Navigating Actuarial Challenges in Public Pension Management Amid Economic Uncertainty

1. Actuarial Issues Affecting Public Pensions in the Current Economic Turmoil NCPERS PUBLIC SAFETY Conference 2009 Presented by Ed Friend & Greg Stump, EFI Actuaries

2. Presentation Agenda • Public Plans Committee • Asset Smoothing Methods • “Market Values” • Actuarial Assumptions, Experience, and Sustainability

3. Public Plans Committee Background GASB Invitation to Comment Suggestions for Improvements in Accounting

4. Asset Smoothing Methods Spreading gains/losses “Corridors”

5. Pay Now or Pay Later • Ideally costs would be a level % of pay year after year • This is unfortunately not possible • How much can contributions be smoothed? • Asset smoothing • Amortization of gains and losses

6. Asset Smoothing: Spreading • Example: 5 year smoothing • Gains/(Losses) based on returns above or below that assumed • Year 1: $10 M gain • Year 2: $20 M loss • Year 3: $5 M gain • Year 4: $80 M loss • Year 5 Market Value = $600 Million • Actuarial Value = $667 Million (recognizing 1/5 of each prior year’s gain or loss at a time) • Year 4 loss will be fully recognized by Year 9

7. Asset Smoothing: Years • 5 year smoothing was the standard for a long time • 3 year smoothing not uncommon • Now, systems are looking at 7, 10, or even 15 year smoothing • Same gain/loss recognition process

8. Asset Smoothing: Years

9. Asset Corridors • “Corridor” = range of values surrounding market value of assets, within which actuarial value is constrained • Example: 20% corridor means actuarial value cannot be outside of the range 80%-120% of market value • Came into play for majority of plans in 2008 or 2009

10. Asset Corridors • 80%-120% corridor was most common • Many systems are considering or using a wider corridor to soften the blow of recent losses • 25%, 30%, higher • Must be very careful about size of corridor (can be too high) • “Hitting the corridor” (at 120% level) means that 20% of losses are not yet recognized.

11. What is Market Value? Facts and Myths

12. “Market Values” • Assets – Value on books: amount of $ assets expected to be worth in open market. • “Liabilities” – no true definition of market value; not relevant for public plans • PPC has opposed the use of so-called MVL (“Market Value of Liabilities”) primarily due to lack of relevance/ usefulness

13. Actuarial Assumptions, Experience, and Sustainability Before the crash After the crash

14. Chart 1: Before the Crash

15. Chart 2: After the Crash

16. Actuarial Assumptions, Experience, and Sustainability What Next? Testing the Sensitivity of contribution rates to various investment return scenarios

17. Chart 3: Softening the Blow

18. Chart 4: Recovery of Half of the Initial 30% Loss, followed by gains Graph reflects smoothing and extended amortization as in Chart 3 * 21.5% return in year 1 represents a recovery of half of the year 0 losses, i.e. [(1-.3)x(1+.215) = .85]

19. Chart 5: Half Recovery, then 0% for 2 Years Graph reflects smoothing and extended amortization as in Chart 3 * 21.5% return in year 1 represents a recovery of half of the year 0 losses, i.e. [(1-.3)x(1+.215) = .85]

20. Chart 6: Half Recovery, then 0% for 2 Years, followed by four years of gains Graph reflects smoothing and extended amortization as in Chart 3 * 21.5% return in year 1 represents a recovery of half of the year 0 losses, i.e. [(1-.3)x(1+.215) = .85]

21. Chart 7: Recovery Reversed by end of year Graph reflects smoothing and extended amortization as in Chart 3 * 21.5% return in year 1 represents a recovery of half of the year 0 losses, i.e. [(1-.3)x(1+.215) = .85]

22. Chart 8: Long Term: Actual < Expected Graph reflects smoothing and extended amortization as in Chart 3

23. Chart 9: Anticipating Lower Returns, Long Term Graph reflects smoothing and extended amortization as in Chart 3

24. Chart 10: Lower Returns Too Conservative? Graph reflects smoothing and extended amortization as in Chart 3

25. Thank You Ed Friend: edfriend@efi-actuaries.com Greg Stump: gstump@efi-actuaries.com