New Trustees Workshop

Transcription

1 State Association of County Retirement Systems New Trustees Workshop May 12, 2015 Graham A. Schmidt, ASA, EA, FCA, MAAA Robert T. McCrory, FSA, FCA, EA, MAAA

2 Thank you! We greatly appreciate the time and effort you expend as Trustees. 1

3 Agenda Structure and Governance Responsibilities and Constraints Actuarial Funding Basics Historical Interlude Investment Interlude Legal Interlude Pension Reform Risk Please, ask questions as we go. 2

4 Structure and Governance The 37 Act Insurance Company 3

5 The 37 Act Insurance Company Board of Retirement County Board of Supervisors Employee Contributions Employer Premiums Pension Fund Benefits Expenses Financial Markets 4 4

6 The 37 Act Insurance Company Goals Solvency Low premiums Stable premiums Controls Benefit levels (Collective Bargaining) Employee contributions (Retirement Board or Collective Bargaining) Employer contributions (Retirement Board) Investment policy (Retirement Board) Advantages Non-profit Comparative permanence Ability to spread risk across generations Unique advantages in investment markets Disadvantages No unified command structure Web of legal protections and requirements inhibits reform 5

7 Responsibilities and Constraints Board Responsibilities Trustee Responsibilities Legal Constraints Actuarial Constraints Accounting Rules 6

8 Board responsibilities Investment Assets are held for the exclusive purpose of providing benefits to members and paying administrative expenses Investments are made to minimize employer cost consistent with risk Retain and supervise investment consultants, managers, and trustees Set investment policy consistent with desired returns and acceptable levels of risk Funding Accumulate assets to pay for retirement benefits during the member s period of active service (expense matching, generational equity) Assure the actuarial competency of fund assets Retain and supervise an actuary to determine funding levels and annual contributions Collect and invest employer and employee contributions Administration assure prompt delivery of benefits and related services to the participants and their beneficiaries Supervise the administration of benefit provisions of the CERL adopted by the employer Retain and supervise administrative staff and related infrastructure Adjudicate claims 7

9 Trustee Responsibilities Loyalty Act in the best interest of Plan participants Takes precedence over all other parties, including trustees, employers, taxpayers Precludes doing business with the Plan Prudence Principally concerns investment of Fund assets Held to the standard of a prudent expert Extends down to the level of individual investments Must pay attention to process, documentation of decisions Operational tasks may be delegated, but must be supervised Care Extends to all facets of funding, investment, and administration Must pay attention to process, documentation of decisions Operational tasks may be delegated, but must be supervised Satisfy requirements for continuing education Ethics Adhere to codes of ethics and conduct 8

10 Constraints Legal Constraints Benefits are specified in CERL Benefit is an employment contract In general, benefits cannot be reduced, even prospectively Legal protections vary by state Actuarial Constraints Actuarial Standards of Practice (ASOPs) govern activities of actuaries Recommended (not mandatory) funding practices established by the California Actuarial Advisory Panel (CAAP) Government Finance Officers Association (GFOA) has published best practices that generally follow CAAP Other organizations are generally following suit (e.g., Big 8, Academy of Actuaries) Imposes limits on funding methods, asset smoothing methods, and amortization methods and periods Accounting Rules New Governmental Accounting Standards Board (GASB) Statements 67 and 68 effective starting in 2014 Funding (actuarial) is now (mostly) separate from accounting Unfunded Accrued Liability will appear on employer balance sheet Some adjustments to actuarial methods (e.g., handling of administrative expenses) must be made to allow use of funding liabilities in financial statements 9

11 Actuarial Funding Basics How does actuarial funding work? Really? Is it that simple? 10

12 Example: College Funding 250,000 Goal 200, , ,000 50,

13 Example: College Funding 250,000 25,000 Goal 200,000 20,000 Asset Target 150,000 15, ,000 10,000 50,000 Annual Cost 5,

