Recent VRS Changes and the New Pension GASB Standard. VGFOA Fall Conference October 17 th, 2012

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1 Recent VRS Changes and the New Pension GASB Standard VGFOA Fall Conference October 17 th, 2012 Panel: William H Leighty, DecideSmart, LLC Robert H Churchman, CPA William M Dowd, Sageview Consulting Barry Faison, VRS 1

2 Agenda: Introductions and disclaimer (Leighty) Context (Leighty) Overview of GASB Standards General overview (Churchman) Impact on a sample plan (Dowd) Impact on VRS Reporting (Faison) VRS Benefit Changes (Faison) Impact of VRS changes on benefits (Dowd) 2

3 Impact of New GASB Reporting Standards Why Change? Improve transparency and consistency in analysis Enhances to comparability of pension fund obligation reporting among systems Normalizes actuarial assumptions Expected Impacts Increased volatility in VRS rates Higher Unfunded liability Calculations for all systems Nationally, reported pension debt will triple Increase in number of credit reviews These do not necessarily mean lower credit ratings 3

4 Context: New GASB Standards Do Not Necessarily Mean Lower Credit Ratings Pension Liability has already largely been factored into Credit Ratings Long Term Debt and Pension Obligation is not the controlling factor in ratings: Economic Strength 40% Financial Strength 30% Management and Governance 20% Debt Profile 10% Source: Use of Key Indicators in the Government Sector, Journal of Government Financial Management Fall 2012, Vol. 61, No.3 4

5 Overview of GASB #67 Scope limited to defined benefit and defined contribution pension plans administered through trusts that meet certain criteria (same as criteria in Statement 68) Few changes from Statement 25 for financial statement recognition Notes/RSI changes primarily to reflect changes in measurement of liabilities of employers RSI schedules prospective (except for contribution schedule if presented), if information not initially available Effective for FYs beginning after June 15,

6 Scope and Applicability Single employer, agent multiple-employer and cost-sharing multipleemployer DB pension plans Benefits provided through trusts that meet certain criteria: Employer/nonemployer contributions irrevocable Plan assets dedicated to providing pensions Plan assets legally protected from creditors Excludes all OPEB Applies to employers and nonemployer contributing entitles that have a legal obligation to make contributions directly to a pension plan 6

7 Defined Benefit Pensions Presentation: Present assets, deferred outflows, liabilities, deferred inflows and fiduciary net position Benefit liabilities to employees Consistent approach applied to all employers (single, agent, cost-sharing) Recognize Pension liability Pension expense Deferred outflows/inflows of resources related to pensions 7

8 Disclosures: Notable changes in note disclosures include: Composition of the pension plan s Board Annual money-weighted rate of return (10 years in RSI) Single employer and cost-sharing plans should disclose: Total pension liability Plans fiduciary net position Net pension liability Fiduciary net position as a percentage of total pension liability Significant assumptions such as ad hoc postemployment benefit changes Notable changes in RSI: Single-employer and cost-sharing employer pension plans (10 years) Schedule of changes in NPL by source Components of NPL/related ratios Schedule of actuarially determined contributions Aggregate employer-related information not required for agent plans 8

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11 Overview of GASB #68 Accounting-based (earnings based) versus funding-based approach to measurement Revises recognition, measurement, disclosure requirements for all employers Liability Measured net of pension plan s fiduciary net position Fully recognized in accrual-basis financial statements Changes in the liability Some recognized as expense in the period of the change Others recognized as deferred outflows/inflows of resources with expense recognized over defined future periods Pensions viewed in the context of an ongoing, career-long employment relationship Focus on the cost to taxpayers over time of providing governmental services Effective for FYs beginning after June 15,

12 Accounting and Financial Reporting Following amounts required to be determined related to a defined benefit plan as of a date no earlier than the end of employer s prior fiscal year: Net pension liability (asset) Pension expense Pension deferred outflows of resources deferred inflows of resources Single Employer 100% Agent Multiple Employer 100% Cost sharing, multiple employer plans proportionate share of the collective amounts 12

