FCERA April 2008 Interest Crediting 4043177 FCERA Board Interest Crediting and Excess Earnings Policy Discussion Wednesday, April 16, 2008 Paul Angelo,

FCERA April 2008 Interest Crediting

4043177

FCERA BoardInterest Crediting and Excess Earnings Policy Discussion

Wednesday, April 16, 2008

Paul Angelo, FSA

Andy Yeung, ASA

The Segal Company

San Francisco

Slide 2


Outline

Actuarial Cost Method Fundamentals Reserve, Interest Crediting and Excess Earnings Mechanics FCERA Reserve Structure FCERA Interest Crediting Policy FCERA Excess Earnings Policy Historical Application of Excess Earnings Review Policy Features and Goals

Slide 3


Current Year Normal Cost

Present Value of Future Benefits

Actuarial AccruedLiability

Future Normal Costs

Current AgeEntry Age Retirement Age

Actuarial Cost Method

Slide 4


Valuation Value of Assets

Unfunded Actuarial Accrued

Liability

Amortization of Unfunded Actuarial Accrued Liability

Normal Cost

Present Value of Future Normal Costs

Annual Cost

Slide 5


Universal Rule of Pension Plans: No free lunch!

Contributions + Investment Income

equals

Benefit Payments + Expenses

Assumptions and funding methods affect only the timing of costs

“Nobody ever made a benefit payment from assumed interest!”

Slide 6


Typical 1937 Act Reserve StructureMarket Value of Assets

Market Stabilization Reserve

Actuarial Value of AssetsLitigation Contingency ReserveBoard Benefit DesignationsUndistributed (Excess) Earnings (Non-Valuation Reserves)Additional Contingency ReserveMinimum Contingency Reserve

Valuation AssetsEmployer Advance ReserveMember Contribution ReserveRetiree Reserve (Valuation Reserves)

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Reserve Mechanics

Reserves track contributions, payments and investment earnings

Add contributions to Member Deposit and Employer Advance Reserves

Transfer PV to Retiree Reserves for new retirees Deduct payments from Member Deposit and Retiree

Reserves Credit interest

Slide 8


Basic Interest Crediting Process

Determine “Available Earnings” for the period All current period earnings Min. (1%) + Add’l (>1%) Contingency Reserve (CR) Maybe some or all of Undistributed (Excess) Earnings Reserve (UER)

Determine earnings needed for credits If Available Earnings is enough, do the credits

Then restore Contingency Reserve Balance to UER Excess Earnings Policy determines use of UER

Slide 9


FCERA Earnings Measure

FCERA uses same measure of earnings for reserves and for funding

Total Reserves = Actuarial Value of Assets Valuation Reserves = Valuation Value of Assets Credit interest at valuation rate to maintain balance Excess Earnings <==> Actuarial Investment Gain

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Mechanics: Undistributed Earnings Reserve

Two-Step process for spending Excess Earnings: First, “siphon” Excess Earnings into a

“non-valuation reserve” Excluded from Valuation Assets Prevents decrease in UAAL contribution rate

Later, “spend” Excess Earnings No sudden impact on contribution rate A form of forced budgeting!

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investments

$ $ $

$

$ $

$

$

$$

$ $ $$

$

$$

$

Assets$

$

$ $$

$

$

$

$ $

PENSIONFUND

$ $

benefits

expenses

employer contributions

employee contributions

Generic Funding Mechanics

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Investment Income

Valuation Assets

Benefits

Expenses

County Contributions

Member Contributions

Undistributed Excess EarningsAd-Hoc

Benefits

Drawing Not to Scale!

