Arizona PSPRS Pension Task Force Actuary PDF Free Download

Table of Contents Actuary 101 (50 minutes) Retirement Plans Actuarial Mathematics Actuarial Assumptions PSPRS Specifics (50 minutes) Understanding PSPRS Valuations Understanding PSPRS Experience Studies PSPRS Recent History and Analysis (50 minutes) Timeline of Events Prior studies and conclusions 2

4 RETIREMENT PLANS

Types of Retirement Plans Defined Benefit (DB) Plans Defined Contribution (DC) Plans Hybrid Plans 5

Pure Defined Benefit Plans Benefit determined by a formula Usually involves Years of Credited Service Final Average Salary (FAS) A multiplier such as 2.0% 2.0% x 30 years x $50,000 = $30,000 per year 6

Pure Defined Contribution Plans A stated percent of earnings is put into an account each year Employee can usually direct the investment of that account Balance in the account is available for distribution at retirement (or earlier) 7

Hybrid Plans Pension plans that have elements of defined benefit plans and defined contribution plans Usually involve the benefit for the participant being awarded as a lump sum instead of as an annuity These types of plans are regulated as defined benefit plans Examples of hybrid pension plans include cash balance and pension equity plans 8

Defined Benefit Plan Risk Characteristics Investment Risk (Poor Performance) Mortality Risk (Long Lives) Inflation Risk (Pay Increases, CPI COLA) Employer bears the risks Benefits are predictable (defined) 9

Defined Contribution Plan Risk Characteristics Investment Risk (Poor Performance) Mortality Risk (Long Lives) Inflation Risk (No COLA) Employee bears the risks Benefits are not predictable 10

11 ACTUARIAL MATHEMATICS

Basic Retirement Funding Equation Where: C I B E C = Contribution Income I = Investment Return B = Benefits Paid E = Expenses Money In = Money Out 12

Basic Retirement Funding Equation C I = B E B depends on Plan Provisions Experience C depends on Short Term: Long Term: Actuarial Assumptions Actuarial Cost Method I, B, E 13

The Concept of Present Value Actuarial calculations almost always begin with the calculation of a present value The present value of an amount of money payable in the future is the amount of money that, if we had it today, would accumulate to the amount that will be payable in the future 14

Funding a $10,000 Annual Pension for a Person Present Value of Benefits At Retirement Date $90,000 At Valuation Date $25,000 $17,000 Actuarial Accrued Liability Allocated to Past and Future Service Actuarial Accrued Liabilities - Accrued Assets Unfunded Actuarial Accrued Liabilities $8,000 Present Value of Future Normal Costs 15

Funding a $10,000 Annual Pension for a Person Allocated to Past and Future Service Actuarial Accrued Liability: $17,000 Present Value of Future Normal Costs: $8,000 Present Value of Benefits at Retirement: $90,000 Present Value of Benefits at Valuation Date: $25,000 16

Funding a $10,000 Annual Pension for a Person Actuarial Accrued Liability Accrued Assets Unfunded Actuarial Accrued Liability 17

Completing the Pension Funding $90,000 PVB Normal Cost $25,000 Accrued Liability $17,000 $8,000 Future Normal Cost 25 X RET As the person ages, the boxes grow northward until the PVB becomes $90,000. At the same time, the normal cost layer moves to the right. At retirement, there is one big square box; the accrued liability and the PVB are both $90,000, and the Future Normal Cost is $0. 18

Completing the Pension Funding $90,000 PVB Normal Cost Accrued Liability Future Normal Cost $25,000 25 X RET As the person ages, the boxes grow northward until the PVB becomes $90,000. At the same time, the normal cost layer moves to the right. At retirement, there is one big square box; the accrued liability and the PVB are both $90,000, and the Future Normal Cost is $0. 19

Completing the Pension Funding $90,000 PVB Accrued Liability=PVB=$90,000 $25,000 25 RET As the person ages, the boxes grow northward until the PVB becomes $90,000. At the same time, the normal cost layer moves to the right. At retirement, there is one big square box; the accrued liability and the PVB are both $90,000, and the Future Normal Cost is $0. 22

