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Tacoma Employees’ Retirement System August 9, 2012 Board Meeting

Tacoma Employees’ Retirement System August 9, 2012 Board Meeting. Actuarial Terminology and Funding Principles 2008 – 2011 Experience Study. Presented by: Mark Olleman and Daniel Wade. Agenda. Actuarial Terminology, Funding Principles, the Board’s Funding & Benefits Policy

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Tacoma Employees’ Retirement System August 9, 2012 Board Meeting

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  1. Tacoma Employees’ Retirement SystemAugust 9, 2012 Board Meeting Actuarial Terminology and Funding Principles 2008 – 2011 Experience Study Presented by: Mark Olleman and Daniel Wade

  2. Agenda • Actuarial Terminology, Funding Principles, the Board’s Funding & Benefits Policy • 2008 – 2011 Experience Study

  3. Actuarial 101 The actuary provides the Retirement Board with sound information based on probability and statistics, so that the Board can make informed decisions concerning the System’s funding and benefits.

  4. Funding Illustration • Ultimately: Contributions + Investments = Benefits + Expenses • Assumptions are key to the timing of contributions. (budgeting)

  5. Assumptions • All liability calculations rely on assumptions • The experience study is a periodic review to “true up” the assumptions based on actual experience: • 4 years of active experience, 2008 – 2011 • 6 years of retired experience, 2006 – 2011 The Four Necessary Elements of an Actuarial Valuation

  6. Normal Cost Rate (Current Assumptions) • Normal Cost Rate = Level % of pay that will fund a member’s benefit if paid over his or her entire career.(Based on 7.75% returns, and all other assumptions) • Normal Cost Rate = 17.34% of Pay • Contribution Rate (Starting January 1, 2012)= 20.00% of Pay

  7. Actuarial Accrued Liability (Current Assumptions) • Actuarial Accrued Liability= all past Normal Costs added together • This is the target level of assets IF: • Contribution Rate = Normal Cost Rate • All future experience = Actuarial Assumptions • No provision for adverse experience • $1,185.5 million

  8. Actuarial Value of Assets • Actuarial Assets smooth market value gains and losses over 4 years. • $ 13M = actual return in 2011 based on 1.3%$( 83M)= expected return in 2011 based on 7.75% assumption,$ (70M ) = difference or “loss.” The $70 M loss is recognized in four equal $17.5 M pieces at January 1 of 2012, 2013, 2014 & 2015. • At January 1, 2012 the following gains and losses have not been recognized: • ¾ of the $ 70 M loss from 2011 = $ (52M) • ½ of the $ 60 M gain from 2010 = $ 30M • ¼ of the $148 M gain from 2009 = $ 37M • Therefore, at January 1, 2012 the $1,068 M Actuarial Value of Assets is $15M smaller than the $1,083M Market Value of Assets.

  9. Comparing Assets to Liabilities (Current Assumptions) • 2012 Unfunded Actuarial Accrued Liability = Assets – AAL • Actuarial Assets - AAL = $1,068.3M – $1,185.5M = ( $117.2M) • Market Assets - AAL = $1,082.9M – $1,185.5M = ($ 102.6M) • 2012 Funding Ratio = Assets ÷ Actuarial Accrued Liability • Actuarial Assets = 90.1% • Market Assets = 91.3%

  10. Amortization Period (Current Assumptions) • When there is an Unfunded Actuarial Accrued Liability (UAAL) the “Amortization Period” is the time required for: • Contributions – Normal Cost Rate to pay off the UAAL • Contribution Rate (20.00%) – Normal Cost Rate (17.34%)= 2.66% of pay • 2.66% of pay is sometimes called the “UAAL Rate” • 2012 actuarial valuation amortization period = 35.0 years. • The 2.66% of pay UAAL rate is projected to pay for the $117.2 million UAAL over 35.0 years. • Contributions would need to be increased to 20.26% to pay off the UAAL over the 30 year metric in the Board’s Funding and Benefits Policy.

  11. What is the Board’s Funding & Benefits Policy? When the Funding Ratio is: • Above 120% - The potential for benefit improvements will be reviewed provided the funding status is expected to remain stable after improvements • Between 95% and 120% - “No action zone” if: • The Contribution Rate is greater than or equal to the Normal Cost Rate, OR • The Funding Reserve is expected to last at least 20 yearsIf neither of the above is true, then consider a contribution increase. • Between 80% and 95% - Consider a contribution increase • Under 80% - Review and re-evaluate Funding & Benefits Policy

  12. What is the Board’s Funding & Benefits Policy? Additional Guidelines: • Maintain a Contribution Rate greater than or equal to the Normal Cost Rate • Contribution increases may be in small increments • Requests for increases should be made at least one year prior to beginning of financial biennium • Contribution increases should consider amortizing the UAAL over 30 years or less • Consider calculations based on Market Value of Assets • Consider long-term funding projections

  13. Tacoma Contribution Rate History • Shared Contributions, 46% by employees and 54% by the City is the long standing pattern. Everyone shares the cost.

