March 26, 2010 Althea A. Schwartz, FSA Consulting Actuary Milliman Inc. Managing DB Pension Plans in Stressful Times

2 These things we know to be true... We won’t know the total cost of a pension plan until the last plan member is paid his/her last benefit check.

3 These things we know to be true... Actuarial assumptions are exactly that... assumptions.

4 These things we know to be true... Everything that we do to manage contributions is a pay now or pay later proposition.

5 Investment returns – CT public plans Source: 16 Milliman clients with July 1 valuation dates Average 2.2% Average -14.5%

6 Change in public pension funding levels Source: NASRA Public Fund Survey of Findings FY 08 Before the big meltdown! Funded Ratio

7 Market loss mitigation strategies Four straightforward ways in which the actuarial method can be modified to manage the Annual Required Contribution Two modify how asset smoothing technique works Two modify how the Unfunded Accrued Liability is amortized

8 Baseline example of funding calculation up from $2.5 million in the prior year 5 year asset smoothing level dollar amortization 15 year amortization period 20% corridor around actuarial value of assets

9 Market loss mitigation strategy #1 Increase the asset smoothing period

10 Smoothing periods – large public plans Source: NASRA Public Fund Survey of Findings FY 08

11 Asset smoothing – actuarial standard Actuarial value should have a “reasonable relationship” to market value:  Actuarial value should be within “reasonable range” around market value and smoothing method should recognize differences from market value in a “reasonable period of time”  Or actuarial value should be within a “sufficiently narrow range” around the market value  Or actuarial value should recognize differences from market value in a “sufficiently short period”

12 Asset smoothing – actuarial standard Translation into plain English:  Use a moderate corridor and a moderate smoothing period  Or use a tighter corridor with a longer smoothing period  Or use no corridor with a shorter smoothing period  But don’t use no corridor with a really long smoothing period

13 Impact of increasing smoothing period This plan had such big gains in the earlier years that the ARC with 8 year smoothing is actually higher than with 5 year smoothing! Compared to $4,954,000 baseline

14 Market loss mitigation strategy #2 Increase or eliminate the asset smoothing corridor

15 Increase or eliminate smoothing corridor Actuarial Value versus Market Value Period of large, sustained market losses - actuarial value is constrained by corridor - this accelerates the recognition of losses Period of large, sustained market gains – corridor accelerates the recognition of asset gains

16 Impact of eliminating the corridor Compared to $4,954,000 baseline 1.Market Value of Assets as of July 1, 2009$91,300,000 2.Delayed Recognition of Market (Gains)/Losses: PercentAmount Plan Year End(Gain)/LossNot Recognized 06/30/2009$24,000,00080%$19,200,000 06/30/200810,000,00060%6,000,000 06/30/2007(8,000,000)40%(3,200,000) 06/30/2006(6,000,000)20%(1,200,000) 20,800,000 3.Preliminary Actuarial Value as of July 1, 2009: (1) + (2)112,100,000 4.Corridor Limit:80% of (1) 120% of (1) 5.Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4)112,100,000 6.Actuarial Accrued Liability140,000,000 7.Unfunded Actuarial Accrued Liability: (6) - (5)27,900,000 8.Amortization Period15 9.Amortization Rate0.00% 10.Amortization Payment: (7) amortized over (8) years2,940, Normal Cost (Net of Expected Employee Contributions)1,400, Interest on (10) + (11)326, Annual Required Contribution: (10) + (11) + (12)4,666,000

17 Market loss mitigation strategy #3 Increase the amortization period

18 Increase amortization period Lengthening the period lowers the annual amortization payment. But it takes that much longer to pay off the Unfunded Accrued Liability and get to 100% funded. Annual Payment Unfunded Accrued Liability

19 Amortization period – actuarial standard GASB 25/27: maximum is 30 years Actuarial standards: the amortization period should bear a “reasonable relationship” to the average working lifetime of active members

20 Amortization period – actuarial standard Translation into plain English:  Town employee plan with age 65 retirement  30 years is probably fine  Police plan with retirement after 20 years  20 years is more appropriate  Frozen plan where all active members are in their 50s and 60s  might want to use 10 years

21 Impact of increasing amortization period Compared to $4,954,000 baseline Lengthened from 15 years

22 Market loss mitigation strategy #4 Change from level dollar to level percent amortization

23 Amortization methods Level Percent amortization payments increase over time along with other compensation and benefit costs. Level Dollar amortization payments are the same amount every year – and are therefore a declining percentage of the overall budget. Level Percent amortization causes the Unfunded Accrued Liability to grow initially, then rapidly decline. Level Dollar amortization causes the Unfunded Accrued Liability to steadily decline. Annual Payment Unfunded Accrued Liability

