Required contributions in a defined benefit plan are calculated by an accredited actuary using assumptions about future events. These assumptions fall into two broad categories: economic and demographic.
As part of our fiduciary responsibility and fiscal best practices, these assumptions are checked regularly and adjusted as needed to ensure plans are properly funded. These reviews are conducted by an independent actuary and follow guidelines set forth by the Actuarial Standards Board in Actuarial Standards of Practice (ASOP).
MERS Funding Policy
Our primary goal is to ensure that each municipality’s plan assets are adequate to provide for the benefits that are expected to be paid and that each plan is making reasonable progress to achieve full funding.
Our secondary goal is to have each generation incur the cost of benefits for the employees who provide service in that generation, rather than deferring those costs to future employees. Our funding policy also supports our overarching organizational goals of transparency and accountability.
Our final goal is to balance contribution stability with the commitment to ensure plans are properly funded.
Economic assumptions are based on forward looking trends. In today’s ever-changing world, it is a fiscal best practice to review economic assumptions more frequently so plans can make incremental changes on an ongoing basis. Public retirement systems, like MERS, follow a process for establishing economic assumptions that consider various financial, economic and market factors, and is based on a long-term view.
Review of Economic Assumptions
A capital market analysis is the process of collecting and interpreting data of anticipated performance of various investment asset classes in an investment portfolio. Our independent actuarial consultants, Gabriel, Roeder, Smith & Company (GRS) conducts a capital market analysis for MERS every three years. During the most recent capital market analysis, in 2021, forward-looking market expectations are that investments returns are trending lower. In order to ensure our plans are properly funded, MERS will follow that trend and reduce the current investment return assumption.
Using Dedicated Gains to Reduce the Investment Return Assumption
Based on feedback from employers, MERS worked with GRS to develop a Dedicated Gains Policy that will allow us to systematically reduce the assumed investment rate of return in a way that mitigates the financial impact on our members by using excess market gains to offset the increase in contributions.
Beginning with the 2021 Annual Actuarial Valuation, we will automatically reduce the investment return using excess market gains. While a portion of the excess returns will continue to be smoothed over a five year period, some of the excess returns will be immediately recognized to offset the increase in contributions. In other words, MERS will be “dedicating” some of our investment returns to pay for the decrease in the return assumption.
Reducing the investment return assumption this way uses the investment gains to absorb the impact, rather than passing the impact directly on to funded levels and increasing required contributions.
Following each capital market analysis, MERS will use the data provided to establish a range of reasonable assumptions that will be used for the next three years. Then, each year, if the current assumption falls above the midpoint of that range, the full amount of excess investment returns will be dedicated to lowering the assumption. If the current assumption falls below the midpoint, then only half of the excess investment returns will be dedicated to lowering the assumption. Any gains not used to buy down the assumed rate of return will continue to be smoothed over a five-year period.
The assumed rate of return should always fall within the range of reasonable assumptions. So it will never be reduced beyond the bottom of the range. Similarly, if the assumed rate of return exceeds the top of the range, MERS will reduce the assumption so that it falls within the high end of the range.
Impact on FY 2023 Contributions
For the majority of plans, the excess gains will to cover both the normal cost and payment toward unfunded accrued liability (UAL) for the next fiscal year. Going forward, the normal cost will continue to be calculated using the lower assumed rate of return of 7.00%, which means the normal cost of plan will be higher.
Full details of this dedicated gains policy are available in the Actuarial Policy. For more information about how MERS uses dedicated gains to reduce the investment return assumption, feel free to contact your Regional Manager.
Demographic assumptions look back at the actual experience of the plan. As a best practice, MERS performs an “Experience Study” at least every five years to check key assumptions against the real world and make adjustments if necessary. Our most recent five-year Experience Study (covering years 2014-2018) was completed in February 2020.
Review of Demographic Assumptions
As a result of this Study, the MERS Retirement Board approved adjustments to several assumptions, including updates to mortality rates, mortality improvement rates, and retirement and withdrawal rates. One key change is that we have implemented a fully-generational mortality improvement assumption, which better positions plans for future life expectancy changes. In theory, a fully-generational assumption should need fewer significant adjustments in the future.
Updated demographic assumptions were effective with your 2020 AAV and impact your FY 2022 contributions.
Partnering to Help You Reduce Unfunded Accrued Liability (UAL) & Contribution Relief Options
Required contributions will be based on the full impact of these assumption changes, which is in keeping with our goal of helping you achieve and maintain adequate funding. Based on feedback from our customers, we understand that some of you may need flexibility to prepare for projected increases. Your Regional Manager is available to discuss plan design strategies that may reduce your projected liability, as well as options to phase-in the impact over a longer period.
In addition, while we strongly recommend groups use the funding policy in place, you may request an analysis to determine if an extension of the amortization schedule for existing UAL is possible. By extending the amortization period, you are deferring costs into the future, which will result in higher overall costs over the long-term. Any new UAL will be layered based on the plan’s original schedule.
For more information on your options, see our Managing UAL Page.
Communicating the Facts
If you are asked to communicate information about your plan with key stakeholders or the media, just give us a call, our Regional Teams are here to partner with you.
Contacted by the media? Please review the Media Protocol sheet (pdf) for tips on how to respond.