The actuarial review notes the July 1, 2024, actuarial valuation shows eight liability layers with a remaining amortization period of 5.208 years and one liability layer with an amortization period of 30 years. This current arrangement meets the PRB Pension Funding Guidelines. The actuarial analysis did not comment on the funding period; however, it is reasonable to assume the funding period would remain within the PRB Pension Funding Guidelines as well as statutory funding requirements under Section 802.2015, Texas Government Code.
SYNOPSIS OF PROVISIONS
The bill would change several benefits for members of HFRRF.
Previously members who were hired on or after July 1, 2017, could retire at the age at which the member's age plus service exceeded 70 years. The bill would change the normal retirement age to the earlier of 20 years of service or age 50 with 10 years of service for all members.
The bill would expand the members eligible to participate in a DROP by allowing members hired or rehired on or after July 1, 2017, to participate. The bill would also enhance the DROP interest rate from 65 percent of the five-year average system returns to 75 percent. For DROP participants who had less than 20 years of service on July 1, 2017, the bill would increase the monthly annuity received after exiting DROP with 1 percent annual increases up to a maximum total increase of 10 percent. It would also slightly increase the DROP interest rate for all members.
The bill would also change the assumptions and methods used to calculate and amortize unfunded liabilities, including increasing the expected investment rate of return from 7.0 percent to 7.5 percent, and allowing the system to extend the amortization period of liability loss layers back to the period that would have been in effect had they not been accelerated to shorter periods in 2017.
FINDINGS AND CONCLUSIONS
The bill would impact all members, with the greatest effect for members hired after July 1, 2017.
The actuarial analysis showed an increase in the UAAL of over $89 million, offset by a reduction in normal cost of 2.26 percent. Combined, the increase in the actuarially determined contribution (ADC) rate would increase by .01 percent.
The analysis provided a 10-year projection of annual cost to the retirement system. This projection shows a reduction in the expected ADC rate from 2027 to 2036, ranging from a reduction of 0.14 percent to 0.64 percent of payroll.
METHODOLOGY AND STANDARDS
The HFRRF analysis relies on the participant data, financial information, benefit structure and actuarial assumptions and methods used in the HFRRF actuarial valuations for July 1, 2024, with the exception of two main differences. The expected return on assets was 7.5 percent rather than 7.0 percent; and the expected DROP crediting rate was set to the assumed investment return, multiplied by 75 percent and increased by 0.10 percent.
According to the PRB actuary, there are several questionable and/or unreasonable assumptions and methods being used to calculate the liabilities:
1. The 7.5 percent expected return. It is extremely rare for a Texas public pension system to increase the expected return assumption in any recent year. The system's self-reported 10-year return as of June 30, 2024, was 7.1 percent.
2. The DROP crediting rate. In the 88th legislative session, using stochastic analysis, another actuary had estimated the DROP crediting rate using the same provisions should have increased an additional 0.56 percent to account for the change from geometric to arithmetic average. During the last five years, the system's DROP crediting rate would have been 44 basis points higher due to this change. By using only 10 basis points to account for the change to arithmetic calculation, the system is likely underestimating the liability.
3. The ultimate entry age normal cost method. The system's use of the ultimate entry age normal cost method is no longer supported by Actuarial Standard of Practice No. 4 (ASOP 4). Ultimate entry age normal is specified in statute as the cost method to use for three Houston municipal pension plans including HFRRF. No other Texas public pension systems use ultimate entry age normal. The entry age normal cost method would comply with ASOP 4. Updating benefits for newer hires to be similar to long-term members will limit the effect of changing the cost method.
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 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 Michael A. Ribble, FSA, EA, MAAA, FCA, Gallagher Benefit Services, April 8, 2025.
Actuarial Review by David Fee, ASA, EA, Staff Actuary, Pension Review Board, April 18, 2025.
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 be adequate to amortize the UAAL over a period which should not exceed 30 years as of September 1, 2025, and not to exceed 15 years after September 1, 2040.
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.
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.
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.