13 Net Pension Liability (Asset) Net pension liability (asset) equals the total pension liability for the pension plan, net of the plan s fiduciary net position Total pension liability is the actuarial present value of projected benefit payments attributed to past employee service Plan s fiduciary net position is determined using same valuation methods as used for plan s GAAP financial reporting Measurement of the total pension liability should be determined as a date no earlier than the end of the employer s prior fiscal year (measurement date): Actuarial valuation performed as of measurement date; or The use of update procedures to roll forward amounts from an actuarial valuation as of a date no more than 30 months and 1 day earlier than the employer s year end 13

14 Determining Total Pension Liability Projected future benefit payments includes all benefits provided in accordance with the terms of the pension arrangement and any other legal agreements in force at the measurement date Three step process: Projecting future benefits: Projected future salary increases Automatic COLAs Life expectancy of employees after retirement Discounting projected future benefit payments to present value Attributing present value of projected future benefits past and future periods 14

15 Discounting Future Benefit Payments A single blended rate should be used to discount projected future benefit payments based on: The long-term expected rate of return on plan investments (net of investment expenses) expected to be used to finance the payment of pension benefits to the extent that projected plan net position is expected to be available for the payment of benefits and invested using a long term strategy to achieve that return; and An index rate for 20 year tax exempt municipal bonds rated AA or higher to the extent that the conditions above are not met To determine extent that projected plan net position is expected to be available, cash flows in and out will have to be projected for each future period: The amount of benefit payments projected to occur each future period; The plan s projected net position at the beginning of the year of each future period All employer contributions intended to fund benefits of current and former employees and all contributions from current employees based on current contribution policies Projected investment earnings on projected plan net position Administrative Expenses Does not include employer contributions intended to fund service costs of future employees or contributions of future employees (unless expected to exceed their own service cost) 15

16 Discount rate determining the single rate Compare projected benefit payments to plan s projected fiduciary net position in each period Apply relevant rate to each period s projected benefit payments Total the present values of all projected benefit payments Calculate single discount rate that results in same present value (if applied to all projected benefit payments) as use of the two rates 16

17 Recognition of Changes Immediately recognize (or recognize in the period of change) as pension expense: Current period service cost Projected earnings on plan investments for the period should be incorporated as a reduction of pension expense Interest on the beginning total pension liability Changes of benefit terms Effects of actuarial differences and changes in assumptions related to economic or demographic factors attributable to inactive/retired employees Deferred outflow/inflow changes are amortized over a closed period reflecting expected remaining service lives of active employees: Effects of actuarial differences and changes in assumptions related to economic or demographic factors attributable to active employees The differences between actual and projected earnings on plan investments amortized as pension expense using a systematic and rational method over five years 17

18 Participation in Cost-Sharing Multiple- Employer Plans An employer s proportion of a cost-sharing multiple employer plan should be: A measure of the employer s expected long-term contribution effort to the plan as compared to the total of all expected long term contributions of employers Established at the actuarial valuation date and may be used to roll forward pension amounts to the employer s fiscal year-end assuming no significant changes in the employer s expected proportion Application of this proportionate share concept results in two types of potential changes in employer net pension liability unique to cost-sharing multiple employer plans: Net effect of a change in the employers proportion of the plan Difference between actual employer contributions and the employer s proportionate share of the collective employer contributions 18

19 Net Effect of a Change in the Employer s Proportion The net effect of a change in the proportion used to calculate employer s share of collective plan net pension liability and deferred amounts should be: Measured as the difference between the plan s collective balances as of the beginning of the employer s fiscal period multiplied by the proportion assumed in the prior and current periods Recognized as a deferred outflow/inflow of resources in the period of change Recognized as part of pension expense beginning in the period of the change over a period equal to the average of the expected remaining service lives of all employees (active, inactive, and retirees) 19

20 Key Note Disclosures All Plans Description of benefits and how benefit provisions are established Classes and number of employees covered (retired, inactive, active) Description of changes in benefit terms and assumptions Discount rate disclosures: Assumptions made about contributions and other projected cash flows Long term expected rate of return on plan investments and how determined, including: How the combined rate of return was developed The best estimate of the long-term expected real rate of return by major asset class The municipal bond index rate, the index from which the rate is derived and the reasons for the selection of the index The periods of projected benefit payments to which the rate of return on plan investments and the municipal bond index were applied The effect of a one-percentage-point increase and decrease in the discount rate on the current-period net pension liability 20

