2/14/07 State Chamber PERS/TRS Presentation

1. 2/14/07 State ChamberPERS/TRS Presentation Prepared By: Michael E. Lamb, CPA, CGFM Chief Financial Officer Fairbanks North Star Borough P.O. Box 71267 Fairbanks, AK 99707-1267 (907) 459-1370

2. The Problem • The basic problem Is: The PERS system has become under-funded. Bottom-line, there is an unpaid bill. • The question is: Whose unpaid bill, whose liability, is it anyway? Who should pay, and why? • Our purpose today: Understand the bill, then reach consensus! • BUT: Before we agree on what we should do, we need to understand what we are actually doing, now!

3. @ 6/30/05 18,262 88.2% Tier I 2,303 11.1% Tier II 138 0.7% Tier III $12.8B $7.1B $5.7B 20,703 100.0% Retirees & Beneficiaries The Employee Universe 73,299 Active & Retired Members Active Retired @ 6/30/05 Active Members: 33,730 Vested Terminations: 6,105 Non-vested Terminations With Balances: 12,761 Total “Active Side”: 52,596 71.8% 28.2% The actuary determines the cost of future benefits (the liability) for each employee in the PERS system. (Employee here means employees and elected officials.)

4. Mile High View Of PERS Active Side Retired Side (Liabilities Fully Funded) Employee Accounts Employer Accounts All Retired EE Actuarial Liabilities Calculated EE Liabilities Allocated To ERs Pro-Rata By Years Total Of All ER Retired Liabilities = The RRA Liability $4.2B Unfunded Obligation – Drives PSC Rate $1.5B $7.1B EE & ER Adjusted Asset Accounts RRA Liability $5.7B $7.1B ER Accrued Liabilities RRA Assets RRA Assets Get Increased To Equal Liabilities RRA Assets Are Allocated To Employers Based Upon ER’s Pro-Rata Liability % Active Employee Liabilities Allocated To Employers Active Employee Actuarial Liabilities Calculated RRA Assets Benefits

5. Significant PERS Timeline Points System Conversion, EE Transfers Not Reported To Actuary Individual Employee Accounts Get Credited With Interest State Absorbs The Retirement Reserve Account Loss/Shortage Most Current PERS System Information Available RetirementReserve Account Established/Used Legislature Authorized A “Shared Consolidated Normal Cost” Rate Defined Benefit Retirement Plan Becomes Effective Legislature Authorized Allocation Of Investment Income To RRA State Stopped ER Transfers To RRA At EE Retirement Retirement Reserve Account Created/Authorized “Statutorily” • EE Contribution Account Transferred At Retirement (Within 1 Year) • Related ER Contributions Transferred At Retirement • Transferred Assets = RRA Liabilities No EE Accts To RRA At Retirmnt 1984 1974 1977 7/1/94 6/30/05 1/1/61 6/30/69 7/1/99 12/31/72 12/31/71 • EE Accounts Maintained • ER Accounts Maintained (Rate Swings A Problem!) • ER Accounts Paid Pension & Refund Costs • Contribution Rate Based on ER’s Actual Experience • EE Contribution Acct Transferred At Retirement • Related ER Contrbs NotTransferred At Retirement • Transferred Assets Now Don’t Equal Liabilities At Retirement

6. RRA $6.3B, 73.3% RRA $7.1B, 82.6% EE Accts $1.4B, 16.3% EE Accts $1.4B, 16.3% ER Accts $0.9B, 10.5% ER Accts $0.1B, 1.2% $0.1 $0.9 $1.0 $1.4 $2.1 $1.4 $1.4 $4.0 $5.8 $1.3 $6.3 $7.1 PERS Assets/Redistributions RRA $4.0B, 54.6% RRA $5.8B, 71.0% ? RRA $?B, ?% EE Accts $1.3B, 17.6% EE Accts $1.4B, 16.6% ER Accts $2.1B, 27.8% ER Accts $1.0B, 12.4% ? Pre Moving The 6/30 $800M From ER To RRA $8.6B @ 6/30/05 Post ER Transfer To RRA $9.4B @ 6/30/06 Post ER Transfer To RRA $7.4B @ 6/30/03 Post ER Transfer To RRA $8.2B @ 6/30/04 Post ER Transfer To RRA $8.6B @ 6/30/05 Pre ER Transfer To RRA

