TO:	Honorable Giovanni Capriglione, Chair, House Committee on Pensions, Investments & Financial Services
FROM:	Jerry McGinty, Director, Legislative Budget Board
IN RE:	HB3340 by Metcalf (relating to the public retirement systems of certain municipalities.), Committee Report 1st House, Substituted

COST ESTIMATE

Based on the July 1, 2022, Actuarial Valuation.

Houston Firefighters' Relief and Retirement Fund (HFRRF)	Current	Proposed	Difference
Normal Cost (% of payroll)	14.75%	14.77%	0.02%
Unfunded Actuarial Accrued Liability (millions)	$231.80	$267.30	$35.50
Funded Ratio	95.40%	94.80%	-0.60%
Amortization Period (years)	7.68	9.32	1.64

Based on the July 1, 2022, Actuarial Valuation.

Houston Police Officers Pension Fund (HPOPS)	Current	Proposed	Difference
Unfunded Actuarial Accrued Liability (millions)	$922	$984	$62
Funded Ratio	87.50%	86.80%	-0.70%
Amortization Period (years)	25	Not Specified	N/A

ACTUARIAL EFFECTS

According to the Houston Firefighters' Relief and Retirement Fund (HFRRF) actuarial analysis, the bill would increase the unfunded accrued liability (UAAL) by $35.5 million, which would increase the system's amortization period from 7.68 to 9.32 years.

According to the Houston Police Officer's Pension System (HPOPS) actuarial analysis, the bill would increase the UAAL by $62 million, which would decrease the funded ratio by 0.7 percent. According to the actuarial review, the analysis shows an implied increase in the funding period, but the actual effect on the amortization period was not provided. The actuarial review notes that it is clear that the resulting amortization period if the bill were enacted would be less than 30 years. 

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 to 25 years being the preferable target range. Under state law, certain systems with funding periods over 30 years are required to prepare a Funding Soundness Restoration Plan (FSRP) to make changes to the pension plan to put the system on a path to eventually achieve full funding.

SYNOPSIS OF PROVISIONS

This bill would amend the governing statutes of both HFRRF and HPOPS.

Houston Fire
The bill would increase the maximum deferred retirement option plan (DROP) period from 13 years to 20 years and the DROP crediting rate would change to 70 percent of the 5-year arithmetic average system returns from 65 percent of the 5-year geometric average system returns. The minimum DROP crediting rate of 2.5 percent applies whether or not the bill is enacted.

It would also change the retirement and DROP eligibility to 20 years of service for all members. Currently members hired on or after July 1, 2017, are not eligible to enter DROP and are not eligible for retirement until the sum of the member's age and service equals 70.

Houston Police
The bill would make the normal retirement age for all tiers of HPOPS either 20 years of credited service (YCS) or age 60 with at least 10 years of service. This would change from the earlier of those two ages for Tier 1 members and the Rule of 70 for Tier 2 members. It would remove a provision allowing certain members who separate from service with between 10 and 20 YCS to receive a monthly service pension upon reaching normal retirement age. It would allow members hired after October 9, 2004, to participate in the DROP and change the DROP benefit credits to be calculated with the average aggregate annual 5-year rate of return rather than the compounded average aggregate annual 5-year rate of return. DROP participants would receive annual credit equal to 70 percent of this average rather than 65 percent.

FINDINGS AND CONCLUSIONS

According to the actuarial review, this bill would extend the maximum period that HFRRF members can remain in DROP, increase the HFRRF DROP crediting rate, and restore some prior benefit reductions for HFRRF members hired on or after July 1, 2017, as outlined in Senate Bill 2190, 85th Regular Legislature, when the system is more than 90 percent funded. Further, the review notes the bill allows for re-amortization of current liabilities to 15 years, in which case the city contribution rate would decrease to 23.09 percent of payroll. It does not appear such a policy is specifically included in the bill language.

According to the actuarial review, the HPOPS analysis states that the calculated city contribution would increase by 1.11 percent of payroll, however the current contribution policy requires the city to contribute at a rate higher than the calculated rate, so the changes would have no impact on the actual city contributions assuming assumptions are met in the future.

While the proposed benefit improvements come with a cost, they would not affect the soundness of either fund.

METHODOLOGY AND STANDARDS

The HFRRF analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the risk sharing valuation study for July 1, 2022, but assuming the DROP crediting rate is equal to 5 percent. The actuarial review noted that the HFRRF analysis did not include a thorough analysis such as stochastic modeling to determine the new expected crediting rate, potentially underestimating the actuarial effect of the new DROP crediting rate formula.

The HPOPS analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the June 30, 2022, risk sharing valuation study, but assuming the DROP crediting rate is equal to 6.26 percent rather than the previously assumed 5.4 percent. The increase in the expected DROP crediting rate includes approximately 0.3 percent due to the formula change from 65 percent to 70 percent, and 0.56 percent due to the averaging mechanics change from a geometric average to an arithmetic average. The HPOPS actuary went further and performed stochastic modeling to evaluate the assumption including the 2.5 percent floor.

According to the PRB actuary, the HPOPS actuarial assumptions, methods and procedures are reasonable for the purpose of this analysis. The PRB actuary noted the assumptions and methods used in the HFRRF analysis do not take into account the effect of the change in averaging mechanism for the DROP crediting rate.
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 and HPOPS 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
HFRRF Actuarial Analysis by Michael Ribble, FSA, MAAA, Buck, March 22, 2023.
HPOPS Actuarial Analysis by Joseph P. Newton, FSA, Gabriel Roeder Smith & Company, April 5, 2023.
Actuarial Review by David Fee, ASA, EA, Staff Actuary, Pension Review Board, April 5, 2023.

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.