FCERA April 2008 Interest Crediting FCERA Board Interest Crediting and Excess Earnings Policy Discussion Wednesday, April 16, 2008 Paul Angelo, FSA Andy Yeung, ASA The Segal Company San Francisco

Slide 2 FCERA April 2008 Interest Crediting Outline  Actuarial Cost Method Fundamentals  Reserve, Interest Crediting and Excess Earnings Mechanics  FCERA Reserve Structure  FCERA Interest Crediting Policy  FCERA Excess Earnings Policy  Historical Application of Excess Earnings  Review Policy Features and Goals

Slide 3 FCERA April 2008 Interest Crediting Current Year Normal Cost Present Value of Future Benefits Actuarial Accrued Liability Future Normal Costs Current AgeEntry AgeRetirement Age Actuarial Cost Method

Slide 4 FCERA April 2008 Interest Crediting Valuation Value of Assets Unfunded Actuarial Accrued Liability Amortization of Unfunded Actuarial Accrued Liability Normal Cost Present Value of Future Normal Costs Annual Cost

Slide 5 FCERA April 2008 Interest Crediting Universal Rule of Pension Plans: No free lunch! Contributions + Investment Income equals Benefit Payments + Expenses  Assumptions and funding methods affect only the timing of costs  “Nobody ever made a benefit payment from assumed interest!”

Slide 6 FCERA April 2008 Interest Crediting Typical 1937 Act Reserve Structure

Slide 7 FCERA April 2008 Interest Crediting Reserve Mechanics  Reserves track contributions, payments and investment earnings  Add contributions to Member Deposit and Employer Advance Reserves  Transfer PV to Retiree Reserves for new retirees  Deduct payments from Member Deposit and Retiree Reserves  Credit interest

Slide 8 FCERA April 2008 Interest Crediting Basic Interest Crediting Process  Determine “Available Earnings” for the period  All current period earnings  Min. (1%) + Add’l (>1%) Contingency Reserve (CR)  Maybe some or all of Undistributed (Excess) Earnings Reserve (UER)  Determine earnings needed for credits  If Available Earnings is enough, do the credits  Then restore Contingency Reserve  Balance to UER  Excess Earnings Policy determines use of UER

Slide 9 FCERA April 2008 Interest Crediting FCERA Earnings Measure  FCERA uses same measure of earnings for reserves and for funding  Total Reserves = Actuarial Value of Assets  Valuation Reserves = Valuation Value of Assets  Credit interest at valuation rate to maintain balance  Excess Earnings Actuarial Investment Gain

Slide 10 FCERA April 2008 Interest Crediting Mechanics: Undistributed Earnings Reserve  Two-Step process for spending Excess Earnings:  First, “siphon” Excess Earnings into a “non-valuation reserve”  Excluded from Valuation Assets  Prevents decrease in UAAL contribution rate  Later, “spend” Excess Earnings  No sudden impact on contribution rate  A form of forced budgeting!

Slide 11 FCERA April 2008 Interest Crediting investments $$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ Assets $ $ $ $ $ $ $ $ $ $ PENSION FUND $ $ benefits expenses employer contributions employee contributions Generic Funding Mechanics

Slide 12 FCERA April 2008 Interest Crediting Investment Income Valuation Assets Benefits Expense s County Contributions Member Contributions Undistributed Excess Earnings Ad-Hoc Benefits Drawing Not to Scale! Contingency Reserve Plumbing for Excess Earnings

Slide 13 FCERA April 2008 Interest Crediting FCERA Interest Crediting Policy  Last reviewed: October 2005  Available Earnings: Return on Actuarial Value plus CR and UER  Credit Member Reserve at rate of retiree COLA  limited to 3%, one-half credited on 6/30 and 12/31  Credit total Valuation reserves (including Member) at valuation rate  Credit Non-Valuation Reserves at valuation rate  Supplemental COLA and Retiree Health Insurance

Slide 14 FCERA April 2008 Interest Crediting FCERA Interest Crediting Policy  If Available Earnings is insufficient: CR may become negative, but CR + UER + Non-Valuation Reserves > 1% of Market Value of Assets  Negative CR used to track interest credit shortfalls  If Available Earnings is sufficient: Earnings available to add to UER

