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Resolution - 2008-R0492 - Accept Final Audit Report Of Fire Pension Fund - 12/17/2008
Resolution No. 2008—RO492 December 17, 2008 Item No. 5.3 RESOLUTION WHEREAS, Section 802.1012 of the Local Government Code requires an independent audit of public retirement systems every five years; and WHEREAS, Gabriel, Roeder, Smith & Company have conducted the required independent audit of the Lubbock Fire Pension Fund; and WHEREAS, the City Fire Pension Board has received said audit and has responded to it as required by law; and WHEREAS, the governing body is required to receive a presentation of the audit at the first meeting after receiving the final audit report and any response from the public retirement system; NOW THEREFORE: BE IT RESOLVED BY THE CITY COUNCIL OF THE CITY OF LUBBOCK: SECTION 1. The City Council of the City of Lubbock hereby accepts the final audit report of Gabriel, Roeder, Smith & Company, attached hereto as Exhibit A, and the response of the Fire Pension Fund, attached hereto as Exhibit B. Both exhibits are hereby made a part of this Resolution for all purposes. SECTION 2. A copy of the final audit report shall be maintained at the office of the City Secretary for public inspection and a copy of said final audit report shall be forward to the State Pension Review Board not more than 30 days following receipt of said final. audit report as required by Sec. 802.1012 of the Government Code. Passel by the City Council this 17th day of December , 2008. TOM MARTIN, MAYOR ATTEST: Rebe ca Garza, City SecretaryC) APPROVED AS TO CONTENT: Andy Bu sham, Chief Financial Officer APPROVED AS TO FORM: D'o-n-V and iver, i4t-y,AAtt orney dd/res/Fi re PensonA udit08R es December 9, 2008 Exhibit A GRS Gabriel Roeder Smith &Company Consultants & Actuaries August 26, 2008 Mr. Andy Burcham Director of Fiscal Policy & Strategic Planning City of Lubbock, Texas 1625 13`h Street Lubbock, TX 79401 Resolution No. 2008-RO492 5605 N. MacArthur Blvd. 469.524.0000 phone Suite 870 469.524.0003 fax Irving, TX 75038-2631 www.gabriciroeder.com Re: Actuarial Audit of the City of Lubbock, TX Fire Pension Fund Dear Mr. Burcham: Gabriel, Roeder, Smith & Company ("GRS") was engaged to perform an actuarial audit of the City of Lubbock Fire Pension Fund ("the Fund" or "the Plan"). The basis of the audit is the last three biennial valuations, ending with and concentrating on the last valuation as of December 31, 2006. Legislative Requirement House Bill 2664, passed by the 80th Legislature of the State of Texas, requires an audit of the actuarial report and related studies of public sector retirement systems at least once every five (5) years by an independent actuary, with the first review due no later than September 1, 2008. Project Scope The new legislation does not provide detailed guidance on the scope of review required for the actuarial plan audit, leaving that open to interpretation by the governmental entities responsible for conducting the process. In response, the City of Lubbock has engaged GRS to perforin a Level One audit (the most detailed and in-depth audit by actuarial standards), including a technical replication of the valuation results as well as a high level review of the actuarial assumptions and methods, including a comparison of actuarial gain and loss experience over the study period. Principal Conclusions The work prepared by Rudd and Wisdom, Inc. in the three audited actuarial valuations and in all of the supporting information we received appears to be thorough, reasonable, and consistent with the Actuarial Standards of Practice. We have developed our findings through a thorough review of the supporting information and a teleconference with Mr. Robert M. May, FSA and Mr. Mark R. Fenlaw, FSA of Rudd and Wisdom, Inc. ("the Actuary"). Andy Burcham August 26, 2008 Page 2 • We strongly agree with the Actuary that no material benefit increases should be granted in the Plan without increased contributions. • In our opinion, Rudd and Wisdom, Inc. is valuing benefits consistently with the major provisions of the Plan Document. • In comparing valuation results based on GRS' actuarial valuation system with those based on other systems, we consider differences of 0-5% to be acceptable. When we valued the Plan's liabilities on our system, using Rudd and Wisdom's assumptions, methodology and Plan interpretation, we were able to match to within I% on all measurements. Therefore, we agree with the results of the latest actuarial valuation report as prepared by the Actuary. • The current economic assumptions generally reflect a 4.00% inflation rate. While we believe this rate may be slightly high, it certainly falls within the range of reasonable long term inflation assumptions. There appears to be no distinction between general price inflation (average increase in the price of goods) and wage inflation (average increase in wages). • The 8.00% assumed annual investment return rate consists of the 4.00% assumed inflation rate, plus a 4.00%© net real rate of return. The 4.00% real rate of return is well within the acceptable range of reasonable assumptions. We agree with the recommendation from the Actuary in correspondence we reviewed stemming from the December 31, 2002 actuarial valuation to decrease the investment return assumption