Discount Rate Adjustment Proposed for SDCERS - FAQ

Date: Sep 21, 2013

 

On November 8, 2013, the SDCERS Board of Administration will vote on a proposed discount rate change. The following FAQ was prepared to provide background information in advance of that vote.

What is a discount rate?
The discount rate is the rate at which a system discounts future liabilities of member benefits to determine their present value today. The discount rate is not used to determine the investment return objectives of the system, however. The investment staff conducts a separate analysis of risk and the capital markets to determine asset allocations in the investment portfolio and what the targeted investment return will be based upon those allocations. The actuarial discount rate is determined by the SDCERS Board with recommendations from the system actuary.

Why is SDCERS reviewing the assumed discount rate?
Pension plans across the country are looking to lower risk as a prudent approach to managing the assets of the system. Lowering the discount rate can reduce the risk of not achieving the assets required to pay future benefits. This risk reduction occurs since lowering the discount rate increases the present value of the system’s liabilities, and requires increased contributions from both the employer (plan sponsor) and the employees. The Board’s risk preference, historical investment returns, projected investment returns, and industry trends are all factors reviewed and considered in a decision to lower the discount rate. SDCERS has adjusted its discount rate based on an analysis of these factors.

How often is the discount rate adjusted?
On November 8, 2013 the Board of Administration will vote on a proposed discount rate change to 7.25% from 7.5%. The board may review the discount rate at any time with input from the system actuary. If approved by the Board of Administration, this will be the third time the rate has been changed since 2008, when the rate was changed from 8.0% to 7.75% for the first change in decades. In 2011, the discount rate was changed to today’s current rate of 7.5%.

What impact will the discount rate change have on the Annual Required Contributions for each of the Plan Sponsors?
If approved by the Board of Administration, lowering the discount rate to reduce risk to the system will increase the Annual Required Contribution for each of the plan sponsors. The exact impact will not be known until the release of the 2013 Actuarial Valuation in January 2014; however, early estimates indicate the City’s ARC would increase by $14 million, the Port’s ARC would increase by $1.0 million and the Airport Authority’s ARC will increase by $0.5 million.

What impact will the discount rate change have on the Unfunded Actuarial Liability (UAL) for each of the Plan Sponsors?
If approved by the Board of Administration, lowering the discount rate to reduce risk to the system, the UAL for each of the plan sponsors will increase, assuming all other actuarial assumptions are met. The exact impact will not be known until the release of the 2013 Actuarial Valuation in January 2014.

Is lowering the discount rate a municipal pension system common practice?
Yes. Lowering the discount rate has become common practice among municipal pension systems across the country. Since the financial crisis of 2009, many plans have reduced their actuarial discount rate, according to a 2012 survey by National Association of State Retirement Administrators. The median assumption is 7.8%; however, the number of plans assuming 7.5% or lower has increased significantly.

Are there any other assumption changes being considered by the Board of Administration on November 8, 2013?
Yes. The Board will consider adjusting the wage inflation rate from 3.75% to 3.25%.

In June 2013, the SDCERS’ Board of Administration voted to defer to FY 2015 the savings from the 5-year freeze on pensionable pay reached between the City and its labor unions. How will those savings be impacted by the discount rate adjustment?
In May 2013, the City of San Diego entered into multi-year agreements with its six labor unions to freeze pensionable pay. The impact to the City’s ARC from these agreements was approximately $1 billion over the next 30 years, with first-year savings of $25 million in FY 2015. Savings from the agreement will still materialize, but will be partially offset by any lowering of the actuarial discount rate.

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Document Under Categories: Board, Discount Rate

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