Sunday, April 17, 2005

Shadows and Light

Rather than wait for PERS to post the Mercer presentation, I discovered that my new scanner will take a two-sided document and scan it in automatically. I just put the Mercer document in and let er rip. You can read the Mercer Study by clicking on the highlighted link. (This is now the "official" copy direct from PERS, in living color).

The objectives of this study are rather clearly stated on the first page. The goal is to show how recent legislation and litigation has affected both member benefits and employer costs. One immediate point that emerges from Mercer's study is that Tier 1/Tier 2 members who retire under Full Formula will be much better off than they would have been without the Legislation (because of the IAP and assuming Full Formula no matter what). Money Match retirements are expected to fall off significantly in 9 - 11 years, even with Strunk and upholding Lipscomb. It might take a bit longer if the court holds that the 1999 earnings distribution was legal.

The next major finding, which wouldn't surprise anyone except Legislators, is that "Contributions to the system are dwarfed by expected investment earnings." Typically, investment earnings represent about 3x contributions to the system in a year where the assumed rate is earned. In 2003 and 2004, the earnings were about 7x contributions and resulted in a significant reduction in the savings expected at the time the 2003 reform legislation passed. Mercer also notes that the volatility in investment earnings creates the volatility in contribution rates, exacerbated by PERS' policy of "smoothing". As of now (pre-City of Eugene appeal decision), the total change in the UAL is only 3.07% or approximately $3 billion instead of the $7.5 billion (7.64%) projected originally. Mercer lays out all the components of how this came to be (see page 11 of the handout). One interesting finding (page 10) is that after the 2003 reform adjusted the 2001 system valuation, there was a temporary surplus and PERB dropped employer rates below the "normal cost" (this is an important point that has ramifications later).

Page 13 contains an important table, which notes that "Over 60% of PERS accrued liability is for retirees and inactives". Moreover, closer inspection of the table shows clearly that retirees and inactive members will be worse off if the City of Eugene settlement stands than they are right now without Strunk implemented. It isn't clear to me from the numbers on this page whether the effects are equal across retirees and inactives, but the numbers speak for themselves (especially compare the effect on actives).

Mercer also reports and explains how high earnings will not have a significant impact on employer rates in the short run, but will have a substantial mitigating effect farther out (pp 16 & 17 of report).

Finally, page 19 of the report offers the clearest insight to date on what both employers and members might expect by way of recommendations from Mercer to the PERB. Under short term measures, they clearly recommend using the Contingency and Capital Preservation reserves to mitigate the effects of the Strunk decision. They also feel that the Board needs to develop a formal policy on interest crediting. It was at this point where the 8% floor discussion arose and where no one challenged the assertion. The discussion was about what to do with earnings above 8% (not above the "assumed rate") and it was here that Mr. Green and Mr. Hartman discussed the role of HB 2001 and agreed. You'll also note the "intermediate term measures" here. You should pay particular attention to the note about "Entry Age Normal" funding, "alternative methods to smooth contribution rates", and "other actuarial methods and assumptions." Expect a Board meeting relatively soon in which Mercer will recommend that the PERB use a different (and actuarially accepted) method to calculate the "normal" funding. This method will differ from the method used by Milliman and will result (almost assuredly) in slightly different actuarial tables. Mercer has much experience with other Public Employee retirement plans and clearly differs with Milliman on the best approach to calculating the "normal" cost for each employee in the system. Mercer also seems to have some concern with the method PERS currently uses to smooth investment returns and diminish volatility in employer contribution rates.

For PERS wonks, this is the opening salvo from a new actuary. Mercer's philosophy appears to be different from Milliman's. This presentation reveals the areas of shadow and light in a picture that is just beginning to develop. Enjoy your read.

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