from the 8.50% prior assumption to the current 8.00% assumption. • The demographic assumptions (mortality, disability, turnover, and retirement) are within an acceptable range and are similar to assumptions used by other public sector plans we have audited. • The calculation of the Actuarial Value of Assets agrees with the stated methodology in the Actuary's latest actuarial valuation report. Side Remark We would like to especially commend the current Actuary for presenting an actuarial valuation report that includes three items which reflect significant effort above what would be considered meeting the "minimal" requirements of an actuarial valuation report. The three items are: A lengthy discussion section at the beginning of the report which details the Plan's current situation. The industry appears to be moving toward actuarial reports which simply present standardized or boiler plate information with little or no commentary with regard to the specific individual plan. Other actuaries are moving in that direction because (1) it takes time to write commentary for each valuation performed, potentially lowering the "profit" generated with each valuation, and (2) comments in the valuation may be misunderstood and used in various ways outside the scope of the valuation. The Actuary, in including a four-page client specific commentary at the beginning of the Gabriel Roeder Smith & Company Andy Burcham August 26, 2008 Page 3 report and other comments throughout, clearly took the time to make the valuation meaningful and valuable to the Fund. 2. A comprehensive discussion explaining any changes since the prior valuation. Not only what the change was, but why and how that impacts the valuation. 3. A sensitivity analysis on the expectations of the next two valuations based on multiple investment returns or payroll growth. An actuarial valuation is a snap shot measurement of a very dynamic financial system. Clients should be careful in putting too much emphasis on the results from one valuation, either positively or negatively. By including a short sensitivity analysis of multiple expectations, the Actuary shows that future results are not certain, and provides the reader a better overall understanding of the funding process. Technical Verification As part of the scope of a Level One audit, we performed a complete technical replication of the December 31, 2006 actuarial valuation results. The following table summarizes the details of our recreation of Rudd and Wisdom's actuarial valuation results and the comparison between the two results with respect to the following: ♦ Present Value of Future Benefits (PVFB) ♦ Unfunded Actuarial Accrued Liability (URAL) ♦ Normal Cost Percentage (NC %) ♦ Funding Period In the aggregate, the above PVFB and NC% are within 0.50%. Given these small differences, GRS is very satisfied that the liabilities of the Plan are being calculated correctly by the Actuary. Actuarial Assumptions In our review of the Fund's actuarial assumptions, we sought to answer the following questions: ♦ Are the assumptions internally consistent? ♦ Are the assumptions reasonable, when compared with those used by other public sector plans? Gabriel Roeder Smith & Company ('000) Rudd and GRS Percentage Wisd©m Difference PVFB (1) (2) (3) Actives $125,068 $124,194 (0.70%x) Retirees and Inactives 80,054 80,236 0.23% Grand Total PVFB $205,123 $204,431 (0.34%) UAAL $26,298 $25,908 (1.48%) EAN-NC% 24.19% 24.30% 0.45% Funding Period 35 Years 35 Years N/A In the aggregate, the above PVFB and NC% are within 0.50%. Given these small differences, GRS is very satisfied that the liabilities of the Plan are being calculated correctly by the Actuary. Actuarial Assumptions In our review of the Fund's actuarial assumptions, we sought to answer the following questions: ♦ Are the assumptions internally consistent? ♦ Are the assumptions reasonable, when compared with those used by other public sector plans? Gabriel Roeder Smith & Company Andy Burcham August 26, 2008 Page 4 ♦ To the extent that there is data on the actual experience of the Plan, are the assumptions consistent with this data? The reader should keep in mind that even given the same underlying experience data, two actuaries will typically never arrive at exactly the same assumptions. There are just too many variables for this to be possible. So the test of a set of assumptions should be whether there are areas of material disagreement between actuaries over the appropriate assumptions to be used for a given situation. We concluded that the Actuary's assumptions are generally internally consistent. In particular, the various economic assumptions are based on an underlying inflation rate of 4.00% (see our comments below), i.e., the assumed annual investment return rate of 8.00% consists of this inflation assumption, plus an assumed net real rate of return of 4.00%. Similarly, the salary increase rate, which is used in projecting members' benefits (if applicable) in the Entry Age Normal ("EAN") Actuarial Cost Method, is the sum of the inflation rate and a merit/seniority/promotional component (which is assumed to be nil by the Actuary). The payroll growth rate, which is used in determining the amortization of the Unfunded Actuarial Accrued Liability, is set equal to the inflation rate/salary scale. (i.e., no growth in membership