Dallas Police and Fire Pension System

Investment Return Assumption

July Board Meeting
July 9, 2015

Investment Return Assumption

The Board has adopted an assumption for the long-term rate of return on
assets
The assumption should be the best estimate of future experience
The assumption is used to value the liabilities of the System
The current assumption is 8.5%, net of investment and administrative
expenses
In order to develop the assumption, we take into account past experience,
future expectations, and professional judgment
Buck uses a model called GEMS Economic Scenario Generator from
Conning and Company to produce asset return forecasts

GEMS
The GEMS is particularly well suited to develop the long-term market
assumptions suitable for public pension
GEMS is calibrated to reflect current conditions
Over the longer term, GEMS allows for a broader range of economic and
capital market environments and related asset performance, determined in
part by historical observations
The broad range of economic and capital market simulations produced by
GEMS provides a more complete picture than more static models of the
potential rewards and risks that a pension fund will be exposed to over its
lifetime

Investment Return Analysis

The results of the asset return analysis produced by GEMS is shown on the
following slides
Please note that we are providing the results at a 30 year investment horizon,
as well as a 20 year investment horizon, for comparison with results produced
by other sources

The results assume administrative expenses of 0.24%

The results assume average annual rates of inflation of roughly 2.75% over
20 years and 3.00% over 30 years

Expected Arithmetic Return

Horizon

Expected
Real
Return

Assumed
Inflation

Expected
Nominal
Return

Administrative
Expenses

Expected Nominal
Return Net of
Expenses

20 years

6.32%

2.79%

9.11%

0.24%

8.87%

30 years

6.61%

3.04%

9.65%

0.24%

9.41%

Expected Geometric Return

Geometric Net Nominal Return
Horizon

40th Percentile

50th Percentile

60th Percentile

20 years

7.52%

8.21%

8.86%

30 years

8.07%

8.81%

9.40%

Assumes Administrative Expenses of 0.24%

20 year horizon: assumed annual rate of inflation of 2.77%

30 year horizon: assumed annual rate of inflation of 3.01%

Recommended Return Considerations

When recommending a return assumption, in the past we have looked at a 30-year
horizon, and assumed that future experience will be close to the 50th percentile of
the distribution of expected returns over that horizon
The System currently maintains a not insignificant portion of its holdings in nontraditional assets
The assets have no liquid market
The revaluation of these assets has resulted in significant write-downs in 2013
and 2014
The report we issued in May showed an actuarial loss of $279 million on assets in
2014
Please note that since the January 1, 2014 valuation did not reflect the final
audited asset values, a portion of the $279 million actuarial loss is due to losses
that actually occurred in 2013
Since May more 2014 asset values have been reported
The resulting actuarial loss for 2014 is now closer to $460 million

Recommended Return Considerations

Considering the magnitude of the 2014 and 2013 losses, as well as the size of
the non-traditional assets, we may need to re-evaluate how the asset return is
determined
Specifically, if we assume that these non-traditional assets will continue to be
a drag on the fund in the near term, we may want to look at an asset return
that is lower than the 50th percentile
As noted on a previous slide, the 40th to 50th percentiles of the distribution of
future asset returns were in the ranges of:
Over a 20 year horizon, 7.52% to 8.21%

Over a 30 year horizon, 8.07% to 8.81%

Recommended Return Considerations

A reduction of the long-term assumed rate of return could be accompanied by a
somewhat greater reduction in the short-term assumed rate of return, if it is
expected that the performance of the non-traditional assets will continue to
dampen the return in the near future
This would be implemented in the form of a select-and-ultimate return
assumption
We would assume that the return is somewhat lower over the near term (the
select period) but will rise to the long-term expected rate of return is after the
select period is over

For example, if we believe the long-term rate of return is actually 7.75%, but
we expect lower returns on the non-traditional assets in the near term, we
might assume the return is 7.5% for 2015 2019 but then increases to
7.75% for 2020 and beyond

Impact of the Asset Losses

The following slide shows the impact of the asset losses for 2014 on the
Systems funded percentage (i.e. the ratio of Actuarial Value of Assets to
Accrued Liability)
The 2014 Report line shows the projection based on the 1/1/2014 valuation
It assumes that the fund earns 8.5% in 2014

It reflects the Plan changes that were implemented in 2015

The May 2015 Report line shows the projection based on the 1/1/2015
valuation that was presented in May
It reflects that the fund had a $279 million actuarial loss in 2014

The Updated July 2015 Assets line shows the projection based on the
1/1/2015 valuation and reflects the most recent 2014 asset valuation
information
It reflects that the fund had a $460 million actuarial loss in 2014

