Study: Pensions underfunded, underperforming

The back-and-forth over who will pay what to state retirement plans has caused plenty of consternation in Juneau the last two weeks, but a new study concludes the debate would be unnecessary if Alaska had just followed its own guidelines the last time state pensions were reformed.

Coincidentally released March 29 — a day after Republican Senate Finance Committee co-chairs Sens. Pete Kelly, R-Fairbanks, and Anna MacKinnon, R-Eagle River, introduced legislation to shift some of the state’s pension fund obligations to municipal governments — a Reason Foundation study claims Alaska’s $6.7 billion unfunded pension liability is largely a result of underfunding by the state and overly optimistic investment return expectations.

The suite of Senate Finance bills and the Reason study address the state’s Public Employees Retirement System, or PERS, and the Teacher Retirement System, or TRS, pension plans.

Senate Bill 209, which would shift the part of the state’s obligation to pay for unexpected PERS costs to local governments, was put on hold after intense public criticism and new consultant analyses that suggest the payments may not be as large as once suspected, at least in the near-term fiscal years.

The defined benefit retirement plans were closed to new participants at the end of the 2006 fiscal year over fears the state could not support the ever-growing pension liability the plans were generating. That liability was a combined $1.9 billion for the plans that were more than 80 percent funded at the end of fiscal year 2004, according to the Reason study.

To stem the liability tide, the Legislature passed the Alaska Retirement Security Act in 2005, which closed PERS and TRS and put state employees and Alaska teachers hired after July 1, 2006, on defined employee contribution plans similar to 401(k) plans in the private sector.

It is there where Reason picked up the story.

According to the study, the state was “erratic” with its PERS and TRS contributions in the years following the passage of the Retirement Security Act, fully funding its annual obligation in only three of the 10 years after pension reform was thrust into the limelight. Cumulatively, the state funded 88 percent of its required contribution from 2005-14.

“The lower-than-required contributions made budgeting easier for lawmakers, but at the long-term expense of the plan, with the missed payments simply being added to unfunded liabilities,” the study states.

It does not examine the state’s health care, disability and medical benefits plans.

The Reason Foundation is a Los Angeles-based policy think tank that advocates for free market ideals.

The underfunding was most prevalent in fiscal years 2005-07, when required contributions in the $400 million per year range to stay on track were paid with actual contributions that were $100 million to $200 million per year short. After two years of full funding, the short stacks resumed in 2010 and carried through 2013, although the second time each year’s contribution was short less than $100 million when yearly cost plus unfunded amortization payments were calculated at $400 million to $600 million per year.

The nine-member Alaska Retirement Management Board, which includes seven public members and the commissioners of Revenue and Administration, sets the annual required contribution for the funds. Legislators do have a say in how amortization of the unfunded liability is calculated and funded.

Lofty investment return goals also added to the PERS-TRS unfunded liabilities, according to the study. Alaska’s pension plans were, and continue to be, based on 8 percent average predicted returns for invested funds. However, during the study period from 2005-14, the pension funds earned a combined average return of 5.8 percent.

After 2008 the average return dropped to 5 percent, primarily due to the financial crisis known as the Great Recession in 2008-09.

Study co-author Anthony Randazzo said in an interview that Alaska is not alone in failing to adequately fund its pension plans and not achieving its targeted rate-of-return for the funds, but the fact that misery loves company doesn’t change the challenge the state is facing.

According to Randazzo, roughly one-third of states have explicitly under-funded their public employee pensions and nearly all have missed investment return goals, which historically have been in the 8 percent range.

An 8 percent investment return was much more feasible in the 1980s when interest rates were higher and most funds were invested in fixed income bonds, he explained. Today, pension funds hold mostly equities and real estate, but common return goals are still in the 7 percent-plus range, Randazzo said.

He contends pension managers should use much more conservative return goals closer to 4 percent per year.

“The actuarial community believes, based on demographic patterns, even if plans are underfunded today, as Alaska’s badly is, you can still use high rates-of-return because the feel there is enough money flowing in to pay the benefits out,” Randazzo said. “That is a short-term focus.”

Further darkening the picture, according to the study, is the fact that future obligation projections are based on an 8 percent average investment return. If that return is not met the unfunded gap grows again.

Randazzo suggested the overly optimistic investment goals over time could compound into the pension plans being up to 40 percent underfunded over 50 years.

“Alaska is part of a group of states that are walking over a fiscal cliff in the coming decades and Alaska is in the group that’s at the head of that pack,” he said.

Officials in the Revenue and Administration departments said the state’s required contribution to its defined benefit plans in fiscal 2017 is still being calculated because it is based on salaries that are projected for the upcoming fiscal year.

Estimates put the state’s 2017 defined benefit PERS obligation at approximately $340 million and the TRS obligation at more than $116 million.

The study acknowledges that Alaska’s PERS and TRS funds are in a better position today than if the state had not closed the defined benefit plans.

Randazzo said Alaska, along with Michigan, was studied because they were among the first states to close defined benefit pension programs.

Through fiscal year 2014, the last year of data included in the study, the PERS plan would have been 61 percent funded without the 2005 reform based on historical state funding, the study concludes. As of the end of fiscal year 2015, the state’s total PERS liability was $13.4 billion, on a net fund position of $8.6 billion, or 64 percent of its obligation, leaving a $4.8 billion unfunded liability.

For TRS, no reform would have resulted in only 55 percent of the state’s liability being funded. The fiscal year 2015 annual report puts the TRS fund at a 74 percent funded position, with a $1.9 billion unfunded liability. Combined, the funds carry an unfunded liability of roughly $6.7 billion, significantly less than the $8.4 billion unfunded burden the state would have faced without closing the defined benefit plans, according to Reason.

The liabilities at the end of fiscal 2015 include a $3 billion infusion from state savings to offset yearly pension payments that were forecasted to approach $1 billion without a substantial down payment.

Still, Randazzo said the state likely would not have had to make that big payment to start the 2015 fiscal year if it had better managed the plans. By paying fully the annual actuarially determined contributions and using a more achievable rate-of-return the State of Alaska could have a $4.1 billion unfunded liability instead of the $6.7 billion it faces today.

“There’s almost no world in which the state would’ve taken $3 billion to pay down a $4.1 billion unfunded liability given that the funding ratio on it would be so much better,” he said.

Instead, that $3 billion that was pulled from savings would likely be available to relieve pressure on the state’s current $4 billion-plus budget gap.

Elwood Brehmer can be reached at elwood.brehmer@alaskajournal.com.

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