21 Key Note Disclosures NPL - employers Descriptive information Benefit terms types of benefits, key elements of benefit formula, number and classes of employees covered, legal authority Contributions basis, authority, rates ($ or % of pay), contributions in reporting period Significant assumptions/other inputs in TPL Inflation, salary changes, postemployment benefit changes, mortality assumptions, dates of experience studies Discount rate rate, assumptions re: cash flows, how long-term expected real rate of return was determined, municipal bond rate (if applicable), periods to which each rate applied, assumed asset allocation/expected real rates of return, NPL at discount rate +/- 1% Information regarding pension plan s fiduciary net position Measurement date, actuarial valuation date Changes of assumptions/other inputs and changes of benefit terms 21

22 Key Note Disclosures NPL employers, continued Pension expense in current reporting period Deferred outflows/deferred inflows of resources (balances by source) Single/agent only schedule of changes in NPL by source for current period: Service cost, interest, benefit changes, contributions by source, plan investment income, etc. Cost-sharing only Employer s proportion, basis for proportion, change in proportion Employer s proportionate share (amount) of collective NPL 22

23 Key RSI Applicable for Each Single Employer or Agent Multiple Employer Plan Ten-year schedule of changes in net pension liability (asset) as of the employer s fiscal year end - same components as note disclosure Ten year schedule of components of net pension liability and covered payroll as of the employer s fiscal year end Ten year schedule related to contributions, if an actuarially determined employer contribution (ADEC) is determined Notes to RSI: Methods and assumptions Factors that significantly affect the identification of trends in the amounts reported 23

24 Key RSI Applicable for Cost Sharing Multiple Employer Plans RSI for participants in cost sharing plans are similar in nature to that for single-employer and agent multiple employer plans: As it relates to the collective plan: Ten year schedule of changes in the net pension liability (asset) as of the employer s fiscal year end Ten year schedule of components of net pension liability Ten year schedule related to employer contributions, if an actuarially calculated employer contribution is determined As it relates to the employer s proportion of the plan: Ten year schedule of components of net pension liability Ten year schedule related to employer contributions, if an actuarially calculated employer contribution is determined Notes to RSI with methods and assumptions 24

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26 Funded Status and Contribution Requirements Serving many masters, each with different perspectives Board of Trustees Governing Body GASB Ratings Agencies Potential impact on a Sample Plan 26

27 Assumptions and Methods Board Governing Body GASB Moody's Proposal Discount Rate 7.50% 8.00% 6.80% 5.50% Asset Value Smoothed Smoothed Market Market Unfunded Liability Amortization Period 25 Years 30 Years n/a 17 Years Unfunded Liability Amortization Method Level % of Pay Level % of Pay n/a Level $ 27

28 Sample Plan $20,000,000 $18,000,000 $16,000,000 $14,000,000 $12,000,000 Actuarial Liability $10,000,000 $8,000,000 Assets $6,000,000 $4,000,000 Unfunded Actuarial Liability $2,000,000 $0 Board Governing Body GASB Moody's Proposal 28

29 Sample Plan 90% 80% 73% 78% 70% 60% 62% 54% 50% 40% 30% Funded Ratio 20% 10% 0% Board Governing Body GASB Moody's Proposal 29

30 Sample Plan $900,000 $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 Contribution to Amortize UAL $100,000 $0 Board Governing Body GASB Moody's Proposal 30

31 GASB Changes Impact of VRS Reporting 31

32 GASB Changes Teacher Cost-Sharing Plan VRS Actuary will report on proportionate share of: Net Pension Liability (NPL) Pension Expense (PE) VRS will provide sample note disclosure information and any information needed by employers that is not provided by the Actuary Local and School Single-Employer Plans VRS Actuary will annual valuation report VRS will provide sample note disclosure information and any information needed by employers that is not provided by the Actuary 32 32

