Re: Arizona Public Safety Personnel Retirement System - Projection Study

October 7, 2013
Mr. James M. Hacking

Administrator
Arizona Public Safety Personnel Retirement System
3010 East Camelback Road, Suite 200
Phoenix, Arizona 85016-4416

Re: Arizona Public Safety Personnel Retirement System Projection Study

Dear Jim:

Enclosed are the results of a supplemental actuarial valuation to measure the financial effect of
closing the Arizona Public Safety Personnel Retirement System (PSPRS) to new hires. This
supplemental valuation further explores concepts from our August 30, 2013 correspondence

The valuation was based upon data furnished by PSPRS. This data is summarized on page 2.
Actuarial methods and assumptions, except as noted, were the same as those used in the last regular
annual actuarial valuation as of June 30, 2012.

Please call if you have any questions regarding the calculations enclosed.

Sincerely,

Mark Buis, FSA, EA, MAAA

MB:ah
Enclosures

cc: Jared Smout, PSPRS
Brian B. Murphy, GRS
James D. Anderson, GRS
Francois Pieterse, GRS

10/07/2013 -1-

ARIZONA PUBLIC SAFETY PERSONNEL RETIREMENT SYSTEM
PROJECTION STUDY
AS OF JUNE 30, 2012

REQUESTED BY: Mr. James Hacking, Administrator

DATE: October 7, 2013

SUBMITTED BY: Mark Buis, FSA, EA, MAAA; James D. Anderson, FSA, EA, MAAA and
Francois Pieterse, ASA, MAAA
Gabriel, Roeder, Smith & Company

This report contains an actuarial valuation of proposed changes to the Arizona Public Safety
Personnel Retirement System (PSPRS). The purpose of the report is to analyze the financial impact
the proposed changes would have on the Plan. This report should not be relied on for any other
purpose. The report has been prepared at the request of the Fund Administrator. The actuaries
issuing this report are Members of the American Academy of Actuaries (MAAA) and meet the
Qualification Standards of the American Academy of Actuaries to render the actuarial opinion
contained herein. The signing actuaries are independent of the plan sponsor.

The date of the valuation was June 30, 2012. This means that the results of the supplemental
valuations are based upon the June 30, 2012 data and assumptions, unless otherwise stated.
Supplemental valuations do not predict the result of future actuarial valuations. Rather,
supplemental valuations give an indication of the probable long-term cost of the plan changes only
without comment on the complete end result of the future valuations.

This valuation was based upon information furnished by Fund Administrator for use in the June 30,
2012 valuation of the Plan and data provided specifically for this proposal. We checked for internal
consistency, but did not otherwise audit the data. We are not responsible for the accuracy or
completeness of the information provided by PSPRS. All actuarial assumptions, methods, and Plan
provisions valued in this report, are as described in the June 30, 2012 valuation report except as
explicitly described in this document.

Future actuarial measurements may differ significantly from the current measurements presented in
this report due to such factors as the following: plan experience differing from that anticipated by
the demographic assumptions; changes in economic or demographic assumptions; increases or
decreases expected as part of the natural operation of the methodology used for these
measurements; and changes in plan provisions or applicable law. Due to the limited scope of the
actuarys assignment, the actuary did not perform an analysis of the potential range of such future
measurements.

10/07/2013 -2-

PROJECTION STUDY
AS OF JUNE 30, 2012

Actuarial assumptions and methods were consistent with those used in the regular actuarial
valuation of the Retirement Plan on the valuation date, unless otherwise noted. Actuarial
assumptions are adopted by the Retirement Board of Trustees. In particular:

The assumed rate of interest was 8.0%.
The valuation method was the aggregate entry age actuarial cost method.

A brief summary of the data, as of June 30, 2012, is presented below:

Years of
No. Age Service 2012 2011
Actives 18,542 39.1 10.6 $72,767 $71,110
Retirees & Beneficiaries 9,802 62.8 49,480 47,739
DROP 1,496 53.0 62,308 61,467
Inactive Vested 1,264 37.6
31,104
Summary of Covered Population Data
June 30, 2012
Annual Pay or
Retirement Allowance
Averages

10/07/2013 -3-

PROJECTION STUDY
AS OF JUNE 30, 2012

PRESENT PLAN:
PSPRS is an open Defined Benefit Plan.
Employees contribute 7.65% of pay plus an additional 2.70% of pay that is used to pay down
the unfunded liability.
Employers contribute the actuarially determined rate (normal cost plus 24-year amortization of
unfunded liability).

