Florida Government Finance Officers Association 2010 Annual Conference Understanding an Actuarial Valuation Report Pens

1. Florida Government Finance Officers Association2010 Annual ConferenceUnderstanding an Actuarial Valuation Report(Pensions) May 25, 2010 Charles T. Carr Southern Actuarial Services Company, Inc.

2. Introduction The actuarial valuation report (pension plans) Actuarial assumptions Actuarial cost methods Key terms and definitions Questions for your actuary Pop quiz

3. The Actuarial Valuation Report Basic contents: Annual plan cost Minimum required contribution GASB 25/27 costs and disclosures Supplemental information about the plan�s liabilities Information about the plan�s assets Statistical/summary information about the plan�s participants and data used for the valuation Outline of actuarial assumptions and cost methods Outline of plan provisions

4. The Actuarial Valuation Report Annual ongoing expected cost of the plan (always equal to NORMAL COST + AMORTIZATION PAYMENT + ALLOWANCE FOR INTEREST & EXPENSES) Is not necessarily a level-dollar cost, but may reflect scheduled increases in the future annual cost of the plan Future cost increases may flow from an increasing normal cost or from increasing amortization payments May be presented as a dollar amount or as a percentage of payroll Valuation report must be filed with the Division of Retirement for approval by the State of Florida

5. The Actuarial Valuation Report Minimum required contribution: Basic rules set forth in Chapter 112, Florida Statutes Starting with the 2009/10 fiscal year, the Florida Division of Retirement says that the minimum required contribution should be based on: Percentage of payroll cost multiplied by Actual payroll for the fiscal year Valuation report should show a minimum required contribution percentage. Minimum required dollar contribution for the fiscal year will likely be different (either more or less) than the dollar amount shown in the valuation report. Minimum required contribution must be made at least quarterly and must be paid in full by the last day of the fiscal year.

6. The Actuarial Valuation Report Minimum required contribution example: Valuation report shows a minimum required contribution percentage equal to 27.50% of payroll. Valuation report shows an estimated payroll equal to $8,000,000 for the 2009/10 fiscal year. Valuation report shows an estimated minimum dollar contribution equal to $2,200,000 (27.50% of $8,000,000). Actual payroll is equal to $10,000,000 for the 2009/10 fiscal year. Actual minimum required contribution is equal to $2,750,000 for the 2009/10 fiscal year (27.50% of $10,000,000). The extra $550,000 of employer contribution will show up as an experience gain in the following actuarial valuation.

7. The Actuarial Valuation Report Effect of changing the basis for the minimum required contribution from a dollar amount to a percentage of payroll: Loss due to new hires is contributed before the next actuarial valuation is completed. Gain or loss due to salary increases that differ from the assumed increase is contributed before the next actuarial valuation is completed. Gain or loss due to retirements or other terminations of employment that differ from the actuarial expectation is contributed before the next actuarial valuation is completed. The plan will have a gain or loss as of the next actuarial valuation to the extent that the actual employer and employee contributions are different from the amounts estimated in the previous actuarial valuation report. For a frozen plan, this method generally results in an underfunding for the fiscal year; for a growing plan, this method generally results in an overfunding for the fiscal year.

8. The Actuarial Valuation Report GASB 25/27 requires the calculation of: Annual required contribution (ARC) � may be equal to the minimum required contribution under Chapter 112 Annual pension cost (APC) � will be equal to the ARC if there is no Net Pension Obligation (NPO) or Net Pension Asset (NPA) Net Pension Obligation is equal to the accumulated shortfall between the APC and cash contributions Net Pension Asset is equal to the accumulated surplus of cash contributions in excess of the APC The ARC and APC may differ from the minimum required contribution under Chapter 112. GASB 25/27 also require a six-year history of the ARC, APC, percentage contributed, and basic valuation results.