33 GASB Changes Assumed Investment Return Based on long-term expected return on assets held in trust unless the fund is expected to be depleted before all benefit payments are made, or Based on blended single-rate (long-term rate while assets are available and municipal bond index for remaining period) Projecting Assets Benefit projections based on closed group of participants Contributions projections based on formal policies and past behavior If past compliance, then future assumes compliance If not, use average of last five-year payment history Funding policy added to Code in

34 Funding the Benefit 34

VRS Total Membership Teachers 146,690 Political Subdivisions 104,427 State Employees 79,030 State Police Officers Retirement System (SPORS) 1,886 Judicial Retirement System (JRS) 380 Virginia

35 VRS Total Membership Teachers 146,690 Political Subdivisions 104,427 State Employees 79,030 State Police Officers Retirement System (SPORS) 1,886 Judicial Retirement System (JRS) 380 Virginia Law Officers Retirement System (VaLORS) 9,413 Total Active Members 341,826 Retirees/Beneficiaries 162,751 Inactive/Deferred Members 111,432 VRS Overall Impact 616, As of June 30,

36 Active Members VRS Active Members 36 36

37 VRS Retirees Retirees 37

38 VRS Fiscal Year Returns VRS Fiscal Year Returns 38 38

39 Net Assets Available for VRS Benefits 39 Fiscal Year 39

40 Funded Status: State Employees 40 40

41 Funded Status: Funded Teachers Status: Teachers 41 41

42 Reasons for Decline in Funded Status Reasons for decline in funded status: Two recessions since 2000, producing investment returns below actuarial assumptions Plan design and other changes: Earlier unreduced benefits (55/30, 50/30) Local ERIP programs that encourage early retirement Workforce Transition Act (WTA benefit for involuntarily terminated state employees, unfunded since October 2008) Local employer option for rate phase-in for FY 2013 FY 2018 Long-term trend (since mid-90s) of funding contribution rates below board certified rates 42 42

43 Changes Made to Improve the Funded Status Changes made to improve the Funded Status: More conservative estimates of long-term future investment gains: Pre-2005: 8.0% : 7.5% 2010 Present: 7.0% Code change in SB498 to increase funding for state employee and teachers to the VRS Board-Certified level by FY 2019 Pension reforms will produce gradual improvement over the next 20 years 43 43

44 Pension Reform in the U.S. 44

45 Changes to Retirement Plans Source: NASRA 45 45

46 Recent Changes Among States Reform Measure Number of States with Changes in 2010 or 2011 Employee Contributions 26 (including VA) Age and Service Requirements 20 (including VA) Revised COLA s 17 (including VA) AFC Component of Retirement Formula 13 (including VA) Vesting Requirements 12 DC and Hybrid Plans 3 Source: NCSL 46 46

47 Member Contribution Rates Surrounding States State General Employee and Teacher Contributions Maryland 7.0% North Carolina 6.0% Kentucky 6.0% Virginia 5.0% West Virginia 4.5% Tennessee State Employees 0.0% Teachers 5.0% Source: NCSL 47 47

48 Past Pension Reform Initiatives 48

49 Past Reform Initiatives in VA Reform Initiative 2008 General Assembly requests JLARC Compensation Study 2010 General Assembly creates Plan 2 for members hired on or after July 1, 2010: Normal retirement changed to Social Security normal retirement age Unreduced benefits commencing at Rule of 90 Reduced retirement moved to age 60 with at least five years of service Members required to pay 5 percent member contribution (Local Option) COLA formula revised Five-year AFC formula 2011 General Assembly enacted 5/5 program for Plan 1 state employees State employee Plan 1 members pay 5% member contribution Offset with 5% salary increase JLARC updated study on pension reform 49 49

50 Pension Reform July 1, 2012 Pension Reform Efforts Passed by the 2012 General Assembly, effective July 1, 2012 Local governments and schools systems begin to impose the 5 percent member contribution with offsetting raises: 83 percent of local government employers opted to impose a 5 percent member contribution with a 5 percent offsetting salary increase 60 percent of school boards opted to impose a 5 percent member contribution with a 5 percent offsetting salary increase Local governments elected either the VRS-certified contribution rate or the alternate rate: 90 percent of local governments elected the VRS-certified contribution rate 50 50

