public plan funding standards david t. kausch, … docs/annual...for example, in the may 31, 2016...

National Conference on Public Employee Retirement SystemsNational Conference on Public Employee Retirement Systems

Public Plan Funding StandardsDavid T. Kausch, FSA, EA, FCA, MAAA

NCPERS 2018 Annual Conference & ExhibitionMay 13 – 16New York, NY

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Agenda

• Why Are We Here?• Where Have We Been?• Where Are We Now?• Where Are We Heading?

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WHY ARE WE HERE?

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Why Are We Here?

Purpose of prefunding– Benefits have been promised to members– Prefunding calls for contributions to meet this commitment– Assets are set aside to help pay benefits when they come due– Trustees have a duty to administer those benefits

The determination of contributions depends on funding objectivesFunding objectives may change over time

What are public plan funding standards?

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WHERE HAVE WE BEEN?

Using the past to predict the future is like driving down a road while looking out the back window

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In the Good Old Days

Governmental Accounting Standards Board (GASB) Statement Nos. 25 and 27 called for the Annual Required Contribution (ARC)

There was flexibility in selecting a funding policyBut the ARC was an actuarially determined employer contributionOften the main policy objective was to keep the contribution rate level as a percent of payroll (even if this was not explicitly stated)

Generally, the default funding policy became – Entry Age Normal Cost plus– 30‐year level percent of payroll amortization

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Funding or Accounting?

Those GASB standards had effectively become funding standardsBut the GASB sets accounting standards, not funding standardsTherefore, the GASB began in 2006 (before the Great Recession) to review and update the accounting standards– GASB Statement No. 67 became effective for plans in 2014– GASB Statement No. 68 became effective for employers in 2015

These are accounting standards, but they are linked to funding– Determination of the GASB discount rate depends on funding policy

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Funding or Accounting? (Continued)

With the release of GASB Statement Nos. 67 and 68 and the corresponding departure from determining the ARC, the question remained:


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WHERE ARE WE NOW?

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Where Are We Now?

Several organizations have responded to this question including the– American Academy of Actuaries Objectives and Principles for Funding Public Sector Pension Plans,

– Conference of Consulting Actuaries white paper on Actuarial Funding Policies and Practices for Public Pension Plans,

– Government Finance Officers Association Core Elements of a Funding Policy,

– Society of Actuaries Blue Ribbon Panel on Public Pension Plan Funding, And more recently– Actuarial Standards Board’s Pension Task Force Report.

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Funding Policy ObjectivesMany themes emerged including funding policy objectives

– Funding adequacy– Intergenerational equity– Contribution stability

These objectives and conventional actuarial principles support the level cost actuarial modelNew focus on level percent of payroll amortization

– Old habits• Rolling or open amortization• Long periods• Negative amortization

– New policies• Closed amortization periods• Shorter periods• Amortization layers

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Funding Policy Objectives (Continued)

The Society of Actuaries Blue Ribbon Panel Report went further and called for – Benefit security added as a policy objective– Contribution benchmarks

• Normal cost plus 15‐year amortization– Risk assessment

• Sensitivity analysis, stress testing– Solvency Liability disclosure


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WHERE ARE WE HEADING?

“The future ain’t what it used to be.”‐ Yogi Berra

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What are Public Plan Funding Standards?

Question still remained about public plan funding standardsThe Actuarial Standards Board (ASB) created the Pension Task Force in response to the SOA Blue Ribbon Panel (and others)

The Pension Task Force was charged with– Reviewing actuarial practice regarding public plan funding– Identifying whether changes to Actuarial Standards of Practice (ASOPs) – or even brand new standards – were needed

– Suggested changes to the ASOPs based on their research

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Actuarial Principles

Some background on the Actuarial Standards of Practice (ASOPs)The ASOPs are

– An actuary’s guide on appropriate actuarial practice– Principles based

The ASOPs are not– “Best” practices– Rules based

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Actuarial Principles (Continued)

Even though the ASOPs are not best practices or rules based, they do give guidance on principles of plan funding

The ASOPs have historically given guidance on actuarial cost methods and selecting assumptions

Some of this guidance sounds straight‐forward– a contribution allocation procedure should be consistent with the plan accumulating adequate assets to make benefit payments when due

– Assumptions and methods must be reasonableThe Pension Task Force report suggested strengthening the ASOPsAs a result, the ASB issued exposure draft of changes to ASOP Nos. 4, 27, and 35

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Reasonable Actuarially Determined Contribution

One noticeable proposed change to the ASOPs is that the actuary must opine on a reasonable Actuarially Determined Contribution (ADC)

A reasonable ADC should– Follow all the current requirements of the ASOPs– Base an individual’s normal cost on the benefits applicable to that individual (no “ultimate” normal cost)

– Constrain amortization to• Consider the sources of any unfunded actuarial accrued liability (i.e., layers)• Payment must either be greater than the nominal interest on the unfunded actuarial accrued liability or pay off the unfunded actuarial accrued liability in a reasonable time period (i.e., no rolling negative amortization)

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Funding Policy Objectives

The Pension Task Force suggested that the actuary consider– Benefit security– Intergenerational equity– Contribution stability and predictability

Note that funding adequacy has been replaced with benefit security Additional disclosures will also be required for plans with inadequate funding policies

–In particular, if applicable•Include estimates of plan depletion if all assumptions are met•Disclose negative amortization and how long it will last•Disclose the history of actual to recommended contributions

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Disclosure of “Solvency” Liability

