NUPGE PENSION BASICS SERIES

Transcription

1 NUPGE PENSION BASICS SERIES Webinar #2: Funding & Role of the Actuary April 8, 2016

2 INTRODUCTION Quick Defined Benefit (DB) Plan Refresher Benefit is defined Monthly lifetime pension benefit at retirement For today, focus on final average earnings plan Benefit based on service and pre-retirement earnings period Similar to other plan types, with additional funding implications for earnings growth First, a hypothetical example

3 Hypothetical Example 3 plans - same plan design, membership, assets Same Plan Actuary 3 different Plan Sponsors: A, B, C December 31, 2015 funding valuation results: A: 95% funded, contributions set at 16% earnings B: 105% funded, contributions set at 12% earnings C: 102% funded, contributions set at 10% earnings

4 Hypothetical Example Questions: 1. Could 3 different sponsors with same plan and same actuary have different results? 2. Can you tell which plan s funding is better? We ll come back to these questions In about 40 minutes.

5 AGENDA Pension Funding Concepts Funding Valuations Role of Plan Actuary Methods & Assumptions Funding Decisions Role of Plan Actuary Reading a Valuation Report Summary Hypothetical Example

6 PENSION FUNDING CONCEPT Contribution Valve Investment Earnings Contributions PENSION FUND Benefit Valve Expenses To Pensioners Contributions + Investment Earnings = Benefits + Expenses

7 FUNDING CONCEPTS Prefunding (most Cdn public sector DB plans): Contributions collected as benefits earned, before paid Tax-deductible contributions invested as a whole, on tax-free basis Advantages of pre-funding: 1. Greater benefit security 2. Investment earnings typical pay 65-80% of plan costs. Employers/members pay balance.

8 FUNDING CONCEPTS Plan Cost: Depends on each individual member Time in plan (start/end dates) Contributory service (full-time, other) Earnings levels (esp. pre-retirement) Time in receipt of pension (start/end dates) Other (e.g., options exercised, spouse, inflation)

9 FUNDING CONCEPTS Pre-funding Dilemma: Funding during member s active membership, BUT Individual member s cost not yet known Future investment performance unknown How to determine contribution rates in advance that, together with investment earnings, are sufficient to pay promised benefits??

10 ANSWER The funding valuation Note, for purposes of this webinar, we will focus on the going-concern funding valuation (other types include accounting (financial reporting), wind up (plan termination), solvency (funding)), all of which are highly prescriptive.

11 FUNDING VALUATION Point-in-time financial assessment of plan Key inputs: valuation assumptions & methods, plan membership data, asset information Calculates plan s current funded status: Assets>Liabilities = Funding Surplus Assets<Liabilities = Funding Deficit Compares to prior valuation results Provides range of permissible contributions until next valuation, in accordance with laws and standards

12 FUNDING VALUATION Legal Requirements Pension laws prescribe minimum required contributions (provincial variations) Tax law limits maximum permissible contributions Actuarial Standards Rules and guidelines for valuations (e.g., valuation methods, assumptions, reporting)

13 ROLE OF PLAN ACTUARY Pension Plan Expert Knowledge of pension and related tax law, actuarial standards Broad exposure to pension and related experience and emerging trends Experts in financial risk measurement and assessment Advisor to Plan Sponsors, Plan Administrators Plan Sponsor is the employer or Board of Trustees Plan Administrator is the Pension Committee, Board of Trustees or Plan Sponsor

14 ROLE OF PLAN ACTUARY Uses expertise and knowledge of client s pension plan design, goals and policies to: Conduct periodic valuation method and assumption reviews Recommend appropriate valuation methods and assumptions Prepare actuarial valuations and other financial forecasts Determine minimum and maximum funding requirements (i.e., contribution rates) Supports development of client s funding and investment policies

15 ROLE OF PLAN ACTUARY VALUATION METHODS & ASSUMPTIONS Plan Actuary does not have final decision on funding valuation methods and assumptions Conducts periodic review of actuarial assumptions and methods, makes recommendation for current valuation Plan Administrator has final approval of actuarial valuation methods and assumptions

16 VALUATION METHODS Methods do not change as often as assumptions, but important to understand Asset Smoothing Most plans use smoothing technique to value assets Investment gains and losses are smoothed over period (5 yrs is common) Reduces volatility between valuations Actuarial Cost Methods Most common cost methods are projected unit credit and modified aggregate Both acceptable to regulators/actuarial profession

