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Boards & Commissions Supporting Documents - 04/11/2006 - Board of Trustees (3)PGA G \�F 0 A /( 0 U N114, O r �x U IVA A� GJ�110�01 AGE DA ITEM Regular Board of Trustees Meeting of April 11, 2006 SUBJECT: Police Pension Fund Actuarial Study FROM: Darrell Langlois 0 BUDGET SOURCE/BUDGET IMPACT: Various accounts in the Police Department RECOMMENDED MOTION: I move that the Village Board either: 1. Accept the recommendation of the Police Pension Fund Board and direct the actuary to complete the 2006 actuarial study using an interest rate assumption of 7.25% or 2. Direct the actuary to complete the 2006 actuarial study using an interest rate assumption of 7.50 %, which is unchanged from the prior study. Background/History: An actuarial study of the Police Pension Fund and Firefighters' Pension Fund is performed annually in order to monitor the funding progress of the two funds as well as determining the Village's contribution for the coming year. Since it is in both the Village's interest and the two pension fund's interest that these studies be performed, 50% of the cost of each study is paid for by the Village and 50% is paid for by the respective pension fund. For approximately the last 10 years the actuarial studies have been performed by Timothy W. Sharpe, Actuary. The actuarial study process begins with the Finance Department providing the actuary with participant salary, contribution, and service credit data. From there, the actuary calculates various scenarios based on prior actuarial assumptions as well as what the impact would be for various changes in actuarial assumptions. The actuary then attends a meeting with each respective Pension Board where the preliminary results and various changes in actuarial assumptions are discussed. Based on the direction given at the meeting, the actuarial studies are completed and then approved by each Pension Board. Once approved, a funding request is r� 0�v Last saved by Default I \ FINANCE\ DLANGLOI \WORD\ACTUARYpolicemtrate doc Last printed 4/4/2006 2 30 PM forwarded to the Village Board (ultimately responsible for both the actuarial study as well ad funding the pension programs). When meeting with the pension funds, the two major assumptions discussed are the salary increase assumption and the interest rate assumption, with the interest rate assumption having the greatest impact on the Village's funding level and contribution amount. When setting the interest rate assumption, the higher the assumed interest rate results in a greater funded percentage and a lower current cost to the Village since it assumes that interest will fund a greater percentage of the cost of the pension (employer and employee contribution fund the remainder). For the 2005 studies, both the Police Pension Fund and Firefighters' Pension Fund used an interest rate assumption of 7.5%. For the last several years, however, the interest rate assumption has been a significant issue with several Police Pension Fund board members. In the late 1990's, when the stock market kept setting all -time highs, a 7.5% interest rate assumption seemed quite achievable. Beginning in 2000, however, the large declines in the stock market coupled with near all -time lows for interest rates (the 90 -day Treasury Bill rate fell below 1% in 2003) made it difficult to expect a long term return of 7.5 %, even if the stock market returns return to historical averages of approximately 10 %. After experiencing four consecutive years of returns below 7.5% (1999- 2002), in 2003 the Police Pension Board requested and the Village Board concurred with a decrease in the interest rate assumption to 7.25 %. In 2003 and 2004, after the investment return assumption was reduced, the stock and bond markets enjoyed a rebound. For 2003, the overall investment return for the Police Pension Fund was 12.14% and in 2004 it was 8.03 %. Since the investment returns for these two years was over the 7.25% actuarial rate at that time, the Police Pension Board recommended and the Village Board approved increasing the actuarial