14 Example: College Funding 250,000 25,000 Goal 200,000 20,000 Asset Target 150,000 15, ,000 10,000 Annual Cost 50,000 5,

15 Example: College Funding 250,000 25,000 Goal 200,000 20, , ,000 Asset Target (Actuarial Accrued Liability) 15,000 10,000 50,000 5,000 - Normal Cost

16 Example: College Funding 250,000 25,000 Goal 200,000 20, ,000 Asset Target (Actuarial Accrued Liability) Asset Shortfall (Unfunded Accrued Liability) 15, ,000 Actual Assets 10,000 50,000 5,000 - Normal Cost

17 Example: College Funding 250,000 Goal 25, ,000 Asset Target (Actuarial Accrued Liability) 20, ,000 Asset Shortfall (Unfunded Accrued Liability) 15, ,000 50,000 Actual Assets Catch Up Contribution (Amortization of UAL) 10,000 5,000 - Normal Cost

18 Example: College Funding What did we do? We prefunded college: Set a goal (Assets needed at retirement) Set an annual contribution (Normal Cost) Set a path to the goal (Accumulated Normal Costs with assumed return Actuarial Accrued Liability) Formulated a plan to make corrections for being either behind or ahead of the asset target (Amortize unfunded or overfunded accrued liability) This is nothing less than actuarial funding This is nothing more than Management

19 Example: College Funding Glossary Normal Cost = Annual Cost (Regular Contribution) Actuarial Liability = Asset Goal Unfunded Actuarial Liability (UAL) = Asset Shortfall Amortization of UAL = Catch Up Contribution Actuarial Cost = Normal Cost + Amortization of UAL 18

20 Historical Interlude History of the County Employee Retirement Law (CERL, 37 Act) History of SACRS 19

21 SACRS Spring 2013 New Trustee Workshop The SACRS Triangle Regular members: Trustees 20 independent County retirement systems Nine trustees each, plus one or two alternates Associate members: Staff The Administrator (CEO) Investment, accounting, legal, benefit administration Affiliate members: Service providers Investment managers and consultants Actuaries, attorneys, auditors 185 firms, first come, first served basis 20

22 SACRS Spring 2013 New Trustee Workshop SACRS organization Officers Executive Committee President (current, past, vice) Secretary, Treasurer Affiliate Chair (non-voting) Committees Standing: Legislative, Nominating, By-laws, Program, Audit, Credentials, Affiliate membership Education Staff Strategic Local Government Services, LLC Separate contract for lobbyist 21

23 SACRS Spring 2013 New Trustee Workshop Origin of SACRS Administrator = County Treasurer Retirement Administrators met in the cafeteria of the L.A. county building First minutes available: September counties, 44 attendees 22

24 SACRS Spring 2013 New Trustee Workshop Major changes: the Early 1990s 1992: Proposition 162 Reaffirmed independence of retirement boards SACRS Long Range Planning Committee Report 18 months, report in Spring 1992 Permanent Affiliate Member Committee Number of affiliates frozen at 185 (now up to 215) Limit of two attendees per firm Official day concept, limits on marketing Increased dues and registration for Affiliates 23

25 SACRS Spring 2013 New Trustee Workshop Major changes: the Early 1990s Permanent staff for SACRS (via RFP) Wagerman/SLGS does day-to-day administration and conferences Separate contract for lobbyist SACRS hosts events, not host county One vote per county 24

26 SACRS Spring 2013 New Trustee Workshop County Retirement Systems in California Independent systems San Francisco and San Luis Obispo CalPERS - 36 counties as of 1999 County Employees Retirement Law of 1937 Commonly called 37 Act or CERL 20 systems adopted, last one in

27 SACRS Spring 2013 New Trustee Workshop The 20 CERL Systems Los Angeles the largest $33 billion Mendocino the smallest $354 million Total assets at $94 billion 245,000 actives, 120,000 in pay status (2006 data, sorry!) Third largest system in California After CalPERS and CalSTRS 26

