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11/17/2014
Monday, November 17, 2014 1:00 PM City of Clearwater City Hall 112 S. Osceola Avenue Clearwater, FL 33756 Council Chambers Pension Trustees Meeting Agenda November 17, 2014Pension Trustees Meeting Agenda 1. Call To Order 2. Approval of Minutes 2.1 Approve the minutes of the October 13, 2014 Pension Trustees meeting as submitted in written summation by the City Clerk. 3. Citizens to be Heard Regarding Items Not on the Agenda 4. New Business Items 4.1 Approve the new hires for acceptance into the Pension Plan as listed. 4.2 Approve the following request of employees Stephen Coward, Fire Department and Kathy LaBelle, Solid Waste General Services Department, to vest their pensions as provided by Section 2.419 of the Employees’ Pension Plan. 4.3 Approve the following request of employees Mark Behring, Information Technology Department; Thomas Bracalento, Police Department; Randy Cline, Marine and Aviation Department; Diane Fitzgerald, Public Communications Department; Gregory Pippins, Solid Waste General Services Department; and William Tedder, Finance Department, for a regular pension as provided by Sections 2.416 and 2.424 of the Employees’ Pension Plan. 4.4 Approve the recommended pension plan expenditures for fiscal year 2015, totaling $309,000. 4.5 Approve a change in the Pension Plan ’s actuarial cost method used for funding purposes, from the current Frozen Entry Age (FEA) method to the Entry Age Normal (EAN) actuarial cost method. 4.6 Provide guidance regarding proposed actuarial funding policy for the Plan. 5. Adjourn Page 2 City of Clearwater Printed on 11/12/2014 Cover Memo City of Clearwater City Hall 112 S. Osceola Avenue Clearwater, FL 33756 File Number: ID#14-690 Agenda Date: 11/17/2014 Status: Agenda ReadyVersion: 1 File Type: MinutesIn Control: Pension Trustees Agenda Number: 2.1 SUBJECT/RECOMMENDATION: Approve the minutes of the October 13, 2014 Pension Trustees meeting as submitted in written summation by the City Clerk. SUMMARY: APPROPRIATION CODE AND AMOUNT: USE OF RESERVE FUNDS: Page 1 City of Clearwater Printed on 11/12/2014 Pension Trustees Meeting Minutes October 13, 2014 City of Clearwater City Hall 112 S. Osceola Avenue Clearwater, FL 33756 Meeting Minutes Monday, October 13, 2014 1:00 PM Council Chambers Pension Trustees Page 1 City of Clearwater Draft Pension Trustees Meeting Minutes October 13, 2014 Roll Call Present 5 - Chair George N. Cretekos, Trustee Doreen Hock-DiPolito, Trustee Jay E. Polglaze, Trustee Bill Jonson, and Trustee Hoyt Hamilton Also Present: William B. Horne II - City Manager, Jill S. Silverboard - Assistant City Manager, Rod Irwin - Assistant City Manager, Pamela K. Akin - City Attorney, and Rosemarie Call - City Clerk To provide continuity for research, items are listed in agenda order although not necessarily discussed in that order. Unapproved 1. Call To Order – Chair Cretekos The meeting was called to order at 1:03 p.m. 2. Approval of Minutes 2.1 Approve the minutes of the September 15, 2014 Pension Trustees meeting as submitted in written summation by the City Clerk. Trustee Hock-DiPolito moved to approve the minutes of the September 15, 2014 Pension Trustees meeting as submitted in written summation by the City Clerk. The motion was duly seconded and carried unanimously. 3. Citizens to be Heard Regarding Items Not on the Agenda – None. 4. New Business Items 4.1 Approve the new hires for acceptance into the Pension Plan as listed. Name, Job. Class, & Dept./Div. Pension Elig. Date Stacie VanNostrand, Devel Review Tech I, Planning and Dev. Dept. 07/28/2014 Patrick Shackton, Parks Service Technician I, Parks and Rec Dept 08/04/2014 James Pleasant, Recreation Leader, Parks & Recreation Department 08/09/2014 Kelly Callihan, Communications Operator, Police Department 08/11/2014 Tracy Garcia, Communications Operator Trainee, Police Department 08/11/2014 Gregory Seymour, Communications Operator, Police Department 08/11/2014 Page 2 City of Clearwater Draft Pension Trustees Meeting Minutes October 13, 2014 Kevin Kerrigan, Industrial Pretreatment Technician, Public Util Dept 08/11/2014 Sharon McAtee-Knight, Accounting Clerk, Finance Department 08/18/2014 Tina Burdo, Customer Service Representative, Customer Service Dept 08/25/2014 Paul Chouinard, Construction Inspector 2, Engineering Department 08/25/2014 Leigh Anne McLain, Service Dispatcher, Gas Department 08/25/2014 Christopher Brown, Gas Technician I, Gas Department 08/25/2014 Jhimmy Vargas-Salinas, Public Utilities Technician I, Public Util Dept 08/25/2014 Seth Eigenmann, Parks Service Technician I, Parks and Rec Dept 08/25/2014 Cedric Foster, Parks Service Technician I, Parks and Recreation Dept 08/25/2014 Trustee Hamilton moved to approve that the new hires be accepted into the Pension Plan as listed. The motion was duly seconded and carried unanimously. 4.2 Approve the following request of employees Patricia Cooke, Police Department, Allen Del Prete, Human Resources Department, Charles Kindred, Solid Waste General Services Department, Karen Miles, Finance Department, and Tina Wilson, Office of Management and Budget, for a regular pension as provided by Sections 2.416 and 2.424 of the Employees’ Pension Plan. Patricia Cooke, Police Office Specialist, Police Department, was employed by the City on July 24, 1995 and her pension service credit is effective on that date. Her pension will be effective October 1, 2014. Based on an average salary of approximately $34,929.43 over the past five years, the formula for computing regular pensions and Ms. Cooke’s selection of the Single Life Annuity, this pension benefit will be approximately $18,418.68 annually. Allen Del Prete, Human Resources Manager, Human Resources Department, was employed by the City on February 11, 1991 and his pension service credit is effective on that date. His pension will be effective October 1, 2014. Based on an average salary of approximately $74,987.60 over the past five years, the formula for computing regular pensions and Mr. Del Prete’s selection of the 10-Year Certain and Life Annuity, this pension benefit will be approximately $48,160.92 annually. Charles Kindred, Fleet Mechanic, Solid Waste General Services Department, was employed by the City on April 28, 1986 and his pension service credit is effective on that date. His pension will be effective February 1, 2015. Based on an average salary of approximately $61,922.36 over the past five years, the formula for computing regular pensions and Mr. Kindred’s selection of the Single Life Annuity with a 10% Partial Lump Sum Distribution, this pension benefit will be approximately $44,044.68 annually. Karen Miles, Accounting Manager, Finance Department, was employed by the City on September 22, 1986 and her pension service credit is effective on that date. Her pension will be effective October 1, 2014. Based on an average Page 3 City of Clearwater Draft Pension Trustees Meeting Minutes October 13, 2014 salary of approximately $81,443.29 over the past five years, the formula for computing regular pensions and Ms. Miles’ selection of the Single Life Annuity, this pension benefit will be approximately $63,540.60 annually. Tina Wilson, Budget Director, Office of Management and Budget, was employed by the City on September 10, 1984 and her pension service credit is effective on that date. Her pension will be effective October 1, 2014. Based on an average salary of approximately $108,851.94 over the past five years, the formula for computing regular pensions and Ms. Wilson’s selection of the Single Life Annuity, this pension benefit will be approximately $89,886 annually. Section 2.416 provides for normal retirement eligibility for non-hazardous duty employees hired prior to the effective date of this reinstatement (January 1, 2013), a member shall be eligible for retirement following the earlier of the date on which a participant has reached the age of fifty-five years and completed twenty years of credited service; the date on which a participant has reached age sixty-five years and completed ten years of credited service; or the date on which a member has completed thirty years of service regardless of age. For non-hazardous duty employees hired on or after the effective date of this restatement, a member shall be eligible for retirement following the earlier of the date on which a participant has reached the age of sixty years and completed twenty-five years of credited service; or the date on which a participant has reached the age of sixty-five years and completed ten years of credited service. Ms. Cooke, Mr. Del Prete, Mr. Kindred, Ms. Miles and Ms. Wilson have met the non-hazardous duty criteria. Section 2.416 provides for normal retirement eligibility for hazardous duty employees, a member shall be eligible for retirement following the earlier of the date on which the participant has completed twenty years of credited service regardless of age, or the date on which the participant has reached fifty-five years and completed ten years of credited service. Trustee Jonson moved to approve the following request of employees Patricia Cooke, Police Department, Allen Del Prete, Human Resources Department, Charles Kindred, Solid Waste General Services Department, Karen Miles, Finance Department, and Tina Wilson, Office of Management and Budget, for a regular pension as provided by Sections 2.416 and 2.424 of the Employees’ Pension Plan. The motion was duly seconded and carried unanimously. 4.3 Recommend approval of the following request of employees Nancy Oakley, Parks and Recreation Department, Samuel Taylor, Police Department and David Weitzel, Parks and Recreation Department, to vest their pensions as provided by Section 2.419 of the Employees’ Pension Plan. Page 4 City of Clearwater Draft Pension Trustees Meeting Minutes October 13, 2014 Nancy Oakley, Accountant, Parks and Recreation Department, was employed by the City on May 3, 2004, and began participating in the Pension Plan on that date. Ms. Oakley terminated from City employment on August 9, 2014. Samuel Taylor, Senior Communications Operator, Police Department, was employed by the City on January 12, 2004 and began participating in the Pension Plan on that date. Mr. Taylor terminated from City employment on August 23, 2014. David Weitzel, Recreation Program Support Technician, Parks and Recreation Department, was employed by the City on January 3, 2000 and began participating in the Pension Plan on that date. Mr. Weitzel will terminate from City employment on October 25, 2014. The Employees’ Pension Plan provides that should an employee cease to be an employee of the City of Clearwater or change status from full-time to part-time after completing ten or more years of creditable service (pension participation), such employee shall acquire a vested interest in the retirement benefits. Vested pension payments commence on the first of the month following the month in which the employee normally would have been eligible for retirement. Section 2.416 provides for normal retirement eligibility for non-hazardous duty employees hired prior to the effective date of this reinstatement (January 1, 2013), a member shall be eligible for retirement following the earlier of the date on which a participant has reached the age of fifty-five years and completed twenty years of credited service; the date on which a participant has reached age sixty-five years and completed ten years of credited service; or the date on which a member has completed thirty years of service regardless of age. For non-hazardous duty employees hired on or after the effective date of this restatement, a member shall be eligible for retirement following the earlier of the date on which a participant has reached the age of sixty years and completed twenty-five years of credited service; or the date on which a participant has reached the age of sixty-five years and completed ten years of credited service. Ms. Oakley, Mr. Taylor and Mr. Weitzel will meet the non-hazardous duty criteria and begin collecting pensions in December 2023, February 2034 and November 2017, respectively. Section 2.416 provides for normal retirement eligibility for hazardous duty employees, a member shall be eligible for retirement following the earlier of the date on which the participant has completed twenty years of credited service regardless of age, or the date on which the participant has reached fifty-five years and completed ten years of credited service. Page 5 City of Clearwater Draft Pension Trustees Meeting Minutes October 13, 2014 Trustee Hock-DiPolito moved to approve the following request of employees Nancy Oakley, Parks and Recreation Department, Samuel Taylor, Police Department and David Weitzel, Parks and Recreation Department, to vest their pensions as provided by Section 2.419 of the Employees’ Pension Plan. The motion was duly seconded and carried unanimously. 4.4 Approve an amendment to the agreement with Gabriel Roeder Smith and Company for actuarial services for the Pension Plan, to extend the agreement for two years, to December 31, 2016, add additional services for an additional not-to-exceed amount of $71,500, and authorize the appropriate officials to execute same. In December 2009, the Trustees approved a five-year actuarial services agreement with Gabriel Roeder Smith and Company for the pension plan, expiring December 31, 2014. The agreement also included annual actuarial services for the City’s Other Post Employment Benefits (OPEB) liability. Those services and costs were separately approved by the City Council in December 2009. Staff recommends extension of the agreement due to the required implementation of GASB Statements 67 and 68 effective with fiscal years 2014 and 2015. These implementations require significant assistance from the Plan’s actuary and staff believes it is the Plan’s best interests to continue with the existing actuary during the transition period. The total not-to-exceed amount includes the following services: $20,500 - annual actuarial valuation as of 1/01/2015 $21,000 - annual actuarial valuation as of 1/01/2016 (prior year increased by CPI not to exceed $21,000) $ 9,000 - actuarial valuation as of 9/30/2014 for implementation of GASB 67 and 68 $ 5,500 - actuarial valuation as of 9/30/2015 per GASB 68 requirement $ 5,500 - actuarial valuation as of 9/30/2016 per GASB 68 requirement $10,000 - contingency for miscellaneous consulting fees @ $5,000 per year $71,500 Requested not-to-exceed The City Council will be considering a similar amendment to the OPEB portion of the agreement on the Council agenda this week, with those costs to be paid from City funds. Page 6 City of Clearwater Draft Pension Trustees Meeting Minutes October 13, 2014 APPROPRIATION CODE AND AMOUNT: 0646-07410-530100-585-000-0000 Trustee Hamilton moved to approve an amendment to the agreement with Gabriel Roeder Smith and Company for actuarial services for the Pension Plan, to extend the agreement for two years, to December 31, 2016, add additional services for an additional not-to-exceed amount of $71,500, and authorize the appropriate officials to execute same. The motion was duly seconded and carried unanimously. 5. Adjourn The meeting adjourned at 1:08 p.m. Chair Employees’ Pension Plan Trustees Attest City Clerk Page 7 City of Clearwater Draft Cover Memo City of Clearwater City Hall 112 S. Osceola Avenue Clearwater, FL 33756 File Number: ID#14-585 Agenda Date: 11/17/2014 Status: Agenda ReadyVersion: 2 File Type: Action ItemIn Control: Pension Trustees Agenda Number: 4.1 SUBJECT/RECOMMENDATION: Approve the new hires for acceptance into the Pension Plan as listed. SUMMARY: Pension Name, Job. Class, & Dept./Div .Elig. Date Kyia Price, Police Comm Operator Trainee, Police Dept 9/8/2014 Jacqueline Armstead, Comm Operator Trainee, Police Dept 9/8/2014 Wendy Ferlanie, Comm Operator Trainee, Police Department 9/8/2014 JaQuay Young, Police Comm Operator Trainee, Police Dept 9/8/2014 Lorraine Young, Accounting Clerk, Finance Department 9/8/2014 Valerie Hunter, Service Dispatcher, Gas Department 9/8/2014 Nikolas Papadopoulos, Traffic Signal Tech, Engineering Dept 9/8/2014 Patrick Competelli, Fire Inspector II, Fire Department 9/22/2014 Shawn Brown, Parking Enforcement Spec, Engineering Dept 9/22/2014 Sonja Cooper, Library Assistant, Library Department 9/22/2014 APPROPRIATION CODE AND AMOUNT: N/A USE OF RESERVE FUNDS: N/A Page 1 City of Clearwater Printed on 11/12/2014 Cover Memo City of Clearwater City Hall 112 S. Osceola Avenue Clearwater, FL 33756 File Number: ID#14-584 Agenda Date: 11/17/2014 Status: Agenda ReadyVersion: 3 File Type: Action ItemIn Control: Pension Trustees Agenda Number: 4.2 SUBJECT/RECOMMENDATION: Approve the following request of employees Stephen Coward, Fire Department and Kathy LaBelle, Solid Waste General Services Department, to vest their pensions as provided by Section 2.419 of the Employees’ Pension Plan. SUMMARY: Stephen Coward, Fire Lieutenant, Fire Department, was employed by the City on March 4, 1996, and began participating in the Pension Plan on that date. Mr. Coward terminated from City employment on September 9, 2014. Kathy LaBelle, Administrative Analyst, Solid Waste General Services Department, was employed by the City on July 6, 1999 and began participating in the Pension Plan on that date . Ms. LaBelle terminated from City employment on September 16, 2014. The Employees’ Pension Plan provides that should an employee cease to be an employee of the City of Clearwater or change status from full -time to part-time after completing ten or more years of creditable service (pension participation ), such employee shall acquire a vested interest in the retirement benefits. Vested pension payments commence on the first of the month following the month in which the employee normally would have been eligible for retirement. Section 2.416 provides for normal retirement eligibility for non -hazardous duty employees hired prior to the effective date of this reinstatement (January 1, 2013), a member shall be eligible for retirement following the earlier of the date on which a participant has reached the age of fifty-five years and completed twenty years of credited service; the date on which a participant has reached age sixty -five years and completed ten years of credited service; or the date on which a member has completed thirty years of service regardless of age. For non-hazardous duty employees hired on or after the effective date of this restatement, a member shall be eligible for retirement following the earlier of the date on which a participant has reached the age of sixty years and completed twenty -five years of credited service; or the date on which a participant has reached the age of sixty -five years and completed ten years of credited service. Ms. LaBelle will meet the non-hazardous duty criteria and begin collecting a pension in June 2019. Section 2.416 provides for normal retirement eligibility for hazardous duty employees, a member shall be eligible for retirement following the earlier of the date on which the participant has completed twenty years of credited service regardless of age, or the date on which the participant has reached fifty -five years and completed ten years of credited service. Mr. Coward will meet the hazardous duty criteria and begin collecting pension in April 2016. Page 1 City of Clearwater Printed on 11/12/2014 File Number: ID#14-584 APPROPRIATION CODE AND AMOUNT: N/A USE OF RESERVE FUNDS: N/A Page 2 City of Clearwater Printed on 11/12/2014 Cover Memo City of Clearwater City Hall 112 S. Osceola Avenue Clearwater, FL 33756 File Number: ID#14-583 Agenda Date: 11/17/2014 Status: Agenda ReadyVersion: 1 File Type: Action ItemIn Control: Pension Trustees Agenda Number: 4.3 SUBJECT/RECOMMENDATION: Approve the following request of employees Mark Behring, Information Technology Department; Thomas Bracalento, Police Department; Randy Cline, Marine and Aviation Department; Diane Fitzgerald, Public Communications Department; Gregory Pippins, Solid Waste General Services Department; and William Tedder, Finance Department, for a regular pension as provided by Sections 2.416 and 2.424 of the Employees’ Pension Plan. SUMMARY: Mark Behring, Senior Systems Programmer, Information Technology Department, was employed by the City on June 4, 1984 and his pension service credit is effective on that date . His pension will be effective October 1, 2014. Based on an average salary of approximately $75,392.35 over the past five years, the formula for computing regular pensions and Mr . Behring’s selection of the 100% Joint and Survivor Annuity, this pension benefit will be approximately $60,744.36 annually. Thomas Bracalento, Police Officer, Police Department, was employed by the City on June 21, 1989 and his pension service credit is effective on that date. His pension will be effective October 1, 2014. Based on an average salary of approximately $82,717.21 over the past five years, the formula for computing regular pensions and Mr. Bracalento’s selection of the 50% Joint and Survivor Annuity, this pension benefit will be approximately $55,544.40 annually. Randy Cline, Marine Supervisor, Marine and Aviation Department, was employed by the City on April 29, 1985 and his pension service credit is effective on that date. His pension will be effective October 1, 2014. Based on an average salary of approximately $52,050.98 over the past five years, the formula for computing regular pensions and Mr. Cline’s selection of the Single Life Annuity, this pension benefit will be approximately $42,234.36 annually. Diane Fitzgerald, Public Information Coordinator, Public Communications Department, was employed by the City on April 20, 1988 and her pension service credit is effective on that date . Her pension will be effective October 1, 2014. Based on an average salary of approximately $59,174.32 over the past five years, the formula for computing regular pensions and Ms . Fitzgerald’s selection of the Single Life Annuity, this pension benefit will be approximately $43,037.40 annually. Gregory Pippins, Transfer Station Scales Operator, Solid Waste General Services Page 1 City of Clearwater Printed on 11/12/2014 File Number: ID#14-583 Department, was employed by the City on December 28, 1987 and his pension service credit is effective on that date. His pension will be effective October 1, 2014. Based on an average salary of approximately $43,577.90 over the past five years, the formula for computing regular pensions and Mr. Pippins’ selection of the 66 2/3% Joint and Survivor Annuity, this pension benefit will be approximately $23,819.04 annually. William Tedder, Accountant, Finance Department, was employed by the City on February 19, 1988 and his pension service credit is effective on that date. His pension will be effective October 1, 2014. Based on an average salary of approximately $47,716.09 over the past five years, the formula for computing regular pensions and Mr. Tedder’s selection of the 50% Joint and Survivor Annuity, this pension benefit will be approximately $32,435.16 annually. Section 2.416 provides for normal retirement eligibility for non -hazardous duty employees hired prior to the effective date of this reinstatement (January 1, 2013), a member shall be eligible for retirement following the earlier of the date on which a participant has reached the age of fifty-five years and completed twenty years of credited service; the date on which a participant has reached age sixty -five years and completed ten years of credited service; or the date on which a member has completed thirty years of service regardless of age. For non-hazardous duty employees hired on or after the effective date of this restatement, a member shall be eligible for retirement following the earlier of the date on which a participant has reached the age of sixty years and completed twenty -five years of credited service; or the date on which a participant has reached the age of sixty -five years and completed ten years of credited service. Mr. Behring, Mr. Cline, Ms. Fitzgerald, Mr. Pippins and Mr. Tedder have met the non-hazardous duty criteria. Section 2.416 provides for normal retirement eligibility for hazardous duty employees, a member shall be eligible for retirement following the earlier of the date on which the participant has completed twenty years of credited service regardless of age, or the date on which the participant has reached fifty -five years and completed ten years of credited service. Mr. Bracalento has met the hazardous duty criteria. APPROPRIATION CODE AND AMOUNT: N/A USE OF RESERVE FUNDS: N/A Page 2 City of Clearwater Printed on 11/12/2014 Cover Memo City of Clearwater City Hall 112 S. Osceola Avenue Clearwater, FL 33756 File Number: ID#14-664 Agenda Date: 11/17/2014 Status: Agenda ReadyVersion: 1 File Type: Action ItemIn Control: Pension Trustees Agenda Number: 4.4 SUBJECT/RECOMMENDATION: Approve the recommended pension plan expenditures for fiscal year 2015, totaling $309,000. SUMMARY: The Employees’ Pension Plan does not have a legally required budget. However the Trustees must approve all expenditures. The following are routine expenditures that staff is requesting approval of for administrative efficiency. The recommended expenditures for fiscal year 2015 reflect a $12,000, or 3.7% decrease from the fiscal 2014 expenditures. This decrease is primarily due to decreased administrative support charges from the Human Resources Department, along with a $5,000 decrease in estimated costs of post-employment physicals. Training and travel are the estimated costs of pension training and related travel, including fiduciary training for the Trustees and Pension Advisory Committee (PAC) members. This is a not-to-exceed amount given uncertainty regarding the number of Trustees and PAC members that may elect to pursue training. Reimbursements to the General Fund and Central Insurance Fund are for the cost of oversight and administration of the Plan. The reimbursements are for services provided by Human Resources, Payroll, and Finance personnel. The firm of Klausner, Kaufman, Jensen and Levinson currently serves as the Plan ’s pension attorneys. Annual attorney fees also include medical bills for medical services authorized by the PAC. Money manager, performance measurement consulting, safekeeping, and actuary fees are all governed by contracts separately approved by the Trustees, and are not included in this agenda item total. APPROPRIATION CODE AND AMOUNT: 0646-xxxxx-5xxxxx (various pension plan expenditure codes) Page 1 City of Clearwater Printed on 11/12/2014 Description FY 14/15 FY 13/14 Increase/ Decrease Printing & Binding 400 400 - Postage 400 400 - Memberships 600 600 - Misc 100 100 - Training 5,000 5,000 - Travel Expense 3,000 3,000 - Physicals 25,000 30,000 (5,000) Reimbursement to General Fund/Central Ins Fund (Human Resources)34,500 43,500 (9,000) Reimbursement to General Fund (Accounting & Finance)20,000 20,000 - Reimbursement to General Fund (Payroll & IT)80,000 78,000 2,000 Pension Attorney 140,000 140,000 - 309,000$ 321,000$ (12,000) City of Clearwater Employees' Pension Plan Administrative Expenses Cover Memo City of Clearwater City Hall 112 S. Osceola Avenue Clearwater, FL 33756 File Number: ID#14-654 Agenda Date: 11/17/2014 Status: Agenda ReadyVersion: 1 File Type: Action ItemIn Control: Pension Trustees Agenda Number: 4.5 SUBJECT/RECOMMENDATION: Approve a change in the Pension Plan ’s actuarial cost method used for funding purposes, from the current Frozen Entry Age (FEA) method to the Entry Age Normal (EAN) actuarial cost method. SUMMARY: The required implementation of Governmental Accounting Standards Board Statements 67 and 68 requires the City use the EAN actuarial cost method for financial reporting. It is not required for funding purposes. The EAN method is the most common method used throughout the State of Florida, and is also used by the Florida Retirement System. The Plan’s actuary recommends changing to the EAN method for funding purposes at this time. Per the actuary, the EAN method more accurately aligns plan funding with the accrual of benefits over the course of each participant’s expected period of employment with the City. Staff recommends changing to the EAN method for funding purposes, to follow the actuary ’s recommendation, to aid in comparability to other plan ’s, and for consistency with the financial reporting method required under GASB 67 and 68. APPROPRIATION CODE AND AMOUNT: N/A USE OF RESERVE FUNDS: N/A Page 1 City of Clearwater Printed on 11/12/2014 CITY OF CLEARWATER EMPLOYEES’ PENSION PLAN FUNDING METHOD STUDY INCLUDING 30-YEAR PROJECTIONS OCTOBER 7, 2014 CITY OF CLEARWATER EMPLOYEES’ PENSION PLAN FUNDING METHOD STUDY INCLUDING 30-YEAR PROJECTIONS TABLE OF CONTENTS Page I. Executive Summary .......................................................................................................... 1 - 2 II. Overview of Funding Methods ......................................................................................... 3 - 4 III. Projection Results ........................................................................................................... 