Nelson and Warren, Inc. Actuarial Report 1
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1 ACTUARIAL REPORT
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/9419Wal regregk t f
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CONSULTING ACTUARIES
III S. BEMISTON AVENUE
ST. LOUIS 5, MISSOURI
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612 WEST 47TH STREET
KANSAS CITY 12, MISSOURI
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ACTUARIAL VALUATION AND REPORT
FOR THE POLICE AND FIREMEN PENSION SYSTEM
' OF THE CITY OF SALINA, KANSAS
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1 NELSON AND WARREN, INC.
Consulting Actuaries
' 612 West 47th Street
Kansas City, Missouri
July, 1963
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I. INTRODUCTION
' This report covers the results of an actuarial valuation
1 of the plan conducted as of January 1, 1963. Its purpose is
to disclose the following:
' (a) The dollar value on January 1, 1963 of all
benefits promised under the terms of the .
plan with respect to present participants
and their beneficiaries;
(b) The annual rate of deposit to the reserve
' fund which, in addition to the participants '
own contributions, is necessary to meet the
current and future financial committments of
1 the plan as they come due; and
(c) The current unfunded accrued liability of
the plan, which is the amount in addition
' . to the future payments computed in (b) above,
necessary to be paid for the accrued benefits
earned to date.
' The following sections of this report outline the pro-
' visions of the plan, explain the funding process, develop the
valuation results, establish current and future reserve levels,
and conclude with our recommendations.
' NELSON AND WARREN, INC.
BY: d' �C �ie
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II. SUMMARY OF BENEFITS AND PROVISIONS
Eligibility : All members and officers of the police and fire
departments become members of the system on their dates of
employment.
Member Contributions : Each member contributes a membership
' fee of $5.00 to the system upon becoming a member and there-
after 3% of his monthly salary for so long as he remains an
' active member of the system. Should a member terminate prior
to becoming eligible for benefits from the system, 50% of his
contributions are refunded upon demand. A requirement of re-
employment is return of the refunded portion to the system.
Retirement Benefits : A member with 22 or more years of service
' with the department may retire at any time after the age of 50.
' In the event of retirement he is entitled to a monthly pension
equal to 50% of his monthly rate of salary prior to retirement
' LESS : the amount of compensation he shall receive from any em-
ployment in excess of the amount of retirement income received
under the plan, such reduction continuing until his sixtieth
' birthday; and provided further that no pension payments shall
be made while the individual is receiving compensation for em-
ployment in or holding of any public office.
Death. Benefits : If a participant should die prior to becoming
' eligible for retirement as a result of service connected cause,
or. should die after becoming eligible for retirement for any
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' cause, his widow shall be entitled to a pension of 50% of his
salary payable for as long as she lives or until she remarries,
whichever occurs first; provided that if the death of the par-
ticipant occurs after he has retired under the plan, his widow
must have been his wife at the date of his retirement. Pro-
vision is made for continuation of the monthly income to minor
children (until age 18 or earlier marriage) in the event there
' is no widow or such widow has remarried.
Disability Benefits : If a member ' shall become permanently in-
jured or disabled while engaged in the performance of his duties
he shall be retired on a pension equal to 50% of his salary. In
the event he recovers and returns to service such period of dis-
' ability shall apply towards years of service for regular retire-
ment purposes.
1 Funding : By statute, the City may levy tax on tangible taxable
property not to exceed one mill for the purpose of maintaining
a reserve, which, together with accumulated employee contribu-
tions and other authorized contributions to the fund (such as
those made from time to time from the firemen' s relief fund) ,
1 will be sufficient to pay all benefits and maintain a reserve of
at least $10,000 but not more than $50,000.
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III. FUNDING THE RETIREMENT SYSTEM BENEFITS
' In its simplest form a retirement system represents a con-
tinuation of the payroll to certain individuals (and/or their
' beneficiaries) who in the future qualify because of retirement,
' disability or death. It is, therefore, simply an additional
payroll cost. This additional payroll cost can be met in three
ways :
A. It can be paid each month as it occurs, just as
are the salaries of active employees.
B. The expected amount of all the payments to a
' qualifying individual or his beneficiary can
be set up in a fund at the time such payments
are to commence.
C. An amount can be set aside each year for the
individual which, when he qualifies for benefit
payments, will then equal the expected amount of
all such payments.
