Town of Andover Contributory Retirement System

Transcription

1 Town of Andover Contributory Retirement System March 29, 2018 Kathleen A. Riley, FSA, MAAA, EA Senior Vice President and Actuary This document has been prepared by Segal Consulting for the benefit of the Town of Andover Contributory Retirement System and is not complete without the presentation provided at the March 29, 2018 meeting. This document should not be shared, copied or quoted, in whole or in part, without the consent of Segal Consulting, except to the extent otherwise required by law. Copyright 2018 by The Segal Group, Inc. All rights reserved.

2 Purpose of Assumption Review > Provides basis for developing recommended assumptions to be used in the actuarial valuation > Review recent experience and trends and compare against current actuarial assumptions and methods > Actuarial Standards of Practice No. 27 and 35 provide guidance on economic and demographic assumption-setting analysis Each assumption should be the actuary's best estimate > Segal's role is to make appropriate "best estimate" recommendations to the Retirement Board The assumptions are the Board's assumptions and the Board can adopt all, none, or some of the recommendations of the actuary *" Segal Consulting 2

3 Background Two Types of Actuarial Assumptions Demographic Inflation Investment rate of return Payroll growth rate Salary increases (salary scale) Mortality - Death in active service - Death after retirement» Healthy» Disabled Turnover (withdrawal) Retirement Disability * Segal Consulting 3

4 Economic Assumptions *Segal Consulting 4

5 Economic Assumptions Building Block Approach Each economic assumption has two or three components (or building blocks). INVESTMENT RATE OF RETURN SALARY INCREASES PAYROLL GROWTH ~~, Prod uctivity 'IJ (if applicable) Building blocks must be consistent across all economic assumptions. *Segal Consulting 5

6 Creating a 7.50/0 Return Portfolio Roiling the Dlce Investors grappling with lower interest rates have to take bigger risks if they want to equal returns of two decades ago. Estimates of what Investors needed to earn 7.5% % Bonds > Reduced inflation expectation has reduced investment returns 52% 33% u.s. Larg~ Cap u.s. 100% 8% Small Cap Bonds 20% 5% 14% 22% Non U.S. Equity 13% Real Estate > More risk is needed now to achieve 7.5% expected return > 7.5 % portfolio has standard deviation of 17% now vs. 6% twenty years ago Expected return Standard deviation' 5% 12% Pr;wate Equity 4% 7.5% 7.5% 7.5% 6.0% 8.9% 17.2% "Likelyamo nt by which returns could vary Sou rce: Cella n Associates TIm W..\LL S'fIWI(T JOUltNAL. "* Segal Consulting 6

7 Inflation Rate > Current Assumption: 3.50% > Inflation continues at relatively low levels from a historical perspective: 20%, , 15% 10% 5% -5% -10% -15% ' ' ~ > Estimates or future inrlation vary depenaing on the purpose of the estimates: Economists are projecting low inflation «2%) in the United States due to a relative shift of investments from equities to fixed income by the growing retiree population. Increasing U.S. debt may drive up inflation. Inflation as a component of the salary increase assumption reflects other variables such as bargaining, other benefits, workforce availability etc. For an actuarial valuation, the inflation assumption is forward looking and longterm. > Recommendation: Maintain current 3.50% inflation assumption. *" Segal Consulting 7

8 Investment Rate of Return > Cu rrent Assumption: 7.25 % > NASRA Survey, February 2018 Nearly 75% of survey respondents lowered the assumption since The majority of plans (87 of the 129 plans measured) have assumptions greater than 7.00% but less than 8.00%. The average is 7.36%. > The investment return assumption was lowered from 7.75 % to 7.25% with the most recent actuarial valuation. *" Segal Consulting 8

