North Dakota Legislative Employee Benefits Committee

NORTH DAKOTA LEGISLATIVE MANAGEMENT
Minutes of the
EMPLOYEE BENEFITS PROGRAMS COMMITTEE
Monday, October 26, 2009
Harvest Room, State Capitol
Bismarck, North Dakota
Representative Bette B. Grande, Chairman, called
the meeting to order at 9:00 a.m.
Members present: Representatives Bette B.
Grande, David Drovdal, Ralph Metcalf, Lisa Wolf;
Senators Ray Holmberg, Ralph L. Kilzer, Carolyn
Nelson
Members absent: Representative Francis J.
Wald; Senator Karen K. Krebsbach
Others present: See Appendix A
Chairman Grande recognized committee counsel.
Committee counsel said the August 6, 2009,
committee minutes should be revised. He said the
second full paragraph on page 2 which states
"Mr. Cochrane said the State Investment Board was
also impacted by the Bernard Madoff financial
scandal. He said the State Investment Board has
written down $40 million and recovered $23 million to
date" should be revised to read "Mr. Cochrane said
the State Investment Board was also impacted by the
financial scandal. He said the State Investment Board
has written down 40 percent of the WG Trading
portion of the assets and recovered $23 million to date
from Westridge."
It was moved by Senator Holmberg, seconded
by Senator Nelson, and carried on a voice vote to
approve the August 6, 2009, minutes as corrected.
At the request of Chairman Grande, committee
counsel distributed a copy of the October 2009 Your
Vested Interest newsletter published by the State
Investment Board. A copy of the newsletter is on file
in the Legislative Council office.
STATE INVESTMENT BOARD
FISCAL YEAR 2009 UPDATE
Chairman Grande recognized Mr. Steve Cochrane,
Executive Director/Investment Director, Retirement
and Investment Office. A copy of Mr. Cochrane's
PowerPoint presentation is attached as Appendix B.
He said the State Investment Board was involved in a
financial fraud this past year but it was not the
Bernard Madoff situation. He said the Bernard Madoff
financial scandal was targeted at individuals. He said
the situation that affected the State Investment Board
involved WG Trading Investors, L.P./Westridge
Capital Management. He said this investment had
been in place for 10 years and had always performed
very consistently. He said there were no particular
indications of wrongdoing and Callan Associates--the
board's investment consultant--performed two due
diligence reviews. He said $23 million, the portion of
the assets with Westridge Capital Management, was
recovered immediately. He said there was
$136 million placed with WG Trading Investors, L.P.,
and the board has taken a 40 percent write-down on
these assets totaling approximately $54 million. He
said approximately 35 entities were invested with
WG Trading Investors, L.P., of which 7 were limited
partners. He said the State Investment Board was a
limited partner and the fraud took place with
investments held by noteholders rather than the
limited partners. Thus, he said, the State Investment
Board believes it should be treated as a separate
class and is moving forward accordingly.
Mr. Cochrane said the State Investment Board has
$4.2 billion under management, of which $2.9 billion is
pension trust money. He said $1.1 billion is insurance
trust funds, of which 95 percent is the Workforce
Safety and Insurance fund. He said for fiscal year
2009, the Teachers' Fund for Retirement was down
27.33 percent and the Public Employees Retirement
System fund was down 24.42 percent. If there is
good news, he said, it is that on the pension side it
appears that approximately 82 percent of the total loss
is unrealized. For Workforce Safety and Insurance,
he said, the unrealized loss is approximately
95 percent. He said the fiscal year return for the
pension trust through October 21, 2009, is
14.59 percent.
