Summary of 2003 Actuarial Valuations

1. 2003-2004 FUNDING LEVELS 

   TABLE I-A: 2003-2004 Funding Levels 

   TABLE I-B: Pattern of Sufficiency (Deficiency): 2001-2003

   TABLE I-C: Accrued Benefit Funding Ratios: 2001-2003

   TABLE I-D: Summary of PERA Consolidation Accounts Prior to Merger 

   TABLE I-E: Analysis of Service Credit Purchases 

2. PLAN PROVISIONS 

3. ACTUARIAL ASSUMPTIONS AND METHODS 

   TABLE III-A: Actuarial Assumptions - Category 1 

   TABLE III-B: Actuarial Assumptions - Category 2 

   TABLE III-C: Actuarial Assumptions - Category 3

APPENDICES

Appendix A: Alternative Analysis of Funded Status

Appendix B: Summary Charts of Liability Funding Ratios

As the Commission Actuary, we have determined the actuarial funding requirements in accordance with the requirements of Section 356.215, Minnesota Statutes, for each of the Funds covered by those statutes. Each employer contributes to their respective Fund on the basis of statutory requirements set by statutes for the individual Fund.

In Table I-A, we provide a detailed comparison of the requirements under Section 356.215 and the statutory employer contribution. It is this comparison which allows an analysis of the Fund’s ability to meet its long-term commitments. Table I-B provides a three-year history of the sufficiency determination. The pattern of these results gives a more complete picture of emerging concerns as to the adequacy of statutory requirements.

Another measure of funding adequacy is the ratio of plan assets to the present value of accrued benefits. These ratios are summarized for the last three valuations in Table I-C. Since this is more of a termination measure of adequacy, it is generally considered a less important measure for public plans than the sufficiency determination summarized in Tables I-A and I-B. Nonetheless, it does give a somewhat different and useful perspective when viewed in conjunction with other factors. If proper funding progress is made, these numbers should move toward a ratio of slightly over 100%.

Tables I-A, I-B, and I-C have been prepared based on the applicable Minnesota Statutes and the Actuarial Standards that have been adopted by the Legislative Commission. Due to the deterioration in the market value of assets experienced in the last three fiscal years, we have provided additional analysis of the funding implications of the economic downturn in Appendix A.

Below we comment by plan on our analysis of the actuarial valuations. This commentary is based on the official valuations which reflect the asset smoothing methodology adopted four years ago. The reader should be cautioned that the analysis prepared in Appendix A presents a significantly bleaker picture for most of the plans.

1. The Public Employees plan experienced a modest decline in the deficiency measure primarily due to asset losses. This plan continues to show a substantial deficiency as statutory contribution rates are significantly lower than required contributions. Improvement in the deficiency measure may be difficult to achieve in the next few years in light of current unrecognized asset losses. Further corrective action by the legislature may be needed to deal with this deficit situation.

2. The Police and Fire plan shows a significant deficiency measure that is primarily due to changes in assumptions coupled with asset losses; moreover, statutory contributions are substantially below ongoing normal costs. Corrective action by the legislature may be needed to deal with this deficit situation.

3. The Police and Fire Consolidation Fund was terminated and merged into the PERA Police and Fire Fund effective July 1, 1999. Table 1-D1 on page 9 summarizes the funded status of each account remaining as of June 30, 2003.

4. The Local Government Correctional plan is a new plan that was first effective July 1, 1999. The modest sufficiency is due mainly to decreases in the Normal Cost rate as new employees enter the plan.

5. The increase in the deficiency measure in the State Employees plan is primarily due to asset losses. Improvement in the deficiency measure may be difficult to achieve in the next few years in light of current unrecognized asset losses. Since Statutory contributions are below ongoing Normal Costs, it may be prudent to consider increases in the contribution rates.

6. All funding ratios declined as did the sufficiency measure in the State Patrol plan. This plan remains well funded. Similar to PERA Police & Fire Plan, ongoing normal costs exceed statutory contributions, albeit to a lesser extent.