28 SACRS Spring 2013 New Trustee Workshop County Classifications And Size ($) Los Angeles 1 1 Orange (S) 2 2 San Diego 3 3 Alameda 4 6 San Bernardino 7 4 Sacramento (S) 8 7 Contra Costa 9 5 San Mateo Fresno 12 9 Ventura 13 8 Kern San Joaquin Santa Barbara (S) Marin Sonoma Stanislaus Tulare Merced Imperial (S) Mendocino

29 SACRS Spring 2013 New Trustee Workshop CERL is a Stunningly Complicated Law Sections generally adopted on a permissive concept of legislation Hard to know what sections apply to which counties Read your plan summary, or the actuarial report (!) Four Methods of Adoption and Application Vote of Board of Supervisors and/or Retirement Board, Named counties Counties of the Nth Class One county in each class! Counties that have adopted other sections 28

30 Investment Interlude What is an investment consultant? What should you know? 29

31 Who is the Investment Consultant? Does not invest the assets Assists the Board in managing the investment process Setting investment policy Finding and selecting managers to implement policy Establishing benchmarks and monitoring investment performance Maintaining data on managers and markets Developing capital market assumptions/expectations Asset allocation PAGE 30

32 The Simple Construct Board Sets Policies and Monitors Progress Consultant Supports Both Board and Staff Staff Implements Policies and Maintains Compliance PAGE 31

33 Consultant s Role: Focus on the Things That Matter Work together with Staff to help the fiduciary body make sound policy and implementation decisions Consultant provides first-hand experience with similar investors and knowledge of industry best practices Consultant should add value in four key areas: Research Strategic Planning (Asset Allocation and Policy/Plan Governance) Capital Markets Process - Asset Allocation Manager Structure Manager Sourcing, Selection, and Oversight Cost Containment through fee negotiations Capital Markets Research Manager Research in Public & Private Markets Consultant provides historical data on capital markets and managers to support decisions, as well as insights on how to use and interpret data Performance Measurement Reporting Consultants should be objective we are fiduciaries PAGE 32

34 Evolution of the Board s Role Expanding importance of fiduciary duties of loyalty and prudence Loyalty Pay to play scandals Secure Funding Defined Benefit backlash Corporate Governance Prudence Consideration of New Asset Classes / approaches Ceding authority (responsibly) Seeking true diversification Staffing and staff compensation Issues Importance of Asset Allocation Policy, Risk Targeting and Budgeting, Cost Effectiveness and Policy Documentation Identifying Actionable Objectives PAGE 33

35 Asset Allocation Issues Total Fund Risk monitoring/management front & center Many defined benefit plans lowering return expectations Fixed Income Yield on Core U.S. Fixed Income below 3.0% Consideration of Alternative Credit strategies to realize higher yield Consideration of Partial Liability Hedge Initially Corporations (accelerated by PPA 06) Publics moving in this direction now (proposed GASB accounting changes) Equities Efficient Asset Groups (Large Cap Core) Passive/Enhanced Fundamental weighted and Smart Beta indices a consideration Inefficient Asset Groups (US & Int l. Small Cap and EM Equities) Active Increasing Exposure to Emerging Markets & International Small Cap PAGE 34

36 Legal Interlude Trustees and their roles as: Fiduciaries Public Officials Retirement System and its role as: A public agency A creation of the California Constitution and the CERL 35

37 Legal Basics For New SACRS Trustees Retirement Board Members Are Fiduciaries Fiduciary principles require board members to exercise their best judgment in the overall best interest of members and beneficiaries of the retirement system, which includes the newest member of the system and the oldest retiree, and every member in between, the safety and general members, and represented and unrepresented members. You must take off any other hat you may wear in other parts of your life and put on your fiduciary hat when acting as a retirement board member. 36

