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12-D Report on City's liability re. firefighters' pension fund JOHN M. CRIDER, JR. RECEIVED MAR 1. 9 2007 TELE9!IX~~~ ~~S;; CONSULTING ACTUARY 1701 GATEWAY BOULEVARD, SUITE 461 RICHARDSON, TEXAS 75080-3627 P.O. Box 832066 RICHARDSON, TEXAS 75083-2066 March 14, 2007 Mr. Ernest Clark Interim City Manager City of Paris, Texas P.O. Box 9037 Paris, Texas 75461-9037 Re: Paris Firefighters' Relief and Retirement Fund Dear Mr. Clark: Following up our telephone conversation, this letter discusses the issue of the City Paris' financial obligation under the Paris Firefighters' Relief and Retirement Fund (Paris FRRF). The conclusion of this letter is that the fire fighters' plan does not represent a financial threat to the City of Paris. Instead, it is an asset which allows the City to provided competitive retirement benefits at a low cost. The City provides retirement benefits to its employees under two retirement systems. General government employees, as well as police officers, are covered under the state-wide Texas Municipal Retirement System (TMRS). Firemen are covered under a plan which is limited to Paris fire fighters and which is administered locally. The fire fighters' plan reports to the City of Paris, the Office of the Fire Fighters' Pension Commissioner, and to the Texas State Pension Review Board. Both TMRS and the Paris FRRF operate as defined benefit pension plans. Both plans' financial results are reported in the City of Paris Comprehensive Annual Financial Report (CAFR). The City contributes the same percentage of pay to each plan. Periodically, someone asks what the City's obligation under the fire fighters' plan would be if the plan were terminated. It appears that the City would have little or no legal obligation if the plan were terminated. In 2004, Texas voters added Section 66 to the Texas Constitution. This amendment provided a series of guarantees to locally administered retirement plans. In a local referendum held May 15, 2005, the citizens of Paris voted to opt out of Section 66 of the Texas Constitution as permitted by the implementing legislation. (TMRS was exempted from the provisions of the constitutional amendment by the legislature.) Mr. Ernest Clark March 14, 2007 Page Two It should be noted that Section 66 of the State Constitution has never been tested in court. Thus, how it is to be interpreted is still open to question. Nevertheless, neither the Paris Firefighters' Relief and Retirement Fund nor the City of Paris is subject to its guarantees. The Paris City Council has asked about the fire fighters' plan previously. At the request of the board, I made a presentation to the City Council on May 18, 2005. During the presentation, I outlined the provisions of the plan and discussed its effect on the financial condition of the City of Paris. At the conclusion of the presentation, I asked Council members whether they had any questions about the plan. No questions were asked. Questions concerning the plan came up again early in 2006. At the request of Mr. Tony Williams and Mr. Gene Anderson, I wrote a letter which discussed some of the technical actuarial terms which seem to cause concern with respect to defined benefit plans such as the Paris FRRF and TMRS. I met with Mr. Williams and Mr. Anderson on January 6, 2006, and discussed the letter with them. It was my understanding that the letter was brought to the attention of the City Council. Contributions under pension plans, such as TMRS and the Paris FRRF, are calculated, in part, by using a quantity know as the "unfunded actuarial accrued liability," or "U AAL. " This term dates from the days when pensions were funded as benefits accrued. The reserves on insurance contracts used to provided plans' benefits represented liabilities on the annual statements of the issuing insurance companies. Thus, when an insurance company actuary-on loan to the IRS during WWII- wrote an IRS bulletin about pension funding in 1945, he used the term "actuarial accrued liability" to describe the reserve which was accumulated in the process of funding benefits. The difference between the reserve and plan assets was referred to as the "unfunded actuarial accrued liability." No thought was given as to how the public would perceive these terms. Today, benefits are funded more rapidly than the rate at which they accrue. However, use of the term "unfunded actuarial accrued liability" has persisted. So, too, has the misunderstanding which it engenders. Guidelines published by the Texas State Pension Review Board (PRB) measure a plan's soundness on an ongoing basis using a quantity know as the plan's "amortization period." The PRB guidelines call for a plan's amortization period to be 40 years or less, with a 25- to 30-year period a more desirable length of time. The 2005 valuation of the Paris FRRF measured its amortization period as 20.9 years. The plan will have a new valuation performed as of January 1, 2007. The Paris FRRF is administered by a board of trustees consisting of three fire fighters elected by plan members, the mayor's designated representative, the City Finance Director and two civilian members. The trustees have been conscientious, responsible stewards of the plan. The fire fighters' ability to tailor benefits to their needs gives them the satisfaction of participating in their retirement planning. Mr. Ernest Clark March 14, 2007 Page Three If you have additional questions concerning this letter or if you need additional information concerning the plan, please feel free to contact me. Sincerely, ~~lLz~, j~~ M. Crider, Jr. (J Enclosure cc: Board of Trustees Paris Firefighters' Relief and Retirement Fund Mr. Gene Anderson Director of Finance City of Paris Mr. Ronnie Grooms Fire Chief City of Paris ParisFf_ Z300\2007corr\Clark20070314.doc JOHN M. CRIDER, JR. CONSULTING ACTUARY 1701 GATEWAY BOULEVARD, SUITE 461 RICHARDSON, TEXAS 75080-3627 P.O. Box 832066 RICHAROSON, TEXAS 75083-2066 TELEPHONE 97a-690-5390 FAX 972-690-5398 January 6, 2006 Mr. Gene Anderson Director of Finance City of Paris, Texas P.O. Box 9037 Paris, Texas 75461-9037 Re: Actuarial Terminology Dear Gene: Following up our conversation, this letter discusses the terms "actuarial accrued liability," and "unfunded actuarial accrued liability. .. Although these terms have been used in actuarial valuation reports for many years, they are not well- understood by the general public or by the press. There are even individuals responsible for the administration of pension plans who do not