FUNDING OF POST-RETIREMENT PENSION INCREASES UNDER PERS AND TRS

PENSIONS ‑- RETIREMENT ‑- FUNDING OF POST-RETIREMENT PENSION INCREASES UNDER PERS AND TRS

Where the actuary employed by either the public employees' or teachers' retirement boards reports that the required employer (in the case of PERS) or legislative (in the case of TRS) contribution rate, expressed as a percentage of salary, is now less than or the same as that required at the time of the enactment of chapters 189 and 190, Laws of 1973, 1st Ex. Sess., either of those boards will have a proper basis to find that cost-of-living pension increases "have been met" by an existing growth in the assets of the system over that required to meet the actuarial liability of the system at that time ‑ and thereupon grant such increases in accordance with RCW 41.40.195(5) or RCW 41.32.499(6), as the case may be.

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                                                                  March 29, 1976

Honorable Frank J. Warnke
State Representative, 30th District
302 House Office Building
Olympia, Washington 98504                                                                                                               Cite as:  AGLO 1976 No. 25

Dear Sir:

            By letter previously acknowledged you have requested our opinion on a question which we paraphrase as follows:

            If either the retirement board of the Washington public employees' retirement system (PERS) or the board of trustees of the Washington state teachers' retirement system (TRS), upon the advice of its actuary, determines that a proposed cost-of-living pension increase can be financed, without an increase in employers' or state contribution rates, by an existing growth in the assets of the system over that required to meet the actuarial liabilities thereof, is it then permissible for either such board to grant the cost-of-living increase even though such action will result in an increase in the total unfunded liability of the system when expressed in dollars?

            We answer this question in the affirmative for the reasons set forth below.

                                                                     ANALYSIS

            The statutory provisions which give rise to your question are contained in RCW 41.40.195(5) and RCW 41.32.499(6).  The first of these two statutes, which pertains to the Washington public employees' retirement system (PERS), reads as follows:

            "Each service retirement allowance payable from July 1st of any year after 1973 until any subsequent adjustment pursuant to this subsection shall be adjusted so as to equal the product of the cost-of-living factor for such year and the amount of said retirement allowance on the initial date of payment:  Provided, That the board finds, at its sole discretion, that the cost of such adjustments shall have been met by the excess of the growth in the assets of the system over that required for meeting the actuarial liabilities of the system at that time."

             [[Orig. Op. Page 2]]

            Similarly, RCW 41.32.499(6), in dealing with retirement allowances payable to members of the Washington state teachers' retirement system (TRS), provides that:

            "Each service retirement allowance payable from July 1st of any year after 1973 until any subsequent adjustment pursuant to this subsection shall be adjusted so as to equal the product of the cost-of-living factor for such year and the amount of said retirement allowance on the initial date of payment:  Provided, That the board finds, at its sole discretion, that the cost of such adjustments shall have been met by the excess of the growth in the assets of the system over that required for meeting the actuarial liabilities of the system at that time."

            The particular language prompting your question is that contained in each of the above two provisos.  Those provisos, as you know, were also the subject of AGLO 1975 No. 50 [[to Frank J. Warnke, State Representative on May 12, 1975 an Informal Opinion, AIR-75550]], which was written to you in May of last year.  There we advised you that if either retirement system has realized actuarial gains sufficiently in excess of actuarially determined general funding requirements to fully fund a post-retirement cost-of-living pension increase, such an increase may not, instead, be financed through increased employers' contributions or (in the case of TRS) by requesting increased state appropriations.  As we understand it, your present question is directed to the possibility that even though actuarial gains sufficient to fund a post-retirement pension increase have thus been made, the granting of such an increase may, nevertheless, cause the unfunded liability of the system involved, expressed in dollars, to increase over that which existed prior to the granting of such an increase.

            There is no question but that this could occur.  As we said at pp. 4-5 of AGLO 1975 No. 50, when either retirement board is presented with such an "actuarial gain"

            ". . . it is then in a position of either (1) granting a cost-of-living increase . . . which does not exceed the gain; (2) reducing the employer [or legislative] contribution rate to reflect the amount of the gain; or (3) doing nothing, leaving the gain to offset any future actuarial losses which might occur. . . ."

             [[Orig. Op. Page 3]]

            Yet under the formula for determining unfunded liability, as codified in the case of the PERS by RCW 41.40.361(4) and implicit in the funding procedure for the TRS under RCW 41.32.401, either of the first two of these three alternatives will, in fact, produce an increase in the dollar amount of the unfunded liability of the systems involved.

