Texas HB 3898, effective on September 1, 2021, makes several amendments to the Texas Government Code that affect the state’s public defined benefit pension plans, including:
- Bolstering the requirements for mandatory plan funding policies;
- Adjusting the standards for the formulation of a funding soundness restoration plan (“FSRP”); and
- Strengthening the requirements for periodic independent review of plan investment practices.
Please note the legislation discussed herein only affects public defined benefit retirement plans. Neither defined contribution plans sponsored by governmental entities nor any private employer plans are impacted by these new rules.
Many different types of retirement plans cover public sector employees in Texas, including statewide systems, individually sponsored plans created by state statute, individually sponsored plans established under local ordinance, and plans that are not dependent on any particular statute or ordinance for their creation or ongoing administration. While these plans are subject to various requirements of the U.S. Internal Revenue Code (e.g., Sections 401(a), 403(b), or 457(b)), they are exempt from the requirements of the Employee Retirement Income Security Act. Because of this exemption, these plans must remain compliant with a myriad of state laws and are subject to the oversight of the state’s Pension Review Board (“PRB”).
Governmental defined benefit pension plans are subject to neither federal plan funding rules nor protection by the U.S. Pension Benefit Guaranty Corporation. This means that the financial viability of these plans is dependent on the oversight of state and local authorities and the governing bodies of the plans themselves. According to a 2014 study commissioned by the PRB, a significant negative shift has occurred in the reported amortization periods of Texas public retirement systems since 2000, when 24 plans had amortization periods of zero. In other words, in 2000, the assets of 24 of the 93 individually sponsored public defined benefit plans in the state were sufficient to satisfy all liabilities and annual contributions fully funded all accruals. In contrast, at the time of the study, 25 out of 93 public retirement plans had amortization periods greater than 40 years, an increase of over 200% since 2000, and only one plan had an amortization period of zero.
An overarching theme of the changes made by the 87th Texas Legislature in HB 3898 is an increased focus on having plans and their associated sponsoring government entities collaborate on matters relating to plan funding. Public plans are typically governed by a fiduciary board of trustees that serves independently from other government bodies, such as the local city council. These boards are often comprised of trustees who are elected by plan members or appointed by elected officials, and their duty is to serve the best interests of the plan and its participants and beneficiaries. The tenure of plan trustees can span multiple state or local administrations, public pension trusts in Texas collectively hold assets in excess of $250 billion dollars, and public employee pensions are often in the spotlight during political campaigns. Accordingly, the funding of such plans and the shared responsibility for contributing toward such funding can be points of contention between plans and their sponsoring entities. The updated rules encourage the cooperation of plans and government entities before there is a funding crisis and enhance the state’s funding guidelines to help better identify at-risk plans before such a crisis occurs. This is all done with the hope that advance planning will help preserve valuable resources and safeguard employees’ retirement income.
Written Funding Policies
Under the new law, plans must work jointly with their sponsoring entity to develop and adopt a written funding policy offering a detailed plan for achieving a funded ratio that is equal to or greater than 100 percent. If applicable, the plan and government entity must jointly revise this policy to reflect any significant changes, including changes required by a FSRP.
For any plan that is subject to a FSRP, a compliant funding policy must outline any automatic contribution or benefit changes that will prevent the need to formulate a revised FSRP, such as automatic risk-sharing mechanisms, actuarially determined contribution structures, and other adjustable benefit or contribution features.
In order to comply with the new law, the plan must file the funding policy with the PRB within 31 days after adoption, make it available at the plan’s office for public inspection, and post it on a publicly available website.
Adjusted Standards for Funding Soundness Restoration Plans
A FSRP is a written program that provides objective details regarding how an underfunded plan will become more actuarially sound. Under the amended Government Code, the governing bodies of both a plan and its associated governmental entity must jointly formulate a FSRP if the plan receives an actuarial valuation concluding that the plan’s amortization period has exceeded 30 years for three consecutive annual actuarial valuations. Effective September 1, 2025, the criteria to trigger a FSRP will automatically change and the plan and governmental entity must comply if the plan’s expected funding period: (i) exceeds 40 years; or (ii) exceeds 30 years and the funded ratio of the plan is less than 65 percent.
To comply with the Government Code, as amended by HB 3898, a FSRP must be:
- Developed by the plan and governmental entity in accordance with the plan’s governing statute;
- Designed to achieve a contribution rate that will be sufficient to amortize the unfunded actuarial accrued liability within 30 years not later than the later of:
- The second anniversary of the valuation date stated in the actuarial valuation that required formulation of the FSRP; or
- September 1, 2025;
- Based on actions agreed to be taken by the plan and governmental entity that were approved by both respective governing bodies before the FSRP was adopted; and
- Adopted at open meetings of both respective governing bodies not later than the second anniversary of the date on which the actuarial valuation that required the preparation of the FSRP was adopted by the plan’s governing body.
Within 90 days after adopting the FSRP, the plan may submit to the PRB a new actuarial valuation that shows the combined impact of all changes under the FSRP. If the plan chooses not to provide such an actuarial valuation to the PRB, the PRB may request that the plan provide, within 90 days, a separate analysis of the combined impact of all changes under the FSRP. This updated actuarial valuation or analysis must include an actuarial projection of the plan’s expected future assets and liabilities and a description of all assumptions and methods used to perform the analysis.
The new law also imposes a requirement to formulate a revised FSRP under certain circumstances if the plan’s funding is not improving under the existing one.
Updates to Independent Review of Investment Practices
The Texas Legislature previously amended the Government Code during the 86th Legislative Session to require that certain plans periodically select an independent firm with substantial representative experience to evaluate the appropriateness, adequacy, and effectiveness of the plan’s investment practices and performance and make recommendations for improving them.
HB 3898 amends this requirement to add a number of ethical requirements, including t that such evaluation must include, in addition to the existing required content:
- A summary of the independent firm’s experience and a statement that the firm’s experience meets the experience required by the state statute;
- A statement indicating the nature of any existing relationship between the independent firm and the plan being evaluated and confirming that the firm and any related entity are not involved in directly or indirectly managing the investments of the plan;
- A list of the types of compensation received by the independent firm from sources other than the plan for services provided to the plan; and
- A statement identifying any potential conflict of interest or any appearance of a conflict of interest that could impact the analysis included in the evaluation due to an existing relationship between the independent firm and:
- The plan; or
- Any current or former member of the governing body of the plan.
The Government Code also now requires that, within 30 days after the evaluation is completed, the firm must submit a substantially completed preliminary draft of the evaluation report to the plan. The firm must also request in writing that the plan, within 30 days after receipt of the draft, submit (i) a description of any action taken or expected to be taken in response to a recommendation made in the evaluation; and (ii) any written response of the plan that the plan wants to accompany the final evaluation report.
Thereafter, the firm must file the final evaluation report, including the evaluation results and any response received from the plan, with the governing body of the plan between 30 and 60 days after the draft was submitted to the plan or, if later, May 1st of the year following the year in which the plan is evaluated.
The Texas Legislature and PRB are eager to reverse the trends of the past 20 years and see improvements in the funding of defined benefit pension plans that benefit government employees in the state. The state is trying to improve plans by increasing early reporting and requiring the governing bodies of underfunded plans to work with their sponsoring government entities to address funding proactively before it is too late.
Please reach out to the author if you are a public sector employer and have any questions about this new legislation or would like assistance with assessing the compliance of any employee benefit plan.