TO:	Honorable Rafael Anchia, Chair, House Committee on Pensions, Investments & Financial Services
FROM:	Jerry McGinty, Director, Legislative Budget Board
IN RE:	HB3397 by Murphy (Relating to contributions to the Employees Retirement System of Texas.), As Introduced

COST ESTIMATE

Based on the February 28, 2021 Actuarial Valuation update.

Employees Retirement System of Texas	Current	Proposed	Difference
Employee Contribution	9.50%	9.50%	0.00%
Employer Contribution	10.00%	15.96%	5.96%
Total Contribution	19.50%	25.46%	5.96%
Amortization Period (years)	Infinite	31	N/A

 
ACTUARIAL EFFECTS
The bill would direct the Employees Retirement System of Texas (ERS) board to adopt an actuarially determined contribution (ADC), consisting of both normal cost and the amount needed to fully fund the system within 31 years. The board would determine how the contribution rate would be split between the employer and member. The actuarial analysis assumes the ERS board would increase the state contribution by 5.96% for the biennium, for a total actuarially sound contribution rate of 25.46%. The analysis further assumes the legislature will appropriate the necessary funds to pay for the total contribution increase for the biennium and the Constitutional ceiling would not prevent the necessary increase in contributions.

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. ERS statute defines actuarial soundness, for purposes of making modifications to benefit and contribution levels, as no more than 31 years. ERS is currently actuarially unsound, with an infinite amortization period. The projected funding period would decrease to 31 years following the passage of this bill.
 
SYNOPSIS OF PROVISIONS
The bill would require the ERS actuary to calculate an ADC rate and recommend to the board for review and adoption the state and member contribution rates. The ADC rate will be apportioned among members, the state, and employers so that the member contributions do not exceed 50% of the ADC rate. The ADC rate must be based on reasonable actuarial assumptions and methods and the funding policy adopted by the board under Government Code Section 802.2011.
The bill would direct the ERS board to adopt an ADC rate, consisting of both normal cost and the amount needed to fully fund the system within 31 years, beginning September 1, 2021.
 
FINDINGS AND CONCLUSIONS
The actuarial analysis indicates that an ADC funding process provides the system the ability to effectively manage total financial risk and results in a more sustainable pension system. It further notes that plans that consistently receive a reasonable ADC have successfully withstood negative plan experience while plans that do not, including ERS, have generally experienced a decline in their funded status.

The actuarial analysis notes the bill would increase total contributions by approximately $900 million for the biennium, but increases in contributions now are expected to result in significant cost savings over the long-term. For example, if the current contribution rate remains in effect, the trust is expected to be depleted becoming a pay-as-you-go system and the unfunded liability will continue to grow, resulting in over $1 trillion in interest charges over the next 100 years. Alternatively, if the contribution is increased to the tread-water rate (the rate needed to simply avoid fund depletion) of 22.22%, total interest charges would be approximately $303 billion instead of $1 trillion, cost savings of nearly $700 billion over the next 100 years. Furthermore, increasing to the current ADC rate of 25.46% decreases total interest charges to $27 billion.

The analysis further highlights the cost associated with making the change now versus waiting until the next biennium. In that case, the additional $900 million that was not contributed would increase total costs by $3.9 billion over a 31- year period.  In other words, any dollar not contributed this biennium will ultimately cost $4 if financed over a 31-year period beginning with the next biennium.

The actuarial review projected the expected increase in contributions, as calculated by the PRB. To the extent a portion of the contribution increase is borne by the employees, the total cost to the state will be lower.

Fiscal Year	Payroll	Current Contribution (in millions)	Proposed Contribution (in millions)	Difference
2022	$         7,417	$            1,446	$            1,888	$           442
2023	$         7,617	$            1,485	$            1,939	$           454
2024	$         7,822	$            1,525	$            1,992	$           466
2025	$         8,034	$            1,567	$            2,045	$           479
2026	$         8,251	$            1,609	$            2,101	$           492
2027	$         8,473	$            1,652	$            2,157	$           505
2028	$         8,702	$            1,697	$            2,216	$           519
2029	$         8,937	$            1,743	$            2,275	$           533
2030	$         9,178	$            1,790	$            2,337	$           547
2031	$         9,426	$            1,838	$            2,400	$           562

 
METHODOLOGY AND STANDARDS
The ERS analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the ERS actuarial valuation update as of February 28, 2021.
 
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 is based on the assumption that no other legislative changes affecting the funding or benefits of ERS 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 (in email format) by Joseph Newton, FSA, Gabriel, Roeder, Smith & Company, March 27, 2021.
Actuarial Review by Kenneth J. Herbold, ASA, EA, MAAA, Staff Actuary, Pension Review Board, March 29, 2021.
Email correspondence from ERS (Ariana Whaley), March29, 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.