is anticipated. This is consistent with GASB 25 requirements.) The assumptions are also generally in line with the actual experience we have seen in working with other public sector plans in the State and across the country, as well. It is our understanding that the Actuary makes periodic changes to the assumptions in the biennial valuations, based on the experience of the Plan. The Inflation Assumption By "inflation," we mean price inflation, as measured by annual increases in the Consumer Price Index (CPI). This inflation assumption underlies all of the other economic assumptions employed. It impacts investment return, payroll growth rate, and salary increases. The current annual inflation assumption is 4.00%. Over the five-year period ending in December 2006, the CPI -U has increased at an average rate of 2.69%. However, the assumed inflation rate is only weakly tied to past results. The chart below shows the average annual inflation in each of the ten consecutive five-year periods over the last fifty years: Gabriel Roeder Smith & Company Andy Burcharn August 26, 2008 Page 5 12.00% 10.0M 8.00"1 6.00% 4.00% 2.00°1 0.00°1 Average Annual Inflation Clai-U, Five Fiscal Year Averages 10.061% Average Annual Increase in CPI -U 7.21% 4.55% 4.53% 1.86% Last fifteen (15) years 3.29% 2.84% 2.69% 2.18% 1957-1961 1962-1966 1967-1971 1972-1976 1977-1981 1982-1986 1987-1991 1992-1996 1997-2001 2002-2006 ■ 5 -yr A% Increase The table below summarizes the average inflation over various periods ending December 2006: Periods Ending December 2006 Average Annual Increase in CPI -U Last five () years ears 2.69% Last ten (10) years 2.44% Last fifteen (15) years 2.57% Last twenty (20) years 3.06% Last thirty (30) years 4.23% Since 1913 (first available year) 3.31% Source: Bureau of Labor Statistics, uiYi-U, all items, not seasonauy aujusreu As you can see, while inflation has been relatively low over the last fifteen years, if we look back over a period of 20 or more years, inflation has averaged above 3.00% per year. We recognize that many of the investment consulting firms, in setting their capital market assumptions, currently assume that inflation will be less than 3.00%. We examined the 2007 and 2008 capital market assumption sets for four large investment consulting firms: Ennis Knupp, PCA, Watson Wyatt, and Wilshire. Gabriel Roeder Smith & Company Andy Burcham August 26, 2008 Page 6 As we discovered in our analysis, the assumptions for inflation used by the above four firms range from an annual rate of 2.25% to 3.00%. However, the investment consulting firms typically set their assumptions based on a five or ten year outlook, while actuaries must make much longer projections. Another source of information about future inflation is the market for US Treasury bonds. For example, the December 31, 2007 yield for a 20 -year inflation indexed Treasury bond was 2.00%4 plus actual inflation. The yield for a 20 -year non -indexed US Treasury bond was 4.50%. This means on December 31, 2007 the bond market was predicting that inflation over the next twenty years would average 2.50% (4.50% — 2.00%) per year. However, this analysis can fluctuate significantly over a short period of time. Since January 1, 2006, this methodology has predicted inflation over a 20 -year period in the range of 2.41% to 2.93% per year. This same approach produced a 2.51% predicted annual inflation rate using Treasury bond yields on December 31, 2006. Another source of information is the Public Funds Survey that is prepared on behalf of the National Association of State Retirement Administrators (NASRA) and the National Council on Teacher Retirement (NCTR). This report surveys 100-125 plans, including all of the largest public funds covering state employees or teachers. The current survey shows that the median annual inflation rate assumed for large public retirement systems in the U.S. is 3.50%. The current 4.00% assumption is used by about 25% of the surveyed systems, with almost all of the remaining entities using assumptions between 3.00% and 4.00%. Using the above sources, the reasonable range for inflation appears to be between 2.75% and 4.00%.. Therefore, the current 4.00% assumption is at the top of the reasonable range, and among the highest utilized in the country. To test this assumption, we reviewed the current economic conditions. In April of 2008, the Bureau of Labor Statistics released that the CPI increased 3.93% from April 2007 to April 2008. By most financial professionals, this was considered high. The 4.00% assumption is supposed to represent the long term average of inflation, meaning that about half the time inflation would be higher than 4.00%. We believe the current assumption is at the top of the current reasonable range and should be examined thoroughly over the next few valuations, and especially before any benefit enhancements are granted. Investment Return Rate The assumed annual investment return rate is 8.00%, net of administrative and investment expenses. This is the rate used in discounting future payments in calculating the actuarial present value of those payments. The current assumption assumes inflation of 4.00% per annum and an annual real rate of return of 4.00%, net of expenses. We agree that the 4.00% expected real rated of return is reasonable and within the best