Regents Meeting May15 &16, 2002 Summary of University of California Retirement Plan Asset/Liability Forecast Study — January 2002 University of California

2 nStudy Objectives/Purpose: 1.Demonstrate fiduciary due diligence 2.Assess current funding policy 3.Address concerns over interest rates and inflation 4.Determine adequacy of assets in conjunction with liabilities 5.Review impact of future plan changes, demographics and cash flow Asset/Liability Studies — Purpose

3 Asset/Liability Studies — Background nThe asset/liability study process requires the following steps: 1.Develop background information 2.Conduct planning meetings with the University 3.Develop baseline forecast results for twenty-year period 4.Generate stochastic results on the basis of a continuation of all current plan provisions and funding policies 5.Run multiple versions of financial analyses to test the effectiveness of the current policies and to identify efficient alternatives 6.Model possible future plan changes and alternative asset portfolios 7.Summarize and present results

4 Asset/Liability Studies — Background (continued) nAsset/liability modeling software forecasts financial results on both deterministic and stochastic bases, using a variety of user-specific assumptions and possible changes in plan provisions nThe model consists of four integrated components: 1.The Liability Projections module calculates a stream of liabilities on the basis of the funding valuation assumptions –Developed for positive and negative changes in the key economic assumptions –Measures sensitivities that generate plan liabilities under all assumption sets needed for the stochastic forecast 2.The Capital Market module simulates interest rates, inflation and asset-class returns for several hundred economic scenarios –Tracks plausible paths as the capital markets move from today’s environment toward expected future results –Utilizes the cascade structure, starting with interest rates and moving through price and wage inflation to dividend growth and asset-class returns –Measures consistency between the movements of assets and liabilities

5 Asset/Liability Studies — Background (continued) 3.The Asset Portfolio module looks at a variety of asset mixes –Models efficient portfolios under a wide variety of risk and reward definitions –Measured with or without recognition of liability growth 4.The Financial Linkage module combines the results of the liability forecasts with alternative asset portfolios and develops –Integrated financial results –Several hundred capital-market scenarios; asset and liability values are determined at each point in time –Exact contribution calculations based on the declared funding policy These four modules have been applied in the modeling of assets and liabilities for the University of California Retirement Plan (UCRP).

6 Capital Market Simulation — A Cascade Model Wage Inflation Domestic Stock Income & Total Return Domestic Stock Income & Total Return Cash & Long Bond Income & Total Return Cash & Long Bond Income & Total Return Other Asset Classes Domestic Stock Dividend Yield Domestic Stock Dividend Yield Domestic Stock Dividend Growth Domestic Stock Dividend Growth Price Inflation Short & Long Interest Rates & Full Treasury Curve Capital Market Simulation Model — Assets nThe simulated behavior of capital market variables -- volatility's and correlation's -- is based on historical behavior together with a judgement about how the future might differ from the past nYield curves drive asset class performance and inflation

7 Wage Inflation Price Inflation Short & Long Interest Rates & Full Treasury Curve COLA Payroll Demographic Factors Actuarial Valuation Assumptions Liabilities Plan Provisions Plan Sponsor/ Actuary/ Regulatory Specifications Capital Market Simulation Model — Liabilities nSimulated yield curves and inflation affect both sides of the balance sheet nYield curves drive liability measurement assumptions nChanges in assets and liabilities are coordinated

8 Long-Term Cost Impact of Plan Changes nChange in Actuarial Accrued Liability, The Actuarial Accrued Liability measures the “earned” portion of projected benefits. This is the liability measure shown in the annual actuarial valuation report nActuarial Accrued Liability is based on current actuarial assumptions, current active and inactive plan members, and forecasts growth in membership nProposed plan changes are described in several Regent’s items; the cost impact for these changes is summarized on page 19

9 Current Plan — Asset/Liability Modeling nCurrent Plan forecast results were developed using:, Current UCRP provisions, Active membership growth (assumed to be 2½% per year through 2011 and 1½% thereafter), Asset allocation CurrentPolicy A –US Bonds35% 30% –TIPS0%*5% –US Equity53% 53% –International Stocks7% 7% –Private Equity 5% 5% –TOTAL100% 100% *TIPS are included in U.S. Bonds under the current asset allocation (TIPS are currently 3.5% of total portfolio), Portfolio statistics (Mean Return) –Nominal returns –Real return –Annual Std deviation

