SACRS SymposiumThe 2008 Market Collapse

WHAT DO WE DO NOW?

BOB MCCRORYEFI ACTUARIES

MARCH 20, 2009

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• Shifting Costs

• Hidden Costs

• Hidden Risk

• Things That Don’t Work

• Flying Pigs

2

Today’s Discussion

• Asset Smoothing Policy

• Amortization Policy

• Direct Cost Smoothing

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ShiftingCosts

Shifting Costs

Tools Asset Smoothing Amortization Policy Direct Cost Smoothing

Ask yourself: What are our choices? What are the rules? What is current practice? What are your limits?

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Asset Smoothing Policy

ChoicesMarket value or actuarial

(smoothed) value?How much smoothing: Three,

five, seven, 15 years?Layered smoothing (one layer

for each year) or combined (rolling)?

Corridor around market value? No corridor?

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Asset Smoothing Policy

Rules “Reasonable range” around market –

ASOP 44, and “Reasonable period of time” to converge to

market – ASOP 44; or “Sufficiently narrow range” or converges in

a “sufficiently short period” Current Practice

Five-year smoothing with 20% corridor is de facto standard (ERISA)

Combined, not layered smoothing, with factor of 15 and 20% corridor (CalPERS)

What is “reasonable”? What is “sufficient”

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Amortization Policy

Choices Actuarial Funding Method: Each

produces different balance between normal cost and accrued liability

Layered amortization or combined? How long? Generally 10 to 30

years Level $ or level % of payroll

(increasing $)? Different bases and periods for

different sources? Gains/losses vs. amendments

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Amortization Policy

Rules No more than 30 years (GASB) Level % of pay is “negative

amortization” after about 17 yearsCurrent Practice

Practice varies widely Gains and losses over a rolling 30-

year, level % payroll (CalPERS) Is level % of payroll reasonable if

employment is likely to drop?

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Direct Cost Smoothing

Choices Actuarial cost Phase into actuarial cost over a

number of years Actuarial cost with limits on level

(e.g., cost must be less than 23.7%)

Actuarial cost with limits on growth (e.g., cost cannot increase more than 0.6% of pay per year)

Single stipulated cost

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Direct Cost Smoothing

Rules CERL requires minimum of normal cost plus

30 year amortization of unfunded Any contribution less than the Annual

Required Contribution will create a Net Pension Obligation under GASB standards

Any limit on contributions could cause insolvency

Underpayments are paid back with interest Current Practice

Practice varies widely Limits always legislated Usually overrides and violates actuarial

practice Is this a loan?

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• Compensation Policy

• Disabilities

• Furloughs

• Early Retirement

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HiddenCosts

Compensation Policy

Review pensionable earnings Earnings structure – therefore pensionable

earnings – may be bargained, subject to immediate change

Review last 50 or so retirements and disabilities. Jumps in pay at retirement (spiking)? Categories of pay not available to all

members? Special pay for some members? Benefit disparities among similarly situated

members? Terminal payments (unused sick leave or

vacation) increasing final average pay? Incentive bonuses?

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Compensation Policy

Review seniority systems Can drive access to overtime, thus final

compensation and payroll What impact does this have? Do you want

to limit this? Goals

Not trying to reduce benefits Improve benefit predictability Improve adherence to pension policy

goals A pension plan, not a lottery

Rough Rule of Thumb: Save $15 in liabilities for every $1 reduction in benefits

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Disabilities

Budgetary restrictions often cause increases in disability rates Encourage less productive employees to take

disability Reduce/privatize limited duty positions Balance department budget on back of the

pension plan Track changes in disabilities

Not just rates: Employee class and department as well

Ongoing monitoring, not just actuarial study Maintain consistency in disability policy Be sure policies for confirming disability,

income offsets are followed

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Hidden Costs

Furloughs Decrease payroll; leave benefit

unchanged Increase cost as a percent of payroll Decrease payroll over which

unfunded liabilities and gains/losses are amortized

Early Retirement In general, earlier retirement

increases plan costs Subsidized early retirement adds

additional cost Also reduces payroll base

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• Plan Maturity

• Layers

• Layoffs

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HiddenRisks

Plan Maturity

’37 Act Plans are maturingBaby Boom is retiringReplacement employees olderPlan improvements increasing

retirement benefitsGovernment employment

static, maybe declining (?)Result is increase in ratio of

assets to payroll

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Plan MaturityAssets as a Percentage of Payroll

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0%

100%

200%

300%

400%

500%

600%

700%

800%

900%

7/1/08 7/1/18 7/1/28 7/1/38 7/1/48 7/1/58 7/1/68

Ac

tua

ria

l V

alu

e o

f A

ss

ets

% A

cti

ve

Pa

yro

ll

Valuation Date

Actuarial Assets(As a percentage of active member payroll)

