The information on this webpage is in the process of being updated to include more plan-specific information. We anticipate these updates will be available at the end of July.

In the course of conducting our actuarial analysis, we make hundreds of assumptions and apply them over measurement periods that often exceed 50 years. In some cases, small changes in these assumptions or experience that plays out differently than expected can lead to significant changes in the measurements. These sensitivities can evolve as the plans grow and mature over time. The Legislature’s response to these changes and their actions governing the state’s pension system also affect plan risk.

To help all users of our actuarial measurements better understand these risks, we have developed this educational webpage. In the sub-sections below (which readers can click to expand/collapse), we illustrate the risks inherent in our actuarial measurements at a system-wide level and consider how our actuarial measurements could vary under different circumstances. Such measurements include contribution rates, funded statuses, and actuarial fiscal notes.

The projected figures shown below are as of the 2017 Actuarial Valuation Report. We intend to update these projections every other year.

Ways to Measure Risk

There are several standard methods available for the assessment of risk. Methods may include, but are not limited to, scenario tests, sensitivity tests, stochastic modeling, and stress tests.

  • Scenario test – a process for assessing the impact of an event on a plan’s financial condition. This may be one possible event, or several simultaneous or sequentially occurring possible events.
  • Sensitivity test – a process for assessing the impact of a change in an actuarial assumption or method on an actuarial measurement.
  • Stochastic modeling – a process for generating numerous potential outcomes (i.e., thousands) by allowing random variables in one or more inputs over time for the purpose of assessing the distribution of those outcomes.
  • Stress test – a process for assessing the impact of adverse changes in one or relatively few factors affecting a plan’s financial condition.

In determining a method for risk assessment, actuaries use their professional judgment to select methods that best account for the nature, scale, and complexity of the plan while also considering the usefulness, reliability, timeliness, and cost efficiency of the methods.

Risk Measurements for Washington’s Public Pension Plans

The Office of the State Actuary uses the methods noted above and combines the methods in some cases. Below are two examples.

Sensitivity Tests

Using our Interactive Reports, a user can assess how the plan’s present value of future benefits, funded status, and contribution rates change when the user selects an assumed rate of investment return or asset valuation method that varies from the best estimates used for the most recent measurement.

These reports provide users with (1) a sense for how a plan’s financial condition or funding requirements may change if our assumptions prove inaccurate, and (2) an understanding of how our most recent actuarial measurements would change if we applied different assumptions or methods at that same measurement date. For example, if we replaced the actuarial (or smoothed) value of assets with the Market Value of Assets (MVA), then how much would a plan’s funded status or contribution rates increase or decrease from current actuarial measurements? As another example, if we assume a lower or higher long-term assumed rate of investment return than our current best estimate, then how much would a plan’s funded status or contribution rates change from our current actuarial measurements? See our Interactive Reports to access these sensitivity tests.

We highlight the impact of the long-term rate of investment return assumption due to the significant impact of that assumption on plan funding. Over the past 20 years across all plans, investment returns have comprised approximately 70 percent of the pension fund’s total income, with the remaining 30 percent coming from employer contributions and employee contributions (split approximately 20 percent and 10 percent, respectively).


Our current best estimate measurements assume that future investment returns will continue to cover a significant share of future pension costs. However, past performance does not guarantee similar, future performance and our assumptions, in the long term, may prove to be inaccurate.


 

Stochastic Modeling

In 2010, we created a custom stochastic model to perform risk assessments periodically on our largest state pension plans. Every five to six years, we review the assumptions and methods used in those assessments as part of our Risk Assessment Assumptions Study.

Stochastic modeling is the most complex and time-consuming method for assessing risk. Unlike sensitivity analysis where you replace a single expected outcome with a different individual outcome under an alternative assumption or method, stochastic modeling provides a distribution of outcomes under numerous alternative assumptions or methods. This type of modeling provides the user with a better sense of the range of potential outcomes and the potential likelihood of those outcomes based on the assumptions and methods from the stochastic model. Because this modeling also includes very pessimistic outcomes, it represents a form of stress testing as well.

In Washington State, we combine scenario testing with stochastic analysis to assess two key risks for our state pension plans: (1) contribution risk – defined in this context as the potential for contributing entities to contribute less than the full actuarially required amount, and (2) benefit enhancement risk – the potential for the Legislature to enact future enhancements to current benefit provisions.

Why are these risks to the systems? Significant and persistent underfunding weakens a plan’s financial condition and leads to significantly higher future contribution requirements. This can create a cycle of funding shortfalls as demonstrated in the graphic below.

Significant one-time benefit enhancements or the practice of regularly enacting smaller benefit enhancements over time can also weaken a plan’s financial condition and lead to unsustainable contribution requirements.

