Actuarial Valuation & Report Police & Firemen Pension System
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ACTUARIAL REPORT
~~~k
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
NELSON AND WARREN, INC.
Consulting Actuaries
612 West 47th Street
Kansas City, Missouri
July, 1963
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1. INTRODUCTION
This report covers the results of an actuarial valuation
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
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, ~/n-~
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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 compensa~ion 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,
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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.
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 relie~ fund),
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
way s :
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
ilpay-as-you-go" system. (B) and (C) represent two types of fund-
ing a plan, the former being termed as "terminal-f.undingJr, the
latter as "advance-funding".
To the employer or taxpayer the advantage of the funding
arrangements over the ilpay-as-you-goll 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 pay 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 2~%, 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 2~%, would grow
to $32,916 at retirement. Asslliuing 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 vJithdraw
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 2~% per annum, there
will be available the recuired $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
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 rese~ve 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.
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
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
each 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-
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 qy
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 ~5, 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
first ten years he was a. participant under the plan. Thus, at
retirement 32% 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
Liabilities
Present Value of Benefits for:
Active Life Retirement
Active Life Death and Disability
Retired Life and Beneficiary
Total Accrued Liabilities
Assets
Present Value of:
Future Member Contributions
Future City Normal Cost
Cash Assets as of 1-1-63
Total Assets
Unfunded Accrued Liability 1-1-63
Total of Assets and Unfunded Liability
Police
$610,884
26,199
274,737
$911,820
$ 60,960
277,563
9,446
$347,969
563,851
$911,820
Firemen
$ 984,010
37,571
192,786
$1,214,367
$ 97,810
253,859
10,381
$ 362,050
852,317
$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-
lated in accordance with the above explanation. The normal
cost for all current participants is:
% of Partici-
pating Salaries
Police
Firemen
$28,322
27,767
21.0
12.4
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% 30.2%
Combined 15.6% 18.4% 34.0%
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V. CONTRIBUl'IONS 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
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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-
ia1ly 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
and 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:
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
and 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 interpretation~ the statute with res-
pect 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
reserve 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 100%. 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 50% of the participants' annual contributions to pay current
pension paYment., a practice we believe most unsound.
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VI. CONCLUSION AND RECOMMENDATIONS
The following observations are made from the standpoint
of an actuarial analysis only, and do not consider the legal
or political feasibility aspects of the situation.
(1)
The annual appropriations by the City to the plan
should at minimum be equal to the normal cost plus
an amount to amortize the unfunded accrued liability
over 30 years.
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.
The funds should be invested and the definition of
permissible investments should be broadened so that
in the future long-term investments with att~active
yield may be obtained. The current size of the fund
is not large enough to provide diversification, but
a larger fund should include some equity investment,
as a target.
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
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
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-
ther 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
groups into a larger body should receive serious con-
sideration by the governing body of the City.
(2)
(3)
(4)
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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
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Sample rates are shown below:
.~
25,
30
35
40
45
50
Withdrawal per 1,000
78.000
73.210
64.138
53,504
43.333
32.102
Normal Retirement
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,% per year to retirement has been
assumed.
Valuation Date
The valuation date is as of January 1, 1963.
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I PARTICIPANT AGE, SERVICE, SALARY DISTRIBUTION
I FIREMEN POLICE
Number Salary Number Salary
I 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
I 21 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
I 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
I 30 2 13 8 , 328 34 1 3 4,320
31 4 24 16,632 35 2 11 8,640
I 32 1 6 4,152 36 2 15 8,640
33 1 10 4, 3 Z8 37 1 5 4,440
I 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
I 40 1 14 4,608 42 1 11 4,560
41 4 67 18,512 44 2 14 11,940
I 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 1 20 4,560
I 45 '2 37 9,376 51 1 18 4,440
46 1 20 4,608 74 1 19 4,320
I 48 1 23 4,848
58 2 51 12,228
I 60 1 37 5,088
Total 52 514 $223,652 Total 31 216 $135,180
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