EMPLOYEES’ RETIREMENT SYSTEM OF THE STATE OF HAWAII REPORT TO BOARD OF TRUSTEES ON THE 90TH ANNUAL ACTUARIAL VALUATION FOR THE YEAR ENDING JUNE 30, 2015 January 21, 2016 Board of Trustees Employees’ Retirement System of The State of Hawaii City Financial Tower 201 Merchant St., Ste. 1400 Honolulu, HI 96813-2980 Dear Trustees: SUBJECT: ACTUARIAL VALUATION AS OF JUNE 30, 2015 We certify that the information contained in the 2015 actuarial valuation report is accurate and fairly presents the actuarial position of the Employees’ Retirement System of the State of Hawaii (ERS) as of June 30, 2015. There have been no adjustments for events which occurred after this date. All calculations have been made in conformity with generally accepted actuarial principles and practices and with the Actuarial Standards of Practice issued by the Actuarial Standards Board. In our opinion, the results presented comply with the requirements of the Hawaii statutes and, where applicable, the Internal Revenue Code, ERISA, and the Statements of the Governmental Accounting Standards Board. The undersigned are independent actuaries. One or more of them are an Enrolled Actuary and/or a Member of the American Academy of Actuaries. All are experienced in performing valuations for large public retirement systems. ACTUARIAL VALUATIONS The primary purpose of the valuation report is to determine the adequacy of the current employer contribution rate through measuring the resulting funding period, to describe the current financial condition of ERS, and to analyze changes in ERS’s condition. In addition, the report provides various summaries of the data. This report may not be appropriate for other purposes. The information required by ERS in connection with Governmental Accounting Standards Board Statement No. 67(GASB No.67) will be provided in a separate report. Valuations are prepared annually, as of June 30th of each year, the last day of ERS’s plan year and fiscal year. Board of Trustees January 21, 2016 Page 2 FINANCING OBJECTIVES Contribution rates are established by Law that, over time, are intended to remain level as a percent of payroll. The employee and employer contribution rates have been set by Law and are intended to provide for the normal cost plus the level percentage of payroll required to amortize the unfunded actuarial accrued liability (UAAL) over a period not in excess of 30 years. PROGRESS TOWARD REALIZATION OF FINANCING OBJECTIVES The funded ratio (the ratio of the actuarial value of assets to the actuarial accrued liability) is a standard measure of a plan’s funded status. The funded status alone is not appropriate for assessing the need for future contributions nor assessing the sufficiency of plan assets to cover the estimated cost of settling the plan's benefit obligations. However, the trend (historical and projected) of the funded ratio is a strong metric to use for assessing the dependability of the current funding policy and its ability to accumulate assets to pay benefits when due. The funded ratio is currently 62.2% and this is higher than the funded ratio from the previous valuation. In fact, the funded ratio has now increased for three straight valuations. The 2011 Legislature made significant changes to the future employer contribution rates. The employer contribution rate for Police and Fire employees will increase to 25.00% in FY2016, and the employer contribution rate for All Other Employees will increase to 17.00% in FY2016. The contribution rates are then expected to stay at those levels until the System is fully funded. The Legislature also made changes to the benefits and member contribution rates for employees hired after June 30, 2012. Because these changes result in significantly higher contributions towards the unfunded liability in the future than in the current year, we believe it is more appropriate to determine the funding period using an open group projection rather than a static mathematical formula, which assumes that all amortization payments in the future will be the same percentage of pay as in the current year. We have determined that the funding period for paying off the UAAL of the System (in aggregate) is 26 years. Because this period does not exceed 30 years, the financing objectives of ERS are currently being realized. (Hawaii Revised Statutes §88-122(e)(1) state that the employer contribution rates are subject to adjustment when the funding period is in excess of 30 years.) The actuarial accrued