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FCERA Board Interest Crediting and Excess Earnings Policy Discussion. Wednesday, April 16, 2008 Paul Angelo, FSA Andy Yeung, ASA The Segal Company San Francisco. 4043177. Outline. Actuarial Cost Method Fundamentals Reserve, Interest Crediting and Excess Earnings Mechanics
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FCERA BoardInterest Crediting and Excess Earnings Policy Discussion Wednesday, April 16, 2008 Paul Angelo, FSA Andy Yeung, ASA The Segal Company San Francisco 4043177
Outline • Actuarial Cost Method Fundamentals • Reserve, Interest Crediting and Excess Earnings Mechanics • FCERA Reserve Structure • FCERA Interest Crediting Policy • FCERA Excess Earnings Policy • Historical Application of Excess Earnings • Review Policy Features and Goals
Actuarial Cost Method Present Value of Future Benefits Current Year Normal Cost Actuarial Accrued Liability Future Normal Costs Entry Age Current Age Retirement Age
Annual Cost Amortization of Unfunded Actuarial Accrued Liability Unfunded Actuarial Accrued Liability Valuation Value of Assets Present Value of Future Normal Costs Normal Cost
Assumptions and funding methods affect only the timing of costs “Nobody ever made a benefit payment from assumed interest!” Universal Rule of Pension Plans: No free lunch! Contributions + Investment Income equals Benefit Payments + Expenses
Reserve Mechanics • Reserves track contributions, payments and investment earnings • Add contributions to Member Deposit and Employer Advance Reserves • Transfer PV to Retiree Reserves for new retirees • Deduct payments from Member Deposit and Retiree Reserves • Credit interest
Basic Interest Crediting Process • Determine “Available Earnings” for the period • All current period earnings • Min. (1%) + Add’l (>1%) Contingency Reserve (CR) • Maybe some or all of Undistributed (Excess) Earnings Reserve (UER) • Determine earnings needed for credits • If Available Earnings is enough, do the credits • Then restore Contingency Reserve • Balance to UER • Excess Earnings Policy determines use of UER
FCERA Earnings Measure • FCERA uses same measure of earnings for reserves and for funding • Total Reserves = Actuarial Value of Assets • Valuation Reserves = Valuation Value of Assets • Credit interest at valuation rate to maintain balance • Excess Earnings <==> Actuarial Investment Gain
Mechanics: Undistributed Earnings Reserve • Two-Step process for spending Excess Earnings: • First, “siphon” Excess Earnings into a “non-valuation reserve” • Excluded from Valuation Assets • Prevents decrease in UAAL contribution rate • Later, “spend” Excess Earnings • No sudden impact on contribution rate • A form of forced budgeting!
Generic Funding Mechanics employer contributions $ $ $ investments $ $ $ $ $ $ $ $ $ $ $ $ Assets $ $ $ $ $ $ employee contributions PENSION FUND $ $ $ $ $ $ $ expenses $ $ benefits
Undistributed Excess Earnings Investment Income Ad-Hoc Benefits Contingency Reserve County Contributions Drawing Not to Scale! Valuation Assets Member Contributions Expenses Benefits Plumbing for Excess Earnings
FCERA Interest Crediting Policy • Last reviewed: October 2005 • Available Earnings: Return on Actuarial Value plus CR and UER • Credit Member Reserve at rate of retiree COLA • limited to 3%, one-half credited on 6/30 and 12/31 • Credit total Valuation reserves (including Member) at valuation rate • Credit Non-Valuation Reserves at valuation rate • Supplemental COLA and Retiree Health Insurance
FCERA Interest Crediting Policy • If Available Earnings is insufficient: CR may become negative, but CR + UER + Non-Valuation Reserves > 1% of Market Value of Assets • Negative CR used to track interest credit shortfalls • If Available Earnings is sufficient: Earnings available to add to UER
FCERA Excess Earnings Policy • Combination of Settlement Agreement and Board discretion • Settlement Agreement • Section 6 – enhanced retirement benefits for active members retiring on or after January 1, 2001 • Section 8 – enhanced retirement benefits for retired members retired before January 1, 2001 • Section 9 – All retirees, $3 per month per year of service, future increase tied to UER. • Latest year Undistributed Earnings available and applied in valuation: June 30, 2002
FCERA Excess Earnings Policy • Order of application of Undistributed Earnings in June 30, 2002 valuation: • Priority #1-Current year employer and member contribution relief for: • Section 8 • Section 6 • Section 9
FCERA Excess Earnings Policy • Order of application of Undistributed Earnings in June 30, 2002 valuation: • Priority 2-Reduce unfunded liabilities (future employer contribution relief) for: • Section 8 • Section 9 • Section 6
FCERA Excess Earnings Policy • Order of application of Undistributed Earnings in June 30, 2002 valuation: • Priority #3-Create new retiree health benefits under Section 9 of Settlement Agreement • Priority #4-Other usesatBoard’s discretion • Supplemental COLA and Retiree Health Insurance
Employer Contribution Relief • Priority #1 - Allow “dollar-for-dollar” contribution credit for settlement benefits • Full or partial contribution offset • Priority #2 - Increase in Valuation Assets for settlement benefits • Reduces Unfunded Actuarial Accrued Liability • Reduces cost on an amortized basis
Member Contribution Relief • Priority #1 - Allow “dollar-for-dollar” contribution credit for settlement benefits • Full or partial member COLA contribution offset
Allocated in June 30, 2002 Valuation • Undistributed Earnings allocated in June 30, 2002 valuation • Priority 1 – Current year contributions: • Section 8: $1.3 million • Section 6: $19.7 million • Section 9: $1.2 million • Priority 2 – Reduce unfunded liabilities: • Section 8: $19.9 million • Section 9: $11.6 million • Section 6: $17.2 million
Review of FCERA Policy Features and Goals • Interest crediting features unique to FCERA • Review application of Undistributed Earnings in June 30, 2002 valuation • Clarify policy features and goals • Legal counsel involvement crucial
Interest on Member Contributions • Affects refunds on withdrawal or death • Form of benefit accrual • Purpose of plan is retirement, not savings • Consistent with DB nature of plan • Credit Member Reserve at rate of retiree COLA (limited to 3%, one-half credited on 6/30 and 12/31) • Why credit more than was actually earned on short-term investment? • Compare to savings deposit rates?
Interest on Non-Valuation Reserves • Credit Non-Valuation Reserves at valuation rate • Supplemental COLA and Retiree Health Insurance • Other 1937 Act Systems: credit interest only on valuation reserves
Contra Account Concept • If Available Earnings is insufficient: CR may become negative, but CR + UER + Non-Valuation Reserves > 1% of Market Value of Assets • Use Contra Account instead? • Track interest credit shortfalls • Any time credits are below the target rate • Negative returns are a special case • Does not ignore the bad investment returns • After a bad year, same impact on employer rates, funding ratios and member balances
Consider Funding Condition? • Regular and settlement benefits • Rather than ask “Does the Plan have excess earnings?” ask “Does the Plan have surplus assets?” • Some 1937 Act Systems consider undistributed earnings “excess” only when plan is over X% funded
FCERA Excess Earnings Policy • Priorities on application of Undistributed Earnings in June 30, 2002 valuation • Satisfy Settlement Agreement • Satisfy Board’s goals and objectives