SPECIAL BOARD MEETING MINUTES ACTUARIAL REPORT PRESENTATION Wednesday, 1:34 P.M. Presiding: Present: Also Present: Absent: Chair Jerry Allen presided. Trustees Al Alys, Mike Chrystal, Rod Dole, Greg Jahn, Kiergan Pegg, and David Rabbitt Retirement Administrator Gary Bei; Assistant Retirement Administrator Kelly Jenkins; Accounting Manager Cathy Lanz, Investment Officer James Failor, Information Systems Manager Diane Ginn, Legal Counsel Neil Baker, Deputy County Counsel IV Jeff Berk; Administrative Aide Jennifer Howze, other attendees included Carol Allen, Marcia Barton, Natalie Brunamonte, Carl Carr, Ed Clites, Lynn Durell, Dave Edmonds, Veronica Ferguson, Philip Garcia, Jose Guillen, Ken Hightower, Carl Jackson, Bob Keyser, Phil Lawrence, Ray Leonard, Carolyn Lopez, Tom Lynch, Wendy Macy, Cindia Martinez, Julee Murphy, Bill Robotka, Jennifer Rogers, Phyris Tobler, Gary Wilkening, Brett Wilkison, and Bob Williamson. Dianne Edwards, Sharon Stockham, and Kimber Williams. I. REGULAR CALENDAR A. PRESENTATIONS: 1. 12/31/10 Actuarial Report Actuaries Paul Angelo and Andy Yeung of The Segal Company presented the SCERA Actuarial Report for the Year Ended 12/31/10. Chair Allen introduced Paul Angelo and Andy Yeung of The Segal Company. Mr. Angelo summarized the actuarial report by explaining the main items that determine the contribution rates: actuarial liability, normal cost, and Unfunded Actuarial Accrued Liability (UAAL) amortization. He then explained that the unfunded liability is amortized over 20 years on a fixed amortization basis, so every year one piece of the liability falls off, and another is added on. Gains and losses relate to all experience such as investments, lifetime of members, salaries, and other experience factors that impact the unfunded liability. In addition, the Retirement Board approved a change in the asset earnings assumption from 8.00% to 7.75% effective with this valuation which increased actuarial liabilities and, in turn, contribution rates. The 1
largest actuarial loss in this year s valuation was from investments ($78 million) which represents five year smoothed recognition of investment experience. The change in interest assumption to 7.75% added $54 million to the UAAL. Salary was a small actuarial loss of $1 million, but would normally be expected to be a gain given the low level of salary changes. Administrator Bei and Actuary Andy Yeung noted that in the 2010 valuation the process for estimating salaries was moved from a projection based on year-end salary data from legacy systems to annual retirement countable earnings from the new integrated pension system. This resulted in a onetime change in process that reduced the salary gain from what it would have otherwise been had the process remained consistent. Using annual retirement countable earnings is the recommended approach for systems with integrated pension systems. The other major factor impacting the UAAL is the Pension Obligation Bond (POB) of $289 million which was received during the year and reduced the UAAL. Interest on the UAAL balance added $24 million to the UAAL in 2010. The UAAL started the year at $402 million and ended the year at $248 million. The funded ratio increased from 79.6% to 88.4% during the year with the POB increasing the funded ratio by 13.5 percentage points. The total employer cost decreased from 20.03% of payroll to 17.11% of payroll due to the impact of the POB (6.29% decrease in employer rates) offset primarily by 1) lower than expected returns on the smoothed value of assets (1.69% increase in employer rates) 2) changes in actuarial assumptions for the interest rate (1.80% increase in employer rates) and 3) lower than expected increases in total payroll (0.11% increase in employer rates). The increase in employee rates from the interest assumption change is 0.41% of payroll on average. After discussion and review of the major elements of the actuarial valuation, Motion was made to accept the Actuarial Report. APPROVED as per the following: Ayes 7 Noes 0 Abstain 0 Absent 2 2. Actuarial Analysis of Financial Experience - Administrator Bei presented a review of the five-year summary of items impacting the Unfunded Actuarial Accrued Liability (UAAL), significant actuarial gains/losses, investment experience, market stabilization reserve amortization/forecast and funded ratio trends. He thanked the attendees for taking the time to the attend the Special Board meeting noting it is a great opportunity to review key elements related to the retirement system funding and factors behind changes in contribution rates. Key statistics that are a part of SCERA communication materials have also been updated and will be reviewed as part of this presentation. The actuarial report focuses on a one-year view, but it is important to look at these key metrics over several years to understand trends. 2
