CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER INTRADEPARTMENTAL CORRESPONDENCE

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1 CITY OF LOS ANGELES DEPARTMENT OF WATER AND POWER INTRADEPARTMENTAL CORRESPONDENCE Date: May 7, 2015 To: Retirement Board Members From: Linda P. Le, Retirement Plan Manager / ~ Subject: Board Agenda Item No. 12: Discussion of Proposed Plan Amendments to Change the Mortality Table and Interest Rate Used in the Calculation of Retirement Allowances and Conversion to Optional Benefits Amounts; and Possible Action (May 13, 2015, Regular Retirement Board Meeting) Recommendation That the Board of Administration (Retirement Board) of the Water and Power Employees' Retirement Plan (Plan) adopt a resolution to recommend approval of the proposed Plan amendments to change the mortality table and the credited interest rate used in the calculation of retirement allowances and conversions to optional benefits amounts; and to direct the Retirement Plan Manager to transmit same to the Board of Water and Power Commissioners for approval. Background On June 26, 2013, Segal Consulting, the Plan's actuary, presented its report, "Analysis of Actuarial Experience during the Period July 1, 2009 through June 30, 2012", which included recommendations to change the mortality table and the credited interest rate used to calculate retirement allowances and optional benefits, so as to align with the actuarial factors used in the annual valuation as adopted by the Retirement Board on April 9, The interest rate assumption used in the valuation is 7.5%, while-the Plan still uses 8.0% to calculate retirement allowances and to convert to optional benefits amounts. The mortality assumptions used in the valuation is based on the RP-2000 Combined Healthy Mortality Table (RP-2000), while the Plan currently uses the 1983 Group Annuity Mortality Table (1983-GAM). At its regular meeting held on October 22, 2014, the Retirement Board approved, in concept, Plan amendments to change the mortality table and interest rate used in the calculation of retirement allowances and conversion to optional benefits amounts, and directed staff to notify the Department of Water and Power's Labor Relations Office to meet with the bargaining units. The meetings have been conducted and the unions have agreed in concept, providing that the Plan amendments do not create a direct link with the Plan experience. Therefore, any future changes in the mortality table and interest rate used in the calculation of retirement allowances and conversions to optional benefits amounts will require additional Plan amendments and meetings with the affected bargaining units. Plan Amendment Process There are three major steps in the Plan amendment process as follows: 1. The Retirement Board adopts a resolution recommending the Board of Water and Power Commissioners approve the proposed Plan amendment; 12.1

2 2. The Board of Water and Power Commissioners adopts a resolution approving the proposed Plan amendment; and 3. The Retirement Board adopts a resolution to amend the Plan. Adoption of the resolution by the Retirement Board will recommend approval of an amendment to Plan Sections Ill C (9), IV F (5), and VII L (3), and will direct the Retirement Plan Manager to transmit same to the Board of Water and Power Commissioners for approval. Implementation of Plan Changes Should the proposed Plan amendments be approved, extensive changes will be needed to implement the new provisions. Required actions will include: 1. Modifications to the Integrated Pension System, which is used to calculate, process, and generate benefit payments; 2. Revisions to printed materials; and 3. Communications to Plan members. It is recommended that the Retirement Board approve the resolution to adopt an operative date of May 1, However, should the Retirement Board prefer a different operative date for the amendments to become effective, a resolution has been attached to this report to allow the Board to specify the date. Fiscal Impact The Los Angeles City Charter and California State law require an actuarial cost study to accompany any proposed Plan amendments prior to the Retirement Board or the Board of Water and Power Commissioners taking action. According to its letter dated May 5, 2015, Segal Consulting has completed the study. Based on the July 1, 2014, valuation, the change to the interest rate and mortality assumptions affecting conversions of the contribution balances to monthly annuities for the Additional Annuity and Money Purchase Annuity at retirement will decrease the required Department contribution rate by 1.35% or $12.2 million annually. The change to the interest rate and mortality assumptions affecting conversions to optional benefits amounts will have no immediate effect. The following documents are attached: Resolution No (option one) Resolution No (option two) Attachment A- Proposed Plan Amendments, Sections Ill C (9), IV F (5), and VII L (3) Letter from Segal Consulting, dated May 5, 2015 LPLNES:II 12.2

