South Dakota Retirement System...Jul 2014 Jan 2015 Jul 2015 Jan 2016 Jul 2016 Jan 2017 Jul 2017 Jan 2018 Jul 2018 Jan 2019 Jul 2019 Index Monthly CPI-W and 3rd Quarter Average 3rd

South Dakota

Retirement System

Projected Funded Status as of June 30, 2019,

Risk Analysis, and SDRS Comparisons

June 5, 2019

1

Projected Funded Status and COLAs

• SDRS contributions are fixed and benefits are variable based on affordability

• COLA is primary variable benefit and will vary directly with both inflation and long-

term affordability

• Fair Value Funded Ratio (FVFR) is expected to remain at 100% but:

– Investment returns significantly or sustained below 6.5% assumption may result in COLA

of 0.5%, a FVFR less than 100%, and a required Corrective Action recommendation

– Returns significantly or sustained above the 6.5% assumption could increase the FVFR

above 100%

• The following exhibits examine:

– SDRS COLAs and inflation since 2010

– Projected FVFR at June 30, 2019 and corresponding COLA range

– Risk analysis showing:

• Projected COLA ranges at June 30, 2020 through June 30, 2022 based on ranges of investment

returns

• Likelihoods based on SDIC June 2018 investment portfolio statistics (mean expected return of

6.19% with 15.4% one-year standard deviation)

2

Inflation and SDRS COLAs Since 2010

0.0%

3.6%

1.7%

1.5%

1.7%

0.0% 0.3%

1.96%

2.79%

1.5%

2.1%

3.1%

2.1%

3.1% 3.1% 3.1%

2.1%

1.89%2.03%

2.5%

0%

1%

2%

3%

4%

2011 2012 2013 2014 2015 2016 2017 2018 2019 Average

Annual Inflation and SDRS COLA Increases 2011-2019

Prior Year Inflation (Increase in 3rd quarter CPI-W) SDRS COLA Effective July

3

Inflation and SDRS COLAs Since 2010

14.3%

14.3%

10.4%

8.5%

6.9%

5.1%

5.1%

4.80%

2.79%

25.0%

22.4%

18.8%

16.3%

12.8%

9.4%

6.1%

3.96%

2.03%

0% 10% 20% 30%

Before 7/1/2010

FY 2011

FY 2012

FY 2013

FY 2014

FY 2015

FY 2016

FY 2017

FY 2018

Retirement Date

Cumulative Inflation and SDRS COLA Increases 2011-2019

Cumulative Inflation (Increase in 3rd Quarter CPI-W) Cumulative SDRS COLA Increases

4

Inflation Measurement

for Social Security and SDRS COLAs

(1) Increase in the third calendar quarter average over the prior highest third calendar quarter average is the specified inflation measurement for the

Social Security COLA effective the following January and the SDRS COLA effective the following July

(2) Increase in most recent three-month average over July to September, 2018 average (through 7 months). April, 2019 index is up 1.21% from the

2018 average.

215

225

235

245

255

Jul 2014 Jan 2015 Jul 2015 Jan 2016 Jul 2016 Jan 2017 Jul 2017 Jan 2018 Jul 2018 Jan 2019 Jul 2019

Index Monthly CPI-W and 3rd Quarter Average

3rd Qtr Ave CPI-W

0.35% Increase(1)

2.79% Increase(1)

0.58% Increase(2)

No Increase(1)

1.96% Increase(1)

5

Projected Funded Status as of June 30,

2019 and 2020 Maximum COLA*

* Before consideration of liability gains/losses for year ending June 30, 2019. June 30, 2018 Baseline FVFR was 97.7% and Restricted Maximum

COLA was 2.03%.

