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Request for Proposals
Actuarial Consulting Services
April 13, 2010
Iowa Public Employees Retirement SystemEconomic Assumptions Review
Presented By: Cavanaugh Macdonald
March 24, 2017
Assumptions have a significant impact on the
calculation of liabilities and actuarial contribution
rates Future benefit payments are dependent on number of contingent
events that are unknown
Actuaries use assumptions to estimate the timing, duration and
amount of future benefit payments
Assumptions will impact the allocation of costs so usually set
neither overly conservative or aggressive
Assumptions are just that – assumptions. If actual
experience differs from the assumption over time,
the costs will differ also
Background
2
Purpose of Experience Study
Provides basis for analyzing existing assumptions and developing recommended changes
Actuary’s role is to make recommendations for each assumption As fiduciaries, the Board is responsible for the selection of
actuarial assumptions
Board can adopt all, none, or some of actuary’s recommendations
Assumptions do not affect the true cost of the plan which is the actual benefit payments paid from the trust
3
Selection of Assumptions
Economic
•Price Inflation
•Investment Return
•Wage Growth
•COLA
•Interest Crediting Rate
•Payroll Growth
Demographic
•Retirement Rates
•Promotional/Step Pay Increases
•Disability
•Turnover
•Mortality
What Are They? Who Selects Them?
Economic
•Board
•Actuary
•Other Advisors
Demographic
•Mostly Actuary
•Board Approves
4
5
IPERS Experience Study
Performed every four years for IPERS
Monitor all actuarial assumptions and methods
used in the valuation process
Last IPERS study covered fiscal years 2010
through 2013
Next study, covering fiscal years 2014 through
2017, is scheduled for June, 2018
Economic assumptions are being reviewed earlier
at Board’s request
6
Actuarial Standards of Practice (ASOP)
Issued by the Actuarial Standards Board
Provides guidance to actuaries in the selection of
assumptions used in valuing pension benefits
Economic assumptions (ASOP 27)
Recommendation is for a “reasonable assumption”
Appropriate for purpose of measurement
Reflects actuary’s professional judgment
Takes into account historical and current economic data
that is relevant
Reflects actuary’s estimate of future experience,
observation of estimates inherent in market data, or
combination
No significant bias (not significantly optimistic or
pessimistic)
Permissible to include some conservatism for adverse
deviation
Advises actuaries not to assign too much credibility
to recent experience
Actuarial Standard of Practice
Number 27
7
Economic Assumptions
Building Block Method
Investment
Return
Individual Salary
Increases
Wage
Inflation
Real Rate
of ReturnMerit Scale
Productivity
Inflation Inflation Inflation
Productivity
Note: inflation assumption and productivity must be consistent in all assumptions.
8
Price inflation represents annual increase in cost of
living, measured by CPI
Current assumption is 3.00%
Indirectly impacts the valuation as a component of
other economic assumptions Investment return
General wage growth (which becomes part of individual salary
increase assumption)
Interest on member contribution balances
Payroll growth for amortization of unfunded actuarial liability
Dividend for pre-1990 retirees
Inflation Assumption
9
Considerations for setting the assumption
Historical inflation
Market expectations
Social Security projections
Peer group comparison
Inflation Assumption
10
Historical Inflation(measured from 12/31/16)
11
Period Inflation Period Inflation
90 Years 2.94% 30 Years 2.65%
60 Years 3.70% 20 Years 2.15%
50 Years 4.09% 10 Years 1.76%
40 Years 3.66%
-5%
0%
5%
10%
15%
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5
Annual
Rat
e
Calendar Year
Price InflationCPI-U
Annual 30-Year Average Assumed 3.00%
Peer Group Comparison
Inflation Assumptions
Jul
20
13Source: NASRA Public Fund Survey 12
Bond Market Pricing – Difference between 30-year
Treasuries and TIPS as of 12/31/16 was 2.1%
Investment consultants’ median long-term inflation
assumption is around 2.3%
Social Security Administration intermediate assumption –
2.6% over next 75 years
Data and analysis supports lowering the inflation assumption
Recommend reducing inflation assumption from 3.00% to
2.60%
Analysis and Recommendation
13
Law sets interest rate at 1% above 1-year CD
rates.
