Iowa Public Employees Retirement System Economic Assumptions Review - - PowerPoint PPT Presentation

Request for Proposals Actuarial Consulting Services April 13, 2010

Iowa Public Employees Retirement System

Economic Assumptions Review Presented By: Cavanaugh Macdonald

March 24, 2017

• 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

Background

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

Economic

• Price Inflation
• Investment Return
• Wage Growth
• COLA
• Interest Crediting

Rate

• Payroll Growth

Demographic

• Retirement Rates
• Promotional/Step

Pay Increases

• Disability
• Turnover
• Mortality

What Are They?

Who Selects Them?

Economic

• Board
• Actuary
• Other Advisors

Demographic

• Mostly Actuary
• Board Approves

4

5

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

6

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)

• 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,
• bservation 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

Actuarial Standard of Practice Number 27

7

Economic Assumptions Building Block Method

Investment Return Individual Salary Increases Wage Inflation

Real Rate

• f Return

Merit Scale Productivity Inflation Inflation Inflation Productivity

Note: inflation assumption and productivity must be consistent in all assumptions.

8

• 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
• ther 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

Inflation Assumption

9

• Considerations for setting the assumption
• Historical inflation
• Market expectations
• Social Security projections
• Peer group comparison

Inflation Assumption

10

Historical Inflation

(measured from 12/31/16)

11

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%

• 5%

0% 5% 10% 15%

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

Annual Rate

Calendar Year

Price Inflation

CPI-U

Annual 30-Year Average Assumed 3.00%

Peer Group Comparison Inflation Assumptions

Jul 20 13

Source: NASRA Public Fund Survey 12

• 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%

Analysis and Recommendation

13

• 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%)

Interest on Member Accounts

14

• 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)

Investment Return Assumption

15

• Retirement funding is a long-term concern and so

a long-term assumption is appropriate

Investment Return Assumption

16

ed

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% 10-Year Return: 6.31% 30-Year Return: 8.64%

• 20%
• 15%
• 10%
• 5%

0% 5% 10% 15% 20% 25% Annual Return Fiscal Year

Current actuarial assumed investment return = 7.50%* 30-year annualized return = 8.64% *Actuarial interest rate assumption: 1953 - 1993: 6.50% 1994 - 1995: 6.75% 1996 - present: 7.50%

IPERS Historical Fiscal Year Returns

17

• Trend has been to lower investment return assumption

Peer Group Comparison

18

Note: Investment mixes may differ significantly between funds

• 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

• f 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

Investment Return Assumption

19

Horizon Survey Assumptions (20-Year Assumptions)

20

0% 2% 4% 6% 8% 10% 12% 14%

Range of Assumptions by Advisors

Minimum Median Maximum

• Median (50th percentile) of expected returns using

Wilshire and Horizon’s capital market assumptions

Investment Return Assumption

21

Wilshire (10-Year) Wilshire (30-Year) Horizon (10-Year) Horizon (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.

Distribution of Expected Returns (Percentile Results)

22

3.1% 4.3% 5.0% 6.1% 6.3% 7.4% 7.6% 8.7% 9.5% 10.7% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 10 years 30 years

95th 95th 75th 75th 50th 50th 25th 25th 5th 5th

Using Wilshire’s capital market assumptions including inflation.

• 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

Analysis of Expected Return

23

• 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

Analysis of Expected Return

24

Expected Real Returns (40th-60th Percentile Results)

25

Percentile Wilshire 30-Year Horizon 20-Year

60th 5.58% 5.72% 55th 5.33% 5.46% 50th 5.09% 5.21% 45th 4.84% 4.96% 40th 4.59% 4.71%

• 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

Administrative Expenses

26

• Recommend decreasing investment return

assumption from 7.50% to 7.00%

Investment Return Assumption

27

Recommended Real Return 4.50% Inflation 2.60% Administrative Expenses (0.05%) Net investment return 7.05%

• Typically consists of price inflation and productivity

(standard of living increase)

• Historical data is based on the national average

wage index from Social Security Administration

General Wage Growth Assumption

28

Historical Statistics

(rolling 30-year periods)

29

0.01 0.02 0.03 0.04 0.05 0.06 0.07

Wage Inflation vs. CPI-U

Wage Index - 30-Year CPI - 30-Year

• Some Limitations

– Reflects entire workforce subject to FICA – Based on increases in average (mean) wage

• Over last 25 years, median real wage increase

was only 0.42% compared to mean wage increase

• f 0.77%
• Median real weekly non-farm wages increased
• nly 0.24% from 2005 to 2015

General Wage Growth Assumption

30

• Assumptions for Social Security projections (high,

intermediate and low cost) range from 0.5% to 1.8%, with 1.2% as the intermediate assumption

• Recommend reduction from 4.00% to 3.25% with

components shown below:

General Wage Growth Assumption

31

Current Proposed Price Inflation 3.00% 2.60% Productivity 1.00% 0.65% General Wage Growth 4.00% 3.25%

• Payroll growth assumption is used to determine the

amortization payment on Unfunded Actuarial Liability

• Unfunded Actuarial Liability is amortized as a level percent of

payroll

• Need an assumption about future payroll amounts over the

amortization period

• Current assumption is 4.00% composed of 3.00%

price inflation and 1.00% real wage growth

• With a given set of economic assumptions, a lower

payroll growth assumption provides a margin for adverse deviation

Payroll Growth Assumption

32

• Recommend no assumed growth in the size of the

active membership

• With a stable population, total covered payroll is

expected to grow with general wage growth

• Actual IPERS’ experience indicates covered payroll

growth near general wage growth, after adjusting for increase in active membership

• Recommend lowering payroll growth assumption

from 4.00% to 3.25%

Payroll Growth Assumption

33

Summary of Recommended Economic Assumptions

34

Assumption Current Recommended Price inflation 3.00% 2.60% Interest on Member Accounts 3.75% 3.50% Investment return 7.50% 7.00% General wage growth 4.00% 3.25% Payroll growth 4.00% 3.25% Effective June 30, 2017

• The change in investment return is the most

significant change

• Lowering investment return assumption results in

higher normal cost and actuarial liabilities

• Actual contribution rate impact will depend on

period over which the increased liability is funded

Cost Impact of Changes

35

• Amortization policy leaves duration of assumption

change to the Board

• Gains and losses are amortized over 20 years, so

assumption change should be no shorter

• Actuarial profession white paper suggests 15-25

years is ideal, but accepts that a longer period may be appropriate

• We suggest a period in the range of 20 to 30 years

Amortization of Changes

36

• Longer period results in lower contribution rates and,

therefore, less immediate impact on members and employers

• Shorter period pushes the System toward fully funding more

quickly (20 years from now instead of 30)

• IPERS Contribution Rate Funding Policy will tend to move the

System toward full funding by maintaining the higher contribution rates until each group reaches 95% funding

• This is the first time the Board has had to address this

situation, so no prior guidance

Board Considerations for Amortization Period

37

Cost Impact: Regular Members

(Using 6/30/16 Valuation)

38 Before Changes Amortize Changes Over 30 Years Amortize Changes Over 20 Years Actuarial Liability ($M) $32,578 $33,884 $33,884 Actuarial Value of Assets ($M) $27,001 $27,001 $27,001 Unfunded Actuarial Liability ($M) $ 5,576 $ 6,883 $ 6,883 Funded Ratio 82.9% 79.7% 79.7% Normal Cost Rate 10.20% 10.42% 10.42% UAL Amortization Rate 4.01% 5.19% 5.48% Actuarial Contribution Rate 14.21% 15.61% 15.90% Required Contribution Rate 14.88% 15.61% 15.88% Employer Contribution Rate 8.93% 9.37% 9.53% Employee Contribution Rate 5.95% 6.24% 6.35% Note: Numbers may not add due to rounding.

Cost Impact: Sheriffs/Deputies

(Using 6/30/16 Valuation)

39 Before Changes Amortize Changes Over 30 Years Amortize Changes Over 20 Years Actuarial Liability ($M) $625 $650 $650 Actuarial Value of Assets ($M) $602 $602 $602 Unfunded Actuarial Liability ($M) $ 23 $ 48 $ 48 Funded Ratio 96.4% 92.6% 92.6% Normal Cost Rate 16.41% 16.82% 16.82% UAL Amortization Rate 0.91% 2.30% 2.68% Actuarial Contribution Rate 17.32% 19.12% 19.50% Required Contribution Rate 18.76% 19.26% 19.50% Employer Contribution Rate 9.38% 9.63% 9.75% Employee Contribution Rate 9.38% 9.63% 6.75% Note: Numbers may not add due to rounding.

Cost Impact: Protection Occupation (Using 6/30/16 Valuation)

40 Before Changes Amortize Changes Over 30 Years Amortize Changes Over 20 Years Actuarial Liability ($M) $1,417 $1,471 $1,471 Actuarial Value of Assets ($M) $1,430 $1,430 $1,430 Unfunded Actuarial Liability ($M) $ (13) $ 41 $ 41 Funded Ratio 100.9% 97.2% 97.2% Normal Cost Rate 15.99% 16.37% 16.37% UAL Amortization Rate 0.00% 0.66% 0.85% Actuarial Contribution Rate 15.99% 17.03% 17.22% Required Contribution Rate 16.40% 17.03% 17.22% Employer Contribution Rate 9.84% 10.22% 10.33% Employee Contribution Rate 6.56% 6.81% 6.89% Note: Numbers may not add due to rounding.