VALUATION OF RETIREMENT,
INSURANCE, AND RETIREMENT HEALTH
INSURANCE PROGRAMS
Chairman Grande recognized Mr. Chris Conradi,
Enrolled Actuary and Senior Consultant, Gabriel
Roeder Smith & Company, Dallas, Texas, who
presented the July 1, 2009, actuarial valuation of the
Teachers' Fund for Retirement (Appendix C). A copy
of the actuarial valuation is on file in the Legislative
Council office. He said an actuarial valuation of the
Teachers' Fund for Retirement is prepared every year
as of July 1 using member data, financial data, benefit
and contribution provisions, actuarial assumptions,
and methods. He said the purposes of the actuarial
valuation are to measure the actuarial liabilities of the
fund; determine the adequacy of current statutory
contributions; provide other information for reporting,
such as Governmental Accounting Standards Board
Statement No. 25 and financial reporting for the
Employee Benefits Programs 2 October 26, 2009
Comprehensive Annual Financial Report; to explain
changes in actuarial conditions; track changes over
time; and to warn about possible future problems and
issues. He noted the Legislative Assembly had
enacted legislation in 2009 affecting the Teachers'
Fund for Retirement. He said the Legislative
Assembly established a supplemental retiree benefit
payment consisting of a one-time supplemental
payment to be paid in December 2009. He said this
payment will be calculated using a formula of
$20 times the years of service plus $15 times the
years retired for the beneficiary. He said the payment
is limited to the greater of 10 percent of the
beneficiary's annual annuity or $750. He said
members are eligible for the supplemental payment if
they retired before January 1, 2009, and are still in
payment on the distribution date. Also, he said, the
Legislative Assembly increased the employer
contribution rate from 8.25 percent to 8.75 percent
effective July 1, 2010. He said the increase in the
employer contribution rate is set to sunset back to
7.75 percent when the Teachers' Fund for Retirement
is 90 percent funded.
Mr. Conradi said the number of active members
increased by 146 from 9,561 to 9,707. He said the
increase is due to implementation of full-day
kindergarten. He said payroll for active members
increased 5.3 percent from $417.7 million to
$440 million. He said payroll has increased an
average of 3.4 percent per year over the last 10 years.
Average pay for active members increased
3.8 percent, he said, from $43,684 to $45,327.
However, he said, the increase in average salary can
be misleading because higher paid teachers who
retire are replaced by new teachers, and there was a
5.8 percent average increase for continuing members.
He said the average age for active members is
44.5 compared to 44.6 last year and to 44.0 ten years
ago. The average years of service for active
members is 14.3, he said, which compares to
14.4 last year and to 14.4 ten years ago. He said the
number of annuitants increased by 149, from 6,317 to
6,466, an increase of 2.4 percent. Over the last
10 years, he said, the number of retirees has grown
an average of 3.5 percent per year. He said the
average annual retiree benefit is $18,162, and there
are 1.5 active members for each retiree.
Concerning assets, Mr. Conradi said the return on
market in fiscal year 2009 was -27 percent. He said
that as far as Gabriel Roeder Smith & Company can
tell, this is the worst market return in the fund's history.
He said a return this bad is expected to occur just
once a century, based on most capital market
assumption sets. He said the -27 percent return is
made worse because it follows a -7 percent return for
fiscal year 2008. He said the fund assumes assets
will earn 8 percent per year net of expenses. Thus,
he said, the shortfall is really -35 percent or
-27% - 8% = -35%. He noted the average return for
the last 10 years was 2.0 percent and the 20-year
average return was 6.6 percent, which is below the
8.0 percent assumed rate of return. In dollar terms,
the shortfall was $632 million, he said.
Mr. Conradi said the fair market value of assets
decreased from $1.846 million on June 30, 2008, to
$1.310 million on June 30, 2009, or $536 million. He
said contributions total $74.4 million and distributions
total $118 million. Therefore, he said, the fund has a
net external cashflow, contributions less benefits and
refunds, of -$43.7 million or -3.3 percent of market
value of assets at the end of the year. Although this
has not been a problem in the past, he said,
projections show the negative net external cashflow
increasing in the future. If this occurs, he said, it may
require adjustments to asset allocation to meet benefit
payments with the fund required to hold more fixed
income or cash assets resulting in lower expected
returns.
Mr. Conradi said all actuarial calculations are
based on the actuarial value of the assets and not
market value. He said the actuarial value reflects
20 percent of the difference between last year's
expected return on market and the actual return. He
said the actuarial value of the fund is now $1.9 million
versus $1.909 million last year. He said the actuarial
return was 1.7 percent in fiscal year 2009 compared
to a -27 percent on the market value of assets. He
said the actuarial value is 145 percent of fair market
value compared to 103 percent last year. However,
he said, there are $590.6 million in deferred losses,
which are not yet recognized.
Concerning the actuarial results, Mr. Conradi said
the unfunded actuarial accrued liability increased from
$421.2 million to $545.6 million. He said the funded
ratio, actuarial assets divided by actuarial accrued
liability, decreased from 81.9 percent to 77.7 percent.