Analyzed last ten years of actual interest credited
compared to inflation
Average was 1.01% above inflation
Recommend assumption change from 3.75% to
3.50% (inflation assumption of 2.60% + 0.90%)
Interest on Member Accounts
14
Building block approach Rate of price inflation (previously addressed)
Real rate of return
Sum is expected investment return
Asset allocation is the key factor in setting this
assumption Portfolios that are more aggressive can generally expect higher
returns along with potentially greater volatility
Most powerful assumption in valuation Small changes can have large impact on liabilities and
contribution rates
Current assumption: 7.50% (3.0% inflation + 4.5% real return)
Investment Return Assumption
15
Retirement funding is a long-term concern and so
a long-term assumption is appropriate
Investment Return Assumption
16
Assumed
ANNUALIZED RETURNS through 6/30/16
1-Year Return: 2.15% 15-Year Return: 6.62%
3-Year Return: 7.17% 20-Year Return: 7.85%
5-Year Return: 7.06% 25-Year Return: 8.43%
10-Year Return: 6.31% 30-Year Return: 8.64%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
An
nu
al R
etu
rn
Fiscal Year
Current actuarial assumed investment return = 7.50%*
30-year annualized return = 8.64%
*Actuarial interest rate assumption:1953 - 1993: 6.50%1994 - 1995: 6.75%1996 - present: 7.50%
IPERS Historical
Fiscal Year Returns
17
Trend has been to lower investment return assumption
Peer Group Comparison
18
Note: Investment mixes may differ significantly between funds
Forward looking analysis using capital market
assumptions
Wilshire (2017 assumptions)
2016 Horizon Actuarial Survey
2016 Horizon Actuarial Survey includes capital
market assumptions for 35 investment consultants
of which 12 provided both short-term and long-term
assumptions
Consider all information, but recognize Wilshire has
greater knowledge and insight into the IPERS
portfolio
Investment Return Assumption
19
Horizon Survey Assumptions
(20-Year Assumptions)
20
0%
2%
4%
6%
8%
10%
12%
14%
Range of Assumptions by Advisors
Minimum Median Maximum
Median (50th percentile) of expected returns using
Wilshire and Horizon’s capital market assumptions
Investment Return Assumption
21
Wilshire
(10-Year)
Wilshire
(30-Year)
Horizon
(10-Year)
Horizon
(20-Year)
Real Return 4.33% 5.09% 4.29% 5.21%
Inflation 1.95% 2.33% 2.16% 2.31%
Nominal Return 6.28% 7.42% 6.45% 7.52%
Note: Each investment consultant’s inflation assumption is reflected here.
Distribution of Expected Returns
(Percentile Results)
22
3.1%
4.3%
5.0%
6.1%6.3%
7.4%7.6%
8.7%
9.5%
10.7%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
10 years 30 years
95th
95th
75th
75th
50th
50th
25th
25th
5th
5th
Using Wilshire’s capital market assumptions including inflation.
Significant difference between expected returns in
short term and long term
Options to address this issue:
Maintain long-term assumption that is significantly higher
than short-term expectations
Lower return assumption to expected return in short-term
Use select and ultimate approach to setting the
assumption (one assumption for 10 years and different
assumption thereafter)
Use a single return assumption that blends both short-
term and long-term return expectations
Analysis of Expected Return
23
Need to maintain long-term perspective
Material difference in short and long-term return
expectations are hard to ignore given impact on
funding of System
Real rate of return expectations (Wilshire)
Short term: 4.33%
Long term: 5.09%
Current assumption of 4.50% lies between the two with
heavier weighting to short term, similar to system liabilities
Analysis of Expected Return
24
Expected Real Returns
(40th-60th Percentile Results)
25
Percentile Wilshire
30-Year
Horizon
20-Year
60th 5.58% 5.72%
55th 5.33% 5.46%
50th 5.09% 5.21%
45th 4.84% 4.96%
40th 4.59% 4.71%
Past practice set the investment return assumption
as net of administrative expenses
Average expense ratio over the last 9 years is
approximately 0.05%
Small adjustment needed to account for
administrative expenses
Administrative Expenses
26
Recommend decreasing investment return
assumption from 7.50% to 7.00%
Investment Return Assumption
27
Recommended
Real Return 4.50%
Inflation 2.60%
Administrative Expenses (0.05%)
Net investment return 7.05%
Typically consists of price inflation and productivity
(standard of living increase)
Historical data is based on the national average
wage index from Social Security Administration
General Wage Growth Assumption
28
Historical Statistics(rolling 30-year periods)
29
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
Wage Inflation vs. CPI-U
Wage Index - 30-Year CPI - 30-Year
Some Limitations
– Reflects entire workforce subject to FICA
– Based on increases in average (mean) wage
