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Did Pension Reform in Alaska Fail?

Victor Nava
May 7, 2014, 2:09pm

It’s been 9 years since the Alaska state legislature passed Senate Bill 141, which among other things replaced the state’s defined benefit pension system with defined contribution accounts for new state employees’ and teachers. The reform was passed with promises that it would improve Alaska’s financial position. However, since implementation, the state’s unfunded pension liability has doubled from roughly $6 billion to $12 billion. Critics of Alaska’s pension reform, and of pension reform elsewhere in the country, claim this decline in funding level is because of SB 141. A closer look shows that the unfunded liability has gotten worse because Alaska didn’t fix enough of its bad pension funding behavior, and with out the reform Alaska would be even deeper in debt.

Politicians like State Rep. Mike Hawker (R-Anchorage), have already begun to distance themselves from the 2005 reforms. Hawker recently was quoted as saying, “I very much was concerned when we closed our retirement systems and went to a defined contribution that by closing those systems we were going to find ourselves in the position we are in today, which was ultimately having to step in with a significant financial bailout…That switch was a mistake.”

Rep. Hawker is very wrong in his understanding of the transition costs of pension reform though. Contributions into the old defined benefit plan have been the same as they would without reform, and have been saved to pay future benefits. Pension benefits are prefunded, and they don’t depend on contributions from new employees being added to the system. The unfunded liability that existed and grew since the reforms passed would still be there even with more employees in the defined benefit plan.

The problem is that Alaska didn’t change its debt payment schedule to speed up getting rid of debt. And further the SB141 bill didn’t correct for systematic errors in actuarial assumptions.

Since the reform passed, officials in Alaska have made just the minimum, or below minimum, payments to their pension system, choosing to fund more popular programs instead. Prior to the 2005 reforms Alaska was doing quite well when it came to making its Annual Required Contribution (ARC) payments to its two main pension systems. PERS averaged ARC payments of 102.9% prior to reform and TRS averaged ARC’s of 106.3% prior to reform.  However post reform, the legislature has done substantially worse at fulfilling both systems’ ARCs.

The Public Employees’ Retirement System (PERS) has averaged actual ARC payments of 85% post reform and the Teachers Retirement System (TRS) has averaged ARC payments of 81%. It’s easy to see why politicians skimp out on ARC payments. When it comes down to making an ARC payment so the pension system is properly funded years down the line or keeping a fire department open, a lot of times politicians shortchange the pension system in favor of funding other state needs. ARC payments include debt service payments, so by not making 100% (or more) of those payments every year, the state allowed the debt to grow and get out of hand.

Unrealistic actuarial assumptions also played a role in the growth of the states unfunded liability. The states assumed rate of return on investments was not changed in the 2005 reform bill, and remained at 8.25% until 2011 when it was lowered to 8%. In the years after reform, PERS has averaged an actual rate of return of 4.80%, much lower than its assumed rate. The most recent data shows that in 2012 PERS’s actual rate of return on investments was a paltry 0.46%. Rosy projections on the books keep the current pension crisis from appearing worse than it really is. A higher assumed rate of return means lower mandatory contributions from the state budget, but it masks the severity of the debt problem.

       Year

 Alaska PERS Actual Rate of      Return on Investments

       2006

                 11.74%

       2007

                 18.88%

       2008

                – 3.06%

       2009

               – 20.49%

       2010

                 11.39%

       2011

                 21.22%

       2012

                  0.46%

    Geometric    Average Rate     of Return

                4.80%

The move to a defined contribution system for new employees was a bold, but necessary step for Alaska given the growing unfunded pension liabilities in the state. But state officials turned a blind eye to the existing debt left behind from the previously unsustainable system. As a result, Alaska’s pension system continues to struggle with high unfunded liabilities and a low funding ratio.

In response to states growing pension woes, last month the Alaska legislature passed Governor Sean Parnell’s plan to use $3 billion from the state’s Constitutional Budget Reserve Fund (essentially a state savings account) to pay down the unfunded pension liability in the public employees' and teachers retirement systems. Under the plan, $1 billion will go to PERS and $2 billion will go to TRS. It’s a big step in the right direction for the state. But it is not one necessary because the initial pension reform back in 2005 failed—its only necessary because the 2005 reform didn’t go far enough to correct Alaska’s pension funding errors and the legislature skimped on its ARC payments in the years after.

The situation in Alaska would likely be much worse today had the defined benefit membership not been closed off. It’s about time that politicians in the state start addressing the budgetary malignance that is its $12 billion pension debt. It was political failure that allowed the debt to get so out of hand, not pension reform failure. 


Victor Nava is Research Assistant


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