Actuary Hour Session I The Role of the Actuary

Transcription

1 Actuary Hour Session I The Role of the Actuary September 17, 2017 Larry Langer, ASA, EA, FCA, MAAA Principal and Consulting Actuary

2 Standard Disclaimer The views and opinions expressed in this presentation are the speaker s and do not necessarily reflect the official policy or position of his employers (current or prior), professional organizations to which he belongs (the Society of Actuaries, the Conference of Consulting Actuaries, the American Academy of Actuaries, or the Joint Board for the Enrollment of Actuaries) or any Retirement System Boards for which he has previously or currently served as actuary. Other views, opinions or questions are welcome throughout Actuary Hour.

3 Actuary Hour Series Seminar I The Role of the Actuary (today) Seminar II The Actuarial Valuation Seminar III Funding Policy If you have a topic you d like to be covered, please include in the session evaluations

4 The Role of the Actuary Actuarial Valuation Experience Review Actuarial Audits Optional Payment Factors Plan Design Supplemental Actuarial Reports

5 Actuarial Valuation Two Primary Pension Plan Structures Defined Contribution (DC) Annual contribution amount placed in a member s account Defined Benefit (DB) Monthly benefit amount payable at retirement

6 Actuarial Valuation Defined Benefit Plan Benefit payments are defined by terms of the plan Multiplier x Credited Service x Final Average Salary An annual cost of living adjustment (COLA) may be provided to prevent benefit erosion due to inflation Primary Risks Investment Risk Mortality Risk Inflation Risk (pay increases, CPI COLA)

7 Actuarial Valuation Basic Retirement Funding Equation C + I = B + E C = contributions I = investment income B = benefits paid E = expenses C+I B+E

8 Actuarial Valuation For a defined benefit pension plan, the ultimate value of future cash flows cannot be predicted with certainty. To estimate the probability and the likely cost of a future event such as disability, retirement, or death, actuaries need to make assumptions. If actual experience does not align with the assumptions used, what is the impact to the plan?

9 Actuarial Valuation What is an Actuary? A person who calculates insurance and annuity premiums, reserves, and dividends. A person trained to assess the financial implications of future contingent events. An introverted accountant.

10 Actuarial Valuation Alternatives for funding benefits Pay as you go Social Security Terminal Funding Pay lump sum value at time of retirement. Pre-Funding Pay lump sum at date of hire. Actuarial Funding Make contributions over a period of time to allow accumulated assets to grow with investment income to help pay the benefits % of benefit payments comes from investment income.

11 Actuarial Valuation The Long-Term Solution to the Equation Pay-As-You-Go Contributions % of Active Member Payroll Investment Income CASH BENEFITS Level Contributions Employer and Employee Contributions Start 50 Years of Time

12 Actuarial Valuation Purpose of the Actuarial Valuation Each year, the actuary determines the amount of contributions to be made to the Retirement System during each member s career, which, when combined with investment return, will be sufficient to pay for retiree benefits. This contribution is determined through the annual actuarial valuation, which is summarized in the annual actuarial valuation report. In addition, the annual actuarial valuation is performed to Determine progress on funding the Retirement Systems Explore why the results of the current valuation differ from the result of the valuation of the previous year Satisfy regulatory and accounting requirements

13 Actuarial Valuation Public Act 314 of 1965 Section 20m The Board of Trustees shall: Confirm in the annual actuarial valuation and summary annual report that the plan provides for the payment of the required employer contribution; and Confirm that the system has received the required employer contribution which is the actuarially determined contribution amount and shall consist of: a current service cost payment and a payment of at least the annual accrued amortized interest and principal on any unfunded actuarial liability.

14 Actuarial Valuation The process uses various inputs to develop certain critical results. Over the short term, contributions are determined by the actuarial valuation based upon estimated investment return, benefits and expenses using assumptions and funding policy (actuarial methods) recommended by the actuary and adopted by the Board. Over the long term, contributions are adjusted to reflect actual investment return, benefits and expenses. Inputs Member Data Asset Data Benefit Provisions Assumptions Funding Policy Results Actuarial Value of Assets Actuarial Accrued Liability Net Actuarial Gain/Loss Funded Ratio Employer Contributions Projections

15 Actuarial Valuation Staff Responsibilities Membership Data Benefit Provisions Asset Data Board Responsibility Actuarial Assumptions Funding Methodology (experience review) 4 to 12 weeks Actuary Responsibilties Actuarial Valuation Report with Required Contribution 4 to 12 weeks Board Responsibilty Accept Actuarial Valuation Report Adopt rates and forward to employer 1 to 2 board meetings Employer Responsibilty Approve and appropriate rates In time for budgets Ideally, the actuarial valuation should be adopted within 4 to 6 months of the valuation date.