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4 RESOLUTION NO RESOLUTION TO RECOMMEND PROPOSED AMENDMENTS TO PLAN SECTIONS Ill C (9), IV F (5), AND VII L (3) TO CHANGE THE MORTALITY TABLE AND INTEREST RATE USED IN THE CALCULATION OF RETIREMENT ALLOWANCES AND CONVERSION TO OPTIONAL BENEFITS AMOUNTS WHEREAS, the Board of Administration (Retirement Board) of the Water and Power Employees' Retirement Plan (Plan) has adopted an investment return assumption of 7.5% and a mortality assumption based on the RP-2000 Combined Healthy Mortality Table; and WHEREAS, retirement allowances and conversions to benefits amounts are calculated pursuant to Sections Ill C (9), IV F (5), and VII L (3) of the Plan. NOW, THEREFORE, BE IT RESOLVED, that the Retirement Board approves the proposed Plan amendments and directs the Retirement Plan Manager to transmit same to the Board of Water and Power Commissioners for approval, as hereinafter provided: 1. Section Ill C (9) is amended by the addition of a paragraph after the third paragraph as shown: On and after the Effective Date of the Amendment, every retirement allowance shall be calculated based upon the "RP Combined Healthy Mortality Table" converted to a unisex basis with adjustments established to reflect Plan experience, and an interest rate of seven and one-half percent (7.5%) per annum; provided, however, that the retirement allowances of members retired prior to the Effective Date of the Amendment shall not be changed. The method of conversion to a unisex basis and the determination of the adjustments shall be adopted by the Board of Administration based on the recommendation of its Actuary. 2. Section IV F (5) is amended by the addition of a paragraph as shown: On and after the Effective Date of the Amendment, interest at the rate of seven and onehalf percent (7.5%) per annum, compounded annually, shall be used in the calculation of benefits under any mortality table adopted by the Retirement Board regardless of the amount of distributable surplus which may be credited to the accounts of members under the provisions of this Plan. 3. Section VII L (3) is amended by the addition of a paragraph as shown: On and after the Effective Date of Amendment, interest at the rate of seven and one-half percent (7.5%) per annum, compounded annually, shall be used in the calculation of benefits under any mortality table adopted by the Retirement Board regardless of the amount of distributable surplus which may be credited to the accounts of members under the provisions of this Plan. 4. Words italicized in this resolution shall not be included in the Plan document, and shall be replaced with the appropriate date. 12.4

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6 Attachment A Ill c (9) Interest Rates and Maintenance of Surplus Interest required to be credited on all contribution accounts and reserves at the end of the fiscal year and at the end of each fiscal year thereafter shall be at the rate of eight percent (8%) per annum. Such rate shall be revised when and as directed by the Board of Water and Power Commissioners. Prior to fiscal year such interest shall be at the regular interest set forth in Section IV A (4). With the exception of remaining balances of amounts which the Department has heretofore prepaid or may hereafter prepay into the Retirement Fund, regular interest shall be credited on all contributions which now are, or hereafter may be deposited in said fund. On and after July 1, 1991, every retirement allowance shall be calculated upon the "1983 Group Annuity Mortality Table" adjusted to a single rate with a setback established from time to time, and an interest rate of eight percent (8%) per annum; provided, however, that the retirement allowances of members retired prior to July 1, 1991, shall not be changed. The method of adjustment of the mortality table to a single rate and the determination of the setback shall be adopted by the Board of Administration based on the recommendation of its Actuary.. On and after the Effective Date of the Amendment, every retirement allowance shall be calculated based upon the "RP Combined Healthy Mortality Table" converted to a unisex basis with adjustments established to reflect Plan experience, and an interest rate of seven and one-half percent (7.5%) per annum; provided, however, that the retirement allowances of members retired prior to the Effective Date of the Amendment shall not be changed. The method of conversion to a unisex basis and the determination of the adjustments shall be adopted by the Board of Administration based on the recommendation of its Actuary. From time to time there shall be credited to reserves such additional sums as mortality adjustments may require. These additional sums and all interest commitments of the Retirement Fund shall be charged against the surplus account of said fund. Should the income and realized gains from the investment of moneys of the Retirement Fund be insufficient to pay the benefits due under the terms of this Plan, the Department shall pay into the Retirement Fund such sum or sums as may be necessary in order to pay such benefits in a timely manner. Attachment A 12.6

7 Attachment A IV F (5) Interest at the rate of eight percent (8%) per annum, compounded annually, shall be used on and after July 1, 1980 in the calculation of benefits under any mortality table adopted by the Board regardless of the amount of distributable surplus which may be credited to the accounts of members under the provisions of this Plan. On and after the Effective Date of the Amendment, interest at the rate of seven and one-half percent (7.5%) per annum, compounded annually, shall be used in the calculation of benefits under any mortality table adopted by the Retirement Board regardless of the amount of distributable surplus which may be credited to the accounts of members under the provisions of this Plan. VII L (3) Interest at the rate of eight percent (8%) per annum, compounded annually, shall be used in the calculation of benefits under any mortality table adopted by the Board regardless of the amount of distributable surplus which may be credited to the accounts of members under the provisions of this Plan. On and after the Effective Date of Amendment, interest at the rate of seven and one-half percent (7.5%) per annum, compounded annually, shall be used in the calculation of benefits under any mortality table adopted by the Retirement Board regardless of the amount of distributable surplus which may be credited to the accounts of members under the provisions of this Plan. 12.7

