Testimony: Reviewing proposed changes to Alaska’s Public Employees’ Retirement System

Prepared for: Members of the Alaska Senate Labor and Commerce Committee

Good afternoon, my name is Ryan Frost and I’m a policy analyst with the Pension Integrity Project at Reason Foundation. I’ve been with Reason since 2019, but prior to that, I spent seven years as the research and policy manager for the Law Enforcement Officers and Firefighters Pension System in Washington State, or LEOFF 2 for short. LEOFF 2 has been one of the top-three best funded public pension plans since its inception in the mid 1970’s, and that’s primarily been accomplished by keeping up to date with best practices in plan and funding design.

Reason Foundation’s pension team has been a key pro-bono technical consultant on 55 pension reforms over the past six years, the two largest plan’s being the public safety plan in Arizona and the Texas Employee’s Retirement System. Those pension reforms included new defined benefit tiers, new hybrid design tiers, new cash balance tiers, and new defined contribution tiers. Each of those reforms has at its very foundation, a way of paying for the public pension system that ensures costs do not eat into state and local budgets, and that these important benefits earned by employees are fully funded for their retirements.

If it’s the legislature’s desire to open a guaranteed-benefit design to the public safety employees of Alaska, that can most certainly be done, but it must be done in a way that protects the state from financial risk. House Bill 55 would attach new public safety employees to a plan that has had trouble with funding spanning back two decades, only sitting at 76% funded even after it benefited from the largest one-year stock market return in recent history. I’d like to lay out a few public pension best practices for the committee to consider, and where HB 55 falls short.

A successful public pension plan pays the full actuarially determined rate using a full 50/50 cost-sharing method. For a defined benefit plan, this means that when underperformance happens in the market, or any of the other dozens of economic and demographic assumptions aren’t met, employees and employers equally share the paydown of that added debt to the pension system.

This bill has been sold as being “risk-shared,” but neither pays the actual cost of earned pension benefits, as determined by the plan’s actuary, nor equally shares those costs between all stakeholders. Setting contribution rates in statute, and capping those rates for employees, is a flawed funding design from yesteryear that no longer follows the best practices in today’s public pension design.

The best funded plans also don’t look to past investment experience when setting future assumed rates of return. The median rate of investment return for public pension systems across the country sits at 7%. House Bill 55 would put all employees into a plan assuming a 7.38% rate of return. Not only does that number fail to track with past investment experience in Alaska, but it also severely overestimates the 10–15-year market assumptions being used by most other public pension systems and institutional investors.

For example, over the past year, two of the largest three public pension plans in the country, the California Public Employees Retirement System and the New York State and Local System, have both stated that they only assume to earn 6% over the next 10 years. Both pension systems made immediate and prudent changes by lowering their assumed rates of return, with New York dropping its assumed rate all the way down to 5.9%.

House Bill 55 has been sold as being “cost neutral” due to having the same contribution rate as the defined contribution plan, but if this new tier earns even an optimistic 6.5% rate of return, while assuming 7.38% returns, the plan’s costs—and debt—will rapidly begin to spike. Quite quickly, the cap on the employee rate will be hit, and the government’s employer rate will continue to climb higher and higher to pay for those missed investment return expectations and the added interest, at 7.38%, that each year of missed returns adds to the plan’s unfunded liabilities.

In conclusion, there is a way forward on reform that can meet whatever needs this legislative body and stakeholders desire, but HB 55, as currently written, would not put this new tier on a successful path. Reason Foundation’s Pension Integrity Project would be happy to work with the committee to help draft a design that best meets those needs and follows best practices in pension design. Thank you for your time today, and I’d be happy to answer any questions.“