PROPOSED PLAN Scenario 1:
PSPRS Defined Benefit would close to new hires effective June 30, 2013.
PSPRS Defined Benefit would operate as a closed system which:
Pays the unfunded liability over 24 years using level dollar amortization.

PROPOSED PLAN Scenario 2:
PSPRS Defined Benefit would close to new hires effective June 30, 2013.
Current Defined Benefit members would continue to participate in the Defined Benefit Plan and
contribute 10.35% of pay.
PSPRS new hires (on or after July 1, 2013) would enroll in a Defined Contribution (DC) Plan
and receive up to a 5% match on all contributions. No other benefits would be payable.
New plan members may withdraw their accumulated contributions (including employer match)
at any time per IRS rules.
Employers contribute a flat percentage rate over all employees (old and new) for 30 years
which:
Pays the unfunded liability of DB plan over 30 years.
Pays the annual normal cost for DB plan participants each year until there are no longer any
DB plan participants.
Pays 5% match for new DC members which is not used for DB plan funding.

10/07/2013 -4-

PROJECTION STUDY SCENARIO 1
AS OF JUNE 30, 2012

The graphs below illustrate the impact of closing the system to new hires. The first graph shows the
contribution as a dollar amount and the second graph shows the contribution in terms of percent of
payroll. Closing the plan to new entrants leads to increasing dollar contributions initially (2012-
2017) due to the use of level dollar amortization of the unfunded liability. More striking
movements are shown when the contribution rates are shown as a percentage of declining payroll.

0.0%
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$-
$200.0
$400.0
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PSPRS Projection Results
Closed Group
Funded Status - Median Funded Status - 75% Confidence Contribution Amount - Median Contribution Amount - 75% Confidence

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PSPRS Projection Results
Closed Group
Funded Status - Median Funded Status - 75% Confidence Contribution Rate - Median Contribution Rate - 75% Confidence

10/07/2013 -5-

AS OF JUNE 30, 2012

Actuarial Analysis

In order to implement this type of funding structure, we determined the flat percentage contribution
rate needed in order to fully fund the current PSPRS Defined Benefit Plan over a 30-year period
(purple line in chart). Using a deterministic approach which assumes all actuarial assumptions are
met each year, the rate needed under the proposal would be approximately 27.5% of total payroll.
For reference, the June 30, 2012 actuarial valuation pension contributions equaled 30.44% of
payroll. The graph below shows that relative to simply closing the Defined Benefit Plan (green line
in the chart) the new structure would result in decreases in contributions in the near term with
increases in contributions toward the end of the 30 years. As a result, the contributions are back
loaded and the existing Defined Benefit Plan could run the risk of running out of money.

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$0.0
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PSPRS Deterministic Projection Results
DC Plan with 27.5% flat rate
Funded Status - proposed Contribution Amount - Closed Plan Scenario Contribution Amount - Proposed

10/07/2013 -6-

AS OF JUNE 30, 2012

Actuarial Analysis (continued)

A drawback of the deterministic approach is that it does not take into account the probability of cost
of living payments or variability in the investment markets. A stochastic projection is needed to
perform this analysis. The following graph shows that a flat contribution rate of 27.5% of total
payroll will result in a 75% probability of attaining 46% funded status by 2042.

To address this situation, we have also modeled the use of higher flat rate contributions. The chart
below shows the same results using a 33% flat rate contribution for 30 years. Under this scenario,
expected median funding ratios decrease for the first 10 years of the program, but there is now a
75% probability of attaining 100% funded status by 2042.

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PSPRS Stochastic Projection Results
Funded Status - Median Funded Status - 75% Confindence
Contribution Amount - Closed Plan Scenario Contribution Amount - Proposed
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PSPRS Stochastic Projection Results
Funded Status - Median Funded Status - 75% Confidence

10/07/2013 -7-

AS OF JUNE 30, 2012


The projections in the prior page assume a 33% flat rate for all employers. Another major
drawback to this design is that PSPRS has many different employers all with different funding
requirements. The following graph for the Tucson Police shows that a flat contribution rate of
33.0% of total payroll will result in the plan running out of money within 15 to 20 years.