9. The Actuarial Valuation Report Supplemental information about the plan�s liabilities: Accrued and projected liability by type of benefit (retirement, disability, death, etc.) Accrued and projected liability by type of participant (actively employed, deferred vested, retired, beneficiary, etc.) Liabilities that are calculated for different purposes (minimum funding liability, SFAS 35 liability, etc.) Funded percentages: Several different funded percentages may be calculated Generally, a funded percentage is equal to the asset value (AAV) divided by the present value of accrued benefits (PVAB) Report may show a funded percentage calculated on a minimum funding basis or calculated on an accounting basis (SFAS 35 funded percentage) Basic formula: FUNDED PERCENTAGE = ASSETS / ACCRUED LIABILITY

10. The Actuarial Valuation Report Information about the plan�s assets: Market value of assets Actuarial value of assets (if different from market value) For Florida public plans, the actuarial value of assets may be based on a three- to five-year phase-in of the unrealized investment appreciation/depreciation or a similar averaging method The ACTUARIAL VALUE OF ASSETS is almost always used to determine funded percentages and plan cost Report should also disclose supplemental information about the assets: Breakdown by investment type (stocks, bonds, real estate, cash, etc.) Historical investment returns Reconciliation of asset values from one year to the next year (e.g. show benefit payments, contributions, expenses, and investment gains and losses from year to year) Division of Retirement wants to see a history of the asset returns and gains and losses if available. The history is used to determine whether the assumed investment return is reasonable. (WARNING: May be difficult to get State acceptance of the valuation report if recent asset returns have been significantly less than the assumed investment return.)

11. The Actuarial Valuation Report Plan assets may be reduced by the amount of: Advance employer contributions (i.e. contributions that have been made in EXCESS of the minimum required contribution that may be used as a credit towards the minimum required contribution in a future year) Excess Chapter 175/185 contributions (applicable to fire/police plans only; annual Chapter 175/185 contributions in excess of the �base� amount cannot be recognized as an asset of the plan)

12. The Actuarial Valuation Report Statistical/summary information about the plan�s participants and data used for the valuation: Number of participants by type (actively employed, deferred vested, retired, beneficiary, etc.) Average age, service, and compensation of actively employed participants (should include an �age-service distribution�) Average increase in employee compensation from the prior year Average benefits being paid to retirees Report may also include: Distribution of retirement ages for one or more years Historical information concerning the averages cited above Division of Retirement will expect to see a history of demographic statistics if available and will use this history as one factor to determine whether the assumed rates of retirement, termination, disability, and death are reasonable. In particular, the Division will want to see a history of compensation increases. (WARNING: If historical compensation increases have exceeded the assumed increases, it may be difficult to obtain State acceptance of the valuation report.)

13. The Actuarial Valuation Report Outline of actuarial assumptions and cost methods: Report should cite all assumptions and methods that were used to calculated the liabilities shown in the report Report should disclose changes in the assumptions and methods from prior years Report may include a glossary to help explain actuarial terms Professional standards for actuaries require sufficient disclosure that another actuary could duplicate the valuation results if he/she had access to the participant data.

14. The Actuarial Valuation Report Outline of plan provisions: Report should contain a summary outline of the plan benefits and eligibility rules Outline should include payment options, requirements for early, normal, late, and disability retirement, requirements for termination and death benefits, and relevant definitions (service, plan compensation, etc.) Report should also provide a summary of plan changes (at least changes since the previous valuation was prepared)

15. Actuarial Assumptions Usually, the three most important assumptions are: Interest rate (sometimes referred to as �discount rate�) Mortality table(s) Salary increase rate (if applicable) Also important are: Employment termination rates (withdrawal rates) Disability rates Retirement rates Less important are: Marriage assumption (% married, age of spouse) Expense loading (if any) Other plan specific assumptions may apply

16. Actuarial Assumptions TOTAL projected liability (PVB or Present Value of Future Benefits) is entirely dependent on the assumptions used, but does NOT depend on the COST METHOD that is used! Important fundamental rule: The actuarial assumptions and cost methods do NOT change the real cost of the plan; they only change the TIMING of the contributions that are required.

