Risk Management: Analytics & Better Methods for Public Safety - PowerPoint PPT Presentation

NCPERS 2016 Public Safety Employees Pension & Benefits Conference October 24, 2016 Risk Management: Analytics & Better Methods for Public Safety Pension Sustainability Leon F. (Rocky) Joyner, Jr. Elizabeth Wiley Vice President & Actuary Consulting Actuary Segal Consulting Cheiron Atlanta, GA McLean, VA

Introduction  Risk is a major concern facing public sector pension plan sponsors, boards and stakeholders.  Identifying and addressing risk appropriately requires an understanding of what the risks are and what information is needed to take action.  Certain tools identify and quantify the types of risk and their magnitude.  Plan sponsors and boards can then make more informed and better decisions for the long term. In this presentation, we will discuss the risks we see today and unfolding in the future 2

Fundamental Risk  Fundamental risk for a pension plan is not being able to make benefit payments with a sustainable contribution  Basic equation being managed is the same for all plans: C + I = B + E Contributions + Investment Income equals Benefit Payments + Expenses 3

Plan Risks Public Sector pension plans have aging populations… Source: Center for Retirement Research at Boston College Public Plan Database 4

Plan Risks …and are getting larger with respect to their sponsoring entities Source: Center for Retirement Research at Boston College Public Plan Database 5

Identification of Risks Risks related to Risks related to Risks related to economic variables demographic events external forces  Investment return  Mortality  Governance risk  Inflation  Payroll and/or  Regulatory risk population growth – Price inflation  Litigation risk  Retirement, disability, – Wage inflation  Political risk termination These risks are These risks are challenging to manage challenging to manage effectively effectively 6

Interest Cost  Compare actual contribution made to normal cost + interest on unfunded actuarial liability (UAL)  Interest on UAL = discount rate x (AL – MVA) / Payroll  Highlights negative amortization  Interest cost correlates generally with funded status as smaller balance to pay interest on if better funded  Negative amortization is not inherently wrong, but needs to be understood  Potential PR risk should be considered 7

GASB 67/68 PR Risk 8

Risk is Very Much in the Eye of the Beholder Investment Returns Changing Workforce Mortality/Longevity and Volatility Demographics  Plan Sponsor:  Plan Sponsor:  Plan Sponsor: Costs will fluctuate Longer life Aging population and may increase to expectancies may result in cost unsustainable levels translate to higher increases  Member: Benefits  Member: Benefits contributions  Member: Benefits levels may change or levels may change or contributions may may not retain contributions may increase purchasing power increase 9

Creating a 7.5% Return Portfolio  Reduced inflation expectation has reduced investment returns  More risk is needed now to achieve 7.5% expected return  7.5% portfolio has standard deviation of 17% now vs. 6% twenty years ago 10

Mortality/Longevity Risk Continued improvements in mortality = longer periods of payment and higher costs Life expectancy of a male retiree at age 65 Age at July 1, 2015 65 45 25 RP-2000 Healthy Annuitant w/Scale AA 84.7 86.1 87.4 RP-2014 Healthy Annuitant w/Scale MP-2015 86.6 88.2 89.9  New table increases liability by 3% to 5%  Lump sum payment = increased chances of retirees outliving their benefits  Is the actuary accurately projecting the future increases in lifespan?  If not, losses will be created 11

Workforce Demographic Risk  Pension plan populations are  Ratio of non-actives to actives getting older  Sign of Plan maturity  Baby boomers aging  More pressure on investments  Difficult to restore financial health  Older participants are closer to after losses payment and generally more expensive than those that are younger – Less future benefits to reduce – Less contributions to increase  Higher ratios of actuarial accrued liability to payroll and market value of assets to payroll exacerbates the impact of investment losses on contributions 12

Analytic Method Approaches  Looking at just a valuation is not enough 13

The Cheiron Advantage Analytic Method Approaches  Need to consider past, present, and future 14

Risk Management Process  Identify the key risks threating the plan  Decide metric to use to evaluate the risk  Maturity examples: liability distribution by active and inactive, membership ratios, etc.  Funding examples: funded ratio, amortization period, unfunded per member, etc.  Consider if you want to look at historic metrics, projected metrics, or both for each metric  Develop policies to manage risks based on identified metrics  Evaluate selected metrics  Respond as required  Revise policies in response to experience and changing circumstances 15

Risk Identification  Example of risk identification from STRS Ohio 16

Metric Selection  There are many possible metrics  Typically no single “right” answer  Instead need to select metric appropriate for the specific plan  Consider characteristics such as maturity and net cash flows  Also consider characteristics of sponsor  Have to balance cost and benefit in selecting options  “Cost” is primarily the time and expenses to develop an option  “Benefit” is the additional information obtained to assist decision makers  Generally projections cost more than historical measures  Developing a multi-year history generally low-cost if done on a prospective basis  As such, we show a few metrics as examples 17

Historic Maturity Metrics  Currently, maturity metrics typically only developed for historic period  However, relatively low cost to develop these if have projections Actuarial Liability Actives Terminated Vesteds In-Pay Members Payroll 70 1.2 1.3 1.3 $2.0 1.4 In Pay 1.5 Counts in Thousands Payroll in Billions 1.5 1.6 Status 60 1.5 1.6 32% 1.7 1.7 1.7 1.8 1.9 $1.6 2.0 50 2.0 Active 2.1 Deferred 2.0 2.1 67% Vested 2% 40 $1.2 2004 Actuarial Liability 30 $0.8 20 Active $0.4 40% 10 In Pay Status 58% 0 $0.0 Deferred Vested 2014 2% June 30, 18

Historic Funding and Contribution Metrics  These should be considered over historic periods longer than just two years Member Contribution State Contribution PRI Transfer State ADC Rate * State Normal Cost $300 14%  Should also consider projections 12% $250 Millions 10% $200 8% $150 6% $100 4% ADC versus Actual Contribution $50 2% $0 0% 50.00% Actuarially Determined Contribution (ADC) 45.00% Fiscal Year Ending Actual Contribution Made 40.00% 35.00% PVAB AL PVB AVA MVA 30.00% $12 Billions 25.00% $10 20.00% 15.00% $8 10.00% 5.00% $6 0.00% $4 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 $2 $0 June 30, 19

Projected Funding and Contribution Metrics  Deterministic projections should be completed at a minimum, including potential membership and asset changes  Should consider value of stochastic projections 20

Historic Assumption Risk Metrics  Look at gain/loss historical experience – macro  Consider stress testing projections for key assumptions such as return and mortality 21

Projected Assumption Risk Metrics  Rate of return assumption most commonly tested  In addition to deterministic testing, can also examine stochastic results 22

Metric Implementation  Risk metrics provide important information, but can be challenging to implement  One solution is to develop a “scorecard” based on the identified metrics for your system 23

Questions 24