Impact of the Asset Losses - Current Plan Provisions

Assumed Future Asset Returns of 8.5%
180.0%

160.0%

140.0%

Funded Percentage

120.0%

100.0%
2014 Report
May 2015 Report

80.0%

Updated July 2015 Assets

60.0%

40.0%

20.0%

0.0%

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Impact of Asset Losses

As seen on the previous graph, under the current plan provisions the asset loss
in 2014 leads to the projection that the System will run out of money, even if it
makes the 8.5% return every year after 2014
Based on the stochastic projections we provided in 2014, without significant
gains in the near future, the return for 2014 puts the results in about the 25th
percentile of those projections
If the asset return assumption of 8.5% is lowered, the results are even worse
since the plan will have less asset return to pay for future benefit payments

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Impact of Revised Asset Assumption

The following slide shows the impact on the same funded percentage
described earlier if the long-term asset assumption is changed
We have made projections under the following assumed rates of asset returns:
8.50% (current assumption)

8.00%
7.75%
7.50%

7.50% for 2015 2019 and 7.75% for 2020 and beyond

7.25%
7.00%

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Impact of Revised Asset Assumption

Current Plan Provisions
80.0%

70.0%
8.50% Return
60.0%

Funded Percentage

8.00% Return
50.0%

7.75% Return

40.0%

7.50% Return

30.0%

7.50% for 20152019, then 7.75%

20.0%

7.25% Return

10.0%

7.00% Return

0.0%

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Impact of Revised Asset Assumption

The January 1, 2015 funded percentage (i.e. the ratio of Actuarial Value of
Assets to Accrued Liability) under each of the scenarios is as follows:
Return Assumption

Funded Percentage

8.50%

71.4%

8.00%

68.3%

7.75%

66.8%

7.50%

65.3%

7.50%/7.75%

66.4%

7.25%

63.8%

7.00%

62.3%

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Impact of Revised Asset Assumption

The asset return assumption should be our best estimate of what we believe
the future long-term return on assets will be
If we believe that certain assets are going to continue to be a drag on the fund,
that should be reflected in the assumed rate of asset return
The GEMS output indicates that the 40th percentile of expected long-term asset
returns is between 7.52% and 8.07%
If ongoing problems with non-traditional assets lead us to expect that future
returns will be in that range, it will be necessary to adjust the assumption
accordingly

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GASB 67 Impact
The asset return assumption also impacts the Total Pension Liability (TPL)
under GASB 67
The long-term rate of return on plan assets can only be used to measure the
TPL if the plan is projected to have assets
If there is a point where assets are no longer projected to be available to pay
for benefits, a municipal bond rate would need to be used.
Therefore, if assets are projected to be depleted, the result is a blended rate
that would be lower than the long-term rate of return on plan assets
As shown on the previous graphs, as a result of the most recent asset writedowns the plan is projected to run out of assets, even if returns of 8.5% per
year can be achieved

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GASB 67 Impact
The following shows the impact of the blended rate, as well as an example of
the impact of changing the return assumption to something lower than 8.5%
The blended rate is computed by applying a discount rate of 3.34% to
benefits projected to be paid after assets are projected to be depleted, which
is based on the S&P Municipal Bond 20 Year High Grade Rate Index
Assumed Rate of Return

8.50%

7.75%

7.50%

Net Pension Liability

at Assumed Rate of Return

$ 2,211,158,099

$ 2,591,207,587

$ 2,729,480,109

6.19%

5.20%

5.01%

Net Pension Liability

at Blended Discount Rate

$ 3,566,972,478

$ 4,353,822,629

$ 4,523,257,470

Assumed Rate of Return

7.25%

7.00%

Net Pension Liability

at Assumed Rate of Return

$ 2,874,106,889

$ 3,025,458,414

4.83%

4.67%

$ 4,689,884,750

$ 4,843,214,819

Blended Discount Rate

Blended Discount Rate

Net Pension Liability
at Blended Discount Rate

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Projection Assumptions
Except as noted in the presentation, results were based on the same plan
provisions, assumptions, methods, assets and data as noted in the 2015
valuation report issued in May.
Specifically assets are assumed to earn the returns noted in the presentation
for 2015 and beyond.

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Certification
Future actuarial measurements may differ significantly from current
measurements due to plan experience differing from that anticipated by the
economic and 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. An analysis of the potential
range of such future differences is beyond the scope of this report.
Use of this presentation for any other purposes or by anyone other than the
Dallas Police and Fire Pension System may not be appropriate and may result in
mistaken conclusions because of failure to understand applicable assumptions,
methods, or inapplicability of the report for that purpose. This presentation should
not be provided without a copy of this certification. No one may make any
representations or warranties based on any statements or conclusions contained
in this presentation without Buck Consultants prior written consent.

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Certification
The results were prepared under the direction of David Driscoll and David Kent
who meet the Qualification Standards of the American Academy of Actuaries to
render the actuarial opinions contained herein. These results have been
prepared in accordance with all applicable Actuarial Standards of Practice, and
we are available to answer questions about them.

David L. Driscoll, FSA, EA, MAAA

Principal, Consulting Actuary

David Kent, FSA, EA, MAAA

Director, Consulting Actuary

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Questions?

THANK YOU

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