The Long Term Solution to the Equation Pay-As-You-Go Contributions % of Active Member Payroll Investment Income CASH BENEFITS Level Contributions Employer and Employee Contributions Start 50 Years of Time 23

Measurement of Assets For assets that have to be used today, Market Value is the most sensible measure In the long term, the Market is always right In the short term, the Market is often volatile and subject to temporary conditions and mood swings that distort the value In pension funding, a volatile measurement of assets would tend to produce volatile contribution rates and funding progress measurements, both of which are undesirable Commonly in pension funding, some type of smoothed market measurement is applied to the assets, and the result is called the "Actuarial Value of Assets" or the "Funding Value of Assets" 24

Example Calculation Total Assets in Millions Beginning Funding Value $ 6,051.6 Plus Net Cash Flow (68.8) + Assumed Return (8.0%) 481.4 +Phased-in Return (loss) (279) =Ending Funding Value of Assets $ 6,185 Market Value of Assets $ 5,557 Ratio 111% The difference between Funding Value and Market Value is $628 which must be phased-in over a period of future years. 25

Development of Funded Ratio Plan Totals (1) Actuarial Accrued Liability $ 10,823.5 (2) Valuation Assets 6,185.1 (3) Unfunded Liability (1)-(2) $ 4,638.4 (4) Funded Ratio (2)/(1)* 57% * The funded Ratio is usually expressed based upon the actuarial value of assets as shown above. An alternate expression based upon the market value of assets can also be helpful. 26

Interpretation of Funded Ratios Difficult to compare from one system to another Actuarial assumptions are not uniform Valuation dates and reporting schedules are different Different past history Trend in funded ratio is more important than the absolute level 27

Which Plan Would You Want To Retire From? Funding Ratio Plan 1 Plan 2 2001 30% 90% 2002 33% 87% 2003 36% 84% 2004 39% 81% 2005 42% 78% 2006 45% 75% 2007 48% 72% 2008 51% 69% 2009 54% 66% 2010 57% 63% 2011 60% 60% 28

Example Contribution Rate Results 20% Contribution for Normal Cost Contribution for Unfunded Actuarial Liability: 30 year financing of $9,074,000 24% 4% 29 Normal Cost is the value of this year s benefit accruals. Some portion is often paid by members. Contributions are usually expressed as a % of payroll.

Funding Unfunded Liabilities Usually funded as a level % of payroll Often over a closed (decreasing) period of years Floating or fixed period (open) also possible Narrow range of practice, but practices change with the market 30

31 ACTUARIAL ASSUMPTIONS

Present Value Assumptions Investment Return Relates to Economic Assumptions Probability that Money will be Paid Relates to Demographic Assumptions, Mortality, Turnover, etc. 33

How Do Economic Assumptions Compare? Information from the FY 2010 NASRA/NCTR Public Fund Survey indicates the following for 126 large Retirement Systems. Assumption Interest Wage Inflation Spread High 8.5% 5.5% 5.5% Low 7.0% 2.5% 2.75% Most Common 8.0% 3.5% 4.5% 34 As a general rule, the most important assumption is the spread. A high spread indicates a higher level of risk, which is similar to, but not necessarily identical to, the Equity Risk Premium share of the interest rate assumption.

Selection of Assumptions What Are They? Who Selects Them? Economic Demographic Economic Demographic Investment Return Payroll Growth Rate Population Growth Rate (Usually, a constant population size is assumed) Retirement Rates Promotional/Step Pay Increases Disability Turnover Mortality Board Actuary Other Advisors Mostly Actuary Board Approves 35

Changes in Major Assumptions Effect on Liabilities and Contributions Assumption Action Usual Effect Interest Rate Increase Decrease Wage Inflation Increase Increase Spread Increase Decrease Population Growth Increase Decrease Retirement Retire Younger Increase Turnover More Quits Decrease Mortality Live Longer Increase 36

Outlook for Public Sector DB Plans Fewer benefit enhancements New tiers for new hires More focus on actuarial assumptions DB Plans could be closed to new entrants Increased focus on Defined Contribution 37

Statewide Plan Prevalence Number Percent Single Employer 19 16% Agent Multiple Employer 11 9% Cost-Sharing Multiple Employer 91 75% Mixed 1 1% Total 122 100% Source: Public Plans Database of 122 state and large local retirement systems (mostly state systems) as of 2009 39

