Funding Status: Using Statistics to Manage the Plan
By Jim Meynard
The bi-annual actuarial study has been completed for both the Pension Fund and the Class 9 Pension Fund. Mellon Consultants, Inc., (formerly known as Buck Consulting,) presented both studies to the Trustees at their regular meeting on November 19, 2003. The presentation and report included recommendations that both funds could support a 1 1/2 % cost of living adjustment (COLA) in benefit payments effective January 1, 2004, should the Board elect to authorize such increases.
The Board voted unanimously to authorize the COLA for January, but not without some deliberation and discussion regarding the current financial health of the funds, in particular the Pension Fund, and the long-term funding prospects. As stewards to the pensioners of the plan, it is the objective of the Board of Trustees to maximize the monthly benefit payments and, to the extent possible, preserve or enhance the purchasing power of the retirement benefit. As stewards to the active participants and future retirees, it is the objective of the Board to preserve the funding status of the trust relative to the future benefit expectations of the membership, which is the pension benefit. We only have to look to the current dilemma of the HOPE scholarship program to see the results of too generous a benefit program with disregard for funding sources.
The following paragraphs offer a layman’s discussion of the funding status of the plan and the statistical analyses that support the decisions governing benefit improvements. By any measure, the plan is well-funded. It is not rich; it is not “over funded.” It is financially sound. (Note: These paragraphs will address the Pension Fund for Class 1-8. The Class 9 Pension Fund is too new, with too few participants, to suffer the same analysis.)
Pension fund management, be it public, such as ours, or private, such as that of a corporation, uses statistical analysis to capture the characteristics of large collections of data and information, such as the life expectancy of the population, the retention and retirement profile of firefighters, insurance premium tax receipts, and returns on assets. Many of the hard numbers that we have to work with are current, like current membership, current value of assets, current interest rates, and so forth. However, the benefit expectations of the membership span the next thirty to forty years. To support these expectations, we must make projections relative to the growth in membership, life expectancy of members, growth in assets (investment returns), growth in tax receipts, and so forth. These projections cannot be approached without the application of sound statistical methods applied to historical data, methods which include present value discounting, regression (trend) analysis, and smoothing techniques, with regard for volatility and correlation (i.e. behavior) in the data.
Let’s start this discussion by looking at what the fund owes the participants. In a simple sense, this is the benefit payments multiplied by the participants. But, it is not so simple. Not all participants will stay in the fund. Not all participants will stay for full retirement. Some will leave early and take a reduced benefit; some will leave much later and delay their benefit. Most have Joint and Survivor Options, but some do not. Based on historical trends, statistical ratios are applied to the membership population, in conjunction with actuarial mortality tables, to estimate the benefit payments due to be paid by the fund under the most likely scenario of membership experience. This is the fund’s benefit liability, and it is considered several ways by the actuary.
If we were to consider what the fund owes its participants now, that is, what has been earned to date, such that we could pay off each participant in cash and close the fund, that amount is labeled the “Present Value of Accumulated Benefits (PVAB).” It is the Present Value of benefits earned to date, discounted to the present from their future payment date, such as an annuity might be on cash out. It is sort of the “cash value of the insurance policy” if you will. As of our valuation date of June 30, 2003, that value for our fund was $427 million and change. The market value of the assets held in trust at that time was $439 million and change. That represented a marginal surplus on an PVAB basis. So far, so good.
But we are not going to close the plan and pay off the participants, and therefore, we need to consider the obligation or liability of the plan on a long-term basis. If we consider what we owe our participants now, (the PVAB,) plus what we expect active participants to earn in the future, on a statistical basis, net, and discount that to the present value, we have our net projected plan benefits or an amount labeled the “Actuarial Accrued Liability (AAL).” That amount stands around $489 million and exceeds the market value of our current assets by a substantial amount, ($50 million as of the study date.) However, some commentary is in order here. For one thing, this is a projected number; we are comparing it to a current number that we would expect to grow over the life of the membership to meet or exceed the projection. Secondly, using smoothing techniques to eliminate volatility from asset returns and allow focus on long term analysis, we compute the “Actuarial Value” of our assets at a little over $500 million.
Well, what is the bottom line on assets versus liability? Statistically, we have a small surplus in an actuarial sense. In a static, real payoff sense, we also have a small surplus. But, for a long term projection, due primarily to recent capital market performance, we are below trend lines and in a deficit position against the projected benefit liability.
The other half of the story relates to receipts and disbursements. Again, taken simplistically, this year, we took in more in taxes than we gave out in benefits. But, it was an unusual year, indeed. Looking at our premium tax receipts, they have grown at 17.2% ($16.8 mm) and 10.4% ($15.2 mm) in each of the last two years, respectively. The average for the most recent ten years, however, is only 7.9% with growth as low as 1.7%. Our expectation for the coming year is some contraction to return to trend, reflecting the weak economic conditions the state has experienced in 2003. At the same time, we have experienced some additional retirements this year, and disbursements are growing. So, on a current cash flow basis, there is a slight cash drain projected for the fund, which is more typical of a normal year and is easily made up by dividends and interest from our investments.
But, we are actually much better off than that sounds. On a long-term actuarial basis, our annual benefit expense, again taken at present value, is just over $12 million. This is a statistical projection of benefits to come due on the current population, discounted to the present, statistically adjusted for how many stay and how long. This value will grow as COLA’s and other benefit improvements may be applied to the plan. And, while we expect some near-term contraction in the growth of tax receipts, we also expect long-term growth in receipts to keep pace with benefit expense, including modest improvements from time to time.
So, can we afford a COLA? In January? In the future?
Simply put, the answer is yes, for January. But it is not a cavalier “yes.” As they should, the Board engaged in thoughtful discussion of future trends relative to asset returns, tax receipts, growth in membership and consequences of future benefit improvements, including COLA cycles. This cycle, January, the fund can support it, and the Board has authorized it. Future cycles look promising at this juncture, but each will be carefully weighed and considered when due.
Our fund is sound. While the membership is growing, (as it should, because this is an especially good benefit for firefighters in our state,) receipts are also on the rise in a long term trend consistent with the economic growth of our state. Too, the capital markets are experiencing a recovery, and, with proper diversification and prudent management, our assets should deliver returns sufficient to support carefully considered and measured benefit improvements in the future. Complex statistical formulae and the associated analyses of historical trends and human behavior will enable proper decisions regarding benefit improvements within the capacity of the fund without jeopardizing the benefits offered to current and future plan participants.
Moves and Changes at the Pension Office
Please welcome the newest addition to our staff, Ms. Stephanie Glover. Stephanie joined us on September 29, 2003, from Newton Federal Savings. She has assumed responsibility for membership dues, records postings and maintenance, and general office support. Occasionally, you will get her bright and cheerful voice on the phone. With the addition of Stephanie, Cindy Cannon will be assuming more responsibility for retirements and retiree matters, and Leanna Johnson will focus on new applications and current membership matters. Leanna will also continue to be our point person for telephone contact. Sharon Drake is our Operations Manager, and as such supervises and supports the office and handles all Board matters. Christian Campen is the Assistant Treasurer and handles accounting and financial matters.
A Joyous Holiday Season to All from the Georgia Firefighters' Pension Fund Staff and the Best Wishes for a Happy and Productive 2004!
Jim Meynard
Executive Director