OHIO PUBLIC EMPLOYEES RETIREMENT SYSTEM 277 EAST TOWN STREET, COLUMBUS, OH PERS (7377)

Transcription

1 OHIO PUBLIC EMPLOYEES RETIREMENT SYSTEM 277 EAST TOWN STREET, COLUMBUS, OH PERS (7377) MEMORANDUM DATE: September 8, 2006 TO: FROM: OPERS Retirement Board Members Karen Carraher, Director - Finance RE: V. Discussion Items: B. Five-Year Experience Study Purpose To present the preliminary results from the experience study and to request the Board select economic alternatives for review and evaluation. Background Section (B) of the Ohio Revised Code requires that at least once in each five-year period, the OPERS board shall have the actuary complete an experience study to update the actuarial assumptions used in the annual actuarial valuations. The statute requires that by November 1, OPERS submit a report to the Ohio Retirement Study Council that includes: (1) a summary of the relevant demographic and economic assumption experience observed over the five-year period of the study, (2) any recommended changes in actuarial assumptions to be used in subsequent actuarial valuations, and (3) a measurement of the financial effect of the recommended changes in actuarial assumptions. OPERS last experience study was completed in October 2001 for the period OPERS actuary, Gabriel, Roeder, Smith & Company (GRS) is currently working on the five-year experience study covering the period As noted above, the purpose of this study is to test whether the demographic and economic assumptions that OPERS has been using to value the fund are in line with actual experience of the fund and to determine whether or not to recommend changes to those assumptions. GRS process begins with a review of the historical experience, comparing the actual results for the last five years to the assumptions used in the annual valuations during the period. Next, GRS focuses on the economic assumptions, reviewing possible alternatives and evaluating the potential impact of those alternatives. The economic assumptions include the investment rate of return, the price inflation and salary increases. At the September meeting, GRS will share the preliminary results and review potential changes in the economic assumptions. GRS is requesting the Board to select the alternatives the Board is interested in reviewing and evaluating. Next month, GRS

2 will update the Board as to their recommendations on the demographic assumptions and will share the impact of the economic assumptions in conjunction with any changes to the demographic assumptions. Demographic assumptions include: turnover rates, disability rates, retirement rates and mortality rates. Next Steps The Board will be requested to determine which economic assumptions presented should be evaluated further in conjunction with the demographic portion of the study.

3 Experience Study Preliminary Economic Assumptions September 20, 2006

4 Experience Study Basics The actuarial valuation calculates funding requirements based upon a variety of assumptions, mortality tables, interest rates, etc. Every 5 years, an Experience Study is performed. The purpose of the study is to true up the actuary s assumptions based upon recent past and projected future experience. 2

5 Two Broad Classes of Assumptions Demographic assumptions relate to what happens to people. Economic assumptions relate to what happens to money. 3

6 Plan for Experience Study Review and understand economic assumptions today. Focus on a couple of alternative economic assumption sets for further study. Actuaries to complete the study of demographic assumptions between now and October meeting. Actuaries return to October meeting with completed study illustrating effects of recommended demographic assumption changes combined with the effects of the alternate economic packages selected by the Board today. 4

7 Demographic Risk Areas Active members Rates of withdrawal Rates of disability Patterns of merit/longevity pay increases Rates of retirement Rates of mortality Retired members Rates of mortality - normal Rates of mortality - disabled lives 5

8 Demographic Risk Areas (Continued) Assumptions related to demographic risk are primarily the responsibility of the actuary. However, the Board and Staff may have insights into the meaning of the figures, that the actuary may not have. 6

9 Economic Risk Areas Economic risk areas include Investment return Price inflation Economic portion of pay increases The Board and investment professionals have a great deal of responsibility in connection with the economic assumptions. The actuary s special role is to make sure that the assumptions relate properly to each other, and to ensure that they are developed with consideration of actuarial funding horizons. 7

10 Relationship to ALM Study ALM Study determines policy mix based upon year investment horizon. It can be and often is the starting point for the economic portion of the experience study. It is definitely an important ingredient. For technical reasons, actuarial expected returns tend to be higher than ALM expected returns given the same portfolio. The actuary must also adjust ALM returns for possibly different inflation bases. 8

11 Economic Assumptions Investment results during are part of history, but not all of it. OPERS is a long term financial arrangement, with some liabilities occurring more than 50 years in the future. Actuary plans for to next 50 to 100 years. 9