Agent Plans vs Cost Sharing Plans Cost Sharing Contribution rates more level and predictable Costs may not represent true cost for each system Less incentive to manage costs Agent Plans More representative of true cost of system Creates incentive to manage costs Cost for very small employers may be very volatile 40

41 PSPRS Valuations

Valuation Data Inputs 1) People 2) Plan Benefits 3) Assets 42

PSPRS Population Member Data 43

Development of Average Contribution Rates Applicable to Fiscal Years 2014-15 Contribution for Fiscal Year Pension Normal cost requirement Service pensions Disability pensions Survivors of active members Refunds of members' accumulated contributions Total normal cost requirement Employee Contributions Total employee rate Less portion not used to reduce employer's contribution Net employee rate Employer normal cost requirement Amortization of unfunded liabilities Total pension contribution requirement Health Normal cost requirement Amortization of unfunded liabilities Total health contribution requirement June 30, 2012 2013 2014 2015 17.28% 16.65% 1.73 1.77 0.59 0.59 1.09 1.19 20.69% 20.20% 10.35 11.05 2.70 3.40 7.65% 7.65% 13.04% 12.55% 16.01% 18.48% 29.05% 31.03% 0.33% 0.34% 1.06% 1.17% 1.39% 1.51% 44 Total contribution requirement 30.44% 32.54% On a Market Value basis, Contributions for FY ending June 30, 2015 would be about 35% of payroll.

Value of Assets ($ Millions) 2013 2012 Funding Value (FV) $6,185 $6,052 Market Value (MV) $5,557 $5,075 Ratio 111.3% 119.3% Difference between FV and MV $ 628 $ 977 Market Value Rate of Return 10.9% (0.8)% C-1 45

How Does Asset Smoothing Impact Future Valuations? Difference between Market Value and Funding Value 46 ($628 million) phased-in over six four years Valuation Date Scheduled Asset Gain/(Loss) Potential Contribution Increase 6/30/2014 ($330,133,818) 1.4% 6/30/2015 ($205,557,260) 0.9% 6/30/2016 ($13,260,293) 0.1% 6/30/2017 ($23,182,567) 0.1% 6/30/2018 ($65,659,551) 0.3% 6/30/2019 $9,994,296 (0.1%) Assumes Market Value earns 7.85% in the next 6 years

0-2 2-4 4-6 6-8 8-10 10-12 12-14 14-16 16-18 18-20 20-22 22-24 24-26 26-28 28-30 30-32 32-34 34-36 36-38 38-40 40 & Up Contribution Rates for Employer Groups 2013 Actuarial Valuation 236 Employers 45 44 40 35 30 28 25 22 20 15 17 15 15 17 12 11 10 5 0 0 0 6 0 2 6 7 8 5 6 6 9 Employer Contribution Rate as a Percentage of Active Member Payroll 47 A-4

Below 50% 50-60% 60-70% 70-80% 80-90% 90-100% 100-110% 110-120% 120-130% 130-140% 140-150% Over 150% Funded Ratios for Employer Groups 2013 Actuarial Valuation 236 Employers 50 45 46 41 40 35 30 35 30 25 20 25 20 15 10 10 14 7 5 3 1 4 0 Funded % 48 A-4

Contribution Rate Changes for Employer Groups - 2013 Actuarial Valuation 236 Employers 140 133 120 100 80 60 53 40 20 0 15 16 9 2 1 1 3 0 0 1 0 2 (5) and less (5)-(3) (3)-(1) (1)-1 1-3 3-5 5-7 7-9 9-11 11-13 13-15 15-17 17-19 19 and over Employer Contribution Rate Change as a Percentage of Active Member Payroll 49

50 PSPRS Experience Study

Experience Study Background PSPRS is a defined benefit plan Benefits are defined in the statute Benefits are paid at some future point in time when certain age and service requirements are met Actuary calculates the value of these benefits as of the valuation date Actuary must make assumptions about future events (investment return, wage inflation, withdrawal, disability, retirement, mortality, etc.) 51

Experience Study Background Primary Risk Areas Demographic Economic Retirement Price Inflation Withdrawal Wage Inflation Mortality Investment Return Disability Merit and Longevity 52