estimate range. Currently, the target of the Fund's assets allocated to equities is approximately 60%. Based on information provided by Rudd and Wisdom, the median gross real rate of return based on the current asset allocation is between 4.59% and 5.07%. Since expenses of the Plan currently account for approximately 0.45% of assets per year, the median expected real return rate is between 4,14%Q and 4.62%. Given these capital market expectations, we find the current 4.00% real rate of return assumption reasonable. Gabriel Roeder Smith & Company Andy Burcham August 26, 2008 Page 7 It is important to note that actuarial assumptions must be built from the ground up, not from the top down. Currently, 8.00% is one of the common investment return rates used in the industry, especially by public retirement systems. Also, past actual performance may support the 8.00% assumption. However, the 8.00% assumption should not be targeted before the underlying building blocks are set. If the underlying inflation assumption is too high for the long term, then the 4.00% real rate of return assumption will not create an 8.00% long term investment return. For example, a 3.50% inflation assumption with the 4.00% real rate of return assumption would build a 7.50%© annual investment return assumption for the valuation, Other economic assumptions We have reviewed the salary scale and wage inflation assumptions, comparing them to assumptions used in other actuarial valuations and to general economic conditions and find them reasonable. Demographic assumptions In reviewing the reports, it appears the Actuary recommends minimal changes to the demographic assumptions within each valuation, based on the experience of the Fund. Due to the number of members in the Fund, this practice is reasonable for setting assumptions since a formal and separate five-year experience study would likely not add significant value. We agree with the recommended changes to the retirement patterns, mortality rates, and other miscellaneous assumptions made in conjunction with the last three actuarial valuations and we find these recommendations from the Actuary appropriate and reasonable. Final thoughts Under the current contribution policy, the City's contribution rate for the Fire Pension Fund is tied to the contributions the City makes on behalf of other City employees into the Texas Municipal Retirement System ("TMRS") and Social Security. For equitability purposes, we understand the reasoning behind tying the City contribution rate for the Fixe Pension Fund to the contributions made for other employees in the City, and find this contribution policy reasonable. The policy of tying the City contribution rate to the rate contributed for other employees of the City probably makes the members of the Fire Pension Fund feel as if they are being treated essentially the same as other employees of the City and the employer makes the same contributions for all of the employees working for the City instead of having multiple contribution rates for separate groups. However, there could be future issues associated with such a policy, as discussed below. The actuarial appropriateness of this direct connection could develop problems in the future simply due to the fact that these are, indeed, separate defined benefit pension plans. The future investment experience, benefit provisions, retirement eligibilities, and demographic experience likely will all be different between the two Plans. For example, the TMRS contribution rates from the City are expected to increase dramatically for the year beginning January 1, 2009, from the current 15.73% of payroll to 21.62% (based on the Gabriel Roeder Smith & Company Andy Burcham August 26, 2008 Page 8 current benefit structure and no eight-year phase-in of the total contribution rate). This increase was made effective in order to more appropriately fund for benefits currently expected by the employees of the City of Lubbock in TMRS. An immediate corresponding increase in the contribution rate for the Fire Pension Fund may or may not be in the best interest of the City. By tying the contribution rates together, adverse experience in one pension fund (TMRS) will have directly impacted the contribution requirements, and potentially the benefit levels, in another fund (Fire). In addition, because the new increased contribution levels to TMRS are now expected to be more consistent over time, eventually paying off the unfunded actuarial accrued liability, and then likely lowering the TMRS contribution requirements, the corresponding current increase in contribution levels to the Fire Pension Fund may not be permanent over the long term. However, any corresponding increases to the benefit accruals under the Fire Pension Fund would be permanent, creating more probability of a disconnect between the contribution requirements of the two Plans in the future. This is a real life example of how the policy of tying the contribution levels of the two pension plans may not be in the best interest of the City or the members of either respective Plan long term. We would recommend the additional contributions be slowly worked into the actuarial assumptions used in the Fund's valuation, and with much conservatism. With proper strategic planning, the additional contributions can be used as appropriate to