(A) represents a non-funded plan and is generally called a
' pay-as-you-go" system. (B) and (C) represent two types of fund-
, ing a plan, the former being termed as "terminal-funding", the
latter as "advance-funding".
' To the employer or taxpayer the advantage of the funding
arrangements over the "pay-as-you-go" system is essentially a
' lower cost over the long run. The following example illustrates
' this.
If a member retires at age 55, with an annual salary
of $4,000 prior to retirement, and lives just his
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life expectancy of 22. 3 years, the plan will ay him
' $2,000 per year over his life expectancy, or $$44,600,
and under the unfunded arrangement this is the cost
' of the plan. If, however, a sum could be appropriated
at the time he retired, which, if invested at 2½7 , would
provide the same retirement income, the cost would be
$$32,916 .instead of $44,600, the difference being interest
earnings on the amount set aside.
Carrying the example one step further, instead of appro-
priating $32,916 at date of retirement, a sum could be
set aside each year which invested at 22%, would grow
to $32,916 at retirement. Assuming the individual in
this example joined the plan at age 25, the annual sum
' required would be $731, or a total of $21,930, spread
over the individual ' s period of active service instead
of $32,916. Thus, the latter method, "advance-funding",
is the least expensive way of providing the retirement
benefits.
Among the active group of participants some will withdraw
and never qualify for the plan retirement benefits. As a result,
' the computation of the advance-funding annual appropriations is
discounted to reflect the expected rate of withdrawals. Thus,
' for all members entering at the age of 25, in this example, in-
stead of an annual appropriation of $731 per member, this amount
is reduced to $289 per member. If the withdrawals occur as assumed
' and the fund earns the assumed interest of 22% per annum, there
will be available the required $32,916 at retirement for all those
' remaining to retire at age 55 with an annual benefit of $2,000.
Thus, even though an appropriation each year is made with respect
- to all of the participants, the cost for each person who retires
' remains $21,930, as against $32,916 under the terminal-funding
arrangement and $44,600 under the unfunded pay-as-you-go method;
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' and the cost for those who do not qualify for retirement benefits
is zero.
In the above example, the effect of member contributions
on the costs has been ignored. However, in each instance the
cost to the City is reduced accordingly, and the comparative re-
' sults are identical. Also, in actual experience the termina-
tions will not occur exactly as predicted or assumed, and in the
' advance funding computations, deviations in the experience are
usually corrected each year.
Furthermore, the greater the interest return on the invested
funds the lesser becomes the required appropriations. In a funded
plan, interest, therefore, is an extremely important factor. In
the early years of a funded plan, the appropriation will be con-
siderably larger than the annual benefit payments. As time goes
1 on, however, this ratio will reverse itself to the point where
' annual costs will represent only 50% to 60% of the benefits paid,
the interest earnings on the reserve funds making up the difference.
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IV. VALUATION
The following valuation of liabilities under the plan and
computation of future costs is based upon various assumptions
' as to what the experience will be under the plan. These assump-
tions are set forth in Section VII, and are conservative.
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There are various methods of calculating costs of a retire-
' ment plan and, consequently, the liabilities at any given time.
' The two principal methods are the level cost and the step-rate
cost. Under the former, future costs tend to remain level, where-
as under the latter, costs increase each year starting out lower
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and ending up higher. The former has been used in this valuation.
' Under this method a level annual cost from the date of entry
into service to the expected normal retirement is calculated for
teach participant. On any given valuation date the fund or reserve
' that should be on hand is the sum of these level deposits for each
year from entry to the plan to the current date, and increased for
the assumed interest earnings. The difference, if any, between
' this sum and the then assets of the plan represents the "unfunded
accrued liability". The level annual costs represent the plan
"normal costs". The level costs for each participant are aggre-
gated and discounted together for the expected effects of with-
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drawals in the future due to terminations, deaths, and disabilities,
and for interest. These adjustments simply reduce the aggregate
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of individual costs to reflect what may be experienced in the
future. To the normal costs for retirement are then added for
' the group as a whole the expected costs of pre-retirement death
benefits and disability retirements to arrive at the normal cost
' for the plan as a whole.
Based upon the provisions of the plan, the annual members'
' contributions are determined. The normal cost to the City is
' then determined by reducing the overall normal cost by a portion
of the members ' contributions. This portion is determined by
' discounting the actual members ' contributions to reflect the fact
in the event of a member' s termination for any cause prior to re-
tirement, at least one-half of the accumulated member' s contribu-
tion will be paid out.
