PERS

1. PERS 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. My Role 1)To communicate, at a global level, mechanically how PERS actually works. 2) To communicate how PERS formulas and methods have changed over time, and the consequence of those changes to your individual entity’s allocated unfunded balances, using examples. 3) Finally, assist in reaching consensus on AML’s position on PERS, and to formulate AML’s message of what specific actions it wants the administration and legislature to undertake.

3. 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!

4. The “Unpaid Bill” Basic Accounting Formula: A = L + (O/E or A/D) For PERS Assets – Liabilities = Equity or (Accumulated Deficit) @ 6/30/05:$8.6B - $12.8B=($4.2B) PERS Valuation Report LanguageAdjusted Assets – Accrued Liability = Unfunded Liability A – L = (A/D)

5. Mile High View Of PERS A – L = (A/D) Active Side Retired Side (Liabilities Fully Funded) EE Active Accts Filled By Compensation x EE Rate ER Active Accts Filled By Total Compensation x ER Rate 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 ER’s Active Asset - Liability= Unfunded Obligation $1.5B $7.1B EE & ER Adjusted Asset Accounts RRA Liability $5.7B $7.1B ER Accrued Liabilities ER RRA LiabilitiesLess Their Allocated Assets Equals Assets Moved From Each Active ER Account To RRASo That A = L RRA Assets RRA Assets Get Increased To Equal Liabilities RRA Assets Are Allocated To Employers Based Upon ER’s Pro-Rata Liability %,Then Active Employee Liabilities Allocated To Employers Active Employee Actuarial Liabilities Calculated RRA Assets Benefits

6. Main Points To Develop & Convey Today PERS, statutorily, is supposed to be a multiple employer, single agency system. It is not.The direct linkage of employer assets is broken every year. PERS, by design, and by actual methods and formulas used, is: a blended consolidated retirement system. The State bears responsibility for a major portion of the unfunded obligation and should transfer said portion onto its books.

7. $5.7B $7.1B $12.8B A – L =(A/D) 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 (active and retired) in the PERS system. (Employee here means employees and elected officials.)

8. 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% 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 A – L =(A/D)

9. Significant PERS Timeline Points A – L = (A/D) 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 RRA Allocated A Pro Rata Share Net Income 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 Investment Income To ER & EE Acts (1969) Only • 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 Not Transferred At Retirement • Transferred Assets Now Don’t Equal Liabilities At Retirement

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. It has credited investment income to employee accounts solely from the current employer’s active account, versus directly. • 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. Cousin Bud Example Active Retired A = L 160 Employer Accts 52,596 EE Accts Bud’s EE Acct RRA ER RRA LiabilitiesDictates The Assets Taken From Each Of The ERs $120k/yr comp. $100k/yr comp. $40k/yr comp. $50k/yr comp. $20k/yr comp. $90k/yr comp. $1k/yr comp. $1k/yr comp. 7/1/94 7/1/99 12/31/71 1984 11/1/00 11/1/77 11/1/74 11/1/90 6/30/04 6/30/06 6/30/05 11/1/80 6 years on School Board, $1k/yr comp. 10 year City employee $30k/yr ave. comp. 10 year UAF employee $70k/yr ave. comp. 4 year State employee $110k/yr ave. comp. A – L = (A/D)

12. Actual RRA assets “allocated” from other employers to employer 232 Employer 232’s RRA liability determination =‘s 232’s required assets A – L = (A/D)

13. 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?

14. Consensus Item #1, To Be Supported:PERS Balances & Payments Are Formula Driven & Have Been Blended Must Recognize: • PERS is an employee and elected official retirement system. The assets balances, and the liability balances, are driven by this fact. • PERS is a formula driven system. If any formula, at any point,blends either an individual employers liabilities, or assets, with another employer, then you must conclude that we don’t have a multiple employer, single agent PERS system. Proposed Consensus Item For Your Consideration: • We have a consolidated cost sharing system that we need to get statutory language adopted that reflects such.

15. Consensus Item #2, To Be Supported: Consequently, Given The Formulas: • Not one of the 160 member employers in PERS knows what their “actual experience driven unfunded obligation” is! Employers only know what their formula calculated unfunded obligation is. This calculation is the basis for the past service cost employer rate. • Therefore, no member employer knows what past service cost rate percentage they should, or shouldn’t, actually be paying. Proposed Consensus Item For Your Consideration: • We need to have one uniform consolidated contribution rate across all employers, for both the normal rate and the unfunded past service cost rate.

16. Consensus Item #3, To Be Supported:The State Had, And Has, The Primary Role In The Current Circumstance Acknowledgement Must Be Given To: • Entities fully paid the PERS bills they were sent by the State. • Many entities have tax caps which can not be adjusted for prior billing shortages. • The State is the only entity that has a constitutional requirement to share its financial resources with members of the State. • The State is the only entity that has the financial capacity to pay a larger portion of the unfunded obligation without jeopardy of insolvency. Proposed Consensus Item For Your Consideration: • The State has the obligation, responsibility, and the financial capacity to accept responsibility for payment of 85%of the annual past service cost, resulting from an unfunded balance, whatever the number.

17. Consensus Item #3, With Current #s:

18. Consensus Item #4, To Be Supported:This Is An Alaskan Issue, Winners Or Losers Can Not Be Determined! Please Appreciate The Fact: • There are no good guys or bad guys. There is just a cumulative consequence of many formula decisions made over many years/decades that has blended employer assets, beyond reconstruction. • Energy and resources spent trying to determine blame is divisive (within the borders of Alaska). Historical recreation of any employer’s specific outcomes, from 1961 to present, cannot be historically and/or factually completed. • Accordingly, determination of specific employer winners, and/or losers, from any shared solution, cannot be determined. This fact must be given due consideration in framing any solution. • Who pays, how much, should be based on ability to pay. Proposed Consensus Item For Your Consideration: • The other 15% of the current annual past service cost, from non-State member entities, should be based upon an individual entity’s total reportable compensation dollars, with a base minimum salary level set using reported 6/30/06 totals. [(39.76% - 14.48% = 25.28%) x (15%)] = 3.79% + 14.48% =18.27% total consolidated rate

19. 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. • 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.

