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March 26, 2010 Althea A. Schwartz, FSA Consulting Actuary Milliman Inc.

Managing DB Pension Plans in Stressful Times. March 26, 2010 Althea A. Schwartz, FSA Consulting Actuary Milliman Inc. 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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March 26, 2010 Althea A. Schwartz, FSA Consulting Actuary Milliman Inc.

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  1. Managing DB Pension Plans in Stressful Times March 26, 2010Althea A. Schwartz, FSAConsulting ActuaryMilliman Inc.

  2. 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.

  3. These things we know to be true . . . • Actuarial assumptions are exactly that . . . assumptions.

  4. These things we know to be true . . . • Everything that we do to manage contributions is a pay now or pay later proposition.

  5. Investment returns – CT public plans Average 2.2% Average -14.5% Source: 16 Milliman clients with July 1 valuation dates

  6. Change in public pension funding levels Funded Ratio Before the big meltdown! Source: NASRA Public Fund Survey of Findings FY 08

  7. 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

  8. Baseline example of funding calculation 5 year asset smoothing 20% corridor around actuarial value of assets 15 year amortization period level dollar amortization up from $2.5 million in the prior year

  9. Market loss mitigation strategy #1Increase the asset smoothing period

  10. Smoothing periods – large public plans Source: NASRA Public Fund Survey of Findings FY 08

  11. 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”

  12. 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

  13. Impact of increasing smoothing period 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

  14. Market loss mitigation strategy #2Increase or eliminate the asset smoothing corridor

  15. Period of large, sustained market losses - actuarial value is constrained by corridor - this accelerates the recognition of losses Increase or eliminate smoothing corridor Actuarial Value versus Market Value Period of large, sustained market gains – corridor accelerates the recognition of asset gains

  16. Impact of eliminating the corridor 1. Market Value of Assets as of July 1, 2009 $91,300,000 2. Delayed Recognition of Market (Gains)/Losses: Percent Amount Plan Year End (Gain)/Loss Not Recognized Not Recognized 06/30/2009 $24,000,000 80% $19,200,000 06/30/2008 10,000,000 60% 6,000,000 06/30/2007 (8,000,000) 40% (3,200,000) 06/30/2006 (6,000,000) 20% (1,200,000) 20,800,000 3. Preliminary Actuarial Value as of July 1, 2009: (1) + (2) 112,100,000 4. Corridor Limit: 80% of (1) 120% of (1) 5. Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4) 112,100,000 6. Actuarial Accrued Liability 140,000,000 7. Unfunded Actuarial Accrued Liability: (6) - (5) 27,900,000 8. Amortization Period 15 9. Amortization Rate 0.00% 10. Amortization Payment: (7) amortized over (8) years 2,940,000 11. Normal Cost (Net of Expected Employee Contributions) 1,400,000 12. Interest on (10) + (11) 326,000 Compared to $4,954,000 baseline 13. Annual Required Contribution: (10) + (11) + (12) 4,666,000

  17. Market loss mitigation strategy #3Increase the amortization period

  18. Increase amortization period Lengthening the period lowers the annual amortization payment. Annual Payment Unfunded Accrued Liability But it takes that much longer to pay off the Unfunded Accrued Liability and get to 100% funded.

  19. 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

  20. 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

  21. Impact of increasing amortization period Lengthened from 15 years Compared to $4,954,000 baseline

  22. Market loss mitigation strategy #4Change from level dollar to level percent amortization

  23. Amortization methods 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 decliningpercentage of the overall budget. Annual Payment Unfunded Accrued Liability 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.

  24. Impact of changing amortization method Compared to $4,954,000 baseline

  25. 1. Market Value of Assets as of July 1, 2009 $91,300,000 2. Delayed Recognition of Market (Gains)/Losses: Percent Amount Plan Year End (Gain)/Loss Not Recognized Not Recognized 06/30/2009 $24,000,000 88% $21,000,000 06/30/2008 10,000,000 75% 7,500,000 06/30/2007 (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) 16,250,000 3. Preliminary Actuarial Value as of July 1, 2009: (1) + (2) 107,550,000 4. Corridor Limit: 80% of (1) 120% of (1) 5. Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4) 107,550,000 6. Actuarial Accrued Liability 140,000,000 7. Unfunded Actuarial Accrued Liability: (6) - (5) 32,450,000 8. Amortization Period 25 9. Amortization Rate 4.00% 10. Amortization Payment: (7) amortized over (8) years 1,877,000 11. Normal Cost (Net of Expected Employee Contributions) 1,400,000 12. Interest on (10) + (11) 246,000 13. Annual Required Contribution: (10) + (11) + (12) 3,523,000 Impact of changing everything! Compared to $4,954,000 baseline

  26. 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?

  27. 100% Funded Ratio No Change 95% Change corridor 90% Change smoothing period 85% Change amortization period 80% Change amortization method 75% 70% 65% 60% 55% 50% Projection – no changes Funded ratio dips and contribution climbs as the 08-09 market losses are gradually recognized Funded Ratio Annual Required Contribution 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.

  28. Eliminate 20% smoothing corridor 100% No Change 95% Change corridor 90% 85% 80% 75% 70% 65% 60% Funded Ratio 55% 50% 9,000,000 No Change 8,000,000 Change corridor 7,000,000 6,000,000 5,000,000 Small but noticeable impact in the first year; contributions are very slightly higher thereafter 4,000,000 3,000,000 Annual Required Contribution 2,000,000 1,000,000 0 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.

  29. Lengthen asset smoothing: 5  8 years 100% No Change 95% 90% Change smoothing period 85% 80% 75% Smoother progression as market losses are recognized more slowly; higher contributions in later years 70% 65% 60% Funded Ratio 55% 50% 9,000,000 No Change 8,000,000 7,000,000 Change smoothing period 6,000,000 5,000,000 4,000,000 3,000,000 Annual Required Contribution 2,000,000 1,000,000 0 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.

  30. Lengthen amortization period: 15  25 100% 95% No Change 90% 85% Change amortization period 80% Contributions are lower, but it will take 10 extra years for funded ratio to reach 100% 75% 70% 65% 60% Funded Ratio 55% 50% 9,000,000 8,000,000 No Change 7,000,000 Change amortization period 6,000,000 5,000,000 4,000,000 3,000,000 Annual Required Contribution 2,000,000 1,000,000 0 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.

  31. Change amortization: level $  level % 100% 95% 90% No Change 85% 80% Change amortization method 75% 70% 65% 60% Funded Ratio 55% 50% 9,000,000 8,000,000 No Change 7,000,000 6,000,000 Change amortization method Lower contributions now, higher contributions later 5,000,000 4,000,000 3,000,000 Annual Required Contribution 2,000,000 1,000,000 0 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.

  32. Change everything 100% 95% 90% 85% No Change 80% Change everything 75% 70% 65% 60% Funded Ratio 55% 50% 9,000,000 8,000,000 7,000,000 No Change 6,000,000 5,000,000 Change everything 4,000,000 3,000,000 Annual Required Contribution 2,000,000 1,000,000 0 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.

  33. 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?

  34. 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?

  35. 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?

  36. 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

  37. Questions

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