' To illustrate how this operates, consider an officer who is
' now age 35 with 10 years of service earning $4,560 per year.
Assuming no future change in his salary, his annual contributions
' will be $136.80, and the City ' s annual normal cost contribution
will be $1,042. 28. If he lives to retire at age 55, when he has
completed 30 years of service, there will be on hand $32,625 as
a result of his total contributions made from the date he entered
the plan and on account of the City ' s normal cost contributions
made from his current age, and from the assumed interest earnings
' on these contributions. This amount, however, will not be suffi-
cient to pay the retirement income for so long as he and his wife
are expected to live. Rather it will be $15,064 short, because
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the normal cost was not put into the plan by the City for the
Ifirst ten years he was a participant under the plan. Thus, at
' retirement 327, of the promised benefit will not have been funded.
This will be true to a greater or lesser extent for all present
' members who have one or more years of past service. Therefore,
it becomes incumbent to find out what the unfunded liability
' for all of those members is as of today in order to learn how much,
' in addition to the 'normal cost, must be put in over a period of
years, so that for all of those members the proper amount of funds
will be on hand when they retire. This is precisely what the
valuation reveals. The results of the valuation are shown in
the following actuarial balance sheet.
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ACTUARIAL BALANCE SHEET
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Liabilities
Police Firemen
Present Value of Benefits for:
Active Life Retirement $610,884 $ 984,010
Active Life Death and Disability 26, 199 37,571
' Retired Life and Beneficiary 274, 737 192,786
Total Accrued Liabilities $911,820 $1, 214,367
' Assets
Present. Value of:
Future Member Contributions $ 60,960 $ 97,810
Future City Normal Cost 277,563 253,859
Cash Assets as of 1-1-63 9,446 10,381
Total Assets $347,969 $ 362,050
' Unfunded Accrued Liability 1-1-63 563,851 852,317
Total of Assets and Unfunded Liability $911,820 $1, 214, 367
In this balance sheet the liabilities represent the current
value of all benefits expected to be paid in the future. There-
' fore, the assets include the current value of all contributions
expected to be received in the future. Thus, the actuarial bal-
ance sheet expresses the fundamental equation that the present
value of all benefits to be paid must equal the present value of
all contributions to be received plus the assets on hand. The
balancing item in the equation is the unfunded accrued liability.
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NORMAL COST
The normal cost is the level cost to the City as calcu-
lilated in accordance with the above explanation. The normal
' cost for all current participants is:
% of Partici-
pating Salaries
Police $28,322 21.0
Firemen 27,767 12.4
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FUTURE COSTS
The unfunded accrued liability represents that amount
which in addition to the normal cost will have to be paid to
completely fund the plan. It currently represents 61.8% of
the total liabilities for police and 70. 2% for firemen. This
' is not unusual for a young plan but is too high for a plan which
has been in existence for twelve years. In most public retire-
ment systems, the initial unfunded liability is spread over 40
years for funding purposes, that being considered the most re-
presentative sharing of costs between present and future taxpayers.
' If the remaining unfunded liability is spread over the next
30 years, the annual contribution toward this will amount to $26,281
' for police and $39, 726 for firemen. These annual contributions are
' 19.4% of current salaries for police and 17.8% for firemen. There-
fore, based on the current size and earnings of the two plans, the
future annual costs for the City in order to fund the benefits on
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a reasonable basis would be the following percents of salaries:
Normal Unfunded Total
' Cost Liability Cost
Police 21.0% 19.4% 40.4%
' Firemen 12.4% 17.8% 30. 27
Combined 15.6% 18.47 34.0%
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IV. CONTRIBUTIONS AND RESERVES
At the present time the minimum annual City contribution
' to keep the unfunded liability from increasing is:
Interest On
Normal Unfunded Total Cost
' Cost Liability. To City
Police $28,322 $14,096 $42,418
' Firemen . .27,767 21,308 49,075
Total $56,089 $35,404 $91,493
' In many retirement systems where the actual experience
with respect to mortality and withdrawals approximates that
' assumed, excess interest earned on the assets is often suffi-
cient to pay the interest on the unfunded liability. .
Not all public retirement systems are funded. The State-
' paid portion of the Kansas School Retirement System, for example,
is on a "pay-as-you-go" basis.