38 Legal Basics For New SACRS Trustees Retirement Board Members Are Public Officials Public officials are governed by conflict of interest, financial disclosure, and other rules of ethics that require diligent compliance. Anticipate that any and all interactions you have with those who do business with, or would like to do business with, your retirement system will be considered public business and are thus subject to public scrutiny. Do not take any actions on the retirement board that are in your own personal financial interest as distinct from the interest of the retirement system members generally. Take your public official ethics course early in your term and determine how you intend to make sure that you comply with the ethical rules that govern you. Try to anticipate potential conflict of interest issues so that you can ask system legal counsel your questions before a problem arises. 37

39 Legal Basics For New SACRS Trustees Retirement Systems Are Public Agencies Retirement system records, and your records relating to retirement system business, are public and subject to disclosure to the public, unless an exception to the disclosure mandate applies. Retirement system business conducted through a quorum of board or standing committee members many only occur at properly noticed, public meetings. Learn the basic Brown Act (open meetings law) and California Public Records Act rules early in your term and continue to refresh yourself on them throughout your term(s). When in doubt, ask retirement system counsel and/or your Administrator/Chief Executive Officer 38

40 Legal Basics For New SACRS Trustees All SACRS Retirement Systems Operate Under the California Constitution and a Complex Web of Government Code Provisions Key Point: The Rules Are Not the Same For All Members, Nor Are They the Same For All CERL Systems The County Employees Retirement Law of 1937 (aka CERL, 1937 Act or 37 ), provides the basic retirement plan rules and benefit provisions. However, for new members as of January 1, 2013, the Public Employees Pension Reform Act of 2013 ( PEPRA ) changed many CERL-based rules. For example, PEPRA members and legacy/classic members are governed by different rules regarding, among other things, how their retirement allowances and contribution rates are calculated. Some CERL provisions are county optional, meaning typically that they need to be adopted by a county board of supervisors before they apply in a given county. Do not assume that because another SACRS system purportedly has a particular rule or benefit system in place that it is necessarily available in your CERL system. 39

41 Pension Reform PEPRA CAAP GASB 40

42 Public Employees Pension Reform Act Enacts the California Public Employees Pension Reform Act of 2013 ( PEPRA ) (Gov. Code section 7522) PEPRA applies to most state and local public retirement systems and to their participating employers Most (but not all) PEPRA provisions are applicable only to new members who are not eligible for reciprocity and who join on and after January 1, 2013 ( New Members ) 41

43 Limits on Pensionable Compensation for All New Members Pensionable compensation used to compute the benefit is initially capped at 120% of the Social Security Taxable Wage Base if the member s service is not included in Social Security, and 100% if it is Pensionable compensation cap is indexed to inflation based on the CPI for All Urban Consumers, and that adjustment shall be effective annually on January 1 following the annual valuation Exclusions from pensionable compensation for new and current members Any compensation determined by the [retirement] board to have been paid to increase a member s retirement benefit under that system. Exclusions by pay type for new members 42

44 Mandatory Formula for New General Members Retirement eligible after five years of service and upon reaching 52 years of age. No service retirement prior to age 52. Minimum 1% at 52, 2.5% maximum at 67 formula required, unless a less costly plan with less risk, as certified by the retirement system actuary, is already in place Three-year final average compensation measuring period PEPRA does not change previously granted disability benefits, vesting provisions, or COLA 43

45 Mandatory Formula for New Safety Members Retirement eligible after five years of service and upon reaching 50 years of age. No service retirement prior to age 50. Basic Formula: 1.426% at 50 increasing to 2% at 57 Option 1: 2% at 50 increasing to 2.5% at 57 Option 2: 2% at 50 increasing to 2.7% at 57 Three-year final average compensation measuring period PEPRA does not change previously granted disability benefits, vesting provisions, or COLA 44

