PERA gets clean audit, but questions remain on Denver Public Schools retiree pensions

By Marianne Goodland

The annual audit of the Public Employees’ Retirement Association (PERA) by state and independent auditors showed the pension plan is well run, although legislators continue to be concerned about the state’s liability regarding the Denver Public Schools Retirement System (DPSRS).

The 2010 audit continues a trend of clean and generally positive reviews that date back to 2006, the last time auditors raised substantive issues about PERA controls that at that time related to administrative and travel expenses that had not been properly documented.

PERA Executive Director Meredith Williams

The audit for the year ending Dec. 31, 2009 was reviewed by the Legislative Audit Committee on August 16. It contained two recommendations from audit firm KPMG, who found PERA lacked a policy to review its vendor list and to ensure whether vendors were “valid entities.” The audit said the Information Technology department needed to have its duties segregated with regard to documentation of testing and approval procedures. Both recommendations have already been implemented, according to PERA officials, and legislators said the audit showed PERA was doing a “pretty good job.”

PERA is not out of the woods on its unfunded liability, according to Cavanaugh Macdonald, an actuarial firm that looked at the impact of SB 10-01 on PERA’s balance sheets and discussed those findings with the audit committee. The Cavanaugh Macdonald report was reviewed by PERA’s board of trustees last month, and showed that all but one of PERA’s four divisions will need more than 30 years to reach full-funded status, at the current expected rate of investment return of 8 percent. The state division has enough assets to cover 67 percent of its liabilities; the school division (which does not include DPSRS) has an asset to liability ratio of 69.2 percent; the local government division, which is the only division likely to reach full funding status by 2040, has a ratio of 76.2 percent; and the judicial division has a ratio of 77.3 percent. However, with the expected increased contributions and changes in benefits that resulted from SB 1, all divisions should be fully funded shortly after the 30-year limit. And Thomas Cavanaugh of Cavanaugh Macdonald pointed out that if PERA were to run out of money, and the plan had to go with a “pay as you go” method for paying benefits, in 2010 for example, the plan would need 40 percent of payroll to pay benefits.

Rep. Jim Kerr, R-Littleton, questioned the expected rate of return, stating that the market has not shown any improvement in 2010 and asked how long it will take for the pension plan to get to full-funded status with another year without investment gains. Kerr also said later that a “pessimistic” rate of return of 6.5 percent is not pessimistic, and PERA will have to change the model it’s using in the future. Otherwise, “the people will have to pay the bill.”

PERA Executive Director Meredith Williams said that rate of return will be evaluated by the trustees in September.

Cavanaugh noted that when assets are valued the actuaries use a “smoothing” technique, which is to spread out losses over a four-year period, to deal with fluctuations in market value from year to year. Cavanaugh pointed out that in the long term PERA has earned more than the actuarial rate of return; however, PERA is still only in the second year of four years of recording the losses from 2008 of more than $12 billion.

David Eberly of KPMG also pointed out that the current lawsuit filed against PERA to block changes resulting from SB 10-01 would have “a material actuarial impact on the funded status of the plan and would affect [its] long-term stability.”

Cavanaugh explained that SB 10-01 has a number of “lynchpins” that all affect PERA’s ability to reach full funded status. One is the reduction in the annual cost of living increase, which is at the heart of the lawsuit against PERA. If the COLA were to be reinstated, it would have a significant impact on the plan but Cavanaugh could not put a dollar figure on that.

PERA officials also pointed out that they have insurance that covers legal fees, with a $500,000 deductible. PERA General Counsel Greg Smith said he believed they would have to pay that deductible and the insurance would cover anything above that.

Legislators raised a number of questions about the relationship between PERA and DPSRS, and how PERA is affected financially by the merger of the two. PERA’s annual financial report includes unaudited figures showing that the DPSRS funded status was 88.3 percent as of Dec. 31, 2009.

In order for the merger to take place, and to put DPSRS on equal footing with PERA, in 2008 DPSRS purchased pension certificates of participation valued at $750 million. The PERA financial report said that if the funded status of DPSRS exceeds that of PERA’s school division (which it does now) DPS would be allowed to offset its employer contribution to PERA by an amount equal to the annual bond payment at a fixed interest rate of 8.5 percent. At the beginning of 2010, the DPS contribution rate per employee to PERA was 1.39 percent, compared to contribution rates ranging from 9.78 percent for employers in the local government division to 13.53 percent for employers in the judicial division.

When DPSRS merged with PERA, $2.7 billion in net assets were transferred to PERA to cover DPS employees, according to the KPMG auditor. “Is that now a financial, contractual and constitutional obligation to the state?” asked Kerr.

Smith responded that PERA’s obligation is to set contribution rates and benefits for the DPSRS division, but that there is no comingling of funds between any divisions. “One cannot subsidize another, and if the DPS [division] were to be underfunded, that affects only DPS,” Smith said. It would be the financial responsibility of the DPS employers, namely, the school district and charter schools. “I don’t believe it is a direct commitment [by the state],” he added.

At Kerr’s request, Cavanaugh also explained a part of the firm’s report on DPSRS that said that division’s unfunded liability is infinite, i.e. would take more than 30 years to pay off, and that the current contribution rate is insufficient to pay off the liabilities.

Cavanaugh said the credits (the amount DPS is allowed to deduct from its employee contributions) nearly wipe out the contribution to PERA for the DPS division. Those credits will be larger in the early years of the merger, he said. In addition, active employees will eventually be replaced with less expensive active employees, and combined with the increased contributions as the credit gets smaller, the DPS division eventually will get to full funded status. Another factor that will help with the DPSRS funded status is the inclusion of hourly employees, whose contributions have not yet been factored into the actuarial assessments, but will be included at the end of 2010.