liability, the unfunded actuarial accrued liability (UAAL), and the determination of the resulting funding period illustrate the progress toward the realization of financing objectives. The System’s UAAL was expected to increase from the prior year based on the three-year phase-in into the 7.5% investment return assumption beginning with this valuation. In addition, the System had a liability experience gain which was caused by favorable experience compared to the assumptions. However, the gains were offset by the losses due to change in actuarial assumptions. As a result, the UAAL grew based on this actuarial valuation as Board of Trustees January 21, 2016 Page 3 of June 30, 2015, ERS’s underfunded status as measured by the UAAL is now $8.775 billion. Because of the less favorable investment performance in FY2015, the System is now deferring only $42 million in investment gains (compared with $561 million in deferred gains last year). If there are no significant investment gains or other actuarial gains over the next two years, the funded status of the System would be expected to decrease, as the remaining phase-in to the lower investment return assumption continues. Thereafter, the funded status would be expected to improve. Thus, given the plan’s contribution allocation procedure and the new tier of benefits, if all actuarial assumptions are met (including the assumption of the plan earning 7.65% on the actuarial valuation of assets), it is expected that: 1. The employer normal cost as a percentage of pay will decrease to the level of the newest tier as the old tier population declines and is replaced by new tier members, 2. The employer contribution will remain level throughout the amortization period, 3. Thus, the net amount available to amortize the UAAL will increase over time, 4. The unfunded actuarial accrued liability will increase in nominal dollars until the net amount for amortization is large enough to cover the interest charges, or approximately 2023, and then begin to decrease 5. The unfunded actuarial accrued liability will be fully amortized after 26 years, and 6. In the absence of benefit improvements, the funded ratio should increase over time, until it reaches 100%. BENEFIT PROVISIONS AND LEGISLATIVE CHANGES This is the third valuation with members covered under the new benefit tier. There have been no changes in the benefit provisions since the prior valuation. See Table 16 of this report for more details on the benefit provisions for members of the System. ASSUMPTIONS AND METHODS The actuarial assumptions used were adopted by the Board in December of 2010 based on the recommendations provided by an Experience Study performed by GRS. There have been no changes to the assumptions or methods since the prior valuation other than the investment return assumption. This is the first year of the three-year phase-in of the investment return assumption. The investment return rate decreased beginning in fiscal year 2016 to 7.65% and will continue to decrease to 7.55% in fiscal year 2017 and to 7.50% in fiscal year 2018 and remain at 7.5% thereafter. Further detail on the assumptions and methods may be found in Table 18 of this report. Board of Trustees January 21, 2016 Page 4 The actuarial assumptions represent estimates of future experience and are not market measures. The results of the actuarial valuation are dependent on the actuarial assumptions used. Actual results can and almost certainly will differ, as actual experience deviates from the assumptions. Even seemingly minor changes in the assumptions can materially change the liabilities, calculated contribution rates and funding periods. Based on the scope of this engagement, we have not performed analysis on the potential range of future measurements based on other factors. The actuarial calculations are intended to provide information for rational decision making. In our opinion, the assumptions are internally consistent and are reasonably based on the actual experience of ERS. DATA Member data for retired, active, and inactive participants was supplied as of March 31, 2015, by ERS’s staff. We have not subjected this data to any auditing procedures, but have examined the data for reasonableness and consistency with the prior year's data. Asset information was supplied by ERS’s staff. RESPONSIBILITY FOR TABLES AND SCHEDULES The actuary is responsible for the information with respect to years after 1999 in the Required Supplementary Information, and