9 US Actuarial Building Blocks-Segal Marco Advisors Capital Market Assumptions as of December 31,2017 Equity Fixed Income Hedge Fund, International Emerging Core Real GTAA, Risk Private Arithmetic Returns by Asset Class Domestic Developed Markets Markets Core High Yield Estate Corrrnodities Parity, etc. Equity 5 Year Time Horizon 7.51% 8.51% 10.91% 2.86% 5.41% 6.21% 6.01% 5.21% 11.81% 10 Year Time Horizon 7.86% 8.86% 11.26% 3.21% 5.76% 6.56% 6.36% 5.56% 12.16% 15 Year Time Horizon i 8.15% 9.15% 11.55% 3.50% 6.05% 6.85% 6.65% 5.85% 12.45% 20 Year Time Horizon i 8.40% 9.40% 11.80% 3.75% 6.30% 7.10% 6.90% 6.10% 12.70% Target Allocation : 37.00% 10.00% 6.00% 10.00% 10.00% 13.00% 2.00% 6.50% 5.50% Returns for Total Total Portfolio (1) (2) (3) Forward Looking Forward Looking Median Expected Expected Geometric Portfolio Arithmetic Return Geometric Return Return Nominal Expected Return as of December 31, Year Time Horizon 7.000/ / /0 10 Year Time Horizon 7.36% 6.74% 6.680/0 15 Year Time Horizon 7.65% 7.01% 6.960/0 20 Year Time Horizon 7.90% 7.24% 7.21% *" Segal Consulting 9

10 Investment Rate of Return continued > Based on the System's target asset allocation and the expected returns by asset class, the annual 15- to 20-year return is expected to be in the 7.0 % % range. > Recommendation: Consider a reduction in investment return assumption to 7.0%. *Segal Consulting 10

11 Salary Increases > Current Assumptions Current salary increase assumptions are unisex and based on years of service and group > Findings Years of Service Group 1 Group 2 Group % 6.00% 7.00% 5.50% 5.50% 6.50% % 5.50% 6.00% % 5.25% 5.75% % 5.25% 5.25% % 4.75% 5.25% % 4.75% 4.75% % 4.50% 4.75% % 4.50% 4.75% % 4.50% 4.75% Salary experience generated a $5.3 million gain for the two-year period ending December 31,2015 and a $0.7 million gain for the two-year period ending December 31,2017. > Recommendation: Maintain current salary increase assumption. '* Segal Consulting 11

12 Payroll Growth > Current Assumption: 3.50% > Comments Used to project employer normal cost payment. May be used to determine amortization payments on the unfunded actuarial accrued liability that that increase at the expected payroll growth assumption. Usually equivalent to inflation assumption. > Recommendation: Maintain 3.50% payroll growth assumption. *Segal Consulting 112

13 Demographic Assumptions '* Segal Consulting 13

14 Mortality Rates > Current Assumptions Healthy Lives: RP-2000 Employee and Healthy Annuitant Mortality Tables projected generationally from 2009 using Scale BB2D Disabled Lives: RP-2000 Healthy Annuitant Mortality Tables projected generationally from 2015 using Scale BB2D > Findings Demographers generally expect that mortality will continue to improve although the rate of improvement has slowed down relative to the Society of Actuaries 2014 projection scales. *Segal Consulting 14

15 Mortality Rates > The Society of Actuaries (SOA) released updated mortality tables in 2014 Many actuaries around the country are updating their mortality assumptions to RP When plans are large enough, tables are adjusted to reflect actual experience. No public sector plans were included in the analysis used to create the RP-2014 tables. The SOA is currently studying public sector mortality. > Recommendation: RP-2014 Blue Collar Employee and Healthy Annuitant Mortality Tables set forward 1 year for females and projected generationally with Scale MP-2017 for healthy lives. RP 2014 Blue Collar Healthy Annuitant Mortality Tables set forward 1 year and projected generationally with Scale MP-2017 for disabled pensioners. *" Segal Consulting 15

