Transcript Document

Experience Studies 101
Presented by
Daniel Wade, FSA, EA, MAAA
June 23, 2010
Overview
What is an Actuarial Valuation?
What is studied during an Experience Study?
How are actuarial assumptions developed?
When is an Experience Study performed?
Analysis of individual assumptions
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What is an Actuarial Valuation?
 It is a measurement at a point in time - the valuation date - of the cash
flows that are expected to come in and go out in the future.
 Present Value of Benefits (PVB) calculated by discounting the cash
flows at the investment return assumption (discount rate).
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Funding a Retirement Program
C
I
C = Contributions
I = Investment Income
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B E
B = Benefits
E = Expenses
Actuarial Cost Method
 The actuarial cost method allocates the financing of benefits to
periods:
– before the valuation date (Actuarial Accrued Liability, AAL)
– after the valuation date (Present Value of Future Normal Costs, PVFNC)
– PVB = AAL + PVFNC
– Normal Cost is for costs allocated to the current year
 SBCERS uses Entry Age Normal Cost method, which allocates based
upon a level percentage of pay throughout each employee’s career
from entry to exit.
 Entry Age Normal Cost method keeps Normal Costs fairly level as a
percentage of payroll over time.
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PVB Exceeds Assets and Future Normal Costs
A
PVFNC
PVB
A = AVA , Actuarial Value of Assets
PVFNC = present value of Future
Normal Cost Contributions
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PVB = Present Value of Benefits
UAAL Brings Equation into Balance
A
PVFNC
UAAL
PVFNC = Future Normal Cost Contributions
UAAL = Unfunded Actuarial Accrued Liability
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PVB
PVB = Future Benefits
A = Current Assets
How are contributions determined?
 Unfunded Actuarial Accrued Liability (UAAL) is determined by
subtracting smoothed value of assets from AAL.
 UAAL = AAL – Assets  Assets + UAAL = AAL
 UAAL is amortized over 17 years per the Board Funding Policy.
 Contribution = Normal Cost plus Amortization of UAAL.
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Where does the actuary get these numbers?
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What is studied during an Experience Study?
 All Actuarial Assumptions that are used in the Actuarial Valuation
 Two Types of Actuarial Assumptions
– Economic
•
Governed by Actuarial Standards of Practice (ASOP) No. 27
– Noneconomic (demographic)
•
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Governed by ASOP No. 35
Actuarial Economic Assumptions
 Investment Rate of Return
(discount rate on value of money)
 General Wage Increase
(general economic increases over time)
 Price Inflation – (Consumer Price Index, CPI)
 Growth in size of work force
– not acceptable for Governmental Accounting Standards Board (GASB)
purposes
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Noneconomic Assumptions
 Promotional Salary Increases (occurs during an individual’s working
career)
 Retirement
 Disability
 Mortality
– Active/Retired
 Termination of Employment
– Refunds of contributions
– Vested Terminations
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Noneconomic Assumptions (continued)
 Terminal Pay Assumption
– Previously no terminal pay assumed; will review this assumption with
2010 Experience Study
 Miscellaneous Assumptions
– Probability of Eligible Survivor
– Beneficiary Age
– Retirement Age for Vested Terminated Members
– Reciprocity
– Health Plan Participation Percentage (for OPEB valuation)
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Trends in Actuarial Assumptions
(Arrows reflect financial impact)
Decreases in assumption rates
– Termination of Employment ()
– Net Rate of Investment Returns ()
– Price Inflation ( )
– Salaries (merit) ()
– Mortality ()
– Refunds ()
– Retirements ( )
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Actuarial Risk
 If actuarial results overestimate ultimate costs
– justified contribution reductions may be inappropriately denied
 If actuarial results underestimate ultimate costs
– inappropriate benefit increases may be approved or future taxpayers may
bear the burden of benefits earned today
 We only know the ultimate cost after the last person dies.
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How are actuarial assumptions developed?
 Estimates for Future Results are based on a mixture of:
– Past Experience
– Future Expectations
– Professional Judgment
 Economic Assumptions
– ASOP 27 explicitly advises against giving undue weight to recent
experience
 Demographic Assumptions
– Based primarily on recent experience
– As with economic assumptions, past performance is no guarantee of
future results. However, it is the best tool we have for predicting
demographic experience.
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When are Experience Studies performed?
 Periodic Experience Studies are the norm for public sector pension
plans.
 Rarely done for corporate pension plans.
 Section 31453 of 1937 Act implies Experience Studies at least once
every three years.
 SBCERS performs one every three years.
 Next one is set for June 30, 2010 and will cover the period from
July 1, 2007 through June 30, 2010.
 Will be completed before the June 30, 2010 Actuarial Valuation. Will
serve as basis for the Actuarial Valuation.
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Analysis of Individual Assumptions
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Consumer Price Index (CPI)
 Used as a component of investment return assumption, general wage
increases and the payroll increase assumption.
 Current Assumption is 3.50% per year.
 Long-term historical data is considered.
 US Treasury issues Treasury Inflation-Protected Securities (TIPS).
-
Implicit market expectations can be determined from TIPS yields.
 Forecasts Considered:
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SBCERS investment consultant – Pension Consulting Alliance (PCA).
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Milliman investment consultants.
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Trustees Report for Social Security Administration
 Will likely recommend that this assumption be lowered this year.
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Investment Return Assumption (Discount Rate)
 Capital market assumptions are made for expected real return and
volatility of each asset class. Correlations between asset classes are
also required.
 Capital market assumptions from PCA and Milliman.
 Based upon capital market assumptions and target asset allocations,
expected real rates of return are determined, along with variance.
 Real returns added to CPI assumption.
 Historical returns given little weight.
 If Excess Earnings are expected to be used for non-valuation benefits
in the future, the assumption should be lowered.
 Current assumption is 8.16%. Likely to recommend lower rate this
year regardless of Excess Earnings issue.
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Wage Growth
Future Salary Increases made up of two components:
1. General Wage Increases
2. Individual Increases due to promotion and longevity
General Wage Increases made up of two components:
1. Consumer Price Index
2. Real Wage Inflation
Current Assumption is 4.00%, 3.50% for CPI and 0.50% for Real
Wage Inflation.
Long-term historical data is considered.
Trustees Report for Social Security Administration considered.
We may recommend Real Wage Inflation increase this year, while
CPI will likely decrease. Not clear what net impact will be.
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Promotional Salary Increases

