THE MISSISSIPPI LEGISLATURE

The Joint Committee on

Performance Evaluation and Expenditure Review

Report # 564

The Public Employees’ Retirement System of Mississippi: A Review of Selected Issues Related to Financial Soundness

Executive Summary

Introduction

The Public Employees’ Retirement System of Mississippi (PERS) was established by state law to provide retirement benefits for officers and employees in the state service and their beneficiaries. The Legislature, legislative advisors, PERS Board of Trustees, PERS staff, and contract advisors all have responsibilities in the design, funding, and management of the state’s retirement system.

PEER conducted this review of PERS pursuant to the authority granted by MISS. CODE ANN. Section 5-3-51 et seq. (1972) and a specific provision of MISS. CODE ANN. Section 25-11-101 (1972), which contains the following mandate:

The Joint Legislative Committee on Performance Evaluation and Expenditure Review is hereby authorized and directed to have performed random actuarial evaluations, as necessary, of the funds and expenses of the Public Employees’ Retirement System and to make annual reports to the Legislature on the financial soundness of the system.

The scope and purpose of this report is to provide a comprehensive look into the decisionmaking processes of the PERS Board of Trustees, its staff, and its contractual advisors to determine whether the PERS Board is positioned to manage the key risks that threaten the viability of its retirement benefits programs.

To achieve this purpose, the PEER Committee established the following objectives for this report:

• to identify and define the roles of all parties involved (i. e., Legislature, legislative advisors, board of trustees, board staff, advisors) in the design, management, and operation of PERS;
• to clarify legal interpretations of the “contractual obligation” issues that have been raised relative to limitations on changing the benefit structure of existing plans;
• to analyze PERS’s approach to meeting its long-term benefit obligations relative to competing assumptions found in professional pension system management literature;
• to explicate the processes PERS uses to allocate and manage assets among different investment options, including its approach to risk management to help ensure the financial soundness of the system; and,
• to determine the extent to which the PERS Board seeks and follows competent expert advice in carrying out its fiduciary responsibilities.

On August 9, 2011, Governor Haley Barbour established the Public Employees’ Retirement System Study Commission through executive order to make recommendations on improving the financial, management, and investment structure of PERS and to publish such in a report to the Legislature and Governor. The study commission released Recommendations on Ways to Strengthen the State’s Retirement Plan on December 14, 2011. The PEER Committee thought it appropriate to review the recommendations of the study commission and:

• to determine which, if any, of the recommendations of the Public Employees’ Retirement System Study Commission have been incorporated into state law and/or PERS’s operations, analyzing the basis for action or lack of action on each recommendation.

Composition of the PERS Board of Trustees (pages 15 through 24 of report)

Since 1952, the Legislature has revised the composition of the PERS Board of Trustees on four occasions, resulting in the present ten-member board structure. Mississippi’s PERS Board is similar in composition to public retirement boards in the contiguous states. However, unlike the majority of retirement boards in the U. S., neither Mississippi’s retirement board nor those in the contiguous states include citizen members as trustees.

Also, while the majority of retirement boards in other states require some of their trustees to possess specific qualifications or work experience, Mississippi law does not require PERS Board members to possess any specific qualifications to serve on the board. While there are no standards as to retirement board composition and member qualifications, board members as a whole should possess the skill set necessary to make informed decisions regarding investment, legal, and administrative issues.

Legal Basis for the State’s Provision of PERS Benefits (pages 25 through 43 of report)

The State of Mississippi is contractually obligated to provide retirement benefits to current public employees who are in PERS-covered positions. The contractual obligation begins when employees become members of PERS upon their employment. PEER determined that:

• The United States and Mississippi constitutions contain clauses that prohibit state action that impairs the obligation of contract. These clauses protect persons who have made contracts and expect the terms of their agreements to be honored.
• Under U. S. Supreme Court authority, state actions that impair the rights private parties acquire in contracts made with the state are strictly scrutinized.
• The Mississippi Supreme Court has applied the U. S. and state contract clauses to cases involving retirement. When state action impairs a contract involving a member of PERS, the impairment must be also accompanied with “new advantages,” or it will be found unconstitutional. This legal principle is known as the “California Rule.” Generally, jurisdictions applying the California Rule protect an employee’s future accruals in a retirement system.
• The Attorney General has opined that any attempt by PERS to increase employee contributions when there are no “new advantages” given would violate the contract clauses.

PEER also notes that one reason for employees continuing public employment is because employers promise them future benefits that become a part of their contract of employment. Changes to the benefits that result in a reduction of these benefits would constitute an impairment of contract.