understand these terms. It is important to distinguish between actuarial accrued liability and the present value of accrued benefits. As participants accumulate benefits under a pension plan, the plan incurs a financial responsibility. The lump sum value of benefits earned as of a given date is referred to as the "present value of accrued benefits." As a general rule, the actuarial cost methods in use today produce trust fund growth which is faster than the growth of the present value of accrued benefits. The discussion on page three of this letter covers exceptions to this rule. As an example, consider a participant who, during a given year, accumulates a monthly benefit of $100. Under representative actuarial assumptions. the present value of this benefit for a participant, currently age 25. is $425. For a participant age 60, however, the present value of $100 per month is $6,792, a much larger figure. If a plan bases its annual contributions on the value of benefits earned during the year. the cost of the plan can escalate significantly as the covered group ages. For this reason, both private-sector plans and plans which cover employees of goverIli.llental entities are required to use actuarial cost methods that produce annual costs which are more level. r - . Mr. Gene Anderson January 6, 2006 Page Two Actuarial cost methods in current use start by developing an annual cost for the portion of benefits which are attributable to a given year. This figure is called the "normal cost." The normal cost is usually calculated so as to be either a level dollar amount or a level percentage of pay over the participant's career. The normal cost funds more than the benefit accrued for the year. It funds the year's share of the pension at retirement, including future salary increases, scheduled changes in rates of benefit accrual and any other factors which will affect the ultimate retirement benefit. The normal cost is one of the two streams of payments which fund a plan's retirement benefits. Once the normal cost has been calculated, an index is calculated which represents the theoretical value to which all prior-year normal costs should have grown. This theoretical figure is called the actuarial accrued liability. The actuarial value of trust fund assets is subtracted from the actuarial accrued liability, and the difference is referred to as the unfunded actuarial accrued liability. It is easy to understand why this term causes concern. On hearing the term, many people infer that a plan is underfunded and that the plan sponsor has a liability for this amount. In my opinion, actuaries, who use this term in their day~to-day work, are comfortable with this language but do not always recognize the effect it has on the general public. The unfunded actuarial accrued liability, or UAAL, is amortized over a period of years. The amortization payments represent the second of the two streams of payments which fund plan benefits. Both private-sector and governmental plan funding rules allow the amortization period to vary in length. The variable length of the amortization period serves as a plan's "shock absorber." Short- term increases and decreases in plan obligations are spread over time, and plan contribution requirements remain more stable than would olherwise be the case. The term "liability" is generaUy understood to mean a financial obligation which an individual or an organization has a legal responsibility to pay. Neither the actuarial accrued liability nor the unfunded actuarial accrued liability meet this definition of "liability." Financial Accounting Standards Board Statement No. 87, which governs financial reporting for private-sector pension plans refers to the actuarial accrued liability as the "Projected Benefit Obligation." Governmental Accounting Standards Board Statements 25 and 27 refer to the unfunded actuarial accrued liability as the "Net Pension Obligation. " Governmental Accounting Standards Board Statements 5, which was superseded by Statements 25 and 27, used the terms actuarial accrued liability and unfunded actuarial accrued liability. The Schedule of Funding Progress, which was brought forward from Statement 5 into Statements 25 and 27 still, unfortunately, uses these terms. As required by Governmental Accounting Standards Board Statement 27> (he City of Paris includes the Schedule of Funding Progress in its Comprehensive Annual Financial Report. Mr. Gene Anderson January 6, 2006 Page Three Termination of a pension plan can accelerate the payment date for benefits. In the private sector, terminating plans are usually subject to the Pension Benefit Guaranty Corporation (PBGC) plan termination insurance program. The PBGe requires that the benefits of terminated plans be valued under much more conservative assumptions than those typically used for ongoing plans. For this reason, termination of a private-sector plan can significantly increase a plan sponsor's financial obligation to its pension plan. The plan terminations in the airline industry are recent examples of the problems which can occur on plan termination. Governmental plans. such as those maintained by the City of Paris, are not subject to PBGe coverage. Governmental plans can also have problems upon plan termination. It is possible for the obligation for benefits to equal the actuarial accrued liability in some cases. [n such instances, it may be necessary to continue funding for several years after benefit accruals have ceased. However, only in an unusual situation would it be necessary for a city to come up with the full difference between the value of accrued benefits and plan assets in a single payment. Several years ago, the City of Paris opted out of the state constitutional amendment guaranteeing accrued benefits. This provides a measure of protection under the fire fighters' plan. The Texas Municipal Retirement System is exempt from the constitutional amendment. We have all read about governmental retirement plans, both here in Texas and elsewhere, that are in financial trouble. Typically. these plans have been the victims of neglect for a considerable period of time. While most retirement plans are still recovering from the 2000 to 2002 market downturn, I do not believe that the majority of governmental pension plans represent a threat to the financial health of their sponsors. If you have questions concerning this letter or if you need additional information, please feel free to contact me. Sincerely, .< l\ \ \ < ,,~ J6~n M. Crider. Jr. v Pans Ff_ Z300\2006corr\A ndcrson20060 I 06.doc