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In researching an issue this week, we stumbled across an article titled, The Anatomy of a Lump-Sum Conversion, written by Corey Swarner, CPC, MBA of Milliman.
In various posts, we've attempted to provide readers with an understanding of how actuarial math including the time-value of money, and actuarial concepts such as life expectancy. But we think Corey really nailed it, and wanted to share his article, which you can read here: https://us.milliman.com/en/insight/the-anatomy-of-a-lumpsum-conversion/ We this this article nicely describes how an actuary calculates an actuarial present value, which is used for lump-sum distributions as well as determining contributions and a defined benefit plan funded ratio. Enjoy!
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At the end of March, we alerted readers to a bill that would amend Sections 218 and 219 of the New York State General Municipal Law to increase the maximum years of service credit that can be earned by a participant from 40 to 50 years. You can read that post here.
The bill is S1091A in the Senate and A2239A in the Assembly. On April 28, 2021, the Senate approved its version of the bill. It was then delivered to the Assembly and referred to the Local Government Committee. Given the activity on these bills, including recent amendments to them, we believe it is very likely that that the Assembly will also pass its version of the bill, paving the way for it to be delivered to the Governor for signature into law. The bill would specifically allow a LOSAP sponsor to extend the maximum years of service credit for up to an additional ten years (i.e., from 40 to 50 years). Additionally, it stipulates that a sponsor could implement that extension in increments or all at once. Finally, the bill clarifies that to amend the program, the sponsor must adopt a resolution and then seek voter approval through a mandatory referendum. The cost impact of increasing the maximum years of service credit will depend on the type of program (DB or DC) and, for DB plans, the actuarial methodology used to determine the contributions. For a defined contribution (DC) plan, there is no immediate cost increase as a result of allowing participants to earn the additional ten years. Instead, the sponsor is simply extending the current cost of the program. Another way to think about it is that the sponsor is postponing a potential cost savings, since costs would decrease once participants reached the maximum years of service credit and could no longer earn a contribution. For a defined benefit (DB) plan, if the actuary is using a funding method that projects benefits into the future, then there could be an immediate cost increase for extending the service cap. If the actuary is not using a projection method, then there likely will be no immediate cost increase. Similar to the DC plan, the sponsor is instead extending the current cost for another ten years. We suggest contacting your actuary for more details. As we follow the progress of these bills, we will post updates here. There are two bills that have been introduced in the current session regarding LOSAP. One appears to be on track to be passed by both houses in 2021. They both would impact only volunteer firefighter LOSAPs adopted pursuant to Article 11-A, not volunteer ambulance squad plans governed by Articles 11-AA and 11-AAA. The purpose of this post is to examine one that is making some progress. This bill would extend the maximum years of service credit that can be earned by a participant from 40 to 50 years. A similar bill was introduced in 2019 and 2020. Both times the bills were passed by the Senate but died in committee in the Assembly. That version of the bill simply crossed out the word "forty" and replaced it with "fifty". This current bill was introduced as S1091 & A2239, with the same proposed change. However, on March 22, 2021, the Senate version was amended and reprinted as S1091-A. It is currently in the third reading, which is the last step before a vote and potential passage by the Senate. In the Assembly, the bill was amended and reprinted as A2239-A, and then recommitted to the local government committee. The amendment is what makes us think this bill is likely to pass both houses in 2021. The amendment adds additional language that fleshes out the details of how a sponsor would implement an amendment to increase the service cap. The new law provides that a sponsor can:
When discussing with clients the original version of the bill that simply replaced forty with fifty, there were two recurring questions: (1) is it mandatory for plans to increase to the 50-year maximum, and (2) if it is not mandatory, is a referendum required? We believe both of these questions are now answered - it is not mandatory and yes, a referendum is required. By removing these two ambiguities, the legislature seems to understand these clarifications were necessary before the bill became law. This appears to be a positive sign that the bill is tracking towards law in 2021. If you'd like to read the bill, you can download a PDF here: 
We'll comment on the other bill in a future post. With every new version of our favorite technology – such as smartphones, televisions, and even cars – we can accomplish or experience something better than we were previously able. The computer has certainly helped the actuary by increasing the speed and accuracy in which calculations can be made. But like many trade-specific tools, the available actuarial software was largely available only to actuaries and required more than just a general understanding of actuarial principles to properly utilize. This has changed with a new website created by the Society of Actuaries, the main governing body for the actuarial profession. This site puts a simple yet powerful tool in the hands of non-actuaries. It can be found here: afc.soa.org/#Calculator. (Note: if this direct link doesn’t work, use this link instead, www.soa.org/resources/tables-calcs-tools/act-practice-tools-landing/ and click the “learn more” link under the “Annuity Factor Calculator”.) It allows the user to calculate an actuarial annuity factor. Having the annuity factor doesn’t do the non-actuary any good, unless the person knows how to apply that value. We hope to give you a basic understanding of how an actuary uses an annuity factor, enabling you to understand and reasonably approximate the numbers in a LOSAP valuation report. The annuity value is used to determine the Actuarial Present Value (APV) of a future obligation. In our context, the obligation is a lifetime monthly service award benefit payment. The APV is then the current lump-sum cash value, in “today’s dollars” of that lifetime monthly service award. If we remove the word “Actuarial” from APV, we are typically removing any decrements, like mortality (life expectancy), disability, and withdrawal (employment termination) from the calculation. Excel can easily calculate the present value of fixed-number of payments with a constant interest rate, whether a lump-sum payable in the future or a series of annual or monthly payments payable over a designated period. A simple example of present value would be to consider that you owe someone $1,000 one year from now. If we assume that we will earn 5% in our savings account during the year, the present value is about $952. If we have $952 in the bank, and earn 5% on that $952 during the year, we will have $1,000 at the end of a year. If we will only earn 1% on our savings account, then the present value increases to $990! That is because we will not earn as much interest, so we need to invest more in our savings account today to have the $1,000 one year from now. The complications ratchet up when we consider a payment that might be $1,000 per month for an individual’s lifetime starting a year from now, and not just a one-time payment. While there are other assumptions the actuary could make in the calculation, for most LOSAPs the two main assumptions are an interest rate and a mortality table. Some factors the actuary must consider:
Ultimately, the APV of a monthly service award is: Monthly Benefit x 12 x Annuity Factor = APV The Annuity Factor is where all of those assumptions are baked into one number. When you first access the tool online, you should see something like this:  There are several different options/assumptions that can be selected. For the more curious reading this article, in the header of the website there is a “Technical Terms” link. By clicking that link you will get more detailed information about some of these options.
