Interpreting Actuarial Information

1. Interpreting Actuarial Information Fritzie Archuleta, ASA MAAA Senior Pension Actuary, CalPERS February 21, 2013

2. Overview • The big picture: understanding pension terminology • Setting the employer contribution rate • What do you mean I’m pooled? • You assumed what? • New report features • Current and Future Events

3. The Big Picture Understanding Pension Terminology

4. How are pension plans funded? • CalPERS public agency plans are pre-funded • Plan assets come from three different sources (ER contributions, EE contributions, investment returns)

5. How are pension plans funded? • Most of the benefits are paid through investment earnings • CalPERS funding method is designed to collect contributions as a level percent of payroll over the members working career

6. Interpreting Actuarial Information Present value of benefits (PVB) “Total dollars needed today to fully fund the pension plan for current members in the plan” • Includes all service that has been earned or will be earned • The number is only as accurate as our assumptions are • Best estimate for one point in time

7. Interpreting Actuarial Information Normal cost (NC) “Annual premium cost associated with one year of service accrual” • Factors that determine the normal cost • Plan provisions • Demographic assumptions • Economic assumptions

8. Interpreting Actuarial Information Accrued liability (AL) “The value of benefits earned to date by members currently in the plan” • Desired level of assets to have on hand • Plan is fully funded if assets exceed the accrued liability

9. Interpreting Actuarial Information Putting the terminology together Present Value of Benefits Future NC Contributions Accrued Liability

10. Interpreting Actuarial Information Market value of assets (MVA) “Market price that pension assets could be sold for” Actuarial value of assets (AVA) “Adjusted value of assets used to set your annual contribution rate”

11. Interpreting Actuarial Information Market value vs. actuarial value of assets Using MVA would result in volatile employer rates Why use an actuarial value of assets?

12. Investment Volatility – Expected vs Assumed

13. Interpreting Actuarial Information Market value vs. actuarial value of assets How are actuarial value of assets determined? • Assets along with the annual cash flows are credited with assumed interest of 7.5 percent • AVA = AVA + (MVA-AVA)/15 • Final AVA must be within 20 percent of MVA

14. Interpreting Actuarial Information Unfunded actuarial liability (UAL) The difference between actuarial value of assets and accrued liabilities • This year pooled plans saw their individual numbers as well as their pool numbers

15. Interpreting Actuarial Information Putting the terminology together Future NC Contributions Future NC Contributions Present Value of Benefits Accrued Liability Unfunded Liability Actuarial Value of Assets

16. Setting the Employer Contribution Rate

17. Interpreting Actuarial Information Components of every rate Every employer rate is made up of two parts: • Pays for a year of benefit accrual 1. The normal cost or annual premium 1. The normal cost or annual premium 2. The amortization bases payment • Pays for deficit or surplus accrued over the years

18. Interpreting Actuarial Information Normal cost or annual premium • The normal cost or annual premium pays for service earned in the upcoming year • Annual cost determined as a percent of payroll • Our funding method is designed to keep this percent fairly level from year to year

19. Interpreting Actuarial Information What events affect the normal cost percent? • Assumption changes • Contract amendments • Fluctuation of aggregate entry age of actives in your plan

20. Interpreting Actuarial Information Amortization bases payment The amortization bases payment gets your plan back to 100 percent funded • We compare AL of the plan to assets on hand • If liability is greater, plan needs to contribute more • If assets are greater, plan can contribute less • Goal is to get to 100 percent How do we come up with the amortization bases payment?

21. Interpreting Actuarial Information A “scale” model of your pension plan Investment Return Benefit Payouts Contributions Inflation Liabilities Assets Salary Retirements Amendments Death Disability

22. Interpreting Actuarial Information The scale never lies… Fully funded • Scales are level no need to add weight to either side Underfunded • Add weight to the asset side via increased contributions • Add weight to the asset side via investment returns • May reduce weight on the liability side through amendments Overfunded • May reduce weight on asset side via lowered contributions • Add weight to liability side via through improved benefits

23. Interpreting Actuarial Information Amortization bases payment Most plans today are underfunded • All gains and losses • Increase in liability due to plan amendment • Assumption/methodology changes • “Fresh start” Each piece of the UL/Surplus is attributed to a source

24. Interpreting Actuarial Information Amortization bases payment (continued) Imagine a homeowners journey through life… • They buy a house for fair market value • Each year the property value goes up or down (gain/loss) • They take out an equity loan to pay for college (assumption change) • They may take out an equity loan to remodel (benefit change) • They refinance to consolidate to one bill (fresh start)

25. Interpreting Actuarial Information Amortization bases payment These bases can be found on page 13 of your report (non-pooled) and on page 13 of section 2 (pooled)

26. Employer contribution rate The bottom line: annual payment by employer is the sum of the normal cost plus or minus the amount needed to bring the assets back in line with the accrued liability ÷ Your CalPERS Employer Contribution Rate = Normal Cost Dollars needed + Amortization Bases Payment on Unfunded Liability Expected Payroll of Active Employees

27. Interpreting Actuarial Information Now the picture is complete Future NC Contributions Present Value of Benefits Accrued Liability Future NC Contributions Future Contributions CY Normal Cost Unfunded Liability Unfunded Liability CY Amortization Actuarial Value of Assets Actuarial Value of Assets

28. Interpreting Actuarial Information How does this look in my non-pooled report? Required Employer Contribution Plan’s total normal cost This can be found on page 5 of your report.Pre-Payment must be received before the first payroll of the new fiscal year and after June 30.

