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Regents Meeting May15 &16, 2002

University of California. Summary of University of California Retirement Plan Asset/Liability Forecast Study — January 2002. Regents Meeting May15 &16, 2002. Asset/Liability Studies — Purpose. Study Objectives/Purpose: 1. Demonstrate fiduciary due diligence

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Regents Meeting May15 &16, 2002

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  1. University of California Summary of University of California Retirement Plan Asset/Liability Forecast Study — January 2002 Regents Meeting May15 &16, 2002

  2. Asset/Liability Studies — Purpose • Study Objectives/Purpose: 1. Demonstrate fiduciary due diligence 2. Assess current funding policy 3. Address concerns over interest rates and inflation 4. Determine adequacy of assets in conjunction with liabilities 5. Review impact of future plan changes, demographics and cash flow

  3. Asset/Liability Studies — Background • The asset/liability study process requires the following steps: 1. Develop background information 2. Conduct planning meetings with the University 3. Develop baseline forecast results for twenty-year period 4. Generate stochastic results on the basis of a continuation of all current plan provisions and funding policies 5. Run multiple versions of financial analyses to test the effectiveness of the current policies and to identify efficient alternatives 6. Model possible future plan changes and alternative asset portfolios 7. Summarize and present results

  4. Asset/Liability Studies — Background (continued) • Asset/liability modeling software forecasts financial results on both deterministic and stochastic bases, using a variety of user-specific assumptions and possible changes in plan provisions • The model consists of four integrated components: 1. The Liability Projections module calculates a stream of liabilities on the basis of the funding valuation assumptions • Developed for positive and negative changes in the key economic assumptions • Measures sensitivities that generate plan liabilities under all assumption sets needed for the stochastic forecast 2. The Capital Market module simulates interest rates, inflation and asset-class returns for several hundred economic scenarios • Tracks plausible paths as the capital markets move from today’s environment toward expected future results • Utilizes the cascade structure, starting with interest rates and moving through price and wage inflation to dividend growth and asset-class returns • Measures consistency between the movements of assets and liabilities

  5. Asset/Liability Studies — Background (continued) 3. The Asset Portfolio module looks at a variety of asset mixes • Models efficient portfolios under a wide variety of risk and reward definitions • Measured with or without recognition of liability growth 4. The Financial Linkage module combines the results of the liability forecasts with alternative asset portfolios and develops • Integrated financial results • Several hundred capital-market scenarios; asset and liability values are determined at each point in time • Exact contribution calculations based on the declared funding policy These four modules have been applied in the modeling of assets and liabilities for the University of California Retirement Plan (UCRP).

  6. Capital Market Simulation — A Cascade Model Short & Long Interest Rates & Full Treasury Curve Price Inflation Wage Inflation Domestic Stock Dividend Growth Domestic Stock Dividend Yield Domestic Stock Income & Total Return Cash & Long Bond Income & Total Return Other Asset Classes Capital Market Simulation Model — Assets • The simulated behavior of capital market variables -- volatility's and correlation's -- is based on historical behavior together with a judgement about how the future might differ from the past • Yield curves drive asset class performance and inflation

  7. Short & Long Interest Rates & Full Treasury Curve Price Inflation Wage Inflation Plan Sponsor/ Actuary/ Regulatory Specifications COLA Demographic Factors Actuarial Valuation Assumptions Payroll Plan Provisions Liabilities Capital Market Simulation Model — Liabilities • Simulated yield curves and inflation affect both sides of the balance sheet • Yield curves drive liability measurement assumptions • Changes in assets and liabilities are coordinated

  8. Long-Term Cost Impact of Plan Changes • Change in Actuarial Accrued Liability • The Actuarial Accrued Liability measures the “earned” portion of projected benefits. This is the liability measure shown in the annual actuarial valuation report • Actuarial Accrued Liability is based on current actuarial assumptions, current active and inactive plan members, and forecasts growth in membership • Proposed plan changes are described in several Regent’s items; the cost impact for these changes is summarized on page 19

  9. Current Plan — Asset/Liability Modeling • Current Plan forecast results were developed using: • Current UCRP provisions • Active membership growth (assumed to be 2½% per year through 2011 and 1½% thereafter) • Asset allocation Current Policy A • US Bonds 35% 30% • TIPS 0%* 5% • US Equity 53% 53% • International Stocks 7% 7% • Private Equity 5% 5% • TOTAL 100% 100% *TIPS are included in U.S. Bonds under the current asset allocation (TIPS are currently 3.5% of total portfolio) • Portfolio statistics (Mean Return) • Nominal returns 8.29 8.28 • Real return 5.99 5.98 • Annual Std deviation 12.98 12.68