46 Member Contribution Rates for New Members Equal sharing of normal costs between public employers and public employees shall be the standard The standard is that employees pay at least 50% of normal costs and that employers not pay any of the required employee contributions Contributions may be more than 50% of normal cost if: Agreed through collective bargaining without impasse Employer is not contributing at a greater rate to the plan for non-represented, managerial, or supervisory employees than it contributes for other public employees of the same employers in related retirement membership classifications 45

47 Restrictions on Increasing Accrued Liabilities After January 1, 2013, no benefit changes can enhance prior service (no retroactive upgrades to past service credit) No purchases of nonqualified service credit, as defined by Section 415(n)(3)(C) of the Internal Revenue Code of

48 Funding Policy Guidance (CAAP) California Actuarial Advisory Panel (CAAP) document intended to provide guidance to actuaries and others on plan funding practices No force of law, advisory only, document states not to be used in lawsuits Document identifies five policy objectives 1. Fully fund benefits 2. Maintain generational equity 3. Manage contribution volatility 4. Support accountability and transparency 5. Address principal/agent issues 47

49 Funding Policy Guidance (CAAP) Document focuses on how various policies achieve (or do not achieve) objectives Actuarial cost methods Asset smoothing Amortization policy Other policies (direct rate smoothing, etc.) 48

50 Funding Policy Guidance (CAAP) Defines five categories for elements of funding policies Level Cost Model Practices: Intended to refer to a specific funding model (LCAM). Document specifically states that model is not intended to be synonymous with best practices Acceptable practices: well established in practice do not require additional analysis Acceptable practices, with conditions: may be acceptable to reflect different objectives or on the basis of additional analysis Non-recommended practices Unacceptable practices Not intended as a grading or scoring mechanism for a system s actuarial funding policy 49

51 Funding Policy Guidance (CAAP) Guidance in CAAP Model Practices Preference for Entry Age Normal cost method (same specific form as new GASB standards) Preference for closed asset smoothing policies, avoiding long periods without corridors For amortization, preference for: Layered, closed periods, with length of period dependent on source of UAAL Level percentage of payroll if benefits pay-based Avoid lengthy amortization of plan amendments Rolling amortization of gains/losses also acceptable, but avoid in conjunction with long periods (negative amortization) New out-of-bounds markers: 25 is the new 30 For asset smoothing, most commonly used methods (5 years, with or with a corridor around market value) are acceptable 50

52 Overview of Accounting Changes Statement 67 Applies to the Plan Effective for Plan years beginning after June 15, 2013 Statement 68 Applies to employers Effective for Employer fiscal years beginning after June 15, 2014 Mostly affects employer accounting Plans will need to provide employers with the information necessary to complete their CAFRs Plan expense on employer financials bears no relationship to employer Plan contributions Accounting and funding are divorced 51

53 Overview of Accounting Changes Mandated uniformity of methods Entry age actuarial cost method for all plans Market value of assets Discount rate changes for some plans Faster recognition of gains and losses, assumption changes, and benefit changes All employers (including cost-sharing employers) will have to report the unfunded accrued liability on their balance sheet Expense largely determined by changes in the unfunded liability Accounting expense will be negative in some years (e.g., an investment gain decreases the unfunded liability) Accounting expense will be significantly more volatile than plan contribution determined by the actuary 52

54 Overview of Accounting Changes Discount rate to compute the unfunded liability may change: If plan assets with future contributions are projected to be sufficient to pay projected benefits: Use the expected rate of return on plan assets As long as the employers make the full actuarial contribution, and each component of the unfunded liability is funded over a fixed, decreasing time frame, this test will usually be passed. If plan assets with future contributions are projected to run out before all benefits are paid: Discount the unpaid benefits using a municipal bond rate This will occur in most cases with a rolling amortization period May cause a small (0.1% to 0.2%) decrease in the overall discount rate, as long as the employer pays the actuarial cost 53

55 Overview of Accounting Changes Expected effects of accounting changes: Large and volatile liability added to employers balance sheets Much more volatility in employer income statements Proportionate share of pension liability and expense will appear in financial statements of all participating employers Probably not much impact on credit rating: Not really any new information for rating bureaus Considerable confusion and uninformed commentary in the press and among the public Substantial and ongoing time commitment required of plan and employer staff, accountants, and actuaries 54

