Copyright © 2011 GRS – All rights reserved.
Economic Assumption Study
Norm Jones, FSABrian Murphy, FSAMark Buis, FSAMarch 10, 2011
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Actuarial Assumptions
Demographic – Things that happen to people
Economic – Things that happen to money
This report focuses on economic issues.
Economic Assumptions
Inflation Investment Return Payroll Growth
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Current Economic Assumptions
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Investment Return 7.80%Inflation 3.00%Wage Growth 4.00%
Historical Price and Wage Inflation
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Year Prices (CPI-U) Wages (NAE) Change1950-1959 2.2% 4.5% 2.3%1960-1969 2.5% 4.3% 1.8%1970-1979 7.4% 6.9% -0.5%1980-1989 5.1% 5.8% 0.7%1990-1999 2.9% 4.2% 1.3%2000-2009 2.5% 3.3% 0.8%
3-Year Avg 1.4% 2.1% 0.7%5-Year Avg 2.2% 3.1% 0.9%
10-Year Avg 2.3% 3.0% 0.7%20-Year Avg 2.7% 3.7% 1.0%30-Year Avg 3.4% 4.4% 1.0%50-Year Avg 4.0% 4.8% 0.8%
Annual Inflation Increase in
Price Inflation
Average assumption for 10 investment consulting firms is 2.56% -- range is 2.00% to 3.25%
Average of last 10 years is 2.3% 2010 annual report of the Social
Security Trustees uses 2.80% as the intermediate assumption
Reasonable long term range would be 2.0 to 3.2% - recommend 2.8% assumption6
Real Wage Growth
National Average Earnings as published by SSA is a useful proxy for general wage changes
NAE has exceeded CPI in most years A 1% gap may be difficult to
maintain in the present economy A reasonable range would be 0.2%
to 0.8%
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Total Wage Growth
Total Wage Growth is equal to inflation plus real wage growth (currently 4.0%)
Results in a reasonable range of 2.5% to 3.7%
Average Salaries for WRS have increased approximately 3.4% over the last 25 years, and 3.0% over the last 10 years
Recommend lowering wage growth to 3.2%
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Investment Return
By statute, the actuary recommends the investment return assumption
Board approves recommendation with advice from actuary and investment professionals
Best estimate range – the range in which results are more than likely as not to fall
Affected by investment policy and market outlook9
Actual and Target Allocation
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Asset Category Current Asset
Allocation 2012 Target Asset
AllocationPublic Equity 55.0% 43.0%
Fixed Income 26.0% 35.0%
TIPS 3.0% 20.0%
Real Estate 6.0% 7.0%
Private Equity 6.0% 7.0%
Active Risk 1.0% 4.0%
MAP 3.0% 4.0%
Cash 0.0% -20.0%
Total 100.0% 100.0%
Capital Market Assumption
GRS does not provide investment advice
Took capital market assumptions from ten different investment consulting firms
Based on history but incorporates forward looking assumptions
Shorter term horizon than actuaries May be a little biased by current
conditions11
Expectations by Consultant
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(1) (2) (3) (4) (5) (6) (7) (8)
1 6.04% 3.00% 3.04% 2.80% 5.84% 0.20% 5.64%
2 6.55% 2.02% 4.53% 2.80% 7.33% 0.20% 7.13%
3 7.49% 2.75% 4.74% 2.80% 7.54% 0.20% 7.34%
4 8.37% 3.25% 5.12% 2.80% 7.92% 0.20% 7.72%
5 7.72% 2.50% 5.22% 2.80% 8.02% 0.20% 7.82%
6 7.79% 2.50% 5.29% 2.80% 8.09% 0.20% 7.89%
7 7.84% 2.50% 5.34% 2.80% 8.14% 0.20% 7.94%
8 7.47% 2.00% 5.47% 2.80% 8.27% 0.20% 8.07%
9 8.49% 2.75% 5.74% 2.80% 8.54% 0.20% 8.34%
10 8.74% 2.30% 6.44% 2.80% 9.24% 0.20% 9.04%
Average 7.65% 2.56% 5.09% 2.80% 7.89% 0.20% 7.69%