16 Experience Reviews Actuarial Gains/(losses) tend to: increase/(decrease) the funded status of a plan Decrease/(increase) the unfunded liability of a plan Decrease/(increase) employer contributions Types of experience that typically results in actuarial gains/(losses) for a system Lower/(higher) salary increases Lower/(higher) health care payments (trend) More/(less) investment return Fewer/(more) retirements More/(fewer) quitters Fewer/(more) disabilities More/(fewer) deaths than assumed in the prior valuation

17 Experience Reviews A single package of assumptions or funding policy will not suffice throughout the existence of a retirement system Selection of assumptions and funding policy is one of the most important duties of the Board To aid in the selection of assumptions and funding policy, the actuary will prepare an experience review compares the assumptions to the actual experience of the plan over a period of time Think of it as the accumulation of several gain/loss analysis Actuary monitors the assumptions through annual gain loss review and periodic experience reviews The actuary may recommend changes in the assumptions and/or funding policy as a result of the study

18 Experience Reviews Actuarial Assumptions vs Funding Policy Actuarial assumptions are used to project benefits expected to be paid from the retirement system. Assumptions are generally categorized as demographic and economic assumptions. Demographic assumptions include mortality, retirement, termination, % electing benefits and disability. Economic assumptions include investment return, trend, salary increases and inflation. Once the projected benefits and returns are developed using actuarial assumptions, the funding policy is used to develop the timing of contributions to be made to the retirement system. The three components of the funding policy are: actuarial cost method asset valuation method amortization method

19 Experience Reviews Experience reviews should be undertaken: Every 3 to 5 years depending on size of plan If system experiences unexplained changes in funded status After major changes in benefit programs when enough experience has been accumulated Selection of assumptions does not determine the final costs of the plan Final costs are dictated by the actual experience of the fund Assumptions that are too optimistic can result in costs being pushed to future generations Assumptions that are too pessimistic can result in higher costs today at the detriment of other priorities

20 Experience Reviews Assumption change Demographic Assumptions Longer lifetimes Earlier retirements More quitters More disabilities Economic Assumptions Decrease investment return Decrease inflation Decrease salary increases Increase Trend Usual Impact on liabilities and employer contribution Increase Increase Decrease Increase Increase Decrease Decrease Increase

21 Experience Reviews Often, Funding Policy (actuarial methods) are reviewed during an experience review. While assumptions estimate the amount to be paid in todays dollars, actuarial methods are used to determine how that amount is to be paid, or the funding policy A funding policy should be developed that results in contributions that: Balance responsiveness to current conditions with stability that is easier to fund trends the funded status of the plan to 100% funding

22 Experience Reviews The setting of a funding policy is one of the most important decisions a Board can make and should be given due process Funding policies should be reviewed during the experience review It is not unreasonable to review funding policies during extraordinary times Extraordinary times do not occur annually

23 Experience Reviews Article 9, Section 24 of the Michigan Constitution Public pension plan and retirement systems, obligation The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby. Financial Benefits, Annual Funding Financial benefits arising on account of service rendered in each fiscal year shall be funded during that year and such funding shall not be used for financing unfunded accrued liabilities.