56 Risk!! Investment Risk Funding Risk Assumption Risk 55

57 Cost Risk: The Actuarial Fantasy 50% Projected Actuarial Cost - Test Plan 45% 40% 35% Cost % Active Payroll 30% 25% 20% 15% 10% 5% 0% Time 56

58 Cost Risk: The Ugly Truth 57

59 Investments: Risk/Reward Tradeoff 58

60 Expected Rate of Return Steps for calculation of expected returns Collect assumptions of returns, risk, and correlations from investment consultant(s) Adjust returns for expenses and differences in inflation Simulate target portfolio using adjusted inputs Returns are: Gross of investment expenses for classes where passive management available (expenses should be minimal) Net of investment expenses for classes without passive management Not adjusted for administrative expenses 59

61 Expected Rates of Return Expected Return (%) Volatility (%) Asset Class Fixed Income Cash Equivalents Investment Grade Bonds TIPS High Yield Bonds Bank Loans Foreign Bonds Emerging Market Bonds (major) Emerging Market Bonds (local) Equities US Equity Developed Market Equity Emerging Market Equity Frontier Market Equity Private Equity Real Assets Real Estate REITs Core Private Real Estate Value Added Real Estate Opportunistic Real Estate Natural Resources (Public) Natural Resources (Private) Commodities (naïve) Infrastructure (Public) Core Infrastructure (Private) Non-Core Infrastructure (Private)

62 Simulated Returns Measure compound average return over 10 years 10,000 simulation trials Average compound return of 7.8% 61

63 Simulated Success Measure probability of exceeding each possible assumed return rate over 10 years 50/50 chance of making 7.8% over the next 10 years 62

64 Risks: Asset Risk 1000% Market Value of Assets as a Percentage of Payroll 900% 800% 700% 600% 500% 400% 300% 200% 100% 0%

65 Risks: Asset Risk Event/Impact Return of 0% vs. 8% assumed Assets = 500% Payroll Assets = 1000% Payroll Actuarial Loss (Assets) 8% of Assets 8% of Assets Actuarial Loss (Payroll) Cost Impact (After Phase-In due to Asset Smoothing) 8% X 5 = 40% of Payroll 8% X 10 = 80% of Payroll 4% of Payroll 8% of Payroll Note: The cost impact of market variation is directly proportional to the ratio of assets to covered payroll. More assets = More risk 64

66 Funding Risk Cost standard deviation plotted against funded ratio 65

67 Assumption Risk: 16% Assumed Year Actuarial Projection Mean SD th Percentile Median th Percentile Simulated actuarial cost of the Model Plan with an assumed rate of return of 16% 66

68 Required Disclosures The purpose of this presentation is to provide educational material for the State Association of County Retirement Systems (SACRS). This presentation is for the use by SACRS in its education and outreach efforts. In preparing this presentation, we relied on information (some oral and some written) supplied by Staff at SACRS. To the best of our knowledge, this presentation and its contents have been prepared in accordance with generally recognized and accepted actuarial principles and practices which are consistent with the Code of Professional Conduct and applicable Actuarial Standards of Practice set out by the Actuarial Standards Board. Furthermore, as credentialed actuaries, we meet the Qualification Standards of the American Academy of Actuaries to render the opinion contained in this presentation. This presentation does not address any contractual or legal issues. We are not attorneys and our firm does not provide any legal services or advice. This presentation was prepared solely for SACRS for the purposes described herein. This presentation is not intended to benefit any third party and Cheiron assumes no duty or liability to any such party. Graham Schmidt ASA, EA Consulting Actuary Robert McCrory, FSA, EA Principal Consulting Actuary 67

69 Contact Information Graham Schmidt (703) x1137 Bob McCrory (206)