1. FCERA April 2008 Interest Crediting 4043177 FCERA Board Interest Crediting and Excess Earnings Policy Discussion Wednesday, April 16, 2008 Paul Angelo, FSA Andy Yeung, ASA The Segal Company San Francisco

2. Slide 2 FCERA April 2008 Interest Crediting Outline  Actuarial Cost Method Fundamentals  Reserve, Interest Crediting and Excess Earnings Mechanics  FCERA Reserve Structure  FCERA Interest Crediting Policy  FCERA Excess Earnings Policy  Historical Application of Excess Earnings  Review Policy Features and Goals

3. Slide 3 FCERA April 2008 Interest Crediting Current Year Normal Cost Present Value of Future Benefits Actuarial Accrued Liability Future Normal Costs Current AgeEntry AgeRetirement Age Actuarial Cost Method

4. Slide 4 FCERA April 2008 Interest Crediting Valuation Value of Assets Unfunded Actuarial Accrued Liability Amortization of Unfunded Actuarial Accrued Liability Normal Cost Present Value of Future Normal Costs Annual Cost

5. Slide 5 FCERA April 2008 Interest Crediting Universal Rule of Pension Plans: No free lunch! Contributions + Investment Income equals Benefit Payments + Expenses  Assumptions and funding methods affect only the timing of costs  “Nobody ever made a benefit payment from assumed interest!”

6. Slide 6 FCERA April 2008 Interest Crediting Typical 1937 Act Reserve Structure

7. Slide 7 FCERA April 2008 Interest Crediting Reserve Mechanics  Reserves track contributions, payments and investment earnings  Add contributions to Member Deposit and Employer Advance Reserves  Transfer PV to Retiree Reserves for new retirees  Deduct payments from Member Deposit and Retiree Reserves  Credit interest

8. Slide 8 FCERA April 2008 Interest Crediting Basic Interest Crediting Process  Determine “Available Earnings” for the period  All current period earnings  Min. (1%) + Add’l (>1%) Contingency Reserve (CR)  Maybe some or all of Undistributed (Excess) Earnings Reserve (UER)  Determine earnings needed for credits  If Available Earnings is enough, do the credits  Then restore Contingency Reserve  Balance to UER  Excess Earnings Policy determines use of UER

9. Slide 9 FCERA April 2008 Interest Crediting FCERA Earnings Measure  FCERA uses same measure of earnings for reserves and for funding  Total Reserves = Actuarial Value of Assets  Valuation Reserves = Valuation Value of Assets  Credit interest at valuation rate to maintain balance  Excess Earnings Actuarial Investment Gain

10. Slide 10 FCERA April 2008 Interest Crediting Mechanics: Undistributed Earnings Reserve  Two-Step process for spending Excess Earnings:  First, “siphon” Excess Earnings into a “non-valuation reserve”  Excluded from Valuation Assets  Prevents decrease in UAAL contribution rate  Later, “spend” Excess Earnings  No sudden impact on contribution rate  A form of forced budgeting!

11. Slide 11 FCERA April 2008 Interest Crediting investments $$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ Assets $ $ $ $ $ $ $ $ $ $ PENSION FUND $ $ benefits expenses employer contributions employee contributions Generic Funding Mechanics

12. Slide 12 FCERA April 2008 Interest Crediting Investment Income Valuation Assets Benefits Expense s County Contributions Member Contributions Undistributed Excess Earnings Ad-Hoc Benefits Drawing Not to Scale! Contingency Reserve Plumbing for Excess Earnings

13. Slide 13 FCERA April 2008 Interest Crediting FCERA Interest Crediting Policy  Last reviewed: October 2005  Available Earnings: Return on Actuarial Value plus CR and UER  Credit Member Reserve at rate of retiree COLA  limited to 3%, one-half credited on 6/30 and 12/31  Credit total Valuation reserves (including Member) at valuation rate  Credit Non-Valuation Reserves at valuation rate  Supplemental COLA and Retiree Health Insurance

14. Slide 14 FCERA April 2008 Interest Crediting FCERA Interest Crediting Policy  If Available Earnings is insufficient: CR may become negative, but CR + UER + Non-Valuation Reserves > 1% of Market Value of Assets  Negative CR used to track interest credit shortfalls  If Available Earnings is sufficient: Earnings available to add to UER