20. 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. 

21. 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.

22. 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.

23. Price Of Uncertainty And Failure To Reach Agreement (To be filled in, or not preferably.)

24. Slides For Detail Backup

25. A – L = (A/D) The Two Rates FY ‘07/08 Past Service Cost Rate, System Wide (The piece of the rate that pays the active member’s unfunded obligation, i.e., that pays the liability over a period of time. The system wide rate is adjusted based upon each employers specific past service obligation.) Shared Consolidated Normal Rate(The rate calculated to fully fund benefits expected to be earned byactive membersduring the fiscal year following the valuation date.) Total Rate 25.28% FNSB FY’03/04 0.51% 14.48% 5.42% 5.93% 39.76% Total Rate x Reportable Compensation = Employer’s PERS Payment(PERS Bill)

26. Employer 101 Employer 106 Employer 113 Employer 116 Employer 151 Employer 156 Employer 172 Employer 180 Employer 200 Employer 294 $7.1B $5.7B $12.8B A – L = (A/D) Employee Liability Allocation 52,596Active 20,703Retired Don, Actuary Calc: $500K NPV 116: (9/18) x 500k = 250k 172: (9/18) x 500k = 250k Ross, Actuary Calc: $800K NPV 129: (3/24) x 800k = 100k 115: (3/24) x 800k = 100k 180: (16/24) x 800k = 533k 101: (2/24) x 800k = 67k Bud, Actuary Calc: $900K NPV 156: (6/30) x 900k = 180k 172: (10/30) x 900k = 300k 113: (10/30) x 900k = 300k 101: (4/30) x 900k = 120k 2 years 3 years Employer 101 4 years ($110k/yr) Employer 106 10 years ($70k/yr) 3 years Employer 115 Employer 116 9 years Employer 129 6 years ($1k/yr) 16 years 9 years Employer 156 10 years ($30k/yr) Employer 172 Employer 180 Employer 200 Employer 294 Every year these %s are used to reallocate the RRA assets!

27. PERS Investment Bucket A – L =(A/D) • Cash In: • Employee Contributions, to EE Individual Accts • 160 Employer Contributions (Compensation Paid x Employers Total Rate) • Investment Earnings(To be allocated at 6/30/06) • Cash Transfers: • Employee Individual AccountsTo RRA As “Appointed” To Retirement • Employer Active AccountsTo RRA @ 7/1/05$8.6B After 12 Months Of Ins & Outs @ 6/30/06$9.4B RRA $6.3B, 73.3% Pre Moving The 6/30 $800M From ER To RRA EE Accts $1.4B, 16.3% • Cash Out: • Employee Pension Payments, From RRA • Retiree Healthcare Premiums, From RRA • OperatingCosts • AdministrationCosts • Refunds, From Active Employee Accts (EE) ER Accts $0.9B, 10.5% S/B $7.1B

28. On-going & Year-End Bucket Activity A – L = (A/D) Investment Income (Operating & Admin) Net Income RR Account Balances @ Y/E 7/1/04 Beginning Balance + FY ’05 Indebtedness Payments, Not Through ER (FY ’05 Pension Payments) (FY ’05 Healthcare Premiums) (FY ’05 Refunds @ termination - spreadsheet) + Transfers From ER Accounts (A = L) = Pre-Net Investment Income Allocation Bal + Share of Net Income = Ending 6/30/05 RR Account Balance ER Account Balances @ Y/E 7/1/04 Beginning Balance + FY ‘05 ER Contributions (Comp x Rate) (6/30/04 Valuation Transfers to RRA) (A = L) (12/31/04 & 6/30 4.5% Investment Income To EE) = Pre-Net Investment Income Allocation Bal + Share of Net Income = Ending 6/30/05 ER Account Balance(s) EE Account Balances @ Y/E 7/1/04 Beginning Balance + FY ‘05 EE Contributions + FY ’05 Indebtedness Payments From ER Withholding + FY ’05 4.5% Investment Income From ER Active = Ending 6/30/05 EE Acct Balance(s) (Should Be Coming Directly From Investments) • Done In System Records, But Not On Spreadsheet That Goes To The Actuary • Post 7/1/99 conversion, EE account balances for new retirees is transferred to the benefit side in the system, but this transfer is not reflected on the spreadsheet used by the actuary to determine ER active assets needed to fully fund the RRA. System shows, actuary doesn’t know. So, RRA balance is understated and EE balances are overstated. ER (on the RRA side) isn’t getting the one-time benefit of the EE asset transfers, so ER has less assets on the RRA side, and thus will have more transferred from active side. Also, the RRA gets less investment income because it has a smaller balance compared to ER active account balance totals. • EE’s voluntary refunds after termination of employment come from the EE accounts in the system, but the spreadsheet that goes to the actuary shows them coming from the RRA. This effectively reduces RRA balance and share of net income. • EE indebtedness payments not made through ER payroll deductions go to EE accounts in the system but the spreadsheet that goes to the actuary shows them going into the RRA, thus increasing the RRA’s balance which increases it share of net income.

29. 11.1% Ave ER Rate 145.25% / 22yrs = 6.6% Ave EE Rate 91.88% / 22yrs = 4.17% Ave ER Rate

30. A – L = (A/D)