17 VALUATION ASSUMPTIONS Used to estimate future outcomes of members (e.g., dates, type of benefit, amount of benefit) Used to estimate present value of future benefit payments Many assumptions, today we focus on most material ones: discount rate, longevity, retirement, earnings, withdrawal

18 ASSUMPTION: Discount Rate Nominal discount rate used to value liabilities Reflects both long-term investment outlook and plan s funding policy, investment policy and asset mix Includes margin for adverse experience which must meet legal and actuarial standards Inclusion of margin lowers the discount rate

19 ASSUMPTION: Discount Rate cont d Real discount rate = nominal discount rate less assumed inflation As real discount rate decreases, liabilities increase and funding ratio decreases Valuation results are sensitive to changes in real discount rate. For example: 1% decrease in real discount rate can increase liabilities by 10-20% and normal cost by 15-25%

20 ASSUMPTION: Longevity Mortality is another key assumption Once pensions in pay, main cost driver is how many payments to each member Increased longevity has materially increased the cost of DB pension plans Actuarial profession periodically develops updated mortality tables If plan has sufficient experience, can customize their mortality assumption

21 ASSUMPTION: Retirement Need to estimate when active members will retire and start to collect pension Rates are plan-specific, based on recent and projected retirement experience Rate tables can be age, service or points (age+service) related Rates vary to capture value of different retirement benefits under the plan

22 ASSUMPTION: Earnings Future earnings growth is needed to estimate future benefits and contributions Plan-specific to reflect merit & promotion increases and collective bargaining, plus general average wage trends Sensitivity of valuation to earnings growth assumption depends on characteristics of plan benefits and plan membership.

23 ASSUMPTION: Withdrawal Need to reflect that some members will not stay in plan until retirement Benefits on termination may not be the same value as retirement benefits Costs vary on whether member leaves benefit in plan or transfers out lump sum Usually age- and service-related rates used, based on plan experience.

24 VALUATION ASSUMPTIONS Actual experience will differ from that assumed Differences produce experience gains and losses which affect plan s funded status Other than margins, generally expect gains/losses to offset over time Periodic assumption review conducted, considers both experience and outlook Trends in one direction can trigger a review

25 VALUATION ASSUMPTIONS Experience gains and losses affect plan s funded status ASSUMPTION EXPERIENCE FUNDED STATUS Discount Rate Pensioner Death Investment Returns HIGHER / LOWER Pensioners Die EARLIER / LATER GAIN / LOSS GAIN / LOSS Retirement Age EARLIER / LATER LOSS / GAIN Earnings Growth HIGHER / LOWER LOSS / GAIN Termination # Deferred Members HIGHER / LOWER GAIN / LOSS

26 FUNDING DECISIONS Plan Sponsor determines funding goals: For example, Minimize contribution volatility Contributions within certain range Contributions below certain level Maximize security of promised benefits Provide conditional benefits Achieve intergenerational equity

27 FUNDING DECISIONS Risks to achieving funding goals Longevity pensioners living longer Challenging investment environment low interest rates, slow growth, volatility Plan maturity faster growth in pensioners than active, contributing members Political, regulatory, actuarial activity

28 FUNDING DECISIONS Funding techniques help manage risks: For example, Funding valuations - asset smoothing and margins Contribution rates - funding reserves Funding valuations timing of filing valuations

29 FUNDING DECISIONS Framework to achieve funding goals outlined in plan s funding policy: Articulates funding goals Who pays (sharing of risk) When and how much Choice of valuation methods and assumptions, reviews Use of margins and reserves Management of funded status (surplus, deficit) Setting of contribution rates and benefit adjustments Monitoring funding performance (valuations, forecasts) Plan Actuary - selection and monitoring

30 FUNDING DECISIONS Funding goals and funding policy incorporated into plan s investment policy (webinar #3) Funding goals, funding policy and investment policy together: reflected in choice of real discount rate for the actuarial funding valuation Used by Plan Sponsor to set contribution rates, adjust benefits, file valuations

31 ROLE OF PLAN ACTUARY FUNDING DECISIONS-Contribution Rates Plan Actuary does not have final decision on Plan s contribution rates Performs funding valuation, determines minimum and maximum funding requirements under pension & tax laws, actuarial standards Plan Sponsor uses funding valuation and plan s funding goals and policies to set contribution rates Adjustments to benefits, as appropriate

32 READING A VALUATION REPORT There is a lot of important information in a valuation report, not just the size of assets and liabilities and the funded status. Important to read report on funding valuation, with consideration of: plan s funding goals and policies, current and projected membership, external environment, funding risks, current contribution rates.