15. Slide 15 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Combination of Settlement Agreement and Board discretion  Settlement Agreement  Section 6 – enhanced retirement benefits for active members retiring on or after January 1, 2001  Section 8 – enhanced retirement benefits for retired members retired before January 1, 2001  Section 9 – All retirees, $3 per month per year of service, future increase tied to UER.  Latest year Undistributed Earnings available and applied in valuation: June 30, 2002

16. Slide 16 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Order of application of Undistributed Earnings in June 30, 2002 valuation:  Priority #1-Current year employer and member contribution relief for:  Section 8  Section 6  Section 9

17. Slide 17 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Order of application of Undistributed Earnings in June 30, 2002 valuation:  Priority 2-Reduce unfunded liabilities (future employer contribution relief) for:  Section 8  Section 9  Section 6

18. Slide 18 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Order of application of Undistributed Earnings in June 30, 2002 valuation:  Priority #3-Create new retiree health benefits under Section 9 of Settlement Agreement  Priority #4-Other uses at Board’s discretion  Supplemental COLA and Retiree Health Insurance

19. Slide 19 FCERA April 2008 Interest Crediting Employer Contribution Relief  Priority #1 - Allow “dollar-for-dollar” contribution credit for settlement benefits  Full or partial contribution offset  Priority #2 - Increase in Valuation Assets for settlement benefits  Reduces Unfunded Actuarial Accrued Liability  Reduces cost on an amortized basis

20. Slide 20 FCERA April 2008 Interest Crediting Member Contribution Relief  Priority #1 - Allow “dollar-for-dollar” contribution credit for settlement benefits  Full or partial member COLA contribution offset

21. Slide 21 FCERA April 2008 Interest Crediting Allocated in June 30, 2002 Valuation  Undistributed Earnings allocated in June 30, 2002 valuation  Priority 1 – Current year contributions:  Section 8: $1.3 million  Section 6: $19.7 million  Section 9: $1.2 million  Priority 2 – Reduce unfunded liabilities:  Section 8: $19.9 million  Section 9: $11.6 million  Section 6: $17.2 million

22. Slide 22 FCERA April 2008 Interest Crediting Review of FCERA Policy Features and Goals  Interest crediting features unique to FCERA  Review application of Undistributed Earnings in June 30, 2002 valuation  Clarify policy features and goals  Legal counsel involvement crucial

23. Slide 23 FCERA April 2008 Interest Crediting Interest on Member Contributions  Affects refunds on withdrawal or death  Form of benefit accrual  Purpose of plan is retirement, not savings  Consistent with DB nature of plan  Credit Member Reserve at rate of retiree COLA (limited to 3%, one-half credited on 6/30 and 12/31)  Why credit more than was actually earned on short- term investment?  Compare to savings deposit rates?

24. Slide 24 FCERA April 2008 Interest Crediting Interest on Non-Valuation Reserves  Credit Non-Valuation Reserves at valuation rate  Supplemental COLA and Retiree Health Insurance  Other 1937 Act Systems: credit interest only on valuation reserves

25. Slide 25 FCERA April 2008 Interest Crediting Contra Account Concept  If Available Earnings is insufficient: CR may become negative, but CR + UER + Non-Valuation Reserves > 1% of Market Value of Assets  Use Contra Account instead?  Track interest credit shortfalls  Any time credits are below the target rate  Negative returns are a special case  Does not ignore the bad investment returns  After a bad year, same impact on employer rates, funding ratios and member balances

26. Slide 26 FCERA April 2008 Interest Crediting Consider Funding Condition?  Regular and settlement benefits  Rather than ask “Does the Plan have excess earnings?” ask “Does the Plan have surplus assets?”  Some 1937 Act Systems consider undistributed earnings “excess” only when plan is over X% funded

27. Slide 27 FCERA April 2008 Interest Crediting FCERA Excess Earnings Policy  Priorities on application of Undistributed Earnings in June 30, 2002 valuation  Satisfy Settlement Agreement  Satisfy Board’s goals and objectives

28. Slide 28 FCERA April 2008 Interest Crediting Q U E S T I O N S