7. The Correctional Employees plan experienced significant deterioration in funding ratios and in the sufficiency measure due to unfavorable asset experience. New job classifications continue to be allowed to transfer into the Correctional plan (we saw a 0.4% increase in active membership in this plan). In most cases, the assets transferred in from MSRS General were not adequate to fully cover the actuarial accrued liability of these new participants. Improvement in the deficiency measure may be difficult to achieve in the next few years in light of current unrecognized asset losses. Since the statutory contribution rates are less than ongoing normal costs of the plan, increases in statutory contribution rates should be considered.

8. The Legislators plan is funded on a terminal funding basis. This funding basis means that the State (as employer) does not pre-fund for benefits earned while service is being performed. Rather, at the time of retirement of one of these participants, the State must fund that portion of the retirement benefit not covered by member contributions. This funding approach has several disadvantages:

   1. It can lead to substantial fluctuations in year-to-year funding requirements;

   2. Due to lack of investment income, it means ultimate State costs are higher; and

   3. It defers funding obligations from one generation of taxpayers to the next.

   The Elective State Officers plan is handled on a pay-as-you-go basis. This funding basis means there is no accumulated funding (other than Member contributions held by the State’s general fund). Actual retirement benefits are paid from the general funds via direct disbursements to the retirees (or beneficiaries). There are no longer any active employees in this plan.

   Due to these funding mechanisms and to budget constraints, no actuarial valuation was prepared for these funds as of July 1, 2003. Since both of these plans have been closed to new members, it is probably not prudent to consider pre-funding at this time.

   We note mixed results in the funding ratios and in the sufficiency measure for the Judges plan. Continued funding at the current statutory rates has substantially diminished any ongoing concern relating to short-term cash shortages.

10. The Minnesota TRA fund continues to have a negative unfunded actuarial accrued liability. The modest decline in the sufficiency measure is due primarily to investment experience.

11. The Duluth Teachers plan showed a large decline in funding ratios and funding status. Unfavorable asset experience contributed to the decreases in the measures of funded status of the plan. This plan continues to show a slight sufficiency.

12. The St. Paul Teachers plan showed deterioration in funding ratios and funding status primarily due to unfavorable asset experience. The decline in the sufficiency measure is contingent, of course, on the current level of State supplemental contributions. We note that the statutory contributions exceed the ongoing Normal Costs. Consequently, the deficiency is the result of the plan’s unfunded accrued liability. This plan will need to be monitored closely in the year ahead.

13. Significant asset losses in the Minneapolis Teachers plan led to further deterioration in all funding ratios and another substantial increase in the deficiency percentage. As of July 1, 2003, the fund is even more severely distressed; the annuitant liability significantly exceeds the actuarial value of assets. Absent significant State supplemental contributions, this plan would be even more substantially deficient. The deficiency percentage can be expected to grow for reasons discussed below; legislative attention is urgently needed.

14. The Minneapolis Employees Retirement Fund had unfavorable asset experience in the 2002-2003 year which was compounded by liability losses. We note that a significant source of the liability losses continues to come from retirement earlier than anticipated by the current actuarial assumptions. As the active membership of this Plan shrinks, the impact of this source of liability loss is likely to become greater as a percentage of active payroll. The State’s portion of the supplemental contribution remains below its statutory maximum, but at a higher level than last year. Meanwhile required contribution rates for contributing employers increased approximately 2% of pay.

Provisions under Minnesota Statutes Chapter 390, Article 4, provide the methodology for determining the amounts required to purchase prior service credits under certain circumstances. Those provisions also require the Commission Actuary to provide an analysis by individual and by plan of the impact on the plan’s funded status of the service credits actually purchased during the 12 months preceding the valuation. However, this requirement was suspended by the LCPR for the July 1, 2003 actuarial valuations. Accordingly, we intentionally omitted Table I-E.

Plans for which statutory contribution increases should be considered are St. Paul Teachers, MSRS General, MSRS Correctional, PERA, and PERA Police and Fire. Minneapolis Teachers needs immediate attention.

