March 26, 2010 Althea A. Schwartz, FSA Consulting Actuary Milliman Inc. Managing DB Pension Plans in...

March 26, 2010

Althea A. Schwartz, FSAConsulting Actuary

Milliman Inc.

Managing DB Pension Plans in Stressful Times

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These things we know to be true . . .

• We won’t know the total cost of a pension plan until the last plan member is paid his/her last benefit check.

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• Actuarial assumptions are exactly that . . . assumptions.

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• Everything that we do to manage contributions is a pay now or pay later proposition.

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-30%

-20%

-10%

0%

10%

20%

30%

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Las

t 8

year

s

Investment returns – CT public plans

Source: 16 Milliman clients with July 1 valuation dates

Average 2.2%

Average -14.5%

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70%

80%

90%

100%

110%

1990 1992 1994 1996 1998 2000 2001 2002 2003 2004 2005 2006 2007 2008

Change in public pension funding levels

Source: NASRA Public Fund Survey of Findings FY 08

Before the big meltdown!

Funded Ratio

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Market loss mitigation strategies

• Four straightforward ways in which the actuarial method can be modified to manage the Annual Required Contribution

• Two modify how asset smoothing technique works

• Two modify how the Unfunded Accrued Liability is amortized

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1. Market Value of Assets as of July 1, 2009 $91,300,000

2. Delayed Recognition of Market (Gains)/Losses:

Percent Amount

Plan Year End (Gain)/Loss Not Recognized Not Recognized

06/30/2009 $24,000,000 80% $19,200,000

06/30/2008 10,000,000 60% 6,000,000

06/30/2007 (8,000,000) 40% (3,200,000)

06/30/2006 (6,000,000) 20% (1,200,000)

20,800,000

3. Preliminary Actuarial Value as of July 1, 2009: (1) + (2) 112,100,000

4. Corridor Limit: 80% of (1) 73,040,000

120% of (1) 109,560,000

5. Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4) 109,560,000

6. Actuarial Accrued Liability 140,000,000

7. Unfunded Actuarial Accrued Liability: (6) - (5) 30,440,000

8. Amortization Period 15

9. Amortization Rate 0.00%

10. Amortization Payment: (7) amortized over (8) years 3,208,000

11. Normal Cost (Net of Expected Employee Contributions) 1,400,000

12. Interest on (10) + (11) 346,000

13. Annual Required Contribution: (10) + (11) + (12) 4,954,000

Baseline example of funding calculation

up from $2.5 million in the prior year

5 year asset smoothing

level dollar amortization

15 year amortization period

20% corridor around actuarial value of assets

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Market loss mitigation strategy #1

Increase the asset smoothing period

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Smoothing periods – large public plans

0%

10%

20%

30%

40%

50%

60%

70%

Market 3 4 5 6 7 8 10 15 Other

Years

Per

cen

t of

Sys

tem

s U

sin

g

Source: NASRA Public Fund Survey of Findings FY 08

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Asset smoothing – actuarial standard

• Actuarial value should have a “reasonable relationship” to market value: Actuarial value should be within “reasonable range”

around market value and smoothing method should recognize differences from market value in a “reasonable period of time”

Or actuarial value should be within a “sufficiently narrow range” around the market value

Or actuarial value should recognize differences from market value in a “sufficiently short period”

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Asset smoothing – actuarial standard

• Translation into plain English: Use a moderate corridor and a moderate

smoothing period Or use a tighter corridor with a longer

smoothing period Or use no corridor with a shorter smoothing

period But don’t use no corridor with a really long

smoothing period

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Impact of increasing smoothing period1. Market Value of Assets as of July 1, 2009 $91,300,000


Percent Amount


06/30/2009 $24,000,000 88% $21,000,000

06/30/2008 10,000,000 75% 7,500,000

06/30/2007 (8,000,000) 63% (5,000,000)

06/30/2006 (6,000,000) 50% (3,000,000)

06/30/2005 (1,000,000) 38% (375,000)

06/30/2004 (12,000,000) 25% (3,000,000)

06/30/2003 (7,000,000) 13% (875,000)

16,250,000



120% of (1) 109,560,000








12. Interest on (10) + (11) 362,000


This plan had such big gains in the earlier years that the ARC with 8 year smoothing is actually higher than with 5 year smoothing!

Compared to $4,954,000 baseline

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Increase or eliminate the asset smoothing corridor

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-30%

-20%

-10%

0%

10%

20%

30%

Without Corridor With 20% Corridor With 10% Corridor

Increase or eliminate smoothing corridor

Actuarial Value versus Market Value

Period of large, sustained market losses - actuarial value is constrained by corridor - this accelerates the recognition of losses

Period of large, sustained market gains – corridor accelerates the recognition of asset gains

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Impact of eliminating the corridor




Percent Amount


06/30/2009 $24,000,000 80% $19,200,000

06/30/2008 10,000,000 60% 6,000,000

06/30/2007 (8,000,000) 40% (3,200,000)

06/30/2006 (6,000,000) 20% (1,200,000)

20,800,000


4. Corridor Limit: 80% of (1)

120% of (1)








12. Interest on (10) + (11) 326,000


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Increase the amortization period

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Increase amortization period

Payment with 20 Year Schedule Payment with 30 Year Schedule

Balance with 20 Year Schedule Balance with 30 Year Schedule

Lengthening the period lowers the annual amortization payment.

But it takes that much longer to pay off the Unfunded Accrued Liability and get to 100% funded.