7. Cousin Bud Example: Assignment of Retirement Liability $120k/yr comp. $100k/yr comp. $40k/yr comp. $50k/yr comp. $20k/yr comp. $90k/yr comp. $1k/yr comp. $1k/yr comp. 11/1/00 11/1/74 6/30/04 11/1/80 11/1/90 10 year City employee $30k/yr 6 years on School Board, $1k/yr 10 year UA employee $70k/yr 4 year State employee $110k/yr

8. Actual RRA assets “allocated” from other employers to employer 232 Employer 232’s RRA liability determination =‘s 232’s required assets

9. City of Kenai Example Calculation of Retiree Reserve Balances by employer 1. Actuary calculates liability for every member in the system. 2. Determines retired liability at end of year 7,130,177,977 A 3. Calculate the transfer needed from active bucket Beginning Retiree Reserve assets 6,261,218,368 Net change in the reserve in total (expense+ income) (67,162,412) Assets in the reserve at YE prior to transfer 6,194,055,956 Difference is what needs to be transferred from Active Bucket 936,122,021 4. Allocate assets in Retiree Reserve This is done by calculating the weighted average of each employer of the total liability Ex: Kenai has YE liability of 29,202,591 B weighted average % of total YE liability (A) 0.40956328% B/A Share of Assets 25,368,579 Amount to be transferred - diff in assets and liability 3,834,012 this has no relationship to the actual cash Also equals weighted avg times amount to be transferred 3,834,012 flow of Kenai retirees City of Kenai FY 05 FY 04 So Kenai's active account is reduced by $3.8 million resulting in 1,356,347 3,898,539 assets available Active Account liability 18,276,644 15,463,800 Unfunded Liability 16,920,297 11,565,261 Amortized over 25 years produces originally published rate 36.67% 29.81% Retiree Reserve Liability 29,202,591 28,152,100 Note the jump in rate is impacted by the decline in assets in the active account. Was it fair for Kenai to have to transfer $3.8 million? Who knows? The retiree liability only increased by less than $1 million. Is Kenai paying for liabilities incurred by other entities? Who knows?

10. The State Had, And Has, The Primary Role In The Current Circumstance • The State established, amended, and has had sole administrative control of the Plan since 1961. • The State selected, contracted with, and has been the sole contact with PERS actuaries. • The State has had sole access to, oversight for, and responsibility for actuarial methods and assumptions. • The State managed PERS without accommodating elected official low compensation levels, versus benefits. • The State has had sole control over the investment of all PERS assets since 1961. • The State has set rates, has billed for, and has collected on all employer PERS contributions since 1961. • The State caused the shifting of employees from cities to boroughs as it formed mandatory boroughs in 1964. • The State has managed investment income since 1969. • The State established the RRA in 1971 and began paying retiree benefits with blended employer dollars. • The State absorbed the RRA shortfall balance in 1972. • The State established the “shared consolidated (blended) normal cost” rate in 1977. • The State started allocating income to the RRA in 1984. • The State stopped transferring, in 1994, employer contributions to the RRA as employees retired. • The State has controlled the timing of employee “appointment” to retirement and the subsequent employee account transfers to the RRA. • The State has reallocated employer’s & employees RRA contributed assets, based upon RRA liabilities. • The State has determined employer’s unfunded obligation, after reallocating employer’s assets. • The State has set employer’s past service cost rates, based upon reallocated asset results. • The State has since 7/1/99 paid refunds from employee accounts, yet booked payments as though they were coming from the RRA. • The State has since 7/1/99 sent direct employee indebtedness payments to the RRA. • The State has since 7/1/99 shown voluntary refunds coming from the RRA, though paid from EE accounts. ("The State" refers to the Legislature, the PERS Administrator, the PERS Board, the ASPIB and the ARMB collectively.) The State needs to accept a larger portion of the unfunded obligation.