Contingency Reserve

Plumbing for Excess Earnings

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FCERA Interest Crediting Policy

Last reviewed: October 2005 Available Earnings: Return on Actuarial Value

plus CR and UER Credit Member Reserve at rate of retiree COLA

limited to 3%, one-half credited on 6/30 and 12/31

Credit total Valuation reserves (including Member) at valuation rate Credit Non-Valuation Reserves at valuation rate

Supplemental COLA and Retiree Health Insurance

Slide 14


FCERA Interest Crediting Policy

If Available Earnings is insufficient: CR may become negative, but CR + UER + Non-Valuation Reserves > 1% of Market Value of Assets Negative CR used to track interest credit shortfalls

If Available Earnings is sufficient: Earnings available to add to UER

Slide 15


FCERA Excess Earnings Policy

Combination of Settlement Agreement and Board discretion

Settlement Agreement Section 6 – enhanced retirement benefits for active

members retiring on or after January 1, 2001 Section 8 – enhanced retirement benefits for retired

members retired before January 1, 2001 Section 9 – All retirees, $3 per month per year of

service, future increase tied to UER.

Latest year Undistributed Earnings available and applied in valuation: June 30, 2002

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Order of application of Undistributed Earnings in June 30, 2002 valuation: Priority #1-Current year employer and member

contribution relief for: Section 8Section 6Section 9

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Order of application of Undistributed Earnings in June 30, 2002 valuation: Priority 2-Reduce unfunded liabilities (future employer

contribution relief) for: Section 8 Section 9 Section 6

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Order of application of Undistributed Earnings in June 30, 2002 valuation: Priority #3-Create new retiree health benefits under

Section 9 of Settlement Agreement Priority #4-Other uses at Board’s discretion

Supplemental COLA and Retiree Health Insurance

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Employer Contribution Relief

Priority #1 - Allow “dollar-for-dollar” contribution credit for settlement benefits Full or partial contribution offset

Priority #2 - Increase in Valuation Assets for settlement benefits Reduces Unfunded Actuarial Accrued Liability Reduces cost on an amortized basis

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Member Contribution Relief

Priority #1 - Allow “dollar-for-dollar” contribution credit for settlement benefits Full or partial member COLA contribution offset

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Allocated in June 30, 2002 Valuation

Undistributed Earnings allocated in June 30, 2002 valuation Priority 1 – Current year contributions:

Section 8: $1.3 million Section 6: $19.7 million Section 9: $1.2 million

Priority 2 – Reduce unfunded liabilities: Section 8: $19.9 million Section 9: $11.6 million Section 6: $17.2 million

Slide 22


Review of FCERA Policy Features and Goals

Interest crediting features unique to FCERA Review application of Undistributed Earnings in

June 30, 2002 valuation Clarify policy features and goals Legal counsel involvement crucial

Slide 23


Interest on Member Contributions

Affects refunds on withdrawal or death Form of benefit accrual Purpose of plan is retirement, not savings Consistent with DB nature of plan

Credit Member Reserve at rate of retiree COLA (limited to 3%, one-half credited on 6/30 and 12/31) Why credit more than was actually earned on short-term

investment?

Compare to savings deposit rates?

Slide 24


Interest on Non-Valuation Reserves

Credit Non-Valuation Reserves at valuation rate Supplemental COLA and Retiree Health Insurance

Other 1937 Act Systems: credit interest only on valuation reserves

Slide 25


Contra Account Concept

If Available Earnings is insufficient: CR may become negative, but CR + UER + Non-Valuation Reserves > 1% of Market Value of Assets

Use Contra Account instead? Track interest credit shortfalls Any time credits are below the target rate Negative returns are a special case Does not ignore the bad investment returns After a bad year, same impact on employer rates, funding ratios and member

balances

Slide 26


Consider Funding Condition?

Regular and settlement benefits Rather than ask “Does the Plan have excess

earnings?” ask “Does the Plan have surplus assets?” Some 1937 Act Systems consider undistributed

earnings “excess” only when plan is over X% funded

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Priorities on application of Undistributed Earnings in June 30, 2002 valuation Satisfy Settlement Agreement Satisfy Board’s goals and objectives

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Q U E S T I O N S

Documents

FCERA April 2008 Interest Crediting 4043177 FCERA Board Interest Crediting and Excess Earnings Policy Discussion Wednesday, April 16, 2008 Paul Angelo,