To assess these risks, we perform stochastic modeling under the following two cases:

  • Current Law – where we assume all plans receive the full, actuarially required contribution amount (subject to certain assumed maximums) and benefit provisions remain unchanged over time, and
  • Past Practices – where we assume all plans receive a percentage (less than 100 percent) of the actuarially required contribution and the Legislature enhances benefit provisions in the future consistent with past practices.

By comparing the stochastic measurements from these two cases, users can see how the plan’s solvency and affordability risks change when the plans receive full funding and benefit provisions remain unchanged or when past practices continue in these areas.

For each case, we display select risk measurements and graphs. The purpose of this information is to help users understand how much certain outcomes can vary from our best estimates and the likelihood of those outcomes based on the assumptions and methods from our stochastic modeling.

See our Risk Assessment webpage to access the results of our latest stochastic and scenario analysis.

Using this same risk assessment model, we also project employee and employer contribution rates for the next two biennia under the current law case. We then summarize the output of our modeling and compare the expected (or median) outcome with both pessimistic and optimistic outcomes. This information can be found on our Contribution Rates Projections webpage.

Demographic Risks

Thus far, we primarily focused our risk discussion on economic outcomes. Demographic risks exist in our actuarial measurements as well.

Two significant demographic assumptions that affect the timing and amount of future pension benefit payments are rates of mortality (including rates of mortality improvement) and rates of retirement. For example, if retirees live significantly longer than currently assumed (longevity risk) or members eligible for subsidized early retirement retire significantly earlier than currently assumed, the plan’s financial condition would weaken and current contribution requirements could be inadequate.

We currently reduce the impacts of these demographic risks by reviewing annual experience and updating these assumptions every five to six years where appropriate after the completion of a comprehensive demographic experience study. In the area of mortality improvement, we reduce longevity risk by applying assumed mortality improvement on a generational basis. Using this basis, we adjust currently assumed rates of mortality downward slightly each year in the future. For example, we would expect a 70-year old in 2021 to live longer than a 70-year old in 2020. The projected rates of mortality improvement we use are based on nationally published tables and informed by professional judgment. See our most recent Demographic Experience Study Report for further information on the development of our current demographic assumptions.

Historical Information

Often the easiest way for users to understand how measures can change over time may be to review a history of past actuarial measurements. See the Historical Data webpage on our website for select historical actuarial measurements from our past actuarial valuation reports.

Plan Maturity Measures

Some risks can emerge just by the nature of a pension plan growing or maturing over time. For example, the more members and annuitants a pension plan has (i.e., as its obligations or contribution requirements grow), the larger it can become as a share of the government enterprise that supports it. In other cases, the larger and more mature a pension plan becomes (i.e., as its assets grow relative to the payroll of contributing members), the more volatile the contribution requirements can become. Both of these outcomes can present “enterprise risk” to the governing entities that sponsor the plan.

For the Public Employees’ Retirement System (PERS), both the state (primarily through the State General-Fund [GF-S]) and local governments support PERS through employer contributions (tax dollars). If employer contribution requirements for PERS grow too large over time, they could “crowd out” other government services. Alternatively, if contribution volatility becomes too significant, it may lead to unaffordable contribution requirements and funding shortfalls. Any funding shortfalls would also serve to increase future contribution requirements.

Affordability and Enterprise Risk Measures

We measure the affordability of state pensions and the associated enterprise risk by comparing historical and projected pension contributions paid from the GF-S to the total GF-S budget. This information is displayed in the following graph. The vertical bars correspond to the left axis and indicate the estimated dollar amount paid from the GF-S budget, while the line on the graph corresponds to the right axis and denotes this same dollar amount as a percentage of the GF-S budget.

As you can see from this graph, the Percent of GF-S Budget that is attributable to Estimated GF-S Contributions has been growing over the past several years. However, in the long-term, we project that this percentage will begin to decline, particularly once employers pay off the Plans 1 Unfunded Actuarial Accrued Liability (UAAL).


*The projections above are based on our best estimate assumptions. Actual experience may vary from those assumptions. We use our stochastic risk model to assess how much the affordability measures may vary from the best estimate projections and the likelihood of that variance. See the Risk Assessment Assumptions Study for further information on the assumptions and methods used in our stochastic risk model.

Contribution Rate Volatility Measures

We measure the volatility risk of pension contributions by determining the ratio of the MVA to active participant payroll. The higher the ratio, the more sensitive (or volatile) contribution rates are to asset gains and losses. For example, at the current ratio for 2017, if assets earn 10 percent less than assumed in a single year without a subsequent and offsetting gain, the loss would require an additional contribution of 2.82 percent for 20 years. If the current ratio were to double in the future, the same asset loss would require a contribution of 5.64 percent for 20 years.

The chart below illustrates that the historical ratio between MVA and Active Participant Payroll has steadily grown from about 3.5 in 2005 to 4.2 in 2017 and is projected to hold around 5.2 in 2050 (about a 16 percent increase from projected 2019 levels).