Over last 25 years, median real wage increase
was only 0.42% compared to mean wage increase
of 0.77%
Median real weekly non-farm wages increased
only 0.24% from 2005 to 2015
General Wage Growth Assumption
30
Assumptions for Social Security projections (high,
intermediate and low cost) range from 0.5% to
1.8%, with 1.2% as the intermediate assumption
Recommend reduction from 4.00% to 3.25% with
components shown below:
General Wage Growth Assumption
31
Current Proposed
Price Inflation 3.00% 2.60%
Productivity 1.00% 0.65%
General Wage Growth 4.00% 3.25%
Payroll growth assumption is used to determine the
amortization payment on Unfunded Actuarial
Liability Unfunded Actuarial Liability is amortized as a level percent of
payroll
Need an assumption about future payroll amounts over the
amortization period
Current assumption is 4.00% composed of 3.00%
price inflation and 1.00% real wage growth
With a given set of economic assumptions, a lower
payroll growth assumption provides a margin for
adverse deviation
Payroll Growth Assumption
32
Recommend no assumed growth in the size of the
active membership
With a stable population, total covered payroll is
expected to grow with general wage growth
Actual IPERS’ experience indicates covered payroll
growth near general wage growth, after adjusting for
increase in active membership
Recommend lowering payroll growth assumption
from 4.00% to 3.25%
Payroll Growth Assumption
33
Summary of Recommended
Economic Assumptions
34
Assumption Current Recommended
Price inflation 3.00% 2.60%
Interest on Member
Accounts
3.75% 3.50%
Investment return 7.50% 7.00%
General wage growth 4.00% 3.25%
Payroll growth 4.00% 3.25%
Effective June 30, 2017
The change in investment return is the most
significant change
Lowering investment return assumption results in
higher normal cost and actuarial liabilities
Actual contribution rate impact will depend on
period over which the increased liability is funded
Cost Impact of Changes
35
Amortization policy leaves duration of assumption
change to the Board
Gains and losses are amortized over 20 years, so
assumption change should be no shorter
Actuarial profession white paper suggests 15-25
years is ideal, but accepts that a longer period
may be appropriate
We suggest a period in the range of 20 to 30 years
Amortization of Changes
36
Longer period results in lower contribution rates and,
therefore, less immediate impact on members and employers
Shorter period pushes the System toward fully funding more
quickly (20 years from now instead of 30)
IPERS Contribution Rate Funding Policy will tend to move the
System toward full funding by maintaining the higher
contribution rates until each group reaches 95% funding
This is the first time the Board has had to address this
situation, so no prior guidance
Board Considerations for
Amortization Period
37
Cost Impact: Regular Members(Using 6/30/16 Valuation)
38
Before Changes
Amortize Changes
Over 30 Years
Amortize Changes
Over 20 Years
Actuarial Liability ($M) $32,578 $33,884 $33,884
Actuarial Value of Assets ($M) $27,001 $27,001 $27,001
Unfunded Actuarial Liability ($M) $ 5,576 $ 6,883 $ 6,883
Funded Ratio 82.9% 79.7% 79.7%
Normal Cost Rate 10.20% 10.42% 10.42%
UAL Amortization Rate 4.01% 5.19% 5.48%
Actuarial Contribution Rate 14.21% 15.61% 15.90%
Required Contribution Rate 14.88% 15.61% 15.88%
Employer Contribution Rate 8.93% 9.37% 9.53%
Employee Contribution Rate 5.95% 6.24% 6.35%
Note: Numbers may not add due to rounding.
Cost Impact: Sheriffs/Deputies(Using 6/30/16 Valuation)
39
Before Changes
Amortize Changes
Over 30 Years
Amortize Changes
Over 20 Years
Actuarial Liability ($M) $625 $650 $650
Actuarial Value of Assets ($M) $602 $602 $602
Unfunded Actuarial Liability ($M) $ 23 $ 48 $ 48
Funded Ratio 96.4% 92.6% 92.6%
Normal Cost Rate 16.41% 16.82% 16.82%
UAL Amortization Rate 0.91% 2.30% 2.68%
Actuarial Contribution Rate 17.32% 19.12% 19.50%
Required Contribution Rate 18.76% 19.26% 19.50%
Employer Contribution Rate 9.38% 9.63% 9.75%
Employee Contribution Rate 9.38% 9.63% 6.75%
Note: Numbers may not add due to rounding.
Cost Impact: Protection Occupation
(Using 6/30/16 Valuation)
40
Before Changes
Amortize Changes
Over 30 Years
Amortize Changes
Over 20 Years
Actuarial Liability ($M) $1,417 $1,471 $1,471
Actuarial Value of Assets ($M) $1,430 $1,430 $1,430
Unfunded Actuarial Liability ($M) $ (13) $ 41 $ 41
Funded Ratio 100.9% 97.2% 97.2%
Normal Cost Rate 15.99% 16.37% 16.37%
UAL Amortization Rate 0.00% 0.66% 0.85%
Actuarial Contribution Rate 15.99% 17.03% 17.22%
Required Contribution Rate 16.40% 17.03% 17.22%
Employer Contribution Rate 9.84% 10.22% 10.33%
Employee Contribution Rate 6.56% 6.81% 6.89%
Note: Numbers may not add due to rounding.