3. Presentation by Pension Consulting Alliance - Asset Liability Study Options

Transcription

1 3. Presentation by Pension Consulting Alliance - Asset Liability Study Options 3

2 Discussion of Asset-Liability Modeling Options Water & Power Employees Retirement Plan November 2010 by Pension Consulting Alliance, Inc.

3 Agenda Background Review of Asset-Liability Modeling Options Recommendation 2

4 Background Brief Review of A/L Process Current Implementation Plans Market Dynamics 3

5 Background BRIEF REVIEW of A/L PROCESS has conducted two prior A/L studies during PCA s tenure; in 2002 and 2007 A/L studies have typically taken place under a 3-5 year window; but many plan sponsors are now tightening the review window as a result of the increased volatility in the investment markets A/L studies have focused on developing longer-term strategic investment policy allocations Plan sponsors are seeking a more dynamic approach to strategic allocation; however, too much shifting in overall strategy could produce sub-optimal risk-adjusted returns 4

6 Background BRIEF REVIEW of A/L PROCESS Key reasons for conducting an A/L study: A change in trustees tolerance for certain plan risks A dramatic change in the investment markets Maintaining an ongoing, documented, prudent level of due diligence of a plan s long-term investment strategy After significant review and discussion of different risk tolerance philosophies, the Board arrived at the following consensus risk philosophy and resulting investment policy in 2007: 2007 Consensus Risk Philosophy & Proposed New Long-term Policy Portfolio Risk Factors 2007 Board Consensus Risk Strategic Classes Prior Policy New Strategic Policy Difference between Policies Comments Seek Improved funding over next 10 years 30% US Equities 40% 34% -6% Public equity rises modestly: from 55% to 58%. Shift Avoid funding below 85% 25% International Equities 15% 24% 9% to a more global orientation. Seek lowest plan costs possible 7% Fixed Income 36% 25% -11% Fixed income reduced to fund new classes. Avoid cost spikes over 35% 17% Real Estate 4% 5% 1% Modest increase in real estate. Seek 8% return portfolios 21% Private Equity 5% 5% 0% No increase in private equity. Still funding allocation. Avoid real returns below 4% 0% Real Return 0% 7% 7% New class that begin to focus on key event risk. 5

7 Background BRIEF REVIEW of A/L PROCESS Through the A/L modeling process, the Board selected a risk philosophy that emphasizes seeking to improve and protect s funded status Based on this risk philosophy, the Board is considering a more broadly diversified investment portfolio Raising exposure over time to public equity risk premium while making that exposure more global in nature Explicit recognition of potential inflation risk via new Real Return strategic allocation Modest increase to Real Estate over time 6

8 Background CURRENT IMPLEMENTATION To step into the new long-term investment policy over time, the Board has adopted a phased-in framework that would seek to implement the policy over a multi-year time frame: Retirement Plan Evolving Investment Policy Allocations Asset Class 1/31/2009 7/1/ /1/2010 Actual* 9/30/2010 6/30/2011 6/30/2012 Cash Fixed Income Real Return Real Estate Domestic Equity International Equity Private Equity *Real Return allocation is 's current Hedge Fund segment allocation Health Plan Evolving Investment Policy Allocations Asset Class 1/31/2009 Actual* -10/1/2009 7/1/2010 6/30/2010 6/30/2011 6/30/2012 Cash Fixed Income Real Return Real Estate Domestic Equity International Equity Private Equity *Real Return allocation is 's current Hedge Fund segment allocation One aspect of the phased-in framework is the gradual reduction in fixed-income 7

9 Background CURRENT IMPLEMENTATION Staff has now implemented/rebalanced portfolio into 10/1/2010 interim policy targets The Board, Staff, and PCA have worked closely to manage the portfolio within policy ranges, but have deviated from policy targets when appropriate (e.g., 2007/2008 crisis) 8