5 - 17 IV. Appendix A – Draft Actuarial Funding Policy V. Appendix B – GRS Research Report: Developing a Pension Funding Policy for State and Local Governments 1 EXECUTIVE SUMMARY As requested, we have developed a draft Funding Policy, analyzed the Plan’s current funding method, and prepared 30-year projections which illustrate the expected City contributions for the City of Clearwater Employees’ Pension Plan under the current funding method (Frozen Entry Age) versus the proposed funding method (Entry Age Normal). To illustrate the impact under a range of potential future outcomes, we have prepared 30-year projections under the following three scenarios of assumed future investment returns: Assuming the Market Value of Assets earns the assumed rate of 7% each year. Assuming the Market Value of Assets earns 6% each year. Assuming the Market Value of Assets earns the assumed rate of 7% during 2014, 2015, and 2017 – 2043, but incurs a 15% loss during 2016. Our draft of a formal written funding policy is included in Appendix A. This initial draft has been prepared for the Board’s review and discussion, and it will be subsequently revised to reflect the decisions made by the Pension Trustees. Appendix B includes a GRS Research Report on funding policy development that the Pension Trustees may find informative. Some of the principal components of a funding policy that need to be agreed on by Pension Trustees include the following: Actuarial cost method Asset smoothing method Amortization methodology (for amortizing the impact of experience gains/losses, assumption changes, plan changes, or method changes) Funding target and objections Process for setting actuarial assumptions Risk management Summary of Results Based on the current City Ordinance, the minimum City contribution is 7% of covered payroll. If the current funding method is retained and assets earn 7% per year as expected, it is estimated that the City contribution rate will hit this 7% floor by the fiscal year ending September 30, 2017. If experience continues to match the assumptions, the City contribution would remain at this rate over the remainder of the 30-year projection period. The minimum 7% of payroll contribution is projected to be greater than the actuarially required contribution amount, so the funded ratio is expected to increase above 100% over time. Under Senate Bill 1128, municipalities are required to contribute at least the Normal Cost each year (i.e., the cost of benefits earned during the current year). If the funding method is changed to Entry Age Normal and assets earn 7% per year as expected, it is estimated that the City contribution rate would hit this “Normal Cost floor” by the fiscal year ending September 30, 2017. If experience continues to match the assumptions, the City contribution would remain at this Normal Cost rate over the remainder of the projection period. The Normal Cost rate is expected to decrease over time as more of the active population includes new members benefitting under the post-January 1, 2013 tier of benefits. Due to the presence of negative (surplus) amortization bases, a contribution equal to the Normal Cost in future years is projected to be greater than the actuarially required contribution amount, so the funded ratio is expected to increase above 100% over time. 2 The funded ratio is expected to exceed 100% to a greater extent under the Entry Age Normal funding method than under the Frozen Entry Age funding method because the minimum contribution (the Normal Cost rate) under the Entry Age Normal Cost method is projected to be higher than 7% of covered payroll. If actual experience is not as expected, gains and losses would be generated. These experience gains and losses would be recognized differently under the two funding methods. The 30-year projections illustrate the difference in the required City contributions under both funding methods reflecting assumed market returns which deviate from 7% each year. The projection results under the Entry Age Normal funding method have been prepared assuming that experience gains and losses are amortized over a 15-year period. Use of a longer amortization period would produce less volatile required contributions, but would increase the time required to return the funded ratio to 100%. Actuarial Assumptions and Methods, Financial Data and Member Census Data The actuarial assumptions and methods, financial data, and member census data used for the purposes of our Actuarial Study are the same as those used for the January 1, 2014 Actuarial Valuation with the exceptions of the funding method and assumed returns on the Market Value of Assets detailed above. Projections are deterministic and throughout the projection period Plan experience is expected to match the assumptions, with the exception of the assumed investment returns on the Market Value of Assets, as described above. Throughout the forecast period, new members are assumed to be hired each year at a rate sufficient to maintain a constant active headcount, or stationary population. New employees are assumed to have the same average demographic characteristics (age, gender, salary – adjusted each year for inflation) as those of members hired over the past five years. We have not reflected adjustments or future increases in the credit balance when the actual contributions (by Statute) are higher than the actuarially determined contribution requirements. It is our opinion that doing so would not have a material impact on the projections. 3 OVERVIEW OF FUNDING METHODS Current Funding Method – Frozen Entry Age Under the Frozen Entry-Age Actuarial Cost Method, the excess of the actuarial present value of all future benefits of the group included in the valuation, over the sum of the actuarial value of assets, the unfunded frozen actuarial accrued liability and the actuarial present value of future member contributions (if any) is allocated as a level percentage of earnings of the overall group over the expected future working years of current active members. This allocation is performed for the group as a whole, not as a sum of individual allocations. The portion that is allocated to a specific year is called the Employer Normal Cost. Under this method, future actuarial experience gains (losses) are not explicitly recognized, but instead reduce (increase) future years’ Normal Costs. The initial unfunded frozen actuarial accrued liability (UFAAL) is determined under the entry age normal actuarial cost method as of the date this funding method is implemented, and it is amortized over a period of time. The initial UFAAL is frozen at that level. Subsequent changes in the UFAAL due to plan amendments and changes in actuarial assumptions or methods are explicitly recognized and added to the UFAAL and amortized over a reasonable period of future years. Proposed Funding Method – Entry Age Normal Under the Entry Age Normal Actuarial Cost Method, an annual level normal cost is calculated for each individual active member, payable from the date of employment to the date of retirement, that is sufficient to accumulate to the value of the member’s benefit at the time of decrement/retirement. Each annual normal cost is calculated as a constant percentage of that member’s year by year projected covered pay. Under this method, actuarial experience gains (losses) are explicitly recognized each year as they occur. They reduce (increase) the Unfunded Actuarial Accrued Liability, and they are amortized separately. The initial Unfunded Actuarial Accrued Liability (UAAL) is amortized over a period of time. Subsequent changes in the UAAL due to actuarial experience gains and losses, amendments, and changes in actuarial assumptions or methods are recognized in the UAAL and amortized over a reasonable period of future years. Entry Age Normal vs. Frozen Entry Age The following lists present several pros and cons of changing to the Entry Age Normal funding method versus retaining the current Frozen Entry Age funding method: Pros of Changing to the Entry Age Normal Funding Method: GASB Statements No. 67 and 68 require the use of the Entry Age Normal funding method in all accounting calculations. The Entry Age Normal funding method is much more commonly used throughout the state of Florida than the Frozen Entry Age funding method. The Entry Age Normal funding method is also the funding method used by the Florida Retirement System. The actuarial accrued liability under the Entry Age Normal funding method more accurately reflects the level of benefits accrued to-date (including incurred experience gains and losses). 4 The normal cost rate under the Entry Age Normal funding method is expected to be more stable as a percentage of covered payroll since it does not include an implicit gain/loss adjustment. If the amortization period for amortizing gains and losses under the Entry Age Normal funding method is longer than the average future number of working years for current active members, then the employer contribution rate would be expected to be more stable under the Entry Age Normal funding method. The funded ratio under the Entry Age Normal funding method is projected to be higher than it is under the Frozen Entry Age funding method under all scenarios analyzed in this Study. There may be a “cross-over date” in the future for GASB No. 67/68 purposes under the Frozen Entry Age funding method. There would not be a cross-over date under the Entry Age Normal funding method. Cons of Changing to the Entry Age Normal Funding Method: The funded ratio may be more volatile under the Entry Age Normal funding method than under the Frozen Entry Age funding method since experience gains and losses are immediately recognized in the funded ratio under the Entry Age Normal funding method. The Frozen Entry Age funding method is expected to recognize gains and losses more quickly (over an approximate equivalent period of 10-11 years) than under the Entry Age Normal funding method (assuming the amortization period for paying off experience gains/losses under the Entry Age Normal funding method is greater than 10-11 years); therefore, the employer contribution rate may respond more quickly to emerging actuarial experience under the current Frozen Entry Age funding method. This could be addressed under the Entry Age Normal funding method by using a shorter period to amortize experience gains and losses. Under Senate Bill 1128, the employer contribution rate cannot be less than the normal cost. If the Plan’s funded ratio exceeds 100%, resulting in an overall net amortization credit (negative amortizations), the required employer contribution would equal the employer normal cost. This would lead to a lower contribution requirement under the Frozen Entry Age funding method than under the Entry Age Normal funding method because the normal cost rate would be greater under the Entry Age Normal funding method (since the normal cost rate under the Frozen Entry Age funding method implicitly recognizes the impact of experience gains/losses). The minimum employer contribution in the City ordinance (7% of covered pay) is projected to be the actual City contribution for many years under the current Frozen Entry Age funding method, assuming actual Plan experience matches the current actuarial assumptions. This contribution rate is lower than the projected required contribution rate under the Entry Age Normal funding method, due to the State’s requirement to fund at least the normal cost each year (and since the normal cost rate under the Entry Age Normal funding method is projected to be higher than 7%). The Entry Age Normal funding method is projected to result in a more over-funded Plan than the Frozen Entry Age funding method if actual Plan experience meets expectations or if there are cumulative future experience gains. This could be considered a “pro” from a labor group perspective because there may be more funds available to improve benefits in future years. From a City and taxpayer perspective, though, it could be considered a “con” because more money could be tied up in the pension trust fund that could have been used for other purposes. 5 PROJECTION RESULTS 6 $ Amount % of Pay $ Amount % of Pay 2015 74,254,159 10,791,098 14.53%93%97%74,254,159 10,791,098 14.53%97%0 2016 75,138,209 6,881,441 9.16%94%100%75,138,209 9,791,028 13.03%100%2,909,588 2017 76,152,700 5,331,783 7.00%94%101%76,152,700 8,640,116 11.35%101%3,308,333 2018 77,190,570 5,403,340 7.00%95%104%77,190,570 8,543,675 11.07%104%3,140,336 2019 78,261,579 5,478,311 7.00%96%105%78,261,579 8,458,401 10.81%106%2,980,090 2020 79,408,355 5,558,585 7.00%96%106%79,408,355 8,388,337 10.56%107%2,829,752 2021 80,752,829 5,652,698 7.00%97%106%80,752,829 8,350,922 10.34%107%2,698,224 2022 82,113,129 5,747,919 7.00%98%106%82,113,129 8,317,011 10.13%108%2,569,092 2023 83,535,967 5,847,518 7.00%99%106%83,535,967 8,284,260 9.92%108%2,436,742 2024 85,060,541 5,954,238 7.00%99%106%85,060,541 8,255,909 9.71%109%2,301,671 2025 86,307,571 6,041,530 7.00%100%106%86,307,571 8,169,918 9.47%109%2,128,388 2026 87,950,419 6,156,529 7.00%101%106%87,950,419 8,157,154 9.27%109%2,000,625 2027 89,715,271 6,280,069 7.00%101%107%89,715,271 8,166,587 9.10%110%1,886,518 2028 91,477,590 6,403,431 7.00%102%107%91,477,590 8,175,227 8.94%110%1,771,796 2029 93,386,066 6,537,025 7.00%103%107%93,386,066 8,205,734 8.79%111%1,668,709 2030 95,528,592 6,687,001 7.00%103%107%95,528,592 8,272,689 8.66%112%1,585,687 2031 97,840,476 6,848,833 7.00%104%108%97,840,476 8,369,797 8.55%112%1,520,964 2032 100,285,119 7,019,958 7.00%104%108%100,285,119 8,487,252 8.46%113%1,467,294 2033 102,823,012 7,197,611 7.00%105%108%102,823,012 8,620,022 8.38%114%1,422,412 2034 105,489,210 7,384,245 7.00%105%109%105,489,210 8,773,419 8.32%114%1,389,174 2035 108,257,818 7,578,047 7.00%106%109%108,257,818 8,942,549 8.26%115%1,364,502 2036 111,077,282 7,775,410 7.00%107%110%111,077,282 9,120,115 8.21%116%1,344,706 2037 113,947,247 7,976,307 7.00%107%110%113,947,247 9,306,519 8.17%117%1,330,211 2038 116,891,021 8,182,371 7.00%108%111%116,891,021 9,503,257 8.13%118%1,320,885 2039 119,896,457 8,392,752 7.00%109%111%119,896,457 9,709,492 8.10%119%1,316,740 2040 122,984,625 8,608,924 7.00%110%112%122,984,625 9,924,998 8.07%120%1,316,074 2041 126,128,803 8,829,016 7.00%110%113%126,128,803 10,149,207 8.05%122%1,320,191 2042 129,350,380 9,054,527 7.00%111%113%129,350,380 10,382,587 8.03%123%1,328,060 2043 132,626,173 9,283,832 7.00%112%114%132,626,173 10,622,095 8.01%124%1,338,263 2044 135,945,396 9,516,178 7.00%100%115%135,945,396 10,867,276 7.99%126%1,351,098 Total 214,400,527 269,746,651 55,346,124 Total Present Value 89,849,766 117,583,607 27,733,841 Required City Contribution Funded Ratio on Valuation Date Difference as $ Amount City of Clearwater Employees' Pension Plan 30-Year Projection of Required City Contributions 7% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age)Proposed Funding Method (Entry Age Normal) Fiscal Year Ending Pensionable Payroll Required City Contribution Funded Ratio on Valuation Date (EAN Basis) Pensionable Payroll Funded Ratio on Valuation Date (FEA Basis) 7 0 2,000,000 4,000,000 6,000,000 8,000,000 10,000,000 12,000,000 0 2,000,000 4,000,000 6,000,000 8,000,000 10,000,000 12,000,000 Projected City ContributionFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution 7% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 8 0% 2% 4% 6% 8% 10% 12% 14% 16% 0% 2% 4% 6% 8% 10% 12% 14% 16%Projected City Contribution as a Percent of PayrollFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution 7% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 9 85% 90% 95% 100% 105% 110% 115% 120% 125% 130% 85% 90% 95% 100% 105% 110% 115% 120% 125% 130%Projected Funded Ratio (EAN Basis)Fiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of Funded Ratio (EAN Basis) 7% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 10 $ Amount % of Pay $ Amount % of Pay 2015 74,254,159 10,791,098 14.53%93%97%74,254,159 10,791,098 14.53%97%0 2016 75,138,209 7,594,512 10.11%94%99%75,138,209 9,972,335 13.27%99%2,377,824 2017 76,152,700 6,400,464 8.40%94%100%76,152,700 8,640,116 11.35%101%2,239,652 2018 77,190,570 5,403,340 7.00%95%103%77,190,570 8,543,675 11.07%103%3,140,336 2019 78,261,579 5,478,311 7.00%95%103%78,261,579 8,458,401 10.81%104%2,980,090 2020 79,408,355 5,558,585 7.00%96%103%79,408,355 8,388,337 10.56%104%2,829,752 2021 80,752,829 5,652,698 7.00%96%102%80,752,829 8,350,922 10.34%103%2,698,224 2022 82,113,129 7,124,961 8.68%97%101%82,113,129 8,317,011 10.13%102%1,192,050 2023 83,535,967 8,883,761 10.63%97%99%83,535,967 8,284,260 9.92%101%(599,501) 2024 85,060,541 10,585,328 12.44%97%98%85,060,541 8,255,909 9.71%100%(2,329,419) 2025 86,307,571 11,947,586 13.84%97%98%86,307,571 9,005,700 10.43%99%(2,941,885) 2026 87,950,419 13,457,117 15.30%98%97%87,950,419 10,214,019 11.61%98%(3,243,098) 2027 89,715,271 13,885,924 15.48%98%96%89,715,271 11,462,026 12.78%97%(2,423,898) 2028 91,477,590 15,233,660 16.65%98%95%91,477,590 12,723,324 13.91%97%(2,510,335) 2029 93,386,066 16,518,867 17.69%98%95%93,386,066 14,018,345 15.01%96%(2,500,521) 2030 95,528,592 17,765,374 18.60%99%94%95,528,592 15,360,264 16.08%95%(2,405,110) 2031 97,840,476 17,410,629 17.79%99%94%97,840,476 16,741,763 17.11%94%(668,866) 2032 100,285,119 18,592,357 18.54%99%93%100,285,119 18,152,229 18.10%94%(440,128) 2033 102,823,012 19,742,871 19.20%99%93%102,823,012 19,586,095 19.05%93%(156,777) 2034 105,489,210 20,882,598 19.80%99%92%105,489,210 21,048,415 19.95%93%165,817 2035 108,257,818 22,000,856 20.32%99%92%108,257,818 22,534,276 20.82%92%533,421 2036 111,077,282 23,084,779 20.78%99%91%111,077,282 24,036,565 21.64%92%951,786 2037 113,947,247 24,137,724 21.18%99%91%113,947,247 24,720,318 21.69%92%582,595 2038 116,891,021 25,164,630 21.53%99%91%116,891,021 26,259,029 22.46%92%1,094,400 2039 119,896,457 26,160,321 21.82%99%90%119,896,457 27,816,663 23.20%91%1,656,341 2040 122,984,625 27,135,582 22.06%99%90%122,984,625 29,393,753 23.90%91%2,258,171 2041 126,128,803 28,081,269 22.26%100%90%126,128,803 29,769,579 23.60%91%1,688,310 2042 129,350,380 29,009,898 22.43%100%90%129,350,380 30,149,060 23.31%91%1,139,162 2043 132,626,173 29,910,105 22.55%100%90%132,626,173 30,533,515 23.02%91%623,409 2044 135,945,396 29,051,610 21.37%100%89%135,945,396 30,925,551 22.75%91%1,873,941 Total 502,646,814 512,452,554 9,805,741 Total Present Value 166,622,969 173,522,052 6,899,083 City of Clearwater Employees' Pension Plan 30-Year Projection of Required City Contributions Current Funding Method (Frozen Entry Age)Proposed Funding Method (Entry Age Normal) Required City Contribution Funded Ratio on Valuation Date (EAN Basis) Required City Contribution Funded Ratio on Valuation Date 6% Actual Return on Market Value of Assets Difference as $ Amount Fiscal Year Ending Pensionable Payroll Pensionable Payroll Funded Ratio on Valuation Date (FEA Basis) 11 0 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 35,000,000 0 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 35,000,000 Projected City ContributionFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution 6% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 12 0% 5% 10% 15% 20% 25% 30% 0% 5% 10% 15% 20% 25% 30%Projected City Contribution as a Percent of PayrollFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution 6% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 13 85% 90% 95% 100% 105% 110% 115% 120% 125% 85% 90% 95% 100% 105% 110% 115% 120% 125%Projected Funded Ratio (EAN Basis)Fiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of Funded Ratio (EAN Basis) 6% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 14 $ Amount % of Pay $ Amount % of Pay 2015 74,254,159 10,791,098 14.53%93%97%74,254,159 10,791,098 14.53%97%0 2016 75,138,209 7,363,142 9.80%94%100%75,138,209 9,791,028 13.03%100%2,427,887 2017 76,152,700 5,705,008 7.49%94%101%76,152,700 8,640,116 11.35%101%2,935,108 2018 77,190,570 7,954,379 10.30%95%99%77,190,570 9,326,282 12.08%100%1,371,903 2019 78,261,579 11,469,869 14.66%95%97%78,261,579 11,718,958 14.97%97%249,090 2020 79,408,355 16,871,236 21.25%95%93%79,408,355 15,865,149 19.98%93%(1,006,086) 2021 80,752,829 22,352,099 27.68%95%89%80,752,829 20,473,512 25.35%89%(1,878,587) 2022 82,113,129 27,625,397 33.64%95%85%82,113,129 25,249,006 30.75%86%(2,376,391) 2023 83,535,967 27,360,732 32.75%96%86%83,535,967 25,840,396 30.93%86%(1,520,336) 2024 85,060,541 26,897,207 31.62%96%87%85,060,541 26,240,613 30.85%87%(656,593) 2025 86,307,571 25,846,933 29.95%97%88%86,307,571 26,094,659 30.23%88%247,726 2026 87,950,419 25,131,808 28.57%97%89%87,950,419 26,198,699 29.79%89%1,066,890 2027 89,715,271 23,222,059 25.88%97%90%89,715,271 24,990,727 27.86%90%1,768,668 2028 91,477,590 22,537,205 24.64%98%90%91,477,590 25,019,387 27.35%91%2,482,182 2029 93,386,066 21,941,920 23.50%98%91%93,386,066 25,059,371 26.83%92%3,117,451 2030 95,528,592 21,459,922 22.46%98%92%95,528,592 25,130,390 26.31%93%3,670,468 2031 97,840,476 19,183,543 19.61%98%93%97,840,476 23,724,080 24.25%94%4,540,538 2032 100,285,119 18,836,026 18.78%99%93%100,285,119 25,509,735 25.44%95%6,673,709 2033 102,823,012 18,531,081 18.02%99%93%102,823,012 26,738,061 26.00%96%8,206,979 2034 105,489,210 18,275,261 17.32%99%94%105,489,210 24,276,403 23.01%97%6,001,142 2035 108,257,818 18,051,202 16.67%99%94%108,257,818 20,049,932 18.52%98%1,998,730 2036 111,077,282 17,851,572 16.07%99%95%111,077,282 15,581,752 14.03%99%(2,269,820) 2037 113,947,247 17,678,673 15.51%99%95%113,947,247 10,958,765 9.62%99%(6,719,907) 2038 116,891,021 17,533,612 15.00%99%95%116,891,021 11,752,195 10.05%100%(5,781,417) 2039 119,896,457 17,414,299 14.52%99%96%119,896,457 11,529,865 9.62%100%(5,884,434) 2040 122,984,625 17,325,077 14.09%99%96%122,984,625 11,495,454 9.35%100%(5,829,623) 2041 126,128,803 17,258,205 13.68%100%97%126,128,803 10,491,377 8.32%100%(6,766,828) 2042 129,350,380 17,218,566 13.31%100%97%129,350,380 10,724,758 8.29%100%(6,493,809) 2043 132,626,173 17,199,259 12.97%100%97%132,626,173 10,622,095 8.01%100%(6,577,164) 2044 135,945,396 15,138,613 11.14%100%98%135,945,396 10,867,276 7.99%100%(4,271,337) Total 552,025,001 540,751,142 (11,273,859) Total Present Value 230,355,026 235,730,283 5,375,257 Required City Contribution Funded Ratio on Valuation Date (EAN Basis) Required City Contribution Funded Ratio on Valuation Date City of Clearwater Employees' Pension Plan 30-Year Projection of Required City Contributions -15% Actual Return on Market Value of Assets During Plan Year Ending December 31, 2016 Current Funding Method (Frozen Entry Age)Proposed Funding Method (Entry Age Normal) Difference as $ Amount Fiscal Year Ending Pensionable Payroll Pensionable Payroll Funded Ratio on Valuation Date (FEA Basis) 15 0 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 - 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 Projected City ContributionFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution -15% Actual Return on Market Value of Assets During PYE 12/31/2016 Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 16 0% 5% 10% 15% 20% 25% 30% 35% 40% 0% 5% 10% 15% 20% 25% 30% 35% 40%Projected City Contribution as a Percent of PayrollFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution -15% Actual Return on Market Value of Assets During PYE 12/31/2016 Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 17 80% 85% 90% 95% 100% 105% 80% 85% 90% 95% 100% 105%Projected Funded Ratio (EAN Basis)Fiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of Funded Ratio (EAN Basis) -15% Actual Return on Market Value of Assets During PYE 12/31/2016 Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) APPENDIX A DRAFT ACTUARIAL FUNDING POLICY City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 1 - FUNDING OBJECTIVES The main funding objective for the defined benefit provisions of the City of Clearwater Employees’ Pension Plan (Plan) is to establish and receive employer (City and State, if any) contributions, expressed as a percentage of active member payroll, which will remain approximately level from year to year and will not have to be increased for future generations of citizens in the absence of benefit changes. This objective is stated in the Plan’s Ordinance and meets the requirements of Part VII, Chapter 112, Florida Statutes, Chapter 175, Florida Statutes, and Chapter 185, Florida Statutes. The employer contributions along with member contributions are to be used for funding the long- term costs of benefits, provided by the Ordinance and collective bargaining agreements, for Plan members and beneficiaries. Additionally, the City is responsible for contributing administrative expenses. From the perspective of the members and beneficiaries, the funding objective is for assets and actuarially determined contributions to be sufficient to pay all benefits provided by Plan when due. From the perspective of the contributing plan sponsors and taxpayers, there are additional funding objectives of keeping the actuarially determined contribution rates relatively stable as a percentage of active member payroll and equitably allocating the costs over the active members’ periods of active service. For pension funding, the payment of benefits is supported in part by income earned on investment assets. This actuarial funding policy meets these objectives. It is stipulated by state law and collective bargaining agreements and is implemented through the application of Board adopted governance policies. Statutory Pension Funding Policy – Ordinance The Ordinance for the Plan sets forth some portions of the actuarial funding policy for the Plan. Ordinance Excerpts: Sec. 2.413. Plan administration. (i) Actuarial valuation; actuarial standards. (1) At least once in each six (6) year period, the trustees shall cause an actuarial investigation to be made into the mortality, service and compensation experience of the members of the retirement plan. Taking into account the result of such investigation, the trustees shall adopt for the retirement plan such mortality, service and other tables as are necessary and proper. On the basis of these tables, an annual actuarial valuation of the assets and liabilities of the retirement plan shall be made. (2) Actuarial assumptions based on the six (6) year experience analysis may be modified by the trustees at such times as they deem appropriate. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 2 - Sec. 2.415. Contributions to the plan. (b) Employer contributions. (1) For each plan year, the employer shall make contributions to the plan in an amount equal to a. Seven percent of the compensation of all employees participating in the plan; plus b. Such additional amounts as may be required to satisfy the plan's funding requirements for the plan year and the cost of administering the plan, as determined by the actuary employed by the trustees. (2) The amount described in subparagraph (b)(1)b. above may be reduced by any available credit balance in accordance with applicable Florida Statutes. Statutory Pension Funding Policy – Florida Statutes Chapter 112, Florida Statutes sets forth some portions of the actuarial funding policy for the Plan. Chapter 112 Excerpts: 112.63 Actuarial reports and statements of actuarial impact; review. (1) Each retirement system or plan subject to the provisions of this act shall have regularly scheduled actuarial reports prepared and certified by an enrolled actuary. The actuarial report shall consist of, but shall not be limited to, the following: (a) Adequacy of employer and employee contribution rates in meeting levels of employee benefits provided in the system and changes, if any, needed in such rates to achieve or preserve a level of funding deemed adequate to enable payment through the indefinite future of the benefit amounts prescribed by the system, which shall include a valuation of present assets, based on statement value, and prospective assets and liabilities of the system and the extent of unfunded accrued liabilities, if any. (b) A plan to amortize any unfunded liability pursuant to s. 112.64 and a description of actions taken to reduce the unfunded liability. (2) The frequency of actuarial reports must be at least every 3 years commencing from the last actuarial report of the plan or system or October 1, 1980, if no actuarial report has been issued within the 3-year period prior to October 1, 1979. The results of each actuarial report shall be filed with the plan administrator within 60 days of certification. Thereafter, the results of each actuarial report shall be made available for inspection upon request. Additionally, each City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 3 - retirement system or plan covered by this act which is not administered directly by the Department of Management Services shall furnish a copy of each actuarial report to the Department of Management Services within 60 days after receipt from the actuary. The requirements of this section are supplemental to actuarial valuations necessary to comply with the requirements of s. 218.39. (3) No unit of local government shall agree to a proposed change in retirement benefits unless the administrator of the system, prior to adoption of the change by the governing body, and prior to the last public hearing thereon, has issued a statement of the actuarial impact of the proposed change upon the local retirement system, consistent with the actuarial review, and has furnished a copy of such statement to the division. Such statement shall also indicate whether the proposed changes are in compliance with s. 14, Art. X of the State Constitution and with s. 112.64. 