He noted the funded ratio using market value is
53.5 percent, down from 79.2 percent. He said the
unfunded actuarial accrued liability is 124 percent of
covered payroll compared to 100.8 percent last year.
He said the negative margin or shortfall declined from
-.99 percent to -2.53 percent, or 8.25 percent, the
statutory contribution rate, - 10.78 percent, the
actuarial required contribution, = -2.53 percent. He
said the funding period based on an employer
contribution rate of 8.25 percent is infinite, and the
5.74 percent amortization payment is insufficient. He
noted the ending period would be infinite even if the
8.75 percent contribution rate was used.
Mr. Conradi said Gabriel Roeder Smith &
Company has prepared projections based on seven
possible investment returns for fiscal year 2010, from
a -24 percent to a +24 percent. He said the
projections assume an 8 percent annual return for
fiscal year 2011 and each year thereafter. He said the
projections assume there will be no noninvestment
actuarial gains or losses, a .5 percent annual
decrease in the number of active members, an
8.75 percent employer contribution rate effective in
fiscal year 2011 and each year thereafter, and no
other benefit or contribution changes. Based on these
assumptions, he said, the projection shows that the
Employee Benefits Programs 3 October 26, 2009
fund would run out of money in 15 to 35 years. Only
with a 24 percent return for fiscal year 2010 will the
trust have assets remaining after 30 years, he said.
He said the 8.75 percent employer contribution rate
never sunsets, the margin never becomes positive,
the unfunded actuarial accrued liability continues to
grow in the future, and funded ratios all reach or are
headed to 0 percent. In order to return to an
82 percent funded ratio by the year 2039, he said, the
fund would need to achieve a 58 percent return in
fiscal year 2010 followed by a constant 8 percent
return thereafter; 17.25 percent for each of the next
five years, followed by a constant 8 percent return
thereafter; or a 10.75 percent return for every year
from fiscal year 2010 through fiscal year 2039. With
no recovery and no other changes, he said, to achieve
an 82 percent funded ratio in 2039, the employer
contribution rate would need to increase to
18.25 percent on July 1, 2011. If nothing is done, he
said, the projected benefits in fiscal year 2035 will cost
$341 million and require an employer contribution rate
of almost 28 percent just to pay that year's benefits.
He said North Dakota is not unique in that markets
have had this kind of effect on almost all public sector
retirement plans, plans across the country are
struggling with what to do, and actions available
depend on the legal environment in each state.
Concerning what other states are doing, he said,
most states are doing or considering forming task
forces or pension commissions, increasing employer
contributions, looking for other revenue sources,
cutting workforces, reducing benefits, increasing
retirement ages, creating new tiers with lower
benefits, making significant asset allocation changes,
establishing longer amortization periods, and
changing to an asset valuation method.
In response to a question from Representative
Drovdal, Mr. Conradi said the Teachers' Fund for
Retirement does not contain any automatic cost-ofliving
adjustment or increase provisions.
In response to a question from Senator Kilzer,
Mr. Conradi said most state teacher retirement plans
are a defined benefit plan with a retirement formula
based on a multiplier. He said the average multiplier
is 2 percent, the same as North Dakota's Teachers'
Fund for Retirement.
Chairman Grande recognized Ms. Fay Kopp,
Deputy Executive Director, Retirement and
Investment Office. She distributed a schedule of
North Dakota school districts not covered by Social
Security (Appendix D), a memorandum concerning
the $14.5 million transfer from the general fund to the
Teachers' Fund for Retirement in 1977 (Appendix E),
and a history of Teachers' Fund for Retirement
retirement plan changes (Appendix F). She said that
as of June 30, 2009, there are 14 North Dakota school
districts not covered by Social Security with
172 teachers not covered by Social Security. She
said in 1977 the Legislative Assembly transferred
$14.5 million from the general fund to the Teachers'
Fund for Retirement to offset the increasing unfunded
liability and decreasing solvency of the fund caused
by a series of benefit increases that were given to
members without funding the cost.