Experience Study Background The assumptions must be reasonable individually and in the aggregate The assumptions should be reviewed periodically in light of recent plan experience and economic environment Understated liabilities/costs can lead to: Inability to pay benefits when due, or Sharp increases in required contributions in the future 53

Experience Study Background Overstated liabilities/costs can lead to: Benefit levels kept below the level that could be supported by the computed rate, or Larger burden on the current generation of participants, employers and taxpayers A single set of assumptions is not suitable indefinitely Things change, along with our understanding of things Actuarial assumptions require regular updates 54

Experience Study Background The following changes were implemented in the June 30, 2011 valuation Investment return changed from 8.5% to 8.25% Wage inflation changed from 5.5% to 5.0% Cost Method changed from Projected Unit Credit to Entry Age Normal Investment return further changed to 8.00% in 2012 valuation 55

Experience Study Background For the 2011 experience study Demographic data was tabulated from the last 5 annual gain/loss analyses. Generally move rates about half way to observed rates over the most recent experience period. Philosophy: Don t overreact to results from any single experience period. It is better to make a series of small changes in the right direction, rather than a single large change that could turn out, with hindsight, to be very wrong. 56

57 Demographic Assumptions

Summary of Mortality Experience Post-retirement mortality additional margin is recommended for all 3 plans However, historical data does indicate differences between classifications of employees PSPRS recommend RP2000 projected to 2015 with 105% multiplier CORP recommend RP2000 (no projection) with 105% multiplier EORP recommend RP2000 projected to 2025 Pre-retirement mortality typically multiplied by lower multiplier members often leave employment (disability or sickness) prior to dying Disabled Mortality data set very small, typically use a set forward of the healthy table such as 10-year 58

Summary of 2011 Experience Study Demographic Results and Recommendations Decrement Change Impact on Plan Costs Mortality Rates decreased (life expectancies lengthened and future improvement) Increase Retirement Rates decreased Decrease Turnover (quits) Rates increased Decrease Disability Rates decreased Decrease Pay Increases Merit and Longevity Portion Increase assumed Merit and Longevity Increase 59

60 Economic Assumptions

Big Picture Interest Rate Assumption Purpose Key Assumptions That Relate to the Purpose What is This Measure Used For? Funding-Statutory Budgets To create a long term funding plan for the pension obligations Investment return assumption (7.85%) equals discount rate Develop the annual funding contribution to the trust Accounting-GASB Books To expense pension at same time as compensation and to the current generation of public service users GASB 25/27 rules: Same as funding GASB 67/68 rules: Possible lower rate Employers use this measure to implement a public accounting policy of assessing users costs to the appropriate users Rating Agencies Moody, S&P, Fitch Bonds To provide comparisons in the debt markets Discount rate of 5.5% (to compare private and public debt and measure budget strain) Debt buyers will have comparisons between offerings and similar market rates for the pension debt Financial Economics Pricing Market Value Liabilities Risk free discount rate (e.g., Treasury bond yield curve) Settlement on a plan termination basis 61

Current Economic Assumptions (2011 Study) Price Inflation Not explicitly defined Wage Inflation 5.00% (4.50% for EORP) Net Investment Return 8.25% in 2011 valuation 8.00% in 2012 valuation 62

Comments on Economic Assumption Selection We are not investment experts, we consider the following items: Historical Patterns Forward expectations of Investment Consultants Investment Policy Funding Levels Gain sharing mechanisms/cost of Living Increases Comparison to other Systems Actuarial Standards of Practice Typically a Board decision with input from Investment Experts and Actuary 63

Historical Price and Wage Inflation Annual Increase in Year Prices (CPI-U) Wages (NAE) Change 1957-1966 1.8% 3.4% 1.6% 1967-1976 5.9% 6.4% 0.5% 1977-1986 6.6% 6.5% -0.1% 1987-1996 3.7% 4.1% 0.4% 1997-2006 2.4% 4.1% 1.7% 2007-2011 2.3% 2.4% 0.1% 5-Year Avg 2.3% 2.4% 0.1% 10-Year Avg 2.5% 2.8% 0.3% 20-Year Avg 2.5% 3.5% 1.0% 30-Year Avg 3.0% 3.9% 0.9% 50-Year Avg 4.1% 4.8% 0.7% 64