112.64 Administration of funds; amortization of unfunded liability. (1) Employee contributions shall be deposited in the retirement system or plan at least monthly. Employer contributions shall be deposited at least quarterly; however, any revenues received from any source by an employer which are specifically collected for the purpose of allocation for deposit into a retirement system or plan shall be so deposited within 30 days of receipt by the employer. All employers and employees participating in the Florida Retirement System and other existing retirement systems which are administered by the Department of Management Services shall continue to make contributions at least monthly. (2) From and after October 1, 1980, for those plans in existence on October 1, 1980, the total contributions to the retirement system or plan shall be sufficient to meet the normal cost of the retirement system or plan and to amortize the unfunded liability, if any, within 40 years; however, nothing contained in this subsection permits any retirement system or plan to amortize its unfunded liabilities over a period longer than that which remains under its current amortization schedule. (3) For a retirement system or plan which comes into existence after October 1, 1980, the unfunded liability, if any, shall be amortized within 40 years of the first plan year. < The reference to 40 years is historical. All current and future unfunded liabilities shall be amortized within 30 years. > (4) The net increase, if any, in unfunded liability under the plan arising from significant plan amendments adopted, changes in actuarial assumptions, changes in funding methods, or actuarial gains or losses shall be amortized within 30 plan years. (5) (a) If the amortization schedule for unfunded liability is to be based on a contribution derived in whole or in part from a percentage of the payroll of the system or plan membership, the assumption as to payroll growth shall not exceed the average payroll growth for the 10 years prior to the latest actuarial valuation of the system or plan unless a transfer, merger, City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 4 - or consolidation of government functions or services occurs, in which case the assumptions for payroll growth may be adjusted and may be based on the membership of the retirement plan or system subsequent to such transfer, merger, or consolidation. (b) An unfunded liability amortization schedule that includes a payroll growth assumption and is in existence on September 30, 1996, or is established thereafter, may be continued using the same payroll growth assumption, or one not exceeding the payroll growth assumption established at the start of the schedule, regardless of the actual 10-year average payroll growth rate, provided that: 1. The assumptions underlying the payroll growth rate are consistent with the actuarial assumptions used to determine unfunded liabilities, including, but not limited to, the inflation assumption; and 2. The payroll growth rate is reasonable and consistent with future expectations of payroll growth. (c) An unfunded liability amortization schedule that does not include a payroll growth assumption and is in existence on September 30, 1996, or is established thereafter, may be continued or modified to include a payroll growth assumption, provided that such assumption does not exceed the 10-year average payroll growth rate as of the actuarial valuation date such change in the amortization schedule commences. Such schedule may be continued thereafter, subject to the reasonable and consistent requirements in paragraph (b). (6) Nothing contained in this section shall result in the allocation of chapter 175 or chapter 185 premium tax funds to any other retirement system or plan or for any other use than the exclusive purpose of providing retirement benefits for firefighters or police officers. 112.66 General provisions. (13) A local government sponsor of a retirement system or plan may not reduce contributions required to fund the normal cost. This subsection does not apply to state-administered retirement systems or plans. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 5 - Portions of Funding Policy Established By Board of Pension Trustees: Actuarial Cost Method The Board of Pension Trustees has adopted the use of the Entry Age Normal/Frozen Entry Age actuarial cost method to determine annual contribution requirements for the Pension Plan. Frozen Entry Age Under the Frozen Entry-Age Actuarial Cost Method, the excess of the actuarial present value of all future benefits of the group included in the valuation, over the sum of the actuarial value of assets, the unfunded frozen actuarial accrued liability and the actuarial present value of future member contributions (if any) is allocated as a level percentage of earnings of the overall group over the expected future working years of current active members. This allocation is performed for the group as a whole, not as a sum of individual allocations. The portion that is allocated to a specific year is called the Employer Normal Cost. Under this method, future actuarial experience gains (losses) are not explicitly recognized, but instead reduce (increase) future years’ Normal Costs. The initial unfunded frozen actuarial accrued liability (UFAAL) is determined under the entry age normal actuarial cost method as of the date this funding method is implemented, and it is amortized over a period of time. The initial UFAAL is frozen at that level. Subsequent changes in the UFAAL due to plan amendments and changes in actuarial assumptions or methods are explicitly recognized and added to the UFAAL and amortized over a reasonable period of future years. Entry Age Normal Under the Entry Age Normal Actuarial Cost Method, an annual level normal cost is calculated for each individual active member, payable from the date of employment to the date of retirement, that is sufficient to accumulate to the value of the member’s benefit at the time of decrement/retirement. Each annual normal cost is calculated as a constant percentage of that member’s year by year projected covered pay. Under this method, actuarial experience gains (losses) are explicitly recognized each year as they occur. They reduce (increase) the Unfunded Actuarial Accrued Liability, and they are amortized separately. The initial Unfunded Actuarial Accrued Liability (UAAL) is amortized over a period of time. Subsequent changes in the UAAL due to actuarial experience gains and losses, amendments, and changes in actuarial assumptions or methods are recognized in the UAAL and amortized over a reasonable period of future years. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 6 - Asset Valuation Method The Actuarial Value of Assets is based on the market value with investment gains and losses smoothed over five years. The Actuarial Value of Assets will not consistently be above or below the Market Value and is expected to converge to the Market Value in a relatively short period of time. At any time it may be either greater or less than Market Value. During periods when investment performance exceeds the assumed rate, the Actuarial Value of Assets will tend to be less than Market Value. During periods when investment performance is less than the assumed rate, the Actuarial Value of Assets will tend to be greater than Market Value. If assumed rates are exactly realized for five consecutive years, the Actuarial Value will become equal to Market Value. The Actuarial Value is limited to a 20% corridor around the Market Value. This means that if the preliminary development of the Actuarial Value results in an amount that is greater than 120% of the Market Value (or less than 80% of the Market Value), the final Actuarial Value is limited to 120% (or 80%) of the Market Value. Any gains or losses on the Market Value outside of the 20% corridor are therefore recognized immediately. Amortization Method Amortization periods of up to 30 years or the maximum period allowed by standards adopted by the Government Accounting Standards Board (GASB), whichever is less. Under GASB Statements Nos. 25 and 27, the GASB accounting standards provided broad guidelines on plan funding. The GASB Statements Nos. 67 and 68 do not address plan funding and only address financial reporting. This Actuarial Funding Policy does not attempt to comply directly with promulgations of GASB. The annual actuarial valuation determining the City contribution rates shall use 30-year closed amortization periods for amendments and changes in actuarial assumptions or methods and 15-year closed amortization periods for actuarial experience gains and losses. Amortization amounts shall be determined as level dollar amounts. Amortization bases will be combined, in accordance with the methodology described for combining and offsetting amortization bases under Internal Revenue Code Section 412(b), if the sum of the outstanding bases is positive while the sum of the amortization payments is negative, or vice versa. Amortization bases may also be combined to reduce volatility in the required employer contributions if adopted by the Board of Pension Trustees based upon the advice and recommendation of the Plan’s actuary. Actuarial Assumptions The actuarial assumptions used will be those last adopted by the Board based upon the advice and recommendation of the Plan’s actuary. The Board may request the actuary to perform an actuarial investigation into the experience of the Plan every six years or another appropriate period as determined by the Board to be utilized to form the basis for recommendations in actuarial assumptions. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 7 - Funding Target The funding objective is to achieve 100% funding. For this purpose, “100% funding” means that the Actuarial Value of Assets equals the Actuarial Accrued Liability. The amortization method allows up to 30 years to achieve this objective. Risk Management The main financial objective of this actuarial funding policy is to fund the long-term costs of benefits to plan members and beneficiaries. There are numerous risks that the Plan faces in trying to achieve this objective including funding risk, demographic risk, investment risk, and benefit risk. The Board policies for managing these risks are outlined in this section. Funding Risk Frequency of Actuarial Valuations Regular valuations manage funding risk by allowing employer contribution rates to reflect actual experience as it emerges. Funding valuations are performed every year as of January 1 to determine employer contribution amounts for the fiscal year beginning nine months later. Separate valuations are required for financial reporting under GASB 67 and 68. Demographic and Investment Risk Process for Reviewing and Updating Actuarial Assumptions The Board adopts actuarial assumptions based on recommendations of the Plan’s actuary. Demographic and investment risks may be managed in part by having regular reviews of the actuarial assumptions. The Board may request the actuary to perform an actuarial investigation into the experience of the Plan every six years or another appropriate period as determined by the Board. Once in receipt of the experience study report, the Board will adopt actuarial assumptions and methods as necessary. If circumstances warrant, the Board may change assumptions more frequently after conferring with the actuary and when investment risks are involved, the investment consultant. The experience study report shall include, but not necessarily be limited to, analysis of and recommendations regarding the following assumptions: i. Pre-retirement withdrawal rates ii. Retirement rates iii. Disability rates iv. Pay increase rates v. Mortality rates both before and after retirement City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 8 - vi. Investment returns considering both real return and inflation, which must be consistent with the investment policy The actuary shall assume no change in the active member population unless there is compelling evidence to support the expectation of a significant increase or decrease in the workforce covered by the Plan. The experience study report will serve as the basis for determinations by the Board regarding whether or not demographic or economic assumptions should be modified for future valuations. Chapter 112.661 (9), Florida Statutes specifies the investment policy adopted by the Board must include a requirement that the Board shall determine the total expected annual rate of return for the current year, for each of the next several years, and for the long term thereafter. This determination must be filed promptly with the Department of Management Services and with the plan’s sponsor and the consulting actuary. Responding to Favorable/Unfavorable Investment Experience Investment risk is addressed in the investment consultant’s quarterly reports. Annual investment experience other than assumed is reflected in the valuation asset method described above. Asset Liability Studies The Board adopts an asset allocation based on recommendations from the investment consultant. The asset allocation approved by the Board may reflect the results of periodic Asset Liability Studies, if performed. Risk Measures In order to quantify the risks outlined in this actuarial funding policy, the following metrics will be included in annual actuarial valuation reports. These metrics provide quantifiable measurements of risk and its movement over time: i. Funded ratio (Actuarial Value of Assets divided by Actuarial Accrued Liability). − Measures progress towards the funding objective of the 100% target funded ratio. ii. Total Unfunded Actuarial Accrued Liability (UAAL) divided by Total Payroll − Measures the risk associated with contribution decreases relative impact on the ability to fund the UAAL. A decrease in this measure indicates a decrease in contribution rate risk. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 9 - iii. Total Actuarial Accrued Liability (AAL) divided by Total Payroll − Measures the risk associated with the ability to respond to liability experience through adjustments in contributions. A decrease in this measure indicates a decrease in liability experience risk. This also provides a long-term measure of the asset risk in situations where the Plan has a funded ratio below 100%. iv. Total Actuarial Value of Assets divided by Total Payroll − Measures the risk associated with the ability to respond to asset experience through adjustments in contributions. A decrease in this measure indicates a decrease in asset experience risk. Benefit Risk Benefit risk may be managed as follows: The Board shall review proposals and legislative changes for the potential legal, administrative, Internal Revenue Code compliance, and funding impact on the Fund. If a proposal has the potential for a meaningful impact on plan funding, the Board shall consult with the actuary to estimate the actuarial impact to the Plan. The Board does not establish the benefit provisions; it administers them. Miscellaneous Matters Associated with Funding: Overall Conformance with Professional Standards of Practice By law, the actuary shall be an Enrolled Actuary and either a Member of the American Academy of Actuaries or an Associate or a Fellow of the Society of Actuaries. The work of the actuary in connection with this policy shall conform to Actuarial Standards of Practice for public employee retirement plans promulgated by the Actuarial Standards Board and shall satisfy the requirements of the Governmental Accounting Standards Board with respect to the development of information needed by the Fund and by the City for financial reporting purposes. APPENDIX B GRS RESEARCH REPORT: DEVELOPING A PENSION FUNDING POLICY FOR STATE AND LOCAL GOVERNMENTS 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -1- Developing a Pension Funding Policy for State and Local Governments By David Kausch and Paul Zorn1 Over the past decade, the Annual Required Contribution (ARC) as described in the Governmental Accounting Standards Board’s (GASB’s) Statements No. 25 and No. 27 has become a de facto funding policy for many public-sector retirement systems. The GASB is currently revising public pension accounting standards and has communicated an important message in the process: accounting standards are not funding standards. In the Exposure Drafts (EDs) of the new Statements No. 25 and No. 27, the GASB has removed all references to the ARC. At the same time, the EDs require disclosure of elements of a plan’s funding policy and the actual funding pattern must be taken into account to determine the plan’s financial disclosures. Now more than ever, public retirement systems need to have a sound, written funding policy to secure member benefits – and a strong funding policy may improve a plan’s financial disclosures as well. Funding Policy Goals The idea of having a written funding policy is not new. In its Best Practice, “Sustainable Funding Practices of Defined Benefit Pension Plans,” the Government Finance Officers Association (GFOA) states that the main financial objective of public employee defined benefit plans is to fund the long-term costs of promised benefits to plan participants.2 Moreover, the GFOA recommends that this be done through a systematic and disciplined accumulation of resources (i.e., contributions and related investment earnings) which are sufficient to the pay promised benefits to plan members over their lifetimes. In addition to this objective, the GFOA’s Best Practice cites other goals as well. To be consistent with the governmental budgeting process, efforts should be made to keep the employer’s pension contributions relatively stable from year to year. Moreover, to satisfy the principle of intergenerational equity, pension costs should be allocated to taxpayers on an equitable basis over time, i.e., not pushed into the future or immediately imposed on current taxpayers. In addition, to help offset related risks, efforts may be made to provide a reasonable margin for adverse experience. Developing a written funding policy can help decision- makers understand the tradeoffs related to reaching these goals and document the reasoning that underlies their decisions. By clarifying the funding policy, decision-makers can come to a better understanding of the principles and practices that help sustain benefits over the long-term. Risk-Management Framework These funding principles can be thought of in a risk-management framework. In an effort to keep the employer’s pension contribution relatively stable from year to year, a funding policy should: (1) identify key 1 David Kausch is chief actuary for GRS and Paul Zorn is director of governmental research. The authors thank Brian Murphy, Theora Braccialarghe, Supriya Kopf, Lewis Ward, Danny White, Dana Woolfrey and Mary Ann Vitale at GRS for their thoughtful comments. However, the authors retain full responsibility for the accuracy of the information. Moreover, the views expressed do not necessarily represent those of GRS as an organization. 2 Government Finance Officers Association, “Sustainable Funding Practices for Defined Benefit Pension Plans,” 2009. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -2- risk areas that add to contribution volatility and (2) identify ways to manage each of those risks. The primary risk areas in funding retirement systems are investment risks, demographic risks within the covered population, benefit or plan design risks, and governance risks. In response to this: • Investment risks can be managed with diversification of asset classes and asset smoothing. • Demographic risks can be measured and managed through the use of regular actuarial valuations and actuarial experience studies. • Benefit or plan design risks are often outside the purview of a retirement system’s board, but may include setting the interest rate on member contributions and deciding when to provide ad-hoc COLAs or thirteenth checks. • Governance risks can be managed with clear policies and controls regarding the major administrative practices of the retirement system. A written funding policy addresses all of these risks and recognizes tradeoffs between mitigating contribution volatility and recognizing gains and losses over a reasonable period. To help decide these tradeoffs and document the reasoning behind the decisions, the GFOA’s Best Practice recommends that plans adopt a written pension funding policy describing the principles and practices that guide the funding decisions. These would include: (1) the reasons for selecting the actuarial methods and assumptions, and (2) the policies related to risk sharing and responding to changes in plan experience. Key elements of a funding policy include decisions related to: • Actuarial cost method and assumptions • Asset valuation method • Amortization method • Funding target • Risk management regarding: o Frequency of actuarial valuations, o Process for reviewing and updating actuarial assumptions, o Responding to legislative proposals and changes, o Responding to favorable/unfavorable investment experience, o Sensitivity analysis and forecasting, and o Asset/Liability modeling. Elements to Consider in Developing a Funding Policy Actuarial Cost Method Different actuarial cost methods produce different patterns of normal costs and actuarial accrued liabilities. Some actuarial cost methods are more useful for determining contributions to an ongoing plan, and some are more useful for closed plans. While a detailed description of each cost method is beyond the scope of this report, the following three methods illustrate key distinctions. A more detailed discussion of actuarial cost methods is presented in Appendix A. • Traditional Unit Credit (TUC) –Under this actuarial cost method, the normal cost for a given year reflects the increase in the benefit earned due to increases in service and salary for the year, but not to service and salary projected to be earned in future years. Generally, this method is not used to fund ongoing public pension plans. • Projected Unit Credit (PUC) – Under this method, normal cost is calculated using benefits based on increases in service for the year, but with salary projected to the retirement date. This method is used by about 10% of public pension plans. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -3- • Entry Age Normal (EAN) – Under this method, normal cost is calculated using benefits based on projected service and salary at retirement and is allocated over an individual’s career as a level percent of payroll. This method is used by about 75% of public pension plans. Funding policy issues related to the actuarial cost method include: • Is the cost method appropriate for the plan? • Does the cost method produce normal costs that are reasonably stable and therefore consistent with the government’s budgeting process? For ongoing plans, the popularity of the EAN cost method is not surprising given governments’ need to limit volatility in contribution rates. Moreover, since contribution rates are initially higher under the EAN method than other cost methods, the EAN method accumulates assets more quickly than the other methods. As a result, the assets can be invested earlier to help offset future contributions. By contrast, the TUC and PUC methods start with lower contributions which increase over time. For closed plans, other actuarial cost methods may be more appropriate. The lack of new entrants into the plan and the shorter service lives of the remaining active members may make it appropriate to fund the plan more rapidly than under the EAN method. This could be done using the Aggregate actuarial cost method. The Aggregate cost method allocates the difference between the value of benefits and assets over the future service of the closed active population as a level percent of payroll. Actuarial Assumptions Actuarial assumptions also play a key role in determining the plan’s normal costs and actuarial accrued liabilities. The assumptions can be categorized into two groups: (1) economic assumptions (including inflation, wage growth, and long-term expected investment returns); and (2) demographic assumptions (including rates of mortality, disability, retirement, and termination). All assumptions should be consistent with Actuarial Standards of Practice and reflect professional judgment regarding future outcomes. Although all assumptions are important, the investment return assumption plays an extremely important role in the actuarial valuation, and strongly influences the calculations of normal costs and actuarial accrued liabilities. For funding purposes, the Actuarial Standards Board’s Actuarial Standards of Practice (ASOP) No. 27 supports the use of discount rates based on the plan’s long-term expected investment return.3 Funding policy issues related to the discount rate include: • Does the long-term expected investment return accurately reflect likely investment returns? • What variations in the actual investment return will likely occur over the long-term? In order for the actuarial valuation to properly fund the benefits, it is important that the discount rate accurately reflect the long-term investment return. If the assumption is too high, the contributions and actuarial liabilities determined by the valuation will be too low. If the assumption is too low, the contributions and actuarial liabilities will be too high. It is also important to understand that the assumption is intended to reflect an average expected return. In given years, actual returns will vary from the expected return. 3 Actuarial Standards Board, ASOP No. 27, Selection of Economic Assumptions for Measuring Pension Obligations, May 2011. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -4- Asset Valuation Method The actuarial methods that are used to determine the plan’s actuarial value of assets (AVA) also play a role in the funding policy. The difference between the actuarial accrued liability (AAL) and the AVA is the plan’s unfunded accrued liability (UAL). To the extent that the plan has a UAL, it must be amortized and included in the contribution rate. Key funding policy issues related to asset valuations include: • Should the actuarial value of assets be smoothed? If so, over what period? • Should a corridor be applied to the smoothed value of assets to prevent it from diverging too far from the market value? Smoothed vs. Market Value of Assets. Investment gains and losses are often “smoothed” into the AVA in order to mitigate the impact of investment volatility on employer contributions. In many cases, this is done by taking the difference between the actual annual investment earnings and the expected annual investment earnings and recognizing a portion of that difference each year over a set number of years. This evens out the impact of investment gains and losses that would otherwise be immediately recognized in the UAL. Smoothing Period. In cases where assets are smoothed, the smoothing period is often 5 years, although some plans use shorter or longer periods. While the smoothing period for governmental plans is not limited by federal laws or regulations, the Actuarial Standards Board has set out principles for asset smoothing in ASOP No. 44.4 Under these principles, when a smoothed asset valuation method is used, the actuary should select a method so that: • The smoothed asset values fall within a reasonable range of the corresponding market values; and • Any differences between the actuarial value and market value of assets should be recognized within a reasonable period. Asset Corridors. To satisfy these principles, many plans that smooth assets over periods longer than 5 years also include corridors that limit the extent to which the smoothed value of assets can diverge from the market value. Appendix B provides an illustration of how asset smoothing and asset corridors interact. Amortization Method In addition to the normal cost, the other major component of the annual contribution is the portion needed to amortize the UAL. Consequently, when setting the funding policy, the structure of the amortization payments and the length of the amortization period are important issues. It should also be noted that during the amortization period, interest accrues on the outstanding UAL at a rate reflecting the long-term expected investment return. In setting up an amortization policy, the following decisions should be made: • Should the amortization period be open or closed? • Should the amortization be on a level-dollar basis or a level-percent-of-pay basis? • What should be the length of the amortization period? • Should there be separate amortization bases for annual gains/losses, benefit changes, and other components of the UAL? A key issue in setting the amortization policy is the possibility of negative amortization. This occurs when the amortization payments are less than the interest accrued on the UAL during the year, and so the outstanding UAL increases rather than decreases. However, this depends on the length of the amortization period, as well as assumptions related to expected investment return and payroll growth. It is important to 4 Actuarial Standards Board, ASOP No. 44, Selection and Use of Asset Valuation Methods for Pension Valuations, May 2011. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -5- note that while the UAL increases when there is negative amortization, it is typically not expected to increase faster than the projected rate of payroll growth and is expected to be fully paid by the end of the period. However, an open amortization period which allows negative amortization may be inconsistent with reaching a funding target of 100% in a reasonable period of time. Closed Amortization vs. Open Amortization. Another issue is whether the UAL should be amortized over a closed amortization period or an open amortization period. If a closed amortization period is used, the UAL will be fully paid by the end of the period. By contrast, under an open amortization period, the period is reset each year. For example, under a 25-year open amortization period, the UAL is refinanced each year over a new 25-year period. Closed amortization periods pay down the UAL more rapidly and limit negative amortization, but produce more volatility in the contribution rate as the period gets shorter. An open period results in a more gradual decline of the UAL and helps to control volatility in the contribution rate, but takes substantially longer to pay down the UAL. Moreover, an open amortization period is more likely to produce negative amortization, at least when the period is 15 to 20 years or longer. Appendix C provides illustrations of the amortization patterns under closed and open amortization periods. Level-dollar vs. Level-percent-of-pay. Another issue is whether the UAL should be amortized on a level- dollar basis or as a level-percent-of-pay. Level-dollar amortization is similar to a fixed-rate home mortgage with a constant dollar payment. Level-percent-of-pay amortization initially has lower dollar payments, but these increase each year. Since level-dollar amortization pays a greater portion of the UAL in earlier years, it is more conservative than level-percent-of-pay amortization. However, level-percent-of pay-amortization may be more consistent with the budgeting process of most governmental entities. Length of the Amortization Period. Generally, for public pension plans, amortization periods range from 15 to 30 years, although some plans use shorter or longer periods. Shorter amortization periods result in the UAL being paid off sooner, but require higher and likely more volatile contributions. Longer amortization periods require lower contributions, but may shift some of the pension costs beyond the working careers of active employees and on to future generations. Single Amortization vs. Separate Amortization Bases. So far the discussion of amortization has focused on amortizing the UAL as a whole over a single amortization period. This approach is straightforward, since there would be no need to track separate amortization bases. However, the UAL is made up of amounts that come from different sources, including: (1) actuarial gains and losses due to differences between actual and assumed plan experience, (2) benefit changes, and (3) changes in actuarial methods and assumptions. As a result, the plan may wish (or in some cases be required) to amortize the UAL from these sources over different periods. For example, changes in the UAL due to benefit changes could be amortized over a shorter period than changes in the UAL due to changes in actuarial assumptions. However, a disadvantage to using multiple amortization periods is that they may increase the volatility of contribution rates. Funding Target The funding target is the funded ratio that the plan is trying to reach and maintain through its funding policy. The GFOA’s Best Practice “Sustainable Funding Practices for Defined Benefit Pension Plans” recommends a funding target of 100%. Setting the funding target to an anything other than 100% means establishing a policy of making contributions that are greater or less than the amounts theoretically needed to fund the plan. However, funding targets of more than 100% may provide a margin for adverse experience. On the other hand, funding targets of less than 100% may help mitigate pressure for benefit increases. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -6- Risk Management As noted at the beginning of this report, there are a variety of risks associated with defined benefit plans, including investment risks, demographic risks, benefit design risks, and governance risks. To manage the risks, it is important to first identify the potential impact of a specific risk on plan funding, and then to identify ways to manage the risk. Pension funding policy should include a discussion of the steps needed to monitor and address the risks facing the plan. Investment risks involve both the risks that investment returns will not meet actuarial expectations and that the volatility of the returns will make contribution rates difficult to budget. Generally, investment risks are managed through changes in asset allocations which, in turn, are based on asset allocation studies and asset/liability analyses. If changes are made to asset allocations, the long-term investment return assumption should also be reviewed and, if necessary, changed to reflect the new asset allocation. Demographic risks involve the risks that the plan’s actual experience related to mortality, retirement patterns, and other demographic factors do not match the actuarial assumptions. It is considered best practice to do experience studies at 5-year intervals to monitor and update the assumptions. Benefit design risks include the risks that benefit changes will result in future contributions that are unaffordable for the sponsoring government. One way to examine these risks is to have an actuarial valuation of the benefit changes done before the changes are approved by the government, an approach recommended by the GFOA. Benefit design risks can also be examined using stochastic projections that compare future benefits with future contributions and investment returns, as well as scenario (stress) tests which examine changes in funding that result from specific changes in assumptions. Changes in benefits may require a change in actuarial assumptions. For example, it may be necessary to lower the investment return assumption if benefit increases are based on favorable investment experience (i.e., actual investment returns that are higher than expected returns). As discussed in the section on actuarial assumptions above, the long-term investment return assumption reflects the actuary’s estimate of the average return. Using excess earnings rather than additional contributions to provide increased benefits reduces the earnings available to pay current benefits. This, in turn, may require a lower investment return assumption be used, thereby increasing the actuarial accrued liability of the plan. Similarly, when investment gains result in lowered contributions, care should be taken to ensure the contributions do not fall to unreasonable levels. Governance risks relate to the risks that the plan’s administrative policies and procedures are appropriate for carrying out the functions of the plan. Funding policy can address governance risks by discussing the administrative structures that should be in place for monitoring compliance with the funding policy and ensuring that the actuarially determined contributions are made. In addition, funding policy can help ensure that the long-term costs of benefit changes are determined before legislative action is taken. Conclusion In funding defined benefit pension plans, governments must satisfy a range of objectives. In addition to the fundamental objective of funding the long-term costs of promised benefits to plan participants, governments also work to: (1) keep employer’s contributions relatively stable from year to year; (2) allocate pension costs to taxpayers on an equitable basis; and (3) manage pension risks. Developing a written funding policy can help decision-makers understand the tradeoffs involved in reaching these goals and document the reasoning that underlies their decisions. By clarifying the funding policy, decision-makers can come to a better understanding of the principles and practices that produce sustainable benefits. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -7- Summary of Funding Policy Elements Element Policy Function Issues to Address Actuarial Cost Method Determines accrual patterns of normal costs and actuarial accrued liabilities • Is the actuarial cost method appropriate for the plan? • Does the cost method produce normal costs that are reasonable stable and consistent with the budgeting process? Actuarial Assumptions Determines the assumptions used in the actuarial valuation and other studies • Does the long-term expected investment return accurately reflect likely investment returns? • How will actual investment returns likely vary from the assumed return over time? • Do the demographic assumptions, including the mortality assumptions, accurately reflect the ongoing experience of the plan? • How often should studies be done to evaluate the actuarial assumptions? Asset Valuation Method Determines the actuarial value of assets and, by extension, the unfunded accrued liability • Should the actuarial value of assets be smoothed? If so, over what period? • Should an asset corridor be applied to prevent the smoothed value of assets from diverging too far from the market value? Amortization Method Determines the portion of the unfunded accrued liability that is amortized in the contribution rate each year • Should the amortization period be open or closed? • Should it be on a level-dollar basis or level- percentage-of-pay basis? • What should be the length of the amortization period? • Should there be separate amortization bases for different components of the unfunded accrued liability? Funding Target Determines the funded ratio targeted by the funding policy • Should the funding target be other than 100%? Risk Management Aligns the funding policy with the risk management framework • How should risks be monitored with regard to investments, demographics, and plan design? • What actions should be taken to address the risks? • How should favorable investment experience be treated? • How should unfavorable investment experience be treated? Governance Monitors plan administration and contributions • What administrative structures should be in place to monitor compliance with the funding policy and ensure actuarially determined contributions are made? • What governance structures should be in place so that the long-term costs of benefit changes are determined before legislative action is taken? 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -8- Appendix A – An Overview of Actuarial Cost Methods In order to make sound decisions related to pension funding, it is important to understand how the actuarial cost methods work and how the employer’s actuarially determined contributions are calculated. Present Value of Future Benefits To determine the contributions needed to fund the plan, the value of benefits to be paid in the future must be converted to amounts as of the valuation date. This is done by projecting the future benefits owed to current plan members based on the plan’s benefit provisions and actuarial assumptions. These projected future benefits are then discounted using a rate that represents the expected long-term rate of investment return on plan assets. The resulting “projected value of future benefits” (PVFB) is the sum of the discounted values of the projected benefits. Essentially, this is the amount on the valuation date which, if invested at the discount rate, would pay all of the projected future benefits (provided the actuarial assumptions are met). Normal Cost An individual’s normal cost is the portion of the PVFB that is allocated to a given year of employee service under the actuarial cost method. The plan’s total normal cost in a given year is the sum of each individual’s normal cost for that year. There are a variety of actuarial cost methods and different methods take different approaches to allocating the normal cost over an individual’s career. Chart 1 illustrates how normal costs vary under three actuarial cost methods: the Traditional Unit Credit (TUC) method, the Projected Unit Credit (PUC) method, and the Entry Age Normal (EAN) cost method. The three lines show the normal cost patterns for an individual employee who begins coverage under the plan at age 30 and retires at age 65, assuming the same benefit and same assumptions. The normal costs are shown as a percent of annual pay. Chart 1 • The TUC method recognizes salary and years of service in the benefit only when earned. As a result, normal costs under this method increase at an accelerating rate as the employee approaches retirement age and as salary increases. 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64Percent of Annual PayAttained Age Normal Cost as a % of Annual Pay for an Employee Starting at Age 30 and Retiring at Age 65 TUC Normal Cost PUC Normal Cost EA Normal Cost 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -9- • The PUC method recognizes years of service when earned, but projects salary to retirement age. As a result, normal costs also increase under this method as an employee approaches retirement, but at a slower rate than under the TUC because future increases in salary are recognized in advance. • The EAN cost method immediately recognizes both projected salary and service. As a result, it allows normal costs to be calculated as a level-dollar amount or as a level-percent-of-pay over the employee’s career. Actuarial Accrued Liability The actuarial accrued liability (AAL) is the accumulated amount of the normal costs attributed to years of service before the valuation date. Given that the different actuarial cost methods result in different normal costs, it follows that they also result in different accrual patterns for the AAL over a member’s employment. Chart 2 shows the accrued AAL for an individual employee who begins coverage under the plan at age 30 and retires at age 65. As with Chart 1, the three lines reflect the different actuarial costs methods applied to the same employee earning the same benefit under the same assumptions. Chart 2 Since the employee will receive the same benefit at retirement, the actuarial cost methods converge to the same actuarial accrued liability. However, the paths they take are different. • Under the TUC method, the AAL starts out low and increases over time as each year’s accumulating salary and years of service are recognized in the AAL. Much of the AAL under the TUC is accrued in the last 5 years before retirement. • Under the PUC method, the AAL increases somewhat more rapidly than under the TUC, but the PUC method still shifts recognition of much of the AAL toward the end of the employee’s career. • Under the EAN cost method, a larger portion of the AAL is recognized in earlier years, which in turn, helps provide for more level contribution rates over the employee’s career. Note that Chart 2 shows only the liability accrual pattern for one employee over time. The accrual pattern for the plan as a whole will depend on the age and service characteristics of all employees in the plan. $‐ $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65Actuarial Accrued LiailityAttained Age Actuarial Accrued Liability Under Different Actuarial Cost Methods for an Employee Entering the Plan at Age 30 and Retiring at Age 65 TUC AAL PUC AAL EAN AAL 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -10- Appendix B – An Example of Asset Smoothing and Asset Corridors As discussed in the report, investment gains and losses are often “smoothed” into the actuarial value of assets (AVA) in order to mitigate the impact of investment volatility on contributions. While most public plans use 5-year smoothing periods, plans that smooth over longer periods often use asset corridors to limit the extent to which the value of smoothed assets can diverge from the market value. For example, under an “80/120” corridor, the smoothed value of assets is not allowed to fall below 80% or rise above 120% of the market value. This helps keep the actuarial value of assets within a reasonable range of the market value. However, during a major market decline or increase, the smoothed value of assets may exceed the corridor. If so, the amount of assets exceeding the corridor must be immediately recognized, adding to the volatility of the UAL and contributions. Chart 3 Chart 3 shows the growth of a hypothetical plan’s investment portfolio with a 60% mix of large cap stocks and a 40% mix of high-quality corporate bonds over the period from 1985 to 2010. The solid black line shows the market value of assets (MVA) at calendar year-end and the gray dotted lines show the 80/120 corridor boundaries. The green line (marked with triangles) shows the 5-year smoothed AVA. Several things are interesting about the chart. First, during most of the 1990s, the 5-year smoothed AVA was below the MVA. This is because actual investment returns were substantially higher than expected returns for most of the decade, and the MVA outpaced the AVA. In fact, the 5-year smoothed AVA was very close to the 80% corridor in 1997 and 1998. When the financial markets declined during 2000-2002, the 5-year smoothed AVA continued increasing, due to continued recognition of gains from the 1990s. When the financial markets picked up again in 2003, the asset losses from 2000-2002 offset part of the asset gains and the 5-year smoothed AVA moved closer to the MVA. However, the financial crisis of 2008 caused the MVA to decline sharply, causing a similar fall in the corridor boundaries. Consequently, in 2008, the 5-year smoothed AVA would have been greater than the upper boundary of the corridor. If the corridor had been in place, the plan would have had to lower its AVA to match the corridor’s upper boundary, increasing its UAL and the amount of the UAL amortized in its contribution rate. $‐ $200,000 $400,000 $600,000 $800,000 $1,000,000 $1,200,000 19851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010Year Illustration of 5‐Year Smoothing and 80/120 Corridor on the Value of Assets for a 60/40 Stock/Bond Portfolio from 1985 through 2010 Market Value of Assets (EOY) Corridor (‐20%) Corridor (+20%) 5‐Year Smoothed AVA 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -11- Appendix C: Amortization Patterns under Closed and Open Periods An important pension funding policy issue is whether the UAL should be amortized over a closed amortization period or an open amortization period. Closed amortization periods pay down the UAL more rapidly and limit negative amortization, but produce more volatility in the contribution rate as the period gets shorter. Open amortization periods help control volatility in the contribution rate, but take longer to pay down the UAL. Another amortization issue is whether the UAL should be amortized on a level-dollar basis or as a level- percent-of-pay. Level-percent-of-pay amortization initially has lower dollar payments, but these increase each year. Since level-dollar amortization pays a greater portion of the UAL in earlier years, it is more conservative than level-percent-of-pay amortization. However, level-percent-of pay-amortization is more consistent with the budgeting process of most governmental entities. Chart 4 shows the UAL amortization patterns for: (1) a 25-year closed level-dollar amortization approach; (2) a 25-year closed level-percent-of pay-approach; and (3) a 25-year open percent-of-pay approach. The amortization payments are expressed in dollars. Chart 4 • Under the closed, level-dollar approach, the dollar payments start higher than under the level- percent-of-pay approaches, and remain level until the end of the amortization period, at which time the UAL is completely amortized. • Under the closed, level-percent-of-pay approach, the dollar payments are initially below the payments made under the level-dollar approach, but exceed the level-dollar payments after approximately 10 years, and ultimately become substantially more than the payments under the level-dollar approach. • Under the open percent-of-pay approach, the dollar payments start at the same amount as the closed, level-percent-of-pay approach, and remain below the dollar payments under the closed approach. However they continue to increase even after the end of the 25-year period and may continue for several decades. $‐ $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $140,000 $160,000 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 Years UAL Amortization Pattern (in Dollars) 25 Year Closed, Level $ 25 Year Closed, Level % Pay 25 Year Open, % of Pay 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -12- The dynamics appear different when the same amortization payments are expressed as a percentage of covered payroll, as in Chart 5: Chart 5 From this perspective, the closed level-dollar payments decline rapidly as a percent of payroll. Under the closed level-percent-of-pay approach the payments remain level until they are fully amortized at the end of the period. However, under the open percent-of-pay approach, the amortization payments extend beyond the 25-year period and continue to decline for decades thereafter. The rate at which they fall depends on a number of factors, including the expected investment return and payroll growth assumption. 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00% 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59Percent of PayrollYears UAL Amortization Pattern (as a % of Payroll) 25 Year Closed, Level $ 25 Year Closed, Level % Pay 25 Year Open, % of Pay Cover Memo City of Clearwater City Hall 112 S. Osceola Avenue Clearwater, FL 33756 File Number: ID#14-655 Agenda Date: 11/17/2014 Status: Agenda ReadyVersion: 1 File Type: Action ItemIn Control: Pension Trustees Agenda Number: 4.6 SUBJECT/RECOMMENDATION: Provide guidance regarding proposed actuarial funding policy for the Plan. SUMMARY: It is recommended that all defined benefit pension plans have a formal funding policy. A formal funding policy provides a long -term road map for plan funding and demonstrates prudent financial management of the plan. The Pension Funding Task Force 2013, including GFOA, ICMA, National League of Cities, and various other national organizations, recommended that all defined benefit pension plans adopt a formal funding policy. The City’s actuary has developed a draft funding policy for the Plan, per Appendix A of the report. Staff recommends adopting the proposed funding policy with the following changes: ·Adopt the Entry Age Normal actuarial cost method and delete references to Frozen Entry Age method. ·Amend the amortization periods to be 25 years, rather than 30 years, for changes in actuarial assumptions or methods. Also, amend the amortization period for plan benefit changes/amendments to be no longer than the average future working period of affected employees (determined at the time a benefit change/amendment is made). These periods are consistent with recent guidance from the Conference of Consulting Actuaries (White Paper on Public Sector Pension Funding issued September 2014). ·Amend the Funding Target from “the funding objective is to achieve 100% funding” to “the funding objective is to achieve and maintain at least 100% funding”. ·Amend language indicating Board “may” request studies of actuarial assumptions every six years to “must” request studies at least every six years, consistent with the pension ordinance requirement. ·Staff is seeking guidance on any changes or additions the Trustees would like to the proposed funding policy. Staff intends to bring a final funding policy to the Trustees for approval at the December Trustees meeting. APPROPRIATION CODE AND AMOUNT: N/A Page 1 City of Clearwater Printed on 11/12/2014 File Number: ID#14-655 USE OF RESERVE FUNDS: N/A Page 2 City of Clearwater Printed on 11/12/2014 APPENDIX A DRAFT ACTUARIAL FUNDING POLICY City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 1 - FUNDING OBJECTIVES The main funding objective for the defined benefit provisions of the City of Clearwater Employees’ Pension Plan (Plan) is to establish and receive employer (City and State, if any) contributions, expressed as a percentage of active member payroll, which will remain approximately level from year to year and will not have to be increased for future generations of citizens in the absence of benefit changes. This objective is stated in the Plan’s Ordinance and meets the requirements of Part VII, Chapter 112, Florida Statutes, Chapter 175, Florida Statutes, and Chapter 185, Florida Statutes. The employer contributions along with member contributions are to be used for funding the long- term costs of benefits, provided by the Ordinance and collective bargaining agreements, for Plan members and beneficiaries. Additionally, the City is responsible for contributing administrative expenses. From the perspective of the members and beneficiaries, the funding objective is for assets and actuarially determined contributions to be sufficient to pay all benefits provided by Plan when due. From the perspective of the contributing plan sponsors and taxpayers, there are additional funding objectives of keeping the actuarially determined contribution rates relatively stable as a percentage of active member payroll and equitably allocating the costs over the active members’ periods of active service. For pension funding, the payment of benefits is supported in part by income earned on investment assets. This actuarial funding policy meets these objectives. It is stipulated by state law and collective bargaining agreements and is implemented through the application of Board adopted governance policies. Statutory Pension Funding Policy – Ordinance The Ordinance for the Plan sets forth some portions of the actuarial funding policy for the Plan. Ordinance Excerpts: Sec. 2.413. Plan administration. (i) Actuarial valuation; actuarial standards. (1) At least once in each six (6) year period, the trustees shall cause an actuarial investigation to be made into the mortality, service and compensation experience of the members of the retirement plan. Taking into account the result of such investigation, the trustees shall adopt for the retirement plan such mortality, service and other tables as are necessary and proper. On the basis of these tables, an annual actuarial valuation of the assets and liabilities of the retirement plan shall be made. (2) Actuarial assumptions based on the six (6) year experience analysis may be modified by the trustees at such times as they deem appropriate. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 2 - Sec. 2.415. Contributions to the plan. (b) Employer contributions. (1) For each plan year, the employer shall make contributions to the plan in an amount equal to a. Seven percent of the compensation of all employees participating in the plan; plus b. Such additional amounts as may be required to satisfy the plan's funding requirements for the plan year and the cost of administering the plan, as determined by the actuary employed by the trustees. (2) The amount described in subparagraph (b)(1)b. above may be reduced by any available credit balance in accordance with applicable Florida Statutes. Statutory Pension Funding Policy – Florida Statutes Chapter 112, Florida Statutes sets forth some portions of the actuarial funding policy for the Plan. Chapter 112 Excerpts: 112.63 Actuarial reports and statements of actuarial impact; review. (1) Each retirement system or plan subject to the provisions of this act shall have regularly scheduled actuarial reports prepared and certified by an enrolled actuary. The actuarial report shall consist of, but shall not be limited to, the following: (a) Adequacy of employer and employee contribution rates in meeting levels of employee benefits provided in the system and changes, if any, needed in such rates to achieve or preserve a level of funding deemed adequate to enable payment through the indefinite future of the benefit amounts prescribed by the system, which shall include a valuation of present assets, based on statement value, and prospective assets and liabilities of the system and the extent of unfunded accrued liabilities, if any. (b) A plan to amortize any unfunded liability pursuant to s. 112.64 and a description of actions taken to reduce the unfunded liability. (2) The frequency of actuarial reports must be at least every 3 years commencing from the last actuarial report of the plan or system or October 1, 1980, if no actuarial report has been issued within the 3-year period prior to October 1, 1979. The results of each actuarial report shall be filed with the plan administrator within 60 days of certification. Thereafter, the results of each actuarial report shall be made available for inspection upon request. Additionally, each City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 3 - retirement system or plan covered by this act which is not administered directly by the Department of Management Services shall furnish a copy of each actuarial report to the Department of Management Services within 60 days after receipt from the actuary. The requirements of this section are supplemental to actuarial valuations necessary to comply with the requirements of s. 218.39. (3) No unit of local government shall agree to a proposed change in retirement benefits unless the administrator of the system, prior to adoption of the change by the governing body, and prior to the last public hearing thereon, has issued a statement of the actuarial impact of the proposed change upon the local retirement system, consistent with the actuarial review, and has furnished a copy of such statement to the division. Such statement shall also indicate whether the proposed changes are in compliance with s. 14, Art. X of the State Constitution and with s. 112.64. 