the Notes to Required Supplementary Information in the Financial Section of the ERS’s Comprehensive Annual Financial Report (CAFR). Information with respect to years prior to 2000 was supplied by ERS. Tables and schedules in the Actuarial Section of the CAFR were generally prepared directly by the Actuary. However, certain of these tables were prepared by ERS utilizing information from this report. When the tables were prepared by ERS from our report, they are so noted. The undersigned are independent actuaries and consultants. Mr. Newton is an Enrolled Actuary, a Member of the American Academy of Actuaries and meets the Qualification Standards of the American Academy of Actuaries. Finally, all of the undersigned are experienced in performing valuations for large public retirement systems. Sincerely, Joseph P. Newton, FSA, EA Lewis Ward Linna Ye, ASA, MAAA Senior Consultant & Actuary Consultant Actuary J:\3046\2015\Val\2015_Val.doc Employees’ Retirement System of the State of Hawaii Table of Contents TABLE OF CONTENTS PAGE SECTION NUMBER COVER LETTER SECTION A 1 EXECUTIVE SUMMARY SECTION B 3 INTRODUCTION SECTION C 5 FUNDED STATUS SECTION D 8 ANALYSIS OF CHANGES SECTION E 11 ERS ASSETS SECTION F 13 BENEFIT PROVISIONS SECTION G 15 GASB DISCLOSURE SECTION H 17 ACTUARIAL ASSUMPTIONS AND METHODS SECTION I 19 MEMBERSHIP DATA SECTION J 21 SUMMARY AND CLOSING COMMENTS SECTION K 23 ACTUARIAL CERTIFICATION STATEMENT SECTION L 26 TABLES SECTION M 76 STATISTICAL TABLES SECTION N 105 DEFINITION OF ACTUARIAL TERMS SECTION A EXECUTIVE SUMMARY Employees’ Retirement System of the State of Hawaii Section A Executive Summary The following table summarizes the key results of the June 30, 2015 actuarial valuation of the Employees' Retirement System of the State of Hawaii (ERS). Item 2015 2014 Membership • Number of - Active members 67,310 67,206 - Retirees and beneficiaries 44,283 43,087 - Inactive, vested 7,413 8,105 - Total 119,006 118,398 • Covered payroll for active members $3,952.6 million $3,871.0 million • Actual benefit payments and refunds $1,181.3 million $1,130.9 million Assets • Actuarial (smoothed) value $14,463.7 million $13,641.8 million • Market value $14,505.5 million $14,203.0 million • Return on actuarial value 7.9% 9.2% • Return on market value 3.9% 17.8% • Employer contributions during fiscal year $717,792,981 $653,127,697 • External cash flow % (1.8%) (2.0%) Actuarial Information • Total normal cost % (employee + employer) 11.66% 10.96% • Unfunded actuarial accrued liability (UAAL) $8,774.7 million $8,578.3 million • Funded ratio (based on smoothed assets) 62.2% 61.4% • Funded ratio (based on market assets) 62.4% 63.9% • Funding period (years)* 26.0 26.0 • Employer contribution rate % of projected payroll** For FY beginning July 1 17.89% 17.28% * Funding Period based on actuarial value of assets, scheduled increases in employer contribution rates, and an ofopre nA gllr oOutphe prr Eojmecptliooyne reesf lbeecgtiinngn icnhga Jnugleys 1 i,n 2 b0e0n8e.fits and future member contribution rates. ** Weighted average of 25.0% Contribution Rate for Police and Firefighters and 17.0% Contribution Rate for All Other Employees for FY 2016, 24.0% and 16.5% respectively for FY 2015. 1 SECTION B INTRODUCTION Employees’ Retirement System of the State of Hawaii Section B Introduction The results of the June 30, 2015 actuarial valuation of ERS are presented in this report. The primary purpose of the valuation report is to determine the adequacy of the current employer contribution rates through measuring the resulting funding period, to describe the current financial condition of ERS, and to analyze changes in ERS’s condition. In preparing this valuation, Gabriel, Roeder, Smith & Company (GRS) has relied on employee data and asset information provided by the staff of ERS. While not verifying the data at their source, GRS has performed such tests for consistency and reasonableness as has been deemed necessary to be satisfied with the appropriateness of using the data supplied. Section C discusses the funded status of ERS. Section D analyzes the change in the UAAL. Section G discusses the disclosure requirements of GASB No. 67. Sections E, F, H, and I discuss background information used in the preparation of this report-- benefit provisions, actuarial assumptions and methods, financial information, and membership data. Section K contains the actuarial certification. All the tables referenced by the other sections appear in Section L. 3