10 Background RECENT MARKET DYNAMICS Since the 2007 A/L Study, the global investment markets have taken quite a journey, putting plan sponsors in a difficult long-term funding predicament In light of the recent past, volatility remains and future investment prospects remain extremely challenging PCA recently revised its capital market assumptions, recognizing significant bond market volatility/valuation dynamics 9

11 Background RECENT MARKET DYNAMICS Deteriorating bond yields compelled PCA to reduce long-term expected core bond risk premium to zero (will revisit in early 2011) US TIPS yields now negative 10

12 Background RECENT MARKET DYNAMICS Expected returns for diversified portfolios have again declined since the end of 2009 (and since Segal s valuation 7/1/2010 valuation report) To maintain a funding improvement path, it is highly likely that a new model portfolio would seek additional risk premiums and a further shift out of fixed income Investment market dynamics may have caused shift in risk tolerance A dramatic shift in risk tolerance would be a strong argument for a multidimensional A/L Study 11

13 Review of Asset-Liability Modeling Options THREE AVAILABLE OPTIONS More robust, multi-dimensional A/L Study Standard mean-variance-based A/L Study Asset allocation review 12

14 Review of Asset-Liability Modeling Options ROBUST MULTI-DIMENSIONAL A/L STUDY Similar in format to 2007 A/L Study Undertaken particularly if Board desires to re-examine its tolerance for overall plan risk Encapsulates multiple risk dimensions (funding, costs, overall plan liquidity, solvency, etc.) Incremental costs required, similar to 2007 (2007 Study cost $120,000) Project timeline: typically 4-6 months Independent verification of current actuarial practices 13

15 Review of Asset-Liability Modeling Options STANDARD MEAN-VARIANCE-BASED A/L STUDY Utilizes PCA s updated capital market assumptions Incorporates Segal projection data from 7/1/2010 valuation Places most emphasis on investment return volatility as a proxy for overall plan risk, but does examine key financial outcomes Does not capture potentially dramatic (2008-like) market outcomes Project timeline: typically 2-4 months Modest incremental costs to have plan actuary model a limited number of scenarios (expected range: $7,500 - $30,000; negotiated by ) 14

16 Review of Asset-Liability Modeling Options MEAN-VARIANCE-BASED ASSET ALLOCATION REVIEW Utilizes PCA s updated capital market assumptions Examines only asset side of Plan s balance sheet Sole focus is investment return/risk tradeoff Does not capture potentially dramatic (2008-like) market outcomes Project timeline: typically 2-3 months No incremental cost 15

17 Review of Asset-Liability Modeling Options SUMMARY of OPTIONS A/L Project Type Multi-Dimensional Risk Asset Allocation Feature Factor Approach Standard M-V Approach Review Explicit recognition of Plan-oriented risk tolerance Yes Modest No Reality-based investment return projections Yes Limited, M-V-based Limited, M-V-based Recognition of Plan liabilities Yes, complete recognition Yes, summary recognition No Timeline 4-6 months 2-4 months 2-3 months Project costs $120,000-$150,000* $7,500-$30,000** None All versions would utilize PCA s updated capital market assumptions Regardless of approach utilized, PCA would (i) introduce one or more strategic class(es) and (ii) discuss potential structural adjustments to existing classes *The incremental cost of the 2007 A/L Study was $120,000; If chose this approach,all output from the Standard M-V Approach would also be made available to. **Covered under PCA s scope-of-services; Incremental costs are associated with the Plan s actuary providing limited scenario analyses to PCA and, in the past, have been negotiated by. 16

18 Recommendation At a minimum, PCA recommends a documented analysis of strategic investment options for the Plan s portfolio Selection of one option versus another will be a function of the Board s desire to fully revisit/vet its tolerance for overall Plan risk Depending on the extent and degree of any change in risk tolerance, the Board s strategic allocation may or may not shift A more limited-scale project today does not preclude the more robust review in one or two years 17