112.64 Administration of funds; amortization of unfunded liability. (1) Employee contributions shall be deposited in the retirement system or plan at least monthly. Employer contributions shall be deposited at least quarterly; however, any revenues received from any source by an employer which are specifically collected for the purpose of allocation for deposit into a retirement system or plan shall be so deposited within 30 days of receipt by the employer. All employers and employees participating in the Florida Retirement System and other existing retirement systems which are administered by the Department of Management Services shall continue to make contributions at least monthly. (2) From and after October 1, 1980, for those plans in existence on October 1, 1980, the total contributions to the retirement system or plan shall be sufficient to meet the normal cost of the retirement system or plan and to amortize the unfunded liability, if any, within 40 years; however, nothing contained in this subsection permits any retirement system or plan to amortize its unfunded liabilities over a period longer than that which remains under its current amortization schedule. (3) For a retirement system or plan which comes into existence after October 1, 1980, the unfunded liability, if any, shall be amortized within 40 years of the first plan year. < The reference to 40 years is historical. All current and future unfunded liabilities shall be amortized within 30 years. > (4) The net increase, if any, in unfunded liability under the plan arising from significant plan amendments adopted, changes in actuarial assumptions, changes in funding methods, or actuarial gains or losses shall be amortized within 30 plan years. (5) (a) If the amortization schedule for unfunded liability is to be based on a contribution derived in whole or in part from a percentage of the payroll of the system or plan membership, the assumption as to payroll growth shall not exceed the average payroll growth for the 10 years prior to the latest actuarial valuation of the system or plan unless a transfer, merger, City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 4 - or consolidation of government functions or services occurs, in which case the assumptions for payroll growth may be adjusted and may be based on the membership of the retirement plan or system subsequent to such transfer, merger, or consolidation. (b) An unfunded liability amortization schedule that includes a payroll growth assumption and is in existence on September 30, 1996, or is established thereafter, may be continued using the same payroll growth assumption, or one not exceeding the payroll growth assumption established at the start of the schedule, regardless of the actual 10-year average payroll growth rate, provided that: 1. The assumptions underlying the payroll growth rate are consistent with the actuarial assumptions used to determine unfunded liabilities, including, but not limited to, the inflation assumption; and 2. The payroll growth rate is reasonable and consistent with future expectations of payroll growth. (c) An unfunded liability amortization schedule that does not include a payroll growth assumption and is in existence on September 30, 1996, or is established thereafter, may be continued or modified to include a payroll growth assumption, provided that such assumption does not exceed the 10-year average payroll growth rate as of the actuarial valuation date such change in the amortization schedule commences. Such schedule may be continued thereafter, subject to the reasonable and consistent requirements in paragraph (b). (6) Nothing contained in this section shall result in the allocation of chapter 175 or chapter 185 premium tax funds to any other retirement system or plan or for any other use than the exclusive purpose of providing retirement benefits for firefighters or police officers. 112.66 General provisions. (13) A local government sponsor of a retirement system or plan may not reduce contributions required to fund the normal cost. This subsection does not apply to state-administered retirement systems or plans. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 5 - Portions of Funding Policy Established By Board of Pension Trustees: Actuarial Cost Method The Board of Pension Trustees has adopted the use of the Entry Age Normal/Frozen Entry Age actuarial cost method to determine annual contribution requirements for the Pension Plan. Frozen Entry Age Under the Frozen Entry-Age Actuarial Cost Method, the excess of the actuarial present value of all future benefits of the group included in the valuation, over the sum of the actuarial value of assets, the unfunded frozen actuarial accrued liability and the actuarial present value of future member contributions (if any) is allocated as a level percentage of earnings of the overall group over the expected future working years of current active members. This allocation is performed for the group as a whole, not as a sum of individual allocations. The portion that is allocated to a specific year is called the Employer Normal Cost. Under this method, future actuarial experience gains (losses) are not explicitly recognized, but instead reduce (increase) future years’ Normal Costs. The initial unfunded frozen actuarial accrued liability (UFAAL) is determined under the entry age normal actuarial cost method as of the date this funding method is implemented, and it is amortized over a period of time. The initial UFAAL is frozen at that level. Subsequent changes in the UFAAL due to plan amendments and changes in actuarial assumptions or methods are explicitly recognized and added to the UFAAL and amortized over a reasonable period of future years. Entry Age Normal Under the Entry Age Normal Actuarial Cost Method, an annual level normal cost is calculated for each individual active member, payable from the date of employment to the date of retirement, that is sufficient to accumulate to the value of the member’s benefit at the time of decrement/retirement. Each annual normal cost is calculated as a constant percentage of that member’s year by year projected covered pay. Under this method, actuarial experience gains (losses) are explicitly recognized each year as they occur. They reduce (increase) the Unfunded Actuarial Accrued Liability, and they are amortized separately. The initial Unfunded Actuarial Accrued Liability (UAAL) is amortized over a period of time. Subsequent changes in the UAAL due to actuarial experience gains and losses, amendments, and changes in actuarial assumptions or methods are recognized in the UAAL and amortized over a reasonable period of future years. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 6 - Asset Valuation Method The Actuarial Value of Assets is based on the market value with investment gains and losses smoothed over five years. The Actuarial Value of Assets will not consistently be above or below the Market Value and is expected to converge to the Market Value in a relatively short period of time. At any time it may be either greater or less than Market Value. During periods when investment performance exceeds the assumed rate, the Actuarial Value of Assets will tend to be less than Market Value. During periods when investment performance is less than the assumed rate, the Actuarial Value of Assets will tend to be greater than Market Value. If assumed rates are exactly realized for five consecutive years, the Actuarial Value will become equal to Market Value. The Actuarial Value is limited to a 20% corridor around the Market Value. This means that if the preliminary development of the Actuarial Value results in an amount that is greater than 120% of the Market Value (or less than 80% of the Market Value), the final Actuarial Value is limited to 120% (or 80%) of the Market Value. Any gains or losses on the Market Value outside of the 20% corridor are therefore recognized immediately. Amortization Method Amortization periods of up to 30 years or the maximum period allowed by standards adopted by the Government Accounting Standards Board (GASB), whichever is less. Under GASB Statements Nos. 25 and 27, the GASB accounting standards provided broad guidelines on plan funding. The GASB Statements Nos. 67 and 68 do not address plan funding and only address financial reporting. This Actuarial Funding Policy does not attempt to comply directly with promulgations of GASB. The annual actuarial valuation determining the City contribution rates shall use 30-year closed amortization periods for amendments and changes in actuarial assumptions or methods and 15-year closed amortization periods for actuarial experience gains and losses. Amortization amounts shall be determined as level dollar amounts. Amortization bases will be combined, in accordance with the methodology described for combining and offsetting amortization bases under Internal Revenue Code Section 412(b), if the sum of the outstanding bases is positive while the sum of the amortization payments is negative, or vice versa. Amortization bases may also be combined to reduce volatility in the required employer contributions if adopted by the Board of Pension Trustees based upon the advice and recommendation of the Plan’s actuary. Actuarial Assumptions The actuarial assumptions used will be those last adopted by the Board based upon the advice and recommendation of the Plan’s actuary. The Board may request the actuary to perform an actuarial investigation into the experience of the Plan every six years or another appropriate period as determined by the Board to be utilized to form the basis for recommendations in actuarial assumptions. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 7 - Funding Target The funding objective is to achieve 100% funding. For this purpose, “100% funding” means that the Actuarial Value of Assets equals the Actuarial Accrued Liability. The amortization method allows up to 30 years to achieve this objective. Risk Management The main financial objective of this actuarial funding policy is to fund the long-term costs of benefits to plan members and beneficiaries. There are numerous risks that the Plan faces in trying to achieve this objective including funding risk, demographic risk, investment risk, and benefit risk. The Board policies for managing these risks are outlined in this section. Funding Risk Frequency of Actuarial Valuations Regular valuations manage funding risk by allowing employer contribution rates to reflect actual experience as it emerges. Funding valuations are performed every year as of January 1 to determine employer contribution amounts for the fiscal year beginning nine months later. Separate valuations are required for financial reporting under GASB 67 and 68. Demographic and Investment Risk Process for Reviewing and Updating Actuarial Assumptions The Board adopts actuarial assumptions based on recommendations of the Plan’s actuary. Demographic and investment risks may be managed in part by having regular reviews of the actuarial assumptions. The Board may request the actuary to perform an actuarial investigation into the experience of the Plan every six years or another appropriate period as determined by the Board. Once in receipt of the experience study report, the Board will adopt actuarial assumptions and methods as necessary. If circumstances warrant, the Board may change assumptions more frequently after conferring with the actuary and when investment risks are involved, the investment consultant. The experience study report shall include, but not necessarily be limited to, analysis of and recommendations regarding the following assumptions: i. Pre-retirement withdrawal rates ii. Retirement rates iii. Disability rates iv. Pay increase rates v. Mortality rates both before and after retirement City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 8 - vi. Investment returns considering both real return and inflation, which must be consistent with the investment policy The actuary shall assume no change in the active member population unless there is compelling evidence to support the expectation of a significant increase or decrease in the workforce covered by the Plan. The experience study report will serve as the basis for determinations by the Board regarding whether or not demographic or economic assumptions should be modified for future valuations. Chapter 112.661 (9), Florida Statutes specifies the investment policy adopted by the Board must include a requirement that the Board shall determine the total expected annual rate of return for the current year, for each of the next several years, and for the long term thereafter. This determination must be filed promptly with the Department of Management Services and with the plan’s sponsor and the consulting actuary. Responding to Favorable/Unfavorable Investment Experience Investment risk is addressed in the investment consultant’s quarterly reports. Annual investment experience other than assumed is reflected in the valuation asset method described above. Asset Liability Studies The Board adopts an asset allocation based on recommendations from the investment consultant. The asset allocation approved by the Board may reflect the results of periodic Asset Liability Studies, if performed. Risk Measures In order to quantify the risks outlined in this actuarial funding policy, the following metrics will be included in annual actuarial valuation reports. These metrics provide quantifiable measurements of risk and its movement over time: i. Funded ratio (Actuarial Value of Assets divided by Actuarial Accrued Liability). − Measures progress towards the funding objective of the 100% target funded ratio. ii. Total Unfunded Actuarial Accrued Liability (UAAL) divided by Total Payroll − Measures the risk associated with contribution decreases relative impact on the ability to fund the UAAL. A decrease in this measure indicates a decrease in contribution rate risk. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 9 - iii. Total Actuarial Accrued Liability (AAL) divided by Total Payroll − Measures the risk associated with the ability to respond to liability experience through adjustments in contributions. A decrease in this measure indicates a decrease in liability experience risk. This also provides a long-term measure of the asset risk in situations where the Plan has a funded ratio below 100%. iv. Total Actuarial Value of Assets divided by Total Payroll − Measures the risk associated with the ability to respond to asset experience through adjustments in contributions. A decrease in this measure indicates a decrease in asset experience risk. Benefit Risk Benefit risk may be managed as follows: The Board shall review proposals and legislative changes for the potential legal, administrative, Internal Revenue Code compliance, and funding impact on the Fund. If a proposal has the potential for a meaningful impact on plan funding, the Board shall consult with the actuary to estimate the actuarial impact to the Plan. The Board does not establish the benefit provisions; it administers them. Miscellaneous Matters Associated with Funding: Overall Conformance with Professional Standards of Practice By law, the actuary shall be an Enrolled Actuary and either a Member of the American Academy of Actuaries or an Associate or a Fellow of the Society of Actuaries. The work of the actuary in connection with this policy shall conform to Actuarial Standards of Practice for public employee retirement plans promulgated by the Actuarial Standards Board and shall satisfy the requirements of the Governmental Accounting Standards Board with respect to the development of information needed by the Fund and by the City for financial reporting purposes. PENSION FUNDING: A Guide for Elected Officials Report from the Pension Funding Task Force 2013 Issued by: National Governors Association (NGA) National Conference of State Legislatures (NCSL) The Council of State Governments (CSG) National Association of Counties (NACo) National League of Cities (NLC) The U.S. Conference of Mayors (USCM) International City/County Management Association (ICMA) National Council on Teacher Retirement (NCTR) National Association of State Auditors, Comptrollers and Treasurers (NASACT) Government Finance Officers Association (GFOA) National Association of State Retirement Administrators (NASRA) Introduction Defined benefit pension plans have a long history in public sector compensation. These plans are typi- cally funded through a combination of employer and employee contributions and earnings from investments. Public pension plans hold more than $3 trillion in assets in trust on behalf of more than 15 million work- ing and 8 million retired state and local government employees and their surviving family members. The pie chart below illustrates the 2011 funded status of 109 state-administered plans and 17 locally administered plans. These plans represent 85 percent of total state and local government pension assets and members. The value of securities held by public and private retirement plans declined significantly following the economic crisis of 2008–2009, causing an increase in unfunded pension liabilities. The range of those unfunded public pension liabilities varies widely among governments. These same governments also have enacted major changes in their retirement plans over the past decade. Today, some public pension plans are well funded, while others have seen their funded status decline. Now another change is on the horizon: new pen- sion accounting standards issued by the Governmental Accounting Standards Board (GASB) in 2012. GASB Statement No. 67, Financial Reporting for Pension Plans, takes effect for pension plan fiscal years begin- ning after June 15, 2013 (fiscal years ending on or after June 30, 2014). GASB Statement No. 68, Accounting and Reporting for Pensions, applies to employers (and contributing nonemployers) in fiscal years beginning after June 15, 2014 (fiscal years ending on or after June 30, 2015). These new accounting standards will change the way public pensions and their sponsoring governments report their pension liabilities. In particular, the new standards no longer provide guidance on how to calcu- late the actuarially determined annual required contri- bution (ARC), which many governments have used not only for accounting, but also to budget their pension plan contribution each year. In fact, these new GASB accounting standards end the relationship between pension accounting and the funding of the ARC. In addition to GASB’s new accounting standards, policymakers should be aware that rating agencies such as Moody’s may use yet another set of criteria to assess the impact of pension obligations on the creditworthiness of a municipal bond issuer. If the ratings agencies publicize their pension calculations, state and local officials would be faced with the chal- lenge of interpreting three sets of pension numbers: an accounting number to comply with the GASB’s financial reporting requirements, an actuarial calcula- tion to determine funding requirements for budgeting purposes, and a financial analysis figure produced by bond rating agencies to evaluate and compare issuers of municipal debt. This guide provides key facts about public pension plans, why it is essential to have a pension funding policy, a brief overview of the new GASB standards, and which issues state and local officials need to address. The guide also offers guidance for policy makers to use when developing their pension plan’s funding policy. Figure 1. Funding of Aggregate Pension Liability, 2011 Unfunded Funded $0.9 trillion $2.7 trillion Source: BC-CRR Estimates based on Public Plans Database (PPD). PENSION FUNDING: A Guide for Elected Officials 4 Pension Funding: A Guide for Elected Officials Pension funding background In the 1970s, it was not uncommon for state and local governments to fund their pensions on a pay-as-you-go basis. Following the passage of ERISA, which set pri- vate sector funding requirements, state and local offi- cials took steps to fully advance-fund their pensions. They were further encouraged to meet their actuarial funding obligations by new accounting and reporting standards issued by the GASB in 1986. The trend to improve pension funding continued over the next decade. When the GASB issued Statements 25 and 27 in 1994, employers were required to disclose information on plan assets and liabilities in their financial reports. More important, to comply with GASB, employ- ers also had to disclose their actuarially determined ARC and the percentage of the ARC the employer actually paid. The GASB defined the ARC to include the normal cost of pensions for today’s employees plus a contribu- tion to pay for any unfunded liabilities, typically amor- tized over a maximum 30-year period. Paying the full ARC has been an important measure of whether or not a pension plan is on track to fund its pension promises. By the turn of the century, public pensions were as well funded as private pensions. In fact, most public plans were nearly 100 percent funded in 2000. Unfor- tunately, the last decade of economic upheaval and the wide swings in the stock market have reduced pension assets in both public and private plans. In 2011, the estimated aggregate ratio of assets to liabilities slipped to 75 percent1. State and local officials have stepped up their efforts to restore pension funding. According to the National Conference of State Legis- latures, 44 states have enacted major changes in state retirement plans from 2009–2012.2 Changes have included increases in employee contributions to pension plans, lon- ger vesting periods, reduced benefit levels, higher retire- ment ages, and lower cost-of-living adjustments. Some modifications may apply to new workers only, while others affect current employees and/or retirees. Pension funding policies A variety of state and local laws and policies guide decisions concerning pension funding practices. Many state and local governments have passed legislation that stipulates how pensions should be funded. Others have policies that address how pension assets are to be invested or if pension reserves must be maintained. Generally speaking, employers with well-funded pension plans take a long-term approach to estimating investment returns, adjust their demographic and other assumptions as needed, and consistently pay their annual required contribution in full. A clear pension funding policy is important because it: ■Lays out a plan to fund pensions; ■Provides guidance in making annual budget decisions; ■Demonstrates prudent financial management practices; ■Reassures bond rating agencies; and ■Shows employees and the public how pensions will be funded. GASB’s new approach Under prior GASB statements, there was a close link between accounting and funding measures. That link has now been broken. The new GASB standards Figure 2. Projected State and Local Funding Ratios Under Three Scenarios, 2011–2015 0% 20% 40% 60% 80% 100% 2011 2012 2013 2014 2015 75% 74% 82% Optimistic Most Likely Pessimistic 98% Source: BC-CRR estimates for 2011–2015 based on Public Plans Database (PPD). 1 Munnell, Alicia H., Aubrey, Jean-Pierre, Hurwitz, Josh, Medinica, Madeline, and Quinby, Laura, “The Funding of State and Local Pensions: 2011–2015,” Center for State and Local Government Excellence, May 2012. 2 Snell, Ron, “State Retirement Legislation 2009–2012,” National Conference of State Legislatures, July 31, 2012. Pension Funding: A Guide for Elected Officials 5 focus entirely on accounting measurements of pen- sion liabilities and no longer on how employers fund the cost of benefits or calculate their ARC. This is a significant change for government employers because the ARC historically served as a guide for policy mak- ers, employees, bond rating agencies and the public to determine whether pension obligations were being appropriately funded. The ARC also often was used to inform budget decisions. Today, employers report a liability on the face of their financial statements only if they fail to fully fund their ARC (just as a homeowner would report a liability only for mortgage payments in arrears). Thus, many government employers today do not report a liability for pensions on the face of their financial statements. How- ever, if the plan they sponsor does have an unfunded pension liability, it is reported in the notes to the finan- cial statements, which are considered an integral part of financial reporting. In contrast, under the new GASB standards, employers will report their unfunded pension liability on the face of their financial statements, even if they fully fund each year’s ARC (just as a homeowner would report a mortgage liability even if all monthly mortgage payments are paid on time, in full). Thus, in the future, all employers will report any unfunded pen- sion liability on the face of their financial statements, and that amount may be substantial for many. Furthermore, those seeking to know how much an employer should be contributing each year to the pension plan and how much the employer actually contributed (funding information) today can find that information in the employer’s financial report. In contrast, under the new GASB pension accounting standards, employers will no longer automatically be required to obtain an actuarially determined ARC and then include information concerning that amount and actual employer contributions in their financial report. Filling the gap in funding guidance Because the GASB’s new standards focus entirely on how state and local governments should account for pension liabilities and no longer focus on how employ- ers fund the costs of benefits or calculate their ARC, a new source of guidance is needed. To help fill that gap, the national associations representing local and state governments established a Pension Funding Task Force (Task Force) to develop policy guidelines. The “Big 7” (National Governors Association, National Conference of State Legislatures, Council of State Govern- ments, National Association of Counties, National League of Cities, U.S. Conference of Mayors, and the International City/County Management Association) and the Govern- ment Finance Officers Association established a pension funding task force in 2012. The National Association of State Auditors, Comptrollers and Treasurers; the National Association of State Retirement Administrators; and the National Council on Teacher Retirement also serve on it. The Center for State and Local Government Excellence is the convening organization for the Task Force. The Task Force has monitored the work of the actuarial community and the rating agencies, as well as considered recommendations from their own organiza- tions to develop guidelines for funding standards and practices and to identify methods for voluntary compli- ance with these standards and practices. The actuarial and finance communities have been working on the pension funding issues and will be invaluable resources as governments make needed changes. Indeed, the California Actuarial Advisory Panel and the Government Finance Officers Association have issued guidelines consistent with the Task Force’s recommendations, but with a greater level of specificity. The Conference of Consulting Actuaries is also preparing similar guidance. State and local officials are encour- aged to review the guidelines and best practices of these organizations. It also is important to note that some governments with well-funded pension plans will determine that they need to make few, if any, changes to their fund- ing policies, while others may face many challenges. Keep in mind that changes can be made over time. A transition plan can address changes that may need to be phased in over a period of years. For example, an employer or retirement board that currently amortizes its unfunded liabilities over 30 years could adopt a transition plan to continue that schedule (as a fixed, decreasing period) for current unfunded liabilities and to amortize any new unfunded liabilities over 25 years. In five years, that pension plan would have completed its transition to a 25-year amortization period. In many cases, governments will need to strike a bal- ance between competing objectives to determine the most appropriate timeframe in which to meet their goals. Task force recommendations States and localities have established distinct statu- tory, administrative and procedural rules governing 6 Pension Funding: A Guide for Elected Officials how retirement benefits are financed. While nothing in the new GASB standards or the possible credit rating agency changes requires a change in funding policy, the Task Force recommends pension funding policies be based on the following five general policy objectives: 1. Have a pension funding policy that is based on an actuarially determined contribution. 