The actuary of the System ensures that adequate assets are being accumulated to pay benefits as they become due using demographic (rates of employee mortality, disability, turnover and retirement) and economic (interest rates, inflation and salary growth) assumptions.
At the beginning of each fiscal year (April 1), the actuary performs an actuarial valuation. First, the actuary determines the dollar amount needed to pay all current and future benefits (actuarial liabilities). Some of the factors used to determine the value of future benefits include:
- Benefits for every member, pensioner and beneficiary
- Future salary and service amounts
- Probabilities of disability, withdrawal and retirement
- Life expectancies
- Inflation for cost-of-living adjustments (COLA)
Once future benefits have been projected, the actuary must discount that cost to its current or present value of benefits (PVB), based on expected investment earnings and mortality rates. The PVB reflects the amount of money needed in the Fund today to pay benefits in the future. Because the System anticipates a 7.5 percent rate of return on its Fund investments, the assumed interest rate is 7.5 percent, though this rate could change with changes in the financial market. The mortality rates are based upon the System’s own experience.
The actuary also establishes the actuarial value of the System’s assets, using a smoothing method to even out volatile shifts in the financial markets. This smoothing method, which only recognizes a portion of the market gains and losses, evens out the value of the System’s assets and, as a result, the assets rarely equal market value.
When the present value of benefits and the actuarial assets are equal, rates are near zero*. When the current value of benefits is greater than actuarial assets, the difference must be made up through employer contributions. That difference is amortized or “spread” over the working lives of current members to determine annual contributions required. Separate calculations are done for each plan, since each plan allows for different benefits.
This graph shows the difference between the System’s actuarial assets and the present value of benefits (PVB) and the amount needed to be raised from employer contributions. It reveals that, from 2000 to 2002, there was very little difference between the System’s actuarial assets and PVB, which corresponds to the near zero percent rates* that employers paid during this period. Starting in 2003, however, the gap between the two became large, in part because of the declining financial market and, as a result, employer rates grew. This gap continues today.
*In 2003, a new law set a minimum contribution of 4.5 percent of payroll for employers every year, including years in which the investment performance of the Fund would make a lower contribution possible.