If Net Investment

Return for FYE

June 30, 2019 is:

Step 1:

Determine Baseline

FVFR(Using Baseline COLA

assumption of 2.25%)

Step 2:

Determine Restricted

Maximum COLA(Resulting in FVFR of 100%)

Step 3:

Determine FVFR(Using Baseline COLA or Restricted

Maximum COLA, if applicable)

(8.3%) 84% 0.50% 100%Minimum Return to

Avoid Corrective Actions

8.8% 100% Unrestricted: 3.5% 100%Minimum Return for

100% FVFR with

Baseline COLA

6.5% 98% 2.04% 100%Assumed Return

(5.0%) 87% 0.88% 100%

(2.5%) 89% 1.15% 100%

0.0% 92% 1.41% 100%

2.5% 94% 1.66% 100%

5.0% 96% 1.90% 100%

7.5% 99% 2.13% 100%

Return Examples

6

Risk Analysis

• Actuarial standards now require identification & assessment of future funding risks

(ASOP 51)

• Assessment methods can include scenario tests, sensitivity tests, stochastic

modeling, stress tests, and comparing liability to “risk-free” liability

• The most significant and immediate risk to SDRS is investment risk

• Investment returns will first impact the variable SDRS COLA

– Less than assumed will reduce restricted maximum COLA or require corrective actions

– Greater than assumed will increase maximum or enable full COLA range

• However, the variable COLA will not be sufficient to maintain 100% FVFR in all

cases and additional corrective actions may be required

• The following exhibits show the likelihood of restrictions to the COLA and

additional corrective actions over the next three years based on the expected

volatility of investment returns

7

Projected Future COLA Ranges: 2021Assuming 2.5% Net Investment Return for FY19

• Following an assumed net investment return of 2.5% for FY19, the likelihoods for 2021 COLA ranges,

which are primarily driven by FY20 investment returns, are:

– 33% likelihood that the baseline COLA will be payable (CPI-W between 0.5% and 3.5%)

– 43% likelihood that the COLA will have a restricted maximum (CPI-W between 0.5% and the restricted maximum)

– 24% likelihood that a 0.5% COLA will be payable and additional Corrective Action recommendations will be required

* Before consideration of liability gains/losses. Likelihoods based on SDIC 2018 investment portfolio statistics. Assumes 2.25% annual inflation.

-60% -40% -20% 0% 20% 40% 60% 80% 100% 120%

FY 2020 Investment Return

24% 43% 33%

76%

FY 2020 Net InvestmentReturn Less than (4.9%)

COLA=0.5% & Corrective Action Recommendations Required

FY 2020 Net Investment Return (4.9%) to 12.8%

Restricted Maximum COLA

FY 2020 Net Investment Return Greater than 12.8%

Full COLA: 0.5% to 3.5%

8


which are primarily driven by FY20 and FY21 investment returns, are:






-60% -40% -20% 0% 20% 40% 60% 80% 100% 120%

FY 2020-2021 Cumulative Investment Return

30% 32% 38%

70%

Cumulative Net InvestmentReturn Less than 0.9%

[Annualized Less Than 0.4%]COLA=0.5% & Corrective Action

Recommendations Required

Cumulative Net Investment Return 0.9% to 20.0%

[Annualized 0.4% to 9.5%]Restricted Maximum COLA

Cumulative Net Investment Return Greater than 20.0%

[Annualized Greater than 9.5%]Full COLA: 0.5% to 3.5%

9


which are primarily driven by FY20, FY21, and FY22 investment returns, are:






-60% -40% -20% 0% 20% 40% 60% 80% 100% 120%


33% 27% 40%

67%

Cumulative Net InvestmentReturn Less than 7.0%

[Annualized Less Than 2.3%]COLA=0.5% & Corrective Action


Cumulative Net Investment Return 7.0% to 27.6%

[Annualized 2.3% to 8.5%]Restricted Maximum COLA

Cumulative Net Investment Return Greater than 27.6%

[Annualized Greater than 8.5%]Full COLA: 0.5% to 3.5%

10

Projected Future COLA Ranges: 2023if Starting Baseline FVFR = 120%

• If the starting baseline FVFR is 120%, the likelihoods for 2023 COLA ranges, which are primarily driven by

FY20, FY21, and FY22 investment returns, are:





-60% -40% -20% 0% 20% 40% 60% 80% 100% 120%


9%

15%76%

91%

Cumulative Net InvestmentReturn Less than (15.7%)

[Annualized Less Than (5.5%)]COLA=0.5% & Corrective Action


Cumulative Net Investment Return (15.7%) to (0.3%)