Chairman Grande recognized Mr. Brad Ramirez,
FSA, MAAA, FCA, EA, Consulting Actuary, The Segal
Company, San Francisco, California. He presented
the results of the July 1, 2009, actuarial valuation of
the Public Employees Retirement System
(Appendix G). A copy of the actuarial valuation is on
file in the Legislative Council office. He said the
purposes of the actuarial valuation are to report the
plan's assets, estimate the plan's liabilities, determine
the recommended contribution for 2009, provide
information for annual financial statements, and
identify emerging trends. To conduct the actuarial
valuation, he said, actuaries gather data as of the
valuation date, project a benefit for each member for
each possible benefit, apply assumptions about
economics and people, apply assumptions to benefits
to determine a total liability and assign liabilities to
service, and apply the funding policy to determine the
recommended contribution. Concerning 2008-09, he
said, there was a significant drop in assets in the
fourth quarter of 2008. He said changes to
contribution rates and funded ratios were dampened
by smoothing methods, but the drop in assets still had
a significant effect.
Concerning the July 1, 2009, valuation results,
Mr. Ramirez said, the market value of the combined
assets for the Public Employees Retirement System
and the Highway Patrolmen's retirement system was
$1.361 billion as compared to $1.817 billion the year
before. He said the combined actuarial value of
assets for the Public Employees Retirement System
and the Highway Patrolmen's retirement system was
$1.667 billion as compared to $1.661 billion last year.
He said the total actuarial value of assets was
122.5 percent of market value of assets on July 1,
2009. He said significant unrecognized losses will be
recognized in subsequent valuations and yield
increases in required contributions, unless offset by
future gains.
Concerning membership, Mr. Ramirez said, the
number of active employees in the main system
increased by 3 percent to 19,686, the judges'
retirement system remained stable at 47 members,
there was a 12 percent decrease in National Guard
members, a 6 percent increase in law enforcement
with prior service members, stable membership in the
law enforcement without prior service plan, and a
3 percent overall increase to 19,943 members. He
said there are 6,416 pensions in force for the main
system, 22 for the judges' retirement system, 7 for the
National Guard retirement system, 16 for the law
enforcement with prior service system, and 0 for the
law enforcement without prior service plan. He said
the average monthly benefit for the combined system
is $891.
Concerning financial information for the Public
Employees Retirement System, Mr. Ramirez said, the
market value of assets decreased from $1.761 billion
Employee Benefits Programs 4 October 26, 2009
to $1.320 billion, the actuarial value of assets
increased from $1.610 billion to $1.617 billion, and the
ratio of actuarial value to market value is
122.5 percent.
Mr. Ramirez said the contribution margin for the
main system is -3.62 percent, 4.04 percent for the
judges' retirement system, 2.79 percent for the
National Guard retirement system, -.80 percent for the
law enforcement with prior main service system, and
-.40 for the law enforcement without prior main service
system. He said the funded ratio for the main system
is 85 percent, 111 percent for the judges' retirement
system, 112 percent for the National Guard retirement
system, 70 percent for the law enforcement with prior
service system, and 62 percent for the law
enforcement without prior service system.
In response to a question from Representative
Wolf, Mr. Sparb Collins, Executive Director, Public
Employees Retirement System, said contributions are
split between the employer and the employee with the
employer paying 4.12 percent and the employee
paying 4.0 percent. For some employers, such as the
state, he said, the employer "picks up" the employee
contribution in lieu of a salary increase.
In response to a question from Senator Nelson,
Mr. Collins said the members of the National Guard
retirement system are security officers and firefighters
not subject to deployment, and thus, the membership
in the system is relatively stable.
Concerning the Highway Patrolmen's retirement
system, Mr. Ramirez said, the number of actives
increased from 130 to 133, an increase of 2.3 percent.
He said the number of pensioners and beneficiaries
also increased from 105 to 109, an increase of
3.8 percent. He said the average monthly benefit for
the Highway Patrolmen's retirement system is $2,542.
He said the market value of assets of the Highway
Patrolmen's retirement system decreased from
$55.6 million to $41 million. He said the actuarial
value of assets decreased from $50.8 million to
$50.2 million. The ratio of actuarial value to market
value, he said, is 123 percent, a difference of
$9.2 million. He said the valuation results for the
Highway Patrolmen's retirement system show a
contribution margin of -2.03 percent of payroll. He
said the Highway Patrolmen's retirement system is
87 percent funded. He said the contribution margin
for the retiree health insurance credit fund is
.14 percent.
