Board Retreat – Oct 20, 2010 FCERA 2010 Retirement Board Retreat October 20, 2010 Paul Angelo, FSA Andy Yeung, ASA The Segal Company, San Francisco 5104107v1

Board Retreat – Oct 20, 2010

FCERA 2010 Retirement Board Retreat

October 20, 2010

Paul Angelo, FSA

Andy Yeung, ASA

The Segal Company, San Francisco

5104107v1

2010 Board Retreat – Actuarial Topics

Slide 2

Outline of Discussion

High level review of FCERA Funding Policy Based on established practices and written policy

documents Comments on current amortization policy

GASB “Preliminary Views” on accounting and financial reporting


Slide 3

Review of FCERA Funding Policy Three components of a typical funding policy

Funding method Asset valuation method Amortization policy

Unique to 1937 Act county systems Interest crediting and “undistributed” earnings allocation policy

Unique to FCERA Settlement Agreement


Slide 4

Actuarial Value of Assets (AVA)

Unfunded Actuarial

Accrued Liability (UAAL)

Amortization of UAAL

Normal Cost

Present Value of Future Normal Costs

Basic Funding Policy Components


Slide 5

Review of FCERA Funding Policy Funding method

Entry Age Normal (EAN) for FCERAModel practice, recently endorsed by GASB

Asset valuation method 5-year smoothing period Expanded 70%-130% market value corridor adopted by the

Board in 2009 (previous corridor was 80%-120%)

UAAL Amortization policy


Slide 6

Amortization policy Amortization structure - current

UAAL amortized in fixed period layers Level percentage of open payroll

Amortization periods - current 30-year for plan amendments 15-year for gains/loss 15 years for changes in actuarial assumptions

Emerging practice Shorter for plan amendments, especially windows Possibly longer for assumption changes


Slide 7

Review of FCERA Funding Policy Interest Crediting and Undistributed Earnings Allocation Policy

Separate document, substantially reviewed in 2008 Lists priorities to follow in crediting regular interest to various reserves

Including steps to follow if insufficient earnings Defines uses of undistributed earnings Provides parameters for granting discretionary benefits

Ad-hoc Supplemental COLA and additional “health” benefits for retirees


Slide 8

Review of FCERA Funding Policy

Settlement Agreement Unique to FCERA

Priorities stated in Undistributed Earnings Policy Section 6 – enhanced benefits for employees retiring on and

after Jan 1, 2001 Section 8 – enhanced benefits for pre-Jan 1, 2001 retirees

and beneficiaries Section 9 – “health” benefits for pre and post 2001 retirees


Slide 9

Review of FCERA Funding Policy Settlement Agreement benefits

Funded with employer and employee contributions or undistributed earnings Amounts funded with undistributed earnings

UAAL for existing Sections 6, 8 and 9 benefitsNew Section 9 benefitsNormal cost for Sections 6 and 9 benefits

Open policy/legal issue Definition of regular vs settlement benefits for active General members

Regular benefit: 31676.12 or 31676.14?


Slide 10

Review of FCERA Funding Policy

Project for 1st quarter of 2011 Prepare written funding policy

Incorporate funding, asset smoothing and UAAL amortization methods into a single document

Consider review of amortization methodConsider clarification of “regular benefit” for General

members Review and adoption by the Board


Slide 11

Q U E S T I O N S


Slide 12

GASB’s Preliminary Views (PV) Document The Preliminary Views are organized around six issues

Issue 1 An Employer’s Obligation to Its Employees Issue 2(a & b) Liability Recognition on Balance Sheet Issue 3(a - d) Measurement of the Total Pension Liability Issue 4(a & b) Attribution of Changes in the Net Pension Liability to

Financial Reporting Periods Issue 5(a & b) Recognition by a Cost-Sharing Employer Issue 6 Frequency and Timing of Valuations

GASB is asking for comments on their view of these issues “Do you agree with this view?” “Why or why not?”