24 Impact of changing amortization method Compared to $4,954,000 baseline

25 Impact of changing everything! Compared to $4,954,000 baseline 1.Market Value of Assets as of July 1, 2009$91,300,000 2.Delayed Recognition of Market (Gains)/Losses: PercentAmount Plan Year End(Gain)/LossNot Recognized 06/30/2009$24,000,00088%$21,000,000 06/30/200810,000,00075%7,500,000 06/30/2007(8,000,000)63%(5,000,000) 06/30/2006(6,000,000)50%(3,000,000) 06/30/2005(1,000,000)38%(375,000) 06/30/2004(12,000,000)25%(3,000,000) 06/30/2003(7,000,000)13%(875,000) 16,250,000 3.Preliminary Actuarial Value as of July 1, 2009: (1) + (2)107,550,000 4.Corridor Limit:80% of (1) 120% of (1) 5.Actuarial Value of Assets as of July 1, 2009: (3) constrained to corridor in (4)107,550,000 6.Actuarial Accrued Liability140,000,000 7.Unfunded Actuarial Accrued Liability: (6) - (5)32,450,000 8.Amortization Period25 9.Amortization Rate4.00% 10.Amortization Payment: (7) amortized over (8) years1,877, Normal Cost (Net of Expected Employee Contributions)1,400, Interest on (10) + (11)246, Annual Required Contribution: (10) + (11) + (12)3,523,000

26 How to choose what changes to make? No “one size fits all” answer! Need to look beyond just the impact on this year’s valuation results. If you are paying less this year, how and when will the “pay later” appear? How will the changes impact the year to year volatility of the contribution?

27 Projection – no changes Funded ratio dips and contribution climbs as the market losses are gradually recognized These figures are for illustration purposes only. Each plan will have different long- term funding patterns and will react differently to changes in the actuarial method. Funded Ratio Annual Required Contribution Funded Ratio 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% No Change Change corridor Change smoothing period Change amortization period Change amortization method

28 Eliminate 20% smoothing corridor Small but noticeable impact in the first year; contributions are very slightly higher thereafter These figures are for illustration purposes only. Each plan will have different long- term funding patterns and will react differently to changes in the actuarial method. Funded Ratio Annual Required Contribution 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% No Change Change corridor 0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 9,000,000 No Change Change corridor

29 Lengthen asset smoothing: 5  8 years Smoother progression as market losses are recognized more slowly; higher contributions in later years These figures are for illustration purposes only. Each plan will have different long- term funding patterns and will react differently to changes in the actuarial method. Funded Ratio Annual Required Contribution 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% No Change Change smoothing period 0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 9,000,000 No Change Change smoothing period

30 Lengthen amortization period: 15  25 Contributions are lower, but it will take 10 extra years for funded ratio to reach 100% These figures are for illustration purposes only. Each plan will have different long- term funding patterns and will react differently to changes in the actuarial method. Funded Ratio Annual Required Contribution 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% No Change Change amortization period 0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 9,000,000 No Change Change amortization period

31 Change amortization: level $  level % Lower contributions now, higher contributions later These figures are for illustration purposes only. Each plan will have different long- term funding patterns and will react differently to changes in the actuarial method. Funded Ratio Annual Required Contribution 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% No Change Change amortization method 0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 9,000,000 No Change Change amortization method

32 Change everything These figures are for illustration purposes only. Each plan will have different long- term funding patterns and will react differently to changes in the actuarial method. Funded Ratio Annual Required Contribution 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% No Change Change everything 0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 9,000,000 No Change Change everything

33 Considerations for plan sponsors Each plan is different  Funding patterns will be different over time  What makes sense for one plan sponsor may not be appropriate for another plan sponsor Need to balance short-term and long-term Intergenerational taxpayer equity – who should shoulder the burden of making up the market losses?

34 Considerations for plan sponsors Is the sky really falling? Should the change(s) be temporary -- e.g., just for a year or two -- or permanent? How will you explain the change(s) to interested parties? What are your criteria for considering such changes in the future? Slippery slope? Who has the authority to make the decision?

35 Considerations for plan sponsors Should you rethink your investment allocation? Can you live with your equity risk? Have you performed an asset / liability study?  How does investment volatility relate to contribution volatility?  Can you really withstand the contribution increases from extreme downturns?

36 Survey of 22 municipalities in CT and RI  7 made no changes  8 removed the asset smoothing corridor  2 removed the asset smoothing corridor and extended the amortization period  1 extended the amortization period  1 removed the asset smoothing corridor and extended the asset smoothing period  1 extended both the amortization period and the asset smoothing period  1 changed from level $ to level % amortization and removed the asset smoothing corridor for 1 year only  1 changed from level $ to level % amortization, removed the asset smoothing corridor, extended both the amortization period and the asset smoothing period

37 Questions