  10. Current Plan Asset/Liability Modeling (continued) • Economic scenario • Return assumptions were a consensus of Wilshire Associates, UC Treasurers’ Office and Towers Perrin • The Towers Perrin simulation model was used to create scenarios of inflation, yields and asset class returns • The average US equity return premium is set at 3.0% above the average LPF Bond Index return. The equity return premiums for international stocks are set equal to the return premium for US equity, in order to maintain neutrality among the classes

  11. Current Plan — Results • Contributions • Current contribution policy • Normal Cost plus thirty-year amortization of unfunded Actuarial Accrued Liability; if plan is Fully Funded the contribution is $0 • 2001/2002 Normal Cost (annual increase in liability due to additional service) • $975 million, or 14.9% of covered payroll • Funded ratios: • Funded ratios are calculated by dividing the Actuarial Value of Assets by the Actuarial Accrued Liability • Actuarial Value of Assets (AVA): A smoothed value of assets over a five-year period that minimizes the volatility of the financial markets • Actuarial Accrued Liability (AAL): The accrued liability as of any valuation for all benefits earned to date for active members, all benefits in pay status for retirees, beneficiaries and disabled members, and all deferred benefits for vested members who have terminated employment and will receive benefits in the future

  12. Current Plan — Results • As of January 1, 2002 the funded ratio is 149% based on: • Previous years of significant investment gains created a cushion of assets due to the smoothing method. Over the forecast period the cushion is reduced and the Actuarial Value of Assets moves toward Market Value AVA = $41,570,000,000 AAL = $27,900,000,000 = 149%

  13. Current Plan — Results • Probability of zero contributions • This is an indication of the need to make contributions during the twenty-year study • The probability shown on the graph is the cumulative probability; that is, if the probability is 75% in a specific year, that means there is a 75% probability there will be no contributions in that year OR any previous year • Results for the Current Plan • Funded ratios (pages 15 and 17) • Probability of zero contributions (page 18)

  14. The following graphs show the results of the stochastic forecasts The medians or averages show the trend The range of results shows the volatility Each forecast includes 500 scenarios and the results are shown in percentiles The bar graphs show ranges of likely results by using floating bar graphs similar to the one shown below. These graphs are interpreted as follows: 95th percentile: 5% of the results are above this level Arithmetic average of all results for that period X.XX 75th percentile: 25% of the results are above this value Median : 50% of the results are above this level and 50% are below 25th percentile: 75% of the results are above this level 5th percentile: 95% of the results are above this level Bar Charts Explained

  15. UNIVERSITY OF CALIFORNIA 2002-2021 Actuarial Value of Assets, Current Policy, Current Plan (Median Prior Projection as Broken Line) 180 170 160 150 140 95th% 130 Mean 75th% 77.3 120 Mean Mean 73.4 50th% 110 69.8 Mean Billions 66.3 Mean 100 25th% 62.9 Mean 59.8 90 Mean 56.7 Mean 80 53.8 Mean 51.2 Mean Mean 70 Mean 48.6 46.0 44.0 Mean 60 Mean Mean 42.7 41.6 41.6 50 40 30 2002 2004 2006 2008 2010 2012 2014 2016 Year Effect on Plan Assets of Capital Markets 1. Prior Asset/Liability study as of July 2000 2. Liabilities forecast in the 2000 study are very close to the liability results in this study as of January 2002. 3. Asset values have reduced over last 18 months (prior Mean reflected in dotted line) • Market value declined 10% from July 2000 to January 2002 • Capital Markets in 2002 are forecast to have lower returns than in July 2000 Mean 99.4 Mean 94.6 Mean Mean 90.1 Mean 85.7 Mean 81.2 5th% 2018 2020

