PROPOSED CHANGE TO LARGER ANNillTY ACTUARIAL CALCULATION METHODOLOGY

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1 LACERS Los Angeles City Employees' Retirement System Report to Bellefit.", AdIllillistratioll COllllllittee i Agenda of: JANUARY 13, 2009 ~' i From: Li Hsi, Chief Benefits Analyst I ITEM: III SUBJECT: PROPOSED CHANGE TO LARGER ANNillTY ACTUARIAL CALCULATION METHODOLOGY Recommendation: That the Committee recommend Board approval of a prospective change in Larger Annuity calculation methodology to reflect a full Cost of Living Adjustment reduction effective July 1,2009. Discussion: The Larger Annuity program is a voluntary program that allows participating members to recei ve a Larger Annuity benefit to supplement their retirement income by making additional member contributions. The Los Angeles Administrative Code Section , effective September 25, 2002, requires that the Larger Annuity benefit should be determined by the actuary to be cost-neutral. With the help of a computer-based calculator provided by the former consulting actuary, Gabriel Roeder Smith & Company (GRS), LACERS began the monthly annuity payments in July 2003 retirement payroll. PensionGold, LACERS' main retirement management software, took over the Larger Annuity benefit calculation after the calculation logic was built and certified by GRS on December 17,2003. At present, there are 153 members and survivors receiving the Larger Annuity benefit. To validate Larger Annuity calculation and methodology, the incumbent consulting actuary, The Segal Company (Segal), reviewed samples from the 60 PensionGold Larger Annuity calculations provided by staff covering various options of five different cases. Based on its review (see attachment), Segal confirmed the PensionGold calculations for "Single Life" annuities. However, Segal indicated that the calculations for "Joint and Survivor" annuities are not cost neutral to LACERS due to the value of the Cost of Living Adjustments (COLAs) not being reflected in converting the Single Life annuity to the Joint and Survivor annuity. For example, for a member and a beneficiary, age 69.5 and 28.5 respectively, with $55,000 at retirement, the 100% Joint and Survivor annuity with Cash Refund is $ per month under the current calculation method, while the Segal's calculation is $239.03, or $51.75 less. Because the Larger Annuity benefit receives annual COLAs just like retirement benefits, the annuity amount must be actuarially reduced in order to make the benefit cost-neutral to LACERS. The current calculation logic does use a COLA reduction factor. The factor is derived from the ratio of Present Value Factors for 8% and 4.854%, which is the 8% rate adjusted for COLA, for "Single Life" members. But the same reduction factor is also used for the Committee Report 1 Jan uary 13, 2009

2 "Joint and Survivor" calculation; therefore, the cost of living reduction applied to the annuity calculated is not a full reduction. The difference between the current calculation and the calculation with full COLA reduction increases if the age difference of the member and the beneficiary becomes larger, and/or if the Joint and Survivor percentage becomes larger. In the example above, if the beneficiary's age is 65, other things being equal, the "100%" Joint and Survivor annuity with Cash Refund is $ per month under the current calculation method, while the calculation with full COLA reduction is $319.37, or $24.69 less; and the "50%" Joint and Survivor annuity with Cash Refund is $ per month under the current calculation method, while the calculation with full COLA reduction is $351.69, or $21.13 less. Staff agrees with the consulting actuary's finding that the Larger Annuity benefit calculation under the Joint and Survivor option currently is not cost-neutral, and recommends that the Committee recommend Board approval of a prospective change in Larger Annuity calculation method to reflect a full COLA reduction in order to ensure cost-neutrality as required by the Administrative Code, effective July 1, This will allow time for modification in PensionGold, testing by staff, and certification by the consulting actuary. TM:LH Attachment: Segal Letter Dated September 23,2008 Committee Report 2 January 13,2009

