Regents Meeting May15 &16, 2002

Regents MeetingMay15 &16, 2002

Summary of University of California Retirement PlanAsset/Liability Forecast Study — January 2002

University of California

2

Study 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

The 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)

Asset/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

The 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

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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).

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Capital Market Simulation — A Cascade Model

Wage InflationWage Inflation

Domestic Stock

Income & Total Return

Domestic Stock

Income & Total ReturnCash & Long Bond


Cash & Long Bond


Other Asset ClassesOther Asset Classes

Domestic Stock

Dividend Yield

Domestic Stock

Dividend YieldDomestic Stock

Dividend Growth

Domestic Stock

Dividend Growth

Price InflationPrice Inflation

Short & Long Interest Rates & Full Treasury CurveShort & Long Interest Rates & Full Treasury Curve

Capital Market Simulation Model — Assets

The 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

Yield curves drive asset class performance and inflation

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Wage InflationWage InflationPrice InflationPrice Inflation

Short & Long Interest Rates & Full Treasury CurveShort & Long Interest Rates & Full Treasury Curve

COLACOLA

PayrollPayroll

Demographic FactorsDemographic Factors

Actuarial Valuation Assumptions

Actuarial Valuation Assumptions

LiabilitiesLiabilities

Plan ProvisionsPlan Provisions

Plan Sponsor/ Actuary/

Regulatory Specifications

Plan Sponsor/ Actuary/

Regulatory Specifications

Capital Market Simulation Model — Liabilities

Simulated yield curves and inflation affect both sides of the balance sheet

Yield curves drive liability measurement assumptions

Changes in assets and liabilities are coordinated

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Long-Term Cost Impact of Plan Changes

Change 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

Actuarial Accrued Liability is based on current actuarial assumptions, current active and inactive plan members, and forecasts growth in membership

Proposed plan changes are described in several Regent’s items; the cost impact for these changes is summarized on page 19

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Current Plan — Asset/Liability Modeling

Current 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 Current Policy A

– US Bonds 35% 30%

– TIPS 0%* 5%

– US Equity 53% 53%

– International Stocks 7% 7%

– Private Equity 5% 5%

– TOTAL 100% 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 8.29 8.28

– Real return 5.99 5.98

– Annual Std deviation 12.98 12.68

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Current Plan Asset/Liability Modeling (continued)

Economic scenario

– Return assumptions were a consensus of Wilshire Associates, UC Treasurers’ Office and Towers Perrin

The Towers Perrin simulation model was used to create scenarios of inflation, yields and asset class returns

The 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

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Current Plan — Results

Contributions

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

Funded 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

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AVA = $41,570,000,000AAL = $27,900,000,000

= 149%


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


Probability 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

Results for the Current Plan

Funded ratios (pages 15 and 17)

Probability of zero contributions (page 18)

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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



Bar Charts Explained

The 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

The bar graphs show ranges of likely results by using floating bar graphs similar to the one shown below. These graphs are interpreted as follows:

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Effect on Plan Assets of Capital Markets

1. Prior Asset/Liability study as of July 2000

2. Liabilities forecast in the 2000 study are very close to the liability results in this study as of January 2002.

3. 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

Mean81.2

Mean85.7

Mean90.1

Mean94.6

Mean99.4

2018 2020

Mean

UNIVERSITY OF CALIFORNIA2002-2021 Actuarial Value of Assets, Current Policy, Current Plan(Median Prior Projection as Broken Line)

Mean41.6

Mean41.6

Mean42.7

Mean44.0

Mean46.0

Mean48.6

Mean51.2

Mean53.8

Mean56.7

Mean59.8

Mean62.9

Mean66.3

Mean69.8

Mean73.4

Mean77.3

30

40

50

60

70

80

90

100

110

120

130

140

150

160

170

180

2002 2004 2006 2008 2010 2012 2014 2016

Year

Bill

ions

95th%

75th%

50th%

25th%

5th%

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Current Plan — Funded RatiosFuture 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

UNIVERSITY OF CALIFORNIAFunded Ratio - AVA (With Contributions) - Current Plan

Mean112%

Mean112%

Mean116%

Mean116%

Mean122%

Mean123%

Mean129%

Mean129%

Mean149%

Mean149%

0

20

40

60

80

100

120

140

160

180

200

220

Curr2002

Pol A Curr2006

Pol A Curr2011

Pol A Curr2016

Pol A Curr2021

Pol A

Year

Per

cent

Mean

95th%

75th%

50th%

25th%

5th%

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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