Plan Maturity

Increase in ratio of assets to payroll Typical ‘37 Act plan is increasing

from about 5X payroll to around 9X payroll

Represents a sensitivity ratio As the ratio increases, investment

gains and losses are larger relative to payroll

Produces more cost volatility Increasing risk is structural, permanent,

unavoidable In addition, OPEB benefits are starting

to be pre-funded

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Layers

Layers (tranches?) in asset smoothing and unfunded liability add to cost volatility Cost steps – up or down – as

layers are established and retired Sometimes these cancel,

sometimes they reinforce each other

Layers bring advantages as well Each layer is eventually retired Layers are reasonably predictable

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Layers21

0%

10%

20%

30%

40%

50%

60%

2008 2013 2018 2023 2028

Total Cost as a Percentage of Pay

AssumedProjected

Layers22

0%

10%

20%

30%

40%

50%

60%

2008 2013 2018 2023 2028

Total Cost as a Percentage of Pay

Assumed

Layered

Combined

Layers23

0%

20%

40%

60%

80%

100%

120%

2008 2013 2018 2023 2028

Funding Ratio

Assumed

Layered

Combined

Layoffs

Our projections routinely assume constant active workforce Implies an increasing active payroll

Layoffs, hiring freezes, pay freezes all violate these assumptions Payroll decreases; benefits in pay status

unchanged Members near retirement not affected much Layoffs usually among younger members who

don’t cost much Increases cost as a percent of payroll Decreases payroll over which unfunded

liabilities and gains/losses are amortized

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• Contribution Limits

• Downsizing

• Defecting to CalPERS

• Quid Pro Quo

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Things That Don’t Work

Contribution Limits

Limit on level or growth of employer contributions Increase by no more than 0.6% of pay

per year Total contribution less than 23.7% of

pay CalSTRS bases maximum

contribution on 1990 formula, benefits, adjusted assets

Generally legislated Can lead to insolvency Must be monitored closely and managed

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Contribution Limits: Funding Ratio27

84.01%

94.87% 97.48% 100.25% 103.51%107.46%

112.98%

0%

50%

100%

150%

200%

250%

300%

1/1/07 1/1/12 1/1/17 1/1/22 1/1/27 1/1/32 1/1/37

Fu

din

g R

ati

o

Valuation Date

Funding Ratio - Board Allocation(500 trials, 50 shown; average shown in red; 25th, 75th percentiles in green)

Contribution Limits: Chaos28

-100%

-50%

0%

50%

100%

150%

200%

12/31/06 12/31/16 12/31/26 12/31/36 12/31/46 12/31/56 12/31/66 12/31/76 12/31/86 12/31/96 12/31/06

Fu

nd

ing

Rati

o

Valuation Date

Actuarial Funding Ratio(Actuarial assets a percentage of actuarial accrued liabilities)

Downsizing

Spinning off operations or subdivisions Lose active members and payroll Employer contribution decreases Often lose a revenue stream

Retirees and disabled remain Fewer active members and payroll

to support the Plan Volatility and risk of remaining Plan

increases Example: General Motors

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Defecting to CalPERS

Some participating employers are withdrawing to join CalPERS. Impact on Legacy Plan: Lose active members and payroll Retirees and disabled remain Fewer active members and payroll to

support the Plan Lose a revenue stream CalPERS amortizes initial unfunded and

gains and losses over 30 years – often longer than Legacy Plan amortization period

Therefore, employer contribution decreases

Volatility and risk of Legacy Plan increases

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Quid Pro Quo

“If the Retirement Board reduces our contribution we will…”

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• The Actuarial World is not the Real World

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FlyingPigs

Flying PigsProjected Actuarial Cost

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0%

10%

20%

30%

40%

50%

60%

2008 2013 2018 2023 2028

Total Cost as a Percentage of Pay

AssumedProjected

Flying PigsSimulated Actuarial Cost

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23.01%

40.15%

34.33%

29.30%

15.55% 16.76% 16.04%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

7/1/08 7/1/13 7/1/18 7/1/23 7/1/28 7/1/33 7/1/38

Co

st %

Ac

tiv

e P

ayro

ll

Valuation Date

Actuarial Cost - Board Allocation(500 trials, 50 shown; average shown in red; 25th, 75th percentiles in green)

• Work Together!

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Best Friends

Work Together!

Pension stakeholders must work together Retirement Board Board of Supervisors and other

employers Employee organizations Retirees

Work together to develop: Shared vision Shared understanding of the

problems Common strategy and tactics Shared sacrifice

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Work Together!

Share information Retirement Board presentations to

employers about current and expected costs

Employer presentations to Retirement Board on employer financial situation

Presentations to employee organizations and retirees on funding basics, current financial environment

Joint planning Working groups with retirement board,

employer, and employee participation Joint press policy

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• Bob McCrory(206) 328-8628bobmccrory@efi-actuaries.com

• Graham Schmidt(415) 439-5313gschmidt@efi-actuaries.com

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Contact Information