  14. Experience Study

  15. Experience Study Summary Three broad groups of assumptions: • Active demographic assumptions • We are recommending small changes that cause a small decrease in the calculated costs. • Retired mortality assumptions • We are recommending strengthening the male mortality assumption which will increase calculated costs. • Economic assumptions – We recommend the Board consider: Lowering price inflation from 3.25% to 3.00% which will cause: • The net investment return assumption to decrease from 7.75% to 7.50% • The general wage growth assumption to decrease from 4.25% to 4.00% • The combined impact on 1/1/2012 calculated costs would be to: • Decrease the funded ratio by 4.1% (90.1% to 86.0%) • Increase the 30 year amortization rate by 2.09% of pay (20.26% to 22.35%)

  16. Implications of the Experience Study based on the Board’s Funding and Benefits Policy • Consider Contribution Increase: The Funding Ratio change from 90.1% to 86.0% is still in the range of 80% to 95% where the policy says the Board should consider a contribution increase. • Contribution changes are usually made based on an actuarial valuation, not an experience study. • If the recommended changes are adopted, and • If there are not experience gains during 2012, • Then it is expected the January 1, 2013 Actuarial Valuation would indicate the Board should consider a total employer plus employee contribution increase of 2.35% of pay or more based on a 30 year amortization period.

  17. Assumption Study Schedule • Tacoma’s prior four-year cycle: • 2006 Retired Mortality (2002 – 2005, 4 years) • 2008 Active Demographic (2004 – 2007, 4 years) • Adjustment to combine studies: • 2010 Retired Mortality deferred (No study) • 2012 Both are Studied • Active Demographic (2008 – 2011, 4 years) • Retired Mortality (2006 – 2011, 6 years) • Next study • 2016 Active and Retired (2012 – 2015, 4 years)

  18. How Should You Set Assumptions? • Assets are accumulated and benefits are paid over a long period of time. • Active working lifetime: 20 – 40 years • Period to receive retirement payments: 20+ years • Longer than most investment projections • What is your sensitivity to changes in the actuarial assumptions and experience?

  19. Actuarial Risk • If actuarial assumptions overestimate actual future costs, contribution increases may be larger than needed, increasing the burden on current taxpayers. • If actuarial assumptions underestimate actual future costs, contribution increases may be smaller than needed, increasing the burden on future taxpayers.

  20. Our Philosophy • Don’t Overreact • Make small adjustments more often than big changes. • Changes in assumptions could be offsetting. • Anticipate Trends • Simplify • There is no point in complexitythat does not improve accuracy.

  21. No Guarantees • The only guarantee is that future experience will not exactly conform to the assumptions. • The assumptions will only predict actual future costs to the extent future experience is consistent with the assumptions. • The assumptions must be reviewed regularly to adapt to experience.

  22. Active Demographic Assumptions • “Merit” Salary increases (promotion and longevity) • Retirement • Disability • Death from active status • “Other” Terminations of Employment • Probability of Withdrawing Contributions

  23. How Do We Test the Assumptions? • Demographic assumptions • Perform an Experience Study • What was expected to occur? • What actually happened? • What do we think the future will hold? • Demographic assumptions are usually based on more objective measurements than economic (easier to test) • Using historical data • Taking into account recent trends, future expectations • Economic Assumptions are more subjective

  24. Merit Salary Increases • These are individual salary increases above the overall general wage increases (for promotion and longevity) • Recommended assumed annual increases are 0.25% lower than current assumptions • Financial impact – lower normal cost rate

  25. Merit Salary Increases

  26. Retirement • Overall • Fewer retirements than expected – both male and female, both early and with full 2% benefit multiplier • Recommendations partially reflect the difference • Do not reflect full experience as there are reasons to believe the last four years were somewhat anomalous • Retirement rates after first year entitled to full benefits not significantly different from later years • Financial impact – somewhat lower measured liabilities

  27. Male Retirement with Full Benefits(After the First Year of Eligibility)

  28. Disability • 5Actual / 6 Expected = 83% • Not statistically valid sample size (and never will be) • Recommended assumptions – unchanged • Financial impact – none

  29. “Other” Terminations of employment • Service-based assumption • Excluding those with < 1 year of service: • Males: 113 Actual / 223 Expected = 60% • Females: 143 Actual / 209 Expected = 68% • Recommend lower assumptions – mostly for those with < 10 years of service • Do not reflect full experience • Financial impact – small changes in measured liabilities

  30. Other Assumptions / Methods • Probability of terminating members withdrawing employee contributions – No recommended change • Member assumed to take benefit with greatest value • Portability – No recommended change • Asset Valuation – No recommended change • Four-year recognition of returns above or below 7.75% assumption • We believe compliant with Actuarial Standard Of Practice No. 44. • Entry Age Normal Actuarial Cost Method – No recommended change • Best method for stable normal costs • Most common method in public sector • Will be required under GASB Statements No. 67 and No. 68

