contribution volatility and asset smoothing

FCERA Board of Retirement and Fresno County Board of Supervisors

Joint Meeting – April 30, 2009

Contribution Volatility and Asset Smoothing

FCERA Board of Retirement andFresno County Board of Supervisors

Joint Meeting - April 30, 2009

Paul Angelo, FSA & Andy Yeung, ASAThe Segal Company

San Francisco5032871

FCERA Asset Smoothing – April 30, 2009

Actuarial Value of Assets (AVA)

Unfunded Actuarial

Accrued Liability (UAAL)

Amortization of UAAL

Normal Cost

Present Value of Future Normal Costs

Current Contribution


Managing Contribution VolatilityAsset allocation – volatility at the sourceAsset smoothing

Specific to investment return volatilityUAAL amortization – assets and liabilities

More than just asset volatility control Direct contribution rate smoothing

Contribution collar – limits increases Contribution rate phase-in – delays full impact


Actuarial Value of AssetsTo reduce the impact of short term asset volatility, plans use

an Actuarial Value of Assets (AVA) which “smoothes” returns Each year, take the difference between:

Actual return on Market Value of Assets (MVA)Assumed return on MVA (currently 8.00%)

Difference is spread over (typically) five yearsReduces volatility without reducing long term expected return


Example: one good year

Year 1 2 3 4 5 6

MVA return 13% 8% 8% 8% 8% 8%

Deferred (5%)

Recognized 1% 1% 1% 1% 1%

AVA return 9% 9% 9% 9% 9% 8%


Example: one good, then one bad year

Year 1 2 3 4 5 6 7

MVA return 13% 3% 8% 8% 8% 8% 8%

Deferred (5%) 5%

1% 1% 1% 1% 1% Recognized (1%) (1%) (1%) (1%) (1%)

AVA return 9% 8% 8% 8% 8% 7% 8%


The one thing to remember:

Actuarial valuation determines the current or “measured” cost, not the ultimate cost

Assumptions and funding methods affect only the timing of costs

C + I = B + EContributions + Investment Income

equalsBenefit Payments + Expenses


Asset Smoothing MechanicsWhen MVA return is greater than assumed

Smoothing “defers gains” Smoothed value (AVA) is less than MVA UAAL and contributions are larger

When MVA return is less than assumed Smoothing “defers losses” Smoothed value (AVA) is greater than MVA UAAL and contributions are smaller


Plan Amount notyr end recognized

thru Dec. thru JuneJun-07 $156,975 $70,522 80% 90% $189,050Jun-06 $61,745 ($26,692) 60% 70% $18,363Jun-05 $111,658 ($56,435) 40% 50% $16,446Jun-04 $141,500 ($42,934) 20% 30% $15,420Jun-03 ($162,072) $67,831 0% 10% $6,783Net GAINS not yet recognized $246,061

Market Value of Assets (MVA) $2,938,652MINUS GAINS not yet recognized ($246,061)Actuarial Value of Assets (AVA) $2,692,591AVA/MVA ratio 92%

Percent notrecognized

Market ValueGain/(loss)

FCERA Actuarial Value of Assets as of June 30, 2007(Market G/L measured in six month increments)



thru Dec. thru JuneJun-08 ($103,817) ($321,390) 80% 90% ($372,305)Jun-07 $156,975 $70,522 60% 70% $143,550Jun-06 $61,745 ($26,692) 40% 50% $11,352Jun-05 $111,658 ($56,435) 20% 30% $5,401Jun-04 $141,500 ($42,934) 0% 10% ($4,293)Net LOSSES not yet recognized ($216,295)

Market Value of Assets (MVA) $2,726,605PLUS LOSSES not yet recognized $216,295Actuarial Value of Assets (AVA) $2,942,900AVA/MVA ratio 108%



FCERA Actuarial Value of Assets as of June 30, 2008(Market G/L measured in six month increments)



thru Dec. thru JuneJun-09 ($981,300) $0 80% 90% ($785,040)Jun-08 ($103,817) ($321,390) 60% 70% ($287,263)Jun-07 $156,975 $70,522 40% 50% $98,051Jun-06 $61,745 ($26,692) 20% 30% $4,341Jun-05 $111,658 ($56,435) 0% 10% ($5,644)Net LOSSES not yet recognized ($975,554)Market Value of Assets (MVA) $1,961,700PLUS LOSSES not yet recognized $975,554Actuarial Value of Assets before corridor $2,937,254Actuarial Value of Assets AFTER corridor $2,354,040AVA/MVA ratio (before corridor) 150%



FCERA Actuarial Value of Assets as of June 30, 2009ESTIMATED 2008/2009 Market Value return = -28%


Asset Smoothing and “MVA Corridor” Many plans (incl. FCERA) limit how far the AVA can get from the MVA by

limiting the AVA ratio Typical 20% “MVA corridor” means the AVA must be between 120% and