8 *Segal Consulting 100 Montgomery Street Suite 500 San Francisco, CA T VIA May 5, 2015 Ms. Linda P. Le Retirement Plan Manager Los Angeles Water and Power Employees' Retirement Plan 111 North Hope Street, Suite 357 Los Angeles, CA Re: Water and Power Employees' Retirement Plan of the City of Los Angeles Impact of Aligning Actuarial Assumptions in Plan Document with those used in Actuarial Valuation Dear Linda: As rt<quested, this letter contains a discussion of the various impacts of aligning the actuarial assumptions in the Plan with those used in the annual actuarial valuation. Our report entitled "Analysis of Actuarial Experience during the Period July 1, 2009 through June 30, 2012" that was dated April 17, 2013 included various recommendations for changes to actuarial assumptions used in the actuarial valuation. The Retirement Board adopted those recommended assumptions and they were implemented in the July 1, 2014 actuarial valuation. That report also included a recommendation that the Retirement Board review the actuarial factors used to calculate member allowances and optional benefits with the goal of making them consistent with those used in the valuation. The report stated,.. "if these assumptions are adopted by the Board, the actuarial factors used for optional forms of payment, present value calculations, etc. should be reviewed for consistency with the investment return, mortality and other assumptions proposed in this report. This would ensure that the optional forms of payment, etc. are actuarially equivalent to the Full Retirement Allowance form of payment that is used in the determination of employer contributions rates. ". Currently, the interest rate and mortality assumptions in the Plan are not consistent with those used in the actuarial valuation. The interest rate assumption used in the valuation is 7.50% per annum while the rates in the Plan are 8.00% for converting optional annuity forms and 7.75% for crediting interest. The mortality assumption used in the valuation is based on the RP-2000 Combined Healthy Mortality Table (RP-2000) while the assumption in the Plan is based on the 1983 Group Annuity Mortality Table (1983 GAM). Benefits, Compensation and HR Consulting. Member of The Segal Group. Offices throughout the United States and Canada 12.8

9 Ms. Linda P. Le May 5, 2015 Page2 These differences in assumptions will impact the actuarial valuation in different ways. First, we will discuss the impact of using different assumptions for crediting interest on contributions. Then we will discuss the impact on converting contribution balances to annuities at retirement for the Additional Annuity Program and Money Purchase Annuities. Finally, we will provide information on the impact on optional form of payment elections at retirements (i.e. Options B through E). IMPACT ON INTEREST CREDITING The Regular Interest Rate credited on member contributions and Additional Annuity contributions is currently 7.75% per year. This Rate affects the amount of the contributions that will be available either when a member withdraws them from the Plan upon termination or when they are converted to an Additional Annuity or Money Purchase Annuity at retirement. The actuarial valuation uses this 7.75% Rate when estimating the future benefits that will be paid upon such future withdrawals or conversions. Because the current valuation assumes investments will grow at 7.50%, using the 7.75% Regular Interest Rate to credit interest means that the member contributions are credited at a rate higher than that assumed to be earned by the underlying assets. Those additional interest credits became part of the employer's cost. If the Regular Interest Rate were to be changed from 7.75% to 7.50% per year, that would eliminate that extra cost. Based on the July 1, 2014 valuation results, we estimate this would decrease the Required Department Contribution Rate by 0.46% of compensation or $4.1 million annually. IMPACT ON CONVERSION OF CONTRIBUTION BALANCES TO ANNuiTIES AT RETIREMENT There are two situations where a contribution balance has to be converted into a monthly annuity at retirement. One is for members who contributed to the Additional Annuity Program and elect to have their Additional Annuity contributions converted to an annuity. The other is for those members who retire and receive a Money Purchase Annuity based on their accumulated member contributions plus Department matching contributions. Each of these conversions is based on actuarial assumptions for both interest rate and mortality, which are described in the Plan (currently 8.00% and 1983 GAM). Since the valuation assumptions are 7.50% interest and the RP-2000 mortality table, the conversion is actually using a higher interest rate and shorter life expectancies, both of which produce a higher annuity benefit than would result from using the valuation assumptions. This means that the annuity conversions increase the cost of the plan to the employer compared to what the cost would be based on the investment return and life expectancies used in the valuation. As for how this higher cost makes its way into the contribution rates, one might think that an actuarial loss would occur at retirement due to the higher converted annuity benefit under the Plan assumptions. However, this is not the case, since we anticipate the cost of these conversions in our valuation by using the Plan assumptions when estimating the benefits that v6/ II 12.9