Slide 15 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Combination of Settlement Agreement and Board discretion  Settlement Agreement  Section 6 – enhanced retirement benefits for active members retiring on or after January 1, 2001  Section 8 – enhanced retirement benefits for retired members retired before January 1, 2001  Section 9 – All retirees, $3 per month per year of service, future increase tied to UER.  Latest year Undistributed Earnings available and applied in valuation: June 30, 2002

Slide 16 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Order of application of Undistributed Earnings in June 30, 2002 valuation:  Priority #1-Current year employer and member contribution relief for:  Section 8  Section 6  Section 9

Slide 17 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Order of application of Undistributed Earnings in June 30, 2002 valuation:  Priority 2-Reduce unfunded liabilities (future employer contribution relief) for:  Section 8  Section 9  Section 6

Slide 18 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Order of application of Undistributed Earnings in June 30, 2002 valuation:  Priority #3-Create new retiree health benefits under Section 9 of Settlement Agreement  Priority #4-Other uses at Board’s discretion  Supplemental COLA and Retiree Health Insurance

Slide 19 FCERA April 2008 Interest Crediting Employer Contribution Relief  Priority #1 - Allow “dollar-for-dollar” contribution credit for settlement benefits  Full or partial contribution offset  Priority #2 - Increase in Valuation Assets for settlement benefits  Reduces Unfunded Actuarial Accrued Liability  Reduces cost on an amortized basis

Slide 20 FCERA April 2008 Interest Crediting Member Contribution Relief  Priority #1 - Allow “dollar-for-dollar” contribution credit for settlement benefits  Full or partial member COLA contribution offset

Slide 21 FCERA April 2008 Interest Crediting Allocated in June 30, 2002 Valuation  Undistributed Earnings allocated in June 30, 2002 valuation  Priority 1 – Current year contributions:  Section 8: $1.3 million  Section 6: $19.7 million  Section 9: $1.2 million  Priority 2 – Reduce unfunded liabilities:  Section 8: $19.9 million  Section 9: $11.6 million  Section 6: $17.2 million

Slide 22 FCERA April 2008 Interest Crediting Review of FCERA Policy Features and Goals  Interest crediting features unique to FCERA  Review application of Undistributed Earnings in June 30, 2002 valuation  Clarify policy features and goals  Legal counsel involvement crucial

Slide 23 FCERA April 2008 Interest Crediting Interest on Member Contributions  Affects refunds on withdrawal or death  Form of benefit accrual  Purpose of plan is retirement, not savings  Consistent with DB nature of plan  Credit Member Reserve at rate of retiree COLA (limited to 3%, one-half credited on 6/30 and 12/31)  Why credit more than was actually earned on short- term investment?  Compare to savings deposit rates?

Slide 24 FCERA April 2008 Interest Crediting Interest on Non-Valuation Reserves  Credit Non-Valuation Reserves at valuation rate  Supplemental COLA and Retiree Health Insurance  Other 1937 Act Systems: credit interest only on valuation reserves

Slide 25 FCERA April 2008 Interest Crediting Contra Account Concept  If Available Earnings is insufficient: CR may become negative, but CR + UER + Non-Valuation Reserves > 1% of Market Value of Assets  Use Contra Account instead?  Track interest credit shortfalls  Any time credits are below the target rate  Negative returns are a special case  Does not ignore the bad investment returns  After a bad year, same impact on employer rates, funding ratios and member balances

Slide 26 FCERA April 2008 Interest Crediting Consider Funding Condition?  Regular and settlement benefits  Rather than ask “Does the Plan have excess earnings?” ask “Does the Plan have surplus assets?”  Some 1937 Act Systems consider undistributed earnings “excess” only when plan is over X% funded

Slide 27 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Priorities on application of Undistributed Earnings in June 30, 2002 valuation  Satisfy Settlement Agreement  Satisfy Board’s goals and objectives

Slide 28 FCERA April 2008 Interest Crediting Q U E S T I O N S