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NCPERS PUBLIC SAFETY
CONFERENCE 2009Presented by Ed Friend & Greg Stump, EFI Actuaries
October 13, 2009
Actuarial Issues Affecting Public
Pensions in the Current Economic Turmoil
Presentation Agenda2
1. Public Plans Committee2. Asset Smoothing Methods3. “Market Values”4. Actuarial Assumptions,
Experience, and Sustainability
BackgroundGASB Invitation to CommentSuggestions for Improvements in Accounting
Public Plans Committee
3
Spreading gains/losses“Corridors”
Asset Smoothing Methods
4
Pay Now or Pay Later5
Ideally costs would be a level % of pay year after year This is unfortunately not possible
How much can contributions be smoothed? Asset smoothing Amortization of gains and losses
Asset Smoothing: Spreading6
Example: 5 year smoothing Gains/(Losses) based on returns above or
below that assumed Year 1: $10 M gain Year 2: $20 M loss Year 3: $5 M gain Year 4: $80 M loss Year 5 Market Value = $600 Million
Actuarial Value = $667 Million (recognizing 1/5 of each prior year’s gain or loss at a time)
Year 4 loss will be fully recognized by Year 9
Asset Smoothing: Years7
5 year smoothing was the standard for a long time 3 year smoothing not uncommon
Now, systems are looking at 7, 10, or even 15 year smoothing Same gain/loss recognition process
Asset Smoothing: Years8
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008Year
Investment Return AveragesReturn 3-Year Avg 5-Year Avg 7-Year Avg
Asset Corridors9
“Corridor” = range of values surrounding market value of assets, within which actuarial value is constrained
Example: 20% corridor means actuarial value cannot be outside of the range 80%-120% of market value Came into play for majority of plans in 2008
or 2009
Asset Corridors10
80%-120% corridor was most common Many systems are considering or using
a wider corridor to soften the blow of recent losses 25%, 30%, higher Must be very careful about size of corridor
(can be too high) “Hitting the corridor” (at 120% level)
means that 20% of losses are not yet recognized.
Facts and Myths
What is Market Value?
11
“Market Values”12
Assets – Value on books: amount of $ assets expected to be worth in open market.
“Liabilities” – no true definition of market value; not relevant for public plans
PPC has opposed the use of so-called MVL (“Market Value of Liabilities”) primarily due to lack of relevance/ usefulness
Before the crashAfter the crash
Actuarial Assumptions, Experience, and Sustainability
13
Chart 1: Before the Crash14
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)Assum
ed Return
A
Year Actual
Return
------0 A
1 A
2 A
3 A
4 A
5 A
6 A
7+ A
Chart 2: After the Crash15
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)
After the Crash
Before the Crash
Assumed
ReturnA A
YearActu
al Retu
rn
Actual
Return
------
- - - - -
0 -30% A
1 A A
2 A A
3 A A
4 A A
5 A A
6 A A
7+ A A
What Next?Testing the Sensitivity of contribution rates to various investment return scenarios
Actuarial Assumptions, Experience, and Sustainability
16
Chart 3: Softening the Blow17
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)
Softening the Blow
After the Crash
Assumed
ReturnA A
YearActu
al Retu
rn
Actual
Return
------ - - - - -
0 -30% -30%
1 A A
2 A A
3 A A
4 A A
5 A A
6 A A
7+ A A
Chart 4: Recovery of Half of the Initial 30% Loss, followed by gains18
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)
Partial Recovery
No Recovery
Assumed
ReturnA A
YearActu
al Retu
rn
Actual
Return
------ - - - - -
0 -30% -30%
1 21.5%*
A
2 A+2%
A
3 A+2%
A
4 A+2%
A
5 A+2%
A
6 A+2%
A
7+ A A
Graph reflects smoothing and extended amortization as in Chart 3
* 21.5% return in year 1represents a recovery of half of the year 0 losses, i.e. [(1-.3)x(1+.215) = .85]
Chart 5: Half Recovery, then 0% for 2 Years
19
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)
Recovery, then Flat
Partial Recovery
Graph reflects smoothing and extended amortization as in Chart 3
Assumed
ReturnA A
YearActu
al Retu
rn
Actual
Return
------ - - - - -
0 -30% -30%
1 21.5%*
21.5%
2 0% A+2%
3 0% A+2%
4 A A+2%
5 A A+2%
6 A A+2%
7+ A A
* 21.5% return in year 1represents a recovery of half of the year 0 losses, i.e. [(1-.3)x(1+.215) = .85]
Chart 6: Half Recovery, then 0% for 2 Years, followed by four years of gains20
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)
Recovery Later
Recovery, then Flat
Graph reflects smoothing and extended amortization as in Chart 3
Assumed Return A A
YearActual Retur
n
Actual
Return
------ - - - - -
0 -30% -30%
1 21.5%* 21.5%
2 0% 0%
3 0% 0%
4 A+2.5%
A
5 A+2.5%
A
6-7 A+2.5%
A
8+ A A
* 21.5% return in year 1represents a recovery of half of the year 0 losses, i.e. [(1-.3)x(1+.215) = .85]
Chart 7: Recovery Reversed by end of year
21
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)
Recovery Reversed
Partial Recovery
Graph reflects smoothing and extended amortization as in Chart 3
Assumed
ReturnA A
YearActu
al Retu
rn
Actual Return
------ - - - - -
0 -30% -30%
1 0% 21.5%*
2 0% A+2%
3 0% A+2%
4-6 A+2% A+2%
7 A+2% A
8 A+2% A
9+ A A
* 21.5% return in year 1represents a recovery of half of the year 0 losses, i.e. [(1-.3)x(1+.215) = .85]
Chart 8: Long Term: Actual < Expected
22
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)
Returns 1% Lower
Returns as Assumed
Graph reflects smoothing and extended amortization as in Chart 3
Assumed
ReturnA A
YearActu
al Retu
rn
Actual
Return
------ - - - - -
0 -30% -30%
1 A - 1%
A
2 A - 1%
A
3 A - 1%
A
4 A - 1%
A
5 A - 1%
A
6 A - 1%
A
7+ A - 1%
A
Chart 9: Anticipating Lower Returns, Long Term
23
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)
ASSUME 1% Lower
Returns as Assumed
Graph reflects smoothing and extended amortization as in Chart 3
Assumed
ReturnA-1% A
YearActu
al Retu
rn
Actual
Return
------ - - - - -
0 -30% -30%
1 A – 1%
A
2 A - 1%
A
3 A - 1%
A
4 A - 1%
A
5 A - 1%
A
6 A - 1%
A
7+ A - 1%
A
Chart 10: Lower Returns Too Conservative?
24
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0 5 10 15 20 25 30 35 40 45YEAR
Employer Contribution Rate (% Payroll)
Returns 1% Higher
Returns as Assumed
Graph reflects smoothing and extended amortization as in Chart 3
Assumed
Return
A-1%
A-1%
YearActu
al Retu
rn
Actual
Return
------
- - - - -
0 -30% -30%
1 A A - 1%
2 A A - 1%
3 A A - 1%
4 A A - 1%
5 A A - 1%
6 A A - 1%
7+ A A - 1%
Ed Friend: [email protected] Stump: [email protected]
Thank You25