allow for ad hoc benefit increases to retired firefighters in a way that minimally increases the contribution risk to the Fund. If the actuarial valuation were to assume that the recent increases to the TMRS contribution levels are permanent (forever) with no reconciliation that the contribution rate may decrease 20 or 30 years from now, then the Plan could be put at risk if the future accruals of the current and future firefighters were increased proportionately to a level that requires the higher contribution amounts to be permanent. One way for the Actuary to make reasonable comparisons between the two Plans' long term costs would be to compare the normal cost from the Fire Pension Fund to the sum of the normal cost from TMRS and the 6.4% payroll tax paid to Social Security. By targeting the normal cost and not the total contribution when setting benefit levels, the probability of the contribution rates being appropriate over the long term should 'increase. Again, we reiterate that we find this current contribution allocation policy to be reasonable; but the City should understand that the potential risks associated with the two separate retirement plans are not the same going forward, the contribution requirements could diverge, and there could be a time in the future when this current arrangement is no longer appropriate. Therefore, we recommend this contribution arrangement be closely monitored over time and for the actuarial assumptions to be set in a conservative manner for recognizing the increase in the contribution rate. Summary We believe the current actuarial assumption set, as a whole, is reasonable and actuarially consistent. As such and with technical verification, we believe the current actuarial valuation accurately portrays the current actuarial condition of the City of Lubbock, TX Fire Pension Fund. We are available to answer any questions you may have and to provide additional details and insights. Gabriel Roeder Smith & Company Andy Burcham August 26, 2008 Page 9 We appreciate the cooperation we received from the Actuary, Rudd and Wisdom, Inc., the Fund and the City staff during the course of our audit. It was our pleasure to work with all of them. Respectfully submitted, Jos,�t eph P. Newton, FSA, EA, MAAA Consultant Mark R. Randall, EA, MAAA Executive Vice President cc: Mr. Robert M. May, FSA Rudd and Wisdom, Inc. Gabriel Roeder Smith & Company Resolution No. 2008-RO492 Exhibit B Lubbock Fire Pension Fund # 15 Briercroft Office Park Lubbock, Texas 79412 (806) 762-1590 FAX (806) 762-1591 September 29, 2008 Mark R. Randall Gabriel Roeder Smith & Company 5605 N. MacArthur Blvd. Suite 870 Irving, TX 75038-2631 Re: Actuarial Audit of the City of Lubbock, TX Fire Pension Fund Dear Mr. Randall: Thank you for your preliminary report to Mr. Andy Burcham, Director of Fiscal Policy and Strategic Planning for the City of Lubbock, dated August 26, 2008. Mr. Burcham also serves as Secretary to the Lubbock Fire Pension Board of Trustees and as such, presented the board with your preliminary report on September 10, 2008 at our regularly scheduled monthly meeting. House Bill 2664 allows for our response to be included in your final report on the matter. This letter along with the enclosed correspondence from our Actuary, Rudd and Wisdom, Inc. constitutes that response. Generally, your report confirms the condition of the Fund moving forward. Earlier this year, our consultant, Mr. Tim Sharp with Smith Barney completed an Asset/Liability Study for us. This study similarly concluded that the Fund was actuarially solvent both presently and into the foreseeable future. Your "Principal Conclusions" reflect agreement with the basic assumptions used in our actuarial studies, and that "the supporting documentation ... appears to be thorough, reasonable and consistent with the Actuarial Standards of Practice". Your report comments expressed concern on two primary points: assumed inflation rate and current contribution arrangement with the city. In the enclosed comments by our Actuary, the particulars of these two items are addressed, as well as a correction comment on the expenses of the Fund ("Investment Return Rate (pages7-8), page 2), requesting restatement of fund expenses from 0.45% to 0.75%. 2 At the beginning of each actuarial cycle, the Board of Trustees engages the Actuary and discusses all assumptions for the upcoming study. Board philosophy is that the assumptions are points of reference and should change only incrementally over time to maintain relevance to the extended nature of the study. Anomalies within the individual assumptions are only reflected to the extent they significantly impact the long-term value expressed by the assumption. Our lowering of investment return from 8.5% to 8% with the 2002 valuation, which you referred to in your study (page 2), was a response to more realistically account for market experience. A similar dialogue will take place on the topic of inflation, as stated by our Actuary (point 4, page 3), in out next actuarial cycle. The concerns expressed within your report on the contribution arrangement that the city currently has with the Fund is sufficiently and accurately addressed by our Actuary in the enclosed commentary also. The fundamental basis for the arrangement is an expression of equity in employee compensation relating