            Expressed in the form of an algebraic equation, unfunded liability is computed as follows:

            A=The present value of all future pension benefits in respect to all existing members and present beneficiaries.

            B=The present value of future employee and employers' contributions (PERS)1/ or employee and legislative contributions (TRS).2/

            C=The amount in the retirement system fund (employee contributions plus employer contributions under PERS) or the teachers' retirement and pension reserve funds (TRS).

            UL=Unfunded liability.

            A ‑ (B + C) = UL.

            Thus, if when it is presented with an actuarial gain either retirement board grants a cost-of-living increase UL will increase because A will be higher than before while (B+C) will remain the same since the gain will not be reflected in either an increase in the employers' or legislative appropriations or an immediate increase in the balance of the funds which make up factor C.  Instead, the gain will be realized over the funding period in the funds which make up that factor.  Similarly if either board reduces the employer or legislative contribution rate3/ UL will increase because (B+C) will decrease while A remains the same ‑ unless the actuarial gain is established solely by anticipating  [[Orig. Op. Page 4]] greater salary levels than formerly expected so that the present value of employer or legislative contributions is the same although the rate is lower.  Otherwise, only if the board "does nothing ‑ leaving the gain to offset any future actuarial losses which might occur ‑ will UL be unaffected by the gain.

            For example, immediately prior to the time of enactment of RCW 41.40.195(5),supra,4/ we are advised that the total unfunded liability of the PERS was so calculated as to require present and future employer contributions at a rate of 6.85% of salary and the total dollar amount of this unfunded liability was $415,000,000.  Later, at the time the first cost-of-living increase was granted pursuant to the authority of this 1973 amendment the total contribution rate requirement was only 6.78% of salary but the dollar amount of the unfunded liability was now $489,000,000.  Accord, the following presentation, in columnar form for ease of reference, of the overall picture during the last several years insofar as the PERS experience is concerned ‑ with cost rates being expressed as percentages of salaries:5/

                        Amount of Unfunded Liability Valuation DateCostAmortizationTotal  (in millions)

            December 31, 1971 5.11%  1.78%  6.89%  $  426 Without Adjustment

            December 31,1972 Without Adjustment 5.35 1.50 6.85 415 With 3% increase6/ 5.35 1.53 6.88 423

            December 31, 1974 Without adjustment 5.20 1.58 6.78 489 With 3% Increase6/ 5.20 1.61 6.81 500

            December 31, 1974 Without Adjustment 5.12 1.73 6.85 579 With 3% Increase6/ 5.12 1.77 6.89 593

             [[Orig. Op. Page 5]]

            As you will thus readily note, it is entirely possible for the actuarial liabilities of the system, as expressed in a total dollar amount, to increase while the same actuarial liabilities, expresses as a percentage of salaries, decrease.  In this manner, using the December, 1971 level as a starting point,7/ the actuarial liabilities of PERS when expressed as a percentage of salaries have declined slightly in spite of the fact that cost-of-living increases have been granted during the intervening years.  In 1973, the required contribution rate regarding the most recently completed valuation was 6.89% whereas that rate in 1975 declined to 6.85% in the absence of any further (1975) pension increase.8/   Of course, had no such increases earlier been granted in 1974 the required contribution rate, expressed as a percentage of salary, would now be even lower.

            While this, at first glance, may seem anomalous, there is a simple explanation.  Imagine an individual who agrees to pay his aged mother a monthly stipend of $100.  Let us further assume that this person, at the time he makes the agreement, is making $1,000 per month.  The stipend therefore represents 10% of his monthly salary and he can calculate that if his mother has a life expectancy of 10 years, his "unfunded liability" to her is $12,000 (100x12x10).  But if his salary then increases to $1,100 per month, the same 10% of his salary would provide his mother with a stipend of $110 per month.  If he in fact grants her a $5 per month increase his "unfunded liability" will immediately increase to $12,600 (105x12x10).  Yet the percentage of his salary which he is devoting to the stipend will be reduced to 9.45% (105¸1100 = .0945).

             [[Orig. Op. Page 6]]

            The situation, in regard to post-retirement pension increases under RCW 41.40.195(5) and RCW 41.32.499(6), supra, although not nearly as simple, is quite similar.  But what this all means is that if "growth in the assets of the system" ‑ within the meaning of those statutes ‑ is ascertained by determining whether the required employer or legislative contribution rate, as a percentage of salary, will remain stable or decrease even though such increases are granted then cost-of-living increases can be granted even though the total unfunded liability of the system, expressed as a dollar amount, will increase as a result.