Legislative Update: SB 2224 and SB 322 October 1, 2019

SB 2224: Funding Policies All public retirement systems are required to adopt a funding policy by January 1, 2020 and submit a copy to their sponsor and the PRB. The funding policy must detail how the system intends to achieve or exceed a 100% funded ratio.

Funding Policy Guidance PRB published an interim study on funding policies for fixed-rate plans in January 2019. PRB is in the process of adopting informal guidance to assist systems in funding policy development. Funding policies should cover the following four components: Clear and concrete funding objectives; Actuarial methods; A roadmap to achieve funding objectives; and Actions that will be taken to address actual experience that diverges from assumptions.

Funding Policy Guidance: Funding Objectives The funding policy must target a funded ratio of 100% or greater. The PRB recommends that systems adopt a funding policy that fully funds the plan over as brief a period as possible using a closed funding period.

Funding Policy Guidance: Actuarial Methods An important role of a funding policy is to set boundaries on what is allowable for actuarial calculations. At a minimum, three actuarial methods should be addressed: actuarial cost method, asset-smoothing method, and amortization policy. Funding policies should outline when negative amortization will occur and provide justification for the use of negative amortization.

Funding Policy Guidance: Roadmap If contributions are not made based on an ADC rate, the following items should be included in the funding policy: an ADC that will be used as a benchmark; conditions that will trigger action when the contribution rate moves away from the benchmark; and steps that will be taken to mitigate the differences between actual and benchmark contribution rates (when triggers are met). A funding policy should also establish parameters under which future benefit increases and contribution reductions can be considered.

Funding Levels: ADC vs. Fixed-Rate Plans Charts do not include closed/frozen plans, plans with "other" contribution structures, or plans with known contribution structure changes in the past 15 years.

Funding Policy Guidance: ADC Benchmarking Example 1

Funding Policy Guidance: ADC Benchmarking Example 2

Funding Policy Guidance: ADC Benchmarking Example 3

Funding Policy Guidance: Actual Experience that Diverges from Assumptions Risk-sharing A funding policy should identify key risks faced by the plan and how those risks/costs will be distributed between the employer and employees. Contributions The funding policy should identify what the trigger should be for a required adjustment to actual contribution rates. Techniques can be used to manage volatility, such as: contribution corridors, contribution smoothing and minimum/maximum contribution rates.

Funding Policy Guidance: Actual Experience that Diverges from Assumptions (continued) Benefits A funding policy may also establish when benefit adjustments will occur. It may include provisions that specify how both positive and negative experience will be addressed. Example: COLAs can be tied to inflation to manage plan costs.

SB 322: Investment Fee Disclosures Systems must include in their CAFRs, by asset class: all direct and indirect commissions and fees paid by the system for the sale, purchase, or management of system assets and the names of their investment managers. The PRB is in the process of drafting rules to implement the fee disclosure requirement.

Investment Expenses: Fees and Commissions Staff recommended defining investment expense as: Direct fees and commissions by asset class Management fees Fees paid from the trust Fees netted from returns (at the fund level) Indirect fees and commissions by asset class Performance fees (profit-sharing/carried interest) Broker fees and commissions (per share) by asset class

Other Investment Expenses To provide standardization, staff recommended including the following in investment expense reporting (which should not be reported by asset class): Investment consulting Custodial services Investment-related legal services Investment research

Investment Fee Disclosures: Asset Classes Staff recommended that fees be reported according to the following asset classes: Cash & Short-Term Real Assets (Private/Public) Equity Fixed Income Alternatives/ Other Money market securities Real estate Commodities Natural resources Private equity Domestic stocks International stocks Emerging market stocks Equity mutual funds Municipal bonds Corporate bonds US Treasuries > 1 yr. Treasury inflation-protected securities Private credit Fixed income mutual funds Hedge funds Venture capital Derivatives

Investment Fee Disclosures: Example

SB 322: Investment Practices and Performance Evaluation Systems with at least $30M in assets must select an independent firm to evaluate the appropriateness, adequacy, and effectiveness of the system’s investment practices and performance and to provide recommendations for improvement.

Investment Practices and Performance Evaluation: Categories Categories for evaluation: Investment policy Asset allocation Investment fees and commissions Investment governance processes Investment manager selection and monitoring process

Investment Practices and Performance Evaluation: Submissions Deadline: First evaluation is due to the governing body of the system by May 1, 2020 and to the PRB by June 1, 2020. Frequency for subsequent evaluations: Systems > $100M in assets: once every 3 years Systems > $30M in assets: once every 6 years Systems < $30M in assets: exempt from reporting requirement

Investment Practices and Performance Evaluation: Guidance The PRB is currently considering informal guidance regarding the evaluations. The evaluations should cover the following: A review of existing investment policies, procedures, and practices. An assessment regarding adherence to the established policies. The strengths and weaknesses of the current policies, procedures, and practices and make recommendations for improvement. A detailed description of the methodology used to perform the evaluation.

PRB Rules and Informal Guidance The Board began discussing proposed rules and informal guidance at its September 19-20 Actuarial Committee meeting. At the October PRB Meeting: Final guidance (SB 322 and SB 2224) will be considered for adoption. Rule language (SB 322 – investment fee disclosures) will be considered for posting the proposed rules in the Texas Register for public comment. Systems are encouraged to provide input at committee and board meetings throughout the process. Written comments on the informal guidance documents are being accepted until October 2, 2019.