12 Present OPERS Economic Assumptions Investment Return 8.0% Wage Growth 4.0% Price Inflation 3.0% to 3.5% "Spread" over Wages 4.0% "Spread" over Prices 4.5% to 5.0% 10

13 Economic Assumptions - Ohio PERS P&F HPRS SERS STRS Investment Return 8.00% 8.25% 8.00% 8.25% 8.00% Wage Growth 4.00% 4.00% 4.00% 4.25% 4.50% Spread 4.00% 4.25% 4.00% 4.00% 3.50% In general, a wider spread leads to lower computed liabilities and costs. A narrower spread has the opposite effect. 11

14 Economic Assumptions - National Economic Assumptions of 55 Systems with Assets Over $10 Billion Investment Return Payroll Growth Spread Range 7.00 to 8.50% 2.50% to 5.00% 3.5% to 5.5% Mean 7.97% 3.52% 4.45% Median 8.00% 3.00% 4.00% OPERS 8.00% 4.00% 4.00% 12

15 Investment Return and Spread The PERS target asset mix is currently 76% in equity assets (common stock, real estate and private equity). With the exception of the most recent period, market returns for portfolios with equity holdings at that level have generally exceeded 8.0% since The related spread over wages (the difference between investment return and wage inflation) has also exceeded 4.0% over the same periods. What the future will bring, is of course unknown. 13

16 PERS Asset Allocation History Allocation Pre Wilshire 1997 SIS 1999 EKA 2001 EKA 2006 Domestic Equity 17.0% 27.0% 35.0% 44.0% 43.0% Domestic Bonds 68.0% 56.5% 35.0% 23.0% 24.0% Non US Equity 0.0% 4.0% 18.0% 20.0% 20.0% Real Estate 7.0% 8.0% 11.0% 9.0% 9.0% Private Equity 0.0% 0.0% 0.0% 4.0% 4.0% Cash 8.0% 4.5% 1.0% 0.0% 0.0% Total 100.0% 100.0% 100.0% 100.0% 100.0% Equity Share 24.0% 39.0% 64.0% 77.0% 76.0% 14

17 Historical Returns Gross Market Returns Calendar Bonds (Long) Cash Year U.S. Corp. Equiv. Stocks Period Treasury (S&P AA) (T Bills) (S&P 500) % 2.6% 2.8% 11.1% Last 50 years 6.6% 6.9% 5.3% 10.4% 15

18 Sample Fund Sample Fund Equities 76% Bonds - Government 12 - Corporate 12 Cash Equivalents 0 100% Fund expenses(e) 0.5% 16

19 Historical Patterns of Investment Return, Pay Increases & Inflation National Calendar Price Average Sample Balanced Fund* Year Inflation Earnings Total Spread: Period (CPI) (NAE) Return (I) I-NAE-e % 3.5% 9.2% 5.2% (3.3) Last 50 Years 4.1% 4.9% 9.8% 4.4% 17

20 OPERS Historical Returns Annualized Returns Year 1-year 3-year 10 Year 20 Year 25 year % 9.11% 9.27% 9.75% %

21 50 Year Historical Results 19

22 10 Year Historical Results 20

23 Observations Over the past 50 years, wages have risen faster than prices by an average of 0.8% per year. GRS assumes continuation of this pattern by an amount in the 0.5% to 1.0% range. A portfolio constructed similar to OPERS current target asset allocation would have produced real returns over both wages and prices that are above current assumed levels. 21

24 Observations Results are similar even over the last 10 years. The standard deviation in both cases is large for equity assets. Past performance is no guarantee of future returns. GRS calculation algorithms are different from EK&A. However, both firms should agree on these matters at least approximately. 22

25 OPERS/EKA Expected Return Compound Geometric Target Geometric Allocation Expected Return US Equities 43% 7.70% Non US Equities 20% 7.30% Real Estate 8% 6.50% REITS 1% 7.40% Private Equity 4% 9.90% Fixed Income 24% 5.40% Total 100% 7.54% Expenses -0.22% Net Expected 7.32% 23