Annual Payment

Unfunded Accrued Liability

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Amortization period – actuarial standard

• GASB 25/27: maximum is 30 years

• Actuarial standards: the amortization period should bear a “reasonable relationship” to the average working lifetime of active members

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Amortization period – actuarial standard

• Translation into plain English: Town employee plan with age 65 retirement

30 years is probably fine

Police plan with retirement after 20 years 20 years is more appropriate

Frozen plan where all active members are in their 50s and 60s might want to use 10 years

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Impact of increasing amortization period1. Market Value of Assets as of July 1, 2009 $91,300,000


Percent Amount


06/30/2009 $24,000,000 80% $19,200,000

06/30/2008 10,000,000 60% 6,000,000

06/30/2007 (8,000,000) 40% (3,200,000)

06/30/2006 (6,000,000) 20% (1,200,000)

20,800,000



120% of (1) 109,560,000








12. Interest on (10) + (11) 296,000

13. Annual Required Contribution: (10) + (11) + (12) 4,236,000Compared to

$4,954,000 baseline

Lengthened from 15 years

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Change from level dollar to level percent amortization

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Amortization methods

Level Percent Payments Level Dollar Payments

Level Percent Balance Level Dollar Balance

Level Percent amortization payments increase over time along with other compensation and benefit costs.

Level Dollar amortization payments are the same amount every year – and are therefore a declining percentage of the overall budget.

Level Percent amortization causes the Unfunded Accrued Liability to grow initially, then rapidly decline.

Level Dollar amortization causes the Unfunded Accrued Liability to steadily decline.

Annual Payment

Unfunded Accrued Liability

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Impact of changing amortization method1. Market Value of Assets as of July 1, 2009 $91,300,000


Percent Amount


06/30/2009 $24,000,000 80% $19,200,000

06/30/2008 10,000,000 60% 6,000,000

06/30/2007 (8,000,000) 40% (3,200,000)

06/30/2006 (6,000,000) 20% (1,200,000)

20,800,000



120% of (1) 109,560,000








12. Interest on (10) + (11) 295,000

13. Annual Required Contribution: (10) + (11) + (12) 4,227,000Compared to

$4,954,000 baseline

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Impact of changing everything!




Percent Amount


06/30/2009 $24,000,000 88% $21,000,000

06/30/2008 10,000,000 75% 7,500,000

06/30/2007 (8,000,000) 63% (5,000,000)

06/30/2006 (6,000,000) 50% (3,000,000)

06/30/2005 (1,000,000) 38% (375,000)

06/30/2004 (12,000,000) 25% (3,000,000)

06/30/2003 (7,000,000) 13% (875,000)

16,250,000


4. Corridor Limit: 80% of (1)

120% of (1)








12. Interest on (10) + (11) 246,000


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How to choose what changes to make?

• No “one size fits all” answer!

• Need to look beyond just the impact on this year’s valuation results.

• If you are paying less this year, how and when will the “pay later” appear?

• How will the changes impact the year to year volatility of the contribution?

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Projection – no changes

Annual Required Contribution

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

No Change

Change corridor

Change smoothing period

Change amortization period

Change amortization method

Funded ratio dips and contribution climbs as the 08-09 market losses are gradually recognized

These figures are for illustration purposes only. Each plan will have different long-term funding patterns and will react differently to changes in the actuarial method.

Funded Ratio


Funded Ratio

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

No Change

Change corridor




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Eliminate 20% smoothing corridor

Small but noticeable impact in the first year; contributions are very slightly higher thereafter


Funded Ratio


50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

No Change

Change corridor

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

No Change

Change corridor

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Lengthen asset smoothing: 5 8 years

Smoother progression as market losses are recognized more slowly; higher contributions in later years


Funded Ratio


50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

No Change


0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

No Change


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Lengthen amortization period: 15 25

Contributions are lower, but it will take 10 extra years for funded ratio to reach 100%


Funded Ratio


50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

No Change


0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

No Change


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Change amortization: level $ level %

Lower contributions now, higher contributions later


Funded Ratio


50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

No Change


0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

No Change


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Change everything


Funded Ratio


50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

No Change

Change everything

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

No Change

Change everything

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Considerations for plan sponsors

• Each plan is different Funding patterns will be different over time What makes sense for one plan sponsor may not

be appropriate for another plan sponsor

• Need to balance short-term and long-term

• Intergenerational taxpayer equity – who should shoulder the burden of making up the 2008-09 market losses?

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• Is the sky really falling?

• Should the change(s) be temporary -- e.g., just for a year or two -- or permanent?

• How will you explain the change(s) to interested parties?

• What are your criteria for considering such changes in the future? Slippery slope?

• Who has the authority to make the decision?

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• Should you rethink your investment allocation? Can you live with your equity risk?

• Have you performed an asset / liability study? How does investment volatility relate to

contribution volatility? Can you really withstand the contribution

increases from extreme downturns?

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Survey of 22 municipalities in CT and RI 7 made no changes 8 removed the asset smoothing corridor 2 removed the asset smoothing corridor and

extended the amortization period 1 extended the amortization period 1 removed the asset smoothing corridor and

extended the asset smoothing period 1 extended both the amortization period and the

asset smoothing period 1 changed from level $ to level % amortization

and removed the asset smoothing corridor for 1 year only

1 changed from level $ to level % amortization, removed the asset smoothing corridor, extended both the amortization period and the asset smoothing period

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Questions

March 26, 2010 Althea A. Schwartz, FSA Consulting Actuary Milliman Inc. Managing DB Pension Plans in...

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