FUNDING REVIEW PANEL Established by Act No. 448 (HB 682) of the 2005 Regular Session. Minutes of Organizational Meeting Tuesday, August 23, 2005

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1 John Neely Kennedy P. O. Box State Treasurer Baton Rouge, LA (225) FUNDING REVIEW PANEL Established by Act No. 448 (HB 682) of the 2005 Regular Session Minutes of Organizational Meeting Tuesday, August 23, 2005 Mr. James H. Napper II, Executive Counsel for the State Treasury and designee of the initial chairman, State Treasurer John Neely Kennedy, called the meeting to order at 10:16 a.m. in Committee Room 5 of the State Capitol, Baton Rouge, LA. Mr. Napper called the roll and introduced each member of the panel. (1) ROLL CALL Recommendations Committee: voting members Members Present: Members Absent: Mr. James H. Napper II, Chairman Mr. Sam Jones designee of State Treasurer John Kennedy appointed by the governor Mayor John A. Berthelot of Gonzales selected by the Louisiana Municipal Association (LMA) Mr. Stacy Birdwell - FRS Board member selected by the Firefighters' Retirement System (FRS) board of trustees Lt. Henry Dean - MPERS Board Chairman selected by the Municipal Police Employees' Retirement System (MPERS) board of trustees Mayor Randy Roach of Lake Charles selected by the Louisiana Conference of Mayors Mr. Bob Rust - MERS Director selected by the Municipal Employees' Retirement System (MERS) board of trustees Rep. Don Trahan appointed by Mr. Napper in the absence of Mr. Sam Jones

2 Advisory Committee: non-voting members Members Present: Members Absent: Sen. Walter J. Boasso Rep. Pete Schneider appointed by the Senate President Chairman, House Retirement Sen. Butch Gautreaux Chairman, Senate Retirement Governor's appointment - unfilled Mr. Charlie Fredieu - FRS Board Chairman selected by the Professional Fire Fighters Association (PFFA) Rep. Brett Geymann (joined the meeting after Roll Call) appointed by the House Speaker Rep. Don Trahan appointed by the House Speaker in the absence of Rep. Geymann Mr. Chris Nassif - MPERS Board Member selected by the International Union of Police Associations (IUPA) Staff Members Present: Laura Gail Sullivan - Panel Attorney Karen Stephens - Panel Secretary Joe Guillory - Senate Staff Attorney Gordon Monk - Legislative Fiscal Office Thomas N. Rice - Acting Legislative Actuary David Mayeaux - Sergeant at Arms Witnesses Present: Mr. Gary Curran - MERS and FRS Actuary Mr. Charles Hall - MPERS Actuary (2) INTRODUCTION OF DESIGNATED AND PARTICIPATING STAFF Mr. Napper introduced the staff members. (3) INTRODUCTORY COMMENTS AND REVIEW OF PROVISIONS OF ACT 448 Rep. Trahan said, "Act 448 was the result of a movement to take a look at at least these [three] parts of our 13 retirement systems, and see if we can't put ourselves in a better position, not only for the taxpayers, but for our retirees and our members." 2