If the Legislature were to consider making changes to the PERS benefits structure, it would have to consider the legal ramifications of any changes affecting PERS members, summarized as follows:

• Changing benefits offered to retirees would pose a high risk of litigation.
• Changes to current employees’ future benefits without the extension of compensating new benefits or advantages would pose a high risk of litigation.
• Changing the benefits structure for future public employees would pose a low risk for litigation.

PERS and the Concept of “Financial Soundness” (pages 44 through 58 of report)

The ability to balance assets and liabilities underpins the concept of financial soundness. Under optimal conditions, the hallmark of a financially sound public pension system would be that its assets consistently meet or exceed its liabilities, a simple concept that requires due diligence and effective management over time if it is to be achieved.

When applied to a public pension system, the term financial soundness, in addition to its focus on balancing assets and liabilities, should be further defined as a multi-faceted construct involving an understanding of the role of actuarial soundness, a broadly defined view of affordability that encompasses sustainability, and an understanding of the role of risk management in the long-term financial health of the system.

• Actuarial soundness is generally viewed as a necessary component of a financially sound public pension system, but it is often used within the context of public pension systems in ways that suggest that it can also be relied upon to define financial soundness sufficiently.
• When considering the financial soundness of a public pension system, the affordability of that system is better informed by adding the broader term sustainable. Sustainability is the concept of being able to be upheld or defended in light of all relevant environmental conditions. A financially sound pension system is one that is sustainable in light of all relevant environmental conditions.
• A financially sound public pension system is one that is structured and operated to manage its long-term risk environment in ways that allow it a reasonable opportunity to collect or earn sufficient assets to meet its benefit obligations.

An unfunded actuarial accrued liability occurs when a pension system’s current actuarial value of assets is less than the present value of benefits earned by retirees, inactive members, and current employees as of the valuation date. However, when considering a pension system’s funded ratio, the American Academy of Actuaries cautions that the trend of a pension system’s funded ratios should be viewed in light of economic conditions existing at the time the funded ratios are calculated rather than focusing on a system’s funded ratio at one particular point in time.

Although an eighty percent funded ratio is often cited as the standard for a financially healthy public pension system, neither the financial or actuarial governing bodies have established a specific funded ratio as evidence of a financially healthy public pension system. PEER believes that a public pension system’s funded ratio should be viewed over a number of years to determine trends and evaluated in context of economic conditions existing during that time. PERS’s funded ratio has decreased from eighty-three percent as of June 30, 2002, to fifty-eight percent as of June 30, 2012.

Regarding actions taken to decrease PERS’s unfunded actuarial accrued liability, since 1990, the PERS Board of Trustees, based on recommendations from the PERS actuary, has approved increases in the employer contribution rate on six occasions, increasing the rate from 9.75% in 1990 to 14.26% in 2012. In addition, the Legislature increased the employee contribution rate from 7.25% to 9.00% effective July 1, 2010, and decreased benefits for employees hired on or after July 1, 2011.

The Governmental Accounting Standards Board has recently adopted statements setting new financial and accounting reporting standards for public pension plans that will go into effect in FY 2014 and FY 2015, respectively. The new standards reflect a major change in pension reporting and will require employers that provide a pension through PERS to report their proportionate share of the net pension obligation on their published financial statements. The statement does not address how governments approach pension plan funding.

PERS’s Investment and Risk Management Practices (pages 59 through 79 of report)

Public pension systems use adherence to an asset allocation strategy over long periods to ride out fluctuations in financial markets. Systems rarely have substantial short positions, typically holding “long” positions in public securities and private investments and diversifying by using a number of asset classes, styles, managers, and approaches. Public pension systems generally attempt to maximize investment return while minimizing or eliminating exposure to risks that are unintended or for which there is no reasonable expectation of return.

PEER believes that PERS is well organized for oversight, has access to needed investment expertise, and is supplied with the technical data needed to minimize the risks that face a defined benefit public pension system. Evidence gleaned from available actuarial assessments, investment reports, and the PERS Board’s minutes and publications shows that the board has acted prudently on available information and has responded within acceptable limits to minimize key risks as they have emerged.

PERS has a full range of competitively procured technical advisors to support risk mitigation efforts through direct interaction with the staff and the board and through a series of specialized reports. The PERS Board has established standards for both professional standing and scope of work for all contract professionals and firms.

PEER notes that the primary risk of any pension system is that assets will not support liabilities. PERS uses information gained from actuarial reviews, asset/liability studies, and asset allocation models to mitigate this risk. To address the risk of markets failing to achieve expected returns, PERS incorporates information from asset allocation reviews, long-term performance measurement, and experience investigations.