The Minneapolis Teachers funding problem is severe and compounded by several factors that ensure that their deficiency measurement will worsen even further in the years to come:

• Current statutory rates being less than required mean that the unfunded actuarial liability is expected to increase.

• Since the current amortization requirement is to a fixed date, this increased amount, funded over a shorter period, will create significantly higher amortization requirements.

• For the most part, the Supplemental Contributions of the 1993, 1996 and 1997 legislative packages are fixed amounts; these amounts will provide a decreasing percentage when expressed as a percent of payroll.

• The mechanics of the post-retirement increase calculation have a built-in bias to contribute a loss to the plan. When the investment return average exceeds 8.5%, retirees get full credit (or nearly full credit) for excess earnings even though the plan is only 57% funded. When the investment return average is less than 8.5%, the retirees get nothing in that year, but the deficiency from the 8.5% may never be recovered.

The combination of all of these factors creates a dim picture indeed for this fund. Without early and substantial corrective legislation, this fund may face the very real possibility of running out of assets. We urge the LCPR to explore corrective actions as soon as possible.

On a broader perspective, results of this year’s valuations confirm that the future funded status of the major public employee retirement plans in the State of Minnesota will be driven primarily by future returns on fund assets. Issues to consider may include:

• What principles should be established for consideration of changes in statutory contribution rates?

• What are the statutory mechanisms for dealing with a previously "overfunded" plan which becomes underfunded due to future asset or liability experience?

• Are there other structural changes in benefits, determination of funding requirements, actuarial methods, or investment policy that the LCPR might consider to improve the long-term financial management of these programs?

As Commission Actuary, we stand ready to assist the Commission with these and other issues.

TABLE 1-A: 2003-2004 FUNDING LEVELS (PERCENTAGES)

TABLE 1-B: PATTERN OF SUFFICIENCY/DEFICIENCY: 2001-2003

TABLE 1-C: ACCRUED BENEFIT FUNDING RATIOS: 2001-2003

Table 1-D1: Summary of Accounts with Positive
Amortizable Bases at June 30, 2003

The analysis of service credit purchases made in period ending June 30, 2003 has been intentionally omitted from the July 1, 2003 Actuarial Valuation Report.

II.  Plan Provisions

This section of our summary presents a brief summary of those changes made to the statutes since last year’s report that had an impact on the actuarial funding of a plan. This section is not designed to provide a comprehensive summary of all changes that were made. For a more detailed description of the plan provisions, please refer to the individual report for each Fund.

For the July 1, 2003 Actuarial Valuation, we highlight the following:

Public Employees (Chapter 353): None.

Police and Fire (Chapter 353): None.

Local Government Correctional Service (Chapter 353E): None.

State Employees (Chapter 352): None.

State Patrol (Chapter 352B): None.

Correctional Employees (Chapter 352): None

Legislators (Chapter 3A): None

Elective State Officers (Chapter 352C): None

Judges (Chapter 490): None

Teachers Retirement Association (Chapter 354): None.

Duluth Teachers (Chapter 354A): None.

St. Paul Teachers (Chapter 354A): None.

Minneapolis Teachers (Chapter 354A): None.

Minneapolis Employees (Chapter 422A): None.

In projecting costs to be incurred by a pension plan in future years, it is necessary to provide actuarial assumptions relating to the future events which trigger those costs. To provide for all significant events, a wide range of assumptions must be utilized. These assumptions may be classified into three different categories.

The first category involves the economic assumptions. These assumptions include assumed investment return, salary increases, social security increases and cost-of-living increases on plan benefits. These assumptions are characterized as economic because they generally tend to be affected by interrelated factors that also affect economic growth.