Slide 13

Funding vs Expense (“Issue Zero”) Current expense based on the Annual Required Contribution or “ARC”

Normal Cost plus UAAL amortization The ARC rules form a viable basis for a funding requirement

Even though strictly it is only an expensing requirement

For pensions, the ARC functions as a de facto funding standard Employer contribution schedule compares actual contributions to expense Current balance sheet liability (net pension obligation or “NPO”) tracks cumulative

actual contributions compared to expense

The Contribution Schedule and NPO tell whether the employer has been funding on an actuarially determined basis The key measure of accountability


Slide 14

Funding vs Expense (“Issue Zero”) From the Plain Language Supplement:

“The principles and concepts in the Preliminary Views would separate how the accounting and financial reporting is determined from how pension benefits are funded.”

“Should the GASB’s preliminary views become accounting and financial reporting standards in the future, governments would not be required to mirror the accounting and financial reporting changes in their funding

approaches.”


Slide 15

Funding vs Expense (“Issue Zero”) PV defines a Net Pension Liability (NPL)

Essentially, NPL is the UAAL using EAN and market value of assets NPL (not the NPO) would go on the balance sheet See more under Issue 2

Under PV, expense is based on year-to-year change in NPL Limited and inconsistent ability to amortize, creating expense volatility

Resulting expense measure is no longer a viable basis for funding GASB PV does not address consequences

Loss of ARC/NPO means loss of information on employer accountability Volatility in the expense results in Interperiod inequity Two competing measures of cost: funding and expense


Slide 16

Actuaries’ Response - Introduction Interperiod Equity: Pension expense should reflect balance between two kind of interperiod

equity Intergenerational – through demographic matching Period-to-period – through volatility management

Pension Accounting and Pension Funding “Issue Zero”

Level Cost of Services Framework GASB endorses this approach to service cost (aka Normal Cost) Treat variations around service cost similar to service cost Framework components

Cost method Asset smoothing NPL (aka UAAL) amortization, where NPL is based on smoothed assets


Slide 17

Next Major Steps Comment period for the PV ended September 17

AAA, CCA, CAAP and SACRS all submitted comments

October: Three hearings on PV comments GASB and staff developing positions on remaining topics

Employer Notes and Required Supplementary information (RSI) Plan basic financial statement, notes and RSI OPEB (but safe to assume OPEB will follow pension)

Exposure Draft (ED) scheduled for June 2011 Comment period for ED by September 2011

Final Pension Standard scheduled for June 2012 Effective date(s) in 2013(?); transition and phase-in periods(?)


Slide 18

Reference Section for GASB’s Preliminary Views (PV) Document


Slide 19

Issue 1 – Employer’s Obligation Employer has obligation for pension benefits due to “employment

exchange” Not satisfied until benefits are paid

Employer remains primarily responsible for pension obligation in excess of plan assets To the extent funded, plan is primary and employer is secondary

Responses: General agreement


Slide 20

Issue 2 – Liability Recognition NPL is Total Pension Liability minus market value of assets

(At this point, we don’t yet know how TPL will be measured) Is NPL a liability and if so where should it be reported?

Issue 2a: NPL meets definition of an accounting “liability” Present obligation to sacrifice resources Little or no discretion to avoid Conclusions based on GASB Concept Statement 4

Issue 2b: NPL is measurable with “sufficient reliability” for recognition in basic financial statements Instead of just Notes or Required Supplementary Information (RSI) Based on GASB Concept Statements 1 and 3


Slide 21

Issue 2 – Liability Recognition NPO rejected as insufficient for sole balance sheet liability

GASB PV does not address loss of what NPO measured “Issue Zero”

Industry response is generally adverse Too large relative to other statement items Too volatile relative to other statement items Some argue insufficient reliability

Asset volatility, liability remeasurements

Actuaries’ response: Base NPL on smoothed assets Addresses volatility concern In GASB terms, MVA based NPL is not sufficiently reliable


