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IPPFA TRUSTEE CERTIFICATION

IPPFA TRUSTEE CERTIFICATION. 1. Art Tepfer, A.S.A., M.A.A.A., E.A. Tepfer Consulting Group, Ltd. 145 Revere Drive Northbrook, IL 60062 847-509-7740 (847-922-8708 cell) atepfer@tepferconsulting.com. Basic Funding Concepts Understanding the Actuarial Valuation. WHAT DOES FUNDING MEAN?.

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IPPFA TRUSTEE CERTIFICATION

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  1. IPPFA TRUSTEE CERTIFICATION 1

  2. Art Tepfer, A.S.A., M.A.A.A., E.A. Tepfer Consulting Group, Ltd. 145 Revere Drive Northbrook, IL 60062 847-509-7740 (847-922-8708 cell) atepfer@tepferconsulting.com Basic Funding Concepts Understanding the Actuarial Valuation

  3. WHAT DOES FUNDING MEAN? • The accumulation of “Reserves” to provide pension benefits. • Reserves are required for all public pension funds in the State of Illinois.

  4. Purposes Of Funding • Benefit Security For Participants • Budgetary Control For Plan Sponsors • Intergenerational Equity • IT’S THE LAW!!!

  5. Purposes Of Funding • In the public sector, the primary purpose is the funding of the pension plan and equity across all generations of taxpayers • Taxpayers hold the risk • Actuarial funding method determines annual contributions which are aimed to create a stable, sustainable benefit program • Balance sheet liability usually not an issue because actuarial liability is not shown on the balance sheet (new GASB rules may change this)

  6. Statement Of The Status Of A Pension Fund At A Specific Point In Time What Is An Actuarial Valuation?

  7. What Does It Tell You? • Measure Of The Assets And Liabilities Of The Fund At A Static Point. • Contribution Requirements Under Statutory Requirements • Recommended Contributions For Current And Future Solvency • Useful Statistics For Planning Purposes

  8. What Doesn’t It Tell You? Where You Are Headed!

  9. Purposes Of FundingThe “Funding Myth”

  10. The “Funding Myth” Funded Percentage – A Quick Ratio Of Assets To Liabilities Easy To Measure Assets---Difficult To Measure Liabilities

  11. The “Funding Myth” The Hole In The Ground

  12. The “Funding Myth” Filling The Hole – Each Year’s Contribution

  13. WHERE DO WE PUT THE BOARD ?AND HOW MUCH DIRT GOES IN THE SHOVEL?

  14. Components Of The Valuation • Structure Of The Plan—Statutory • Demographics – Unique to the Group • Actuarial Assumptions

  15. The Fundamental Equation Of Pension Funding

  16. The Fundamental Equation Of Pension Funding C + I = B(+e)

  17. The Fundamental Equation of Pension Funding

  18. The Fundamental Equation Of Pension Funding C + I = B

  19. Types of Pension Plans • Defined Benefit Pension Plans • The benefit is known and defined in the Plan • Defined Contribution Pension Plans • The contribution is known and defined in the Plan

  20. The Fundamental Equation Of Pension Funding C + I = B

  21. Types of Pension Plans Defined Contribution C + I = B Benefits are unknown Interest income is known Contribution is defined Defined Benefit C + I = B Benefits are defined Interest income is assumed Contribution is unknown

  22. FUTURE C + I = B PAST The Fundamental Equation Of Pension Funding

  23. WHERE DO WE PUT THE BOARD ?AND HOW MUCH DIRT GOES IN THE SHOVEL?

  24. TYPES OF FUNDING METHODS Cost Allocation Cost Method Prospective benefit at retirement is estimated, the actuarial value at the entry age or attained age is estimated and the cost allocated to a particular year. Example: Entry Age Normal Cost or Aggregate Cost Benefit Allocation Cost Method Benefits are allocated to a particular year and the actuarial value of the allocated portion is assigned to each year. Example: Unit Credit or Projected Unit Credit

  25. Determination of Normal Cost Cost Allocation Cost Method • Estimate prospective benefit • Determine actuarial value of prospective benefit. • Divide this value by the value of $1 per year from point A to point B • Normal Cost is the resulting quotient Benefit Allocation Cost Method • Must ascertain the “accumulated benefit” (amount allocated to a particular year) • Determine the actuarial value of the accumulated benefit • Normal Cost is the increase in accumulated benefit each year

  26. Actuarial Impactof the New Pension Law For the first time the new pension law mandates actuarial methodology for Public Safety funds. • Actuarial calculations must use the Projected Unit Credit Method. • Assets must be valued using a specific actuarial smoothing method.