Expected Nominal
Return Net of Expenses
(6)-(7)Investment Consultant
Investment Consultant
Expected Nominal Return
Investment Consultant
Inflation Assumption
Expected Real
Return (2)–(3)
Actuary Inflation
Assumption
Plan Incurred Expense
Assumption
Expected Nominal Return (4)+(5)
Comments
Consultants not in agreement Significant range of results (5.6% to
9.0%) Arithmetic average of 7.7% is
slightly below current WRS assumption
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Geometric Results over 20 Years
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Probability of exceeding
Probability of exceeding
Probability of exceeding
Probability of exceeding
25th 50th 75th 7.80% * 7.50% 7.20% 7.00% (1) (2) (3) (4) (5) (4) (3) (2)
1 3.54% 5.10% 6.70% 12.8% 15.6% 18.8% 21.1%
2 4.92% 6.55% 8.21% 30.6% 35.0% 39.6% 42.8%
3 5.31% 6.84% 8.38% 33.7% 38.6% 43.7% 47.1%
4 5.75% 7.24% 8.76% 40.2% 45.4% 50.8% 54.4%
5 6.10% 7.44% 8.79% 42.8% 48.7% 54.7% 58.7%
6 5.67% 7.31% 8.99% 42.2% 47.0% 51.8% 55.1%
7 5.94% 7.46% 8.99% 44.0% 49.2% 54.5% 58.0%
8 6.49% 7.74% 9.01% 48.7% 55.1% 61.4% 65.5%
9 6.01% 7.72% 9.46% 48.7% 53.4% 58.1% 61.1%
10 7.38% 8.68% 10.00% 67.6% 72.9% 77.9% 77.9%
Average 5.71% 7.21% 8.73% 41.1% 46.1% 51.1% 54.2%
*Plan's current return assumption net of expenses.
Investment Consultant
Distribution of 20-Year Average Geometric Net Nominal Return
Comments
Based on average forecasts of all consultants (with a 2.8% inflation assumption), it is unlikely to achieve the current interest rate assumption of 7.8%
Level contribution rate objective achieved by selecting the approximate median interest rate
There is a lot of subjectivity here (averages of averages) and the expectations change frequently
Recommend lowering of return assumption to 7.2%
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Impact on Actuarially Determined Contributions
Impact on General group is approximately cost neutral
Impact on other groups will vary slightly
Contribution rate expected to increase in 2010 valuation due to phase-in of asset losses
Pending legislation will also impact contribution rates
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Recent Changes by Other Systems
Colorado PERA, 8.5 to 8.0 Pennsylvania PSRS, 8.5 to 8.25 effective 6/30/08, then to
8.0 effective 6/30/09 Pennsylvania SERS, 8.5 to 8.0 San Francisco City & County, 8.0 to 7.75 Virginia RS, 7.5 to 7.0 NY Common, 8.0 to 7.5 Indiana TRF, 7.5 to 7.0 Indiana PERF, 7.25 to 7.0 District of Columbia Retirement Board, 7.5 to 7.0 Illinois SERS and SURS, 8.5 to 7.75 Arizona Public Safety, 8.5 to 8.0 over 2 years
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Comments
Typically would recommend smaller incremental changes in assumptions
Market events from 2008 have changed forecasts significantly
Final Recommendation►Interest rate: 7.2%►Wage Inflation: 3.2%
Would impact rates in calendar year 2012
Assumptions reviewed again in 2 years
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Limitations
Circular 230 Notice: Pursuant to regulations issued by the IRS, to the extent this presentation concerns tax matters, it is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) marketing or recommending to another party any tax-related matter addressed within. Each taxpayer should seek advice based on the individual’s circumstances from an independent tax advisor.
This presentation shall not be construed to provide tax advice, legal advice or investment advice.
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