Other Plan Maturity Measures

As a pension plan matures, more members move from active to inactive status. While in active status, members generally contribute to the pension plan. While in inactive status, members stop contributing to the plan and either are in receipt of a pension benefit (drawing down plan assets) or have a vested right to receive a future pension benefit.

The relative maturity of a pension plan in this area can have implications on future contributions in two areas:

  1. A reduction in the share of total plan costs paid by contributing members, thus increasing the share paid by employers, and
  2. A reduction in the plan’s cash flow (annual contributions minus annual benefit payments), thus increasing the liquidity needs of the plan. The need for increased liquidity generally lowers the portion of plan costs covered by investment returns, leading to increased member and employer contributions. Additional information on liquidity can be found further below.

Generally, these risks increase for closed plans (closed to new members) and have less relevance for open plans unless they become significantly underfunded.

All but three of Washington’s largest public plans are open to new members. As of our most recent measurements, all those plans have funded statuses that exceed 85 percent under current assumptions and methods. The open plans have matured since their inception, but the rate of maturity was reasonable, and we expect the future rate of maturity to stabilize based on our most recent projections.

The graph below illustrates several pertinent plan maturity ratios for each year, along with how those ratios have changed historically and how we expect them to change in the future.


*The ratio of benefit payments to contributions in 2005 is significantly higher because contribution rates were historically low during this time-period. See the graph in the “Affordability and Enterprise Risk Measures” section above for a broader history of contributions.

Historically, the ratio of retiree liability to total liability – “Retirees/Total (Liability)” – has climbed while the ratio of active to retiree headcounts – “Actives/Retirees (Headcount)” – has declined. This is the result of the baby boomer generation moving from active in the workforce to retired over time. Based on our most recent projections, we expect these maturity measures to stabilize, except the ratio of annual benefit payments to contributions – “Benefit Payments/Contributions” – which spikes after employers pay off the Plans 1 UAAL.

PERS 1, the Teachers’ Retirement System (TRS) 1, and the Law Enforcement Officers’ and Fire Fighters’ (LEOFF) 1 are all closed plans - closed to new members since October 1977. As of our most recent measurements, LEOFF 1 was 131 percent funded, nearly all members have retired, and the likelihood of future contributions remains low. As such, we observe very little plan maturity risk in LEOFF 1 at this time. PERS 1 and TRS 1, on the other hand, are approaching 100 percent inactive members and have a funded status of 57 percent and 60 percent respectively as of our most recent measurements.

To reduce some of the maturity risks in PERS 1 and TRS 1, the Legislature enacted a funding policy to amortize the unfunded liabilities over the payroll of the entire system, including the payroll from the open plans. Under this policy, employers of Plan 2 and Plan 3 members contribute to the Plan 1 unfunded liability, in addition to contributing to Plan 2/3. As of our 2017 projections, PERS 1 and TRS 1 will reach a fully funded status in 2028 and 2026 respectively under this funding policy if all future contributions are made and all assumptions are realized. These full funding dates would occur sooner/later under optimistic/pessimistic future outcomes.

To supplement this funding policy, the Legislature enacted a funding policy for the open plans to fully fund plan benefits over the working lifetimes of the covered members. If all future contribution requirements are met under this funding policy, the chances of developing significant unfunded liabilities in the open plans will be reduced significantly.

Liquidity Risk Measures

The Washington State Investment Board monitors the on-going cash flow needs of the Commingled Trust Fund (CTF) and sets the asset allocation for the CTF with consideration of the expected cash flow needs. One common measure of liquidity needs is the ratio of (contributions less benefit payments) to the MVA, represented by the green line in the graph below. The vertical bars in this graph correspond to the left axis and are negative dollar amounts indicating that benefit payments have and are expected to exceed contributions, while the line on the graph corresponds to the right axis and denotes this same dollar amount as a percentage of the MVA.



The CTF cash-flow measurement in the graph does not account for investment returns, which have comprised approximately 70 percent of the pension fund’s total income over the past 20 years. When you exclude expected investment returns from this measure, we observe a negative cash-flow measure for the CTF. If the measure becomes significantly more negative, as a percentage of the MVA, it indicates increased liquidity needs for the CTF. That outcome would likely result in a change in asset allocation, a lower assumed rate of investment return, and an increase in future contribution requirements.

When considering liquidity risk, it is also important to note that the open plans in the CTF provide liquidity for the closed plans invested in the same CTF. More specifically, the closed plans are shrinking and need to sell assets to pay benefits whereas the open plans are growing, currently take in more in contributions than benefit payments, and need to buy more illiquid assets in the CTF. In this circumstance, the open plans can buy the closed plans shares/units of the CTF invested in illiquid assets. This allows the closed plans to remain invested in the CTF and benefit from higher investment rates of return without the liquidity risk they would face if invested in a separate trust fund with the same asset allocation.


Last Reviewed: 06/11/2020

Last Updated: 06/11/2020