Iowa Public Employees Retirement System Economic Assumptions Review Presented By: Cavanaugh Macdonald March 24, 2017 Request for Proposals Actuarial Consulting Services April 13, 2010
Background Assumptions have a significant impact on the calculation of liabilities and actuarial contribution rates Future benefit payments are dependent on number of contingent events that are unknown Actuaries use assumptions to estimate the timing, duration and amount of future benefit payments Assumptions will impact the allocation of costs so usually set neither overly conservative or aggressive Assumptions are just that – assumptions. If actual experience differs from the assumption over time, the costs will differ also 2
Purpose of Experience Study Provides basis for analyzing existing assumptions and developing recommended changes Actuary’s role is to make recommendations for each assumption As fiduciaries, the Board is responsible for the selection of actuarial assumptions Board can adopt all, none, or some of actuary’s recommendations Assumptions do not affect the true cost of the plan which is the actual benefit payments paid from the trust 3
Selection of Assumptions What Are They? Who Selects Them? Economic Demographic Economic Demographic • Price Inflation • Retirement Rates • Board • Mostly Actuary • Investment Return • Promotional/Step • Actuary • Board Approves Pay Increases • Wage Growth • Other Advisors • Disability • COLA • Turnover • Interest Crediting Rate • Mortality • Payroll Growth 4
IPERS Experience Study Performed every four years for IPERS Monitor all actuarial assumptions and methods used in the valuation process Last IPERS study covered fiscal years 2010 through 2013 Next study, covering fiscal years 2014 through 2017, is scheduled for June, 2018 Economic assumptions are being reviewed earlier at Board’s request 5
Actuarial Standards of Practice (ASOP) Issued by the Actuarial Standards Board Provides guidance to actuaries in the selection of assumptions used in valuing pension benefits Economic assumptions (ASOP 27) 6
Actuarial Standard of Practice Number 27 Recommendation is for a “reasonable assumption” Appropriate for purpose of measurement Reflects actuary’s professional judgment Takes into account historical and current economic data that is relevant Reflects actuary’s estimate of future experience, observation of estimates inherent in market data, or combination No significant bias (not significantly optimistic or pessimistic) Permissible to include some conservatism for adverse deviation Advises actuaries not to assign too much credibility to recent experience 7
Economic Assumptions Building Block Method Investment Individual Salary Wage Return Increases Inflation Real Rate Merit Scale of Return Productivity Productivity Inflation Inflation Inflation Note: inflation assumption and productivity must be consistent in all assumptions . 8
Inflation Assumption Price inflation represents annual increase in cost of living, measured by CPI Current assumption is 3.00% Indirectly impacts the valuation as a component of other economic assumptions Investment return General wage growth (which becomes part of individual salary increase assumption) Interest on member contribution balances Payroll growth for amortization of unfunded actuarial liability Dividend for pre-1990 retirees 9
Inflation Assumption Considerations for setting the assumption Historical inflation Market expectations Social Security projections Peer group comparison 10
Historical Inflation (measured from 12/31/16) Price Inflation CPI-U 15% 10% Annual Rate 5% 0% 1945 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 -5% Calendar Year Annual 30-Year Average Assumed 3.00% Period Inflation Period Inflation 90 Years 2.94% 30 Years 2.65% 60 Years 3.70% 20 Years 2.15% 50 Years 4.09% 10 Years 1.76% 40 Years 3.66% 11
Peer Group Comparison Inflation Assumptions Jul 20 13 12 Source: NASRA Public Fund Survey
Analysis and Recommendation Bond Market Pricing – Difference between 30-year Treasuries and TIPS as of 12/31/16 was 2.1% Investment consultants’ median long -term inflation assumption is around 2.3% Social Security Administration intermediate assumption – 2.6% over next 75 years Data and analysis supports lowering the inflation assumption Recommend reducing inflation assumption from 3.00% to 2.60% 13