The first topic covered was a review of factors behind the changes in the UAAL and a table included annually in the Comprehensive Annual Financial Report (CAFR) was reviewed. Changes in the UAAL are the primary driver of changes in contribution rates. The major factors impacting the UAAL for the last five years were investment experience, the new cash allowance benefit, changes from two triennial experience studies, interest on the UAAL balance and the interest assumption change. The largest reduction in the UAAL came from the POB received in 2010. The SCERA funded ratio was in the 90% to 100% range for several years leading up to 2008 where the market downturn reduced the ratio to the 60% range at market value. At the end of 2010, the funded ratio is 82% at market value and 88% at the actuarial value of assets. A slide was reviewed showing that the funded ratio of US public pension plans and the impact of economic and financial market cycles very evident with the funded ratio ranging between 70% and 100% until 2008 when the ratio dipped into the mid-50% range. From the end of 2008 to March 31, 2011 the average US public pension system funded ratio has increased from the mid-50% range to 76% based on the market value of assets. The drop in funded ratio in 2008 is a major reason that public retirement systems have been in the news so prominently recently. Significant improvement has occurred with the market rebound and SCERA continues to manage through the economic and financial market cycles with disciplined implementation of a long-term investment strategy which includes rebalancing of the portfolio to the target asset allocation. This has allowed SCERA to fully participate in the market rebound since 2008. Regarding demographics, SCERA ended 2010 with the same number of active employees and retirees at 3780 for each. This is typical of a maturing plan. Paul Angelo commented that the number of retirees being close to the number of actives is common for the public plans that he supports. There were 283 retirements in 2010, a record number for SCERA and approximately a 7% retirement rate as a percentage of total employees. Retirees in 2011 are also expected to be at record levels due to the tough budget environment. The average retirement age was close to 60 for general members and 53 for safety members. The average annual benefit paid for all retirees is approximately $28,300 and $46,900 for employees retiring in 2010. The distribution of benefits paid by age was reviewed and the modest benefit of approximately $1000 per month for general member retirees and $2000 per month for safety retirees over age 75 was noted along with the importance of the ad-hoc COLA program for older retirees which has maintained purchasing power at approximately 75% based on the last COLA in 2007. Leave cash-outs for vacation, sick and holiday are estimated at 4% for general members and 6% for safety members and built into contribution rates for the employer and employees. These assumptions are tracking well. 3
Investment returns were in good shape across all time periods through 2007 and then the market downturn occurred in 2008 with a significant fear cycle in the market. Even absorbing the impact of the 2008 market downturn, long-term returns of 20-year and 30-year periods continue to look strong and are the most important return measure for a retirement system given its time horizon. Markets have rebounded since 2008 and SCERA returns were 18.2% in 2009 and 12.6% in 2010, net of fees. At the end of 2010, the annualized return for 20-years was 8.00% and for 30-years was 9.7%. The SCERA fund market value was $1.61 billion after receiving POB proceeds on September 1, 2010 and finished April 30, 2011 at approximately $1.91 billion, an increase of approximately $300 million in market gains over the past 8 months. A slide was reviewed which shows the US stock market returns by year from 1926 to 2010 and the major market downturns and rebound periods were noted which is reflective of economic and financial market cycles. The investment experience is smoothed over five years and the balance in the smoothing account typically ranges between positive $200 million to negative $200 million over the last 15 years. At the end of 2008 the balance was a negative $483 million, but as of the end of 2010 the balance has decreased to a negative $139 million. SCERA is managing through the financial market cycles as always with the difference being the magnitude of this past market cycle given the largest downturn since the Great Depression. The smoothing of investment experience from the 2008 market downturn is the major driver of retirement rate cost increases to employers and the primary reason retirement systems are in the news so frequently lately. There are two remaining negative years of investment recognition projected and then the recognition should turn positive in 2013 and 2014 from recent positive investment experience. SCERA has requested forward modeling of retirement rates to project forward the impact of the smoothing process of investment experience on rates and this will be covered in the next topic. This is helpful for the plan sponsors budget planning. Administrator Bei noted that the rates from the December 31, 2010 will take effect in July 2012, 18 months after the date of the valuation. Since the interest assumption change added 1.80% to employer rates this will be phased-in over three years per SCERA policy starting in July 2012. The employee rate changes will take effect fully in July 2012. It was also noted that the increase in contribution rates for Fiscal Year 2011/2012 will be reviewed by the Retirement Board at the May 19, 2011 meeting. The employer rates for Fiscal Year 2011/2012 are increasing in the range of 1.6% to 2.2% for general members and 1.0% to 1.2% for safety members. 4
3. Projections of Employer Contribution Rates, Unfunded Actuarial Accrued Liabilities (UAAL) and Funding Percentages - assuming future investment earnings at 7.75% annually from January 1, 2011. Actuaries Paul Angelo and Andy Yeung of The Segal Company presented the forward modeling of retirement rates assuming investment returns at the assumed rate. From the asset smoothing impact of investment returns the employer contribution rates increase to the 22% range in 2012 and then begin decreasing in subsequent years. The UAAL peaks in 2012 and then decreases over subsequent years. The funded ratio decreases to around 80% in 2012 and then increases over subsequent years to the mid-90% range. A comparison chart of the projections compared to the prior year projections were reviewed as the charts showed significant improvement from the prior year. The notable impacts being the issuance of POBs in 2010, positive 2010 investment experience partially offset by the interest assumption change. If the POB had not been issued the rates would have closer to 28%. The unfunded liability will decrease as it is paid off over the next 20 years, and contribution rates are also expected to level off over that time period. B. ADMINISTRATOR S REPORT: 1. County of Sonoma Request for SCERA to Pay a Portion of the Actuarial Cost Related to Retirement Benefit Studies policy discussion. Administrator Bei introduced the agenda item saying the County and labor union representatives are doing early work looking at alternatives for possible changes in benefits and have requested a range of actuarial studies by Segal as SCERA actuaries. He reviewed the policy framework regarding who typically funds actuarial studies of this type and noted that the County historically has funded actuarial studies for changes in benefits. This is based on the principle that actuarial costs of administering the plan, meaning the current plan benefits, are reasonable expenses related to administration of the plan. Benefit studies for changes in benefits are generally funded by the employer. After this initial discussion, the County wanted to request a review of that policy for the current benefit studies. The County is requesting SCERA share in the cost of actuarial studies for those changes where the information provided would be beneficial to the system and its members. Administrator Bei noted that the major categories of changes being considered in the benefit studies involve areas like new benefit formulas, one versus three year final compensation, with and without supplemental employee contributions, 30 year forward modeling of costs and different staffing level scenarios. Neil Baker provided an overview of the legal principles surrounding this request. The Trustees are obligated to discharge fiduciary duties as laid out in CERL, the State Constitution, and trust law. The Retirement System is a separate legal entity from the County and participating Districts. Under the Government Code, the County has the duty to secure the services of an actuary when considering changes in retirement benefits. Retirement System funds may only be used for system purposes to pay promised benefits and to defray 5