  16. UNIVERSITY OF CALIFORNIA Funded Ratio - AVA (With Contributions) - Current Plan 220 Mean Mean 200 Mean 112% Mean 112% 122% 123% Mean Mean 116% 116% 180 Mean Mean 129% 129% Mean Mean Mean 160 95th% 149% 149% 140 75th% 120 50th% Percent 25th% 100 5th% 80 60 40 20 0 Curr Pol A Curr Pol A Curr Pol A Curr Pol A Curr Pol A 2002 2006 2011 2016 2021 Year Current Plan — Funded RatiosFuture UC Contributions Required 1. Funded ratios use Actuarial Value of Assets (AVA); Current Policy and Policy A asset allocations are shown 2. The January 1, 2002 funded ratio is 149% 3. The chart shows the funded ratios from 2002 to 2021 in five-year increments • In year 2006, the funded ratio (Policy A) ranges from 102% to 168% with a Mean of 129% (as noted at the top of the bar) • In year 2021, the funded ratio (Policy A) ranges from 67% to 189% with a Mean of 112% (as noted at the top of the bar); however, there is just over a 50% probability that the ratio will be at least 100% in year 20

  17. UNIVERSITY OF CALIFORNIA Contributions as a Percentage of Payroll - Current Plan 40 Mean Mean 13% 13% 35 Mean Mean 10% 11% 30 Mean Mean Mean 95th% 7% 7% 25 75th% Mean Mean 3% 3% 20 50th% Percent 25th% 15 5th% 10 5 Mean Mean 0% 0% 0 -5 Curr Pol Pol A Curr Pol Pol A Curr Pol Pol A Curr Pol Pol A Curr Pol Pol A 2002 2006 2011 2016 2021 Year Current Plan — Contributions 1. Contributions are shown as a percentage of covered compensation for both Current Policy and Policy A (note: current Normal Cost is 15%) 2. Asset/Liability Modeling (previous page) develops contributions, if needed, based on current contribution policy 3. The chart shows the contribution from 2002 to 2021 in five-year increments • In year 2006, the contribution Mean is 3% of covered compensation, or $241 million • In year 2021, the contri-bution Mean is 13% (Policy A) of covered compen-sation, or $2.2 billion

  18. UNIVERSITY OF CALIFORNIA Funded Ratio - AVA (No Contributions) - Current Plan 220 200 Mean Mean Mean Mean 116% 116% 77% 78% Mean Mean 180 98% Mean Mean 98% 128% 128% Mean Mean Mean 160 95th% 149% 149% 140 75th% 120 50th% Percent 100 25th% 5th% 80 60 40 20 0 Curr Pol Pol A Curr Pol Pol A Curr Pol Pol A Curr Pol Pol A Curr Pol Pol A 2002 2006 2011 2016 2021 Year Current Plan — Funded Ratios$0 Future UC Contributions 1. Funded ratios use Actuarial Value of Assets (AVA) for Current Policy and Policy A (asset allocation) 2. The January 1, 2002 funded ratio is 149% 3. The chart shows the funded ratios, from 2002 to 2021, in five-year increments • In year 2006, the funded ratio (Policy A) ranges from 98% to 168% with a Mean of 128% (as noted at the top of the bar) • In year 2021, the funded ratio (Policy A) ranges from 2% to 186% with a Mean of 77% (as noted at the top of the bar); however, there is approximately a 75% probability that the ratio will be less than 100% in year 20

  19. UNIVERSITY OF CALIFORNIA 2002-2021 Probability of Zero Cumulative Contributions - Current Plan, Current Policy & Policy A 100 90 80 70 60 Current Policy Probability (%) 50 Policy A 40 30 20 10 0 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Year Current Plan — Probability of Zero Contributions This graph shows the probability of zero contributions on a cumulative basis (Current Policy and Policy A asset allocation) • This result shows impact of market value declines and effect of future capital markets • From 2002 to 2007, the probability of zero contributions is at least 70% for the five-year period • In 2021, the probability is 18% that there will be zero contributions throughout the twenty-year period

  20. Increase in Actuarial Increase in Accrued Liability (AAL) Normal Cost Percent of Percent of $ (in millions) Current AAL* $ (in millions) Covered Payroll* Member with Domestic Partner (DP) – Pre- and Post-Retirement Death Benefit n ¾ All Same-Sex (SS) DPs $34.9 0.1% $1.9 0.03% ¾ All Opposite-Sex (OS) DPs 104.6 0.4% 5.4 0.08% ¾ One OS DP over 62 and eligible for Social 68.4 0.2% 3.0 0.05% Security (per State definition) Unmarried Member with no Eligible Survivor – Post-Retirement Death Benefit Only n ¾ Unmarried (assumes SS DP and 96.3 0.4% 4.2 0.06% All OS DP coverage adopted) Long-Term Cost Impact of Plan Changes • Compared to the Current Plan, the Relative Equity plan change increases the initial Actuarial Accrued Liability by as much as 0.9% (SS DP, OS DP and Unmarried) * Cost increases are as of July 1, 2001

