March 26, 2010 Althea A. Schwartz, FSA Consulting Actuary Milliman Inc.
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Transcript of March 26, 2010 Althea A. Schwartz, FSA Consulting Actuary Milliman Inc.
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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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These things we know to be true . . .
• Actuarial assumptions are exactly that . . . assumptions.
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These things we know to be true . . .
• 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 y
ears
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 $91,300,0002. Delayed Recognition of Market (Gains)/Losses:
Percent AmountPlan Year End (Gain)/Loss Not Recognized Not Recognized
06/30/2009 $24,000,000 80% $19,200,00006/30/2008 10,000,000 60% 6,000,00006/30/2007 (8,000,000) 40% (3,200,000)06/30/2006 (6,000,000) 20% (1,200,000)
20,800,0003. Preliminary Actuarial Value as of July 1, 2009: (1) + (2) 112,100,0004. Corridor Limit: 80% of (1) 73,040,000
120% of (1) 109,560,0005. Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4) 109,560,0006. Actuarial Accrued Liability 140,000,0007. Unfunded Actuarial Accrued Liability: (6) - (5) 30,440,0008. Amortization Period 159. Amortization Rate 0.00%10. Amortization Payment: (7) amortized over (8) years 3,208,00011. Normal Cost (Net of Expected Employee Contributions) 1,400,00012. Interest on (10) + (11) 346,00013. 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 amortization15 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
Perc
ent o
f Sys
tem
s Usin
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 $91,300,0002. Delayed Recognition of Market (Gains)/Losses:
Percent AmountPlan Year End (Gain)/Loss Not Recognized Not Recognized
06/30/2009 $24,000,000 88% $21,000,00006/30/2008 10,000,000 75% 7,500,00006/30/2007 (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)
16,250,0003. Preliminary Actuarial Value as of July 1, 2009: (1) + (2) 107,550,0004. Corridor Limit: 80% of (1) 73,040,000
120% of (1) 109,560,0005. Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4) 107,550,0006. Actuarial Accrued Liability 140,000,0007. Unfunded Actuarial Accrued Liability: (6) - (5) 32,450,0008. Amortization Period 159. Amortization Rate 0.00%10. Amortization Payment: (7) amortized over (8) years 3,420,00011. Normal Cost (Net of Expected Employee Contributions) 1,400,00012. Interest on (10) + (11) 362,00013. Annual Required Contribution: (10) + (11) + (12) 5,182,000
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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Market loss mitigation strategy #2
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 corridorActuarial 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
Compared to $4,954,000 baseline
1. Market Value of Assets as of July 1, 2009 $91,300,0002. Delayed Recognition of Market (Gains)/Losses:
Percent AmountPlan Year End (Gain)/Loss Not Recognized Not Recognized
06/30/2009 $24,000,000 80% $19,200,00006/30/2008 10,000,000 60% 6,000,00006/30/2007 (8,000,000) 40% (3,200,000)06/30/2006 (6,000,000) 20% (1,200,000)
20,800,0003. Preliminary Actuarial Value as of July 1, 2009: (1) + (2) 112,100,0004. Corridor Limit: 80% of (1)
120% of (1)5. Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4) 112,100,0006. Actuarial Accrued Liability 140,000,0007. Unfunded Actuarial Accrued Liability: (6) - (5) 27,900,0008. Amortization Period 159. Amortization Rate 0.00%10. Amortization Payment: (7) amortized over (8) years 2,940,00011. Normal Cost (Net of Expected Employee Contributions) 1,400,00012. Interest on (10) + (11) 326,00013. Annual Required Contribution: (10) + (11) + (12) 4,666,000
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Market loss mitigation strategy #3
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 $91,300,0002. Delayed Recognition of Market (Gains)/Losses:
Percent AmountPlan Year End (Gain)/Loss Not Recognized Not Recognized
06/30/2009 $24,000,000 80% $19,200,00006/30/2008 10,000,000 60% 6,000,00006/30/2007 (8,000,000) 40% (3,200,000)06/30/2006 (6,000,000) 20% (1,200,000)
20,800,0003. Preliminary Actuarial Value as of July 1, 2009: (1) + (2) 112,100,0004. Corridor Limit: 80% of (1) 73,040,000
120% of (1) 109,560,0005. Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4) 109,560,0006. Actuarial Accrued Liability 140,000,0007. Unfunded Actuarial Accrued Liability: (6) - (5) 30,440,0008. Amortization Period 259. Amortization Rate 0.00%10. Amortization Payment: (7) amortized over (8) years 2,540,00011. Normal Cost (Net of Expected Employee Contributions) 1,400,00012. Interest on (10) + (11) 296,00013. Annual Required Contribution: (10) + (11) + (12) 4,236,000