10 Ms. Linda P. Le May 5, 2015 Page3 will result from these conversions. This means that the employer contribution rate already reflects the additional cost of doing these conversions based on Plan interest rate and mortality assumptions that are different from the valuation. If the interest rate and mortality assumptions were to be changed to 7.50% and a blended version of the RP-2000 mortality table, then based on the July 1, 2014 valuation results, we estimate that the Required Department Contribution Rate would decrease by 1.35% of compensation or $12.2 million annually. IMPACf ON OPTIONAL FORM OF PAYMENT ELECTIONS AT RETIREMENT At retirement, members are eligible to elect any one of Options B l through E instead of Option Full. These other options provide varying levels of continuance benefits to Eligible Spouses, Domestic Partners and/or other beneficiaries (in the case of Options Band C) instead ofthe generally 50% continuance provided under Option Full. The conversions to these optional forms of payment are again based on the interest rate and mortality assumptions in the Plan (8.00% and 1983 GAM). As it turns out, when compared to the valuation assumptions of7.50% and RP-2000, the differences in these two assumptions have an opposite effect on the determination of the optional benefit amounts. If the optional benefit amounts were based on the valuation assumptions, the lower interest rate of 7.50% would produce lower optional benefit amounts, while the longer life expectancies under RP would produce higher optional benefit amounts. The net result could be higher or lower depending on the ages of the member and beneficiary. In the actuarial valuation it is assumed that all members will elect Option Full. Therefore, when one of these members actually elects Options B through Eat retirement, an actuarial gain or loss occurs in the valuation due to the different assumptions. This actuarial gain or loss is amortized over a period of 15 years (with all other gains and losses) and leads to a change in the employer contribution rate determined in the valuation. Note that this is different from the timing of the impact of not using the valuation assumptions for member interest crediting and the conversion of contribution balances to annuities discussed earlier. This is because there the cost impact of the different assumptions is already anticipated in the valuation, rather than being recognized only at retirement. Also, note that, since there are offsetting impacts due to the interest rate versus the mortality assumptions, these gains and losses due to optional form of payment elections should be smaller and of less significance than Members can also elect Option A at retirement which provides for a refund of any unused portion ofthe member's contribution balance upon death. Under that option, an actuarial gain or loss also occurs upon retirement. Ifthe assumptions were also aligned for Option A then the actuarial gains or losses that would otherwise occur at retirement under that option would be eliminated. The calculation ofthe factors for Option A involves considerations beyond just the actuarial assumptions and includes the relationship between the member's contribution balance at retirement, annuity benefit and total retirement benefit. This would require a separate discussion to address these factors if desired by the Retirement Board v6/

11 Ms. Linda P. Le May 5, 2015 Page4 those that occur when contribution balances are converted to annuities. Overall, we believe that using the current Plan assumptions is generating small actuarial gains at retirement as compared to using the new assumptions used in the actuarial valuation. If the interest rate and mortality assumptions were to be changed to 7.50% and a blended version of the RP-2000 mortality table, this would result in the elimination of the future actuarial gains or losses that would otherwise occur based on using the current assumptions used for determining option factors. However, there would be no immediate change in expected cost since we assume that all members elect Option Full. SUMMARY Aligning the actuarial assumptions in the Plan with those used in the annual actuarial valuation can impact the Retirement Plan in different ways as described above. For member interest crediting and the conversion of contribution balances to annuities, there is a higher cost associated with using the Plan assumptions and that cost is already reflected in the valuation and corresponding employer contribution rates. A change to those assumptions to be consistent with the valuation assumptions would result in a cost decrease. For elections of optional forms of payments, because the different Plan assumptions are not reflected in the valuation, relatively small gains and losses occur over time as members elect Options B through E. This leads to changes in the employer contribution rates as these gains or losses occur. A change to those assumptions to be consistent with the valuation assumptions would result in the elimination of those future gains and losses, but would not result in an immediate change in expected cost. These calculations are based on the July 1, 2014 actuarial valuation results, including the participant data and actuarial assumptions on which that valuation was based. That valuation and these calculations were completed under the supervision of John Monroe, ASA, MAAA, Enrolled Actuary. We look forward to discussing this with the Retirement Board. Sincerely, Paul Angelo, FSA, MAAA, FCA, EA Senior Vice President & Actuary John Monroe, ASA, MAAA, EA Vice President & Actuary /bqb:jc v6/