80% of MVA Maximum deferred gain or loss is 20% of MVA Hitting the MVA corridor effectively stops smoothing

MVA corridor will have major impact starting in 2009 For FCERA, 6/30/2009 AVA is 150% of MVA Immediate cost increase with MVA corridor: 15.0% Immediate cost increase w/o MVA corridor: 3.3%


$1.0

$2.0

$3.0

$4.0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009Valuation Date (6/30)

Asse

ts ($

in B

illio

ns)

MVAAVA with corridorAVA w/o corridor

FCERA Historical MVA and AVA

Ratio of AVA to MVA (before 20% MVA Corridor)

86% 86% 95% 95% 116% 116% 106% 100% 97% 92% 108% 150%


Actuarial Standards of Practice #44ASOP 44 focuses on two key features

How close does AVA stay to MVARatio of AVA to MVA (“AVA Ratio”)

How long before AVA returns to MVASmoothing period

ASOP 44 also provides some structure If “likely” to be “reasonable”, both are required If “sufficiently close” or “sufficiently short” then only one or the other is

required


Longer Asset Smoothing Period?Possible Systemic Reasons

Longer business/economic cycles Greater actual market volatility (assets) Greater sensitivity to contribution rate volatility Greater asset volatility relative to payroll

Higher funded percentages More mature plan, larger benefit levels

Practical Reasons Reduce immediate impact of market losses Delay full impact of market losses


5 year Smoothing and MVA Corridor Under ASOP 44, is 5 years “sufficiently short”?

Widespread use, industry opinions Also consider cash flow, employer ability to pay

If any action taken, consider wider MVA corridor Considerations beyond just complying with ASOP Maintains policy of some control on AVA vs MVA

Important if also considering longer smoothing Use actual 5 yr smoothing AVA ratio as a guide

For FCERA, consider 130% or 140%Fully aware of current and future implications


Longer Smoothing and MVA Corridor Longer smoothing means larger AVA ratios Longer period increases need for MVA corridor Possible framework for policy alternatives

5 year smoothing: corridor based on actual AVA ratio Longer periods: use this corridor or narrower

Allows more time to get to ultimate contribution rateDoes not lower immediate rate impact

For longest periods (10 - 15 years) use 120%-130%


Q U E S T I O N S


20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Valuation Date (6/30)

Perc

ent o

f Pay

roll

Scenario 1-A: 80%-120% CorridorScenario 1-B: 70%-130% CorridorScenario 1-C: 60%-140% CorridorScenario 1-D: No Corridor

5 Year Smoothing Period (Exhibit 3-1)

108% 150% 144% 128% 113% 101% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Ratio of AVA to MVA(No Corridor) Shown Above

-28% return for 2008/2009, 0% for 2009/2010 and then 8% per year

Employer Contribution Rates


20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Valuation Date (6/30)

Perc

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roll



108% 153% 150% 137% 124% 114% 107% 101% 100% 100% 100% 100% 100% 100% 100%





20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Valuation Date (6/30)

Perc

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f Pay

roll



108% 155% 155% 144% 132% 123% 117% 112% 107% 104% 100% 100% 100% 100% 100%





20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Valuation Date (6/30)

Perc

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108% 156% 157% 146% 135% 127% 121% 116% 112% 108% 105% 102% 100% 100% 100%





20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Valuation Date (6/30)

Perc

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roll

Scenario 1-D: No CorridorScenario 2-D: No CorridorScenario 3-D: No CorridorScenario 4-D: No Corridor

Various Smoothing Periods – No Corridor (Exhibit 6)




20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Valuation Date (6/30)

Perc

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roll

Scenario 1-A: 80%-120% CorridorScenario 2-A: 80%-120% CorridorScenario 3-A: 80%-120% CorridorScenario 4-A: 80%-120% Corridor

Various Smoothing Periods – 120% Corridor (Exhibit 7)




20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Valuation Date (6/30)

Perc

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roll

Scenario 1-B: 70%-130% CorridorScenario 2-B: 70%-130% CorridorScenario 3-B: 70%-130% CorridorScenario 4-B: 70%-130% Corridor





20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Valuation Date (6/30)

Perc

ent o

f Pay

roll

Scenario 1-C: 60%-140% CorridorScenario 2-C: 60%-140% CorridorScenario 3-C: 60%-140% CorridorScenario 4-C: 60%-140% Corridor





20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Valuation Date (6/30)

Perc

ent o

f Pay

roll

Scenario 1-D: No CorridorScenario 2-D: No CorridorScenario 3-D: No CorridorScenario 4-D: No Corridor

Various Smoothing Periods – No Corridor (Exhibit 6)




Q U E S T I O N S

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