PERS shortfall will hurt cities

State retirement program could increase 5 percent

Posted: Monday, August 04, 2003

Rapidly rising health care costs and poorly performing investments in the state-run public employee retirement program is about to cost Kenai Peninsula municipalities dearly.

The Alaska Public Employees' Retirement System, or PERS, which funds pension plans and retirement health care benefits for some 161 public employers, including the state and 160 political subdivisions such as peninsula municipalities, is about $2.5 billion short.

Meanwhile, the Alaska Teach-ers' Retirement System, or TRS, is $1.7 billion short as well.

According to the actuarial analysis done by the Seattle-based Mercer Human Resource Counsel-ing, to pay up that PERS shortfall over 25 years, the average rate currently paid into the system by communities ($6.77 on each $100 of salary) would have to rise to $24.90 per $100 -- almost a four-fold boost.

State law prevents any annual increases to exceed 5 percent, however, so rates are expected to rise steadily at 5 percent per year over the next few years. The increases are based on projections of future liabilities and investment returns, so if the stock market goes high into positive territory, the projections would change, perhaps dramatically. That likely would mean a reduction of the expected increases, perhaps even a decrease. Such ups and downs have happened before and are expected to occur again.

Nevertheless, at the moment at least, projections don't look good for member communities.

It should be noted that the rates paid by individual employers often vary from the average for a host of reasons, including number of employees, rate of retirements and mortality to name a few.

Here's a quick look at impact on some of the peninsula cities over the next two years.

In 2003, the city of Kenai paid into the system at a rate of 2.63 percent. On July 1, the start of fiscal year 2004, that rate rose to 3.67. In 2005, it will jump to 8.67 percent, the first 5-percent increase instituted by the PERS board. That kicks in July 1, 2004.

Soldotna, meanwhile, is paying 4.46 percent this year, but will see that rate jump to 9.46 percent in 2005. Likewise, Homer's 2.92-percent 2004 rate goes to 7.92 in '05. Seward's will go from 3.74 percent to 8.74 percent.

Seldovia, on the other hand, paid 10.18 percent in 2003 and saw that drop to 5.42 percent in '04. That's because Seldovia is new to the system and paid in at a higher rate to boost its fund reserves quickly. In '05, however, Seldovia's rate will bounce back to 10.42 percent because of the increases.

For the city of Kenai, 5 percent is equivalent to $240,000.

"It's one of those things you have to deal with that will give you a headache," Kenai Finance Director Larry Semmens said Friday. "I think we are facing a very serious problem. It's more than a headache."

Kenai, already reeling from the loss of significant property and sales taxes with the demise of Big Kmart, has made efforts to meet its financial problems, including reducing staff and contracting with the private sector. But sizable increases in the cost of employees could mean more layoffs, Semmens warned.

"If we do see rates go to what the actuary predicted -- 25 percent -- we will see significantly less employees," he said, adding that if the percentage hits the expected rate, by 2010, Kenai would be paying into PERS about $1 million a year.

"There's no question we'll be feeling the effects."

"All increases cause a headache," agreed Tom Boedeker, city manager for Soldotna, where the rate effectively doubled this year and will again next.

Soldotna will pay about $128,000 this year, and $250,000 in fiscal year 2005.

"It will be almost 10 percent of payroll," he said. "That's a healthy chunk."

In the early 1990s, the rate was around 13 to 14 percent, Boedeker said. But the good times that followed led the PERS board to cut rates. He said it might have been wiser to leave them a little higher then, thus avoiding at least some of the current pain.

He acknowledged, however, that politically, that probably would have been a hard choice for board members. Boedeker said Soldotna might not lay off workers, but it might tend to hire fewer.

The Kenai Peninsula Borough will see its fiscal year 2004 rate of 7.81 percent jump to 12.81 percent come July 1, 2005. But the borough happens to be in better financial shape than some borough cities, and the impact won't be as dramatic in terms of financial pain, said Craig Chapman, acting director of finance for the borough.

The problems facing PERS have been building for several years, he said. The falling stock market is the biggest cause, but so is the cost of health care, which he said is rising at a rate of about 15 percent a year over the past few years.

"It's not causing us a headache, but for small entities, it will definitely have an impact," he said. "The teachers' is a separate plan, but it is facing the same issues."

Jeff Sinz, former finance director for the borough and currently the chief financial officer for the municipality of Anchorage, is a member of the Alaska State Pension Investment Board, which oversees how pension funds are invested. He is a former chair of that board.

The investment board has nothing to do with setting rates, he said. Those are the duties of the PERS and TRS boards. But he is knowledgeable about the rates and their comparative effects on municipalities.

The increases won't hurt the Kenai Peninsula Borough, he said, because the borough relies heavily on external contractors, he said. For instance, the Kenai Peninsula Road Service Area has some employees, but contracts out most of the actual roadwork. The same goes in solid waste management, he said.

"As a result, the Kenai Peninsula Borough is not as impacted as much as those who rely on internal resources or public employees to do the work," he said.

The actuarial projections on investments assumed a rate of return of 8.25 percent. Instead, in fiscal year 2001 and 2002 combined, the PERS fund lost nearly $890 million. Rising prescription drug and medical care costs added even more to the negative numbers.

"On a longer-term basis, earnings have been just below 7 percent. That's not a great deviation, but below assumptions," Sinz said.

Things were different just a few years ago. In the late 1990s, earnings substantially exceeded projections and medical costs had stabilized, Sinz said. Today, there are indications that the pendulum may be swinging back to a healthier stock market.

"This year, to date, earnings are again exceeding, or look like they may exceed actuarial projections," Sinz said.

A few years of that, and projections might look a lot different than they do today.

"This is not a phenomenon unique to Alaska," Sinz said. "Look at private sector employers. They have been hit (with rising costs) severely. Public sector employers across the country have been hit with the same thing. This is just sort of Alaska's version of a broad economic situation. In many respects, we are much better off than a lot of places in terms of the impact of these changes."

Semmens said in his opinion, just ensuring that employees currently in the system will be covered would require an average rate next year something on the order of 13 percent, not the 11.77 the board has instituted.

"From that you can deduce we're not even paying the current year's cost," he said.

Kevin Worley, an accounting supervisor with the Division of Retirement and Benefits, confirmed that. It also means, barring a dramatic turnaround in the market, that the system will continue to fall behind, which could extend the 25-year payback period, he said.

Semmens said he has tried to get "straight answers" from the division without satisfaction, leaving him with a healthy skepticism about the accuracy of the actuarial projections. There should be an independent review to determine if the numbers support the predictions for the next several years, he added.

Sinz said an independent audit was conducted within the past year, one that assessed the actuarial firms assumptions and methodology. Worley said the audit required some changes but tended to confirm the validity of those factors.

"Actuaries use a set of assumptions," Sinz said. "There are alternative assumptions. I believe that it is a function of the PERS and TRS boards to approve actuarial assumptions."

With state law limiting the rate at which contribution rates can rise to 5 percent per year, and the current cap on the rate of individual employee contributions, there is little the boards can do but await the vagaries of the market and hope that medical costs level off.

An option that could be on the table by next year, however, would be to alter the rate paid by individual workers.

"I think most workers would agree to an increase before seeing the system under- funded," Semmens said.

At present, there is no legislation under consideration by state lawmakers to make that move.



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