33 READING A VALUATION REPORT 1. CHANGES SINCE PRIOR VALUATION Usually summarized in report intro, details later Includes change in plan design, valuation methods/assumptions, rules/guidelines, Plan Actuary Also good to know external environment influencers (e.g., investments, economic) Can impact valuation results and plan funding Even if offsetting, important to be aware

34 READING A VALUATION REPORT 2. METHODS & ASSUMPTIONS Changes, if any, since last valuation Date of last full review Do they still reflect future outlook? Especially, discount rate: How determined, margin, sensitivity to change Size of margin versus prior valuation Remember, more margin = more conservatism = lower real discount rate = higher liabilities higher cost

35 READING A VALUATION REPORT 3. PLAN MEMBERSHIP Reconciliation (entry, termination, exit, retirement, disability, death) Any large membership activity since last report? Growing, stable, shrinking? Why? Proportion of active (contributing) vs others? Statistics (age, service, earnings, gender, FT vs other) Look for emerging trends for active/inactive groups Shifting characteristics can change funding risk profile, impact future contributions/benefits Age/service distribution charts

36 READING A VALUATION REPORT 4. PLAN ASSETS Reconciliation and statement of assets Alignment to investment policy? Compare to external investment markets Net pension cashflow negative is indicator of maturity risk (net cashflow = contributions less {benfefits+expenses} Performance higher or lower than assumed discount rate? Look for emerging trends, whether discount rate has been adjusted

37 READING A VALUATION REPORT 5. EXPERIENCE (GAIN/LOSS) ANALYSIS Compares actual experience versus assumed Impact of changes in plan design, conditional benefits, laws/standards, methods & assumptions Impact of contribution decisions in respect of surplus, deficits, reserves Best to view over period of time (e.g., 5 years), to consider trends offsetting vs one direction

38 READING A VALUATION REPORT 6. FUNDED POSITION Assets Impact of smoothing: negative or positive, trends Liabilities Active/inactive ratio, trends Funded Status Surplus/deficit, funded ratio, reconciliation to prior Contributions Min/max versus current rates, trends, use of reserves

39 SUMMARY Funding is guided by plan s funding goals & policies. Plan valuation is point-in-time estimate of financial position of plan. Valuation methods & assumptions, especially discount rate, are key recommendations by Plan Actuary. Plan Administrator has final decision on assumptions and methods. Plan Actuary performs funding valuation and determines contribution range, while Plan Sponsor sets contribution rates and adjusts benefits, guided by funding goals and policies. VALUATION REPORT is a wealth of information, to be read with funding and investment policies. Use it to review financial status, use of margins and reserves and changes since last report. Look for trends. Valuation report provides answer and should prompt questions.

40 Hypothetical Example 3 plans - same plan design, membership, assets Same Plan Actuary 3 different Plan Sponsors: A, B, C December 31, 2015 funding valuation results: A: 95% funded, contributions set at 16% earnings B: 105% funded, contributions set at 12% earnings C: 102% funded, contributions set at 10% earnings

41 Hypothetical Example Question 1: Could 3 different sponsors with same plan and same actuary have different results? Yes. Plan Sponsors and Plan Administrators determine valuation methods/assumptions and contribution rates, not actuary. Funding goals and funding and investment policies will influence choice of methods/assumptions and decisions about contribution rates and benefit adjustments.

42 Hypothetical Example Question 2: Can you tell which plan s funding is better? No. Funding success depends on the probability of achieving the plan s funding goals. In the absence of each plan s funding goals, funding and investment policies, and full actuarial valuation, you cannot measure this.

43 Hypothetical Example Purpose of this example: To demonstrate that one should be careful not to jump to conclusion that higher funded status or lower contribution rates means a plan s funding is better than another the valuation methods/assumptions may be different, and/or the plans funding goals may not be the same.

44 ?? QUESTIONS??

45 This has been: Plan Funding and the Role of the Actuary This is the second in a series of pension webinars hosted by NUPGE. Please join us for upcoming sessions. Friday April 29 Webinar #3 Pension investment Friday May 20 Webinar #4 Pension law Friday June 10 Webinar #5 Capital stewardship Further details, including information about the moderator and the instructor for each webinar, can be found by visiting National Union of Public and General Employees PENSION BASICS Webinar Series