16 Turnover Rates > Current Assumptions Current withdrawal rates are unisex and based on years of service and group. For Group 1 employees, rates decrease from 15% in the first year of employment to 1% in years For Group 4 employees, rates are 1.5% for years > Findings Two-year Period Ending Expected Terminations Actual Terminations > Recommendation: No change to current turnover rates at this time. *Segal Consulting 16

17 Retirement Rates > Current Assumptions Current retirement rates are based on years of age and group. There are separate retirement rates for Group 1 males and females. For Group 1 employees, rates begin at age 50, with higher rates beginning at age 60 for males and age 61 for females, and continue through age 70. For Group 4 employees, rates begin at age 45, with higher rates beginning at age 55, and continue through age 65. > Findings Two-year Period Ending Expected Retirements Actual Retirements > Recommendation: No changes to current retirement rates at this time. *Segal Consulting 17

18 Disability Rates > Current Assumptions Plan participants are eligible for accidental disability benefits at any age and ordinary disability benefits with 10 years of service. The assumption is based on a table of unisex rates varying by age and group. For Group 1 employees, rates range from.01% at age 20 to.28% at age 60. For Group 4 employees, 0.85% at age 60. rates range from.10 % at age 20 to 1.25% at age 50 to 55% of Group 1 disabilities and 90% of Group 4 disabilities are assumed to be accidental. 20% of Group 1 accidental disabilities and 60% of Group 4 accidental disabilities are assumed to die from the same cause as the disability. *Segal Consulting 18

19 Disability Rates continued > Findings Two-year Period Ending Expected Disabilities Actual Disabilities > Recommendation: No change to current disability rates at this time. *Segal Consulting 19

20 Preliminary 2018 Valuation Results *Segal Consulting 20

21 January 1, 2018 Actuarial Valuation Preliminary Results > The unfunded liability was expected to increase from $128.9 million as of January 1, 2016 to $134.2 million as of January 1, > The actual unfunded liability as of January 1, 2018, prior to any assumption changes, is $136.4 million. > There was an experience loss of $2.2 million for the two-year period ending December 31, 2017 due to the following factors: There was an investment gain on an actuarial basis of $2.3 million Actual administrative expenses were less than assumed by $60,000. There was an experience loss due to all other factors (primarily mortality experience, partially offset by a small gain from salary experience) of $4.5 million. *Segal Consulting 21

22 Appendix *Segal Consulting 23

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24 Investment Return Assumptions September 2016 Current 3 < 7.5% 7.5% - 7.9% 8%0 8.1% % 0 8.5%0

25 NASRA Issue Brief: Public Pension Plan Investment Return Assumptions Updated February 2018 NASRA As of September 30,2017, state and local government retirement systems held assets of $4.16 trllllon." These assets are held in trust and invested to pre-fund the cost of pension benefits. The investment return on these assets matters, as investment earnings account for a majority of public pension financing. A shortfall in long-term expected investment earnings must be made up by higher contributions or reduced benefits. Funding a pension benefit requires the use of projections, known as actuarial assumptions, about future events. Actuarial assumptions fall into one of two broad categories: demographic and economic. Demographic assumptions are those pertaining to a pension plan's membership, such as changes in the number of working and retired plan participants; when participants will retire, and how long they'll live after they retire. Economic assumptions pertain to such factors as the rate of wage growth and the future expected investment return on the fund's assets. As with other actuarial assumptions, projecting public pension fund investment returns requires a focus on the long-term. This brief discusses how investment return assumptions are established and evaluated, compares these assumptions with public funds' actual investment experience, and the challenging investment environment public retirement systems currently face. Because investment earnings account for a majority of revenue for a typical public pension fund, the accuracy of the return assumption has a major effect on a plan's finances and actuarial funding level. An investment return assumption that is set too low will overstate liabilities and costs, causing current taxpayers to be overcharged and future taxpayers to be undercharged. A rate set too high will understate liabilities, undercharging current taxpayers, at the expense of future taxpayers. An assumption that is Significantly wrong in either direction will cause a misallocation of resources and unfairly distribute costs among generations of taxpayers. Figure 1: Public Pension Sources of Revenue, As shown in Figure 1, since 1987, public pension funds have accrued approximately $7.0 trillion in revenue, of which $4.3 trillion, or 61 percent, is from investment earnings. Employer contributions account for $1.9 trillion, or 27 percent of the total, and employee contributions total $844 billion, or 12 percent.' Compiled by NASRA based on u.s.census Bureau data Most public retirement systems review their actuarial assumptions regularly, pursuant to state or local statute or system policy. The entity (or entities) responsible for setting the return assumption, as identified in Appendix B, typically works with one or more professional actuaries, who follow guidelines set forth by the Actuarial Standards Board in Actuarial Standards of Practice No. 27 (Selection of Economic Assumptions for Measuring Pension Obligations) (ASOP27). ASOP 27 prescribes the factors actuaries should consider in setting economic actuarial assumptions, and recommends that actuaries consider the context of the measurement they are making, as defined by such factors as the purpose of the I Federal Reserve, Flow of Funds Accounts of the United States: Flows and Outstandings, Third Quarter 2017, Table L US Census Bureau, Annual Survey of Public Pensions, State & Local Data February 2018 NASRAISSUEBRIEF:Public Pension Plan Investment Return Assumptions Page 1

