Kevin Woodrich, FSA, FCA, EA, MAAA Cheiron R. Evan Inglis, FSA, CFA Nuveen NCPERS 2018 Annual Conference & Exhibition May New York, NY

Transcription

1 Plan sustainability vs. Plan solvency Kevin Woodrich, FSA, FCA, EA, MAAA Cheiron R. Evan Inglis, FSA, CFA Nuveen NCPERS 2018 Annual Conference & Exhibition May New York, NY 1

2 Definitions Solvency Having assets to meet all obligations with near certainty Ability to pay one s debts when due (i.e. promised benefits) Not running out of money to ensure all benefits get paid when due 2

3 Definitions Sustainability Ability to be maintained at a certain rate or level Proportion of pension plan s contributions to sponsor s revenue stream Ability of a plan sponsor to maintain the level of contributions to meet their obligation 3

4 Questions of Sustainability Who measures it? When is it reached? Whose problem is it? National Conference on Public Employee Retirement Systems What metrics can a Board and plan sponsor monitor to mitigate both these risks? 4

5 Risks that Pension Plans Face Return Volatility Credit Risks Mortality Liquidity Risk Currency Risk Anti selection Diversification Contribution Volatility Funding Ratios Asset Allocation National Conference on Public Employee Retirement Systems Political Public Media Transparency Risk Public Perception Fraud Regulatory 5

6 Ultimate Risk National Conference on Public Employee Retirement Systems The inability to pay the plan s promised benefits at funding levels that can be afforded 6

7 Factors that can lead to Ultimate Risk Plan design issues Politics Actuarial assumptions / techniques Systematic underfunding Investment risk Acts of God 7

8 Factors that Board can Largely Manage Actuarial assumptions / techniques Investment risk 8

9 Traditional Pension Funding Metrics Funding Ratios Investment Return Performance 120% Funding Ratio and Investment Return Assumption 100% 80% Funding Ratio 60% 40% 20% 0% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% Investment Return Assumption 9

10 Recent Pension Funding Metrics Pension Plan Maturity Levels Net Cash Flow to Assets Support Ratio (Inactive / Active headcount) 10

11 Analysis of Net Cash Flow and Change in Funded Ratio from

12 Recent Pension Funding Metrics Plan Size to Revenue City A City B Revenue $ 10,000 $ 10,000 Pension Assets $ 1,000 $ 9,000 Assets / Revenue 10% 90% 10% Investment Loss ($ 100) ($ 900) Investment Loss as % of Revenue (1%) (9%) 12

13 Additional Questions to Ask Your Advisors What will the funded status of the plan look like over in the future if investment returns are X%? What is the probability that contribution rates could are more than Y%? Or contribution dollars are more than $Z? 13

14 Deterministic Projections Projection based on assumed 7.0% returns 14

15 Stress Testing Projections if returns mirror National Conference on Public Employee Retirement Systems 15

16 Monte Carlo Stochastic Simulations 16

17 Stochastic Simulations of Pension Plans 17

18 Addressing Investment Risk How much risk can you afford? National Conference on Public Employee Retirement Systems 18

19 Addressing Investment Risk Typical approach is to start with expected return National Conference on Public Employee Retirement Systems 19

20 Asset Allocation Approach should start with risk National Conference on Public Employee Retirement Systems 20

21 Stochastic Testing for Asset Allocation Curr 95th-100th Neg Curr 80th-95th Neg Curr 60th-80th Neg Curr 40th-60th Neg Curr 20th-40th Neg 140% Base 95th-100th Neg Base 80th-95th Neg Base 60th-80th Neg Base 40th-60th Neg Base 20th-40th Neg 120% 100% 80% 60% 40% 20% 0% Mean: 70.10% Median: 70.75% Std Dev: 14.4% Geometric Standard Discount Asset Smoothing Immunize Inactive Liab Return Deviation Rate Period Corridor Portion Disct Rate Current 6.50% 9.00% 7.125% 5 20% 0% 4.50% Complete Baseline 7.50% 11.99% 7.125% 5 20% 0% 4.50% Complete 21