3 Mayor Roach said, "Act 448 was much longer when it was originally filed, and we had a lot of things that we wanted to try to accomplish. We recognized during the legislative process that there are a lot of parties involved in the retirement issue, and we also recognized that if we're going to make any real changes, those changes have to be carefully considered and they have to be supported or we're not going to be able to make them happen. The original legislation was born out of a financial crisis for the municipalities. I can tell you that just for the City of Lake Charles, the excess retirement contributions for all of our employees, not just fire and police, cost the city an extra $1.5 million every year. That represents almost 4% of our operating budget. Fortunately, this legislation authorized a change in the [actuarially assumed] rate [of return] for firemen and policemen and just making that one change has saved the City of Lake Charles $500,000. What we were hoping is that we could explore ways to make some minor adjustments in various pieces of legislation that affect the various components that drive the overall cost of retirement and make a recommendation to the legislature so that we could enact it in the next session. The composition of the [panel] reflects the intent to bring all the parties to the table, and get input from as many different people as we can to fashion as good a solution as we can, and to have in the process a very frank discussion about the issues that we have to deal with." Ms. Sullivan explained that Act No. 448 of the 2005 Regular Session established the Funding Review Panel to conduct a comprehensive review of the actuarial funding and benefit structure of FRS, MERS, and MPERS. She further explained that the legislation required the study of eligibility for retirement, benefit calculation including final average compensation, contributions, actuarial assumptions, and the cost-of-living adjustment (COLA) criteria, although the panel was not limited only to those components. She said that the Recommendations Committee members had voting rights, and that a quorum of the Recommendations Committee was necessary in order to take action (vote), however, a quorum of the entire panel was necessary in order to convene a meeting and conduct business. Ms. Sullivan stated that the first duty of the panel was to elect a chairman and vice chairman, and that one of the duties of the chairman was to select a member of the Advisory Committee to serve on the Recommendations Committee, in the event that a Recommendations Committee member was absent from the meeting. She said that the panel was required to submit a report to the House and Senate Committees on Retirement and the Legislative Actuary by February 15, 2006, which must include recommendations for increasing the actuarial soundness of the three systems while providing a generous, affordable benefit for the members of each system. (4) ELECTION OF CHAIRMAN AND VICE CHAIRMAN Mr. Napper asked for nominations for chairman. Rep. Trahan nominated the State Treasurer, Mr. John Kennedy; second by Sen. Butch Gautreaux. There were no other nominations. Rep. Trahan moved the nominations be closed; second by Mayor Roach. Mr. Napper offered a motion to elect Mr. Kennedy chairman of the panel, to which there was no objection. Mr. John Kennedy was elected chairman of the panel by a vote of 11 yeas, 0 nays. Those voting yea were Mr. Napper, Mayor Berthelot, Mr. Birdwell, Sen. Boasso, Lt. Dean, Mr. Fredieu, Sen. Butch Gautreaux, Mr. Nassif, Mayor Roach, Mr. Rust, and Rep. Trahan. 3

4 Mr. Napper asked for nominations for vice chairman. Rep. Trahan nominated Sen. Butch Gautreaux. Mr. Napper explained that the vice chairman must be a member of the Recommendations Committee. Rep. Trahan nominated Mayor Randy Roach; second by Mayor Berthelot. There were no other nominations. Mayor Berthelot moved the nominations be closed; second by Mr. Napper. Mayor Berthelot offered a motion to elect Mayor Roach vice chairman of the panel, to which there was no objection. Mayor Randy Roach was elected vice chairman of the panel by a vote of 11 yeas, 0 nays. Those voting yea were Mr. Napper, Mayor Berthelot, Mr. Birdwell, Sen. Boasso, Lt. Dean, Mr. Fredieu, Sen. Butch Gautreaux, Mr. Nassif, Mayor Roach, Mr. Rust, and Rep. Trahan. Mr. Napper appointed Rep. Trahan to the Recommendations Committee in the absence of Mr. Sam Jones. (5) PRESENTATION BY THE MUNICIPAL EMPLOYEES' RETIREMENT SYSTEM (MERS) Mr. Bob Rust, director of MERS, distributed a hand-out (Attachment 1). He gave a brief history of the system, which began in 1954 with four municipalities, and has grown to include 7,377 individual members in 138 towns, cities, and villages. He said that system assets are about $600 million, and retirees (mostly Louisiana residents) receive $3 million per month in benefits. He explained that "Plan B" of the retirement fund included Social Security participation, and "Plan A", the larger of the two funds, did not. He stated that the valuation interest rate was 8% and last year's funding ratio was 86.79% for Plan A and 93.04% for Plan B. Mr. Rust said that MERS was the only "voluntary" system in the state, outlined the make-up of the board (three mayors, three city workers, chairmen of Senate and House retirement committees, and the Louisiana Municipal Association (LMA) president), and spoke at length about retirement eligibility and other aspects of the system. Rep. Trahan asked about the administrative costs and investment management fees. Mr. Rust stated that the administrative costs were $900,000/year and fees were $1.2 million/year. Sen. Boasso asked to be provided with the actuarial rate of return for the last 10 years, a copy of the budget, and a copy of the fee structure. Mr. Napper asked Mr. Rust to forward those materials to staff for distribution to the panel. Mr. Napper asked if the system was fully funded prior to the downturn in the market several years ago. Mr. Gary Curran said, "most of the negative activity has had very little effect on the funded ratio of the plan because investment experience losses are funded through normal costs rather than unfunded liability." Mr. Napper asked about the status of COLAs. Mr. Rust said that COLAs have not been granted by the board since 2001, because the system has not enjoyed an actuarial rate of return in excess of the assumed rate of return, as required by law. Mr. Curran explained the statutes that apply to the granting of COLAs, and further stated his belief that, unless the law was amended, the ratio of assets to liabilities would not meet the target specified by law for many years. 4