29. What do You Mean I’m Pooled?

30. Interpreting Actuarial Information Pooling “Sharing the risk” • Normal cost • Employers within a pool have the same net normal cost • Surcharges account for additional optional benefits • Amortization base (UL/surplus) • Experience gains and losses, assumption changes shared by all in the pool since June 2003

31. Pooling (continued) • Normal cost rate components • Net employer normal cost • Optional benefit surcharges • Normal cost phase-out • Amortization bases rate components • Risk pool’s amortization bases • Agency’s side fund

32. Interpreting Actuarial Information How does this look in my pooled report? Required Employer Contributions Plan’s total normal cost is the sum of the highlighted amounts and employee contributions * Payment must be received before the first payroll of the new fiscal year and after June 30.

33. Pooling Interpreting Actuarial Information Side fund • Represents the remaining balance of your UL or surplus from entry to the pool • Behaves like a mortgage account • Currently charges 7.5 percent • Payments are on a set amortization schedule • Agency has control over the balance • Retroactive benefit enhancements, golden handshakes, and additional payments are events that can increase or decrease the side fund balance

34. Pooling • For pooled plans side fund rate is usually most volatile • Payment is predictable, increasing at 3.00 percent each year • Payroll is expected to increase at same rate as payments • Volatility ensues if payroll does not increase at 3.00 percent

35. Pooling Side fund Volatility - Example * Note side fund payment increases by exactly 3.00 percent each year ** SF rate = SF Pmt divided by payroll

36. Interpreting Actuarial Information How does this look in my pooled report? Pooled side fund Plan’s side fund balance as of 6/30/2013

37. You Assumed What?

38. Interpreting Actuarial Information Actuarial assumptions “Predictions developed by actuaries on what will happen to your plan in the future • Actuaries must make predictions about your employees to calculate a cost for their benefits • Several key assumptions used • Investment return, 7.5 percent • Salary increases • Retirement rates • Life expectancy

39. Interpreting Actuarial Information Actuarial assumptions Assumptions DO determine the expected costs of a plan • Actual cost = benefits paid + administrative expenses Assumptions DO NOT determine the actual cost of a plan Where do discrepancies come from? • Investment returns differ from 7.5 percent • Salary increases, retirement rates are different from what we expect • Discrepancies result in gains or losses for the plan

40. 2011 assumption changes • The actuarial office does an experience study every few years to keep assumptions current • Early this year, CalPERS board adopted a change to the price inflation assumption • What assumptions were changed as a consequence? • The assumed investment return was lowered from 7.75 percent to 7.5 percent • The overall payroll growth was lowered from 3.25 percent to 3.00 percent

41. Interpreting Actuarial Information 2011 assumption changes • How did the change in assumptions impact my rate? • Expect increases of 1-2 percent for miscellaneous plans and 2-3 percent increases in safety plans • CalPERS Board will allow employers to “phase in” the increase to the rate over the next two years • Agencies should watch for GASB compliance

42. New Report Features

43. Interpreting Actuarial Information Risk analysis • This is appendix D for non-pooled plans and Appendix E of Section 2 for pooled plans • Volatility ratios – how sensitive is your plan to real life experience • Rate projections – a range of what you can expect given various market returns • Discount rate sensitivity – what your rate look like if the discount rate were changed

44. Interpreting Actuarial Information Termination liabilities • What would it cost for my agency to terminate? • Agencies now have some idea • Agencies still need to request a pre termination valuation to initiate the process

45. Current and Future Events

46. Pension Reform (Key Provisions) • Mandates benefit formulas for new members • Eliminates one-year final average compensation • Benefit enhancements are only prospective (for most available benefit enhancements) • Eliminates air-time purchases • New members pay half the “cost” of the plan

47. Pension Reform (Timing) • Expect to see pension reform data starting June 30, 2013 valuation • Savings will only be realized as your employees turn over • Average “cost” for the 2.7%@55 is 21% (fire) and 24% (police) • Average “cost” for the 2%@62 is 12.5% (miscellaneous)

48. GASB 68 Requirements • GASB 68 replaces GASB 27 • Employers will need special GASB valuations done around the same time your 6/30/2013 valuations are done • Employers will need to pay for valuations to be done • Alan Milligan is speaking in detail about this topic tomorrow

49. In The Future… • Smoothing Method • Would affect rates as early as 2014-15 • Assumptions • Both demographic and economic • Would affect rates as early as 2015-16 • Alan Milligan is speaking in detail about these topics tomorrow

50. Questions?