The PERS Board has a detailed investment policy statement that sets the stage for comprehensive asset allocation to the fund level. The asset allocation policy also sets targets and ranges for asset classes that allow for diversification into unrelated investments.

Status of Recommendations of the Public Employees’ Retirement System Study Commission (pages 80 through 97 of report)

As noted previously, Governor Haley Barbour established the Public Employees’ Retirement System Study Commission to make recommendations on improving the financial, management, and investment structure of PERS in order to ensure its long-term sustainability. The PERS Study Commission developed recommendations intended to help meet goals of increasing system funding while reducing contributions, with a particular focus on reducing employer contributions, which the commission considered an “undue burden on taxpayers.”

The study commission recommended changes to PERS Board membership, assumptions regarding projected investment earnings and member experience, and benefits (including the annual cost of living adjustment [COLA]). The commission also recommended further analysis of issues such as the addition of a defined contribution component to the retirement program, the appropriateness of continuing the Supplemental Legislative Retirement Plan (SLRP), and the proper division of PERS-related responsibilities between the PERS Board, staff, and the Legislature.

As of the date of this report, neither the Legislature nor the PERS Board had taken any action in response to the study commission’s recommendations.

Recommendations

• While PEER acknowledges the seriousness of the funding concerns facing PERS, the Committee believes PERS’s current financial condition is sufficiently sound to make any modification of current employees’ and retirees’ benefits legally inadvisable. Therefore, the Legislature should carefully consider PERS’s October 2012 proposal for achieving an 80% funded ratio by 2042 (see page 42 of the report) as a reasonable course of action for long-term stability.
• In preparation for an uncertain future, the Legislature should require the State Personnel Board, Department of Finance and Administration, and State Economist to study, with necessary assistance from PERS and the Attorney General, the benefits package (e. g., compensation, retirement, leave) used as an incentive to hire and retain a quality government workforce in Mississippi.
  
  Such a study should help determine what future modifications of the retirement system, if any, might be warranted to preserve a quality government workforce and what elements should be protected, should economic conditions require significant future changes in the retirement system. The study would also provide information for policymakers to develop a more level playing field regarding total compensation of private and public sector employees who have equivalent knowledge and skill sets.
• The PERS Board of Trustees should develop and maintain an ongoing assessment, catalog, and prioritization of possible PERS reform options that would be available to the Legislature should it request such.
• In further acknowledgment of the largely uncharted economic course that the state and the PERS system now face, the Legislature should amend MISS. CODE ANN. Section 25-11-15 (1972) to require the PERS Board of Trustees to work with the legislative liaisons, the Attorney General, actuaries, and investment advisors to establish the elements of a risk assessment strategy that would provide both the PERS Board and the Legislature with a working definition of “imminent collapse,” along with the information needed to make early identification of any threat of imminent collapse of the system. Such information would allow the Legislature to modify the benefit structure of the system for all participants based on risk, priority, and impact, should economic conditions force such change to become the only option for protecting the viability of the system.
• The Legislature should require the PERS Board of Trustees to work with relevant control agencies or associations of state and local government to survey participating employers to determine compensation practices (e. g., “stacking,” “spiking”) that could create an excessive liability for the system. By January 1, 2014, the board should provide to the Legislature recommendations to address such practices administratively or statutorily.
• While PEER finds no improper actions on the part of the current PERS Board, to improve the public’s confidence regarding the objectivity of the board in making decisions that affect the system, the Legislature should amend MISS. CODE ANN. Section 25-11-15 (1972) to revise the board’s composition as follows:
  
  
  • change one of the two system member positions provided for in subsection (c) (i. e., state employee members) and one of the two positions of a member receiving a retirement allowance as provided for in subsection (f) (i. e., retiree members); and,
  • replace these two members with individuals who are not members or retirees of the system, one appointed by the Governor and one appointed by the Lieutenant Governor. In making such appointments, the Governor and Lieutenant Governor should give preference to individuals with expertise in investments or financial management.
  Also, the Legislature should amend subsection (b) of MISS. CODE ANN. Section 25-11-15 (1972) to state that in making this appointment (i. e., the gubernatorial appointment currently required by law), the Governor should give preference to an individual with expertise in investments or financial management.
• As addressed by PEER in at least two previous reports (see PEER reports #191 and #273), PERS should seek an appropriation for all of its administrative expenditures, including investment managers’ fees, trading costs, and other investment-related fees. Since PERS is a state agency and not a private corporation, it is subject to the budgetary laws of the state as well as to the Legislature’s constitutional authority to make appropriations.

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