specifically to retirement funding. The additional contributions derived from an increase in TMRS contribution rates are, at least in part, due to TMRS benefit enhancement over the past several years. During this same period of time the Fund's beneficiaries have seen no increases, whether active or retired. Had increases been given out without actuarially accounting for them, as TMRS reportedly did, the contribution increase would serve simply as a correction for us, bringing normal cost back into range. In summary, The Board of Trustees of the Lubbock Fire Pension Fund has always maintained a conservative approach to the underlying assumptions on which our actuarial studies are based. Our Actuary has consistently been faithful in replicating that conservatism in studies performed for us. I believe that I speak for the Board in thanking you for confirming the accuracy of both the assumptions and the professional standards exhibited in their work. Respectfully, Jack Watkins Board Chairman Lubbock Fire Pension Fund Mudd and Wisdom, Inc. Mitchell L. Bilbe, F.S.A. Evan L. Dial, F.S.A. Philip S. Dial, F.S.A. Charles V. Faerber, F.S.A., A.C.A.S. Mark R. Fenlaw, F.S.A. Carl L. Frammolino, F.S.A. Christopher S. Johnson, F.S.A. Robert M. May, F.S.A Board of Trustees Lubbock Fire Pension Fund 15 Briercroft Office Park Lubbock, Texas 79412 CONSULTING ACTUARIES 9500 Arboretum Blvd., Suite 200 Austin, Texas 78759 Post Office Box 204209 Austin, Texas 78720-4209 Phone: (512) 346-1590 Fax: (512} 345-7437 E-mail: rw@ruddwisdom.com Dear Members of the Board of Trustees: J. Christopher McCaul, F.S.A. Edward A. Mire, F.S.A. Rebecca B. Morris, A.S.A. Michael J. Muth, F.S.A. Ronald W. Tobleman, F.S.A. David G. Wilkes, F.S.A. Valerie M. Zinzer, F.S.A. September 26, 2008 Re: Actuarial Audit Response At your request, we are writing to respond to some of the recommendations and commentary contained in the preliminary report of the actuarial audit of the Lubbock Fire Pension Fund (Fire Fund) by Gabriel, Roeder, Smith & Company (GRS) for the City of Lubbock (City). The City was required by Texas state law to have this audit performed. We appreciate the quality of the GRS audit and the professional way in which they interacted with us in performing their audit. We are responding to three parts of the GRS report. Inflation Assumption (pages 4-6) 1. We agree that our "current 4.00% inflation assumption is at the top of the reasonable range"; however for the long-term future (401-60 years), we think 4.00%fl has been an appropriate assumption in recent valuations. 2. The historical average annual rates of inflation shown on page 5 are useful for reviewing our current inflation assumption, but are somewhat incomplete. When we review historical inflation, we like to include more periods that exceed 30 years because the long-term future for a defined benefit pension plan is 40-60 years. For example when we reviewed historical inflation as a part of preparing for the December 31, 2006 actuarial valuation, we prepared the following table: Board of Trustees Page 2 September 26 2008 Price Inflation in the USA Average Annual Rates of Increase in the CPI -U Years Number Average fDec. to Dec.) of Years Annual Increase 1951-2006 55 3.76% 1956— 2006 50 4.06 1961-2006 45 4.33 1966— 2006 40 4.64 1971-2006 35 4.65 1976— 2006 30 4.23 1981-2006 25 3.10 1986 —2006 20 3.06 1991-2006 15 2.57 1996— 2006 10 2.44 3. We agree that this assumption "should be examined thoroughly over the next few valuations." In fact, in recent years we have reviewed it before each biennial actuarial valuation for the Fire Fund, and we will continue that practice. 4. When we review this assumption for the December 31, 2008 actuarial valuation, we will consider lowering it. Investment Return Rate (pages 6-7) The preliminary report includes two sentences on page 6 that say "Since expenses of the Plan currently account for approximately 0.45% of assets per year, the median expected real return is between 4.14% and 4.62%. Given these capital market expectations, we find the current 4.00% real rate of return assumption reasonable." The numbers in the first sentence were from our review of economic assumptions for the December 31, 2002 actuarial valuation. We suggest that GRS quote numbers from our review of economic assumptions for the December 31, 2006 actuarial valuation, and rewrite the first sentence in the final report to read, "Since expenses of the Plan are expected to account for approximately 0.75% of assets per year, the expected real return, net of expenses, is between 3.94% and 4.50%." Final 'Thoughts (pages 7-8) This section of the GRS report begins with two short paragraphs that are summarized by one of their sentences: "For equitability purposes, we understand the reasoning behind tying the city contribution rate for the Fire Pension Fund to the contributions made for other employees in the City, and find this contribution policy reasonable." We agree with GRS that this contribution policy is reasonable. Board of Trustees Page 3 September 26, 2008 This contribution policy was developed around 1978 by Sterling Miller (deceased), Director of Finance, City of Lubbock and Robert M. May of Rudd and Wisdom, Inc. Mr. Miller wanted to develop a formula that balanced the interests of the city firefighters and other city employees. Mr. Miller and Mr. May developed the contribution parity formula to implement the contribution policy. We believe that this long-standing and continuous contribution policy has worked exceptionally well for both the City and the Fire Fund for the reasons below. 