[Annualized (5.5%) to (0.1%)]Restricted Maximum COLA

Cumulative Net Investment Return Greater than (0.3%)

[Annualized Greater than (0.1%)]Full COLA: 0.5% to 3.5%

11

Projected Funded Status and Risk

Analysis Summary

• Absent a significant run up or downturn in investment markets, the FVFR will be

100% at June 30, 2019

– Net FY19 returns greater than approximately 9% would result in an unrestricted 2020

COLA (COLA equal to inflation between 0.5% and 3.5%)

– Net FY19 returns less than approximately -8% would reduce the 2020 restricted

maximum COLA to 0.5% and also require corrective action recommendations

• Results to date would indicate a FY20 SDRS COLA equal to inflation – but inflation

and investment returns can change quickly and dramatically

• Assuming FY19 net investment returns remain at approximately 2.5%, the

likelihood of additional required corrective action recommendations in the near

future varies from approximately 24% (one year) to approximately 33% (three

years)

12

Stress Testing

• Stress testing is one risk assessment method listed in ASOP 51

• A few organizations are advocating mandatory standardized stress testing:

– Striving to have their version endorsed as appropriate standard approach

– Working to have state legislatures require standard approach

– Often includes funding implications of a sustained, significant economic downturn

without recognizing the impact of future plan adjustments

• To be valuable, risk analysis must:

– Be tailored to each plan specifics

– Include actions that will be taken in an economic downturn

– Answer questions specific to each system

– Offer decision-useful information

• SDRS has actively assessed risks prior to these requirements and has focused on

SDRS specifics identifying the economic conditions that would require corrective

actions and the likelihood of those events

13

Additional Risk Assessments

• Additional insight can be gained from scenario testing – examining the impact of

specified conditions or events on SDRS

• The following exhibits compare future results if investment returns equal the

assumed 6.5% with the results if future returns are 5% and:

– All other experience matches assumptions

– FY 2019 net investment returns equal 2.5%

• Results are stable under the 6.5% scenario with gradual increases in the restricted

maximum COLA

• Under the 5.0% return scenario, funding will slowly deteriorate until reaching the

corrective action threshold in 2031

14

Additional Risk Assessments:

5% Investment Returns

94%

97%

93%

84% 83%

60%

80%

100%

120%

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034

Projected Baseline Fair Value Funded Ratio

6.5% Future Returns

5.0% Future Returns

Corrective Actions Required in 2031

1.68%

1.96%

1.54%

0.50% 0.50%

0.50%

0.0%

1.0%

2.0%

3.0%

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035

Projected COLA Range 6.5% Future Returns

5.0% Future Returns


15


Negative Cash Flow

• The amount of negative cash flow (contributions less benefit payments and

expenses) is also an important risk factor since it can also impact future

investment returns

– The projected negative cash flow is expected to grow from approximately 3% to almost

4% of beginning of year assets with a 6.5% return

– If returns are 5.0% per year, the negative cash flow grows more rapidly

-3.3%

-3.8%-3.3%

-4.1%

-5.0%

-4.0%

-3.0%

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034

Projected Net Cashflow as Percent of Assets

6.5% Future Returns

5.0% Future Returns


Future Payroll Growth = 3.0%

16


Negative Cash Flow

• Changes in the growth of covered payroll can also influence cash flows

– If payroll growth slows to 1.5% per year, the projected negative cash flow will be larger

– Investment return less than the assumed 6.5% together with lower payroll growth results

in even larger negative cash flow

-3.3%

-4.2%

-3.4%

-4.5%

-5.0%

-4.0%

-3.0%

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034

Projected Net Cashflow as Percent of Assets

6.5% Future Returns

5.0% Future Returns


Future Payroll Growth = 1.5%

17

Cash Flow Considerations:

Benefit Starts

• As expected, the number of benefit starts during FY19 is up considerably from prior years

0

100

200

300

400

500

600

July August September October November December January February March April May June

Benefit Starts by Fiscal Year and Month

FY 2015 FY 2016 FY 2017 FY 2018 FY 2019

18

• After three years of declining retirements, the number of retirements in FY19 is up 19%