Generally decrease as length of service increases.

Sometimes based upon age, but service is a better predictor.

Split by General (including APCD) vs. Safety.

First calculate general wage growth.

Determine promotional increase by removing general wage growth
from total wage increase.

Higher rates mean higher liabilities.
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Promotional Salary Increases
6.00%
Increase Net of Wage Growth
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
Years of Service
Actual
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Alternative Assumptions
Old Age Assumptions
Service Retirement

Generally increases with age
–
Can be spikes at first eligibility
–
Can also be spikes at ages 62 and 65 due to Social Security and
Medicare eligibility
–
Can also be spikes when benefits maximize at 100% of Salary

Patterns can vary by sex

Patterns will vary by General vs. Safety

Patterns will likely vary by Safety Plan 4 vs. Safety Plan 6 as different
benefit structures affect behavior
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Service Retirement
110%
100%
90%
Annual Rate
80%
70%
60%
50%
40%
30%
20%
10%
0%
50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74
Age
Milliman Actual
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Old Assumptions
Proposed
Disability Retirement

Generally increases with age

Safety has higher rates

Split by Service-Connected and Non-Service-Connected
–
General Service-Connected is infrequent; can be hard to study

Can vary by sex

Higher rates will mean higher liabilities as benefits are greater than
service retirement benefits.
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Terminations
(Refund of Contributions and Vested Terminations)

Rates generally decrease when service increases

Sometimes based upon age, but service is a better predictor

Sex distinct patterns are common

General rates differ from Safety rates

Usually study the total terminations, then develop separate, servicebased assumption for likelihood of taking a refund by withdrawing
contributions
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Terminal Pay Assumption

Additional pay can be received during final pay period for vacation
cashouts and other items

Final Average Earnings can be increased as a result

Do not currently reflect in the valuation assumptions

Will study during upcoming Experience Study

May result in higher contribution rates
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Mortality

Separate assumptions for disabled vs. service retirees

Higher rates for males

Higher rates for disabled

General Approach is to take standard mortality table and make
adjustments for System’s experience

–
Currently use RP-2000, setback 3 years for Males
–
RP-2000, setback 2 years for Females
To reflect future improvements in mortality, a margin is used
–

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The actual deaths for the study period should be greater than those
implied by the assumption table
Over time, margins will fade as longevity continues to increase
Mortality (continued)
30%
Annual Rate of Death
25%
20%
15%
10%
5%
0%
55
60
65
70
75
80
Age
Actual
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Old Assumptions
Proposed
85
90
Questions?
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Caveats and Disclaimers
Milliman's work product was prepared exclusively for SBCERS for a
specific and limited purpose. It is a complex, technical analysis that
assumes a high level of knowledge concerning SBCERS’s
operations. It is not for the use or benefit of any third party for any
purpose. Any third party recipient of Milliman's work product who
desires professional guidance should not rely upon Milliman's work
product, but should engage qualified professionals for advice
appropriate to its own specific needs.
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