TO:	Honorable Rafael Anchia, Chair, House Committee on Pensions, Investments & Financial Services
FROM:	Jerry McGinty, Director, Legislative Budget Board
IN RE:	HB3375 by Davis (Relating to certain benefits payable by the public retirement systems for police and fire fighters in certain municipalities.), As Introduced

COST ESTIMATE

Based on the January 1, 2020 Actuarial Valuation and projected as of January 1, 2022.

Dallas Police & Fire Pension System (DPFPS)	Current	Proposed	Difference
Actuarial Accrued Liability (AAL) (millions)	$4,822	$3,888	($934)
Actuarial Value of Assets (AVA) (millions)	$1,984	$930	($1,054)
Unfunded Actuarial Accrued Liability (UAAL) (millions)	$2,838	$2,959	$121
AVA Funded Ratio	41.10%	23.90%	-17.20%
Actuarial Soundness	Unsound	Unsound	N/A

 
ACTUARIAL EFFECTS

The actuarial analysis notes that if all assumptions are met exactly each year the system may not become insolvent if the bill is passed as long as the market value of assets earns at least 5.25 percent in 2021, 5.75 percent in 2022, 6.25 percent in 2023, and 7.00 percent in each year thereafter. However, even under these assumptions if the bill is enacted the funded ratio would drop below 20 percent for the 28-year period from January 1, 2024 through January 1, 2051 and under 10 percent for the period January 1, 2034 through January 1, 2043. The market value of assets would also be expected to decline to less than one-fifth of their value as of January 1, 2020.

The Pension Review Board (PRB) actuarial review cautions that the projections provided by the actuarial analysis indicating the retirement system may not run out of money are based on a projection of achieving a 7 percent return on assets in nearly every single year other than those noted above. Another approach to truly measure the risk associated with the provisions of the bill would look at the probability of running out of money given a stochastic analysis of expected returns and considering the significant risk to the retirement system in attempting to maintain cash flow and prevent losses.

The actuarial review further 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.  Dallas Police & Fire Pension System (DPFPS) is currently unsound. Under the bill, DPFPS would continue to be unsound, projecting to be fully funded by 2077.

SYNOPSIS OF PROVISIONS
 
The bill would amend Vernon's Texas Civil Statutes, Article 6243a-1, to make changes to the distribution of benefits for DPFPS.  The bill would allow a person who was eligible to receive a monthly death benefit to elect to receive a partial lump-sum distribution in the event of an unforeseeable emergency or financial hardship as long as the benefits that would have been received otherwise are reduced accordingly. A surviving spouse or other beneficiary would also be allowed to receive a partial lump-sum payment of the member's Deferred Retirement Option Plan (DROP) balance due to an unforeseeable emergency or hardship. The DPFPS board would be required to adopt rules to define the types of death benefits that may receive the lump-sum option, the maximum amount of the lump-sum, and what constitutes an emergency and a financial hardship to become eligible to receive the lump-sum payment.

Additionally, the bill would allow a member to elect to receive their DROP benefit upon leaving active service in the form of a single-sum distribution or as a monthly or annual annuity to be paid over the life expectancy of the member. The member may choose to defer payment any time prior to April 1 of the year after the member is 70 1/2 years of age. Finally, the bill would allow retirees already receiving a distribution of their DROP benefit in the form of an annuity, who were subject to the current statute effective September 1, 2017 through September 1, 2021, a one-time election to receive a lump-sum distribution of their benefit. The Board would be required to establish rules for the process that would allow eligible members to receive the distribution.

FINDINGS AND CONCLUSIONS

The actuarial review states, given the funded status of the plan, liquidity is a significant concern. The 2017 legislative reform addressed this potential problem by eliminating the ability of plan participants to take lump sum payments of the DROP accounts, which represent a significant portion of total plan assets. The bill would reverse that change and very likely subject the plan to a significant, immediate reduction in its assets forcing the plan to liquidate assets without realizing their full potential and expected return.

Further, given the current funded status of the plan and the already significant negative cash flow, the use of a 7 percent assumed rate of return to value the liabilities seems optimistic. The actuary acknowledges this is not a likely return in the near-term by using a lower assumed rate of return to project the expected assets, which implies all other years would be expected to earn greater than 7 percent to make up the difference. While a standard outlook would indicate a 7 percent discount rate is reasonable, the extreme nature of DPFPS' expected cash flow likely warrants a more conservative approach to determining a reasonable discount rate. A lower rate would illustrate the plan is at even greater risk of experiencing a lower funded ratio and longer expected funding period than the current valuation and projection indicates. The bill would indirectly impact current and future members of the plan by providing them with different payment options regarding their DROP account or death benefit payment.

METHODOLOGY AND STANDARDS

The DPFPS analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the DPFPS actuarial valuations for January 1, 2020, except 100 percent of members currently in DROP are assumed to retire immediately, 100 percent of future eligible members are assumed to elect to enter DROP, 100 percent of current retirees and beneficiaries and 100 percent of future retirees are assumed to elect a lump sum distribution of DROP benefits and members who participate in DROP are assumed to retire after 10 years of participation in the program.

According to the PRB actuaries, 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 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 Jeffrey S. Williams, FCA, ASA, MAAA, Segal, April 13, 2021.
Actuarial Review by Marcia Dush, FSA, EA, MAAA, Board Actuary; and Kenneth J. Herbold, ASA, EA, MAAA, Staff Actuary, Pension Review Board, April 14, 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 State Pension Review Board 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.
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.