UNIVERSITY OF CALIFORNIAContributions as a Percentage of Payroll - Current Plan

Mean13%

Mean13%

Mean11%

Mean10%

Mean7%

Mean7%

Mean3%

Mean3%

Mean0%

Mean0%

-5

0

5

10

15

20

25

30

35

40

Curr Pol2002

Pol A Curr Pol2006

Pol A Curr Pol2011

Pol A Curr Pol2016

Pol A Curr Pol2021

Pol A

Year

Per

cent

Mean

95th%

75th%

50th%

25th%

5th%

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

UNIVERSITY OF CALIFORNIAFunded Ratio - AVA (No Contributions) - Current Plan

Mean77%

Mean78%

Mean98%

Mean98%

Mean116%

Mean116%

Mean128%

Mean

128%

Mean149%

Mean149%

0

20

40

60

80

100

120

140

160

180

200

220

Curr Pol2002

Pol A Curr Pol2006

Pol A Curr Pol2011

Pol A Curr Pol2016

Pol A Curr Pol2021

Pol A

Year

Per

cent

Mean

95th%

75th%

50th%

25th%

5th%

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

UNIVERSITY OF CALIFORNIA2002-2021 Probability of Zero Cumulative Contributions - Current Plan, Current Policy & Policy A

0

10

20

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50

60

70

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90

100

2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Year

Pro

babi

lity

(%)

Current Policy Policy A

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Compared 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

Increase in ActuarialAccrued Liability (AAL)

Increase inNormal Cost

$ (in millions)Percent of

Current AAL* $ (in millions)Percent of

Covered Payroll*

Member with Domestic Partner (DP) – Pre- and Post-Retirement Death Benefit

All Same-Sex (SS) DPs $34.9 0.1% $1.9 0.03%

All Opposite-Sex (OS) DPs 104.6 0.4% 5.4 0.08%

One OS DP over 62 and eligible for SocialSecurity (per State definition)

68.4 0.2% 3.0 0.05%

Unmarried Member with no Eligible Survivor – Post-Retirement Death Benefit Only

Unmarried (assumes SS DP andAll OS DP coverage adopted)

96.3 0.4% 4.2 0.06%

* Cost increases are as of July 1, 2001

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Potential Proposed Plan Change:Relative Equity in Benefits

The impact of Relative Equity variations contain small incremental differences in value and have been combined in the forecasting

The economic scenario forecasting is the same as the Current Plan

Includes a comparison for Current Policy and Policy A asset portfolios

Demographic growth forecasting is the same as under the Current Plan

Results of plan change

Funded ratios (page 21 & 22)

Probability of zero contributions (page 23)

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Current Plan with Relative EquityFuture 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

UNIVERSITY OF CALIFORNIAFunded Ratio - AVA (With Contributions) - Current and Relative Equity Plans, Policy A

Mean112%

Mean112%

Mean116%

Mean116%

Mean122%

Mean122%

Mean128%

Mean129%

Mean148%

Mean149%

0

20

40

60

80

100

120

140

160

180

200

220

Curr Pl2002

Rel Eq Curr Pl2006

Rel Eq Curr Pl2011

Rel Eq Curr Pl2016

Rel Eq Curr Pl2021

Rel Eq

Year

Per

cent

Mean

95th%

75th%

50th%

25th%

5th%

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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


UNIVERSITY OF CALIFORNIAFunded Ratio - AVA (No Contributions) - Current and Relative Equity Plans, Policy A

Mean77%

Mean77%

Mean97%

Mean98%

Mean115%

Mean116%

Mean127%

Mean128%

Mean148%

Mean149%

0

20

40

60

80

100

120

140

160

180

200

220

Curr Pl2002

Rel Eq Curr Pl2006

Rel Eq Curr Pl2011

Rel Eq Curr Pl2016

Rel Eq Curr Pl2021

Rel Eq

Year

Per

cent

Mean

95th%

75th%

50th%

25th%

5th%

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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)

The probability of zero contributions is just under 70% for five years and steadily declines to 16% in 2021. Relative Equity decreases the probability slightly

UNIVERSITY OF CALIFORNIA2002-2021 Probability of Zero Cumulative Contributions - Current and Relative Equity Plans,

Policy A

0

10

20

30

40

50

60

70

80

90

100

2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Year

Pro

babi

lity

(%)

Current Plan

Relative Equity


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Summary

The funded status has reduced since the prior study; smoothed asset values have dampened the effect of volatile market values

Probability of contributions has increased since 2000 due to recent asset performance and lower expected future returns

Effect of the Relative Equity changes have minimal impact on future liabilities and contributions to the plan

Documents

Regents Meeting May15 &16, 2002