August 2016 Asset/Liability Study Texas Municipal Retirement System
Asset/Liability Study Texas Municipal Retirement System Table of Contents A CKNOWLEDGEMENTS ........................................................................... P AGE 2 I NTRODUCTION ....................................................................................... P AGE 3 C URRENT S TATUS ................................................................................. P AGE 7 D ETERMINISTIC A NALYSIS ...................................................................... P AGE 8 D ETERMINISTIC S CENARIO A NALYSIS ................................................... P AGE 19 S TOCHASTIC A NALYSIS ........................................................................ P AGE 21 A PPENDIX 1: S UPPLEMENTAL S TOCHASTIC E XHIBITS ........................... P AGE 44 A PPENDIX 2: S ENSITIVITY A NALYSIS : V OLATILITY ................................. P AGE 48 A PPENDIX 3: S ENSITIVITY A NALYSIS : C ORRELATIONS ........................... P AGE 51 A PPENDIX 4: A SSUMPTIONS AND M ETHODS .......................................... P AGE 54 1
Asset/Liability Study Texas Municipal Retirement System Acknowledgements P REPARED B Y : J AMES V OYTKO , S ENIOR C ONSULTANT , RVK, I NC . R YAN S ULLIVAN , C ONSULTANT , RVK, I NC . M ATTHIAS B AUER , C ONSULTANT , RVK, I NC . W ITH THE C OOPERATION OF : D AVID D OUGHERTY , LLC (RVK C ONSULTING A CTUARY ) G ABRIEL R OEDER S MITH & C OMPANY (S YSTEM A CTUARY ) 2
Asset/Liability Study Texas Municipal Retirement System Introduction RVK, Inc. (RVK) has prepared this report for the Texas Municipal Retirement System (TMRS) to: o Present projected valuation results with respect to the funded status of the Plan. o Present projected benefit payments of the Plan. o Investigate asset mixes to determine those which best serve to protect and increase funding levels, while providing adequate liquidity for benefit payments. The valuation projections are shown using both a deterministic and stochastic process. The deterministic process provides an open group analysis of projected valuation results based on a fixed set of future assumptions (see summary in the Assumptions and Methods section of this report). The stochastic process provides an open group analysis of projected valuation results under many capital market environments based on expected asset returns and inflation, and their expected volatility. Using a Monte Carlo simulation technique, both assets and liabilities are assumed to vary stochastically, linked together by changes in inflation. Expected values, variances of the returns and inflation, and correlations are used to generate 2,000 trials to produce a distribution of potential outcomes. A stochastic analysis can answer questions about the best/worst case outcomes along with the probability of such outcomes. 3
Asset/Liability Study Texas Municipal Retirement System Introduction (continued) What is an Asset/Liability Study? Investment programs and the strategy they seek to implement (Investment Policy) do not exist in a vacuum. They seek to satisfy one or more investment objectives and operate within a plan framework that includes the investment objectives (Benefit Policy) and plan funding (Contribution Policy). The purpose of an Asset/Liability Study is to examine how well alternative investment strategies (i.e., differing asset allocations) address the objectives served by the Plan—the Plan’s “liabilities” in the context of the Plan’s funding streams—the Plan’s Contribution Policy. It is the only standard analysis that fully links all three aspects of the Plan’s key financial drivers. In doing so, it creates an important “guidepost” for the actual asset allocation for the Plan; the asset allocation chosen by the Plan’s fiduciaries will likely reflect the nature of the liabilities but also numerous other factors including risk preferences, liquidity, implementation constraints, etc. For the TMRS Asset/Liability Study, we assume the objectives are: 1. Fund all participants’ benefits over time. Investment 2. Assure sufficient liquidity to pay benefits at all times. Policy 3. Foster a stable contribution stream consistent with objectives 1 and 2. 4. Achieve adequate returns without accepting unnecessary or imprudent levels of risk. Asset Liability An Asset/Liability Study is NOT . . . Analysis An actuarial study of the TMRS liabilities—that is the purview of the Plan’s actuary. Benefit Contribution A prescription for Plan benefits—that is the purview of the elected representatives. Policy Policy An assessment of the affordability of contribution levels—that is the purview of the elected officials and their constituents. The sole determinant of the final asset allocation adopted for the Plan—there are a number of factors, including insights from an Asset/Liability Study, which will bear on the optimal asset allocation. 4
Asset/Liability Study Texas Municipal Retirement System Introduction (continued) Asset/Liability Studies in Practice . . . Begin with a forecast of the financial liabilities (i.e., benefit obligations). Include a baseline estimation of the financial contributions to the Plan over time. Compare alternative investment strategies (i.e., total fund asset allocations to the Plan’s financial needs). Draw conclusions regarding how well various investment strategies satisfy the Plan’s financial needs. This Asset/Liability Study . . . Uses data from the December 31, 2015 TMRS Actuarial Valuation provided by the Gabriel Roeder Smith & Company (GRS) to project pension liabilities. Uses the actuarial cost method and the actuarial assumptions described in the December 31, 2015 TMRS Actuarial Valuation prepared by GRS. Compares these specific investment strategies—(A) the Current Allocation (as of April 30, 2016), (B) the Target Allocation, (C) a conservative illustrative portfolio (100% Fixed Income), (D) a diversified portfolio with reduced risk and a diversified portfolio with increased risk relative to the Target Allocation (Lower Risk and Higher Risk), and (E) an aggressive illustrative portfolio (100% Equity). Assumes the Plan’s current benefit policy throughout the entire projection period—changes to the benefit policy are the purview of the elected representatives. Note: Does not assume any actuarial adjustments that may take place in future years. 5
Asset/Liability Study Texas Municipal Retirement System Introduction (continued) Key Takeaways Assets are available to cover 84% of the System’s liabilities as currently estimated by the System’s actuary. This equates to a shortfall of approximately $4.7 billion. The funding ratio on a market value basis is expected to gradually increase to approximately 98% by 2035 from the current value of 84%. The present funding level is unquestionably a strong financial position relative to most other public pension plans. This Study suggests that continued diversification in the investment strategy of the System’s assets is desirable. This Study does not suggest changes to the current investment strategy in place. This Study does not suggest changes to the long-term strategic target allocation. The incremental cost of additional volatility does not justify the potential increase in median outcomes. Reducing volatility increases contributions and does not improve the median outcome. 6
Asset/Liability Study Texas Municipal Retirement System Current Status A summary of the Plan follows: Valuation Date December 31, 2015 Current Status As of December 31, 2015 $35 Assumed Rate $28.4 $30 of Return 6.75% $23.7 $25 Billions $20 Market Value $15 of Assets (MVA) $23.7 billion $10 $4.7 $5 Actuarial Value $0 of Assets (AVA) $24.3 billion Market Value Actuarial Accrued Deficit of Assets Liability Actuarial Accrued Liability (AAL) $28.4 billion Market Value Funded Demographics Ratio (MVA/AAL) 84% 120,000 106,894 Actuarial Value Funded 100,000 86% Ratio (AVA/AAL) 80,000 56,481 Active 106,894 50,707 60,000 40,000 Retirees and 20,000 Beneficiaries 56,481 0 Inactive Vested 50,707 Active Retirees and Inactive Vested Beneficiaries 7
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