Another noticeable change is the requirement to disclose the “Investment Risk Defeasement Measure” (IRDM)– Formerly referred to as Solvency Liability– This is a market‐based liability measurement– The discount rates used to determine the IRDM are determined by either spot rates associated with the yields on U.S. Treasuries or rates at which the pension obligation can be effectively settled

– The actuarial cost method is changed to take into account only benefits accrued to date, the unit credit method

IRDM will generally be much higher and more volatile than actuarial accrued liability

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The Purpose of IRDM

The Pension Task Force suggests that the IRDM– Gives the intended users an understanding of how much the plan sponsor would need in assets to secure the accrued benefit promises made to members of the plan

– Gives the intended users an understanding of the risk to members’ benefits if the plan were to be wound up and the sponsor were unable to make up any shortfall

– Provides information about the amount of risk being taken by the plan

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Key Point about the IRDM

Actuarial principles generally allow us to presume all assumptions will be met in the long run

What if they aren’t?In public plans, there is also a presumption that the plan sponsor will always be ready, willing, and able to provide additional funding if experience is worse than assumed

What if they aren’t?If we are never going to receive another dollar from the employer, how much do we need to set aside to insure against investment risk? IRDM gives us an estimate

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Enhanced Disclosures

The Pension Task Force also had suggestions on assumptions– Require a clear statement by the actuary that assumptions are (or are not) reasonable

– Clarification that the rationale for assumptions must include the reasons why the actuary thinks they are (or are not) reasonable

– Phase‐in of assumptions is only allowed if each assumption used at each step of the phase‐in is reasonable

– Consider whether additional analysis is needed (e.g., experience studies, gain/loss analysis, etc.)

– Disclose the length of time since an assumption was reviewed and the basis of each assumption

– Consider recently published mortality tables

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Risk AssessmentIn addition to the Pension Task Force suggestions, there is a new ASOP on

assessing and disclosing risk associated with measuring pension obligationsBroadly speaking, risk means outcomes other than expected and their

associated impactRisk assessment may be qualitative or quantitativeQuantitative risk assessment may include

– Sensitivity analysis (e.g., +/‐1% change in discount rate)– Scenario testing– Stress testing– Stochastic analysis

The actuary may recommend any (or none) of these

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Risk Assessment – Plan Maturity Metrics

Retirement plans have a life cycle analogous to an individual– An immature plan may have mostly active members with contributions coming into the plan and little to no benefits being paid out • Relatively large positive cash flow into the plan

– A mature plan may have a mix of actives and retirees with contributions coming in and benefits being paid out • Modest positive or negative cash flow into/out of the plan

– A super mature plan may have mostly retirees with little to no contributions coming in and benefits being paid out • Relatively large negative cash flow out of the plan

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Risk Assessment – Plan Maturity Metrics (Continued)

The new Risk ASOP requires disclosure of plan maturity metrics that are significant to understanding the risks associated with the plan

Some suggested metrics are– The ratio of actives to retirees– The ratio of assets to payroll– The net cash flow as a percent of assets– The duration of liability

These metrics will likely change over time as a plan matures A historical schedule of these metrics can illustrate trends

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An Example of Risk Assessment

Consider the plan maturity metric: ratio of assets to payrollIt is not uncommon for a plan to have a current ratio of assets to payroll of about 4

20 years ago, it would not have been uncommon for the same plan to have a ratio of assets to payroll of 2

In this example, the ratio doubled in 20 yearsBy itself, the metric is abstractWhat does this say about risk? In particular, what can we say about contribution volatility?

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An Example of Risk Assessment (Continued)

Investment Consultants may point out that risk in the market has increased in recent years

For example, in the May 31, 2016 Wall Street Journal article, Callan Associates Inc., indicated that in order to achieve a 7.5% assumed rate of return the standard deviation of returns (one measure of investment risk) would have had to increase from 6.0% in 1995 to 17.2% in 2015 – increased by a factor of almost 3 in 20 years

Clearly, this has implications on investment volatility The combined risk multiplies: the standard deviation of returns on assets would have increased by a factor of 6 over 20 years

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An Example of Risk Assessment (Concluded)

What does this tell us?The rule of thumb with standard deviation of returns is

– Two out of every three years we expect that the return will be within one standard deviation of the expected return

– That means one out of every three years we expect the return to differ from expected by more than one standard deviation (may be higher, may be lower)

Back in 1995, we would have expected one out of every three years for investment gains or losses to exceed 12% of payroll (2 x 6.0%)

In 2015, we would have expected one out of every three years for investment gains or losses to exceed 69% of payroll (4 x 17.2%), nearly six times as big

Now imagine having to fund a loss of that magnitude

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Plan Governance

In general, the ASOPs provide guidance to practicing actuariesActuaries are generally advisors to retirement systemsImportant plan governance areas involving the actuary include

– Monitoring plan experience– Reviewing actuarial assumptions and methods– Funding Policy– Risk Assessment– Possibly administrative, accounting, legislative, benefit, investment policy and others

All parties benefit from a clear articulation of who sets policy and who advises

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Plan Governance


We can only answer this togetherThe actuarial principles discussed in this presentation provide guidance for

setting funding policy– But there is no one‐size‐fits all answer

The actuaries, their expertise, and their tools provide information for reviewing and assessing the needs of each plan in its own unique circumstances

Guiding principles, actuarial expertise and tools will only help if actuaries and trustees work together to rise to the challenge

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Thank you!

Questions?

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Disclaimers

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.

This presentation expresses the views of the author and does not necessarily express the views of Gabriel, Roeder, Smith & Company.

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public plan funding standards david t. kausch, … docs/annual...for example, in the may 31, 2016...

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