' Currently the assets of the Police and Firemen are in cash
tand do not provide any income. However, assuming a yield rate
of 3.57° could be obtained, which is 1% above the valuation rate,
' a reserve fund of $402,742 for police, and $608,800 for firemen
would be needed to provide the required interest to keep the un-
funded liability from increasing. These amounts of reserve are
' larger than permitted under the statutes. Thus, even if the re-
serve for each plan were at the maximum level and invested, the
City would be required to pay each year the deficiency in interest
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on the unfunded liability plus the normal cost, if the plan
were just to keep even with the growing liability.
In small groups such as these, there is, of course, a
time distortion. The build-up in the "pay-as-you-go" costs
' due to those individuals close to retirement, is rapid in the
early years and levels off thereafter for quite some time. Un-
der these circumstances, if the plan is to have any basis for
actuarial soundness, the minimum reserve target should be that
which equals the. existing value of payments being made to re-
tired lives and beneficiaries at any given time. Currently this
level is $274,737 for police, and $192,786 for firemen. In a
larger group the. past payment of the normal costs due, plus amor-
tization of the initial unfunded liability over 40. years would
' generally produce a reserve large enough to cover the liabilities
for retired lives at any given point. In the instant case, the
value of retirement payments, plus the fact that previous con-
tributions to the fund have not been sufficient to pay the normal
cost and the interest on the unfunded liability, have placed the
• plan in a current position where it cannot be considered actuar-
ially sound. During the year 1962, the appropriation from the
' City plus the annual employee contributions was less than the
sum of the annual benefit payments and refunds for both the Police
Iand Firemen. . .
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Furthermore, there is not sufficient reserve in either
plan to provide for the 50% of the accumulated contributions
which is returnable when the members resign. Stated another.
way, if the plan were terminated tomorrow with respect to all
persons other than those currently receiving benefits, the
' funds on hand would not be sufficient to meet the current
' year' s benefits and return one-half of the accumulated member
contributions. The following chart illustrates this:
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50% of
' Accumulated Pension % of
Contribution Payments Total Fund
Police $12,785 $16,248 $29,033 307
Firemen 23,755 10,525 34,280 330
Total $36,540 . $26,773 $63,313 319
' The primary reason for building a reserve in a funded plan
is to use the interest to help pay for the benefits. The sec-
ondary
purpose is to provide a source of benefit payments when
' sufficient contributions cannot be made.
The present level of the reserve is wholly inadequate to
meet either purpose even if the funds were invested, and the
maximum reserve prescribed by the statutes is not large enough
to permit the City to properly fund the plan.
' Current annual payments under the police plan are equal to
50% of the combined City and employee normal cost contributions
IIand the comparable figure for firemen is 31%. These ratios can
' be expected to increase from year to year because of additional
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retirements for age and disability. The 1964 tax levy will be
approximately equal to the pensions paid for the year providing
' no further death or disability payments occur. There may be
some question as to the interpretationcf the statute with res-
tpect to the maximum reserve limit and the maximum tax levy
applying separately to the police and firemen or on a combined
basis. If interpreted to apply separately (the more liberal
interpretation) , the permissible levy in each case could be
made, but only for a period of about two years, as the maximum
Ireserve levels would then be reached; and thereafter, a con-
tribution equal to the normal cost could only be resumed when
the above ratios equal or exceed 1007,. Thus, with no change in
the ordinance or statute the City is locked into a "pay-as-you-
go basis". For years prior to 1964, the City has used more
than 5070 of the participants' annual contributions to pay current
pension payments, a practice we believe most unsound.
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VI. CONCLUSION AND RECOMMENDATIONS
The following observations are made from the standpoint
1 of an actuarial analysis only, and do not consider. the legal
1 or political feasibility aspects of the situation.
(1) The annual appropriations by the City to the plan
1 should at minimum be equal to the normal cost plus
an amount to amortize the unfunded accrued liability
over 30 years.
1 (2) The level of reserve at the end of each fiscal year
adopted by the governing body of the City should be
set by formula to equal the reserve at the beginning
of the year plus the excess of receipts over dis-
bursements during the year; since such level already
exceeds the statute ceiling, steps should be taken
' to remove that ceiling.
