Due to rising costs and unfunded liabilities in its traditional public pension system, Alaska was one of the early state pioneers in transitioning newly hired governmental workers into new and financially sustainable retirement plans. In 2005, it became one of the only states to enact legislation shifting all new hires in the public workforce to a pure, 401(k)-style defined contribution (DC) retirement plan which precisely controls costs and eliminates all future risk of unfunded liabilities. Though the DC plan is structured according to industry best practice standards, there have been repeated legislative attempts to reopen Alaska’s two major legacy—and still underfunded—pension systems. Most attempts have failed to generate any momentum.
But in the 2021-22 legislative session, HB55 and HB220 both advanced through the state House of Representatives policy and fiscal committees with strong political support despite no apparent scrutiny and actuarial analysis. These bills would have opened new and financially risky tiers of the now-closed legacy pension systems for all new government workers. A Pension Integrity Project analysis found that implementing HB55 alone could have easily exposed the state to over $200 million in new unfunded liabilities by allowing current DC plan participants to switch to the proposed plan.
There were two major arguments for the swap to a DC plan in 2005. First, the pension funds’ unfunded liabilities had already started ramping up to unsustainable levels, meaning the paydown of those debts were starting to eat too much into the state budget. Second, the state greatly feared another revenue shortage like it had in the 80s and 90s, impacting the legislature’s ability to fund already accrued and future benefits.
The arguments from bill supporters centered around a desire to recruit and retain more public employees. Yet there is little, if any, evidence that a defined benefit pension is a relevant factor that helps drive employee recruitment and retention. A Reason Foundation working paper examining teacher retention in Alaska finds that retention rates did not change when the state swapped from a DB to DC in 2005. In addition, 86% of police stations across the country are facing a shortage of members and every one of those stations, outside of Alaska, has a pension with some defined benefit component.
While the fiscal note analysis performed by Alaska’s pension system actuaries presented only a five-year cost projection, based on the assumption that the proposed pension tier would meet all of its actuarial assumptions, even that analysis raised some major concerns for state policymakers. It stated: “Adverse plan experience (due to poor asset returns and/or unexpected growth in liabilities) or changes to more conservative assumptions will increase the PERS DB (defined benefit) unfunded liabilities, resulting in higher contribution rates.”
Lacking any meaningful actuarial or fiscal analyses, legislators and staff uncertain about the impacts of these bills sought an independent evaluation of potential outcomes, prompting several organizations—including the Pension Integrity Project at Reason Foundation, Americans for Prosperity, Alaska Policy Forum, Americans for Tax Reform, the American Legislative Exchange Council, and the Heritage Foundation—to provide technical assistance, policy analysis, and legislative testimony.
Reintroducing Risk Via New Pension Tiers
Pension Integrity Project’s analysis found that while the pension designs proposed under HB55 and HB220 did include a few modest improvements relative to the original legacy pension tiers, the designs still left far too much financial risk on the table.
A key problem is the proposals’ use of a 7.38% assumed rate of return on investments, far higher than the national median—and higher than previous iterations of these proposals put forth by public employee stakeholders. This assumption is vital to get correct. Soon after the proposed inception of this new tier, the pension systems would have up to 15 years of liabilities already on their books because the bills stipulated that, for any member who chooses to enter the new tier, all their previously earned service in the DC plan will be transferred into the new defined benefit pension at the current 7.38% discount rate. This sets up a pension obligation bond-like situation where any downturn in market performance or lowering of investment return assumptions—both situations being almost a certainty based on 10-15 year market forecasts—would immediately create unfunded liabilities in the pension system.
So why would a new pension proposal go the opposite direction on investment risk when all other public pension systems are rapidly dropping their assumed rates of investment return, and market forecasts predict returns more than 1% lower than the Alaska bills envisioned? The only possible explanation is that the use of a lower assumption would raise the cost of these proposals to a level that would make the supporters’ arguments of these bills being “cost neutral” an impossibility. The supposed “cost neutrality” argument from supporters is especially important due to the way Alaska funds its pension systems. Alaska has, for all intents and purposes, capped its employer contribution at 22% of pay. This new proposal, using faulty assumptions that hide the actual cost of the plan, would have eaten into the portion of that 22% that’s used to pay down legacy pension debt. If the plan was properly priced, even less would go toward paying down Alaska’s pension debt which would introduce significant risk to the promises the state has made on accrued benefits.
Additionally, the pension systems’ actuaries noted a critical point—the current DC plan (DCR) offers nearly the same retirement benefit as proposed under HB 55 (PERS DB). Increasing employer contributions in the current DC plan and adding more annuity purchase options could yield an equivalent benefit and provide lifetime income options. In the fiscal analysis of HB55, the plan actuaries found, “On average, approximately 94% of DCR service as of June 30, 2021 was credited to PERS DB.”
Evaluation of Alaska’s Current Retirement Offerings
An actual state-by-state comparison of the retirement benefits earned by Alaska employees versus other statewide public employees would be prudent, because they have possibly the most generous post-employment benefits in the country. Not only does the state offer a solid contribution rate to its DC members, a Social Security replacement plan, the Supplemental Annuity Plan (SBS-AP), that puts the amount that would have gone into Social Security instead into a 401(a) account is also offered. Anyone relatively familiar with Social Security knows the poor benefit it offers for the dollars contributed into it, meaning Alaska’s employees will almost certainly earn more through the SBS-AP, if they are eligible, than they would have if they were paying into Social Security.
Between the 12.26% of pay going into the SBS-AP (6.13% each from employee and employer) and the 13-15% of pay going into a member’s DC account (split depending on employee classification), an employee of Alaska has between 25.26% and 27.26% of pay going toward their retirement benefits each year.
The Future for Alaska Retirement Policy
While HB55 and HB220 fell short this legislative session, efforts to upend the state’s previous reforms will likely arise again in future legislative sessions. Recruiting and retaining public employees continues to be challenging for all states, not just Alaska. Despite misguided reasoning, there will be pressure to address these challenges with concessions in public retirement benefits. But reopening the doors to the beleaguered pension plan will resurrect major unacceptable risks while doing little to improve the state’s retention issues. Alaska policymakers will need to look elsewhere to address these challenges.
That is not to say that there are no reforms Alaska lawmakers could consider to improve the state’s retirement systems. The legacy $7.4 billion in unfunded pension liabilities are still generating major costs in state budgets, and accounting of these debts is suboptimal, understating their magnitude with outdated market assumptions that need to be brought in line with broader industry trends. Policymakers should direct their attention to eliminating this debt as quickly as possible. Several other states have recently committed supplemental payments to address pension funding shortfalls, and Alaska would be wise to do the same.
In 2005, Alaska policymakers made the prudent decision to recalibrate their retirement systems in a way that better served the mobility of the modern workforce and ceased any future exposure of unexpected costs for state budgets, blazing a trail for the rest of the country. Since Alaska’s landmark reform, several other states have adopted similar risk reducing measures. Instead of unraveling the state’s progress from the last 17 years, policymakers should seek to bolster the policies that brought resiliency and reliability to the retirement benefits of public workers.
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