Compared to $4,954,000 baseline
Lengthened from 15 years
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Market loss mitigation strategy #4
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 $91,300,0002. Delayed Recognition of Market (Gains)/Losses:
Percent AmountPlan Year End (Gain)/Loss Not Recognized Not Recognized
06/30/2009 $24,000,000 80% $19,200,00006/30/2008 10,000,000 60% 6,000,00006/30/2007 (8,000,000) 40% (3,200,000)06/30/2006 (6,000,000) 20% (1,200,000)
20,800,0003. Preliminary Actuarial Value as of July 1, 2009: (1) + (2) 112,100,0004. Corridor Limit: 80% of (1) 73,040,000
120% of (1) 109,560,0005. Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4) 109,560,0006. Actuarial Accrued Liability 140,000,0007. Unfunded Actuarial Accrued Liability: (6) - (5) 30,440,0008. Amortization Period 159. Amortization Rate 4.00%10. Amortization Payment: (7) amortized over (8) years 2,532,00011. Normal Cost (Net of Expected Employee Contributions) 1,400,00012. Interest on (10) + (11) 295,00013. Annual Required Contribution: (10) + (11) + (12) 4,227,000
Compared to $4,954,000 baseline
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Impact of changing everything!
Compared to $4,954,000 baseline
1. Market Value of Assets as of July 1, 2009 $91,300,0002. Delayed Recognition of Market (Gains)/Losses:
Percent AmountPlan Year End (Gain)/Loss Not Recognized Not Recognized
06/30/2009 $24,000,000 88% $21,000,00006/30/2008 10,000,000 75% 7,500,00006/30/2007 (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)
16,250,0003. Preliminary Actuarial Value as of July 1, 2009: (1) + (2) 107,550,0004. Corridor Limit: 80% of (1)
120% of (1)5. Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4) 107,550,0006. Actuarial Accrued Liability 140,000,0007. Unfunded Actuarial Accrued Liability: (6) - (5) 32,450,0008. Amortization Period 259. Amortization Rate 4.00%10. Amortization Payment: (7) amortized over (8) years 1,877,00011. Normal Cost (Net of Expected Employee Contributions) 1,400,00012. Interest on (10) + (11) 246,00013. Annual Required Contribution: (10) + (11) + (12) 3,523,000
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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 ChangeChange corridorChange smoothing periodChange amortization periodChange 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
Annual Required Contribution
Funded Ratio
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
No ChangeChange corridorChange smoothing periodChange amortization periodChange amortization method
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Eliminate 20% smoothing corridor
Small but noticeable impact in the first year; contributions are very slightly higher thereafter
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
Annual Required Contribution
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
No ChangeChange 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 ChangeChange 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
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
Annual Required Contribution
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
No Change
Change smoothing period
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 smoothing period
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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%
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
Annual Required Contribution
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
No Change
Change amortization period
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 amortization period
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Change amortization: level $ level %
Lower contributions now, higher contributions later
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
Annual Required Contribution
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
No Change
Change amortization method
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 amortization method
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Change everything
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
Annual Required Contribution
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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Considerations for plan sponsors• 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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Considerations for plan sponsors• 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