  31. Retired Mortality • Six years of history studied: 2006 – 2011 • Generational mortality tables already used – anticipate longer lives for members born later • In the past six years, males have lived longer than anticipated, while women have not lived as long as anticipated • Prefer to have a margin (expected deaths less than actual deaths) • People with higher benefits tend to live longer • A study by Society of Actuaries suggests mortality improving faster than previously anticipated. • Recommendation: Decrease expected mortality for males, leave female rates unchanged. • Financial impact – higher measured liabilities

  32. Male Retired Mortality

  33. Current Economic Assumptions • Price Inflation = 3.25% • Real Wage Growth = 1.00% • Also called “productivity” • General Wage Growth = 4.25% • (price inflation + real wage growth) • Expenses • Investment Expenses = 0.35% of Assets • Administrative Expenses = 0.90% of Pay (added to Normal Cost) • Real Rate of Return = 4.50% net (4.85% gross) • Investment Return = 7.75% net (8.10% gross) • (price inflation + real rate of return)

  34. How Do We Test the Assumptions? • Economic assumptions • Actuarial Standard of Practice No. 27 • Consider the purpose • Identify the components • Evaluate relevant data • Past: Recent and long-term historical data. Do not give undue weight to recent experience. • Present: Current economic data • Future: Forecasts • Consider other general factors including adverse deviation and the views of experts

  35. Price Inflation • Currently 3.25% • Historical CPI-U • 86-year average = 3.0% • Last 20 years = 2.5% • Forecasts • Market Pricing: 2.2% (over next 30 years) • Social Security: 1.8% - 3.8% • Milliman Reasonable Range • 2% to 4% • Recommendation • Reduce to 3.00% • Middle of range • Long term average

  36. Real Wage Growth • Represents wage increases larger than price inflation • Currently = 1.00% • Historical National Averages • 1.4% over last 84 years • 0.8% over last 20 years • Over 1% in more thanhalf of 20-year periods • Forecast (Social Security) • 0.6% to 1.8% • Milliman Reasonable Range • 0.25% to 1.25% • Recommendation: Keep 1.00%

  37. General Wage Growth • An individual’s wage increases are based on the sum of: • Price Inflation • Real Wage Growth (also called productivity) • Individual Merit increases (also called Promotion and Longevity) • Merit scales are studied separately. • Total payroll is assumed to grow based on price inflation and real wage increases. CurrentRecommend Price Inflation 3.25% 3.00% Real Wage Growth 1.00 1.00 General Wage Growth 4.25% 4.00%

  38. Expenses • Two Types • Investment • Currently 0.35% of assets • Consistent with expectations for investments • Recommend no change • Administration • Currently 0.90% of payroll is added tothe Normal Cost Rate • Actual has ranged from 0.75% to 1.07%over the last 16 years, but between 0.75%and 0.85% over the last 10 years. • Recommendation: Reduce to 0.85% of pay

  39. Investment Return Components • Building Block Approach • Recognizes the components of investment return • Components of Current Assumption Gross Real Return 4.85% Expenses - 0.35% Net Real Return 4.50% Inflation + 3.25% Total Net Return 7.75% (Total Gross Return = 8.10%)

  40. Investment Return Considerations • Investment return assumption has biggest impact on liabilities • Higher assumption = lower calculated liabilities and contribution rates • Lower assumption = higher calculated liabilities and contribution rates • Gains and Losses • Higher assumption means bigger losses and smaller gains • Lower assumption means smaller losses and bigger gains • Room for adverse deviation • Purpose of the measurement / stability of funding • Investment environment: Asset allocation, investment volatility, investment fees, and manger performance

  41. Investment Return Modeling • Mathematical Model • Based on target asset allocation • Capital Market Assumptions • Used assumptions from Wilshire, Milliman and other Consultants • Used to determine best estimate range • Net total return adjusted for: • 3.00% recommended inflation assumption • 0.35% investment expenses

  42. Best Estimate Range for Net Real Return • Total Gross Return includes Wilshire’s 2.15% inflation assumption • Net Real Return excludes 2.15% inflation and 0.35% investment expenses: 7.11% - 2.15% - 0.35% = 4.61%

  43. Best Estimate Range for Net Total Return • Adjusted for 3.0% inflation 4.61% + 3.00% = 7.61% • Best estimate range is 25th to 75th percentile: 6.22% - 9.02%

  44. Investment Return Recommendation • We recommend maintaining the 4.50% net real return assumption which combined with a 3.00% inflation assumption leads to a 7.50% net total return assumption. • Both the current and recommended assumption are within the “best estimate” range.

  45. Capital Market Assumptions Vary with Time • This suggests making gradual changes.

  46. Capital Market Assumptions Vary by Consultant

  47. Peer Groups • The 7.50% recommendation is on the low end of the current mainstream. • Many systems have recently lowered their assumption. Many are still considering lowering their assumption.

  48. Investment Return Summary • The current net total return assumption of 7.75% and the recommendation of 7.50% are both within the best estimate range and reflect a 4.50% net real rate of return. • The 7.50% net total return reflects a 3.00% inflation assumption instead of 3.25%. • There is not one right answer. The Board has the final responsibility to make decisions and adopt assumptions.

  49. Economic Assumption Summary

  50. Projected Financial Impact

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