10 Current Plan Asset/Liability Modeling (continued), Economic scenario –Return assumptions were a consensus of Wilshire Associates, UC Treasurers’ Office and Towers Perrin âThe Towers Perrin simulation model was used to create scenarios of inflation, yields and asset class returns âThe average US equity return premium is set at 3.0% above the average LPF Bond Index return. The equity return premiums for international stocks are set equal to the return premium for US equity, in order to maintain neutrality among the classes

11 Current Plan — Results nContributions, Current contribution policy –Normal Cost plus thirty-year amortization of unfunded Actuarial Accrued Liability; if plan is Fully Funded the contribution is $0, 2001/2002 Normal Cost (annual increase in liability due to additional service) –$975 million, or 14.9% of covered payroll nFunded ratios:, Funded ratios are calculated by dividing the Actuarial Value of Assets by the Actuarial Accrued Liability –Actuarial Value of Assets (AVA): A smoothed value of assets over a five-year period that minimizes the volatility of the financial markets –Actuarial Accrued Liability (AAL): The accrued liability as of any valuation for all benefits earned to date for active members, all benefits in pay status for retirees, beneficiaries and disabled members, and all deferred benefits for vested members who have terminated employment and will receive benefits in the future

12 AVA = $41,570,000,000 AAL = $27,900,000,000 = 149% Current Plan — Results, As of January 1, 2002 the funded ratio is 149% based on:, Previous years of significant investment gains created a cushion of assets due to the smoothing method. Over the forecast period the cushion is reduced and the Actuarial Value of Assets moves toward Market Value

13 Current Plan — Results nProbability of zero contributions, This is an indication of the need to make contributions during the twenty-year study, The probability shown on the graph is the cumulative probability; that is, if the probability is 75% in a specific year, that means there is a 75% probability there will be no contributions in that year OR any previous year nResults for the Current Plan, Funded ratios (pages 15 and 17), Probability of zero contributions (page 18)

14 X.XX Arithmetic average of all results for that period 95th percentile: 5% of the results are above this level 75th percentile: 25% of the results are above this value Median : 50% of the results are above this level and 50% are below 25th percentile: 75% of the results are above this level 5th percentile: 95% of the results are above this level Bar Charts Explained nThe following graphs show the results of the stochastic forecasts, The medians or averages show the trend, The range of results shows the volatility, Each forecast includes 500 scenarios and the results are shown in percentiles nThe bar graphs show ranges of likely results by using floating bar graphs similar to the one shown below. These graphs are interpreted as follows:

15 Effect on Plan Assets of Capital Markets 1.Prior Asset/Liability study as of July Liabilities forecast in the 2000 study are very close to the liability results in this study as of January Asset values have reduced over last 18 months (prior Mean reflected in dotted line), Market value declined 10% from July 2000 to January 2002, Capital Markets in 2002 are forecast to have lower returns than in July 2000 Mean 81.2 Mean 85.7 Mean 90.1 Mean 94.6 Mean Mean UNIVERSITY OF CALIFORNIA Actuarial Value of Assets, Current Policy, Current Plan (Median Prior Projection as Broken Line) Mean 41.6 Mean 41.6 Mean 42.7 Mean 44.0 Mean 46.0 Mean 48.6 Mean 51.2 Mean 53.8 Mean 56.7 Mean 59.8 Mean 62.9 Mean 66.3 Mean 69.8 Mean 73.4 Mean Year Billions 95th% 75th% 50th% 25th% 5th%

16 Current Plan — Funded Ratios Future UC Contributions Required 1.Funded ratios use Actuarial Value of Assets (AVA); Current Policy and Policy A asset allocations are shown 2.The January 1, 2002 funded ratio is 149% 3.The chart shows the funded ratios from 2002 to 2021 in five-year increments, In year 2006, the funded ratio (Policy A) ranges from 102% to 168% with a Mean of 129% (as noted at the top of the bar), In year 2021, the funded ratio (Policy A) ranges from 67% to 189% with a Mean of 112% (as noted at the top of the bar); however, there is just over a 50% probability that the ratio will be at least 100% in year 20