5 Sen. Boasso asked how long it would take the plan to go from 86% funded to 100% funded. Mr. Curran said that law allowed 40 years, that the system was years into that time frame, and that Plan A would be fully funded by Sen. Boasso observed that employer contributions have doubled in the last four years. Mr. Curran said that in order to stay whole, the increase in contribution rates was necessary to offset the shortfalls in investment earnings. Sen. Boasso asked if there was a plan in place to "clean up the UAL (Unfunded Accrued Liability), besides putting it on the back of the local governments". Mr. Curran said that any fluctuations, positive or negative, were passed on to local government. Sen. Boasso asked about the earnings forecast for the next 10 years. Mr. Curran said that long-range, "8% was difficult, but do-able". There were no further questions. (6) PRESENTATION BY THE MUNICIPAL POLICE EMPLOYEES' RETIREMENT SYSTEM (MPERS) Lt. Henry Dean, chairman of the MPERS board, distributed a hand-out (Attachment 2) and gave a brief history of the system. He said that MPERS had recently raised the assumed rate of return, which in turn lowered the employers' contribution rate from 20.25% to 16.25%, and further stated that the move was a "short-term fix" for the overall problem. He went over the remainder of the hand-out, which included an explanation of the funding of the system, the eligibility for retirement, and the calculation of retirement benefits. Lt. Dean said that the fund value was $1.306 billion as of June 30, Mr. Napper asked about the recent change in the rate of return. Lt. Dean said the rate was raised from 7% to 7.5%. Sen. Boasso asked how long the Deferred Retirement Option Plan (DROP) had been in place, and whether DROP was a cost to the system or revenue-neutral. Lt. Dean stated that DROP was put into place in 1984, and that there was a slight liability. Sen. Boasso asked for the required rate of return and a copy of the operating budget. Lt. Dean said that the assumed rate of return was 7.50%. Sen. Boasso and Lt. Dean briefly discussed the Insurance Premium Tax Fund (IPTF). Mr. Napper said the tax was part of the funding for the systems and would be discussed at another meeting. Rep. Trahan asked for a description of the board and management costs. Lt. Dean gave a brief outline of the board make-up and offered to provide management cost information at a later date. Rep. Trahan and Lt. Dean briefly discussed the real estate investments of the board, including the golf courses which have received so much press coverage, and recent litigation involving the board. Mayor Roach asked for an explanation of the liability associated with DROP. Lt. Dean said, "DROP accounts are earmarked for participants, but that [DROP] money is co-mingled in an investment portfolio. We don't have a separate [DROP] account for John Smith and Jane Doe... and where I perceive a bit of liability is, several years ago... we were heading towards a negative return... Under the DROP program, if we pay ½% below an investment return, what do we do with an investment loss? The attorney general [opinion]... says that [DROP] is a retirement benefit, and by law, cannot be taken away or reduced... But the system sustains a loss based on that portion of 5