Price Inflation Long term averages approach 4%, while shorter term averages range between 2% and 3% Investment consulting firm s expectations vary between 2% and 3% 2012 annual report of the Social Security Trustees uses 2.80% as the intermediate assumption Recommend setting this assumption at 3% Not explicitly used in valuation, but required by Actuarial Standards 65

Wage Inflation Long term averages approach 5% while shorter term averages vary between 3% and 4%. Results in a reasonable range of 3.5% to 4.5%. Average Salary increase for last 5 years: 2.8% for PSPRS 2.6% for CORP 2.9% for EORP Recommend changing to 4% for all plans. 66

Historical Patterns of Investment Return, Pay Increases and Inflation Sample Balanced Fund Equities 75% Bonds - Government 5% - Corporate 15% Cash Equivalents 5% 100% 67

Historical Patterns of Investment Return, Pay Increases and Inflation Gross Market Returns Calendar Bonds (Long) Cash Price National Sample Balanced Fund Year U.S. Corp. Equiv. Stocks Inflation Average Total Spread: Period Treasury (S&P AA) (T Bills) (S&P 500) (CPI) Earnings Return (I) I - NAE - e 1957-1966 2.9 % 3.3 % 3.0 % 9.2 % 1.8 % 3.4 % 8.0 % 4.1 % 1967-1976 4.3 % 5.4 % 5.6 % 6.6 % 5.9 % 6.4 % 6.6 % (0.3)% 1977-1986 9.7 % 9.9 % 9.1 % 13.8 % 6.6 % 6.5 % 13.0 % 6.0 % 1987-1996 9.4 % 9.5 % 5.5 % 15.3 % 3.7 % 4.1 % 13.7 % 9.1 % 1997-2006 7.8 % 7.7 % 3.6 % 8.4 % 2.4 % 4.1 % 8.5 % 3.9 % 2007 9.9 % 2.6 % 4.7 % 5.5 % 4.1 % 4.5 % 5.2 % 0.2 % 2008 25.9 % 8.8 % 1.6 % (37.0)% 0.1 % 2.3 % (25.1)% (27.9)% 2009 (14.9)% 3.0 % 0.1 % 26.5 % 2.7 % (1.5)% 19.6 % 20.6 % 2010 10.1 % 12.4 % 0.1 % 15.1 % 1.5 % 2.4 % 13.7 % 10.8 % 2011 28.2 % 18.0 % 0.0 2.1 % 3.0 % 4.4 % 5.7 % 0.8 % Last 5 Years 10.7 % 8.8 % 1.3 % (0.3)% 2.3 % 2.4 % 2.5 % (0.4)% Last 10 Years 8.9 % 8.3 % 1.8 % 2.9 % 2.5 % 2.8 % 4.6 % 1.3 % Last 55 Years 7.1 % 7.3 % 5.0 % 9.6 % 3.9 % 4.7 % 9.2 % 4.0 % 68

Investment Return Capital Markets GRS does not provide investment advice Looked at capital market assumptions from twelve different investment consulting firms Based on history but incorporates forward looking assumptions Shorter term horizon than actuaries May be a little biased by current conditions 45% investment in Alternative Investments make comparisons less accurate 69

Geometric Results over 20 Years 70 Investment Consultant Distribution of 20-Year Average Geometric Net Nominal Return Probability of exceeding Expected Nominal Rate 25th 50th 75th 8.00% * of Return** (1) (2) (3) (4) (5) (6) 1 4.52% 6.61% 8.74% 32.9% 7.55% 2 5.69% 7.32% 8.97% 39.0% 7.88% 3 4.97% 7.01% 9.09% 37.3% 7.91% 4 5.12% 7.16% 9.24% 39.2% 8.06% 5 5.65% 7.48% 9.33% 42.4% 8.19% 6 6.02% 7.87% 9.76% 48.2% 8.60% 7 5.50% 7.65% 9.85% 45.7% 8.65% 8 5.52% 7.68% 9.88% 46.0% 8.67% 9 5.29% 7.74% 10.24% 47.2% 9.02% 10 7.80% 9.59% 11.40% 72.6% 10.25% 11 7.16% 9.60% 12.08% 67.0% 10.84% 12 8.42% 10.20% 12.02% 79.8% 10.87% Average 5.97% 7.99% 10.05% 49.8% 8.87% * Plan's current return assumption net of expenses. ** Based on 3.0% Inflation assumption

