GREAT LAKES ADVISORS THE PENSION PROMISE SESSION THREE. A Presentation to the: National Conference on Public Employee Retirement Systems

Transcription

1 GREAT LAKES ADVISORS THE PENSION PROMISE SESSION THREE Presenter: Kelly Weller Managing Director, Client Service (312) A Presentation to the: National Conference on Public Employee Retirement Systems Trustee Educational Conference 2015

2 NCPERS DISCUSSION TOPICS The Pension Promise Session Three The Time Value Money This session will explore the eighth wonder of the world, compounding interest, and will seek to help the trustee understand this concept through the application of future value (accumulation phase) and net present value (payment phase) on a typical pension annuity 2

3 COMPOUND INTEREST IS THE EIGHTH WONDER OF THE WORLD. HE WHO UNDERSTANDS IT, EARNS IT... HE WHO DOESN T... PAYS IT! Albert Einstein 3

4 YOU WIN THE LOTTERY! You have (2) options to receive your 1,000,000: Annuity pay you an annual payment for a set number of years in the future, or Lump Sum Lottery will provide you a discounted lump sum amount now. The Lottery has (2) ways to fund the payout: Pay As You Go Payouts funded from Annual Revenue or, Create an Asset Pool funded from a Pool of set aside assets. 4

5 CALCULATING THE ANNUITY: Solving for a simple annuity: 20 years = Contract Term 50,000 = Annual Payment Cash received by the winner over the contract term 1,000,000 CALCULATING THE LUMP SUM : Solving for Present Value (PV): 7% = RATE (Discount Rate) 20 years = NPER (Number of Periods) 50,000 = PMT (Annual Payment) 0 = FV (Future Value) 1 = TYPE (Payment at the beginning of the period) Cash lump sum amount = 566,780 5

6 PAY AS YOU GO Payments are made with earning or surplus This structure applies to a Lottery or Social Security in its current form. Odds or Benefit Valve (Extremely Dynamic) Lottery Earnings Payments To Winners 6

7 ASSET POOL A pool requires: Time Estimate Periods (NPER) Career Life Expectancy (Retirees & Survivors) Expected Rate of Return or Discount Rate (RATE) Actuarial Historical Expected based on Asset Allocation Tiered Corporate Bond Rates Systematic Contributions Payment (PMT) Static Fixed or % Dynamic Actuarial Necessary to meet expected liability(s) in the future = Future Value (FV) Assets to provide payments for: Actual liability today = Net Present Value (NPV) That generate investment return over time equal to (or greater than) the expected rate of return 7

8 ILLUSTRATION: DEFINED BENEFIT PLAN Employer Contributions Plan Sponsor Contribution Valve Actuarial DIP STICK Investment Return Gauge Dynamic Employee Contribution Valve Investment Earnings Investment pump pressure reflects a realistic return assumption LOW RISK Employee Contributions Static Pension Fund Administrative Costs Benefit Valve To Pensioners Static?? Retirement Benefits Source: The ABC s of Pension Systems, Olivia S. Mitchell. June

9 CONTRIBUTIONS REQUIRED TO FUND THE POOL: Solving for the required annual contribution (PMT): 566,780 = FV (Future Liability) 0 Beginning Value = PV 7% = RATE (Discount Rate) 25 Years = NPER (Number of Periods Career or Life Expectancy) TYPE 0 = Contributions made at the end of the Period Annual contribution or payment (PMT) = 8,961 Total contribution 224,027 or 42% 25 Payments of 8,961 Payments = 224,025 Earnings attribution 342,755 or 58% 566, ,025 = 342,755 9

10 CALCULATING A TYPICAL RETIREMENT PAYMENT: A normal retirement with no survivors Final Average Pay = 66,700 Creditable Service = 25 Years Creditable Service Formula = 3% Retirement Age 54 - Life Expectancy 74 years = 20 Years Pension Annuity = 66,700 x 75% = 50,000 Solving for the amount to fund the benefit (PV): 7% = RATE (Actuarial Rate of Return) 20 years = NPER (Life Expectancy) 50,000 = PMT (Pension Annuity Amount) 0 = FV (Value at Death) 1 = TYPE (Payment at the beginning of the period) Actuarial Equivalent Liability = 566,780 (PV) 8% Actuarial Rate of Return requires a PV of 530,179 6% Actuarial Rate of Return requires a PV of 607,904 If the Plan is 70% funded, it has 400,000 on hand (MV) to fund the benefit 10

11 CONTRIBUTION AMOUNT REQUIRED TO FUND THE RETIREMENT PAYMENT: Retirement benefit on an employee retiring in 25 years Retirement Payment (Annuity) = 20 annual payments of 50,000 Solving for the required annual contribution (PMT): 566,780 = FV (Future Liability) 0 Beginning Value = PV 7% = RATE (Actuarial Rate of Return) 25 Years = NPER (Career Length) TYPE 0 = Contributions made at the end of the Period Annual required contribution (PMT) = 8,961 Total contributions = (8,961 x 25 = 224,027) or 42% Earnings = 58% Earnings + Employee Contributions (Assumption 10%) 2/3 OF REQUIRED ACTUARIAL EQUIVALENT LIABILITY 11