  27. Actuarial Funding Methods • There are several funding methods which all have the same ultimate goal: “guarantee” that there will be enough money available to pay the benefits when they come due • However, each funding method has characteristics which will make one more appropriate than others in certain situations • Front load • Back load • Level payroll • Level contributions

  28. Entry Age Normal Cost(Cost Allocation) • Entry age normal attempts to create level contributions throughout the working career of the employee • Can be level dollar or a level percent of payroll • By far the most utilized funding method in the public sector • More costly early in the career of an employee

  29. Projected Unit Credit (PUC)(Benefit Allocation) • Projected Unit Credit attempts to fund the “true” present value of the benefits as they accrue, no spreading of costs • Creates lower costs early in an employee’s career • Costs increase dramatically as retirement nears • Most common method in private sector valuations

  30. Entry Age Normal vs PUC

  31. Actuarial Accrued Liability (AAL) • The actuarial accrued liability is the accumulation of all normal costs that have occurred in the past • Current retirees have accrued all of their normal costs AAL = PVB • Active members have only accrued some of their normal costs AAL = PVB less PVFNC (present value of future normal costs)

  32. Actuarial Accrued Liability (AAL) • The AAL is the sum of all of the AAL’s of the individual members • This represents the amount of assets needed in the trust to exactly match the past accruals per the funding method

  33. Illustration of AAL Method One Method Two Yr ContributionAAL 1 $10,000 $10,000 2 $20,000 $30,000 3 $30,000 $60,000 4 $40,000 $100,000 5 $50,000 $150,000 AAL is the Total Goal less the sum of future contribs Yr ContributionAAL 1 $30,000 $30,000 2 $30,000 $60,000 3 $30,000 $90,000 4 $30,000 $120,000 5 $30,000 $150,000 AAL is the sum of all contributions made to date

  34. Unfunded Actuarial Accrued Liability (UAAL) • What if you don’t exactly match? • What if the trust does not have to have that much money today • The UAAL is defined as the difference between the AAL and the amount of assets in the trust (AVA)

  35. Actuarial Value of Assets (AVA) New Tax Law On March 30, 2011, the actuarial value of the fund’s assets shall be equal to the market value of the assets as of that date. In determining the actuarial value of the fund’s assets for fiscal years after March 30, 2011, any actuarial gains or losses from investment returns incurred in a fiscal year shall be recognized in equal annual amounts over the 5-year period following that fiscal year.

  36. Illustration of UAAL Method One Method Two Yr ContributionAAL 1 $10,000 $10,000 2 $20,000 $30,000 3 $30,000 $60,000 4 $40,000 $100,000 5 $50,000 $150,000 AAL is the Total Goal less the sum of future contribs Yr ContributionAAL 1 $30,000 $30,000 2 $30,000 $60,000 3 $30,000 $90,000 4 $30,000 $120,000 5 $30,000 $150,000 AAL is the sum of all contributions made to date

  37. The “Funding Myth” Funded Percentage – A Quick Ratio Of Assets To Liabilities Easy To Measure Assets---Difficult To Measure Liabilities

  38. Funded Percentage • Let’s skip the third payment and assume no interest earnings and no payouts!!! • The assets therefore are missing one $30,000 contribution. • Watch what happens

  39. Illustration of UAAL Method One Method Two Yr ContributionAAL Assets 1 $10,000 $10,000 $10,000 2 $20,000 $30,000 $30,000 3 $30,000 $60,000 $30,000 4 $40,000 $100,000 $70,000 5 $50,000 $150,000 $120,000 FUNDED PERCENTAGE 1 100% 2 100% 3 50% 470% 5 80% Yr ContributionAALAssets 1 $30,000 $30,000 $30,000 2 $30,000 $60,000 $60,000 3 $30,000 $90,000 $60,000 4 $30,000 $120,000 $90,000 5 $30,000 $150,000 $120,000 FUNDED PERCENTAGE 1 100% 2 100% 3 66.7% 4 75% 5 80%

  40. The Contribution Requirement • The contribution is set to be the sum of: • The normal cost for the year and • The amortization of the UAAL [90% under law] • Another way to look at it: • The contribution for the current year plus • The contribution to make up any shortfall that may have occurred due to past experience or plan changes

  41. WHY DO WE HAVE AN UAAL? • If contributions have been made equal to the actuarially determined contribution for the life of the fund, why does the UAAL exist? • New base at law change • Benefit increases which change the accrual for past service • Experience differing from actuarial expectations (assumptions)

  42. BUT NO MATTER HOW YOU LOOKAT ITIT ALWAYS COMES BACK TO

  43. The Fundamental Equation Of Pension Funding C + I = B

  44. BREAK TIME(BACK IN 15 MINUTES)

  45. Present Value Concepts • Time Value of Money- present value is inversely proportional to interest rate • Probability of Payment- depends upon a contingent condition • Life Annuity- series of payments made for lifetime • Life Insurance- payment made at death

  46. Assumption Setting Economic Assumptions Investment Return Salary Increases Inflation Asset Valuation Methodology Demographic Assumptions Mortality And Disability Rates Termination Of Service (Retirement And Severance) Definition of Actuarial Assumptions The value of a parameter, or other choice, having an impact on an estimate of a future cost or other actuarial item under evaluation. - Glossary of actuarial terms The economic and demographic estimates used to calculate the present value of the plan’s future obligations.

  47. Key Issues Selection of Assumptions should be a team approach (Board and City). Assumptions should be evaluated at regular intervals by performing a “gain and loss” analysis. The larger the fund, the more frequent and detailed the analysis.

  48. Reasonableness Of Assumptions Is The Most Important Aspect!

  49. SELECTION OF DEMOGRAPHIC ASSUMPTIONS Types of Demographic Assumptions— The types of demographic assumptions used to measure pension obligations may include, but are not necessarily limited to, the following: a. retirement b. mortality c. termination of employment

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