17 Current Plan — Contributions 1.Contributions are shown as a percentage of covered compensation for both Current Policy and Policy A (note: current Normal Cost is 15%) 2.Asset/Liability Modeling (previous page) develops contributions, if needed, based on current contribution policy 3.The chart shows the contribution from 2002 to 2021 in five-year increments, In year 2006, the contribution Mean is 3% of covered compensation, or $241 million, In year 2021, the contri- bution Mean is 13% (Policy A) of covered compen- sation, or $2.2 billion

18 Current Plan — Funded Ratios $0 Future UC Contributions 1.Funded ratios use Actuarial Value of Assets (AVA) for Current Policy and Policy A (asset allocation) 2.The January 1, 2002 funded ratio is 149% 3.The chart shows the funded ratios, from 2002 to 2021, in five-year increments, In year 2006, the funded ratio (Policy A) ranges from 98% to 168% with a Mean of 128% (as noted at the top of the bar), In year 2021, the funded ratio (Policy A) ranges from 2% to 186% with a Mean of 77% (as noted at the top of the bar); however, there is approximately a 75% probability that the ratio will be less than 100% in year 20

19 Current Plan — Probability of Zero Contributions This graph shows the probability of zero contributions on a cumulative basis (Current Policy and Policy A asset allocation), This result shows impact of market value declines and effect of future capital markets, From 2002 to 2007, the probability of zero contributions is at least 70% for the five-year period, In 2021, the probability is 18% that there will be zero contributions throughout the twenty- year period

20 nCompared to the Current Plan, the Relative Equity plan change increases the initial Actuarial Accrued Liability by as much as 0.9% (SS DP, OS DP and Unmarried) Long-Term Cost Impact of Plan Changes * Cost increases are as of July 1, 2001

21 Potential Proposed Plan Change: Relative Equity in Benefits nThe impact of Relative Equity variations contain small incremental differences in value and have been combined in the forecasting nThe economic scenario forecasting is the same as the Current Plan nIncludes a comparison for Current Policy and Policy A asset portfolios nDemographic growth forecasting is the same as under the Current Plan nResults of plan change, Funded ratios (page 21 & 22), Probability of zero contributions (page 23)

22 Current Plan with Relative Equity Future UC Contributions Required 1.Funded ratios use Actuarial Value of Assets (AVA) 2.The chart shows the funded ratios from 2002 to 2021 for the Current Plan (Policy A), and Relative Equity (Policy A), In year 2011, the funded ratio (Policy A), before and after the Relative Equity ranges from 84% to 187% with a Mean of 122%. There is almost a 75% probability that the funded ratio will be at least 100% in year 10 after the changes, In year 2021, the funded ratio (Policy A) before and after Relative Equity ranges from 67% to 189% with a Mean of 112%. There is just under a 50% probability that the funded ratio will be less than 100% in year 20 Note: Only Policy A is shown, as it is very close to the Current Policy

23 Current Plan with Relative Equity $0 Future UC Contributions 1.Funded ratios use Actuarial Value of Assets (AVA) 2.The chart shows the funded ratios from 2002 to 2021 for the Current Plan (Policy A), and Relative Equity (Policy A), In year 2011, the funded ratio (Policy A), after Relative Equity of ranges from 63% to 187% with a Mean of 115%. There is about a 40% probability that the funded ratio will be less than 100% in year 10 after the changes, In year 2021, the funded ratio (Policy A) before and after Relative Equity ranges from 2% to 185% with a Mean of 77%. There is about a 70% probability that the funded ratio will be less than 100% in year 20 Note: Only Policy A is shown, as it is very close to the Current Policy

24 Current Plan, Current Plan with Relative Equity — Probability of Zero Contributions “Curr Plan” = Current Plan (Policy A) “Rel Equity” = Current Plan with Relative Equity changes (Policy A) nThe probability of zero contributions is just under 70% for five years and steadily declines to 16% in Relative Equity decreases the probability slightly Note: Only Policy A is shown, as it is very close to the Current Policy

25 Summary nThe funded status has reduced since the prior study; smoothed asset values have dampened the effect of volatile market values nProbability of contributions has increased since 2000 due to recent asset performance and lower expected future returns nEffect of the Relative Equity changes have minimal impact on future liabilities and contributions to the plan