17. Actuarial Cost Methods The Actuarial Cost Method does not affect the total projected liability (PVB); the cost method determines the allocation of total liability between the PAST (accrued liability) and the FUTURE (future normal costs) Several acceptable cost methods that are used for different purposes: Aggregate cost method (probably the most common method used for smaller governmental plans, including Florida public plans; arguably, the most conservative cost method available) Individual entry age normal cost method (fairly common for Florida public plans) Frozen initial liability cost method (sometimes called �frozen entry age cost method�; not as common for Florida public plans as in years past) Attained age normal cost method (rarely used) Unit credit cost method (rarely used) Projected unit credit cost method (preferred cost method under corporate accounting rules; rarely used for Florida public plans) Individual level premium cost method (rarely used) Individual aggregate cost method (rarely used in the public sector) Aggregate entry age cost method (rarely seen except for large governmental plans like state employee pension plans)

18. Actuarial Cost Methods In order to allocate the past and future service liability to each year of employment, an actuarial cost method must be used. In summary, the present value of future benefits (PVB or present value of benefits) is the liability for ALL benefits expected to be paid from the plan, both today and in the future; the PVB includes future benefit accruals. An actuarial cost method is used to divide the PVB into two portions: one portion is allocated to past service (accrued liability) and the other portion is allocated to future service (future normal cost). The �normal cost� is the portion of the future normal cost that is allocated to a single year (either to the current plan year or to a future plan year).

19. Actuarial Cost Methods PVB = $1,000,000

20. Actuarial Cost Methods PVB = $1,000,000

21. Actuarial Cost Methods

22. Actuarial Cost Methods

23. Actuarial Cost Methods

24. Actuarial Cost Methods The annual cost of the plan depends on two things: Actuarial cost method Amortization period (i.e., the number of years that the plan will take to �pay off� the unfunded accrued liability) What will happen to the annual cost of the plan if the unfunded accrued liability amortization period is lengthened from 10 years to 30 years? (This is akin to an individual who replaces a 10-year mortgage with a 30-year mortgage.) Does the actuarial cost method affect the amount of the PVB (�present value of future benefits� or �total projected benefit liability�)? Does the actuarial cost method affect the normal cost and the amount of the unfunded accrued liability? Do the actuarial assumptions affect all of the liability amounts shown on the bar?

25. Actuarial Cost Methods Different cost methods divide the PVB into past service liability (accrued liability) and future service liability (future normal cost) in different places on the bar Some cost methods give a LOWER accrued liability and a HIGHER future normal cost Other cost methods give a HIGHER accrued liability and a LOWER future normal cost

26. Key Terms and Definitions Present value of future benefits (sometimes called �present value of benefits� or �total future benefit liability�) (PVB or PVFB) � total amount of assets that the plan must accumulate eventually in order to pay all benefits that are expected to come due to participants. Actuarial accrued liability (AAL) � the portion of the PVB that is allocated to past service (sometimes called the �past service liability�). Unfunded actuarial accrued liability (UAAL) (sometimes called the �unfunded liability�) � the portion of the AAL that is NOT covered by the accumulated plan assets. Amortization payment (sometimes called the �unfunded liability payment�) � the annual payment towards the UAAL; think of this payment as the plan�s �mortgage payment�!

27. Key Terms and Definitions Normal cost (NC) � the portion of the PVB that is allocated to a single plan year (i.e., the cost of benefits that are expected to be earned during a single plan year) Actuarial value of asset (AAV) � the asset value that the actuary uses to calculated the UAAL; the AAV is not always the same amount as the market value of assets (MVA). Minimum required contribution � minimum amount that MUST be contributed during a single plan year; this amount is calculated as the minimum required contribution percentage multiplied by the actual covered payroll for the year.