interest rate to back to 7.5% for the 2005 valuation. Now that the 2005 results are in and the actual 2005 return was 4.77 %, the Police Pension Board is recommending returning to an interest rate assumption of 7.25 %. As indicated on Exhibit 1, the impact of a 0.25% reduction in the interest rate is significant. If the interest rate is reduced, the Village's funded percentage would be reduced from 86.3% to 83.8 %, the unfunded liability would increase by $847,804, the Village's contribution as a percentage of payroll would increase from 18.59% to 21.06% (17.75% was used in the budget), and the Village's estimated contribution would be approximately $74,000 higher than if no change was made. Also, the Village would now be using different rates (7.25% for Police and 7.50% for Fire) for funds that have a nearly identical investment allocation. When setting the interest rate assumption, the actuarial study should consider the long term nature of the Pension Fund, should consider long term investment performance, and should avoid reacting too much to positive or negative data that has been experienced for only one or two years. The following is information the Village Board may wish to consider in making this determination: • Historical Investment Performance - Exhibit 2 shows the eight year average investment performance at 6.11% since Oak Brook Bank began managing the assets in 1998. When considering this table, it should be noted that legislation increasing the limit for equity investments from 10% to 45% did not happen until 1999. Thus, when the equity investment returns were strong during 1998 and 1999 the Fund only had about 10% of it's assets in equities. On the other hand, when the stock market declined in 2000 -2002, Last saved by Default I \ FINANCE\ DLANGLOI \WORD\ACTUARYpolicemtrate doc Last printed 4/4/2006 2 30 PM the fund had between 25% and 30% of it's assets in equities. If a consistent stock/bond allocation could have been used, investment performance would have been better. ® Past Index Performance- Exhibit 3 was prepared by Oak Brook Bank in order to demonstrate what the index performance would have been over a 1, 3, 5, 7 and 10 year period assuming consistent equity /fixed income allocations. This was done to offset the effects of not having ten years of historical data and not having a consistent equity /fixed income allocation due to the change in State Statutes in 1999. The Police Pension Fund's investment policy provides for a limit of 45% on equity investments, and on December 31, 2005 the Fund had 42% in equity investments. As this table indicates, the ten year return data for a 35% and 45% equity allocation both exceed the 7.50% assumption used in the prior actuarial study. However, the return data for the 5 and 7 year period is substantially below the 7.50% actuarial rate. It is the 5 and 7 year data that give several Police Pension Board members their biggest concern. What are other pension funds using? In the Police and Fire Pension Fund universe, most have similar equity /fixed income investment allocations and by law all are limited to a maximum of 45% in equity investments. Exhibit 4 is a survey done of 45 area pension fiends and indicates that the investment return assumption for these funds ranged from 7.00% to 8.25 %; the average investment return assumption was 7.41 %; and 30 of the 45 funds survey used an investment return assumption equal to or greater than 7.50 %. • Future expectations- despite some statistics based on historical data that indicate that 7.5% may be appropriate, a Police Pension Board member is concerned about the economy going forward as indicated by this comment: "The post 9/11 world environment is a different world from what we have experienced in the past. A world of terrorism, expensive energy costs, competition from new emerging economies such as China and a continuing decline in hard good production in the United States should be taken into consideration in determining future rates of returns expected from our investments." No matter what interest rate is used, it is likely that