1. Who is Actually Paying the Bill? By Brad Heinrichs, FSA, EA, MAAA

2. Topics for Discussion Who/What Pays for the Pensions?
Pension Funding Exercise
Buyback Cost Neutrality
Timing of Sponsor Contributions

3. Fundamental Truth
B + E = C + I

4. Funding Basics Advance funding
Benefits + Expenses = Contributions + Investment Earnings
Advance funding 4 4

5. The Big Question
What percentage of the pension benefits are paid for by investment returns?
NASRA 2016 Issue Brief….says 64.3%
Employers pay 24.4%
Employees pay 11.3%
Pew Charitable Trust group….says 60%
CALPERS says 65% on their website

6. Present Value of Benefits
Member Info:
Hire Age: 25
Retirement Age: 55
Salary at hire: $25,000
Plan Provisions:
3.0% Benefit Accrual Rate
5-Year Average Final Compensation
6.0% Member Contribution Rate
Assumptions:
5.0% Salary Increases
8.0% Investment Return
RP2000 Mortality Table Projected to Valuation Date

7. Accumulated Present Value of Benefits
Age

8. Accumulated Present Value of Benefits when Fund Earns Assumed Rate (8
Age

9. Accumulated Present Value of Benefits when Fund Earns 7.0%
Age

10. Accumulated Present Value of Benefits when Fund Earns 6.0%
Age

11. Summary of Results

12. Summary of Results

13. Takeaways from Summary
There is no exact percentage of benefits that are paid for by investment performance.
For each 1% reduction in investment return the cost of paying pension benefits will increase by over 10%
The average ratio of cost-sharing can increase from 2:1 to nearly 5:1 solely due to investment performance being subpar by 2%

14. What about current annual costs?
Queried the Foster & Foster public funds database (over 300 public funds)
For Police & Fire funds, the employees are currently picking up 19% of the annual pension costs, on average
For General employees’ funds (not public safety), the employees are currently picking up 15% of the annual pension costs, on average
The average total costs, however, are 10% of payroll higher, on average, for Police & Fire vs General Employees

15. What about annual costs in Louisiana?
Of the benefits being earned, what percentage do employees pay?
Louisiana "State" Public Retirement Systems
Projected Fiscal Year 2016/17 Normal Cost
Average Employee Contribution
Aggregate Employer Normal Cost **
Aggregate Total Normal Cost**
Percentage Of NC Paid by Employee
Teachers Retirement System of Louisiana
8.0%
4.2%
12.2%
65.6%
Louisiana State Employees' Retirement System
4.0%
12.0%
66.7%
Louisiana State Police Retirement System
9.0%
17.6%
26.6%
33.9%
Louisiana School Employees' Retirement System
9.7%
17.7%
45.1%
** Does not include administrative expenses
Illustration does not include "Statewide" Plans due to differing cost methods for some plans
Source: June 30, 2015 Valuation Reports,

16. Bored yet?

17. Clear your mind….
Temporarily dispose of all that you’ve learned about pension funding and get ready for an exercise!

18. What is the goal of a pension plan?

19. Possible goal…
…is to provide a high level of benefits at the lowest possible cost.

20. What would that look like?
Benefits + Expenses = Contributions Investment Earnings

21. What would that look like?
Maximize benefits
Minimize expenses
Minimize contributions
Maximize investment earnings

22. Key question…
How do we minimize contributions while maximizing benefits?

23. The answer….
Maximize investment earnings!!!!

24. How do we maximize investment earnings?
What should our asset allocation be if we want to maximize investment earnings?
X% stocks?
Y% bonds/fixed income?
Over the life of the pension fund, will stocks or bonds generate the largest return?

25. Stats… Over the long term, stocks have outperformed bonds
From , the difference was about 4% per year
Different time periods yield different outcomes
In EVERY rolling 30 year period from 1915 to 2015 stocks have outperformed bonds

26. So the obvious question…
Why don’t all public pension funds invest primarily in equities?
Common answers
Too much risk
It’s not what their investment consultant recommends
Actuary set low investment return assumption

27. Let’s examine the answers…
Too much risk?
Who is ultimately funding the pension plan?
Where are the remainder of the plan sponsor’s assets invested?
What percentage of their overall assets are invested in equities?
What happens when the pension fund investments do poorly?
What is the single biggest advantage that a public pension fund has?
If investing for the long term, how much risk is there that stocks will outperform bonds?

28. Let’s examine the answers…
The Investment Consultant said so…
Most investment consultants try to get the most return while minimizing downside risk
Minimizing downside risk means adding fixed income instruments to the portfolio, which prevents maximization of investment earnings
Does the investment consultant share the same goal/objective that you have?

29. Let’s examine the answers…
The actuary set a low expected rate of return assumption…
So the actuary thinks that the goal isn’t to maximize investment earnings…but rather to achieve a modest return
Who should be setting the goal?

30. Key takeaways…. What is the goal of your pension fund?
Do each of your professionals provide advice that is consistent with your goals?
Should your asset allocation be reexamined in order to be more in line with your goals?
Are you taking advantage of the single biggest advantage that a public pension fund has?

31. Buybacks
Members are typically allowed to buy back prior service at “no cost to the plan.”
What does “no cost” actually mean?
No increase in Present Value of Future Benefits?
No increase in the Present Value of Accrued Benefits?
No increase in the Unfunded Actuarial Accrued Liability?
No increase in the Sponsor Contribution Requirement?

32. Buybacks Plan Provisions: Accrual Rate: 2.5%
5-Year Average Final Compensation
Normal Retirement:
Age 60 with 10 Years of Service,
Age 55 with 25 Years of Service, or
30 Years of Service, regardless of Age
Assumptions:
7.75% Interest
RP2000 Mortality Table Projected to Valuation Date
Purchase Request: 3 Years

33. Buybacks Member Info: Age: 23 Service: <1 Year Salary: $35,000
Purchase Request: 3 Years
Method
Before Purchase
After Purchase
Cost
PVB
$27,703
$55,915
$28,212
PVAB
$650
$2,990
$2,339 AL
$4,281
$22,720
$18,439
Contribution Req.
$1,481 per year

34. Buybacks Member Info: Age: 40 Service: 4 Years Salary: $45,000
Purchase Request: 3 Years
Method
Before Purchase
After Purchase
Cost
PVB
$79,847
$104,251
$24,404
PVAB
$4,119
$8,962
$4,843 AL
$27,858
$52,018
$24,160
Contribution Req.
$1,684 per year

35. Buybacks Member Info: Age: 50 Service: 5 Years Salary: $55,000
Purchase Request: 3 Years
Method
Before Purchase
After Purchase
Cost
PVB
$117,558
$152,257
$34,699
PVAB
$10,179
$22,356
$12,177 AL
$50,753
$85,996
$35,243
Contribution Req.
$2,368 per year

36. Want a quick way to make your plan sponsor happy?

37. Contribution Timing
Actuaries typically apply an interest adjustment when determining the contribution requirements since they may be made anytime throughout the plan year
Typically ½ of assumed interest rate
For plans where it is known the contribution is made at the beginning of the plan year, this interest adjustment may be removed

38. Contribution Timing (Example)
Assumed Interest Rate: 8.0%
Valuation Payroll: $3.2 Million
Normal Cost: $866,000
Administrative Expenses: $64,000
UAAL Payment: $1,300,000
Total Required Contribution (TRC), with interest load:
Interest Adjustment: 1.04
TRC = $2,319,200 or 72.5% of Payroll
Total Required Contribution (TRC), assuming beginning of year payment:
Interest Adjustment: None
TRC = $2,230,000 or 69.7% of Payroll