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Actuarial Valuation & Report Police & Firemen Pension System I I I I I I I I I I I I I I I I I I . ACTUARIAL REPORT ~~~k CONSULTING ACTUARIES III S.BEMISTON AVENUE ST. LOUIS 5, MISSOURI . 612 WEST 47TH STREET KANSAS CITY 12, MISSOURI I I I I I I I I I I I I I I I I I I I 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 I I I I I I I I I I I I I I I I I I I 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-~ I I I I I I I I I I I I I I I I I I I 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, i or should die after becoming eligible for retirement for any -2- --- I I I I I I I I I I I I I I I I I I I 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. -3- I I I I I I I I I I I I I I I I I I I 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 -4- I I I I I I I I I I I I I I I I I I I 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; -5- I I I I I I I I I I I I I I I I I I I 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. -6- I I I I I I I I I I I I I I I I I I I 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 -7- I I I I I I I I I I I I I I I I I I I 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 -8- I I I I I I I I I I I I I I I I I I I 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. -9- I I I I I I I I I I I I I I I I I I I r:" ---~."-'" ...".'~.~" no ~ -"..- 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. -10- I I I I I I I I I I I I I I I I I I I 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. -11- I I I I I I I I I I I I I I I I I I I 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% -12- I I I. I I I I I I I I I I I I I I I I 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 -13- I I I I I I I I I I I I I I I I I I I 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.. -14- I I I I I I I I I I' I I I I I I I I I 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 -15- I I I I I I I I I I I I I I I I I I I 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. -16- I I I I I I I I I I I I I I I I I I I 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) -17- I I I I I I I I I I I I I I I I I I I 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. -18- I I I I I I I I I I I I I I I I I I I VII. APPENDIX ACTUARIAL ASSUMPTIONS PARTICIPANT AGE, SERVICE, SALARY DISTRIBUTION . I I I I I I I I I I I I I I I I I I I ACTUARIAL ASSUMPTIONS -20- I I I I I I I I I I I I I I I I I I I 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. -21- I 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 I -22-