28. Questions for Your Actuary In your actuarial valuation report, find the following amounts: What is the total future benefit liability of the plan? What is the actuarial accrued liability? What is the value of plan assets? What is the unfunded accrued liability? What is the annual amortization payment (�mortgage payment�) towards the unfunded liability? What is the normal cost? What is the total annual cost of the plan (equal to the amortization payment plus normal cost plus interest and expense adjustment)?

29. Questions for Your Actuary What is the funded status of the plan? Is the funded status expected to change within the near future? Why or why not? Is the plan expected to have any cash flow problems (i.e., problems meeting benefit payments) in the near future? Do you recommend consideration of assumption or method changes in order to more accurately predict future plan experience? If so, which assumptions should be changed and why? Do you anticipate recommending assumption changes in the near future?

30. Pop Quiz Question 1: If a plan has $1,000,000 of future benefit liability and $400,000 of future normal cost, how much is the actuarial accrued liability? Question 2: If a plan has $100,000 of normal cost and an amortization payment of $250,000 towards the unfunded accrued liability, how much is the annual cost of the plan if expenses are $25,000 and there is no interest adjustment? Question 3: TRUE or FALSE � If the plan�s actuary uses a different actuarial cost method, then the future benefit liability will be different.

31. Pop Quiz Question 4: TRUE or FALSE - If the plan�s actuary uses a different actuarial cost method, then the plan�s normal cost will probably be different. Question 5: TRUE or FALSE � Chapter 112 requires the use of the entry age normal cost method and doesn�t allow any other cost method to be used to calculate the minimum required contribution. Question 6: TRUE or FALSE � The Division of Retirement says that the minimum required contribution should �float� with the actual covered payroll for the fiscal year.

32. Pop Quiz Question 7: TRUE or FALSE � If a plan has excess Chapter 175/185 contributions, the actuarial value of assets must be increased by the amount of the excess. Question 8: What two amounts are always excluded from the actuarial value of assets? Question 9: TRUE or FALSE � The employer may use a net pension asset under GASB 25/27 as a credit towards the minimum required contribution under Chapter 112.

33. Pop Quiz Question 10: TRUE or FALSE � For most plans, the three most important actuarial assumptions are: (1) the interest rate, (2) the retirement rates, and (3) mortality table.

34. Pop Quiz Question 1: If a plan has $1,000,000 of future benefit liability and $400,000 of future normal cost, how much is the actuarial accrued liability? $600,000 Question 2: If a plan has $100,000 of normal cost and an amortization payment of $250,000 towards the unfunded accrued liability, how much is the annual cost of the plan if expenses are $25,000 and there is no interest adjustment? $375,000 Question 3: TRUE or FALSE � If the plan�s actuary uses a different actuarial cost method, then the future benefit liability will be different. FALSE

35. Pop Quiz Question 4: TRUE or FALSE - If the plan�s actuary uses a different actuarial cost method, then the plan�s normal cost will probably be different. TRUE Question 5: TRUE or FALSE - Chapter 112 requires the use of the entry age normal cost method and doesn�t allow any other cost method to be used to calculate the minimum required contribution. FALSE Question 6: TRUE or FALSE � The Division of Retirement says that the minimum required contribution should �float� with the actual covered payroll for the fiscal year. TRUE

36. Pop Quiz Question 7: TRUE or FALSE � If a plan has excess Chapter 175/185 contributions, the actuarial value of assets must be increased by the amount of the excess. FALSE Question 8: What two amounts are always excluded from the actuarial value of assets? Advance employer contributions and excess Chapter 175/185 contributions Question 9: TRUE or FALSE � The employer may use a net pension asset under GASB 25/27 as a credit towards the minimum required contribution under Chapter 112. FALSE

37. Pop Quiz Question 10: TRUE or FALSE � For most plans, the three most important actuarial assumptions are: (1) the interest rate, (2) the retirement rates, and (3) mortality table.