Slide 22

Issue 3 – Measurement of Total Pension Liability (TPL)

Process: project benefits, discount, attribute (allocate) to service Issue 3a: What to include in projecting benefits

Automatic COLAs Ad hoc COLAs if “not substantively different” from automatic COLAs Future salary increases and service

Issue 3b: Criteria for Ad hoc COLAs that are “not substantively different” Response: General agreement

Criteria for including ad hoc COLAs should reflect basis, process and authority for granting them

Could involve an assumption like “3 of 5 years”


Slide 23

Issue 3 – Measurement of Total Pension Liability

Issue 3c: Discount rate Separate projected benefits for current members into two benefit streams

Projected benefits that covered by projected assets: discount at the long-term expected rate of return

Benefits payable after assets run out: discount at municipal bond index rate Determine single discount rate that produces same combined present value

Use that “single equivalent” discount rate for entire calculation Service Cost, TPL, interest on TPL, etc

Response: General agreement GASB PV agrees that employer's cost is "reduced by the expected return on investments“

But only if there are still any invested assets Rejected market pricing discount rates


Slide 24

Issue 3c – Discount Rate Common misunderstandings

A 80% funded plan would use a discount rate of 80% of the expected return plus 20% of the municipal index rate

Wrong: Single rate depends on projected assets and benefits, not current funded status

Benefits after assets run out are discounted at municipal index rate only back to when assets run out; before that use the expected return

Wrong: projected benefits payable after assets run out are discounted at municipal index rate for all years back to valuation date

Responses on municipal bond index Taxable or nontaxable: prefer taxable Current rate or average: prefer average


Slide 25

Issue 3c – Discount Rate Projecting Employer Contributions (for depletion date)

GASB PV says use “employer’s stated contribution policy and recent contribution pattern” Not just the current contribution rate (except for fixed rate plans)

Responses: Include all contributions that fund benefits for current members GASB PV is inconsistent on this

• “include projected future contributions from all sources related to funding the benefits of employees currently in the plan”

• “reasonable expectation of future employer contribution levels for current employees” GASB should clarify to include all UAAL payments even if amortized as percent of open

payroll (including future hires)• Excluding member and employer normal cost contributions for future hires


Slide 26

Issue 3 – Total Pension Liability Measurement

Issue 3d: Attribution Method – Entry Age Normal Assigns value consistently to past and future years Consistent relationship to base salary level Consistent with ongoing, career-long view of employment exchange Rejected accrued benefit measures (including PUC)

Discount rate and attribution method are clear endorsement of level cost over market pricing model “Board emphasizes that fair valuing the total pension liability is not a

relevant objective for accounting and financial reporting”

Response: Strong agreement


Slide 27

Issue 4 – Attribution of NPL Changes to Periods

Expense amounts are determined by attributing year-to-year changes in the NPL to reporting periods. GASB treats changes in TPL and plan assets separately

Differs from ARC where amortization is based on changes in UAAL

Expense components (preview!) Entry age service cost (normal cost) Plus assumed interest (at single equivalent rate) on TPL Less expected investment return (at expected return) on MVA, Plus/minus cumulative differences in actual vs expected investment returns if over 15% of MVA (see issue

4b) Plus/minus short amortization of “other changes” in active TPL (issue 4a) Plus/minus entire amount of “other changes” in inactive TPL (issue 4a) Other changes include plan amendments, liability gains (-) or losses (+),

assumption changes


Slide 28

Issue 4a – Changes in Total Pension Liability

Same treatment for three types of changes Plan amendments Liability gains and losses Assumption changes

Changes for inactive members (including retirees) are recognized immediately. Changes for active members are recognized over a weighted average of remaining

service lives. Very short: 10 years or less

PV is silent on amortization method Separating out interest on assets and total liability could imply straight line principal

amortization Not consistent with level cost methodology for service cost


Slide 29

Issue 4a – Changes in Total Pension Liability

Concept is that change in liability determines expense Deferred recognition justified only by “interperiod equity” matching of cost with services Liability gain/loss and assumption changes lumped with plan amendments

“to avoid unnecessary complexity” (!)

