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					          31st Annual Police Officers’
                and Firefighters’
           Pension Trustees’ School

              Actuarial Magic?
Actuarial Value of Assets & Other Mysteries
                         May 26, 2010


                                              1
Actuaries




            2
Actuaries

Work on Problems in Business and Finance Involving
 Payment of money in the future that is contingent
  upon occurrence of future events
 Risk management




                                                      3
Actuary’s Work for Retirement System

Actuarial Valuation
 Calculate contribution rates
 Determine funded status
 Prepare GASB reporting information
 Special studies on proposed benefits
 Opinion on actuarial soundness




                                         4
Basic Retirement Funding Equation



       C+I=B+E
   C   =   Contributions
   I   =   Investment Income
   B   =   Benefits Paid
   E   =   Expenses (administration)


                                       5
Benefit Policy




  How much, when and to whom
  are benefits paid?




                               6
Funding Policy




  How much and when to
  contribute?




                         7
Two Fundamentally Different Methods of
Financing Retirement Benefits

Social Security: Pay-As-You-Go
                 Current generation pays benefits
                 of prior generation.

Most Public     Prefunded
Systems:        Current generation saves money for
                its own retirement; prior generation
                did the same.


                                                       8
                                  Cash Benefits
% of
Active
Member
Payroll




          Start       50
                  Years of Time



                                                  9
                           Pay-As-You-Go Contributions

                                   Cash Benefits
% of
Active
Member
Payroll




          Start       50
                  Years of Time



                                                         10
                                        Pay-As-You-Go Contributions

                                                Cash Benefits
% of
Active                      Prefunded Investment Income
Member                                Prefunded Level Contributions
Payroll


                  Prefunded Employer and Employee Contributions


          Start                    50
                               Years of Time



                                                                      11
Selecting Assumptions
About Future Events




                        12
Decremental

   Withdrawal
   Death while active
   Disability
   Retirement
   Death after retirement




                             13
Economic

   Inflation
   Real return for assets
   Salary increases
   COLA’s




                             14
Economic Adjustments

 Inflation should be consistently applied
 Real returns should reflect asset mix




                                             15
Understanding Economic Assumptions



           Interest Rate
         - Inflation Rate
         = Real Rate of Return




                                     16
   Actuarial Check-Ups
(Experience Investigations)




                              17
Why

 The only thing an actuary can state with certainty
  is that in any one year, the assumptions made
  about events will be wrong. The magnitude and
  direction of the impact of these mismatches (with
  the possible exception of investment returns)
  should produce minor fluctuations in employer
  contribution rates.
 Gains/losses when actuarial assumptions are
  “wrong”




                                                       18
Purpose

 To compare actual plan experience with actuarial
  assumptions used in the valuation
 Make recommendations where appropriate to
  better align experience with assumptions




                                                     19
Frequency

 Every 3 to 5 years
 May not be reliable for small plans with insufficient
  credible experience
 Annual actuarial valuation opportunity for actuary
  to review experience without formal study




                                                          20
Decremental Adjustments

 Follow experience
 Watch trends (e.g., improving mortality)
 Factor in special events during investigation period
  (e.g., retirement incentive programs)




                                                         21
    Fundamentals of
   Actuarial Valuations
& Plan Sponsor Liabilities


                             22
Present Value

 The present value of an amount of money payable
  in the future is the amount of money that, if we had
  it today, would accumulate to the amount that will
  be payable considering
    Investment Return
    Probability that money will be paid




                                                         23
Valuation Results

  Contribution For                Description
  Normal Cost                Value of this year's expected
                             benefit accruals

  UAL                        Unfunded Liability
                             Accrued Liability - Assets
  "Unfunded Liabilities" are a natural part of retirement
  system funding, comparable to a mortgage on a home.
  A plan which is 100% funded is required to contribute
  the normal cost.

                                                             24
Causes of Unfunded Actuarial
Accrued Liabilities

1. Granting initial benefits or granting benefit
   increases for service already rendered.
2. Actual experience which is less favorable than
   assumed. Examples follow:
   a.   Higher salary increases
   b.   Earlier retirement date(s)
   c.   Lower death rates
   d.   Lower rates of investment earnings
   e.   Lower rates of non-death terminations




                                                    25
Unfunded vs. Underfunded

 Most actuarial methods facilitate smoothing of
  costs by assigning a portion of the funding
  obligation to a bucket called accrued liability. The
  amount in this bucket that is not yet met by
  existing assets (the unfunded accrued liability
  (UAL)) is financed over a period of years (30 or
  less) thus aiding in the desired smoothing.
 The UAL is one of the most misunderstood items
  in actuarial parlance. There is nothing intrinsically
  wrong with having a UAL.



