Pension De-Risking. 112 th Annual Conference May 6-9, 2018 St. Louis, Missouri

Transcription

1 1:30 2:30 May 6, 2018 Room th Annual Conference May 6-9, 2018 St. Louis, Missouri Moderator/Speakers: Mark Whelan Chief Financial Officer, Kentucky Teachers Retirement System Les Richmond, ASA, EA, MAAA, FCA Vice President and Actuary, Build America Mutual Douglas J. Fiddler, FCA, MAAA, ASA, EA Senior Actuary, South Dakota Retirement System (SDRS) Pension De-Risking #GFOA2018

2 Risk Basics #GFOA2018

3 Pension De-Risking GFOA Conference, St. Louis Presented by Les Richmond, Vice President and Actuary May 6, 2018

4 Agenda Risk definition Factors that drive pension-related risks Actuarial Standard of Practice No. 51 De-risking in the private sector 4

5 Risk Definition Merriam-Webster Definition of RISK 5

6 Risk Definition How does risk apply to state and local government pensions? In general, it means that pension and OPEB costs rise to a financially burdensome level Stakeholder groups each have their own perspective on what this risk means Taxpayers: Possibility that tax increases are needed Possibility that services will be affected Government employees: May face workforce / salary reductions Pension reform may be needed State and local government leaders: Possibility that services will be affected Volatility of pension asset performance may lead to budget gaps; may lead to:» Asset dip: Non-payment of pension contributions and/or revenue increase requirements» Asset spike: Benefit improvements Possible lower credit ratings, increasing cost of borrowing Bond investors/bond insurers: Ratings volatility Bankruptcy / Bond default 6

7 What Factors Drive Pension-Related Risk? The Center for Retirement Research at Boston College (CRR) reported the sources of changes in unfunded liabilities for 150 plans in its Public Plans Database for the period 2001 to 2013 ( How Did State/Local Plans Become Underfunded? by Alicia H. Munnell, Jean-Pierre Aubry, and Mark Cafarelli, January 2015) During that period, aggregate funding ratios in the CRR database declined from just over 100% to about 72% Factor Percentage of the Change in Unfunded Pension Liabilities from 2001 to 2013 Investment return lower/(higher) than assumed 60.4% Contribution lower/(higher) than normal cost + interest on UAAL 23.7% Actuarial experience worse/(better) than expected 2.4% Benefit changes 0.8% Changes to assumptions and methods 7.2% Other 7.1% Total 100.0% 7

8 What Factors Drive Pension-Related Risk? Investment performance and volatility What is the assumed rate of return on plan assets? How much of the pension plan portfolio is invested in more volatile asset classes, such as equities and alternatives? Based on NASRA Public Fund Survey, published November 2017, the average pension portfolio consists of: Equities 47.6% Alternatives 18.3% Real estate 6.6% Fixed income 23.2% Cash/other 4.3% Why does the size of the plan matter? Funding policy Are actuarially determined contributions being paid in full? Under GASB 67/68 rules, is a depletion date being disclosed in the government s financial statements? How many years will it take to pay off the disclosed net pension liability? Demographics Defined benefit plans inherently assume longevity risk Continuing trend of an aging workforce presents its own set of risks In the pension plan population, what is the ratio of active employees to retirees? How do the plan demographics relate to: Funding policy? Investment allocation? 8

9 Actuarial Standard of Practice (ASOP) No. 51 Assessment and Disclosure of Risk Associated with Measuring Pension Obligations and Determining Pension Contributions Applies to funding valuations, pricing valuations and separate risk assessments with measurement dates on or after November 1, 2018 ASOP No. 51 risk definition: Potential that actual future measurements deviate from those expected, as a result of future actual experience deviating from assumed. For example: Investment risk Asset/liability mismatch risk Interest rate risk Longevity/demographic risk Contribution risk 9

10 Actuarial Standard of Practice (ASOP) No. 51 Suggested Tasks for Actuaries Identify risks that, in the actuary s judgment, may significantly affect the plan s future financial condition Assess identified risks, including potential effects on plan s future financial condition, taking into account plan s specific circumstances Recommend a more detailed assessment if it would be significantly beneficial for the intended user to understand the identified risks Disclose plan maturity measures that, in the actuary s judgment, will significantly improve understanding of the risks. For example: Ratio of market value of assets to payroll Ratio of retiree to active plan liabilities Ratio of benefits to contributions Disclose historical plan actuarial measures that, in the actuary s judgment, will significantly improve understanding plan risks. For example: Risk maturity measures Actuarially determined contributions Funded status Actuarial gains and losses Plan settlement liability Question: Will state and local governments need to consider changes to disclosures? 10