24 Experience Reviews Public Sector Retirement System Funding Policy Resources Conference of Consulting Actuaries Public Plans Community White Paper "Actuarial Funding Policies and Practices for Public Pension Plans Policy.pdf American Academy of Actuaries Issue Brief Objectives and Principles for Funding Public Sector Pension Plans California Actuarial Advisory Panel White Paper Model Actuarial Funding Policies and Practices for Public Pension and OPEB Plans ARD/BudLeg/CAAP_Funding_Policies_w_letter.pdf Report from the Pension Funding Task Force 2013 (convened by the Center for State and Local Government Excellence) Pension Funding: A Guide for Elected Officials GFOA Best Practice Core Elements of a Pension Funding Policy (no PDF) Society of Actuaries Blue Ribbon Panel on Public Pension Plan Funding Report of the Blue Ribbon Panel on Public Pension Plan Funding (report, summary, video and guide)

25 Experience Reviews Boards should consider establishing a policy for periodic experience reviews Establishing the timing of experience reviews: Allows all stakeholders to prepare in advance Is an effective measure for mitigating off-cycle changes

26 Actuarial Audits An actuarial audit is the audit of one actuary s work by another actuary to ensure that the valuations are performed correctly and that the assumptions and methods are reasonable System staff, retained actuary, and reviewing actuary all work together to ensure that actuarial work is correct in a cooperative process Like getting a second opinion before surgery The purpose of an actuarial audit Verify that the actuarial work is accurate Verify that the actuarial advise given is sound Provide a level of assurance to trustees, staff and other stakeholders that the finance condition of the plan is accurate

27 Actuarial Audits Need for actuarial audits Actuarial valuations are complicated because of the math and the provisions. Well being of individuals directly affected by actuary s work. Mistakes are often obscure and can remain undiscovered for years, potentially undermining the plan s financial security. Actuarial valuation tends top go to low bidder.

28 Actuarial Audits Varying degrees of Audits High level review of report Full replication where the reviewing actuary redoes the valuation and opines on the assumptions and methods When to perform an actuarial audit When something doesn t smell right Unexplained decline (or increase) in assets or liabilities Protracted change in funded ratio or contribution rates without explanation Preferably every 5 to 10 years as spelled out in your policy

29 The Valuation Control Cycle Monitor Plan Metrics Annual Valuation Report Plan CAFR 5-Year Experience Studies Update Assumptions and Methods Review Plan Experience Annual Gain/Loss Analysis Actuarial Audits 5-Year Experience Studies

30 Optional Payment Factors The benefit calculated is often paid for the life of the participant Often plans provide for optional or alternative forms of payment: Joint and x% survivor X year certain and life The amount of benefit paid under these optional forms are often developed using a concept called actuarial equivalence Under actuarial equivalence, the value of the of the life benefit and the optional form are the same based upon plan assumptions, such as mortality and investment return Administrative factors are used to maintain actuarial equivalence Plans may consider updating these factors with every experience review as investment return and mortality are updated

31 Plan Design An actuary has training in the design of various benefits This knowledge is necessary to evaluate the costs of the plan I struggled to fill this rest of this slide so added this filler bullet as a transition to the next slide

32 Supplemental Actuarial Reports Public Act 314 of Section 20h A system shall provide a supplemental actuarial analysis before adoption of pension benefit changes. The supplemental actuarial analysis shall: be provided by the system's actuary; include an analysis of the long-term costs associated with any proposed pension benefit change; be provided to the board of the particular system and to the decision-making body at least 7 days prior to adoption. For purposes of this subsection, "proposed pension benefit change means a proposal to change the amount of pension benefits.

33 Supplemental Actuarial Reports Analysis often involve actuary updating program to change the current valuation model to reflect proposed plan Change 2% multiplier to 2.25% Change Rule of 80 to rule of 75 Can result in a need to recommend a change in assumptions or funding policy New retirement rates Fund an early retirement window or closed plan over shorter period Actuary may have to give a range of results: For example, if no change in retirement or retirement occurs earlier/later

34 Supplemental Actuarial Reports Sometimes difficult to determine if analysis is needed Direct change to plan provisions pretty clearly require an analysis Change in multiplier, COLA, retirement eligibility Closure of plan Enhanced early retirement benefits But what about Change in rehire practice Early retirement incentive outside of system Change in vacation/sick leave payouts Call the actuary or attorney if you are unsure

35 The Role of the Actuary Actuarial Valuation Experience Review Actuarial Audits Plan Design Optional Payment Factors Supplemental Actuarial Reports

36 Thank you!! Larry Langer, ASA, EA, FCA, MAAA Principal and Consulting Actuary Cavanaugh Macdonald Consulting, LLC 819 N. Brainard Naperville, IL (630)