Virginia was one of the earlier states to statutorily mandate stress testing of its public pension systems. In 2017, the state passed HB 1768, which required the Virginia Retirement System to formally adopt stress testing and report the results online. The bill passed both chambers of the legislature unanimously and was estimated to have no fiscal impacts.
Hawaii also statutorily mandated stress testing in 2017 for its Employees’ Retirement System, and explicitly specified scenarios to be included in the risk assessment. The state instructed actuaries to project a 30-year outlook for the system under two scenarios: if investment returns are 2% lower than assumed and if there is a one-year, 20% loss on planned investments followed by 20 years of investment returns two percentage points lower than assumed. The latter scenario is to be tested twice: once under the assumption that employer contributions are adjusted based on current policy and then under the assumption that employer contributions are held constant at baseline levels. The bill that codified these requirements, HB 1182, passed both houses unanimously.
In 2019, Indiana enacted SB 545, which requires the executive director of the Indiana Public Retirement System and the trustee of the Indiana State Police Pension Trust to report the results of any stress tests conducted to Indiana’s interim legislative study committee on pension management oversight. Though the measure did not codify any requirements to conduct stress tests, it standardizes the way stress test results are communicated to the legislature, with the hopes of improving legislators’ awareness of the fiscal stability of the systems.
California was one of the first states to regularly stress test its public pensions. 2010 and 2011 legislation codified in CA Govt Code § 20229 requires the CalPERS Board to provide an annual report, which includes certain information related to state employees. This includes liabilities and contribution rate calculations using an investment return assumption that is 2% higher and 2% lower than the board’s current discount rate assumption. These statutory requirements are fulfilled by the State Actuarial Valuations, which set forth a detailed risk analysis and illustrate the sensitivity of employer contribution rates to a change in the discount rate assumption. CalSTRS is also required by statute to provide a report to the legislature every five years on the progress of the funding plan. The first progress report was completed and provided to the legislature in June 2019.
Pennsylvania’s comprehensive reform effort in 2017 established the Public Pension Management and Asset Investment Review Commission to study the financial health of the Pennsylvania Public School Employees' Retirement System and the Pennsylvania State Employees' Retirement System, and to evaluate the merits of formalized, mandatory stress testing. The commission released its findings in 2018 and made several recommendations, including passing legislation to mandate future stress testing. In response, the Pennsylvania legislature introduced HB 1962 during the 2019-2020 session. The legislation was signed into law in November 2020 and calls for annual stress testing to be reported to the governor, General Assembly, and Independent Fiscal Office.
Stress Testing Methodology
Stress testing is an umbrella phrase that can encompass several methods of assessing a pension system’s risk, including sensitivity analyses, scenario testing and stochastic modeling. Fundamentally, stress testing analyzes the risk of not meeting goals.
Sensitivity analyses allow actuaries to isolate variables in a pension plan. They assess the impact of a change in an actuarial assumption on an actuarial measurement. A sensitivity analysis typically focuses on a small number of actuarial assumptions that have significant bearing on the condition of a pension plan. These assumptions often relate to investment returns, inflation, population growth, payroll growth and employer contributions.
Scenario testing allows pension administrators to select a whole set of conditions and examine the outcomes, enabling policymakers to analyze the effects of hypothetical scenarios such as an unexpected recession or a prolonged period of sluggish investment returns.
Stochastic modeling is a more complex form of analysis in which actuaries run thousands of random simulations. The outcomes of all of these individual runs are compiled to forecast an “expected result” along with rough probabilities of various outcomes. Stochastic modeling is a useful tool since it allows pension administrators to understand which scenarios are most likely to occur as well as what range of outcomes has a reasonable chance of occurring.
One expressed concern is the cost of conducting stress tests, which range from hundreds to hundreds of thousands of dollars, depending on the scope of the stress test and whether a state contracts an independent actuarial firm to perform it. Stress testing proponents counter that states often appropriate additional funds when an outside firm is contracted, and that, regardless of the source of funding, stress tests are well worth the costs considering the long-term instability they can help avoid.
Another concern is that the results of stress tests will be misinterpreted. Vermont Treasurer Beth Pearce has advocated for pension risk assessment to be conducted by a pension system’s trustees, out of concern that outside stress tests could present a slanted assessment that leads to problematic reforms. However, legislatures that have implemented stress testing appear confident in their ability to interpret the results.
Lastly, some argue that mandated stress tests are repetitive in light of the adoption of ASOP 51.
Since virtually every public pension plan is regularly reviewed by actuaries to determine required funding levels, these plans will now be regularly stress tested, even in the absence of any statutory mandates. Nonetheless, proponents say there are still benefits of codifying risk assessment procedures, namely that legislators can specify scenarios to be evaluated or standardize the way results are reported.
Additional Resources and Recent Developments in Pension Risk Reporting
Public Pension Management Tools in Action, Part 1: Economic Scenario Modeling and Stress Testing in the Time of COVID-19 | NCSL Webinar, October 2020
Putting Data to Action: Stress Testing as a Tool for State Budgets and Public Pensions | 2020 NCSL Atlantic States Fiscal Leaders Meeting Session, February 2020
Putting Public Pensions Through Their Paces |State Legislatures Magazine, June 2018
Don't Stress Out About Pension Stress Testing | NCSL Webinar, May 2018
Data Tools for Policymakers: Stress Testing Pension Plans | NCSL Webinar, July 2017
Arkansas, Minnesota, Indiana, and North Carolina consider legislation.
Colorado implements plan design reforms to its Public Employees Retirement Association plans for state workers and teachers and codifies routine stress testing reporting requirements as part of the reforms.
ASOP No. 51 goes into effect for all reporting on or after November 2018.
Virginia and Hawaii publish their second annual stress testing reports, respectively.
Public Pension Management and Asset Investment Review Commission in Pennsylvania recommends annual stress testing of the state’s retirement plans for workers and teachers.
Connecticut adopts annual stress testing requirements.