from the results provided in the actuarial analysis provided by the City.

 

The HFRRF analysis prepared by Conduent relies on assumptions, methods, and plan provisions outlined in the July 1, 2016 actuarial valuation report and the changes proposed in the bill.

Based on the benefit provisions as provided in the other three analyses, the establishment of the Baseline scenarios, and assuming the issues raised specifically with the HFRRF analysis prepared by RHI would not result in a material difference in results, the actuarial analyses prepared by GRS and RHI provide a reasonable estimate of the changes due to the bill.

 

GASB EFFECTS

All three actuarial analyses include data showing impact on accounting information. The passage of CSSB 2190 with the assumption and benefit changes (lower discount rate, strengthened funding policy, employee contribution increases, and benefit reductions) is likely to have a positive impact on the retirement systems and the City under the Governmental Accounting Standards Board (GASB) reporting standards (GASB 67 & 68).   

 

 

 

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 analyses 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 HFRRF, HPOPS, or HMEPS 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

City of Houston Cost Analysis for HFRRF by David A Sawyer, FSA, EA, MAAA; and Carly A. Nichols, FSA, EA, MAAA, Retirement Horizons Incorporated, March 15, 2017.

HFRRF Actuarial Analysis by David L. Driscoll, FSA,EA, MAAA, FCA; and Janie Shaw, ASA, MAAA, Conduent Business Services, LLC,March 23, 2017

HPOPS Actuarial Analysis by Mark R. Randall, FCA, MAAA,EA; and Joseph P. Newton, FSA, EA, MAAA, Gabriel Roeder Smith & Company, March7, 2017.

HMEPS Actuarial Analysis by Lewis Ward; and Joseph P.Newton, FSA, EA, MAAA, , Gabriel Roeder Smith & Company, February 17, 2017.

Actuarial Review by Robert M. May, FSA, EA, MAAA,Board Actuary; and Kenneth J. Herbold, ASA, EA, MAAA, Staff Actuary, PensionReview Board, March 17, 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 - Theyearly payments made to reduce the Unfunded Actuarial Accrued Liability (UAAL).

Amortization Period - The numberof years required to pay off the unfunded actuarial accrued liability. TheState Pension Review Board recommends that funding should be adequate toamortize the UAAL over a period which should not exceed 40 years, with 15-25years being a more preferable target. An amortization period of 0-15 years isalso a more preferable target.  

Actuarial Cost Method - Amethod used by actuaries to divide the Present Value of Future Benefits (PVFB)into the Actuarial Accrued Liability (AAL), the Present Value of Future NormalCosts (PVFNC), and the Normal Cost (NC).

Funded Ratio (FR) - The ratioof actuarial assets to the actuarial accrued liabilities.

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

Total Pension Liability (TPL) - Theportion of the actuarial present value of projected benefit payments attributedto past periods of employee service under the Entry Age Normal valuationmethod.

Discount Rate - A single rate used todiscount and calculate the TPL which is equivalent to discounting futurepayments reflected in the TPL at the long-term expected rate of return untilplan assets are projected to be exhausted, and discounting at the municipalbond 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 portionof the PVFB that is attributed to the current year of service.

Present Value of FutureBenefits (PVFB) - The present value of all benefits expected to be paid fromthe plan to current plan participants.

Present Value of Future NormalCosts (PVFNC) - The portion of the PVFB that will be attributed to future yearsof service.

Unfunded Actuarial AccruedLiability (UAAL) - The Actuarial Accrued Liability (AAL) less the ActuarialValue of Assets (AVA).