In a typical actuarial valuation of a LOSAP, the actuary does not assume mortality before the entitlement age (the tool calls it Mortality Before BCA). The use of a projection method on the mortality varies. For our purposes, we made the following changes:
After making these changes, the resulting annuity factor is 5.7859. Note we did not change the “Primary Annuitant Age” from 45, which means this factor is only for a 45-year-old and based on the assumptions we noted. That being said, if this 45-year-old had accrued a $200 monthly benefit, the APV would be $13,886. In plain English, this essentially means we need $13,886 in the bank today in order to pay a 45-year-old male $200 per month for the rest of his lifetime beginning at age 62. Where you can experiment a bit with this tool is to make changes to the assumptions, such as:
There are a couple limitations to this tool that you must be aware of, especially when trying to compare results to your actuarial report or participant statement:
This free tool from the Society of Actuaries is a valuable resource to help municipalities, participants, and auditors understand a bit of the actuarial mathematics and to verify that the calculations in the actuarial report. You will not likely get a 100% match on the APV you calculate compared the actuarial report, but you should end up with a reasonable approximation. We hope you will give it a try! If a village, town, city, or fire district elected to participate in the “State pension” in order to provide a retirement benefit to its employees, that municipality is participating in the New York State and Local Retirement System (NYSLRS). This system is actually comprised of two pension plans – the Employee’s Retirement System (ERS) and the Police and Fire Retirement System (PFRS).
While a LOSAP is not part of the NYSLRS, and the scale and scope of the NYSLRS is significantly greater than a LOSAP, it can be an interesting benchmark for comparison. How much larger is the NYSLRS than an average DB LOSAP? Based on information we received from the State on 256 defined benefit (DB) fire department LOSAPs, the average DB had $2 million in assets. We know that 256 DB plans is not representative of the total number in New York – the actual amount is likely between 475 and 500 based on other information that is available. If all DB plans were considered, the average of $2 million per plan would certainly be different. Additionally, those values are now over two years old. For our purposes, however, an average DB LOSAP in New York could be reasonably assumed to have an asset value of around $2 million. In general, each DB plan is individually managed by the sponsoring municipality. That $2 million being managed by a sponsor pales in comparison to the value of the assets held for the NYSLRS, which is $194.3 billion as of March 31, 2020. This means from an asset standpoint, the NYSLRS is about 100,000 times larger than an average LOSAP! Therefore, drawing conclusions between the two can be misleading if the proper context is not kept. That said, it is interesting to see the financial condition of the NYSLRS and use some of the information provided as a comparison to a locally-administered LOSAP. On September 3, 2020 the Office of the State Comptroller released the contribution rates for the NYSLRS. The rates for the ERS increased from 14.6% to 16.2% of payroll, and PFRS from 24.4% to 28.3% of payroll. That represents increases of about 11% and 16% respectively. The funded ratio was reported to be 86.2%, a decrease from 96.1% as of 2019 and 98% as of 2018. You can read the press release here: https://www.osc.state.ny.us/press/releases/2020/09/nyslrs-announces-employer-contribution-rates-retirement-system-2021-22 The assumed rate of return on the Common Retirement Fund assets is 6.80%. The Fund earned -2.68% during the fiscal year that ended on March 31, 2020. The fiscal-year end of March 31 was bad timing this year, when the investment markets saw significant declines in March due to the onset of the COVID-19 pandemic. This was a significant factor in the increase in the contribution rates. As of March 31, 2020, the Fund had about 49% of the assets allocated to publicly traded equities, with another 11% in private equity. About 26% was in cash, bonds, and mortgages, 10% in real estate and real assets, and the remaining in alternative strategies. Additional information about the Common Retirement Fund can be found in this press release: https://www.osc.state.ny.us/press/releases/2020/07/dinapoli-state-pension-fund-value-1943-billion Each year, the Retirement Systems Actuary issues a report on the actuarial assumptions used to determine the employer contribution rates. Michael Dutcher is the Actuary and is very skilled and clear in his written communications. We suggest you download and read the report, which is located here: https://www.osc.state.ny.us/sites/default/files/retirement/documents/pdf/2020-09/actuarial-assumptions-2020.pdf We suggest reading the Executive Summary and the section on the Investment Rate of Return found on pages 5 to 9. Mr. Dutcher does an excellent job walking the reader through the importance of the Investment Rate of Return Assumption and the process used to select it. Some key takeaways from this information for LOSAP sponsors are:
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