12 FUN CALCULATIONS: Cornelius Vanderbilt Built the Breakers as a summer home, he never lived in it. Erected in 1895 at a cost of 7,450,000. What is the inflation adjusted cost of this home today? Solving for FV: 7,450,000 = PV 0 = PMT 2.83% = RATE (Annualized Inflation) 120 = NPER (YEARS) TYPE 1 = Payments made at the beginning of the Period 212,097,998 = FV Kelly Weller Wants to purchase this home, for it s current FV with a 20% down payment and to borrow the balance over a 30 year mortgage at 4.25%. What is my monthly payment? Solving for PMT: 20% Down = 42,419,600 (212,097,998-42,419,600) = 169,678,398 Mortgage Amount = PV 4.25% = RATE (APR) 360 = NPER (Months 30 x 12) TYPE 0 = Payments made at the end of the Period 0 = FV (loan will be paid in full) 834,715 = PMT (Monthly) = 300 MM Total 12

13 FUN CALCULATIONS: Was IBM a good investment from January 1962 to January 2015? Solving for RATE: 2.41 = PV (Opening Price 1/1/1962) Make a Negative! = FV (Price adjusted for Splits and Dividends on 1/1/2015) 0 = PMT (Dividends went to expense and not re-invested) 53 = NPER (YEARS) TYPE 1 = Payments made at the beginning of the Period 8.23% = RATE (Annualized Return) What about Apple Solving for RATE:.53 = PV (Opening Price 1/1/1980) Make a Negative! = FV (Price adjusted for Splits and Dividends on 1/1/2015) 0 = PMT (Dividends went to expense and not re-invested) 35 = NPER (YEARS) TYPE 1 = Payments made at the beginning of the Period 16.47% = RATE (Annualized Return) 13

14 FUN CALCULATIONS: Thirty Year Treasury? Solving for PV: 10% Coupon - 1,000,000 PAR 30 Year Maturity issued June 1985 Purchased in 1986, yielding 8% What price would you offer? Solving for PV: 1,000,000 = FV 50,000 = PMT (Semi Annual)) 29 x 2 = NPER (PERIODS REMAINING) TYPE 1 = Payments made at the beginning of the Period 8% = Rate 1,224,295 PV = Premium Purchased in 1989, yielding 11.5% What price would you offer? Solving for PV: 1,000,000 = FV 50,000 = PMT (Semi Annual)) 26 x 2 = NPER (PERIODS REMAINING) TYPE 1 = Payments made at the beginning of the Period 11.25% = Rate 876,690 PV = Discount 14

15 QUESTIONS 1. If it was offered, would you elect to receive a portion of your retirement in a lump sum? a. Yes b. No 2. Do you have a DROP option within your Plan? a. Yes b. No 3. What Discount Rate Does your Plan Use? a. Less than 6% b. Between 6% & 7% c. Between 7% & 8% d. Great than 8% 4. If you discount rate goes down, do pension liabilities go down or up? a. Up b. Down 5. Where does approximately 60% of the dollars required for benefits come from? a. Employer Contributions b. Employee Contributions c. Investment Return d. A tax on the 1% Source: National Conference on Public Employee Retirement Systems, The Evolution of Public Pension Plans 15

16 BIOGRAPHY Kelly J. Weller, Director Client Service & Sales Kelly is the Managing Director of Client Service and Sales for Great Lakes Advisors, LLC. With over 20 years of experience in the financial and investment business, he specializes in investment solutions for public, corporate, and multi-employer retirement plans. A former public fund trustee and lobbyist, Kelly brings a strong investment background and practical retirement plan experience to our clients. Prior to joining Great Lakes Advisors, LLC, Kelly held positions with PNC Capital Advisors, LLC, and JP Morgan Asset Management Company. He received his undergraduate degree in accounting from Illinois College, an MBA from the University of Illinois, Springfield, and is a Certified Public Accountant (not in practice). Great Lakes Advisors, LLC ( Great Lakes or GLA ) is an investment advisor registered with the Securities and Exchange Commission under the Investment Advisors Act of Established in 1981, Great Lakes is a subsidiary of Wintrust Financial Corporation and a part of the Wintrust Wealth Management family of companies. On October 1, 2013, majority owned subsidiary Advanced Investment Partners, LLC ( AIP ) became fully-owned and integrated into Great Lakes. Great Lakes is a distinct business unit with distinct investment processes and procedures relating to the management and/or trading of investment portfolios for its clients. Great Lakes Advisors, LLC claims compliance with the Global Investment Performance Standards (GIPS ). A complete list of firm composites and performance results, and the policies for valuing portfolios, calculating performance, and preparing GIPS compliant presentations are available upon request by calling Great Lakes Advisors, LLC s fees are available upon request and may be found in our Form ADV Part 2A. 16