the actual investment returns will vary widely. The varying returns end up impacting the Village's unfunded liability. By state law the Village's unfunded liability is amortized as a percent of payroll to 2033. Since the biggest concern in setting an interest rate assumption is setting the rate too high, it is likely that in down market either 7.5% or 7.25% would both be too high. If the Village does not change the investment return assumption and investment returns are below 7.5 %, this would result in a higher unfunded liability and thus the amortization payment in future would be greater. By lowering the investment return assumption, the Village's would-be paying an additional $74,000 today and in bad markets the amortization payment would be less in future years, but it would take until 2033 to even out the $74,000. In a good investment market, lowering the interest rate assumption and having returns in excess of the assumed rate would result in lower amortization payments in future years. Please feel free to contact me if you have any questions or need further information. Timothy Sharpe, the Village's actuary, will be in attendance at the Board meeting should you have any questions on the actuarial process or interest rate assumptions used by other jurisdications. Last saved by Default I \ FINANCE\ DLANGLOI\WORDWCTUARYpolicemtrate doc Last nrmted 4/4/2006 2 30 PM r January 18, 2006 POLICE 1. Village Normal Cost 2. Accrued Liability 3. Assets (Market) 4. Unfunded Liability /(SLUrolus) 5. Amortization of UL 6. Tax Levy Requirement (1 +5) 7. TLR Payroll Percentage (6/8) 8. Payroll 9. Percent Funded (3/2) VILLAGE OF OAK BROOK Actuarial Valuation Results 111105 1/1/06 Int:7.50% Int:7.50% Int:7.25% Sal: 5.25% Sal: 5.25% Sal: 5.25% 358,478 370,090 410,358 27,106,938 2803,431 29,531,235 24,091,690 24,739,984 245739,984 3,015;248 3,9435447 4,791,251 137,643 184,677 218,096 496.121 554.767 628.454 17.66% 18.59% 21.06% 258085631 2,984,609 2,98409 88.9% 86.3% 83.8% Timothy W Sharpe, Actuary, Geneva, IL (630) 262 -0600 Oak Brook Police Pension Fund Long-Term Portfolio Performance _ L��s' ✓_:iii- �^.r�,..- �s1:Mw,�'2fr��ri!�;�`:- 'i.�7,�... �x,�sz�s .,srx.:�.5� -i,a,:ortt�ar{�:�• " .:._. a�k��i�zf.; 1998 199,9 2000 2001 2002 2003 2004 2005 Since Inception (annualized) 10.46% 28.58% 462% 2104% 614% -9 10% 156% - 11.88% 166% -2209% 12.14% 28.68% 8.03% 10.87% 6.11% 4.79% 985% -2.11% 13 11% 7.18% 11.30% 236% 3.42% 2.66% 5.86% 5.23% 485% 618% 4.42% 178% 1.15% 1.33% 3.07% 3.49% Note All returns are total returns This includes income as well as changes in the portfolio's market value The returns presented are time - weighted returns The annualized return is the geometric mean return 'Standard & Poor's 500 Index 2 ML Treasury/Agency Index 3 90 -Day U.S T -Bill Performance Review as of 12/31/05 Page 4 U1 /U1 /Ud 1HLi lO :.SU rA.& Oak Brook Police Pension Fund y UAA b.KUL)n DAPM 1ALIa1 tvj UUJ 10 Year Index Performance 1<CiUrDS arc a weigniea ave"ge Ul [tic 367-r 3UU ana 1 reosury /Agency Master reTums. � Y Village of Oak Brook j Pension Fund Investment Return Survey Addison Fire 750% Number of Funds Using - Aurora Fire 700% 700% 11 Aurora Police 700% 725% 4 Bartlett 750% 750% 25 Bartlett Fire 750% 775% 1 Bensenville Fire 750% 800% 3 Bensenville Police 750% 825% 1 Bloomingdale Fire 750% Burr Ridge 750% 45 Carol Stream 825% Clarendon Hills 725% Clarendon Hills 725% Downers Grove Fire 800% Downers Grove Police 800% Elmhurst Fire 725% Elmhurst Police 725% Glen Ellyn Police 750% Glendale Heights Police 700% Hanover Park Fire 750% Hanover Park Police 750% Hinsdale Fire 750% Hinsdale Police 750% Itasca 750% Lemont Fire 700% Lisle Police 700% Lombard Fire 750% Lombard Police 750% Oak Brook Fire 750% Oak Brook Police- Current 750% Roselle Fire 750% Roselle Police 750% Schaumburg Fire 750% Schaumburg Police 750% St Charles Police 700% St Charles Fire 700% Villa Park Fire 700% Villa Park Police 700% Warrenville Police 700% West Chicago Police 700% Westmont Police 750% Wheaton Fire 750% - Wheaton Police 750% Willowbrook 750% Winfield 800% Woodridge 775% Average 7 41 %