2. Build funding discipline into the policy to ensure that promised benefits can be paid. 3. Maintain intergenerational equity so that the cost of employee benefits is paid by the generation of taxpayers who receives services. 4. Make employer costs a consistent percentage of payroll. 5. Require clear reporting to show how and when pension plans will be fully funded. A sound pension funding policy should address at least the following three core elements of pension fund- ing in a manner consistent with the policy objectives: ■Actuarial cost method; ■Asset smoothing method; and ■Amortization policy. These core elements should be consistent with the parameters established by GASB Statement No. 27, Accounting for Pensions by State and Local Governmen- tal Employers, with which most governmental entities currently comply. Such parameters specify an actuari- ally determined ARC that should comply with appli- cable Actuarial Standards of Practice (ASOP No. 4), be based on an estimated long-term investment yield for the plan, and should amortize unfunded liabilities over no more than 30 years. The actuarially determined ARC, the parameters for determining the ARC, and the percentage of the ARC the employer actually paid should be disclosed and reassessed periodically to be sure that they remain effective. To that end, the Task Force recommends that state and local governments not only stay within the ARC calculation parameters established in GASB 27, but also consider the following policy objectives when reviewing each core element of their funding policy: Actuarial Cost Method: the method used to allocate the pension costs (and contributions) over an employee’s working career. Policy Objectives: 1. Each participant’s benefit should be fully funded under a reasonable allocation method by the expected retirement date. 2. The benefit costs should be determined as a level percentage of member compensation and include expected income adjustments. Asset Smoothing Method: the method used to recognize gains or losses in pension assets over some period of time to reduce the effects of market volatility and provide stability to contributions. Policy Objectives: 1. The funding policy should specify all components of asset smoothing, such as the amount of return subject to smoothing and the time period(s) used for smoothing a specific gain or loss. 2. The asset smoothing method should be the same for both gains and losses and should not be reset or biased toward high or low investment returns. Amortization Policy: the policy that determines the length of time and structure of payments required to systematically fund accrued employee benefits not covered by the actuarial value of assets. Policy Objectives: 1. The adjustments to contributions should be made over periods that appropriately balance intergenerational equity against the goal of keeping contributions level as a percentage of payroll over time. 2. The amortization policy should reflect explicit consideration of (a) gains and losses actually experienced by a plan, (b) any changes in assump- tions and methods, and (c) benefit or plan changes. 3. The amortization of surplus requires special consideration consistent with the goal of stable costs and intergenerational equity. The Entry Age Normal (level percentage of payroll) actuarial cost method is especially well-suited to meeting these policy objectives. The use of a five-year period for “smoothing” invest- ment experience is especially well-suited to meet- ing these policy objectives. Amortizing the various components of the unfunded actuarial accrued liability over periods that focus on matching participant demographics but also, except for plan amendments, consider managing contribution volatility, is especially well-suited to meeting these policy objectives. Pension Funding: A Guide for Elected Officials 7 Conclusion The most important step for local and state govern- ments to take is to base their pension funding policy on an actuarially determined contribution (ADC). The ADC should be obtained on an annual or biannual basis. The pension policy should promote fiscal disci- pline and intergenerational equity, and clearly report when and how pension plans will be fully funded. Other issues to address in the policy are periodic audits and outside reviews. The ultimate goal is to ensure that pension promises can be paid, employer costs can be managed, and the plan to fund pensions is clear to everyone. Resources 1. GFOA best practice, Guidelines for Funding Defined Benefit Pension Plans, at: www.gfoa.org 2. GASB Statements No. 67 and 68 at: www.GASB.org 3. GASB Statement 27: http://www.gasb.org/cs/ContentServer?site= GASB&c=Document_C&pagename=GASB%2FDocument_C%2FG ASBDocumentPage&cid=1176160029312 4. Moody’s Request for Comments: Adjustments to US State and Local Government Reported Pension Data at: http://www. wikipension.com/wiki/Moodys_Request_For_Comments 5. National Conference of State Legislatures, changes to state pension plans at: http://www.ncsl.org/documents/employ/ 2012-LEGISLATION-FINAL-Aug-31-2012.pdf 6. The National Association of State Retirement Administrators for examples of state funding policies at: www.NASRA.org 7. Center for State and Local Government Excellence for examples of changes to state and local government pension plans at: http://slge.org 8. California Actuarial Advisory Panel at: http://www.sco.ca.gov/ caap.html 9. Conference of Consulting Actuaries at: http://www.ccactuaries .org/index.cfm For More Information National Governors Association Barry Anderson ■ (202) 624-5318, banderson@nga.org National Conference of State Legislatures Michael Bird ■ (202) 624-8686, michael.bird@ncsl.org Jeff Hurley ■ (202) 624-7753, jeff.hurley@ncsl.org The Council of State Governments Chris Whatley ■ (202) 624-5460, cwhatley@csg.org National Association of Counties Deseree Gardner ■ (202) 942-4204, dgardner@naco.org National League of Cities Neil Bomberg ■ (202) 626-3042, bomberg@nlc.org The U.S. Conference of Mayors Larry Jones ■ (202) 861-6709, ljones@usmayors.org International City/County Management Association Joshua Franzel ■ (202) 682-6104, jfranzel@icma.org Center for State and Local Government Excellence Elizabeth Kellar ■ (202) 962-3611, ekellar@slge.org National Association of State Auditors, Comptrollers and Treasurers Cornelia Chebinou ■ (202) 624-5451, cchebinou@nasact.org Government Finance Officers Association Barrie Tabin Berger ■ (202) 393-8467, btberger@gfoa.org National Association of State Retirement Administrators Jeannine Markoe Raymond ■ (202) 624-1417, jeannine@nasra.org National Council on Teacher Retirement Leigh Snell ■ (540) 333-1015, lsnell@nctr.org CITY OF CLEARWATER EMPLOYEES’ PENSION PLAN FUNDING METHOD STUDY INCLUDING 30-YEAR PROJECTIONS OCTOBER 7, 2014 CITY OF CLEARWATER EMPLOYEES’ PENSION PLAN FUNDING METHOD STUDY INCLUDING 30-YEAR PROJECTIONS TABLE OF CONTENTS Page I. Executive Summary .......................................................................................................... 1 - 2 II. Overview of Funding Methods ......................................................................................... 3 - 4 III. Projection Results ........................................................................................................... 5 - 17 IV. Appendix A – Draft Actuarial Funding Policy V. Appendix B – GRS Research Report: Developing a Pension Funding Policy for State and Local Governments 1 EXECUTIVE SUMMARY As requested, we have developed a draft Funding Policy, analyzed the Plan’s current funding method, and prepared 30-year projections which illustrate the expected City contributions for the City of Clearwater Employees’ Pension Plan under the current funding method (Frozen Entry Age) versus the proposed funding method (Entry Age Normal). To illustrate the impact under a range of potential future outcomes, we have prepared 30-year projections under the following three scenarios of assumed future investment returns: Assuming the Market Value of Assets earns the assumed rate of 7% each year. Assuming the Market Value of Assets earns 6% each year. Assuming the Market Value of Assets earns the assumed rate of 7% during 2014, 2015, and 2017 – 2043, but incurs a 15% loss during 2016. Our draft of a formal written funding policy is included in Appendix A. This initial draft has been prepared for the Board’s review and discussion, and it will be subsequently revised to reflect the decisions made by the Pension Trustees. Appendix B includes a GRS Research Report on funding policy development that the Pension Trustees may find informative. Some of the principal components of a funding policy that need to be agreed on by Pension Trustees include the following: Actuarial cost method Asset smoothing method Amortization methodology (for amortizing the impact of experience gains/losses, assumption changes, plan changes, or method changes) Funding target and objections Process for setting actuarial assumptions Risk management Summary of Results Based on the current City Ordinance, the minimum City contribution is 7% of covered payroll. If the current funding method is retained and assets earn 7% per year as expected, it is estimated that the City contribution rate will hit this 7% floor by the fiscal year ending September 30, 2017. If experience continues to match the assumptions, the City contribution would remain at this rate over the remainder of the 30-year projection period. The minimum 7% of payroll contribution is projected to be greater than the actuarially required contribution amount, so the funded ratio is expected to increase above 100% over time. Under Senate Bill 1128, municipalities are required to contribute at least the Normal Cost each year (i.e., the cost of benefits earned during the current year). If the funding method is changed to Entry Age Normal and assets earn 7% per year as expected, it is estimated that the City contribution rate would hit this “Normal Cost floor” by the fiscal year ending September 30, 2017. If experience continues to match the assumptions, the City contribution would remain at this Normal Cost rate over the remainder of the projection period. The Normal Cost rate is expected to decrease over time as more of the active population includes new members benefitting under the post-January 1, 2013 tier of benefits. Due to the presence of negative (surplus) amortization bases, a contribution equal to the Normal Cost in future years is projected to be greater than the actuarially required contribution amount, so the funded ratio is expected to increase above 100% over time. 2 The funded ratio is expected to exceed 100% to a greater extent under the Entry Age Normal funding method than under the Frozen Entry Age funding method because the minimum contribution (the Normal Cost rate) under the Entry Age Normal Cost method is projected to be higher than 7% of covered payroll. If actual experience is not as expected, gains and losses would be generated. These experience gains and losses would be recognized differently under the two funding methods. The 30-year projections illustrate the difference in the required City contributions under both funding methods reflecting assumed market returns which deviate from 7% each year. The projection results under the Entry Age Normal funding method have been prepared assuming that experience gains and losses are amortized over a 15-year period. Use of a longer amortization period would produce less volatile required contributions, but would increase the time required to return the funded ratio to 100%. Actuarial Assumptions and Methods, Financial Data and Member Census Data The actuarial assumptions and methods, financial data, and member census data used for the purposes of our Actuarial Study are the same as those used for the January 1, 2014 Actuarial Valuation with the exceptions of the funding method and assumed returns on the Market Value of Assets detailed above. Projections are deterministic and throughout the projection period Plan experience is expected to match the assumptions, with the exception of the assumed investment returns on the Market Value of Assets, as described above. Throughout the forecast period, new members are assumed to be hired each year at a rate sufficient to maintain a constant active headcount, or stationary population. New employees are assumed to have the same average demographic characteristics (age, gender, salary – adjusted each year for inflation) as those of members hired over the past five years. We have not reflected adjustments or future increases in the credit balance when the actual contributions (by Statute) are higher than the actuarially determined contribution requirements. It is our opinion that doing so would not have a material impact on the projections. 3 OVERVIEW OF FUNDING METHODS Current Funding Method – Frozen Entry Age Under the Frozen Entry-Age Actuarial Cost Method, the excess of the actuarial present value of all future benefits of the group included in the valuation, over the sum of the actuarial value of assets, the unfunded frozen actuarial accrued liability and the actuarial present value of future member contributions (if any) is allocated as a level percentage of earnings of the overall group over the expected future working years of current active members. This allocation is performed for the group as a whole, not as a sum of individual allocations. The portion that is allocated to a specific year is called the Employer Normal Cost. Under this method, future actuarial experience gains (losses) are not explicitly recognized, but instead reduce (increase) future years’ Normal Costs. The initial unfunded frozen actuarial accrued liability (UFAAL) is determined under the entry age normal actuarial cost method as of the date this funding method is implemented, and it is amortized over a period of time. The initial UFAAL is frozen at that level. Subsequent changes in the UFAAL due to plan amendments and changes in actuarial assumptions or methods are explicitly recognized and added to the UFAAL and amortized over a reasonable period of future years. Proposed Funding Method – Entry Age Normal Under the Entry Age Normal Actuarial Cost Method, an annual level normal cost is calculated for each individual active member, payable from the date of employment to the date of retirement, that is sufficient to accumulate to the value of the member’s benefit at the time of decrement/retirement. Each annual normal cost is calculated as a constant percentage of that member’s year by year projected covered pay. Under this method, actuarial experience gains (losses) are explicitly recognized each year as they occur. They reduce (increase) the Unfunded Actuarial Accrued Liability, and they are amortized separately. The initial Unfunded Actuarial Accrued Liability (UAAL) is amortized over a period of time. Subsequent changes in the UAAL due to actuarial experience gains and losses, amendments, and changes in actuarial assumptions or methods are recognized in the UAAL and amortized over a reasonable period of future years. Entry Age Normal vs. Frozen Entry Age The following lists present several pros and cons of changing to the Entry Age Normal funding method versus retaining the current Frozen Entry Age funding method: Pros of Changing to the Entry Age Normal Funding Method: GASB Statements No. 67 and 68 require the use of the Entry Age Normal funding method in all accounting calculations. The Entry Age Normal funding method is much more commonly used throughout the state of Florida than the Frozen Entry Age funding method. The Entry Age Normal funding method is also the funding method used by the Florida Retirement System. The actuarial accrued liability under the Entry Age Normal funding method more accurately reflects the level of benefits accrued to-date (including incurred experience gains and losses). 4 The normal cost rate under the Entry Age Normal funding method is expected to be more stable as a percentage of covered payroll since it does not include an implicit gain/loss adjustment. If the amortization period for amortizing gains and losses under the Entry Age Normal funding method is longer than the average future number of working years for current active members, then the employer contribution rate would be expected to be more stable under the Entry Age Normal funding method. The funded ratio under the Entry Age Normal funding method is projected to be higher than it is under the Frozen Entry Age funding method under all scenarios analyzed in this Study. There may be a “cross-over date” in the future for GASB No. 67/68 purposes under the Frozen Entry Age funding method. There would not be a cross-over date under the Entry Age Normal funding method. Cons of Changing to the Entry Age Normal Funding Method: The funded ratio may be more volatile under the Entry Age Normal funding method than under the Frozen Entry Age funding method since experience gains and losses are immediately recognized in the funded ratio under the Entry Age Normal funding method. The Frozen Entry Age funding method is expected to recognize gains and losses more quickly (over an approximate equivalent period of 10-11 years) than under the Entry Age Normal funding method (assuming the amortization period for paying off experience gains/losses under the Entry Age Normal funding method is greater than 10-11 years); therefore, the employer contribution rate may respond more quickly to emerging actuarial experience under the current Frozen Entry Age funding method. This could be addressed under the Entry Age Normal funding method by using a shorter period to amortize experience gains and losses. Under Senate Bill 1128, the employer contribution rate cannot be less than the normal cost. If the Plan’s funded ratio exceeds 100%, resulting in an overall net amortization credit (negative amortizations), the required employer contribution would equal the employer normal cost. This would lead to a lower contribution requirement under the Frozen Entry Age funding method than under the Entry Age Normal funding method because the normal cost rate would be greater under the Entry Age Normal funding method (since the normal cost rate under the Frozen Entry Age funding method implicitly recognizes the impact of experience gains/losses). The minimum employer contribution in the City ordinance (7% of covered pay) is projected to be the actual City contribution for many years under the current Frozen Entry Age funding method, assuming actual Plan experience matches the current actuarial assumptions. This contribution rate is lower than the projected required contribution rate under the Entry Age Normal funding method, due to the State’s requirement to fund at least the normal cost each year (and since the normal cost rate under the Entry Age Normal funding method is projected to be higher than 7%). The Entry Age Normal funding method is projected to result in a more over-funded Plan than the Frozen Entry Age funding method if actual Plan experience meets expectations or if there are cumulative future experience gains. This could be considered a “pro” from a labor group perspective because there may be more funds available to improve benefits in future years. From a City and taxpayer perspective, though, it could be considered a “con” because more money could be tied up in the pension trust fund that could have been used for other purposes. 5 PROJECTION RESULTS 6 $ Amount % of Pay $ Amount % of Pay 2015 74,254,159 10,791,098 14.53%93%97%74,254,159 10,791,098 14.53%97%0 2016 75,138,209 6,881,441 9.16%94%100%75,138,209 9,791,028 13.03%100%2,909,588 2017 76,152,700 5,331,783 7.00%94%101%76,152,700 8,640,116 11.35%101%3,308,333 2018 77,190,570 5,403,340 7.00%95%104%77,190,570 8,543,675 11.07%104%3,140,336 2019 78,261,579 5,478,311 7.00%96%105%78,261,579 8,458,401 10.81%106%2,980,090 2020 79,408,355 5,558,585 7.00%96%106%79,408,355 8,388,337 10.56%107%2,829,752 2021 80,752,829 5,652,698 7.00%97%106%80,752,829 8,350,922 10.34%107%2,698,224 2022 82,113,129 5,747,919 7.00%98%106%82,113,129 8,317,011 10.13%108%2,569,092 2023 83,535,967 5,847,518 7.00%99%106%83,535,967 8,284,260 9.92%108%2,436,742 2024 85,060,541 5,954,238 7.00%99%106%85,060,541 8,255,909 9.71%109%2,301,671 2025 86,307,571 6,041,530 7.00%100%106%86,307,571 8,169,918 9.47%109%2,128,388 2026 87,950,419 6,156,529 7.00%101%106%87,950,419 8,157,154 9.27%109%2,000,625 2027 89,715,271 6,280,069 7.00%101%107%89,715,271 8,166,587 9.10%110%1,886,518 2028 91,477,590 6,403,431 7.00%102%107%91,477,590 8,175,227 8.94%110%1,771,796 2029 93,386,066 6,537,025 7.00%103%107%93,386,066 8,205,734 8.79%111%1,668,709 2030 95,528,592 6,687,001 7.00%103%107%95,528,592 8,272,689 8.66%112%1,585,687 2031 97,840,476 6,848,833 7.00%104%108%97,840,476 8,369,797 8.55%112%1,520,964 2032 100,285,119 7,019,958 7.00%104%108%100,285,119 8,487,252 8.46%113%1,467,294 2033 102,823,012 7,197,611 7.00%105%108%102,823,012 8,620,022 8.38%114%1,422,412 2034 105,489,210 7,384,245 7.00%105%109%105,489,210 8,773,419 8.32%114%1,389,174 2035 108,257,818 7,578,047 7.00%106%109%108,257,818 8,942,549 8.26%115%1,364,502 2036 111,077,282 7,775,410 7.00%107%110%111,077,282 9,120,115 8.21%116%1,344,706 2037 113,947,247 7,976,307 7.00%107%110%113,947,247 9,306,519 8.17%117%1,330,211 2038 116,891,021 8,182,371 7.00%108%111%116,891,021 9,503,257 8.13%118%1,320,885 2039 119,896,457 8,392,752 7.00%109%111%119,896,457 9,709,492 8.10%119%1,316,740 2040 122,984,625 8,608,924 7.00%110%112%122,984,625 9,924,998 8.07%120%1,316,074 2041 126,128,803 8,829,016 7.00%110%113%126,128,803 10,149,207 8.05%122%1,320,191 2042 129,350,380 9,054,527 7.00%111%113%129,350,380 10,382,587 8.03%123%1,328,060 2043 132,626,173 9,283,832 7.00%112%114%132,626,173 10,622,095 8.01%124%1,338,263 2044 135,945,396 9,516,178 7.00%100%115%135,945,396 10,867,276 7.99%126%1,351,098 Total 214,400,527 269,746,651 55,346,124 Total Present Value 89,849,766 117,583,607 27,733,841 Required City Contribution Funded Ratio on Valuation Date Difference as $ Amount City of Clearwater Employees' Pension Plan 30-Year Projection of Required City Contributions 7% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age)Proposed Funding Method (Entry Age Normal) Fiscal Year Ending Pensionable Payroll Required City Contribution Funded Ratio on Valuation Date (EAN Basis) Pensionable Payroll Funded Ratio on Valuation Date (FEA Basis) 7 0 2,000,000 4,000,000 6,000,000 8,000,000 10,000,000 12,000,000 0 2,000,000 4,000,000 6,000,000 8,000,000 10,000,000 12,000,000 Projected City ContributionFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution 7% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 8 0% 2% 4% 6% 8% 10% 12% 14% 16% 0% 2% 4% 6% 8% 10% 12% 14% 16%Projected City Contribution as a Percent of PayrollFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution 7% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 9 85% 90% 95% 100% 105% 110% 115% 120% 125% 130% 85% 90% 95% 100% 105% 110% 115% 120% 125% 130%Projected Funded Ratio (EAN Basis)Fiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of Funded Ratio (EAN Basis) 7% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 10 $ Amount % of Pay $ Amount % of Pay 2015 74,254,159 10,791,098 14.53%93%97%74,254,159 10,791,098 14.53%97%0 2016 75,138,209 7,594,512 10.11%94%99%75,138,209 9,972,335 13.27%99%2,377,824 2017 76,152,700 6,400,464 8.40%94%100%76,152,700 8,640,116 11.35%101%2,239,652 2018 77,190,570 5,403,340 7.00%95%103%77,190,570 8,543,675 11.07%103%3,140,336 2019 78,261,579 5,478,311 7.00%95%103%78,261,579 8,458,401 10.81%104%2,980,090 2020 79,408,355 5,558,585 7.00%96%103%79,408,355 8,388,337 10.56%104%2,829,752 2021 80,752,829 5,652,698 7.00%96%102%80,752,829 8,350,922 10.34%103%2,698,224 2022 82,113,129 7,124,961 8.68%97%101%82,113,129 8,317,011 10.13%102%1,192,050 2023 83,535,967 8,883,761 10.63%97%99%83,535,967 8,284,260 9.92%101%(599,501) 2024 85,060,541 10,585,328 12.44%97%98%85,060,541 8,255,909 9.71%100%(2,329,419) 2025 86,307,571 11,947,586 13.84%97%98%86,307,571 9,005,700 10.43%99%(2,941,885) 2026 87,950,419 13,457,117 15.30%98%97%87,950,419 10,214,019 11.61%98%(3,243,098) 2027 89,715,271 13,885,924 15.48%98%96%89,715,271 11,462,026 12.78%97%(2,423,898) 2028 91,477,590 15,233,660 16.65%98%95%91,477,590 12,723,324 13.91%97%(2,510,335) 2029 93,386,066 16,518,867 17.69%98%95%93,386,066 14,018,345 15.01%96%(2,500,521) 2030 95,528,592 17,765,374 18.60%99%94%95,528,592 15,360,264 16.08%95%(2,405,110) 2031 97,840,476 17,410,629 17.79%99%94%97,840,476 16,741,763 17.11%94%(668,866) 2032 100,285,119 18,592,357 18.54%99%93%100,285,119 18,152,229 18.10%94%(440,128) 2033 102,823,012 19,742,871 19.20%99%93%102,823,012 19,586,095 19.05%93%(156,777) 2034 105,489,210 20,882,598 19.80%99%92%105,489,210 21,048,415 19.95%93%165,817 2035 108,257,818 22,000,856 20.32%99%92%108,257,818 22,534,276 20.82%92%533,421 2036 111,077,282 23,084,779 20.78%99%91%111,077,282 24,036,565 21.64%92%951,786 2037 113,947,247 24,137,724 21.18%99%91%113,947,247 24,720,318 21.69%92%582,595 2038 116,891,021 25,164,630 21.53%99%91%116,891,021 26,259,029 22.46%92%1,094,400 2039 119,896,457 26,160,321 21.82%99%90%119,896,457 27,816,663 23.20%91%1,656,341 2040 122,984,625 27,135,582 22.06%99%90%122,984,625 29,393,753 23.90%91%2,258,171 2041 126,128,803 28,081,269 22.26%100%90%126,128,803 29,769,579 23.60%91%1,688,310 2042 129,350,380 29,009,898 22.43%100%90%129,350,380 30,149,060 23.31%91%1,139,162 2043 132,626,173 29,910,105 22.55%100%90%132,626,173 30,533,515 23.02%91%623,409 2044 135,945,396 29,051,610 21.37%100%89%135,945,396 30,925,551 22.75%91%1,873,941 Total 502,646,814 512,452,554 9,805,741 Total Present Value 166,622,969 173,522,052 6,899,083 City of Clearwater Employees' Pension Plan 30-Year Projection of Required City Contributions Current Funding Method (Frozen Entry Age)Proposed Funding Method (Entry Age Normal) Required City Contribution Funded Ratio on Valuation Date (EAN Basis) Required City Contribution Funded Ratio on Valuation Date 6% Actual Return on Market Value of Assets Difference as $ Amount Fiscal Year Ending Pensionable Payroll Pensionable Payroll Funded Ratio on Valuation Date (FEA Basis) 11 0 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 35,000,000 0 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 35,000,000 Projected City ContributionFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution 6% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 12 0% 5% 10% 15% 20% 25% 30% 0% 5% 10% 15% 20% 25% 30%Projected City Contribution as a Percent of PayrollFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution 6% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 13 85% 90% 95% 100% 105% 110% 115% 120% 125% 85% 90% 95% 100% 105% 110% 115% 120% 125%Projected Funded Ratio (EAN Basis)Fiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of Funded Ratio (EAN Basis) 6% Actual Return on Market Value of Assets Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 14 $ Amount % of Pay $ Amount % of Pay 2015 74,254,159 10,791,098 14.53%93%97%74,254,159 10,791,098 14.53%97%0 2016 75,138,209 7,363,142 9.80%94%100%75,138,209 9,791,028 13.03%100%2,427,887 2017 76,152,700 5,705,008 7.49%94%101%76,152,700 8,640,116 11.35%101%2,935,108 2018 77,190,570 7,954,379 10.30%95%99%77,190,570 9,326,282 12.08%100%1,371,903 2019 78,261,579 11,469,869 14.66%95%97%78,261,579 11,718,958 14.97%97%249,090 2020 79,408,355 16,871,236 21.25%95%93%79,408,355 15,865,149 19.98%93%(1,006,086) 2021 80,752,829 22,352,099 27.68%95%89%80,752,829 20,473,512 25.35%89%(1,878,587) 2022 82,113,129 27,625,397 33.64%95%85%82,113,129 25,249,006 30.75%86%(2,376,391) 2023 83,535,967 27,360,732 32.75%96%86%83,535,967 25,840,396 30.93%86%(1,520,336) 2024 85,060,541 26,897,207 31.62%96%87%85,060,541 26,240,613 30.85%87%(656,593) 2025 86,307,571 25,846,933 29.95%97%88%86,307,571 26,094,659 30.23%88%247,726 2026 87,950,419 25,131,808 28.57%97%89%87,950,419 26,198,699 29.79%89%1,066,890 2027 89,715,271 23,222,059 25.88%97%90%89,715,271 24,990,727 27.86%90%1,768,668 2028 91,477,590 22,537,205 24.64%98%90%91,477,590 25,019,387 27.35%91%2,482,182 2029 93,386,066 21,941,920 23.50%98%91%93,386,066 25,059,371 26.83%92%3,117,451 2030 95,528,592 21,459,922 22.46%98%92%95,528,592 25,130,390 26.31%93%3,670,468 2031 97,840,476 19,183,543 19.61%98%93%97,840,476 23,724,080 24.25%94%4,540,538 2032 100,285,119 18,836,026 18.78%99%93%100,285,119 25,509,735 25.44%95%6,673,709 2033 102,823,012 18,531,081 18.02%99%93%102,823,012 26,738,061 26.00%96%8,206,979 2034 105,489,210 18,275,261 17.32%99%94%105,489,210 24,276,403 23.01%97%6,001,142 2035 108,257,818 18,051,202 16.67%99%94%108,257,818 20,049,932 18.52%98%1,998,730 2036 111,077,282 17,851,572 16.07%99%95%111,077,282 15,581,752 14.03%99%(2,269,820) 2037 113,947,247 17,678,673 15.51%99%95%113,947,247 10,958,765 9.62%99%(6,719,907) 2038 116,891,021 17,533,612 15.00%99%95%116,891,021 11,752,195 10.05%100%(5,781,417) 2039 119,896,457 17,414,299 14.52%99%96%119,896,457 11,529,865 9.62%100%(5,884,434) 2040 122,984,625 17,325,077 14.09%99%96%122,984,625 11,495,454 9.35%100%(5,829,623) 2041 126,128,803 17,258,205 13.68%100%97%126,128,803 10,491,377 8.32%100%(6,766,828) 2042 129,350,380 17,218,566 13.31%100%97%129,350,380 10,724,758 8.29%100%(6,493,809) 2043 132,626,173 17,199,259 12.97%100%97%132,626,173 