51 Planned Pension Reform Initiatives 51

52 Pension Reform January 1, 2013 Changes to the DB Plan Effective 1/1/2013 Plan Feature Group Comment 60-month AFC 1.65% multiplier for service after 1/1/13 Rule of 90 COLA COLA General state employees, SPORS, VaLORS, JRS, teachers and localities (including hazardous duty with enhanced benefits) General state employees, teachers, localities and JRS (Does not apply to SPORS, VaLORS or local hazardous duty with enhanced benefits) General state employees, teachers and localities (Does not apply to SPORS, VaLORS or local hazardous duty with enhanced benefits) General state employees, SPORS, VaLORS, JRS, teachers and localities (including local hazardous duty with enhanced benefits) General state employees, SPORS, VaLORS, JRS, teachers and localities (including local hazardous duty with enhanced benefits) Applies to Plan 1 members who are not vested as of 1/1/13. Already applies to Plan 2 members. Applies to non-vested Plan 1 and Plan 2 members as of 1/1/13. Applies to Plan 1 members who are not vested as of 1/1/13. Already applies to Plan 2 members. Employees within 5 years of eligibility for an unreduced benefit as of 1/1/13 are grandfathered. No COLA until member who retires with less than 20 years of service has received an allowance for 1 full calendar year after reaching unreduced retirement age. Applies to all Plan 2 members and Plan 1 members who are not vested as of 1/1/13. COLA capped at 3% (first 2% of CPI-U plus one-half of the next 2%, for a maximum total of 3%)

53 Pension Reform January 1, 2014 Changes to the DB Plan Effective 1/1/2014 Implement Mandatory Hybrid Plan, Effective 1/1/2014: New state and local employees eligible for regular VRS or JRS automatically enrolled in a hybrid plan with both DB and DC features. Public safety employees with hazardous duty coverage are exempt. Public safety employees without hazardous duty coverage are covered with the same benefits provided to general employees of the locality. Employees currently in an ORP would not be eligible to participate in the new plan; future employees eligible for the ORP may elect the hybrid. DB component would have a 1.0% multiplier meant to produce a nearly 30% replacement rate after 30 years of service. DC component requires employee and employer contributions to self-directed employee accounts on VRS investment platform. Total mandatory employee contribution (both DC/DB) is 5%; total possible employee contribution is 9%. Employee contributions automatically escalated every three years by one-half of a percentage point, unless the employee opts out or the employee is already at the maximum contribution of 5% to the DC component. Employer contributions to the DB component based on actuarial valuations. Employer contributions to the DC component consist of the mandatory 1% match, plus a 1% match on the first percent elected by the employee, plus a one-half matching contribution on the next 3% elected by the employee. Total contributions as much as 5% from employee and 3.5% from employer. Provides a new optional disability program. The locality may choose to join the VRS-administered program or provide a disability program with comparable coverage from another source

54 VRS Benefit Changes Sample Employee Age 35 at hire; 30 years at age 65 $40,000 salary Assumptions used to compare VRS 2 to VRS Hybrid 2% annual salary increases 7% and 5% return in Hybrid DC plan 4% annuity conversion interest rate for Hybrid DC plan Results for different age, service, and investment return assumptions can vary widely 54

55 % of Pay Sample Employee 80% 70% 60% 50% 40% 30% 20% 10% 0% Retirement Age VRS 2 H: 1% + 1% (7% Return) H: 2% + 2% (7% Return) H: 5% + 3.5% (7% Return) With a 7% annual return in the DC plan, the hybrid plan can match VRS 2 if the employee elects to contribute 2% (6% combined between the DB and DC). The DC plan does not, however, provide for a COLA. Results for different age, service, and investment return assumptions can vary widely. 55

56 % of Pay Sample Employee 70% 60% 50% 40% 30% 20% 10% 0% Retirement Age VRS 2 H: 1% + 1% (5% Return) H: 2% + 2% (5% Return) H: 5% + 3.5% (5% Return) With a 5% annual return in the DC plan, the hybrid plan can match VRS 2 if the employee elects to contribute 3% - 4% (7% - 8% combined between the DB and DC). The DC plan does not, however, provide for a COLA. Results for different age, service, and investment return assumptions can vary widely. 56

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