6 the investment portfolio. So, in my mind... that presents a bit of a liability. It's not an overpowering liability." Mayor Roach asked if the member was guaranteed the actuarial rate of return of 8% on his DROP account. Lt. Dean said no, the law stated that the accounts be paid at ½% below the investment return on the portfolio, and that no system could guarantee a positive return on their portfolio. He further stated that if the investment return was positive, the return for the member was positive, but if the investment return was negative, the member lost nothing. Sen. Boasso asked about the possibility of cost-of-living-adjustments (COLAs), if the system forecast 7.5% earnings for the next years. Lt. Dean agreed that no COLAs would be given if earnings remained at 7.5%. Mayor Berthelot commented on the difference in the employee contribution rates between MERS and MPERS, with MERS being higher. Mr. Fredieu asked if a member accrued interest on his DROP money if he continued in active service after the DROP period. Lt. Dean said yes. There were no further questions. Mr. Napper asked that a copy of the materials be sent to Sen. Boasso and Rep. Trahan asked that copies also be sent to staff for distribution to the remainder of the panel. He suggested that panel members make note of the items they wished to have included in the final report of the panel. (7) PRESENTATION BY THE FIREFIGHTERS' RETIREMENT SYSTEM (FRS) Mr. Steven Stockstill, executive director of FRS, announced that system information dating back several years, including the operating budget, financial statement, actuarial statement, and minutes, could be found on the system website: He distributed a chart (Attachment 3) which detailed the asset allocations by class, fees, percentage of overall portfolio, and the returns for each of the system's investment managers. He addressed Sen. Boasso's previous question about the forecast of earnings for the next 10 years. Mr. Stockstill cited an independent study sponsored by Goldman-Sachs which projected expectations of returns at 5.8% for the long term, based on reduced returns from equity risk and falling interest rates. Mr. Stockstill distributed a hand-out (Attachment 4) and gave a brief overview of the inception of the system and the membership. Mr. Fredieu asked why Orleans and Lafayette parishes were excepted from the membership. Mr. Stockstill said that Lafayette was authorized to merge, and Orleans was excluded because they have their own system. Sen. Boasso asked why the membership had doubled in the last 10 years. Mr. Stockstill answered that the system was created in 1980, was "young" in comparison to MERS and MPERS, and was still growing as municipalities merged into the system. Rep. Geymann, the House Speaker's appointee to the Advisory Committee, joined the meeting. 6

7 Mayor Randy Roach asked whether the 1993 authorization to merge systems into the state system had contributed to the problem that FRS had experienced in recent years. Mr. Stockstill answered, "Indirectly, yes." He explained the sources of system funding, including the IPTF. Mr. Napper reminded Mr. Stockstill that the panel intended to address the funding of the systems in detail at another meeting. Mr. Stockstill outlined the difference between the actual (9%) and required (9.02% to 30.75%) employer contribution rate for the years He said the employer contribution rate was subsidized and the "difference was made up" from IPTF contributions. Mr. Stockstill pointed out that millions of dollars per year in excess IPTF monies have been turned back over to the state's general fund, although the excess amounts had sharply decreased since Mayor Roach said, "I would just argue that this is the shortfall that was generated by virtue of the fact that we kept our employer rate and our employee rate the same over that time, in other words, it's not something that I would like this committee to think that just the employer is the only one that is responsible for paying this difference. I think that's the whole purpose behind our discussion in this committee is to figure out how we can fund that difference here and adjust that required employer contribution rate and keeping it level at 9% - I just don't want us to just assume that's the only way that we can go to make up any difference - make up any shortfall that any of these systems may experience... when we say "required", it was left at 9%, and that was what was required. And what you're seeing here [Attachment 4] is the difference in the shortfall by leaving it and not addressing the problem back in 1994, '95, '96, and '97. This is how we got to where we are today." Sen. Boasso pointed out that the returns exceeded the assumed rate, and asked why there was such a disparity. Mr. Stockstill answered that the system was taking in groups of members and assuming massive amounts of liability. Sen. Boasso asked about the funded ratio. Mr. Stockstill said the ratio was 72%. Mr. Birdwell said, "...maybe "responsible" party, instead of "required". The employer was responsible for that amount, right? But they weren't required to pay but the lower amount because of the offsets. It's been that way since inception on January 1, 1980, the cities wanting to get out of the pension business knew that was going to be their responsible part, that if we got offsets from somewhere else - IPTF and the market returns - it would be reduced. Unfortunately, over the years, we've had changes in management in all of the cities, and a lot of them don't realize the way that was set up back in If PRSAC [Public Retirement Systems' Actuarial Committee], when they give their notice, had put maybe what the "responsible" amount was, but only the part to be remitted or the part that you would be "required" to pay, it might have been more clear over the years." Mr. Fredieu stated his belief that the FRS employer rate rose to 13% in 1987 and Ms. Sullivan said, "I believe Steven [Stockstill] is using the terminology "required contribution" and it's understood to be a required employer contribution just by the way the actuaries usually present their information to PRSAC. There are only two kinds of contributions - the employee 7