In conclusion, Mr. Ramirez said, the asset
smoothing and amortization method employed by the
Public Employees Retirement System has dampened
the effects of last year's losses as intended. However,
he said, significant asset losses will be recognized
over the next five years, potentially leading to
increased contribution requirements. He said
potential risks to the system include a continued aging
of the population, unforeseen demographic shocks,
and a change in asset return environment. He
recommended the board consider projections and
studies to help quantify these risks and make changes
to the system, if appropriate. Also, he said, the asset
valuation method should be reviewed.
Mr. Ramirez also reviewed projections for the
Public Employees Retirement System (Appendix H).
Based upon a market return for each year after fiscal
year 2010 of 8 percent, he said, if the market return
for fiscal year 2010 is 24 percent the available margin
on June 30, 2010, will be -4.43 percent declining to
-7.18 percent on June 30, 2014. If the market return
for fiscal year 2010 is 16 percent, he said, the margin
on June 30, 2010, will be -4.63 percent declining to
-8.21 percent on June 30, 2014. If the market return
for fiscal year 2010 is 8 percent, he said, the June 30,
2010, margin will be -4.83 percent declining to
-9.24 percent on June 30, 2014. If the market return
for fiscal year 2010 is 0 percent, he said, the margin
on June 30, 2010, will be -5.03 percent declining to
-10.26 percent on June 30, 2014. He also calculated
available margins based upon a market return for
fiscal year 2010 of -8 percent, -16 percent, and
-24 percent. He said if the market return after fiscal
year 2010 is always 9.3 percent, the projected
margins for 2010 through 2014 are always negative.
Chairman Grande recognized Mr. Aaron Webb,
Assistant Attorney General, Attorney General's office.
He discussed constitutional implications of reducing
benefits or increasing contributions for existing
members of public employee retirement plans
(Appendix I). He said the legality of benefit structure
changes is an evolving area of law, and the two
questions asked are whether member contribution
levels may be increased and whether member
benefits may be decreased. In essence, he said, the
questions ask whether the state of North Dakota
would have the authority or power to unilaterally
change the benefit structures contained within the
current law to the disadvantage of any Public
Employees Retirement System or Teachers' Fund for
Retirement member or what legal entitlement a Public
Employees Retirement System or Teachers' Fund for
Retirement member has to the terms of his or her
pension. He said courts review constitutional
provisions, existing retirement statutes and rules, prior
case law, policy grounds, plans, and a combination of
these factors in determining legal entitlement to
pensions. He said there are three main entitlements
theories, which may be categorized as the gratuity
theory, qualification or trigger theory, and contracts
theory. Under the gratuity theory, he said, pensions
are a gift; legislative modification or elimination of the
retirement benefit structures can be made without
regard to the employee's interest in those benefits.
Under the qualification theory or trigger theory, he
said, public employees vest for the purposes of
protection under the contracts clause once specific
requirements are met for that member to secure a
pension benefit under the retirement statutes. Up to
that point, he said, the member has no protection.
Under the contracts theory, he said, retirement
benefits are considered earned compensation
contracted for at the time of employment, the terms of
Employee Benefits Programs 5 October 26, 2009
which are either completely protected or only subject
to modification under limited circumstances. He said
the legal landscape has evolved from the gratuity
theory of the early 20th century to a minority contracts
approach in the 1960s to a majority contracts
approach under current law. He said the trend is
moving toward more protection for the employee. He
said there is only one and at most two states that still
follow the gratuity theory. He said several states
follow the qualification theory, and the majority follow
the contracts approach. In summary, he said, if the
Legislative Assembly does not make changes
modifying existing benefit structures to the members'
detriment, such as increases to the contribution levels
of active members or reductions to member benefits,
no constitutional challenge would occur. He said this
is the most defensive position for the state. However,
he said, if the Legislative Assembly makes a decision
to modify existing benefit structures to the members'
detriment, depending on the level of change and
membership subject to the change, the action could
trigger a constitutional challenge whereby a court
would need to make a decision based on modern law.
He said this would be a potential risk for the state. He
said it is clear that the Legislative Assembly can make
changes for new or future hires and that retirees are
absolutely protected even under the old theories.
However, he said, the risk would increase as the
Legislative Assembly made changes to nonvested
employees, vested employees, or vested employees
eligible to retire.
No further business appearing, Chairman Grande
adjourned the meeting at 1:15 p.m.
___________________________________________
Jeffrey N. Nelson
Committee Counsel
ATTACH:9