The Building Blocks of an Actuarial Valuation LAPERS 2017 The Building Blocks of an Actuarial Valuation Gregory M. Curran, FCA, MAAA, ASA, EA Consulting Actuary G. S. Curran & Company, Ltd. 10555 N. Glenstone Place Baton Rouge, Louisiana 70810 (225)769-4825

Points of Discussion Training required to be an actuary Building an actuarial valuation model

Topics Studied By Actuaries Probability Exam General probability and statistics Univariate probability distributions Multivariate probability distributions Financial Mathematics Time value of money/Interest theory Annuities and cash flows with non-contingent payments Loans General cash flows and portfolios Portfolio Immunization

Topics Studied By Actuaries (continued) Models for Financial Economics Derivative securities General properties of options Binomial Option Pricing Model Black-Scholes Option Pricing Model Models for Life Contingencies Present Value Random Variables Calculation of insurance premiums Insurance Reserves Applying models to pension benefits

Topics Studied By Actuaries (continued) Construction and Evaluation of Actuarial Models Security Models Frequency Models Aggregate Claim Models Risk Measures Construction of Empirical Models Credibility Simulation

Topics Studied By Actuaries (continued) Required College Coursework Economics Corporate Finance Applied Statistics and Methods

In addition to Actuarial Exams and required coursework: 8 Learning Modules on the Fundamentals of Actuarial Practice titled … Role of the Professional Actuary Core External Forces Risk in Actuarial Calculations Actuarial Solutions Design and Pricing of Actuarial Solutions Model Selection and Solution Design Selecting Assumptions Monitoring Results

Enrolled Actuary Exams – for Pension Actuaries Mathematics of Compound Interest Mathematics of Life Contingencies Demographic Analysis Exam 2 – Segment F Actuarial Assumptions Actuarial Cost Methods Calculation of Minimum Required Contributions Calculation of Maximum Deductible Contributions Exam 2 – Segment L Covers ERISA and related federal laws

Description of Items Needed in Building an Actuarial Valuation Model

Building an Actuarial Model Actuarial valuation software must be set up to include benefit projections for each type of benefit available at future dates along with setting eligibility rules for each benefit. Withdrawal benefits Disability benefits Retirement benefits DROP or Back-DROP benefits Survivor benefits

Building an Actuarial Model Build a set of assumptions within the model Demographic Assumptions Probabilities/Rates of Withdrawal, Disability, Retirement, DROP Entry Mortality Tables for actives, retired, and disabled Rates of remarriage Probability of service related disability/death Family Statistics Percent of members who are married Percent of members with Children Average Number of Children Average Age of Children

Building an Actuarial Model (Continued) Financial assumptions Valuation Interest Rate/Discount Rate/Assumed Rate of Return Inflation Assumption Salary scale assumption Final average compensation Period Account for Early Retirement Reductions when not set to be reduced actuarially

Building an Actuarial Model (Continued) Must consider minimum service required for each type of benefit Vested benefits Disability benefits Survivor benefits Lifetime spousal benefits Minor child benefits Retirement benefits

Actuarial models include many types of payments like… Level payment lifetime monthly annuity Deferred lifetime monthly annuity – payments do not begin until a member reaches a particular age or until a certain number of years have passed Deferred Lump Sum – Payment of DROP/IBO/Back-DROP lump sums occur after an accumulation period and perhaps an additional service period Immediate Lump Sum Geometrically increasing lifetime monthly annuity

A few types of annuities: Life Annuity - Payable for the life of the member Reversionary Annuity - Payable for the life of a named beneficiary upon death of the member if the beneficiary is alive at the member’s death Life Annuity (Cease on Remarriage) - Survivor benefits payable until remarriage of the recipient. Temporary Life Annuity - Payable while alive but only during a specified period. Period Certain Annuity - Payable for a specified period even if the member dies

A few types of annuities (continued): Certain and Continuous Annuity – Lifetime annuity with a guarantee of payments for a certain period regardless of death Cash refund annuity – Annuity that pays a designated beneficiary the difference between the cash balance originally annuitized and the sum of annuity payments received prior to death, if any.

Special Situations Account for benefit limits Account for members who are vested but choose to take a refund at termination Inclusion of average accumulated leave in benefit formulas for systems that allow conversion of unused leave to retirement credit Do contributions cease for employees who reach 100% accrual? Does the system receive contributions during DROP period? Accrual rates that change after reaching a specified period of service

Special Situations (Continued) Option factors needed within the model to account for automatic option 2 benefits to survivors Different setup for each tier of benefits May have to separate data into multiple sub-plans with different benefit rules and possibly different assumptions

A funding method is needed to determine funding requirements The funding method determines the annual cost allocations – Normal Cost The funding method also specifies the method for determining the Unfunded Accrued Liability, if any. Determining the Unfunded Accrued Liability is separate from determining the annual payments required to pay off the UAL. Funding methods seek to collect sufficient assets to reach full funding over a particular time frame Some methods seek to fully fund over the future working lifetime of members Some set arbitrary periods over which to pay off Unfunded Accrued Liabilities

Items considered in determining the minimum actuarially required employer contribution Normal cost Payments on any Unfunded Accrued Liabilities Anticipated administrative costs (unless handled through a change in assumptions) If not explicitly handled in determining required contributions or implicitly through adjusting assumptions, will affect UAL or NC and be spread over a specified period or future working lifetime of members Adjustment for employee contributions and other dedicated funds which offset employer contributions

Inputs to the valuation process Data on every member, former member, retiree and beneficiary potentially due payments from the system in the future. Audited financial statements for the system as of the valuation date with support for certain payable liabilities set up by the auditor. Administrative questionnaire – information provided by the Director related to the system, Board decisions over the past years, and the membership.

Inputs to the valuation process (continued) Data related special circumstances Handling of split benefits payable to alternate payees Annualizing salaries for new hires or individuals who did not work a full year Handling of members on leave without pay or worker’s compensation as of the valuation date Reemployed retirees Offset benefits for disabled members with outside income or financial awards

Actuarial Reports Although the primary purpose of the actuarial valuation is to determine the minimum recommended employer contribution rate, the actuarial report has many additional purposes, including: Determining rates of return for use in administration of the retirement system Providing the Board of Trustees with commentary on system risks and funded status Providing information to the Board and other stakeholders related to the impacts of gains and losses Discussing the cost and availability of COLAs to system retirees in accordance with the law.

Actuarial Reports (Continued) Providing historical information related to the system’s actuarial funded status Summarizing statutory changes affecting the retirement system in the most recent legislative year Describing the system’s census of members, former members due some payment, and retirees Providing a Summary of Plan Provisions Providing the actuary’s recommended changes in assumptions and methods Providing important communications from the actuary to the Board necessary to support upcoming decisions.