(3) The funds should be invested and the definition of
1 permissible investments should be broadened so that
in the future long-term investments with attractive
yield may obtained. The current size of the fund
is not large enough to provide diversification, but
1 a larger fund should include some equity investment,
as a target.
1 (4) With the two groups combined, the plan in terms of
number of participants would normally be classified
as large enough to stand on its own. However, the
1 very high value of the death and disability benefits,
in view of the wholly unfunded condition of the plan,
can expose the plan to extreme deviations in exper-
ience from year to year. Chance fluctuations in the
1 short run are more likely to add financial strain
than to alleviate it, and operating under its present
financial schedule, the plan cannot afford any fur-
1 they financial strain. Therefore, from the stand-
point of stability in funding and the City ' s ability
to meet all future benefits, the combination of these
1 groups into a larger body should receive serious con-
sideration by the governing body of the City.
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Specifically, if there is any move within the State
to consolidate the various City police and firemen
' retirement systems into a single plan, this propo-
sition, again from an actuarial point of view, should
be thoroughly weighed for its definite merits. Simi-
larly, should a method be found to tie in the two sys-
tems with KPERS the same merits would exist and should
be given a careful review.
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' VII. APPENDIX
ACTUARIAL ASSUMPTIONS
' PARTICIPANT AGE, SERVICE, SALARY DISTRIBUTION •
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ACTUARIAL ASSUMPTIONS
Actuarial Assumptions are those with respect to interest,
' mortality, terminations, salaries, retirement ages and other
factors which will ultimately affect the cost of the plan.
IActual experience more favorable than assumed, such as greater
' interest earnings, reduce the projected costs, and experience
less favorable will ultimately increase the costs over those
projected in this valuation.
Interest .
' An interest rate of 2%7, was used throughout. This assump-
tion contemplates that all funds held now and accumulated in the
future will earn 2A% interest and that likewise the liabilities .
for all benefits will increase by this reserve rate.
Mortality
' The basis of computing the effect of mortality on retired
' lives and for computing the liability for death and disability
benefits prior to retirement (on active lives) is the 1951 Group
Annuity Table rated back one year.
Withdrawals
tThe liabilities for future normal retirement benefits have
been discounted for withdrawals from the plan for all causes,
(i.e. termination of employment, pre-retirement death and disabili-
ties) .
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Sample rates are shown below:
' Age Withdrawal per 1,000
25 78,000
30 73, 210
' 35
40 64,138
53,504
45 43,333
50 32,102
' Normal Retirement j
For those attaining 22 years of service prior to the age
of 55, it has been assumed they will normally retire at age 55.
' For all others, retirement is assumed to, commence when 22 years
' of service has been attained.
Salary Increments
' A salary increase of 2%7. per year to retirement has been
assumed.
t . Valuation Date
The valuation date is as of January 1, 1963.
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' PARTICIPANT AGE, SERVICE, SALARY DISTRIBUTION
FIRE POLICE
IINumber Number Salary Number Salary
of Parti- Years of Base of Parti- Years of Base
' Age cipants Service. 1962 Age cipants Service 1962
20 2 3 $ 7,920 23 1 -0- $ 3,600
I21 5 3 18, 240 25 1 3 4,080
I 22 4 2 14,880 27 2 7 8,520
23 3 5 11,760 28 2 10 8,520
' 24 4 12 16,200. 29 1 5 4,440
27 2 9 8,232 30 1 5 4,080
I 29. 1 6 4,176 31 3 15 11,760
il 30 2 ' 13 8,328 34 1 3 4,320
31 4 24 16,632 35 2 11 8,640
' .32 1 6 4,152 36 2 15 8,640
33 1 10 4,328 37 1 5 4,440
' 36 3 38 13,016 . 38 2 20 8,880
I 37 1 11 4,296 39 2 8 8, 160
39 2 26 8,984 41 1 4 . 4,080
' 40 1 14 4,608 42 1 11 4,560
41 4 67 . 18,512 44 2 14 11,940
' 42 ' . 1 19 4,768 45 2 12 8,880
I 43 1 17 . 4,608 46 1 11 4,320
44 3 61 13,864 48 4 1 20 4,560
I45 2 37 9,376 51 1 18 4,440
46 1 20 4,608 74 1 19 . 4,320
' 48 1 23 4,848 .. .
.58 ' . 2 51 12,228
60 1 37 5,088
' Total 52 , 514 $223,652 Total 31 216 ' $135,180
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