• We expect the elevated number of retirements to continue through FY 2022

• All South Dakota public employers will need to replace a large portion of their workforce

0

500

1,000

1,500

2,000

July August September October November December January February March April May June

CumulativeFY Starts Cumulative Benefit Starts by Fiscal Year and Month

FY 2015 FY 2016 FY 2017 FY 2018 FY 2019

Total Starts2012 1,5602013 1,5092014 1,5592015 1,5632016 1,4922017 1,4212018 1,4192019 1,687

Cash Flow Considerations:

Benefit Starts

19

• Projected benefit payment increase was 6%. Through April, payments had increased 5.4%.

$450

$482$510

$541$564

$495

7.1%(1)5.8%(1)

6.0%(1)4.3%(2)

5.4%(3)

$0

$200

$400

$600

FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019 thru April

Millions Benefit Payments and Refunds by Fiscal Year

Annuities Refunds Increase

(1) Increase includes 3.1% COLA.(2) Increase includes 2.1% COLA. (3) Increase in FY 2019 through April over FY 2018 through April. Increase includes 1.89% COLA.

Historical Cash Flow Growth

20

Summary of Additional Risk

Assessments

• Automatically adjusting features of SDRS will stabilize the funded status and cash

flow requirements under many scenarios

• However, severe or sustained economic downturns or slowdowns may result in

SDRS reaching corrective action thresholds and may increase the cash flow

requirements

• Identifying and monitoring risks will remain critical

• Refining an action plan will help drive decisions in a crisis

21

Public Plan Criticism

• Frequent criticism of public plans focuses on high and consistently increasing

contribution requirements, increasing unfunded liability and their perceived causes

• Most frequently cited causes:

– Contributions have been less than actuarial requirements

– Defined benefit plans are unsustainable:

• Benefits are too generous

• Can be manipulated by employee or employer actions

• Retirement can last longer than career

– Assumptions are too optimistic and assumed investment return should be reduced

• Recent returns have been less than assumed

• Benefits should be valued on “risk-free” discount rate

• Arguments often conflated, touting “risk-free” discount rate as more realistic assumed investment

return

– Actuarial practices that have not highlighted the risks of inadequate funding

• A combination of these causes has frequently magnified the problem

22

SDRS is Different

SDRS

• Fixed member and employer

contributions

• Variable benefits

• Statutory thresholds delineating

acceptable funding measurements

– Corrective actions required if

thresholds not met

• 6.5% investment return assumption

• SDIC invests assets

Typical State Retirement System

• Fixed member, variable employer

contributions

• Fixed benefits

• No pre-determined limits on

measurements

– No definitive call to action

.

• 7.25% investment return assumption

• Responsibility for asset management

may be combined with administration,

or separate

These structural and operational differences have been key to SDRS success

23

SDIC Results: Statewide Pension Plan

One-Year Returns

Investment return data on 114 statewide plans from Public Plans Database. Calendar year 2018 returns assumed to be -3% if not yet reported.

-30%

-20%

-10%

0%

10%

20%

30%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Annual Investment Returns

SDRS Median

24


Five-Year Returns


-5%

0%

5%

10%

15%

20%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Rolling 5-Year Geometric Average Returns

SDRS Median

25


10-Year Returns


0%

2%

4%

6%

8%

10%

12%

2010 2011 2012 2013 2014 2015 2016 2017 2018

Rolling 10-Year Geometric Average Returns

SDRS Median

26


18-Year Returns

OK Teachers 7.36%SDRS 7.27%

Vermont State 7.08%


Median5.88%

0%

2%

4%

6%

8%

18-Year Geometric Average Returns for 114 Statewide Plans SDRS 7.27%

27

SDRS Results:

Funded Status Comparisons

Data from Public Plans Database. Many calendar year 2018 results are not yet reported and when reported will likely reduce the 2018 median plan

funded ratio.