The second category relates to assumptions which affect the expected working lifetime (and retired lifetime) of a member. These assumptions include mortality rates, disability rates and rates of separation due to other causes. Within a particular group classification (such as teachers or policemen), year-to-year mortality and disability rates may be reasonably represented by standard published tables. Separation due to other causes may vary considerably and should be reviewed and monitored on an individual group basis. In particular, where a subsidized benefit exists (such as for early retirement), extra care must be provided with respect to the rate of separation which is assumed to occur (such as the rate of early retirement).

The third category relates to miscellaneous assumptions which are needed to accommodate special plan provisions which are not adequately covered in the first two categories. These would include (but are not limited to) items such as assumed family composition, plan expenses, election to specific benefit forms, etc. These assumptions need to be monitored so that they remain consistent with the plan provisions which are in effect.

In Tables III-A, III-B and III-C, we have prepared a summary of some of the assumptions being used by each plan in all three categories. For a comprehensive review of all assumptions being used for a particular plan, please refer to the July 1, 2003 Actuarial Valuation for that Fund.

In our opinion the assumptions used for July 1, 2003 valuations are reasonable and well within the mainstream of current actuarial practice. Experience during the 1997-2001 period has been analyzed for the Public Employees Police and Fire Fund. The approved changes in the assumptions for the plan has been included in the July 1, 2003 actuarial valuation.

Effective with the July 1, 2000 actuarial valuation, Minnesota Statutes require that the asset value used for actuarial purposes spread differences between actual return (measured on a market-value basis) and expected return on non-MPRIF (non-RBF assets for MERF) assets over five years, in a manner similar to that already being used within the MPRIF. The previous method required under Minnesota Statutes recognized one third of the unrealized gains and losses. An Asset Valuation Method requirement exists because market values (which include all unrealized gains and losses) are typically volatile and can produce erratic changes in the contribution requirements from year to year. The intent of the change to the current method is to employ a more effective asset smoothing technique which is market-value based and which eliminates artificial bias related to manager style. The effective date of this requirement is July 1, 2000 with full transition to be accomplished as of July 1, 2003.

The calculation of the Actuarial Value of Assets for each fund is determined as:

Market Value of Assets at June 30, 2003, less

80% of the current year Unrecognized Asset Return at July 1, 2003 (the difference between actual net return on Market Value of Assets between June 30, 2002 and June 30, 2003 and the asset return expected during that period based on the assumed interest rate employed in the July 1, 2002 Actuarial Valuation); less

60% of the current year Unrecognized Asset Return at July 1, 2002 (the difference between actual net return on Market Value of Assets between June 30, 2001 and June 30, 2002 and the asset return expected during that period based on the assumed interest rate employed in the July 1, 2001 Actuarial Valuation); less

40% of the current year Unrecognized Asset Return at July 1, 2001 (the difference between actual net return on Market Value of Assets between June 30, 2000 and June 30, 2001 and the asset return expected during that period based on the assumed interest rate employed in the July 1, 2000 Actuarial Valuation); less

20% of the current year Unrecognized Asset Return at July 1, 2000 (the difference between actual net return on Market Value of Assets between June 30, 1999 and June 30, 2000 and the asset return expected during that period based on the assumed interest rate employed in the July 1, 1999 Actuarial Valuation).

The term "Actuarial Value of Assets" is used to indicate that the value was determined for use in the actuarial valuations. Minnesota Statutes refer to this value as "Current Assets."

Effective with the July 1, 2000 actuarial valuations, if the Current assets exceed the Actuarial Accrued Liability for any fund, the surplus amount shall be amortized over 30 years as a level percentage of payroll. Prior to July 1, 2000, some of the funds did not amortize the surplus amount, while others amortized to a fixed amortization date.

TABLE III-A: JULY 1, 2003 ACTUARIAL ASSUMPTIONS - CATEGORY 1
(Highlighted box indicates change from prior year.)

(1)Graded rates using a 5.0% base increase plus a merit scale.
(2) Select and ultimate rates using a 5.0% base increase plus a merit scale plus a 10-year select period.

TABLE III-B: JULY 1, 2003 ACTUARIAL ASSUMPTIONS - CATEGORY 2
(Highlighted box indicates change from prior year.)