To address this situation, we would have to use a higher flat rate contribution for every employer.
The chart below shows the Tucson Police results using a 48% flat rate contribution for 30 years.
Under this scenario, expected median funding ratios decrease for the first 5 years of the program,
but there is now a 75% probability of attaining 100% funded status by 2042.

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2012 2017 2022 2027 2032 2037 2042
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Tuscon Police Stochastic Projection Results
Funded Status - Median Funded Status - proposed
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Tuscon Police Stochastic Projection Results

10/07/2013 -8-

AS OF JUNE 30, 2012


The charts on this page illustrate that a different rate would need to be developed and monitored for
every employer in order to attain a 75% probability of attaining 100% funding within 30 years.

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Phoenix Fire Stochastic Projection Results
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Tuscon Fire Stochastic Projection Results
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Phoenix Police Stochastic Projection Results

10/07/2013 -9-

PROJECTION STUDY
AS OF JUNE 30, 2012

Comments

Comment 1 - The proposed structure in scenario 2 will result in most of the unfunded liability
being paid off in the last few years of the 30 year program. Similar programs have been used in
Illinois and other places and have resulted in very low funded ratios and the potential to run out of
system assets prior to all benefits being paid to plan participants. Moreover, a single rate is not
suitable for all employers. Different rates would need to be developed, tested and continually
monitored for over 250 different employers.

Comment 2 - The funding of the closed DB plan is based on an 8.0% rate of return. When a plan
closes, steadily increasing cash flow requirements will make earning the assumed rate of return
more difficult. For example, if the fund is only able to earn 7.0% per year, the flat rate contribution
would need to be increased by approximately 4.0% of payroll starting immediately.

Comment 3 - The funding of the Closed DB plan also depends on payroll increases (at a rate of
4.5% per year June 30, 2013 and after) for new hires in the DC plan. To the extent that pay
increases are less than 4.5% or that the active population decreases, the Closed DB plan runs
additional risks of running out of money. For example, if pays only increased at a rate of 3.5% per
year, the flat rate would need to be immediately increased by approximately 2.0% of payroll.

Comment 4 - The proposed funding structure in scenario 2 will result in contributions that will be
less than the GASB Statement No. 25 Annual Required Contribution in the early years of the
projection. This will likely result in a Net Pension Obligation (NPO) on the Systems financial
statements.

Comment 5 Our analysis assumed that recent legislative changes to the System (including
additional member contributions and changes to the cost of living benefits) are upheld. If these
changes are subsequently overturned, our analysis would change and a new study should be
conducted.

Comment 6 If DC accounts are managed by PSPRS, there is a risk that individuals nearing
retirement would be subject to the risk of a downturn in the market just prior to retirement. With
PSPRS as the investment manager, this could result in some litigation risk. Additionally, if both
DB and DC assets are managed by PSPRS in the same manner, the asset allocation in the DC
accounts may be influenced by the liquidity needs in the DB plan resulting in lower rates of return
for DC participants than might have been earned if the asset allocation were based solely in the
interest of DC participants.

Comment 7 We recommend that the structure be reviewed by legal and fiduciary counsel.

10/07/2013 -10-

PROJECTION STUDY
AS OF JUNE 30, 2012

Comments (concluded)

Comment 8 If you have reason to believe that the information provided in this report is
inaccurate, or is in any way incomplete, or if you need further information in order to make an
informed decision on the subject matter of this report, please contact the authors of the report prior
to making such decision.

Comment 9 This report is intended to describe the financial effect of the proposed plan changes.
No statement in this report is intended to be interpreted as a recommendation in favor of the
changes, or in opposition to them.

Comment 10 This report is intended to describe the financial effect of the proposed plan
changes on the Retirement Plan. Except as otherwise noted, potential effects on other benefit plans
were not considered.

Comment 11 A full review of the proposal for compliance with Federal, State, or Local laws or
regulations was out of the scope of this study and not performed.

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October 7, 2013

Mr. James M. Hacking

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