11 De-Risking in the Private Sector Pension de-risking in the private sector has focused primarily on three approaches: asset management, risk transfer and plan design Asset management approaches Liability-driven investing Immunization Lowering asset allocation risk profile Risk transfer approaches Annuitization: pay an insurance company to take the pension liabilities off your hands for a price Attractiveness increases as interest rates rise Several high profile annuity purchases have taken place. For example, in 2017: Hartford Financial Group $1.6 billion Accenture $1 billion Lump sum payouts (example: UPS $685 million in 2017) Plan design approaches Move to defined contribution plans Tie defined benefit plan pension calculations to asset performance, i.e., certain cash balance plan designs 11

12 The Kentucky TRS Experience #GFOA2018

13 Pension De-Risking: Kentucky Experience Presented by Mark E. Whelan CPA Chief Financial Officer May 6, 2018

14 Cost sharing, defined benefit, multipleemployer plan What is TRS? Provides, pension, health, life, disability & survivor benefits Replaces Social Security for Teachers

15 TRS at a Glance Membership of over 133,500 $19.8 billion in assets Members contribute on $3.5 billion of salaries Distributes approximately $ 162 million monthly in retirement benefits More than 53,000 receive a benefit from TRS

16 Recap of Actuarial Status of the System as of June 30, 2017 Assets In Millions of Dollars Liabilities Unfunded Percent PENSION 18, , , % GASB 67 Valuation 18, , , % Assets Liabilities Unfunded Percent MEDICAL , , % GASB 74 Valuation , , % 16

17 How has Kentucky Reduced Pension Risk? State paid contributions recommended by the actuary for FY 2017 & State has enacted a budget to pay recommended contributions for FY 2019 & Hybrid cash balance plan for new teachers beginning January 1, Committed to level dollar funding beginning FY 2021.

18 Hybrid Cash Balance Plan Hybrid cash balance plan for new teachers beginning January 1, Benefit at retirement is the account balance based on a teacher s contributions plus employer and interest credits. Benefits can begin: At age 57 when age plus service are at least 87 (Rule of 87), or At age 65 with 5 years of service. Employer credits refundable to the member after 5 years of service. Interest floor of zero percent. Changes can be made but the balance in the account at the time of future changes is protected.

19 Unfunded Accrued Liability 14,305,248,000 Level Percentage of Pay Level Dollar Year Payment EOY Balance Payment EOY Balance 1 823,737,116 14,492,624,200 1,157,618,789 14,133,701, ,567,915 14,663,060,507 1,157,618,789 13,949,288, ,407,792 14,814,201,668 1,157,618,789 13,751,045, ,292,065 14,943,477,824 1,157,618,789 13,537,933,467 What is Level Dollar Funding? 5 945,257,287 15,048,087,077 1,157,618,789 13,308,838, ,341,292 15,124,976,719 1,157,618,789 13,062,560, ,012,583,237 15,170,822,993 1,157,618,789 12,797,812, ,048,023,651 15,182,009,293 1,157,618,789 12,513,208, ,084,704,478 15,154,602,676 1,157,618,789 12,207,259, ,122,669,135 15,084,328,557 1,157,618,789 11,878,363, ,880,862,423 4,550,978,482 1,157,618,789 2,643,877, ,946,692,608 2,799,607,316 1,157,618,789 1,597,727, ,014,826, ,639,002 1,157,618, ,117, ,639, ,117,051 0 Total Payments 36,889,601,076 31,728,824,360 Assumptions: Remaining Period 27.4 years; Interest 7.5%; Payroll Growth 3.5%

20 How has the System Reduced Risk? Closed amortization period to amortize liabilities. Average retirement age increased from 54 to 59. High 3 salaries used at age 55 and 27 years of service. 3% factor on the years beyond 30. Return-to-work rules improved. Funding plan established for medical insurance.

21 How has the System Reduced Risk? Conducts an actuarial experience study every five years. Conducts a Level 1 actuarial audit every 10 years. Conducts asset/liability modeling at least every five years.