This expense model is clearly not a viable basis for funding Example: immediate recognition of assumption changes for retirees

Actuaries’ response: Pension expense should reflect balance between two kind of interperiod equity (from Introduction) Intergenerational – through demographic matching Period-to-period – through volatility management Also consistent with level cost methodology for service cost

Treat variations around service cost similar to service cost


Slide 30

Issue 4a – TPL Changes - Responses Distinguish plan amendments from other changes For plan changes: Accept short amortization

For liability gains/losses and assumption changes: Attribution period that balances demographic matching with longer periods

that manage volatility Promotes both long and short term interperiod equity

This leads to range of 15 to 20 years 15 year period also assures a minimum attribution of interest on the

beginning-of-year liability amount (no negative amortization)


Slide 31

Issue 4a – TPL Changes - Responses Possible basis for both expense and a New ARC,

New ARC allows for a range of amortization periods Expense is based on short end of range

Source Expensing Funding

Active Amendments Demographic Demographic

Inactive Amendments 1 year Demographic

Gain/Loss 15 15 to 20

Assumption Changes 15 15 to 25

Surplus 30 30


Slide 32

Issue 4b – Changes in Plan Assets Investment earnings different from the long-term expected rate are deferred

indefinitely Until cumulative deferral exceeds 15% of fair value, Amounts beyond 15% recognized immediately in pension expense

This is unlimited asset smoothing within a narrow market value corridor Based on belief that past gain/loss will be offset by future loss/gain Leads to either too little or too much expense volatility

This expense model is not a viable basis for funding No recognition of investment gains/losses inside a narrow corridor Immediate recognition of investment gains/losses outside a narrow corridor

Also, recognized investment gains/losses are not amortized (more later)


Slide 33

Issue 4b – Asset Changes - Responses Add a “return to market” condition to recognize investment gains and

losses over a short period (e.g., five years) Note that under actuarial standards of practice, a “sufficiently short” return

to market condition can eliminate the need for market value corridor

Actuaries’ response: five year smoothing, no corridor Used for defining NPL (under issue 2b) Replaces PV method under Issue 4b

Implied result – both smooth and amortize investment volatility Key feature of level cost of services model Required by extraordinary asset volatility, compared to other experience


Slide 34

Issue 5 – Cost Sharing Employers Issue 5a: Each employer should recognize a proportionate share of the

plan’s collective total NPL and changes in NPL Issue 5b: GASB suggests prorate on contributions and asks for

alternative methods Industry response is adverse

Violates the pooling concept of a cost sharing plan Not a reliable estimate of each employer’s own liability and expense

Actuaries’ response references GASB 27 rationale Also includes example of inequitable results


Slide 35

Issue 6 – Frequency and Timing of Measurements

Actuarial valuations must be performed at least every other year The “comprehensive measurement” date must be

No more than 24 months prior to the employer’s fiscal year end (FYE) If not at FYE, must use the most recent available

Valuation is “updated” to FYE, reflecting: (a) significant changes occurring since that valuation (c) market value of assets as of the employer’s fiscal year end (implied?)

Response using example: 6/30/2010 valuation for 2011/2012 FY Intervening actuarial valuation at 6/30/2011 Need to know expense and contributions before FYE – and even FYB Ability to roll forward assets and liabilities Different plan and fiscal years, especially for multiple employer plans


Slide 36

Q U E S T I O N S

Documents

Board Retreat – Oct 20, 2010 FCERA 2010 Retirement Board Retreat October 20, 2010 Paul Angelo, FSA Andy Yeung, ASA The Segal Company, San Francisco 5104107v1