TO:	Honorable Jane Nelson, Chair, Senate Committee on Finance
FROM:	Jerry McGinty, Director, Legislative Budget Board
IN RE:	HB4368 by Rodriguez (relating to participation in, contributions to, and the benefits and administration of retirement systems for police officers in certain municipalities.), Committee Report 2nd House, Substituted

COST ESTIMATE

Based on the December 31, 2019 Actuarial Valuation projected to December 31, 2020.
Effective January 1, 2022

Austin Police Retirement System (APRS)	Current	Proposed	Difference
Employee Contribution (% of payroll)	13.00%	15.00%	2.00%
Employer Contribution (% of payroll)*	21.31%	25.09%	3.78%
Total Contribution (% of payroll)	34.31%	40.09%	5.78%
Long-term Normal Cost (% of payroll)	24.98%	18.60%	(6.38%)
Amortization Period (years)	Infinite	30	N/A
Actuarial Soundness	Unsound	Sound	N/A

*The employer contribution rate effective January 1, 2022 will be based on a closed 30-year amortization period of the December 31, 2020 unfunded liability, including a three-year phase-in of the new contribution rates which would result in the employer contribution rate increasing approximately 3.777 percent of payroll for the first three years.
 
ACTUARIAL EFFECTS

The bill would amend Vernon's Civil Statutes to make significant changes to the benefits and financing structure of the Austin Police Retirement System (APRS). The bill would add a new benefit tier (Group B), increase employee contributions, establish a payment schedule to eliminate the legacy liability, and add an actuarially determined contribution (ADC) for the employer. The new benefit tier would not change current member benefits and therefore would not change the current unfunded actuarially accrued liability (UAAL) or funding status; however, it would reduce the long-term cost associated with the plan. The city contributions for fiscal year 2022 could increase by almost $7 million.

The actuarial review states under the current Pension Review Board (PRB) Pension Funding Guidelines, 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. APRS is currently actuarially unsound, with an infinite amortization period. The bill would decrease the long-term normal cost by over six percent of payroll due to benefit changes, and the contribution changes in the bill would lower the amortization period from infinite to 30 years, effective January 1, 2022.
 
SYNOPSIS OF PROVISIONS

Benefit changes:

The bill would create a second benefit tier (Group B) for new hires beginning January 1, 2022. The primary differences between the current benefits and new tier benefits are outlined below:

	Group A (current benefit)	Group B (new tier)
Benefit Multiplier	3.2%	2.5%
Final Average Salary (Months)	Highest 36 months	Highest 60 months
Normal Retirement Date; earlier of	Age 55/ 20 years of service        23 years of service              Age 62	Age 50/ 25 years of service              Age 62

 
 
Financing changes:

The bill would establish a statutory funding policy for APRS consisting of an increase in employee contributions from 13 percent to 15 percent beginning January 1, 2022, and an actuarially determined contribution rate for the city.  The city contribution rate would consist of two parts. First, the bill would establish a specified dollar payment that would pay off the existing UAAL (as of December 31, 2020), known as the legacy liability, over 30 installments. The payments for the first three years would be the result of a phase-in of approximately one-third of the contribution increase and grow at a rate of three percent thereafter.  The second part would be comprised of the employer's normal cost combined with a layered amortization component designed to eliminate any unexpected future changes in the unfunded liability. Each year's valuation would produce an amortization layer, with losses amortized over a period of no more than 30 years.
 
Contribution Corridor:

The portion of the employer contribution rate designed to fund future benefit accruals would be subject to a minimum and maximum corridor of plus or minus five percent of the projected corridor mid-point.  If the estimated employer contribution rate exceeds the corridor maximum, the employer contribution rate will be the corridor maximum.  Additionally, the employee contribution rate would be increased by the difference between the estimated employer contribution and the corridor maximum, up to two percent.  If the estimated employer contribution rate is more than two percent of payroll greater than the corridor maximum, the city and the board must enter into discussions to determine additional funding solutions. If the estimated employer contribution rate falls below the corridor minimum, the city would contribute the minimum rate.

Actuarial Assumptions and Experience Study:

The bill would require the board's actuary to perform an experience study at least every five years, and the board would be required to notify the city of the study.  The city would then inform the system whether it would conduct its own experience study; have its actuary review the experience study; or accept the system's experience study. If the city decided to conduct an experience study, or review the system's experience study, both the city and the system's actuary must determine the hypothetical city contribution rate based on the proposed assumptions. If the difference was greater than two percent of payroll, the city and the system's actuary would attempt to reconcile the difference within 20 business days. If they could not reconcile the difference, an agreed upon third-party actuary would be required to opine on the differences in the assumptions and methods used by both actuaries. Under the proposed bill, the board would retain its constitutional responsibility to decide on actuarial assumptions.

Board Composition and Authority:

The bill would change the board composition to decrease the number of active members by one and replace that member with a citizen with finance or investment experience appointed by the city council. The bill would also add that the current citizen member that is appointed by the retirement board must have demonstrated finance or investment experience. Additionally, the bill would remove the board's authority to increase benefits, lower retirement eligibility, or grant cost-of-living-adjustments.
 
FINDINGS AND CONCLUSIONS

The analysis highlights that while the benefit changes would have no immediate impact on the funding status of the system, as they would only affect members hired after January 1, 2022, the long-term cost of the system would be reduced, and the contribution changes would move the system from an infinite amortization period to an effective amortization period of 30 years, effective January 1, 2022. The analysis further notes that the assets for the system are expected to be depleted within the 50 years if no action is taken.
 
The review notes that the analysis does not include a projection of the expected corridor mid-point or the amortization schedule of the legacy liability. Below is the anticipated contribution changes for fiscal year 2022, based on the December 31, 2019 actuarial valuation.

Contributions (in millions)	Current	If Bill enacted
Member	$23.3	$26.9
Employer	$38.2	$44.9
Total	$61.5	$71.8

Based on the information included in the analysis, the projected $44.9 million employer contribution for fiscal year 2022 would increase to $53.2 and $62.0 million for fiscal years 2023 and 2024. The gradual increase in employer contribution is due to the three-year phase-in approach the bill proposes. The legacy liability payments would increase at a rate of three percent per year thereafter.

According to the review, the corridor midpoint is the expected employer normal cost and would therefore be highly dependent on the actuary's assumptions regarding how quickly current members will be replaced by new members. Over time, the corridor midpoint would be expected to decrease as a percent of total pay, as new members with a lower normal cost replace current members. However, the corridor mid-point would increase on a dollar basis over the near term. At some point the increase in total payroll would be outpaced by the transition from Group A members to Group B members, such that the expected corridor mid-point could decrease on both a dollar and percent of pay basis, for at least a short period, until it reaches the ultimate long term normal cost of 18.6 percent.
 
METHODOLOGY AND STANDARDS

The APRS analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the APRS actuarial valuation for December 31, 2019 project to December 31, 2020.  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 APRS 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 Lewis Ward and Ryan Falls, FSA,EA, MAAA, Gabriel, Roeder, Smith & Company, May 6, 2021.
Actuarial Review by Marcia Dush, FSA, EA, MAAA, Board Actuary and Kenneth J. Herbold, ASA, EA, MAAA, Staff Actuary, Pension Review Board, May 7, 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.
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.