1. Contributions to the Fire Fund, Texas Municipal Retirement System (TMRS) and Social Security are expressed as rates that are objective and concise percents of covered payroll. These rates are transparent and easy to compare. The contribution policy using the parity formula provides a reasonable relationship between (a) contributions made by firefighters and on behalf of firefighters by the City and (b) contributions made by other city employees and on behalf of other city employees by the City. However, benefits are not transparent and are very difficult to compare because: a. The retirement, disability, survivor, termination and post-retirement cost-of- living ost-ofliving (COLA) benefit and eligibility provisions of the City's three defined benefit plans (Fire Fund, TMRS and Social Security) are substantially different. b. Assumptions, which are subjective, must be made to compare benefits. Differences in these assumptions (retirement age, years of service at retirement, future annual pay increases, amount and frequency of post-retirement COLAs, etc.) can materially affect comparisons. e. TMRS benefits are particularly difficult to understand and compare. As retained actuaries for the Fire Fund and former retained actuaries for TMRS we are well qualified to make a benefit comparison study. However, we have never been asked to make this type of study and do not recommend it because we believe it would produce inconclusive and potentially misleading results. It would also be expensive to complete. 2. The City has increased retirement benefits in its TMRS plan for the non -firefighter (other) city employees and retirees from time to time over the past 30 years. This has caused increases in the City's annually determined TMRS contribution rate. The contribution parity formula has resulted in increases in the City's contribution rate to the Fire Fund as increases have been made to the City's TMRS contribution rate. These increases in contributions to the Fire Fund have allowed its Board of Trustees to increase retirement benefits for firefighters and retired firefighters over the past years. Board of Trustees Page 4 September 26, 2008 3. These increases in contributions to the Fire Fund resulting from the parity formula have allowed it to grow faster than comparable Texas local firefighter retirement funds, as shown by the table below. We believe the Fire Fund would have been significantly less than $154.7 million on December 31, 2007 if Lubbock had not consistently contributed the annual contribution rates determined by the parity formula for the past 30 years. Active December 31, 2007 City Firefighters Population_ Fire Fund Balance Corpus Christi 414 278,520 $101.3 million Irving 306 191,615 115.6 Laredo 335 191,538 71.5 Lubbock 301 203,715 154.7 4. With higher past city contributions to the Fire Fund resulting from use of the parity formula, its Board of Trustees has being able to increase benefits more than comparable Texas local firefighter retirement funds, as shown by the table below. Retirement Benefit Formula Percent of Final Average Monthly Benefit for Each Cites_ Salary (FAS) for First 20 Years Year Above 20 Corpus Christi 50.80% $137 Irving 63.50 $ 60 Laredo 57.60 2.88% x FAS Lubbock 68.92 $335 We would note that the GRS description of this contribution policy is inaccurate in the second paragraph of this section. "...the employer makes the same contributions for all of the employees working for the City instead of having multiple contribution rates for separate groups." However, the city does have multiple contribution rates, as shown in the table below, because the contribution policy is guided by a mathematical formula that solves for the City's contributions to the Fire Fund based on (1) the City's contributions to its plan in TMRS and to Social Security for its non -firefighter employees, (2) the non - firefighter employees' contributions to TMRS and to Social Security, and (3) the firefighters' contributions to the Fire Find. The contribution rates for 2008 are shown below. Board of Trustees Page 5 September 26, 2008 Non -firefighter Employees TMRS Social Security Total Firefighter Employees Fire Fund Social Security Total 2008 Contribution Rates Ci1y EmpIoyee 15.89% 7.00% 7.65 7.65 23.54% 14.65% 19.97% 12.43% 0.00* 0.00` 19.97% 12.43% For firefighters not required to participate in Medicare, there is no contribution. For those participating in Medicare, the rate is 1.45%. The parity formula was developed before the change in Federal law requiring the firefighters hired after March 1986 to participate in Medicare. The formula components for 2008 reveal that (a) the firefighters' contribution rate to the Fire Fund (12.43%) is less than the total of the non -firefighter employees' contribution rates to TMRS and Social Security (14.65%) and (b) the city's contribution rate to the Fire Fund (19.97%) is less than the total of the City's contribution rates to TMRS and Social Security (23.54%). Over the past 30 years, the City has always contributed a smaller rate for firefighters than for non -firefighters because the firefighters have always contributed a smaller rate than non -firefighters. Even though GRS says both at the beginning and end of this section that the current contribution policy is reasonable, GRS also says that "there could be a time in the future when this current arrangement is no longer appropriate." The primary reasons given by GRS are the changes in the TMRS contribution policy being implemented in 2009. The near-term effect of this policy change is an increase the City's TMRS contribution rate from 15.89% in 2008 to 16.83%©, an increase of 0.94% of covered payroll. This 2009 rate is the fust rate in an eight-year phase-in to an ultimate higher rate beginning in 2016, e.g., 23.00%© of payroll. CRS correctly states the reason for this significant increase in future TMRS rates: "This increase was made effective in order to more appropriately fund for benefits currently expected by the employees of the City of Lubbock in TMRS." If the change made by TMRS to more appropriately fund the "annually repeating" COLAs for pensioners and updated service credits for employees had been in place when the City first adopted those two annually repeating provisions, then the City's rates would have been higher than they were in the last 10 years. So part of the significant increase in the City's rate is to make up for past under -contributing for these annually repeating provisions. We believe the Fire Fund deserves a comparable increase in the City's rate to make up for the past under -contributing to the Fire Fund in those 10 years. Continuation of the parity formula would accomplish that. Board of Trustees Page 6 September 26, 2008 The long-term effect of the new TMRS contribution policy is a closed 30 -year amortization period for the unfunded actuarial accrued liability of the City's TMRS plan. This change brings with it an expectation that the City's TMRS contribution rate will decrease significantly after the closed 30 -year amortization period has expired beginning in 2039. The primary concern of GRS appears to be that if the parity formula is continued with the new TMRS contribution policy beginning in 2009, the Fire Fund might permanently increase its level of benefits too much, relying on increases in the City's contribution rate that may not be permanent over the long term. We believe that is a reasonable concern. However, we strongly disagree that this concern makes continuation of the parity formula inappropriate for the future. The Fire Fund does not have automatic or annually repeating COLAs for its pensioners as the City's TMRS plan does for all other city pensioners. The higher city contribution rates that would result from the continuation of the parity formula increase the likelihood that the Fire Fund would be able to provide more meaningful and more frequent ad hoc COLAs to its pensioners in the future. This would make the ad hoc Fire Fund COLAs for pensioners somewhat more comparable to the quasi -automatic annual TMRS COLAs and automatic annual Social Security COLAs that other retired city employees have received and probably will receive in fixture years. We agree in principle with the recommendation in the first sentence of the first full paragraph on page 8 of the GRS report that the additional city contributions due to the continuation of the parity formula "be slowly worked into the actuarial assumptions used in the Fund's valuation, and with much conservatism." The suggestion by GRS for making comparisons between the two plans' long-term costs in the last two sentences of that paragraph is good in concept but short on details. We believe a better approach for the long-term future is to provide guidance for the Fire Fund's benefit improvements so that its normal cost contribution rate is an adequate amount below the sum of the firefighters' contribution rare and the City's lower expected contribution rate according to the parity formula after 30 years beginning in 2039. This approach would include our using a conservative assumption of future city contribution rates and recognizing the new TMRS contribution policy's expectation for an eventual lower city contribution rate in each of our biennial actuarial valuations for the Fire Fund in the calculation of the amortization period and in the approval of benefit improvements. In summary, we believe that the City's long-standing contribution policy using the parity formula has been a good policy for both the City and the Fire Fund. We believe this policy should be continued, and we strongly disagree with the assertion by GRS that the parity formula may be inappropriate in the future. We believe the appropriate response to the new TMRS contribution policy is to base each future actuarial valuation and every consideration of benefit improvements for the firefighters and pensioners on a conservative actuarial assumption of future city contribution rates, recognizing the new Board of Trustees Page 7 September 26, 2008 TMRS contribution policy's expectation that there will be a reduction in the City's TMRS rate beginning in 2039. Please let us know if you have any questions about these responses to the GRS preliminary report of their actuarial audit. Sincerely, Mark R. Fenlaw, F.S.A. W. X Robert M. May, F.S.A. MRF;RMM:ph I:1ciientsTire\wd120081iubbocklBOT-audit response 0426.doc