Investment Return Comments Consultants not in agreement Significant range of results Results in range of 8.0% (median) to 8.9% arithmetic average (mean) Results do not take into account the COLA program 71

Investment Return Comments Value of COLA gain sharing program 2010 analysis placed a value of approximately 2% rate of return After changes in provisions to COLA program, value reduced to 0.5% Value of COLA program should be factored into investment return assumptions Proposed changes in GASB and ASOPs likely to recommend explicit assumption for gain sharing provision 72

Recent Changes by Other Systems (2011 data) Colorado PERA, 8.5% to 8.0% Pennsylvania PSRS, 8.5% to 8.25% effective 6/30/08, then to 8.0% effective 6/30/09 Pennsylvania SERS, 8.5% to 8.0% San Francisco City & County, 8.0% to 7.75% Virginia RS, 7.5% to 7.0% NY Common, 8.0% to 7.5% Indiana TRF, 7.5% to 7.0% Indiana PERF, 7.25% to 7.0% District of Columbia Retirement Board, 7.5% to 7.0% Illinois SERS and SURS, 8.5% to 7.75% Wisconsin, 7.8% to 7.2% New York City, 8.0% to 7.0% 73

Recent Changes by Other State Systems (2013-2014 data) Illinois SERS and SURS, 7.75% to 7.25% Louisiana Teachers, 8.25% to 8.0% Louisiana School Employees, 7.5% to 7.25% Missouri Highway, 8.25% to 7.75% 74

Investment Return Recommendation Recommendation is for continuation of the scheduled reduction in assumed investment return July 1, 2012 valuation 8.00% (already scheduled) July 1, 2013 valuation 7.75% (board adopted 7.85%) July 1, 2014 valuation 7.50% (board adopted 7.85%) Phase-in approach would allow for gradual adjustment in rates for plan sponsor, although System generally better with more money sooner Continue to monitor in light of performance and asset allocation changes 75

PSPRS - Summary Results Employer Contribution Rate Present Demographic Revised Demographic Assumptions 8.25%/5.0% 8.25%/5.0% 8.0%/5.0% 7.75%/4.5% 7.5%/4.0% 7.85%/4.5% Employer Normal Cost 12.61% 12.32% 13.32% 13.42% 13.52% 13.00% Amortization 14.57% 14.95% 15.57% 16.95% 18.44% 16.68% Total 27.18% 27.27% 28.89% 30.37% 31.96% 29.68% Funded Status Accrued Liabilities $9,365,260,877 $9,455,721,026 $9,707,184,628 $9,903,381,712 $10,107,681,513 $9,797,730,238 Funding Value of Assets 5,795,944,673 5,795,944,673 5,795,944,673 5,795,944,673 5,795,944,673 5,795,944,673 Funded Ratio 61.9% 61.3% 59.7% 58.5% 57.3% 59.2% 76

PSPRS Recent Timeline YEAR Audit #1 (Segal) 2005 Audit #2 (Audit of Audit by Milliman) 2007 GRS Hired 2009 Stochastic Projection Studies Part 1 2010 SB 1609 2011 Reversal of SB1609 2013 Stochastic Projection Studies Part 2 2014 Task Force begins 2014 78

Actuarial Audit #1 79 Limited Scope study Assumptions too aggressive 8.5% investment return 6.0% payroll growth 1971 mortality table Result is understated liabilities and contribution rates Recommended full replication audit and revise Valuation and Experience Study reports

Actuarial Audit #2 Full replication audit Assumptions too aggressive Projected Unit Credit cost method 8.5% investment return No recognition of PBI 30 year open amortization Use of outdated mortality Result is understated liabilities and contribution rates 80

Stochastic Studies Part 1 9.5% 9.0% 8.5% 8.0% 7.5% Median Return without COLA program 7.0% 6.5% 6.0% 5.5% 5.0% 2011 2014 2019 2024 2029 2034 2039 2044 2049 2054 2058 Year Median Compounded Return with COLA Program 81