reasonable expenses of administration. Expenditure of System funds for actuarial valuation on a periodic basis as necessary to set funding policies and set contribution rates is permitted. When further actuarial work is needed to set benefits, the System may determine whether it is reasonable and prudent to use funds to help defray the costs of such studies to the public entity. The Board needs to be satisfied that this would be a proper appropriation of funds. A letter from County Administrator Veronica Ferguson was part of the board package outlining the County s interest in cost sharing related to the benefit studies. An email was attached to the letter referencing past cost sharing relating to new benefit tiers. Neil Baker explained the background to the cost sharing was that the County and SCERA were named parties to the Ventura lawsuit at the time, which was the basis for the cost sharing. Paul Angelo noted that while most systems will authorize use of its actuary, costs are generally funded by the Plan Sponsor when considering benefit changes. In some cases where studies have been required by both entities, the costs have been shared. Mr. Baker said that if it is only a matter of considering possible changes in benefits, he feels it would not be proper to share in the cost of the studies. However, if there are other reasons to perform the study, it may make sense for SCERA to participate and share in the cost. Administrator Bei commented that there is a continuum of phases of actuarial analysis related to benefit changes from early modeling about possible benefit changes to final analysis prior to implementation or even mandated changes based on legislative action like a state-wide change in retirement benefits. This framework is important to consider in determining the linkage of the actuarial study to the administration of the retirement plan. Veronica Ferguson briefly addressed the board, followed by board member discussion. Trustee Dole noted it could be of general benefit to SCERA members if the benefits are changed to support the long-term stability of the fund and lower the cost of retirement benefits to employers. Trustee Chrystal commented that any cost sharing for these benefits studies should not be considered precedent setting for future actuarial studies related to benefit changes. The Board Members discussed the item and decided to approve support for some cost sharing with the details to be worked out at the next meeting after reviewing additional information. This will help to determine the amount of contribution from SCERA for the actuarial study. Motion to approve participating in cost sharing of the benefit studies up to 50% of the total cost with a maximum disbursement of $25,000. APPROVED as per the following: Alys N Chrystal X Dole X Edwards (see Chrystal vote) Jahn N Rabbitt X Pegg N Stockham A Williams A Allen X Ayes 4 Noes 3 Abstain 0 Absent 2 6
C. GENERAL DISCUSSION MATTERS: A letter from Tom Lynch to the SCERA Board was handed out. Board members agreed to take no action or discuss the letter at this time. II. PUBLIC COMMENT None III. NEXT MEETINGS ADMINISTRATIVE/BENEFITS COMMITTEE: Thursday, May 16, 2011 at approximately 9:30 A.M.(immediately following the Disability Committee meeting) in the SCERA Board Room located at 433 Aviation Boulevard, Suite 100 in Santa Rosa, CA. AUDIT COMMITTEE: Wednesday, May 18, 2011 at approximately 11:30 A.M. (immediately following the Investment Committee meeting) in the SCERA Board Room located at 433 Aviation Boulevard, Suite 100, Santa Rosa, CA. DISABILITY COMMITTEE: INVESTMENT COMMITTEE: RETIREMENT BOARD: Monday, May 16, 2011 at 8:30 A.M. in the SCERA Board Room located at 433 Aviation Boulevard, Suite 100 in Santa Rosa, CA. Wednesday, May 18, 2011 at 8:30 A.M. in the SCERA Board Room located at 433 Aviation Boulevard, Suite 100, Santa Rosa, CA. The presentation scheduled for this meeting is by JP Morgan Strategic Property Fund. Thursday, May 19, 2011 at 8:30 A.M. in the SCERA Board Room located at 433 Aviation Boulevard, Suite 100, in Santa Rosa, CA. 7
V. ADJOURNMENT The meeting was adjourned at 4:56 P.M. to the next Retirement Board meeting on Thursday, May 19, 2011 at 8:30 A.M. in the SCERA Board Room located at 433 Aviation Boulevard, Suite 100, Santa Rosa, CA. JERRY ALLEN, CHAIR Respectfully Submitted, GARY BEI SECRETARY/RETIREMENT ADMINISTRATOR By Jennifer Howze 8