26 measurement, the length oftime cash flows. the measurement period is intended to cover, and the projected pattern of the plan's Figure 2: Average nominal and real rate of return, and average assumed inflation rate, FY02 - FY 16 ASOP27 also advises that actuarial assumptions be 8.05% 4.21% 3.84% - Average Assumed 7.56% Nominal Rate of Return Average Assumed Real Rate of Return reasonable, defined in subsection 3.6 as being consistent with five specified characteristics; and requires that actuaries consider relevant data, such as current and projected interest rates and rates of inflation; historic and projected returns for individual asset classes; and historic returns of the fund itself. For plans that remain open to new members, actuaries focus chiefly on a long investment horizon, i.e., 20 to 30 years, which is the length of a typical public pension plan's funding period. One key purpose for relying on a long timeframe is to promote the key policy 4.60% Average Assumed objectives of cost stability and predictability, and Inflation Rate intergenerational equity among taxpayers % The investment return assumption used by public pension Fiscal Year Public PlansData and Public FundSurvev plans typically contains two components: inflation and the real rate of return. The sum of these components is the nominal return rate, which is the rate that is most often used and cited. The system's inflation assumption typically is applied also to other actuarial assumptions, such as the level of wage growth and, where relevant, assumed rates of cost-of-living adjustments (COLAs).Achieving an investment return approximately commensurate with the inflation rate normally is attainable by investing in securities, such as USTreasury bonds, that are often characterized as risk-free, i.e., that pay a guaranteed rate of return. The second component of the investment return assumption is the real rate of return, which is the return on investment after adjusting for inflation. The real rate of return is intended to reflect the return produced as a result ofthe risk taken by investing the assets. Achieving a return higher than the risk-free rate requires taking some investment risk; for public pension funds, this risk takes the form of investments in assets such as public and private equities and real estate, which contain more risk than Treasury bonds. Figure 2 illustrates the changes in the average nominal (noninflation-adjusted) return, the inflation assumption, and the resulting real rate of return assumption. As the chart shows, although the average nominal public pension fund investment return has been declining, because the average rate of assumed inflation has been dropping more quickly, the average real rate of return has risen, from 4.21 percent in FY02 to 4.60 percent in FY16. One factor that may be contributing to the higher real rate of return is public pension funds' higher allocations to alternative assets, particularly to private equities, which usually have a higher expected return than other asset classes. Figure 3 plots median public pension fund annualized investment returns for a range of periods ended December 31, As the figure shows, relatively strong returns in recent years are somewhat offset by the effects of market declines of Figure 3: Median public pension annualized investment returns for period ended 12/31/ % 8.8% 8.7% 8.1% Median 7.6% Investment 6.8% Return II Assumption = 7.50% Years ended 12/31/17 Callan Associates and , which are affecting returns for the 10- or 20-year periods ended 12/31/17, or both. February 2018 NASRAISSUEBRIEF:Public Pension Plan Investment Return Assumptions Page 2