26 EKA Economic Assumptions Price Inflation Wage Inflation * 10-Yr. Treasury Yield (BOY) Returns on US Bonds Returns on US Equities Expected value Current year (2006) 2.6% 4.6% 4.4% 4.8% 8.2% Next 5 years 2.6% to 2.6% 3.9% to 3.6% 4.6% to 5.3% 4.9% to 6.0% 8.3 to 9.4% Years % 3.6% 5.4% 6.1% 9.5% 15-yr. averages: Compound (geometric) average 2.6% 3.6% 5.4% 7.7% Arithmetic average 2.6% 3.6% 5.6% 9.0% Range covered by simulation: 50% probability range 1.7% to 3.4% 2.8% to 4.3% 4.4% to 6.0% 1% to 10% -3% to 20% 90% probability range 0.6% to 5.2% 2.1% to 5.9% 3.3% to 7.3% -5% to 15% -19% to 37% Full simulation range -2.5% to 11.8% 1.5% to 9.6% 0.8% to 13.0% -18% to 38% -50% to 70% * Basic US wage inflation only. Actuarial assumption includes a seniority/promotional component, which is also recognized in the model. Equity risk premium = equity return less bond return =2.3% 24

27 Economic Assumptions - Compared GRS/OPERS Actuarial EK&A Investment Investment Return 8.00% 7.30% Wage Growth 4.00% 3.70% Price Inflation 3.0% to 3.5% 2.60% "Spread" over Wages 4.0% 3.60% "Spread" over Prices 4.5% to 5.0% 4.70% 25

28 Comments Current OPERS assumptions and EK&A are in agreement on the spread over prices. EK&A spread is in middle of GRS range. EK&A has a lower short term price inflation forecast than OPERS currently uses. Leading to a shorter term (15 year) investment return forecast than OPERS current longer term assumptions. 26

29 Comments After adjusting EK&A results for differences in assumed price inflation, and for known differences in various algorithms, GRS thinks that continued use of an 8.0% return assumption for actuarial purposes is compatible with the EK&A 7.3% projection. Other choices are certainly possible, and will be discussed later. 27

30 Comments Changes to economic assumptions should be made in small increments. We caution OPERS to consider the long term past and future in setting economic assumptions. The most important single assumption is the spread over wages. Since the current spread is 4.0%, a change of even 0.5% would actually be quite significant. 28

31 Effects of Changing the Spread Direction of Change Increase Decrease Accrued Liabilities Down Up Unfunded Liabilities Down Up Normal Cost Down Up Pension Contribution Rate Down Up Funded Ratio Up Down Risk Up Down 29

32 Summary of December 31, 2005 Valuation Results by Division Based Upon Economic Assumption Changes 30

33 Cautions The next chart reflects changes in funded position measured as though the 12/31/2005 valuation were reproduced with the various economic assumptions that are described. Possible demographic changes are not accounted for in the next slide. Demographic changes are likely to be in a worsening direction. Although the facts are not all in yet, it is not impossible that demographic changes could add as much as 10 years to amortization periods. 31

34 December 31, 2005 Valuation Illustrative Results Current Alternative Economic Assumptions Return 8.00% 8.00% 7.75% 7.50% Wage Growth 4.00% 3.75% 4.00% 3.75% 3.50% 3.75% 3.50% 3.25% Spread 4.00% 4.25% 3.75% 4.00% 4.25% 3.75% 4.00% 4.25% State Funded Ratio 89.5% 90% 87% 88% 88% 85% 86% 86% Financing Years (HCPP) N/A N/A 73 Contribution Increase Needed 0.00% 0.00% 0.85% 0.44% 0.05% 1.92% 1.54% 1.14% for 30 Year Amortization Local Funded Ratio 89.0% 90% 86% 87% 88% 85% 85% 86% Financing Years (HCPP) N/A Contribution Increase Needed 0.00% 0.00% 0.34% 0.00% 0.00% 1.33% 0.93% 0.55% for 30 Year Amortization Law Funded Ratio 85.7% 86% 83% 84% 84% 81% 82% 82% Financing Years (HCPP) N/A N/A 81 N/A N/A N/A Contribution Increase Needed 0.11% 2.45% 1.94% 1.41% 3.83% 3.46% 2.78% for 30 Year Amortization Total Funded Ratio 89.1% 90% 87% 87% 88% 85% 85% 86% Financing Years (HCPP) N/A Contribution Increase Needed 0.00% 0.00% 0.57% 0.18% 0.00% 1.60% 1.21% 0.81% for 30 Year Amortization 32

35 Decision Points Adopt economic assumptions for further testing Two suggested in addition to the present: 8.00% interest / 3.75% wage growth / 4.25% spread 7.75% interest / 3.50% wage growth / 4.25% spread What are the Board s thoughts? Actuaries will return next month with combined effect of demographic recommendations and economic alternates. Remember that demographic assumption changes could increase the computed amortization period by as much as 10 years. 33