TO:	Honorable Rafael Anchia, Chair, House Committee on Pensions, Investments & Financial Services
FROM:	Jerry McGinty, Director, Legislative Budget Board
IN RE:	HB672 by Martinez (Relating to cost-of-living increases applicable to benefits paid by the Teacher Retirement System of Texas.), As Introduced

ACTUARIAL EFFECTS

The bill would amend the Government Code to establish an annual automatic cost-of-living adjustment (COLA), equivalent to the annual increase in United States Social Security benefits (the actuarial analysis assumes it to be equal to the valuation inflation assumption, or 2.3 percent per annum), for all current and future retirees. The COLA would only be granted when the Teacher Retirement System (TRS) board finds the system actuarially sound and has money available to pay the increased benefit. The Pension Review Board's (PRB) actuarial review notes that the bill would have a significant negative impact on the long-term funding of the retirement system.
 
The actuarial analysis states that the automatic trigger to provide the COLA coupled with the restriction to only provide the COLA when it is possible for the system to remain actuarially sound following the increase creates a benefit that is difficult to value.  However, because the bill does not provide for decreases in the benefits but only provides for potential increases, it is not possible to define the bill as cost neutral. Therefore, the COLA provisions must have some value and any reasonable COLA assumption would increase the funding period beyond 31 years and passage of the bill would violate Government Code 821.006 (b), which relates to action increasing the amortization period of TRS.
 
The actuarial review states under the current PRB Pension Funding Guidelines, funding should be sufficient to cover the normal cost and to amortize the unfunded actuarial accrued liability (UAAL) over as brief a period as possible, but not to exceed 30 years, with 10 - 25 years being the preferable target range. TRS statute defines actuarial soundness, for purposes of making modifications to benefit and contribution levels, as no more than 31 years. TRS is currently actuarially sound, with an amortization period of 26 years. TRS would be actuarially unsound following the passage of the bill.
 
SYNOPSIS OF PROVISIONS
 
The bill would establish an automatic COLA for current and future annuitants equal to the automatic COLA made by the U.S. Social Security Administration. Each year, during the last seven days of October, the TRS board would set the COLA rate for the next calendar year to equal the annual percentage increase, if any, in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).  A COLA for a specific year would only be paid if the TRS board found the retirement system to be actuarially sound. If the system is actuarially sound, but the money available is not sufficient to pay the full amount of the COLA, the board would provide a partial amount to allow the system to remain actuarially sound after granting the partial COLA.  The first COLA would be granted on January 1, 2022, and subsequent COLAs could be granted each year on January 1.
 
FINDINGS AND CONCLUSIONS

The analysis states that for the bill to meet funding period requirement of the TRS governing statute, it would require an immediate increase in contributions of 10 percent of payroll, allowing TRS to make regular COLAs. This would increase the UAAL by approximately $52 billion while lowering the funded ratio to 62.4 percent. 
 
Lastly, according to PRB, the actuarial analysis notes that an attempt to value this benefit using traditional actuarial methodologies can lead to circular logic where assuming the COLA is paid results in an amortization period that would not allow the COLA to be paid, while assuming the COLA is not paid results in triggering the provision requiring the COLA to be paid and is therefore difficult to measure.
 
GOVERNMENTAL ACCOUNTING STANDARDS BOARD (GASB) EFFECTS

The actuarial analysis notes that a pattern of providing benefit enhancements could be deemed to be substantially automatic and thus the advance recognition of other likely future enhancements would be reflected in the Net Pension Liability (NPL) on the State's balance sheet. Additionally, the NPL on the State's balance sheet will increase by its proportionate share of the enhancement. The state would be allocated 55 percent of that and the remaining 45 percent would be allocated to participating employers.
 
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 valuation for February 28, 2021.  According to the PRB actuary, the actuarial assumptions, methods and procedures are reasonable for the purpose of this analysis. 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 assumes 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 Daniel Siblik, ASA, and Joseph P. Newton, FSA, Gabriel Roeder Smith & Company, April 2, 2021.
Actuarial Review by Kenneth J. Herbold, ASA, EA, MAAA, Staff Actuary, Pension Review Board, April 3, 2021.

GLOSSARY

Actuarial Accrued Liability (AAL) -The current value of benefits attributed to past years.
Actuarial Value of Assets (AVA)- The value of assets used for the actuarial valuation. The AVA can be either the market value (MVA) or a smoothed value of assets.
Amortization Payments - The portion of the total contribution used to reduce the unfunded actuarial accrued liability (UAAL).
Amortization Period - The specified length of time used when calculating the amortization payment portion of an actuarially determined contribution, or as the time it would theoretically take to fully fund the UAAL or fully recognize a surplus. The PRB recommends that funding should be sufficient to cover the normal cost and to amortize the UAAL over as brief a period as possible, but not to exceed 30 years, with 10-25 years being the preferable target range.
Actuarial Cost Method - An actuarial cost method is a way to allocate pieces of a participant's total expected benefit to each year of their working career. In other words, it is a technique to determine how much of the present value of future benefits (PVFB) to assign to past service (AAL) vs. future service (present value of future normal costs, or PVFNC).
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 June 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 June 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) - Computed differently under different actuarial cost methods, the normal cost generally represents the current value of benefits attributed to the present year. The employer normal cost equals the total normal cost of the plan reduced by employee contributions.
Present Value of Future Benefits (PVFB) - The current value of all benefits expected to be paid from the plan to current plan participants.
Present Value of Future Normal Costs (PVFNC) - The current value of benefits attributed to the present year and all future years (includes the normal cost as the first year).
Unfunded Actuarial Accrued Liability (UAAL) - The difference between the actuarial accrued liability and the actuarial value of assets; therefore, the UAAL is the amount that is still owed to the fund for past obligations.