Interest on Member Accounts Law sets interest rate at 1% above 1-year CD rates. Analyzed last ten years of actual interest credited compared to inflation Average was 1.01% above inflation Recommend assumption change from 3.75% to 3.50% (inflation assumption of 2.60% + 0.90%) 14
Investment Return Assumption Building block approach Rate of price inflation (previously addressed) Real rate of return Sum is expected investment return Asset allocation is the key factor in setting this assumption Portfolios that are more aggressive can generally expect higher returns along with potentially greater volatility Most powerful assumption in valuation Small changes can have large impact on liabilities and contribution rates Current assumption: 7.50% (3.0% inflation + 4.5% real return) 15
Investment Return Assumption Retirement funding is a long-term concern and so a long-term assumption is appropriate 16
IPERS Historical Fiscal Year Returns ed 25% Current actuarial assumed investment return = 7.50%* 20% 30-year annualized return = 8.64% 15% 10% Annual Return 5% 0% -5% -10% -15% -20% Fiscal Year *Actuarial interest rate assumption: 1953 - 1993: 6.50% 1994 - 1995: 6.75% 1996 - present: 7.50% ANNUALIZED RETURNS through 6/30/16 1-Year Return: 2.15% 15-Year Return: 6.62% 3-Year Return: 7.17% 20-Year Return: 7.85% 5-Year Return: 7.06% 25-Year Return: 8.43% 17 10-Year Return: 6.31% 30-Year Return: 8.64%
Peer Group Comparison Trend has been to lower investment return assumption Note: Investment mixes may differ significantly between funds 18
Investment Return Assumption Forward looking analysis using capital market assumptions Wilshire (2017 assumptions) 2016 Horizon Actuarial Survey 2016 Horizon Actuarial Survey includes capital market assumptions for 35 investment consultants of which 12 provided both short-term and long-term assumptions Consider all information, but recognize Wilshire has greater knowledge and insight into the IPERS portfolio 19
Horizon Survey Assumptions (20-Year Assumptions) Range of Assumptions by Advisors 14% 12% 10% 8% 6% 4% 2% 0% Minimum Median Maximum 20
Investment Return Assumption Median (50 th percentile) of expected returns using Wilshire and Horizon’s capital market assumptions Wilshire Wilshire Horizon Horizon (10-Year) (30-Year) (10-Year) (20-Year) Real Return 4.33% 5.09% 4.29% 5.21% Inflation 1.95% 2.33% 2.16% 2.31% Nominal Return 6.28% 7.42% 6.45% 7.52% Note: Each investment consultant’s inflation assumption is reflected here. 21
Distribution of Expected Returns (Percentile Results) 11.0% 10.7% 95 th 10.0% 9.5% 95 th 9.0% 8.7% 75 th 8.0% 7.6% 75 th 7.4% 50 th 7.0% 6.3% 50 th 6.1% 25 th 6.0% 5.0% 5.0% 25 th 4.3% 5 th 4.0% 3.1% 5 th 3.0% 10 years 30 years Using Wilshire’s capital market assumptions including inflation. 22
Analysis of Expected Return Significant difference between expected returns in short term and long term Options to address this issue: Maintain long-term assumption that is significantly higher than short-term expectations Lower return assumption to expected return in short-term Use select and ultimate approach to setting the assumption (one assumption for 10 years and different assumption thereafter) Use a single return assumption that blends both short- term and long-term return expectations 23
Analysis of Expected Return Need to maintain long-term perspective Material difference in short and long-term return expectations are hard to ignore given impact on funding of System Real rate of return expectations (Wilshire) Short term: 4.33% Long term: 5.09% Current assumption of 4.50% lies between the two with heavier weighting to short term, similar to system liabilities 24
Expected Real Returns (40 th -60 th Percentile Results) Percentile Wilshire Horizon 30-Year 20-Year 60 th 5.58% 5.72% 55 th 5.33% 5.46% 50 th 5.09% 5.21% 45 th 4.84% 4.96% 40 th 4.59% 4.71% 25
Administrative Expenses Past practice set the investment return assumption as net of administrative expenses Average expense ratio over the last 9 years is approximately 0.05% Small adjustment needed to account for administrative expenses 26
Investment Return Assumption Recommended Real Return 4.50% Inflation 2.60% Administrative Expenses (0.05%) Net investment return 7.05% Recommend decreasing investment return assumption from 7.50% to 7.00% 27
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