  21. Potential Proposed Plan Change:Relative Equity in Benefits • The impact of Relative Equity variations contain small incremental differences in value and have been combined in the forecasting • The economic scenario forecasting is the same as the Current Plan • Includes a comparison for Current Policy and Policy A asset portfolios • Demographic growth forecasting is the same as under the Current Plan • Results of plan change • Funded ratios (page 21 & 22) • Probability of zero contributions (page 23)

  22. UNIVERSITY OF CALIFORNIA Funded Ratio - AVA (With Contributions) - Current and Relative Equity Plans, Policy A 220 Mean Mean 200 Mean Mean 112% 112% 122% 122% Mean Mean 116% 116% 180 Mean Mean 129% 128% Mean Mean 160 Mean 95th% 149% 148% 140 75th% 120 50th% Percent 25th% 100 5th% 80 60 40 20 0 Curr Pl Rel Eq Curr Pl Rel Eq Curr Pl Rel Eq Curr Pl Rel Eq Curr Pl Rel Eq 2002 2006 2011 2016 2021 Year Current Plan with Relative EquityFuture UC Contributions Required 1. Funded ratios use Actuarial Value of Assets (AVA) 2. The chart shows the funded ratios from 2002 to 2021 for the Current Plan (Policy A), and Relative Equity (Policy A) • In year 2011, the funded ratio (Policy A), before and after the Relative Equity ranges from 84% to 187% with a Mean of 122%. There is almost a 75% probability that the funded ratio will be at least 100% in year 10 after the changes • In year 2021, the funded ratio (Policy A) before and after Relative Equity ranges from 67% to 189% with a Mean of 112%. There is just under a 50% probability that the funded ratio will be less than 100% in year 20 Note: Only Policy A is shown, as it is very close to the Current Policy

  23. UNIVERSITY OF CALIFORNIA Funded Ratio - AVA (No Contributions) - Current and Relative Equity Plans, Policy A 220 200 Mean Mean Mean Mean 116% 115% 77% 77% Mean Mean 180 98% Mean 97% Mean 128% 127% Mean Mean 160 Mean 95th% 149% 148% 140 75th% 120 50th% Percent 25th% 100 5th% 80 60 40 20 0 Curr Pl Rel Eq Curr Pl Rel Eq Curr Pl Rel Eq Curr Pl Rel Eq Curr Pl Rel Eq 2002 2006 2011 2016 2021 Year Current Plan with Relative Equity$0 Future UC Contributions 1. Funded ratios use Actuarial Value of Assets (AVA) 2. The chart shows the funded ratios from 2002 to 2021 for the Current Plan (Policy A), and Relative Equity (Policy A) • In year 2011, the funded ratio (Policy A), after Relative Equity of ranges from 63% to 187% with a Mean of 115%. There is about a 40% probability that the funded ratio will be less than 100% in year 10 after the changes • In year 2021, the funded ratio (Policy A) before and after Relative Equity ranges from 2% to 185% with a Mean of 77%. There is about a 70% probability that the funded ratio will be less than 100% in year 20 Note: Only Policy A is shown, as it is very close to the Current Policy

  24. UNIVERSITY OF CALIFORNIA 2002-2021 Probability of Zero Cumulative Contributions - Current and Relative Equity Plans, Policy A 100 90 80 70 60 Current Plan Probability (%) 50 Relative Equity 40 30 20 10 0 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Year Current Plan, Current Plan with Relative Equity — Probability of Zero Contributions “Curr Plan” = Current Plan (Policy A) “Rel Equity” = Current Plan with Relative Equity changes (Policy A) • The probability of zero contributions is just under 70% for five years and steadily declines to 16% in 2021. Relative Equity decreases the probability slightly Note: Only Policy A is shown, as it is very close to the Current Policy

  25. Summary • The funded status has reduced since the prior study; smoothed asset values have dampened the effect of volatile market values • Probability of contributions has increased since 2000 due to recent asset performance and lower expected future returns • Effect of the Relative Equity changes have minimal impact on future liabilities and contributions to the plan

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