3 y -y~ SEGAL THE SEGAL COMPANY Paul Angelo, FSA 120 Montgomery Street Suite 500 San Francisco, CA Senior Vice President & Actuary T F pangelo@segalco.com VIA AND USPS September 23, 2008 Mr. Li Hsi Los Angeles City Employees' Retirement System 360 E Second Street, Eighth Floor Los Angeles, CA Re: Review of Sample Calculations Produced by the System's,...' Pension Gold Larger Annuity Calculation Software '~..,' Dear Li: This letter outlines our findings associated with our review of sample benefit calculations prepared using the Pension Gold larger annuity calculation program. BACKGROUND Under Section of the Administrative Code, employees have the opportunity to make additional contributions to receive a larger annuity benefit at the time of retirement. Under the Code, the larger annuity program has to be cost-neutral to the System. The System has performed sample calculations for five members. The calculations included a single life annuity that provided a lifetime only payment to each member and several joint and survivor annuity forms that provide a payment to the member with a continuance benefit to his/her beneficiary. In addition to the two alternative forms of payment, the calculations included a cash refund feature that allowed the refund of any unpaid larger annuity contribution account balance to the estate upon the death of the member and the beneficiary. OBSERVATIONS A comparison ofthe monthly benefits available under the single life annuity and the 100% joint and survivor annuity is provided in the attached table. In addition, we have calculated the monthly benefits with and without the cash refund feature. We have not compared montwy benefits under the other joint and survivor options that provide less than 100% continuance produced by Pension Gold; however, we expect those results to follow a pattern similar to that we have observed for the 100% continuance. Benefits, Compensation and HR Consulting ATLANTA BOSTON CHICAGO CLEVELAND DENVER HARTFORD HOUSTON LOS ANGELES MINNEAPOLIS NEW ORLEANS NEW YORK PHILADELPHIA PHOENIX SAN FRANCISCO TORONTO WASHINGTON, DC Multinational Group of Actuaries and Consultants BARCELONA BRUSSELS DUBLIN GENEVA HAMBURG JOHANNESBURG LONDON MELBOURNE MEXICO CITY OSLO PARIS

4 Mr. Li Hsi September 23,2008 Page 2 The current actuarial assumptions used by LACERS include: (a) 8% interest, (b) 3% annual cost-of-living adjustments (COLA), (c) the 1994 Group Annuity Mortality Table weighted 60% male and 40% female for the member and (d) the 1994 Group Annuity Mortality Table weighted 40% male and 60% female for the beneficiary. Conversion Under Single Life Annuity There are virtually no differences between the Pension Gold and Segal results without cash refund. In particular, the cost of the 3% COLA payable to the member is included in the calculation. Some of the differences in the benefit with the cash refund option may be explained by rounding and/or differences in the methodology used by Pension Gold and Segal in determining the value of the cash refund. Conversion Under 100% Joint and Survivor Annuity In calculating the benefit payable under the 100% joint and survivor annuity, Pension Gold took the single life annuity benefit calculated above for the member with the 3% COLA and multiplied it times the ratio of a single life annuity factor payable to the member calculated without the 3% COLA to a 100% joint and survivor annuity factor payable to the member and his/her beneficiary, also calculated without the 3% COLA. We understand that, by not reflecting the 3% COLA, the method used by Pension Gold in converting a single life annuity to a joint and survivor annuity for the larger annuity program is consistent with that used by LACERS in similar conversions for the regular retirement plan benefit. However, this method does not reflect the full value of COLA being payable over the longer joint life expectancies of the member and hislher beneficiary. For that reason, it understates the full cost for larger annuity purchases ofjoint and survivor annuities, and so is not cost-neutral to the System. We have prepared results including the 3% COLA in the conversion for your comparison. OTHER CONSIDERATIONS As you know, we cannot vouch for the accuracy of the calculations beyond those that we have reviewed. We would be glad to review any additional calculations if we are requested to do so by the System. Please let us know if you have any questions. Si U Paul Angelo JKH/kek Enclosure v3/05B

5 Mr. Li Hsi September 23, 2008 Page 3 Attachment: Comparison of Larger Annuity Calculations Prepared by Pension Gold and Segal Larger Single 100%J&S Annuity Member Beneficiary Single Annuity wi 100%J&S Annuity wi Name Balance Age Age Annuity % Oiff Cash Refund % Oiff Annuity % Oiff Cash Refund % Oiff Nieto, Richard - Pension Gold $55, Segal (100% J&S calculated with 3% COLA) % % % % - Segal (100% J&S calculated without 3% COLA) % % 2 Posten Bruce - Pension Gold $65, Segal (100% J&S calculated with 3% COLA) % % % % - Segal (100% J&S calculated without 3% COLA) % % 3 Crosby, Michele - Pension Gold $50, Segal (100% J&S calculated with 3% COLA) % % % % - Segal (100% J&S calculated without 3% COLA) % % 4 Munoz, Ruben - Pension Gold $50, Segal (100% J&S calculated with 3% COLA) % % % % - Segal (100% J&S calculated without 3% COLA) % % 5 Morgan, Otis - Pension Gold $40, Segal (100% J&S calculated with 3% COLA) % % % % - Segal (100% J&S calculated without 3% COLA) % % M:\LaCity.cli\Bencalc\[PGoldTestSummary.xls]Sheet v3/