1. FCERA Board of Retirement and Fresno County Board of Supervisors Joint Meeting – April 30, 2009 Contribution Volatility and Asset Smoothing FCERA Board of Retirement and Fresno County Board of Supervisors Joint Meeting - April 30, 2009 Paul Angelo, FSA & Andy Yeung, ASA The Segal Company San Francisco 5032871

2. Slide 2 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

3. Slide 3 FCERA Asset Smoothing – April 30, 2009 Managing Contribution Volatility  Asset allocation – volatility at the source  Asset smoothing  Specific to investment return volatility  UAAL 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

4. Slide 4 FCERA Asset Smoothing – April 30, 2009 Actuarial Value of Assets  To 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 years  Reduces volatility without reducing long term expected return

5. Slide 5 FCERA Asset Smoothing – April 30, 2009 Example: one good year

6. Slide 6 FCERA Asset Smoothing – April 30, 2009 Example: one good, then one bad year

7. Slide 7 FCERA Asset Smoothing – April 30, 2009 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 + E Contributions + Investment Income equals Benefit Payments + Expenses

8. Slide 8 FCERA Asset Smoothing – April 30, 2009 Asset Smoothing Mechanics  When 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

9. Slide 9 FCERA Asset Smoothing – April 30, 2009 FCERA Actuarial Value of Assets as of June 30, 2007 (Market G/L measured in six month increments)

10. Slide 10 FCERA Asset Smoothing – April 30, 2009 FCERA Actuarial Value of Assets as of June 30, 2008 (Market G/L measured in six month increments)

11. Slide 11 FCERA Asset Smoothing – April 30, 2009 FCERA Actuarial Value of Assets as of June 30, 2009 ESTIMATED 2008/2009 Market Value return = -28%

12. Slide 12 FCERA Asset Smoothing – April 30, 2009 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%

13. Slide 13 FCERA Asset Smoothing – April 30, 2009 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%

14. Slide 14 FCERA Asset Smoothing – April 30, 2009 Actuarial Standards of Practice #44  ASOP 44 focuses on two key features  How close does AVA stay to MVA  Ratio of AVA to MVA (“AVA Ratio”)  How long before AVA returns to MVA  Smoothing 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

15. Slide 15 FCERA Asset Smoothing – April 30, 2009 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

16. Slide 16 FCERA Asset Smoothing – April 30, 2009 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

17. Slide 17 FCERA Asset Smoothing – April 30, 2009 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 rate  Does not lower immediate rate impact  For longest periods (10 - 15 years) use 120%-130%

18. Slide 18 FCERA Asset Smoothing – April 30, 2009 Q U E S T I O N S

19. Slide 19 FCERA Asset Smoothing – April 30, 2009 5 Year Smoothing Period (Exhibit 3-1) 108%150%144%128%113%101%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. Slide 20 FCERA Asset Smoothing – April 30, 2009 7 Year Smoothing Period (Exhibit 3-2) 108%153%150%137%124%114%107%101%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

21. Slide 21 FCERA Asset Smoothing – April 30, 2009 10 Year Smoothing Period (Exhibit 3-3) 108%155% 144%132%123%117%112%107%104%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

22. Slide 22 FCERA Asset Smoothing – April 30, 2009 12 Year Smoothing Period (Exhibit 3-4) 108%156%157%146%135%127%121%116%112%108%105%102%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

23. Slide 23 FCERA Asset Smoothing – April 30, 2009 Various Smoothing Periods – No Corridor (Exhibit 6) -28% return for 2008/2009, 0% for 2009/2010 and then 8% per year Employer Contribution Rates

24. Slide 24 FCERA Asset Smoothing – April 30, 2009 Various Smoothing Periods – 120% Corridor (Exhibit 7) Employer Contribution Rates -28% return for 2008/2009, 0% for 2009/2010 and then 8% per year

25. Slide 25 FCERA Asset Smoothing – April 30, 2009 Various Smoothing Periods – 130% Corridor (Exhibit 8) Employer Contribution Rates -28% return for 2008/2009, 0% for 2009/2010 and then 8% per year

26. Slide 26 FCERA Asset Smoothing – April 30, 2009 Various Smoothing Periods – 140% Corridor (Exhibit 9) Employer Contribution Rates -28% return for 2008/2009, 0% for 2009/2010 and then 8% per year

27. Slide 27 FCERA Asset Smoothing – April 30, 2009 Various Smoothing Periods – No Corridor (Exhibit 6) -28% return for 2008/2009, 0% for 2009/2010 and then 8% per year Employer Contribution Rates

28. Slide 28 FCERA Asset Smoothing – April 30, 2009 Q U E S T I O N S