10,622,095 8.01%100%(6,577,164) 2044 135,945,396 15,138,613 11.14%100%98%135,945,396 10,867,276 7.99%100%(4,271,337) Total 552,025,001 540,751,142 (11,273,859) Total Present Value 230,355,026 235,730,283 5,375,257 Required City Contribution Funded Ratio on Valuation Date (EAN Basis) Required City Contribution Funded Ratio on Valuation Date City of Clearwater Employees' Pension Plan 30-Year Projection of Required City Contributions -15% Actual Return on Market Value of Assets During Plan Year Ending December 31, 2016 Current Funding Method (Frozen Entry Age)Proposed Funding Method (Entry Age Normal) Difference as $ Amount Fiscal Year Ending Pensionable Payroll Pensionable Payroll Funded Ratio on Valuation Date (FEA Basis) 15 0 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 - 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 Projected City ContributionFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution -15% Actual Return on Market Value of Assets During PYE 12/31/2016 Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 16 0% 5% 10% 15% 20% 25% 30% 35% 40% 0% 5% 10% 15% 20% 25% 30% 35% 40%Projected City Contribution as a Percent of PayrollFiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of City Contribution -15% Actual Return on Market Value of Assets During PYE 12/31/2016 Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) 17 80% 85% 90% 95% 100% 105% 80% 85% 90% 95% 100% 105%Projected Funded Ratio (EAN Basis)Fiscal Year End City of Clearwater Employees' Pension Plan 30-Year Projection of Funded Ratio (EAN Basis) -15% Actual Return on Market Value of Assets During PYE 12/31/2016 Current Funding Method (Frozen Entry Age) Proposed Funding Method (Entry Age Normal) APPENDIX A DRAFT ACTUARIAL FUNDING POLICY City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 1 - FUNDING OBJECTIVES The main funding objective for the defined benefit provisions of the City of Clearwater Employees’ Pension Plan (Plan) is to establish and receive employer (City and State, if any) contributions, expressed as a percentage of active member payroll, which will remain approximately level from year to year and will not have to be increased for future generations of citizens in the absence of benefit changes. This objective is stated in the Plan’s Ordinance and meets the requirements of Part VII, Chapter 112, Florida Statutes, Chapter 175, Florida Statutes, and Chapter 185, Florida Statutes. The employer contributions along with member contributions are to be used for funding the long- term costs of benefits, provided by the Ordinance and collective bargaining agreements, for Plan members and beneficiaries. Additionally, the City is responsible for contributing administrative expenses. From the perspective of the members and beneficiaries, the funding objective is for assets and actuarially determined contributions to be sufficient to pay all benefits provided by Plan when due. From the perspective of the contributing plan sponsors and taxpayers, there are additional funding objectives of keeping the actuarially determined contribution rates relatively stable as a percentage of active member payroll and equitably allocating the costs over the active members’ periods of active service. For pension funding, the payment of benefits is supported in part by income earned on investment assets. This actuarial funding policy meets these objectives. It is stipulated by state law and collective bargaining agreements and is implemented through the application of Board adopted governance policies. Statutory Pension Funding Policy – Ordinance The Ordinance for the Plan sets forth some portions of the actuarial funding policy for the Plan. Ordinance Excerpts: Sec. 2.413. Plan administration. (i) Actuarial valuation; actuarial standards. (1) At least once in each six (6) year period, the trustees shall cause an actuarial investigation to be made into the mortality, service and compensation experience of the members of the retirement plan. Taking into account the result of such investigation, the trustees shall adopt for the retirement plan such mortality, service and other tables as are necessary and proper. On the basis of these tables, an annual actuarial valuation of the assets and liabilities of the retirement plan shall be made. (2) Actuarial assumptions based on the six (6) year experience analysis may be modified by the trustees at such times as they deem appropriate. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 2 - Sec. 2.415. Contributions to the plan. (b) Employer contributions. (1) For each plan year, the employer shall make contributions to the plan in an amount equal to a. Seven percent of the compensation of all employees participating in the plan; plus b. Such additional amounts as may be required to satisfy the plan's funding requirements for the plan year and the cost of administering the plan, as determined by the actuary employed by the trustees. (2) The amount described in subparagraph (b)(1)b. above may be reduced by any available credit balance in accordance with applicable Florida Statutes. Statutory Pension Funding Policy – Florida Statutes Chapter 112, Florida Statutes sets forth some portions of the actuarial funding policy for the Plan. Chapter 112 Excerpts: 112.63 Actuarial reports and statements of actuarial impact; review. (1) Each retirement system or plan subject to the provisions of this act shall have regularly scheduled actuarial reports prepared and certified by an enrolled actuary. The actuarial report shall consist of, but shall not be limited to, the following: (a) Adequacy of employer and employee contribution rates in meeting levels of employee benefits provided in the system and changes, if any, needed in such rates to achieve or preserve a level of funding deemed adequate to enable payment through the indefinite future of the benefit amounts prescribed by the system, which shall include a valuation of present assets, based on statement value, and prospective assets and liabilities of the system and the extent of unfunded accrued liabilities, if any. (b) A plan to amortize any unfunded liability pursuant to s. 112.64 and a description of actions taken to reduce the unfunded liability. (2) The frequency of actuarial reports must be at least every 3 years commencing from the last actuarial report of the plan or system or October 1, 1980, if no actuarial report has been issued within the 3-year period prior to October 1, 1979. The results of each actuarial report shall be filed with the plan administrator within 60 days of certification. Thereafter, the results of each actuarial report shall be made available for inspection upon request. Additionally, each City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 3 - retirement system or plan covered by this act which is not administered directly by the Department of Management Services shall furnish a copy of each actuarial report to the Department of Management Services within 60 days after receipt from the actuary. The requirements of this section are supplemental to actuarial valuations necessary to comply with the requirements of s. 218.39. (3) No unit of local government shall agree to a proposed change in retirement benefits unless the administrator of the system, prior to adoption of the change by the governing body, and prior to the last public hearing thereon, has issued a statement of the actuarial impact of the proposed change upon the local retirement system, consistent with the actuarial review, and has furnished a copy of such statement to the division. Such statement shall also indicate whether the proposed changes are in compliance with s. 14, Art. X of the State Constitution and with s. 112.64. 112.64 Administration of funds; amortization of unfunded liability. (1) Employee contributions shall be deposited in the retirement system or plan at least monthly. Employer contributions shall be deposited at least quarterly; however, any revenues received from any source by an employer which are specifically collected for the purpose of allocation for deposit into a retirement system or plan shall be so deposited within 30 days of receipt by the employer. All employers and employees participating in the Florida Retirement System and other existing retirement systems which are administered by the Department of Management Services shall continue to make contributions at least monthly. (2) From and after October 1, 1980, for those plans in existence on October 1, 1980, the total contributions to the retirement system or plan shall be sufficient to meet the normal cost of the retirement system or plan and to amortize the unfunded liability, if any, within 40 years; however, nothing contained in this subsection permits any retirement system or plan to amortize its unfunded liabilities over a period longer than that which remains under its current amortization schedule. (3) For a retirement system or plan which comes into existence after October 1, 1980, the unfunded liability, if any, shall be amortized within 40 years of the first plan year. < The reference to 40 years is historical. All current and future unfunded liabilities shall be amortized within 30 years. > (4) The net increase, if any, in unfunded liability under the plan arising from significant plan amendments adopted, changes in actuarial assumptions, changes in funding methods, or actuarial gains or losses shall be amortized within 30 plan years. (5) (a) If the amortization schedule for unfunded liability is to be based on a contribution derived in whole or in part from a percentage of the payroll of the system or plan membership, the assumption as to payroll growth shall not exceed the average payroll growth for the 10 years prior to the latest actuarial valuation of the system or plan unless a transfer, merger, City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 4 - or consolidation of government functions or services occurs, in which case the assumptions for payroll growth may be adjusted and may be based on the membership of the retirement plan or system subsequent to such transfer, merger, or consolidation. (b) An unfunded liability amortization schedule that includes a payroll growth assumption and is in existence on September 30, 1996, or is established thereafter, may be continued using the same payroll growth assumption, or one not exceeding the payroll growth assumption established at the start of the schedule, regardless of the actual 10-year average payroll growth rate, provided that: 1. The assumptions underlying the payroll growth rate are consistent with the actuarial assumptions used to determine unfunded liabilities, including, but not limited to, the inflation assumption; and 2. The payroll growth rate is reasonable and consistent with future expectations of payroll growth. (c) An unfunded liability amortization schedule that does not include a payroll growth assumption and is in existence on September 30, 1996, or is established thereafter, may be continued or modified to include a payroll growth assumption, provided that such assumption does not exceed the 10-year average payroll growth rate as of the actuarial valuation date such change in the amortization schedule commences. Such schedule may be continued thereafter, subject to the reasonable and consistent requirements in paragraph (b). (6) Nothing contained in this section shall result in the allocation of chapter 175 or chapter 185 premium tax funds to any other retirement system or plan or for any other use than the exclusive purpose of providing retirement benefits for firefighters or police officers. 112.66 General provisions. (13) A local government sponsor of a retirement system or plan may not reduce contributions required to fund the normal cost. This subsection does not apply to state-administered retirement systems or plans. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 5 - Portions of Funding Policy Established By Board of Pension Trustees: Actuarial Cost Method The Board of Pension Trustees has adopted the use of the Entry Age Normal/Frozen Entry Age actuarial cost method to determine annual contribution requirements for the Pension Plan. Frozen Entry Age Under the Frozen Entry-Age Actuarial Cost Method, the excess of the actuarial present value of all future benefits of the group included in the valuation, over the sum of the actuarial value of assets, the unfunded frozen actuarial accrued liability and the actuarial present value of future member contributions (if any) is allocated as a level percentage of earnings of the overall group over the expected future working years of current active members. This allocation is performed for the group as a whole, not as a sum of individual allocations. The portion that is allocated to a specific year is called the Employer Normal Cost. Under this method, future actuarial experience gains (losses) are not explicitly recognized, but instead reduce (increase) future years’ Normal Costs. The initial unfunded frozen actuarial accrued liability (UFAAL) is determined under the entry age normal actuarial cost method as of the date this funding method is implemented, and it is amortized over a period of time. The initial UFAAL is frozen at that level. Subsequent changes in the UFAAL due to plan amendments and changes in actuarial assumptions or methods are explicitly recognized and added to the UFAAL and amortized over a reasonable period of future years. Entry Age Normal Under the Entry Age Normal Actuarial Cost Method, an annual level normal cost is calculated for each individual active member, payable from the date of employment to the date of retirement, that is sufficient to accumulate to the value of the member’s benefit at the time of decrement/retirement. Each annual normal cost is calculated as a constant percentage of that member’s year by year projected covered pay. Under this method, actuarial experience gains (losses) are explicitly recognized each year as they occur. They reduce (increase) the Unfunded Actuarial Accrued Liability, and they are amortized separately. The initial Unfunded Actuarial Accrued Liability (UAAL) is amortized over a period of time. Subsequent changes in the UAAL due to actuarial experience gains and losses, amendments, and changes in actuarial assumptions or methods are recognized in the UAAL and amortized over a reasonable period of future years. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 6 - Asset Valuation Method The Actuarial Value of Assets is based on the market value with investment gains and losses smoothed over five years. The Actuarial Value of Assets will not consistently be above or below the Market Value and is expected to converge to the Market Value in a relatively short period of time. At any time it may be either greater or less than Market Value. During periods when investment performance exceeds the assumed rate, the Actuarial Value of Assets will tend to be less than Market Value. During periods when investment performance is less than the assumed rate, the Actuarial Value of Assets will tend to be greater than Market Value. If assumed rates are exactly realized for five consecutive years, the Actuarial Value will become equal to Market Value. The Actuarial Value is limited to a 20% corridor around the Market Value. This means that if the preliminary development of the Actuarial Value results in an amount that is greater than 120% of the Market Value (or less than 80% of the Market Value), the final Actuarial Value is limited to 120% (or 80%) of the Market Value. Any gains or losses on the Market Value outside of the 20% corridor are therefore recognized immediately. Amortization Method Amortization periods of up to 30 years or the maximum period allowed by standards adopted by the Government Accounting Standards Board (GASB), whichever is less. Under GASB Statements Nos. 25 and 27, the GASB accounting standards provided broad guidelines on plan funding. The GASB Statements Nos. 67 and 68 do not address plan funding and only address financial reporting. This Actuarial Funding Policy does not attempt to comply directly with promulgations of GASB. The annual actuarial valuation determining the City contribution rates shall use 30-year closed amortization periods for amendments and changes in actuarial assumptions or methods and 15-year closed amortization periods for actuarial experience gains and losses. Amortization amounts shall be determined as level dollar amounts. Amortization bases will be combined, in accordance with the methodology described for combining and offsetting amortization bases under Internal Revenue Code Section 412(b), if the sum of the outstanding bases is positive while the sum of the amortization payments is negative, or vice versa. Amortization bases may also be combined to reduce volatility in the required employer contributions if adopted by the Board of Pension Trustees based upon the advice and recommendation of the Plan’s actuary. Actuarial Assumptions The actuarial assumptions used will be those last adopted by the Board based upon the advice and recommendation of the Plan’s actuary. The Board may request the actuary to perform an actuarial investigation into the experience of the Plan every six years or another appropriate period as determined by the Board to be utilized to form the basis for recommendations in actuarial assumptions. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 7 - Funding Target The funding objective is to achieve 100% funding. For this purpose, “100% funding” means that the Actuarial Value of Assets equals the Actuarial Accrued Liability. The amortization method allows up to 30 years to achieve this objective. Risk Management The main financial objective of this actuarial funding policy is to fund the long-term costs of benefits to plan members and beneficiaries. There are numerous risks that the Plan faces in trying to achieve this objective including funding risk, demographic risk, investment risk, and benefit risk. The Board policies for managing these risks are outlined in this section. Funding Risk Frequency of Actuarial Valuations Regular valuations manage funding risk by allowing employer contribution rates to reflect actual experience as it emerges. Funding valuations are performed every year as of January 1 to determine employer contribution amounts for the fiscal year beginning nine months later. Separate valuations are required for financial reporting under GASB 67 and 68. Demographic and Investment Risk Process for Reviewing and Updating Actuarial Assumptions The Board adopts actuarial assumptions based on recommendations of the Plan’s actuary. Demographic and investment risks may be managed in part by having regular reviews of the actuarial assumptions. The Board may request the actuary to perform an actuarial investigation into the experience of the Plan every six years or another appropriate period as determined by the Board. Once in receipt of the experience study report, the Board will adopt actuarial assumptions and methods as necessary. If circumstances warrant, the Board may change assumptions more frequently after conferring with the actuary and when investment risks are involved, the investment consultant. The experience study report shall include, but not necessarily be limited to, analysis of and recommendations regarding the following assumptions: i. Pre-retirement withdrawal rates ii. Retirement rates iii. Disability rates iv. Pay increase rates v. Mortality rates both before and after retirement City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 8 - vi. Investment returns considering both real return and inflation, which must be consistent with the investment policy The actuary shall assume no change in the active member population unless there is compelling evidence to support the expectation of a significant increase or decrease in the workforce covered by the Plan. The experience study report will serve as the basis for determinations by the Board regarding whether or not demographic or economic assumptions should be modified for future valuations. Chapter 112.661 (9), Florida Statutes specifies the investment policy adopted by the Board must include a requirement that the Board shall determine the total expected annual rate of return for the current year, for each of the next several years, and for the long term thereafter. This determination must be filed promptly with the Department of Management Services and with the plan’s sponsor and the consulting actuary. Responding to Favorable/Unfavorable Investment Experience Investment risk is addressed in the investment consultant’s quarterly reports. Annual investment experience other than assumed is reflected in the valuation asset method described above. Asset Liability Studies The Board adopts an asset allocation based on recommendations from the investment consultant. The asset allocation approved by the Board may reflect the results of periodic Asset Liability Studies, if performed. Risk Measures In order to quantify the risks outlined in this actuarial funding policy, the following metrics will be included in annual actuarial valuation reports. These metrics provide quantifiable measurements of risk and its movement over time: i. Funded ratio (Actuarial Value of Assets divided by Actuarial Accrued Liability). − Measures progress towards the funding objective of the 100% target funded ratio. ii. Total Unfunded Actuarial Accrued Liability (UAAL) divided by Total Payroll − Measures the risk associated with contribution decreases relative impact on the ability to fund the UAAL. A decrease in this measure indicates a decrease in contribution rate risk. City of Clearwater Employees’ Pension Plan DRAFT Actuarial Funding Policy Adopted: MM DD, 2014 - 9 - iii. Total Actuarial Accrued Liability (AAL) divided by Total Payroll − Measures the risk associated with the ability to respond to liability experience through adjustments in contributions. A decrease in this measure indicates a decrease in liability experience risk. This also provides a long-term measure of the asset risk in situations where the Plan has a funded ratio below 100%. iv. Total Actuarial Value of Assets divided by Total Payroll − Measures the risk associated with the ability to respond to asset experience through adjustments in contributions. A decrease in this measure indicates a decrease in asset experience risk. Benefit Risk Benefit risk may be managed as follows: The Board shall review proposals and legislative changes for the potential legal, administrative, Internal Revenue Code compliance, and funding impact on the Fund. If a proposal has the potential for a meaningful impact on plan funding, the Board shall consult with the actuary to estimate the actuarial impact to the Plan. The Board does not establish the benefit provisions; it administers them. Miscellaneous Matters Associated with Funding: Overall Conformance with Professional Standards of Practice By law, the actuary shall be an Enrolled Actuary and either a Member of the American Academy of Actuaries or an Associate or a Fellow of the Society of Actuaries. The work of the actuary in connection with this policy shall conform to Actuarial Standards of Practice for public employee retirement plans promulgated by the Actuarial Standards Board and shall satisfy the requirements of the Governmental Accounting Standards Board with respect to the development of information needed by the Fund and by the City for financial reporting purposes. APPENDIX B GRS RESEARCH REPORT: DEVELOPING A PENSION FUNDING POLICY FOR STATE AND LOCAL GOVERNMENTS 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -1- Developing a Pension Funding Policy for State and Local Governments By David Kausch and Paul Zorn1 Over the past decade, the Annual Required Contribution (ARC) as described in the Governmental Accounting Standards Board’s (GASB’s) Statements No. 25 and No. 27 has become a de facto funding policy for many public-sector retirement systems. The GASB is currently revising public pension accounting standards and has communicated an important message in the process: accounting standards are not funding standards. In the Exposure Drafts (EDs) of the new Statements No. 25 and No. 27, the GASB has removed all references to the ARC. At the same time, the EDs require disclosure of elements of a plan’s funding policy and the actual funding pattern must be taken into account to determine the plan’s financial disclosures. Now more than ever, public retirement systems need to have a sound, written funding policy to secure member benefits – and a strong funding policy may improve a plan’s financial disclosures as well. Funding Policy Goals The idea of having a written funding policy is not new. In its Best Practice, “Sustainable Funding Practices of Defined Benefit Pension Plans,” the Government Finance Officers Association (GFOA) states that the main financial objective of public employee defined benefit plans is to fund the long-term costs of promised benefits to plan participants.2 Moreover, the GFOA recommends that this be done through a systematic and disciplined accumulation of resources (i.e., contributions and related investment earnings) which are sufficient to the pay promised benefits to plan members over their lifetimes. In addition to this objective, the GFOA’s Best Practice cites other goals as well. To be consistent with the governmental budgeting process, efforts should be made to keep the employer’s pension contributions relatively stable from year to year. Moreover, to satisfy the principle of intergenerational equity, pension costs should be allocated to taxpayers on an equitable basis over time, i.e., not pushed into the future or immediately imposed on current taxpayers. In addition, to help offset related risks, efforts may be made to provide a reasonable margin for adverse experience. Developing a written funding policy can help decision- makers understand the tradeoffs related to reaching these goals and document the reasoning that underlies their decisions. By clarifying the funding policy, decision-makers can come to a better understanding of the principles and practices that help sustain benefits over the long-term. Risk-Management Framework These funding principles can be thought of in a risk-management framework. In an effort to keep the employer’s pension contribution relatively stable from year to year, a funding policy should: (1) identify key 1 David Kausch is chief actuary for GRS and Paul Zorn is director of governmental research. The authors thank Brian Murphy, Theora Braccialarghe, Supriya Kopf, Lewis Ward, Danny White, Dana Woolfrey and Mary Ann Vitale at GRS for their thoughtful comments. However, the authors retain full responsibility for the accuracy of the information. Moreover, the views expressed do not necessarily represent those of GRS as an organization. 2 Government Finance Officers Association, “Sustainable Funding Practices for Defined Benefit Pension Plans,” 2009. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -2- risk areas that add to contribution volatility and (2) identify ways to manage each of those risks. The primary risk areas in funding retirement systems are investment risks, demographic risks within the covered population, benefit or plan design risks, and governance risks. In response to this: • Investment risks can be managed with diversification of asset classes and asset smoothing. • Demographic risks can be measured and managed through the use of regular actuarial valuations and actuarial experience studies. • Benefit or plan design risks are often outside the purview of a retirement system’s board, but may include setting the interest rate on member contributions and deciding when to provide ad-hoc COLAs or thirteenth checks. • Governance risks can be managed with clear policies and controls regarding the major administrative practices of the retirement system. A written funding policy addresses all of these risks and recognizes tradeoffs between mitigating contribution volatility and recognizing gains and losses over a reasonable period. To help decide these tradeoffs and document the reasoning behind the decisions, the GFOA’s Best Practice recommends that plans adopt a written pension funding policy describing the principles and practices that guide the funding decisions. These would include: (1) the reasons for selecting the actuarial methods and assumptions, and (2) the policies related to risk sharing and responding to changes in plan experience. Key elements of a funding policy include decisions related to: • Actuarial cost method and assumptions • Asset valuation method • Amortization method • Funding target • Risk management regarding: o Frequency of actuarial valuations, o Process for reviewing and updating actuarial assumptions, o Responding to legislative proposals and changes, o Responding to favorable/unfavorable investment experience, o Sensitivity analysis and forecasting, and o Asset/Liability modeling. Elements to Consider in Developing a Funding Policy Actuarial Cost Method Different actuarial cost methods produce different patterns of normal costs and actuarial accrued liabilities. Some actuarial cost methods are more useful for determining contributions to an ongoing plan, and some are more useful for closed plans. While a detailed description of each cost method is beyond the scope of this report, the following three methods illustrate key distinctions. A more detailed discussion of actuarial cost methods is presented in Appendix A. • Traditional Unit Credit (TUC) –Under this actuarial cost method, the normal cost for a given year reflects the increase in the benefit earned due to increases in service and salary for the year, but not to service and salary projected to be earned in future years. Generally, this method is not used to fund ongoing public pension plans. • Projected Unit Credit (PUC) – Under this method, normal cost is calculated using benefits based on increases in service for the year, but with salary projected to the retirement date. This method is used by about 10% of public pension plans. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -3- • Entry Age Normal (EAN) – Under this method, normal cost is calculated using benefits based on projected service and salary at retirement and is allocated over an individual’s career as a level percent of payroll. This method is used by about 75% of public pension plans. Funding policy issues related to the actuarial cost method include: • Is the cost method appropriate for the plan? • Does the cost method produce normal costs that are reasonably stable and therefore consistent with the government’s budgeting process? For ongoing plans, the popularity of the EAN cost method is not surprising given governments’ need to limit volatility in contribution rates. Moreover, since contribution rates are initially higher under the EAN method than other cost methods, the EAN method accumulates assets more quickly than the other methods. As a result, the assets can be invested earlier to help offset future contributions. By contrast, the TUC and PUC methods start with lower contributions which increase over time. For closed plans, other actuarial cost methods may be more appropriate. The lack of new entrants into the plan and the shorter service lives of the remaining active members may make it appropriate to fund the plan more rapidly than under the EAN method. This could be done using the Aggregate actuarial cost method. The Aggregate cost method allocates the difference between the value of benefits and assets over the future service of the closed active population as a level percent of payroll. Actuarial Assumptions Actuarial assumptions also play a key role in determining the plan’s normal costs and actuarial accrued liabilities. The assumptions can be categorized into two groups: (1) economic assumptions (including inflation, wage growth, and long-term expected investment returns); and (2) demographic assumptions (including rates of mortality, disability, retirement, and termination). All assumptions should be consistent with Actuarial Standards of Practice and reflect professional judgment regarding future outcomes. Although all assumptions are important, the investment return assumption plays an extremely important role in the actuarial valuation, and strongly influences the calculations of normal costs and actuarial accrued liabilities. For funding purposes, the Actuarial Standards Board’s Actuarial Standards of Practice (ASOP) No. 27 supports the use of discount rates based on the plan’s long-term expected investment return.3 Funding policy issues related to the discount rate include: • Does the long-term expected investment return accurately reflect likely investment returns? • What variations in the actual investment return will likely occur over the long-term? In order for the actuarial valuation to properly fund the benefits, it is important that the discount rate accurately reflect the long-term investment return. If the assumption is too high, the contributions and actuarial liabilities determined by the valuation will be too low. If the assumption is too low, the contributions and actuarial liabilities will be too high. It is also important to understand that the assumption is intended to reflect an average expected return. In given years, actual returns will vary from the expected return. 3 Actuarial Standards Board, ASOP No. 27, Selection of Economic Assumptions for Measuring Pension Obligations, May 2011. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -4- Asset Valuation Method The actuarial methods that are used to determine the plan’s actuarial value of assets (AVA) also play a role in the funding policy. The difference between the actuarial accrued liability (AAL) and the AVA is the plan’s unfunded accrued liability (UAL). To the extent that the plan has a UAL, it must be amortized and included in the contribution rate. Key funding policy issues related to asset valuations include: • Should the actuarial value of assets be smoothed? If so, over what period? • Should a corridor be applied to the smoothed value of assets to prevent it from diverging too far from the market value? Smoothed vs. Market Value of Assets. Investment gains and losses are often “smoothed” into the AVA in order to mitigate the impact of investment volatility on employer contributions. In many cases, this is done by taking the difference between the actual annual investment earnings and the expected annual investment earnings and recognizing a portion of that difference each year over a set number of years. This evens out the impact of investment gains and losses that would otherwise be immediately recognized in the UAL. Smoothing Period. In cases where assets are smoothed, the smoothing period is often 5 years, although some plans use shorter or longer periods. While the smoothing period for governmental plans is not limited by federal laws or regulations, the Actuarial Standards Board has set out principles for asset smoothing in ASOP No. 44.4 Under these principles, when a smoothed asset valuation method is used, the actuary should select a method so that: • The smoothed asset values fall within a reasonable range of the corresponding market values; and • Any differences between the actuarial value and market value of assets should be recognized within a reasonable period. Asset Corridors. To satisfy these principles, many plans that smooth assets over periods longer than 5 years also include corridors that limit the extent to which the smoothed value of assets can diverge from the market value. Appendix B provides an illustration of how asset smoothing and asset corridors interact. Amortization Method In addition to the normal cost, the other major component of the annual contribution is the portion needed to amortize the UAL. Consequently, when setting the funding policy, the structure of the amortization payments and the length of the amortization period are important issues. It should also be noted that during the amortization period, interest accrues on the outstanding UAL at a rate reflecting the long-term expected investment return. In setting up an amortization policy, the following decisions should be made: • Should the amortization period be open or closed? • Should the amortization be on a level-dollar basis or a level-percent-of-pay basis? • What should be the length of the amortization period? • Should there be separate amortization bases for annual gains/losses, benefit changes, and other components of the UAL? A key issue in setting the amortization policy is the possibility of negative amortization. This occurs when the amortization payments are less than the interest accrued on the UAL during the year, and so the outstanding UAL increases rather than decreases. However, this depends on the length of the amortization period, as well as assumptions related to expected investment return and payroll growth. It is important to 4 Actuarial Standards Board, ASOP No. 44, Selection and Use of Asset Valuation Methods for Pension Valuations, May 2011. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -5- note that while the UAL increases when there is negative amortization, it is typically not expected to increase faster than the projected rate of payroll growth and is expected to be fully paid by the end of the period. However, an open amortization period which allows negative amortization may be inconsistent with reaching a funding target of 100% in a reasonable period of time. Closed Amortization vs. Open Amortization. Another issue is whether the UAL should be amortized over a closed amortization period or an open amortization period. If a closed amortization period is used, the UAL will be fully paid by the end of the period. By contrast, under an open amortization period, the period is reset each year. For example, under a 25-year open amortization period, the UAL is refinanced each year over a new 25-year period. Closed amortization periods pay down the UAL more rapidly and limit negative amortization, but produce more volatility in the contribution rate as the period gets shorter. An open period results in a more gradual decline of the UAL and helps to control volatility in the contribution rate, but takes substantially longer to pay down the UAL. Moreover, an open amortization period is more likely to produce negative amortization, at least when the period is 15 to 20 years or longer. Appendix C provides illustrations of the amortization patterns under closed and open amortization periods. Level-dollar vs. Level-percent-of-pay. Another issue is whether the UAL should be amortized on a level- dollar basis or as a level-percent-of-pay. Level-dollar amortization is similar to a fixed-rate home mortgage with a constant dollar payment. Level-percent-of-pay amortization initially has lower dollar payments, but these increase each year. Since level-dollar amortization pays a greater portion of the UAL in earlier years, it is more conservative than level-percent-of-pay amortization. However, level-percent-of pay-amortization may be more consistent with the budgeting process of most governmental entities. Length of the Amortization Period. Generally, for public pension plans, amortization periods range from 15 to 30 years, although some plans use shorter or longer periods. Shorter amortization periods result in the UAL being paid off sooner, but require higher and likely more volatile contributions. Longer amortization periods require lower contributions, but may shift some of the pension costs beyond the working careers of active employees and on to future generations. Single Amortization vs. Separate Amortization Bases. So far the discussion of amortization has focused on amortizing the UAL as a whole over a single amortization period. This approach is straightforward, since there would be no need to track separate amortization bases. However, the UAL is made up of amounts that come from different sources, including: (1) actuarial gains and losses due to differences between actual and assumed plan experience, (2) benefit changes, and (3) changes in actuarial methods and assumptions. As a result, the plan may wish (or in some cases be required) to amortize the UAL from these sources over different periods. For example, changes in the UAL due to benefit changes could be amortized over a shorter period than changes in the UAL due to changes in actuarial assumptions. However, a disadvantage to using multiple amortization periods is that they may increase the volatility of contribution rates. Funding Target The funding target is the funded ratio that the plan is trying to reach and maintain through its funding policy. The GFOA’s Best Practice “Sustainable Funding Practices for Defined Benefit Pension Plans” recommends a funding target of 100%. Setting the funding target to an anything other than 100% means establishing a policy of making contributions that are greater or less than the amounts theoretically needed to fund the plan. However, funding targets of more than 100% may provide a margin for adverse experience. On the other hand, funding targets of less than 100% may help mitigate pressure for benefit increases. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -6- Risk Management As noted at the beginning of this report, there are a variety of risks associated with defined benefit plans, including investment risks, demographic risks, benefit design risks, and governance risks. To manage the risks, it is important to first identify the potential impact of a specific risk on plan funding, and then to identify ways to manage the risk. Pension funding policy should include a discussion of the steps needed to monitor and address the risks facing the plan. Investment risks involve both the risks that investment returns will not meet actuarial expectations and that the volatility of the returns will make contribution rates difficult to budget. Generally, investment risks are managed through changes in asset allocations which, in turn, are based on asset allocation studies and asset/liability analyses. If changes are made to asset allocations, the long-term investment return assumption should also be reviewed and, if necessary, changed to reflect the new asset allocation. Demographic risks involve the risks that the plan’s actual experience related to mortality, retirement patterns, and other demographic factors do not match the actuarial assumptions. It is considered best practice to do experience studies at 5-year intervals to monitor and update the assumptions. Benefit design risks include the risks that benefit changes will result in future contributions that are unaffordable for the sponsoring government. One way to examine these risks is to have an actuarial valuation of the benefit changes done before the changes are approved by the government, an approach recommended by the GFOA. Benefit design risks can also be examined using stochastic projections that compare future benefits with future contributions and investment returns, as well as scenario (stress) tests which examine changes in funding that result from specific changes in assumptions. Changes in benefits may require a change in actuarial assumptions. For example, it may be necessary to lower the investment return assumption if benefit increases are based on favorable investment experience (i.e., actual investment returns that are higher than expected returns). As discussed in the section on actuarial assumptions above, the long-term investment return assumption reflects the actuary’s estimate of the average return. Using excess earnings rather than additional contributions to provide increased benefits reduces the earnings available to pay current benefits. This, in turn, may require a lower investment return assumption be used, thereby increasing the actuarial accrued liability of the plan. Similarly, when investment gains result in lowered contributions, care should be taken to ensure the contributions do not fall to unreasonable levels. Governance risks relate to the risks that the plan’s administrative policies and procedures are appropriate for carrying out the functions of the plan. Funding policy can address governance risks by discussing the administrative structures that should be in place for monitoring compliance with the funding policy and ensuring that the actuarially determined contributions are made. In addition, funding policy can help ensure that the long-term costs of benefit changes are determined before legislative action is taken. Conclusion In funding defined benefit pension plans, governments must satisfy a range of objectives. In addition to the fundamental objective of funding the long-term costs of promised benefits to plan participants, governments also work to: (1) keep employer’s contributions relatively stable from year to year; (2) allocate pension costs to taxpayers on an equitable basis; and (3) manage pension risks. Developing a written funding policy can help decision-makers understand the tradeoffs involved in reaching these goals and document the reasoning that underlies their decisions. By clarifying the funding policy, decision-makers can come to a better understanding of the principles and practices that produce sustainable benefits. 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -7- Summary of Funding Policy Elements Element Policy Function Issues to Address Actuarial Cost Method Determines accrual patterns of normal costs and actuarial accrued liabilities • Is the actuarial cost method appropriate for the plan? • Does the cost method produce normal costs that are reasonable stable and consistent with the budgeting process? Actuarial Assumptions Determines the assumptions used in the actuarial valuation and other studies • Does the long-term expected investment return accurately reflect likely investment returns? • How will actual investment returns likely vary from the assumed return over time? • Do the demographic assumptions, including the mortality assumptions, accurately reflect the ongoing experience of the plan? • How often should studies be done to evaluate the actuarial assumptions? Asset Valuation Method Determines the actuarial value of assets and, by extension, the unfunded accrued liability • Should the actuarial value of assets be smoothed? If so, over what period? • Should an asset corridor be applied to prevent the smoothed value of assets from diverging too far from the market value? Amortization Method Determines the portion of the unfunded accrued liability that is amortized in the contribution rate each year • Should the amortization period be open or closed? • Should it be on a level-dollar basis or level- percentage-of-pay basis? • What should be the length of the amortization period? • Should there be separate amortization bases for different components of the unfunded accrued liability? Funding Target Determines the funded ratio targeted by the funding policy • Should the funding target be other than 100%? Risk Management Aligns the funding policy with the risk management framework • How should risks be monitored with regard to investments, demographics, and plan design? • What actions should be taken to address the risks? • How should favorable investment experience be treated? • How should unfavorable investment experience be treated? Governance Monitors plan administration and contributions • What administrative structures should be in place to monitor compliance with the funding policy and ensure actuarially determined contributions are made? • What governance structures should be in place so that the long-term costs of benefit changes are determined before legislative action is taken? 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -8- Appendix A – An Overview of Actuarial Cost Methods In order to make sound decisions related to pension funding, it is important to understand how the actuarial cost methods work and how the employer’s actuarially determined contributions are calculated. Present Value of Future Benefits To determine the contributions needed to fund the plan, the value of benefits to be paid in the future must be converted to amounts as of the valuation date. This is done by projecting the future benefits owed to current plan members based on the plan’s benefit provisions and actuarial assumptions. These projected future benefits are then discounted using a rate that represents the expected long-term rate of investment return on plan assets. The resulting “projected value of future benefits” (PVFB) is the sum of the discounted values of the projected benefits. Essentially, this is the amount on the valuation date which, if invested at the discount rate, would pay all of the projected future benefits (provided the actuarial assumptions are met). Normal Cost An individual’s normal cost is the portion of the PVFB that is allocated to a given year of employee service under the actuarial cost method. The plan’s total normal cost in a given year is the sum of each individual’s normal cost for that year. There are a variety of actuarial cost methods and different methods take different approaches to allocating the normal cost over an individual’s career. Chart 1 illustrates how normal costs vary under three actuarial cost methods: the Traditional Unit Credit (TUC) method, the Projected Unit Credit (PUC) method, and the Entry Age Normal (EAN) cost method. The three lines show the normal cost patterns for an individual employee who begins coverage under the plan at age 30 and retires at age 65, assuming the same benefit and same assumptions. The normal costs are shown as a percent of annual pay. Chart 1 • The TUC method recognizes salary and years of service in the benefit only when earned. As a result, normal costs under this method increase at an accelerating rate as the employee approaches retirement age and as salary increases. 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64Percent of Annual PayAttained Age Normal Cost as a % of Annual Pay for an Employee Starting at Age 30 and Retiring at Age 65 TUC Normal Cost PUC Normal Cost EA Normal Cost 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -9- • The PUC method recognizes years of service when earned, but projects salary to retirement age. As a result, normal costs also increase under this method as an employee approaches retirement, but at a slower rate than under the TUC because future increases in salary are recognized in advance. • The EAN cost method immediately recognizes both projected salary and service. As a result, it allows normal costs to be calculated as a level-dollar amount or as a level-percent-of-pay over the employee’s career. Actuarial Accrued Liability The actuarial accrued liability (AAL) is the accumulated amount of the normal costs attributed to years of service before the valuation date. Given that the different actuarial cost methods result in different normal costs, it follows that they also result in different accrual patterns for the AAL over a member’s employment. Chart 2 shows the accrued AAL for an individual employee who begins coverage under the plan at age 30 and retires at age 65. As with Chart 1, the three lines reflect the different actuarial costs methods applied to the same employee earning the same benefit under the same assumptions. Chart 2 Since the employee will receive the same benefit at retirement, the actuarial cost methods converge to the same actuarial accrued liability. However, the paths they take are different. • Under the TUC method, the AAL starts out low and increases over time as each year’s accumulating salary and years of service are recognized in the AAL. Much of the AAL under the TUC is accrued in the last 5 years before retirement. • Under the PUC method, the AAL increases somewhat more rapidly than under the TUC, but the PUC method still shifts recognition of much of the AAL toward the end of the employee’s career. • Under the EAN cost method, a larger portion of the AAL is recognized in earlier years, which in turn, helps provide for more level contribution rates over the employee’s career. Note that Chart 2 shows only the liability accrual pattern for one employee over time. The accrual pattern for the plan as a whole will depend on the age and service characteristics of all employees in the plan. $‐ $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65Actuarial Accrued LiailityAttained Age Actuarial Accrued Liability Under Different Actuarial Cost Methods for an Employee Entering the Plan at Age 30 and Retiring at Age 65 TUC AAL PUC AAL EAN AAL 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -10- Appendix B – An Example of Asset Smoothing and Asset Corridors As discussed in the report, investment gains and losses are often “smoothed” into the actuarial value of assets (AVA) in order to mitigate the impact of investment volatility on contributions. While most public plans use 5-year smoothing periods, plans that smooth over longer periods often use asset corridors to limit the extent to which the value of smoothed assets can diverge from the market value. For example, under an “80/120” corridor, the smoothed value of assets is not allowed to fall below 80% or rise above 120% of the market value. This helps keep the actuarial value of assets within a reasonable range of the market value. However, during a major market decline or increase, the smoothed value of assets may exceed the corridor. If so, the amount of assets exceeding the corridor must be immediately recognized, adding to the volatility of the UAL and contributions. Chart 3 Chart 3 shows the growth of a hypothetical plan’s investment portfolio with a 60% mix of large cap stocks and a 40% mix of high-quality corporate bonds over the period from 1985 to 2010. The solid black line shows the market value of assets (MVA) at calendar year-end and the gray dotted lines show the 80/120 corridor boundaries. The green line (marked with triangles) shows the 5-year smoothed AVA. Several things are interesting about the chart. First, during most of the 1990s, the 5-year smoothed AVA was below the MVA. This is because actual investment returns were substantially higher than expected returns for most of the decade, and the MVA outpaced the AVA. In fact, the 5-year smoothed AVA was very close to the 80% corridor in 1997 and 1998. When the financial markets declined during 2000-2002, the 5-year smoothed AVA continued increasing, due to continued recognition of gains from the 1990s. When the financial markets picked up again in 2003, the asset losses from 2000-2002 offset part of the asset gains and the 5-year smoothed AVA moved closer to the MVA. However, the financial crisis of 2008 caused the MVA to decline sharply, causing a similar fall in the corridor boundaries. Consequently, in 2008, the 5-year smoothed AVA would have been greater than the upper boundary of the corridor. If the corridor had been in place, the plan would have had to lower its AVA to match the corridor’s upper boundary, increasing its UAL and the amount of the UAL amortized in its contribution rate. $‐ $200,000 $400,000 $600,000 $800,000 $1,000,000 $1,200,000 19851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010Year Illustration of 5‐Year Smoothing and 80/120 Corridor on the Value of Assets for a 60/40 Stock/Bond Portfolio from 1985 through 2010 Market Value of Assets (EOY) Corridor (‐20%) Corridor (+20%) 5‐Year Smoothed AVA 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -11- Appendix C: Amortization Patterns under Closed and Open Periods An important pension funding policy issue is whether the UAL should be amortized over a closed amortization period or an open amortization period. Closed amortization periods pay down the UAL more rapidly and limit negative amortization, but produce more volatility in the contribution rate as the period gets shorter. Open amortization periods help control volatility in the contribution rate, but take longer to pay down the UAL. Another amortization issue is whether the UAL should be amortized on a level-dollar basis or as a level- percent-of-pay. Level-percent-of-pay amortization initially has lower dollar payments, but these increase each year. Since level-dollar amortization pays a greater portion of the UAL in earlier years, it is more conservative than level-percent-of-pay amortization. However, level-percent-of pay-amortization is more consistent with the budgeting process of most governmental entities. Chart 4 shows the UAL amortization patterns for: (1) a 25-year closed level-dollar amortization approach; (2) a 25-year closed level-percent-of pay-approach; and (3) a 25-year open percent-of-pay approach. The amortization payments are expressed in dollars. Chart 4 • Under the closed, level-dollar approach, the dollar payments start higher than under the level- percent-of-pay approaches, and remain level until the end of the amortization period, at which time the UAL is completely amortized. • Under the closed, level-percent-of-pay approach, the dollar payments are initially below the payments made under the level-dollar approach, but exceed the level-dollar payments after approximately 10 years, and ultimately become substantially more than the payments under the level-dollar approach. • Under the open percent-of-pay approach, the dollar payments start at the same amount as the closed, level-percent-of-pay approach, and remain below the dollar payments under the closed approach. However they continue to increase even after the end of the 25-year period and may continue for several decades. $‐ $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $140,000 $160,000 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 Years UAL Amortization Pattern (in Dollars) 25 Year Closed, Level $ 25 Year Closed, Level % Pay 25 Year Open, % of Pay 1/25/2012 © 2012 - Gabriel Roeder Smith & Company -12- The dynamics appear different when the same amortization payments are expressed as a percentage of covered payroll, as in Chart 5: Chart 5 From this perspective, the closed level-dollar payments decline rapidly as a percent of payroll. Under the closed level-percent-of-pay approach the payments remain level until they are fully amortized at the end of the period. However, under the open percent-of-pay approach, the amortization payments extend beyond the 25-year period and continue to decline for decades thereafter. The rate at which they fall depends on a number of factors, including the expected investment return and payroll growth assumption. 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00% 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59Percent of PayrollYears UAL Amortization Pattern (as a % of Payroll) 25 Year Closed, Level $ 25 Year Closed, Level % Pay 25 Year Open, % of Pay