22 Key Takeaways Plan sponsors and Boards should focus on ensuring both solvency and sustainability Understanding the risks is instrumental Consider present situation but focus on projections of potential future when making decisions 22

23 Consequences of Not Managing Risk 23

24 Pension plan sustainability Benefit security without financial distress for decades to come

25 Current state of pension assets & liabilities Assets Late in cyclical boom + Early in long term slowdown + Liabilities Negative cash flow Shorter time horizon Downturn risk Low return risk

26 Risk evolution Retiree population large Lower investment risk advised Funded status 100% Funded High investment risk OK small

27 Risk evolution details Plan population older: 50%+ retirees High risk, negative cash flow, shorter horizon Lower investment risk advised Funded status low: <60% Seek to improve funded status Funded status high: 100%+ Seek to maintain funded status High investment risk OK Plan population younger: <30% retirees Low risk, good cash flow, long horizon

28 Demographic Based Investing (DBI) Align Asset Cash Flow with Benefit Payments Fixed income with predictable payment amounts Equity with growth & inflation sensitive payments Real estate has elements of growth & income Evolve Risk as Plan Population Ages Lower risk as time horizon decreases Minimize impact of downturns when cash flow is negative More liquidity as payment requirements increase

29 Plan demographic evolution leveraged risk Young plan Mature plan After downsizing Retired members Pension growth is primarily with retiree liability Retired members Retired Retired members members Retired members Revenue is proportional to active workforce Active members Active members Active members Low cost & risk High cost & risk Extreme cost & risk

30 Bond matched with payment obligation Bond payment Pension payment obligation Market value

31 Plan demographic evolution leveraged risk Young plan Mature plan After downsizing Retired members Pension growth is primarily with retiree liability Retired members Matching fixed income Retired members Retired members Matching fixed income Retired members Matching fixed income Revenue is proportional to active workforce Active members Active members Active members Low cost & risk High cost & risk Extreme cost & risk

32 Plan demographics impact investment strategy Actives Long horizon Asset growth Generating return Accumulation Cash inflow Diversification Balance shifts over time Retirees Short horizon Making payments Managing risk Liquidity Cash outflow Asset liability matching

33 Recovering from a downturn Lower funded status and negative cash flow make it harder to recover Rate of return needed to regain funded status 10 years after -15% return Original Funded Status Net cash flow % of assets 4% 2% 0% 2% 60% 12.60% 11.40% 10.30% 9.50% 80% 11.80% 11.00% 10.30% 9.80% 100% 10.90% 10.60% 10.30% 10.10% Source: Nuveen Asset Management. Contributions assumed to cover normal cost only 33

34 Demographic based investing Focuses on creating the cash flow to pay benefits Brings assets & liabilities together in a single risk framework Adapts level of risk to plan demographics Risk is reduced as plan population ages because Investment time horizon decreases Impact of negative returns increases with negative cash flow Plan assets & liability are larger relative to revenue base demographic leveraging Liquidity becomes more important

35 Managing risk with an advisor team Investment manager Investment consultant Actuary Retirement system Conventional approach Investment manager Investment consultant Retirement system Team approach Actuary

36 Risk management tips for boards & trustees Explicitly state an objective to secure members benefits Share this with advisors and other stakeholders Keep track of your ratios Active to retiree (high risk is 1.0 or lower) Liability to revenue (high risk is 200% or higher) Net cash flow to assets (high risk is 3.0% or lower) Tell your advisors that you want to hear the bad news (and mean it) What will the situation look like if returns over the next 10 years are x%? What will the situation look like if payroll does not grow over the next 5 years? Find someone who knows both investments and pension liabilities to advise on risk

37 Managing pension risk to enhance sustainability Understand your liabilities Limit increases in risk by aligning assets and liabilities Invest with an understanding of time horizon Use your advisors wisely INST-AN-04/18