99.3%

109.2% 110.6%

116.8%121.4%

104.8%

76.5%

87.9%

102.9%

92.8%

103.2%107.3%

104.1%

96.9%100.1% 100.0%

80.4%84.5% 86.4% 86.8%

93.0%

75.1%

62.6%66.0%

70.1% 68.7%72.0%

77.6%74.3%

71.0%73.9% 75.1%

0%

50%

100%

150%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Fair Value Funded Ratio

SDRS Median Public Sector Plan

SDRS' FVFR exceeds median by an average of 26.1% since 2003

28

SDRS Results:

Contribution Comparisons

Data from NASRA Public Fund Survey.

6.0%

6.5%

8.5%

9.4%10.6%

12.9% 13.3% 12.8%

5.0%5.7%

6.0%

0%

5%

10%

15%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Fiscal Year

Contribution Rates for General EmployeesSDRS and Median, Large Public Sector Plans (In Social Security)

SDRS - Member and Employer Median Employer Median Member

29

SDRS Results:

Plan Maturity Comparisons

Median public sector plan data from Public Plan Database.

4.284.74

5.115.57

6.29

5.36

3.894.36

5.32 5.225.98

6.68 6.516.10 6.30 6.43

3.804.22 4.39 4.60

4.984.22

3.463.85 4.14 4.25

4.635.21 5.00 4.84

5.24 5.19

0.00

2.00

4.00

6.00

8.00

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Fair Value of Assets to Active Payroll Ratio

SDRS Median Public Plan

SDRS’ assets to payroll ratio is growing about 70% faster than other systems’

4.31 4.34 4.62 4.765.18 5.12 5.09 4.96 5.17

5.62 5.796.23 6.26 6.29 6.29 6.43

5.08 5.25 5.38 5.45 5.59 5.70 5.84 5.97 6.27 6.55 6.82 6.94 7.15 7.26 7.35 7.24

0.00

2.00

4.00

6.00

8.00

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Accrued Liability to Active Payroll Ratio

SDRS Median Public Plan

SDRS’ liability to payrollratio is growing about 12% slower than other systems’

30

SDRS Results:

Cash Flow Comparisons


-1.1%

-0.9%

-1.4%

-1.6% -1.7%

-1.5%

-2.0%

-2.9%-2.7%

-2.5%

-2.9%

-2.6%-2.5%

-2.7%

-2.9%-2.7%

-2.4%-2.3% -2.3% -2.2% -2.2%

-1.8%

-2.4%

-3.1% -3.0%

-2.9%

-3.1%

-2.8%

-2.6%

-3.0%

-3.2%

-3.0%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net External Cash Flow as a Percentage of Beginning Assets


In recent years, SDRS net

external cash flow has been a

similar percentage of assets as

the median public sector plan

31

Cash Flow Comparisons


3.3% 3.8%3.0% 2.7% 2.5% 2.2% 2.6%

3.5% 3.1%2.5% 2.6% 2.4% 2.1% 2.1% 2.3% 2.1%

3.9% 4.2% 4.0% 4.0% 4.0% 3.8%4.5%

5.6% 5.2% 5.0% 5.1% 5.2% 5.0% 5.4% 5.5% 5.3%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Contributions as a Percentage of Beginning Assets


-4.4% -4.6% -4.4% -4.3% -4.2% -3.7%-4.6%

-6.3%-5.8%

-5.0% -5.4% -5.0% -4.6% -4.8% -5.2% -4.9%

-6.4% -6.5% -6.2% -6.1% -6.3% -5.9%-7.1%

-8.8% -8.7% -8.2% -8.5% -8.2% -7.8% -8.2%-8.7% -8.4%-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Benefits and Expenses as a Percentage of Beginning Assets


But both SDRS contributions and expenses are a smaller percentage of assets than the median plan

32

Summary of SDRS Success

• Investment performance has been the primary driver

• Fixed contributions, variable benefits, benefit improvement discipline, and statutory

requirements for corrective actions have been important factors

• Investment assumptions aligned with SDIC outlook

• Risks evaluated and communicated

• Planning, goal setting, and monitoring results

South Dakota Retirement System...Jul 2014 Jan 2015 Jul 2015 Jan 2016 Jul 2016 Jan 2017 Jul 2017 Jan 2018 Jul 2018 Jan 2019 Jul 2019 Index Monthly CPI-W and 3rd Quarter Average 3rd

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