11. Take Away & Solution Frame Work Main points a Shared Solution needs to consider: • Individual member employer liabilities have been affected by other employer’s actions. • Since the creation of the retirement reserve account, in 1971, a member’s assets have been blended and reallocated yearly to other member employers. • As a result of 1 and 2 above, the State cannot say what any member’s actual individual asset or liability balance is, and therefore, can’t say what their unfunded liability is either, which drives the PSC rate. • The normal rate paid since 1977, by State action, has been a “shared consolidated” rate. • PERS is a consolidated system due to its formulas and the blending of assets and liabilities. • Historical recreation of records going back to 1971 isn’t possible. • Advantaged, and/or, disadvantaged employers isn’t determinable. • Fiduciary duty and legal issues will rise without an equitable and timely resolution, a key component being a fair allocation of the unfunded obligation to the State. Some components of a final Shared Solution: • Amending State statutes to reflect an actual consolidated PERS Plan. • Having one uniform consolidated normal cost rate that all member employers pay. • Having 85% of the unfunded obligation go on the State’s books and be accounted for and paid by the State as a separate stand alone obligation. • The other 15% of the unfunded obligation belongs to all PERS member employers. • To pay the 15% unfunded obligation, there should be a separate uniform consolidated past service cost rate that all member employers pay, that is a separate rate from the normal cost rate. • The TRS obligation should likewise be broken into an 85%/15% split with 85% being accounted for as a separate obligation on the State’s books. As with PERS, there should be two separate rates, a uniform normal cost rate and a uniform past service cost rate that amortizes the 15% unfunded obligation. • Methods to reduce the future carrying costs of the unfunded obligations should be sought and used.

12. WHY 85/15? • We can’t recreate historical records, or outcomes. • Accordingly: A clean legal solution wherein the State would send a properly and legally allocated bill to each participant isn’t achievable, nor probably even desirable given how our system works. • Therefore, if the debt cannot be legally allocated and billed, we need to devise a method of allocating the unfunded obligation in a manner that meets the standards of logic and rational thought, and, which somehow captures the practical realities of what participant employers reasonably could have expected. 

13. WHY 85/15? • FNSB Example: • For 22 years (FY ’83 to FY ’05) FNSB had a 4.17% total average employer PERS rate. • An 85/15 rate for FY ’08 would be: 14.48 + 3.79 = 18.27%. This is a 438% increase of the 4.17%! • The FY ’08 ARMB approved rate for FNSB is 29.98%. This is a 719% increase of the 4.17%! • With a FY ’08 system wide average rate of 39.76%, FNSB would face a 953% increase! • With a FY ’09 projected PERS rate of 46.64%, FNSB would face a 1,118% increase! • Thus: • Even an 85/15 Shared Solution probably falls outside of what a participant employer (the FNSB here), could reasonably have expected as an adjustment to a two decade old average rate for system assumption and method changes. • More than a 438% increase clearly exceeds what a participant using logic and rational thought could have expected, and clearly does not meet any standard of predictability, stability, or affordability. • Therefore, as in this real example, an 85/15 allocation of the unfunded obligation presents a more than reasonable and fair settlement of the unfunded obligation wherein all employers are paying more, (i.e., a Shared Solution) but where they aren’t driven into a position of fiscal incapacity.Please understand, that right now, all employers are paying more than they reasonably expected.

14. WHY 85/15? If/Then: One could argue that if a fiduciary cannot send an accurate bill (when as a fiduciary they had a duty to properly account for activities such that an accurate bill could be sent) and they didn’t and can’t, then no bill can be sent. Accordingly: With 100% authority comes an equivalent level of responsibility. The responsibility and duty the State had as a fiduciary for the System creates the reasonable conclusion that an 85/15 split is accommodative to the circumstances.

15. Price Of Uncertainty And Failure To Reach Agreement

16. Respectfully, I Ask The State Chamber To Formally Support: A Shared Solution: • Amending State statutes to reflect an actual consolidated PERS Plan. • Having one uniform consolidated normal cost rate that all member employers pay. • Having 85% of the unfunded obligation go on the State’s books and be accounted for and paid by the State as a separate stand alone obligation. • The other 15% of the unfunded obligation belongs to all PERS member employers. • To pay the 15% unfunded obligation, there should be a separate uniform consolidated past service cost rate that all member employers pay, that is a separate rate from the normal cost rate. • The TRS obligation should likewise be broken into an 85%/15% split with 85% being accounted for as a separate obligation on the State’s books. As with PERS, there should be two separate rates, a uniform normal cost rate and a uniform past service cost rate that amortizes the 15% unfunded obligation. • Methods to reduce the future carrying costs of the unfunded obligations should be sought and used.