27 In the wake ofthe decline in capital markets and Great Recession, global interest rates and inflation have remained low by historic standards, due partly to so-called quantitative easing of central banks in many industrialized economies, including the U.S. Now in their ninth year, these low interest rates, with low rates of projected global economic growth, have led to reductions in projected returns for most asset classes, which, in turn, have resulted in an unprecedented number of reductions in the investment return assumption used by public pension plans. This trend is illustrated by Figure 4, which plots the distribution of investment return assumptions among a representative group of plans since Among the 129 plans Figure 4: Change in Distribution of Public Pension Investment Return Assumptions, FY01 to FY18 :85~~iUlnl.U".. >8.0 < Public Fund Survey, NASRA Feb 18 Fiscal Year % >7.5 < 8.0 measured, nearly three-fourths have reduced their investment return assumption since fiscal year 2010, resulting in a decline in the average return assumption from 7.91 percent to 7.36 percent. If projected returns continue to decline, investment return assumptions are likely to also to continue their downward trend. Appendix A lists the assumptions in use or adopted for future use by the 129 plans in this dataset. Median = 7.50% One challenging facet of setting the investment > return assumption that has emerged more 7.0 recently is a divergence between expected returns over the near term, i.e., the next five to 10 years, and over the longer term, i.e., 20 to 30 years". A growing number of investment return projections are concluding that near-term returns will be materially lower than both historic norms as well as projected returns over longer timeframes. Because many near-term projections calculated recently are well below the long-term assumption most plans are using, some plans face the difficult choice of either maintaining a return assumption that is higher than near-term expectations, or lowering their return assumption to reflect near-term expectations. If actual investment returns in the near-term prove to be lower than historic norms, plans that maintain their long-term return assumption risk experiencing a steady increase in unfunded pension liabilities and corresponding costs. Alternatively, plans that reduce their assumption in the face of diminished near-term projections will experience an immediate increase unfunded liabilities and required costs. As a rule ofthumb, a 25 basis point reduction in the return assumption, such as from 8.0 percent to 7.75 percent, will increase the cost of a plan that has a COLA,by three percent of pay (such as from 10 percent to 13 percent), and a plan that does not have a COLA,by two percent of pay. Conclusion The investment return assumption is the single most consequential of all actuarial assumptions in terms of its effect on a pension plan's finances. The sustained period of low interest rates since 2009 has caused many public pension plans to re-evaluate their long-term expected investment returns, leading to an uprecedented number of reductions in plan investment return assumptions. Absent other changes, a lower investment return assumption increases both the plan's unfunded liabilities and cost. The process for evaluating a pension plan's investment return assumption should include abundant input and feedback from professional experts and actuaries, and should reflect consideration ofthe factors prescribed in actuarial standards of practice. 3 Horizon Actuarial Services, "Survey of Capital Market Assumptions, 2017 Edition (August 2017) p4 February 2018 NASRAISSUEBRIEF:Public Pension Plan Investment Return Assumptions Page 3

28 See Also: Actuarial Standards of Practice No. 27, Actuarial Standards Board The Liability Side of the Equation Revisited, Missouri SERS, September 2006 Figure 5: Distribution of investment return assumptions 34 % (\..~ (\..<t:>'\<t:> (:> (:> ~ % '\~ q,' q,' q,' t- I-- J,;, ~<t:> NASRA ~~ -t Feb-18 #'f Contact: Keith Brainard, Research Director, keith@nasra.org Alex Brown, Research Manager, alex@nasra.org National Association of State Retirement Administrators February 2018 NASRA ISSUE BRIEF: Public Pension Plan Investment Return Assumptions Page 4