                                                          26
Unfunded vs. Underfunded

 It must be noted that the term “underfunded” is
  misused extensively and leads to unwarranted
  conclusions about the financial viability of public
  pension plans. Although there is a significant
  difference between “unfunded” and “underfunded”,
  the media all too often substitutes the latter for the
  former.
 Just because a plan has an unfunded accrued
  liability does not mean the plan is underfunded.




                                                           27
Gains & Losses

 Actuarial experience different from expected
 Remember any one year actuarial assumptions
  will be wrong – assumptions will not exactly match
  experience
 Actual experience can be more favorable than
  assumed (a Gain) or less favorable than assumed
  (a Loss)
 Amortized over a number of years (up to 30)
 Amortization methods
    Level dollar (like a mortgage)
    Level percent of pay (increasing amount as payroll
     goes up)
                                                          28
Intergenerational Equity

 Florida Statutes, Chapter 112 “prohibit the use of
  any procedure, methodology, or assumptions the
  effect of which is to transfer to future taxpayers
  any portion of the costs which may reasonably
  have been expected to be paid by the current
  taxpayers”
 Actuary’s job to help smooth fluctuations in cost to
  spread costs over years of service performed by
  employees
    If assumptions too conservative, current taxpayers
     pay for what future taxpayers should be paying
    On the other hand, if assumptions too optimistic
     costs may be transferred to future taxpayers
                                                          29
Changes in Major Assumptions
Effect on Liabilities and Contributions

  Assumption        Action                Usual Effect


  Interest Rate     Increase              Decrease

  Retirement Rate   Retire younger        Increase


  Turnover Rate     More Terminations     Decrease




                                                     30
Asset Valuation Methods for
Public Retirement Systems




                              31
Asset Valuation Methods

 Market
 Smoothed Market




                          32
Smoothing Methods

 Recognize some portion of market return each
  year
 Can be straight line or weighted
 Most commonly used is straight line, 5-year
  smoothing
 Can be with or without corridor, i.e., actuarial value
  cannot be less than x% or more than x% of market
  value
 Florida Statutes require use of corridor
 Most common corridor is 80%-120% of market
  value

                                                           33
Funding Value of Assets
                           Actuarial Value vs. Market Value
   $ in Millions

   140

   120

   100

    80

    60

    40

    20
          1    2   3   4   5   6   7   8   9   10 11 12 13 14 15 16 17 18 19 20
                           Market Value         Time     Actuarial Value

               Actuarial Value is expected to be:
                   Below Market when market is doing well
                   Above Market when market is doing poorly
                                                                                  34
              Current Issues

Economic recession

Market decline

Timing of recovery

                               35
Impact of Market Downturn
on Pension Plans

 Increase in contribution rates
 Decline in funding ratios




                                   36
Possible Remedies

   Investment returns
   Benefit changes
   Contribution changes
   Give pension plan time to recover




                                        37
Investment Returns

   FY 07-08 market return was -15%
   FY 08-09 market return was 0%
   Actuarially assumed return was 8% per year
   Returns needed over various periods to “make up”
    the loss:
     One year:      48%
     Three years:   20%
     Five years:    15%
 Recovery will take time and patience
 Consistent with long-term nature of pension plans


                                                       38
Benefit Changes

 Legal limitations
    Accrued benefit protected
    New hires only
 Premium tax moneys
 Two-tier systems
 Plan changes may result in cost increases in
  short-term
 Benefit components that drive cost:
      Retirement eligibility
      Benefit accrual rate
      Average final compensation definition
      COLA
                                                 39
Contribution Changes

 Increase current active member and new hire
  member contribution rates
 No increase in member contributions without
  increase in benefits.




                                                40
Governmental Accounting
    Standards Board
 Current Pension Project


                           41
Governmental Accounting Standards Board
Statements 25 and 27

 Statement            Standard


     25      Financial Reporting for Defined Benefit Pension Plans
             and Note Disclosures for Defined Contribution Plans

     27      Accounting for Pensions by State and Local
             Governmental Employers




                                                                     42
Current GASB Project

   Separate funding and accounting
   Unfunded liability on employer balance sheet
   Accelerate accrual of cost
   May not change funding
   Likely to impact employer financial statements




                                                     43
Current GASB Project - Timing

 GASB expected to issue Preliminary Views in
  June 2010
 Opportunity for interested parties (such as,
  pension boards, plan sponsors, actuaries,
  accountants) to comment
 Exposure Draft
 Final Statement – 2012?




                                                 44

				
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