22 The South Dakota Experience #GFOA2018

23 South Dakota Retirement System Cost-sharing, multiple employer defined benefit plan with hybrid features Covers essentially all public employees in South Dakota Almost all members participate in Social Security Member and employer contributions fixed and equal Routinely one of the most well-funded state retirement systems New benefit structure effective for hires after June 30, 2017 Benefits restructured at same total cost as initial tier Added flexible benefits Eliminated subsidies and sources of unexpected losses COLA changes impacting all members enacted in

24 Risk Sharing Benefit Design Pure defined benefit plan: Plan sponsor contributions actuarially determined and unlimited Absolutely guaranteed benefits Longevity and investment timing risks pooled Pure defined contribution plan: Plan sponsor contributions fixed Benefits dependent on investment return Member bears longevity and investment timing risk Plan Sponsor Risk: Contribution increases/volatility Balance sheet impact Essential services crowded out Member Risk: Insufficient retirement income Uncertain retirement income Inability to retire Shared risk plans: Benefits partially dependent on future experience Plan sponsor contribution limits Longevity and investment timing risks may be pooled 24

25 Acceptable Risk Level Questions Defined Benefit Plan: Can the plan sponsor make unlimited actuarially determined contributions if future conditions change? Can the plan sponsor accept a lower credit rating if larger unfunded liabilities develop? Defined Contribution Plan: Will investment returns allow members to retire at reasonable ages? Will retirees need public assistance following lower investment returns or after outliving savings? Shared Risk Plan: What is the maximum tolerable employer contribution requirement? What is the minimum acceptable funded ratio? Which benefits or features are fixed? Which benefits or features will vary automatically with plan experience? Which benefits or features will be adjusted in a financial crisis? 25

26 South Dakota Plan Design Principles Member and employer contributions are equal and fixed Benefits must be managed within the resources provided by the fixed contributions Defined funding thresholds dictate when benefit reductions are required and when benefit improvements can be considered Variable benefits based on affordability measures are essential for sustainability Benefits should meet income replacement objectives, but artificially inflated benefits must be avoided Subsidies available to only a portion of the membership should be avoided 26

27 South Dakota Recent Design Changes Normal retirement age of 67 Reduced early retirement available with approximately actuarial reduction Cash balance feature added annually credited with 1.5% of pay and actual investment return of trust, payable upon retirement, death, or disability COLA equal to inflation between 0.5% and 3.5%, but maximum reduces to level necessary to remain 100% funded on a fair value basis COLA Process: 27

28 South Dakota Funding Thresholds Statutory Funding Requirements: Fair value funded ratio must equal at least 100% Contributions must at least equal the minimum actuarial requirement If either of these is not met, corrective actions (benefit reductions) are recommended to the legislature Benefit Improvement Requirements: Fair value funded ratio must equal at least 120% after fully funding the improvement Investment gains are recognized over 5 years in determining availability to fund improvement Past improvements have been formula increases; future improvements will likely be allocations to cash balance feature or one-time payments 28

29 Quarterly Board Risk Communication Projected 2020 SDRS COLA Range Assuming 5% Net Investment Return for FY18 FY 2018 Net Investment Return 6.0% to 11.6% Restricted Maximum COLA FY 2018 Net Investment Return Less than 6.0% COLA=0.5% & Corrective Action Recommendations Required 22% 42% 36% 78% FY 2018 Net Investment Return Greater than 11.6% Full COLA: 0.5% to 3.5% (55.5%) (40.1%) (24.7%) (9.3%) 6.1% 21.5% 36.9% 52.3% 67.7% FY 2019 Investment Return Followinganassumednetinvestmentreturnof5%for FY18, the likelihoods for 2020 COLA ranges, which are primarily driven by FY19 investment returns, are: 36% likelihood that the baseline COLA will be payable (CPI-W between 0.5% and 3.5%) 42% likelihood that the COLA will have a restricted maximum (CPI-W between 0.5% and the restricted maximum) 22% likelihood that a 0.5% COLA will be payable and additional Corrective Action recommendations will be required * Before consideration of liability gains/losses. Likelihoods based on SDIC 2017 investment portfolio statistics. Assumes 2.25% annual inflation. 29

30 South Dakota Design Takeaways Defined benefit plans efficiently provide lifetime benefits Changing economic and demographic conditions must be anticipated Set a maximum employer contribution level Set a minimum acceptable funded ratio A portion of benefits should automatically adjust to investment returns or funded ratio Have a plan for unexpected future conditions 30

31 Speaker Contact Information: Les Richmond Mark Whelan Douglas Fiddler 112 th Annual Conference May 6-9, 2018 St. Louis, Missouri Questions: Speakers will take questions and comments. This session is being recorded, please utilize the microphone in the aisle to ask all questions. Provide Feedback: Please take a few minutes to provide your feedback at Discuss/Comment: Join the discussion at #GFOA2018 Contact GFOA: To contact GFOA about session topics please research@gfoa.org #GFOA2018