8 contribution and the employer contribution. When the actuary does his calculation he subtracts out what he believes the amount of dollars will be that the employee contribution will yield and the amount of dollars that are remaining in that actuarially required contribution are treated by PRSAC and the actuaries as an employer contribution. After that employer contribution is established, then the taxes are backed out, whether it's revenue sharing or ad valorem or, in this case, the IPTF. So, I think Steven has been meaning the terminology that was used by PRSAC and the actuaries, if you go back and look at the history of the way things were set up. I don't think he was making any assumption about what was legally required under the constitution or through the Supreme Court case. The second point I would make is that the term "Insurance Premium Tax Fund" is [only] used within the retirement group. If you go to the Department of Insurance and ask them about the IPTF they don't know what you're talking about. What we are talking about are the taxes that are, at this point, used for four of our systems that are generated pursuant to R.S. 22:1419. You'll sometimes hear them referred to that way - the R.S. 22:1419 monies, instead of the IPTF." Mr. Stockstill agreed. He said that the term the actuaries use is the "net direct actuarially required employer contribution" and explained the remainder of the FRS charts and hand-outs. Mayor Roach said that, under the law, the employee rate was fixed, and that after all of the other resources were developed, the employer was left to pick up the difference. He asked if FRS was still accepting mergers and not requiring that they be fully funded, and if so, what could be done about that, and what could be done about the systems that are already merged into FRS that are not fully funded. Mr. Stockstill said that he took exception to part of the way the mayor characterized those systems. He said that the system actuary would go into more depth at a later date about the mergers, pay outs, and liabilities that were created. Mr. Fredieu stated his belief that FRS funding was improving. There were no further questions. (8) DISCUSSION OF FUTURE MEETINGS, SCHEDULING, AND TOPICS FOR CONSIDERATION Mr. Napper distributed the Proposed Meeting Schedule and invited discussion of the dates, etc. Mr. Fredieu said "With the IPTF - I would like to see some legislation that, rather than that [money] going back to the general fund if you don't need it, that it goes towards paying down the UAL." Mr. Napper said Mr. Fredieu had made the first proposed recommendation of the panel, and with the permission of the panel, and the understanding that the panel could change its direction at a future point, he and Ms. Sullivan would proceed with developing Mr. Fredieu's idea. Mr. Napper invited Rep. Geymann to make his introductory remarks. Rep. Geymann thanked the panel members for agreeing to serve, and said he looked forward to working with them on proposals that would move them in the right direction. 8

9 (9) OTHER BUSINESS There was no other business. Mr. Napper offered a motion to adjourn the meeting, to which there was no objection. The meeting was adjourned at 12:26 p.m. Respectfully submitted, James H. Napper II, designee of John Neely Kennedy Chairman /kls Date approved: 9