Stochastic Studies Part 1 50.0% 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 2011 2014 2019 2024 2029 2034 2039 2044 2049 2054 2058 Year Median Contribution Rate with COLA Program Median Contribution Rate without COLA program 82

Stochastic Studies Part 1 Studies showed that current PBI program was very costly (produced 2.0% compound COLA on average) Either needed changes to program, or Advance fund with increases in contribution rates Over 50 separate plan design studies were conducted Input from Board, Legislature and Union Groups Changes to PBI program and Employee contribution rate had the most impact Result was SB1609 83

SB 1609 Key features Change PBI program for all members Investment threshold increased from 9% to 10.5% New funded status threshold of 60% created Maximum PBI based on funded ratio (varied from 2% to 4%) PBI fund no longer accumulates COLA delayed to age 55 for new hires Additional employee contributions to pay down unfunded liabilities (up to 4% of pay) Lower Tier of benefits for new hires 84

SB1609 Reversal Fields case restores original PBI formula for members who were retired as of June 1, 2011 Hall case (pending) would restore original PBI formula for current active members and reverse changes in the employee contribution rate 85

Impact on Employer Contributions Hypothetical Results as of June 30, 2013 - PSPRS Fields Fields and Hall Valuation Lawsuit Lawsuits Results Reversed Reversed Assumed COLA for future retirees 0.00% 0.00% 2.00% Assumed COLA for current retirees 0.00% 2.00% 2.00% Actuarial Accrued Liability (millions) - Future Retirees $ 5,402 $ 5,402 $ 6,274 - Current Retirees 5,142 6,309 6,364 - Total $10,544 $11,711 $12,638 Assets (millions) $ 6,185 $ 6,185 $ 6,185 Unfunded Liability $ 4,359 $ 5,526 $ 6,453 Funded Status 58.7% 52.8% 48.9% Contribution Rate - Employer Normal Cost 12.55% 12.55% 14.96% - 23 year amort UAL payment 18.48% 23.62% 27.53% - Total 31.03% 36.17% 42.49% 86 Note that contribution requirements for FY2016 are expected to increase due to continued phase-in of assets losses from prior years.

Stochastic Studies Part 2 As a result of the reversal of SB1609, a new set of studies have been conducted Plan Closure study (legislative) Plan Redesign study (fire proposal) Various other analysis 87

Plan Closure (sidebar) So why not just close the plan? For unfunded plans, closing plan is very expensive in the short term Open plans use level % of pay amortization Closed plans use level $ amortization Closed plans typically use lower investment return assumption Shorter time horizon Larger Liquidity needs 88

Amortization Examples Closed, level-dollar approach: Dollar payments remain level until end of amortization period Closed, level-percent-of-pay: Dollar payments start below level-dollar payments, but exceed the level-dollar payments after approximately 10 years Ultimately become substantially more than the payments under the level-dollar approach Open percent-of-pay approach: Payments remain below the closed level-dollar payments But continue to increase even after the end of the 25-year period and may continue for several decades 89

Amortization Example - Dollars $160,000 $140,000 UAL Amortization Pattern (in Dollars) 25 Year Closed, Level $ 25 Year Closed, Level % Pay 25 Year Open, % of Pay $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $- 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 Years 90

Percent of Payroll Amortization Example - % of Payroll 10.00% UAL Amortization Pattern (as a % of Payroll) 9.00% 8.00% 25 Year Closed, Level $ 25 Year Closed, Level % Pay 25 Year Open, % of Pay 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 Years 91

Plan Closure (sidebar) Interest Rate: 7.85% 7.85% 6.85% Amortization Method: Level % Level $ Level $ 1. Actuarial Liability (in millions) 2,264.9 2,264.9 2,491.4 2. Present Assets (in millions) 1,268.5 1,268.5 1,268.5 3. Ratio 56% 56% 51% 4. Unfunded Liability (in millions) 996.4 996.4 1,222.9 5. 23 Year Amortization Factor 16.35397 10.90564 11.80479 6. Amortization Amount 60.9 91.4 103.6 7. Amortization % 22.68% 37.15% 42.12% 8. Normal Cost % 13.38% 13.38% 17.38% 9. Employer Contribution % 36.06% 50.53% 59.50% 92

Plan Closure Study Study requested by legislature patterned after EORP Key features Close Defined Benefit Plan Create Defined Contribution Plan for new hires with 5% of pay employer match Employers contribute flat rate over 30 years: Pays off unfunded liability of DB plan at end of 30 years Pays annual normal cost of current DB plan members Pays 5% match for new DC members 93

Plan Closure Study Flat rate of 27.5% achieves only 42% funding in 30 years with 75% confidence. 94

Plan Closure Study By relying on difference between flat rate and 5% match of new hires 20 to 30 years from now, this structure results in backloaded contributions. As a result, structure is very sensitive to actuarial assumptions If investments earn 7% instead of 8%, contribution rates increase by about 4% of pay If payroll growth increases 3.5% instead of 4.5%, contribution rates increase by about 2% of pay If population declines by 10% instead of static, contribution rates increase by about 3% of pay If standard deviation of portfolio is 10.4% instead of 9.4%, contribution rates increase by about 3% of pay A single rate will not be suitable for all employers 95

% of Pay So Why Have Contribution Rates Been Increasing? PSPRS Contribution Rates 35.00 30.00 25.00 20.00 15.00 10.00 5.00-2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year Employer Normal Cost & Other Asset Loss Payroll decline Assumptions & Methods 96

So Why Have Contribution Rates Been Increasing? In most systems, assets losses and gains tend to offset each over time In PSPRS, asset gains also fund the Permanent Benefit Increases (PBI) The current return assumption is 7.85% One-half of excess return over 9% funds the PBI When markets are volatile, high returns will not completely offset the low returns 97

So Why Have Contribution Rates Been Increasing? Volatility Low High Average Average Measure Return Return Before PBI PBI After PBI +/- 1.00% 6.85% 8.85% 7.85% 0.00% 7.85% +/- 2.00% 5.85% 9.85% 7.85% 0.43% 7.64% +/- 3.00% 4.85% 10.85% 7.85% 0.93% 7.39% +/- 4.00% 3.85% 11.85% 7.85% 1.43% 7.14% +/- 5.00% 2.85% 12.85% 7.85% 1.93% 6.89% +/- 6.00% 1.85% 13.85% 7.85% 2.43% 6.64% +/- 7.00% 0.85% 14.85% 7.85% 2.93% 6.39% +/- 8.00% -0.15% 15.85% 7.85% 3.43% 6.14% +/- 9.00% -1.15% 16.85% 7.85% 3.93% 5.89% +/- 10.00% -2.15% 17.85% 7.85% 4.43% 5.64% 98

Other analysis All PBI s are not created equal Each Member receives the average PBI Total High Low 1. Average Monthly Retiree Benefit 4,133.0 7,200.0 1,208.0 2. PBI based on 4% average benefit 165.3 165.3 165.3 3. Ratio 4.0% 2.3% 13.7% 99

So what have other plans done with regard to COLAs? Wisconsin COLA is paid to retirees in the form of a dividend Prior dividends can be taken back if investments are poor Illinois 13 th check program is funded by employer contribution of.62% of payroll 100

So what have other agent plans done with regard to cost? Michigan MERS allows each employer to select from a menu of benefits based on what they can afford Illinois Allows larger employers to be individually rated and select assumptions based on their experience 101

Task Force key takeaways No easy solutions Current PBI structure is costly and difficult to manage Solutions must be carefully thought out and studied Consensus among stakeholders 102

103 Thank You

Disclaimers Circular 230 Notice: Pursuant to regulations issued by the IRS, to the extent this presentation concerns tax matters, it is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) marketing or recommending to another party any tax-related matter addressed within. Each taxpayer should seek advice based on the individual s circumstances from an independent tax advisor. This presentation shall not be construed to provide tax advice, legal advice or investment advice. Readers are cautioned to examine original source materials and to consult with subject matter experts before making decisions related to the subject matter of this presentation. 104 This presentation does not necessarily express the views of PSPRS, or of Gabriel, Roeder, Smith & Company, and may not even express the views of the speakers.

Arizona PSPRS Pension Task Force Actuary 101