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Review of Economic Assumptions

November 8, 2006

P

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Syllabus

• Assumptions– Economic Model– Inflation and Investment Return

• Expectations• Other 37 Act Systems• Recommendations

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Assumptions

• Best guess of what will happen in the future

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Economic Assumptions

• Describe impact on money

• InflationSalary IncreasesReturn on InvestmentsCost-of-Living Adjustments

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Demographic Assumptions

• Describe member movement from one category to another

• TerminationDisabilityRetirementDeath

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Economic Assumption Model

Inflation Inflation Inflation

Merit & Longevity

Real Investment

Return

COLA (limited to 3% )

Salary Increase

Investment Return

Across the Board

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Annual Inflation RateGraph 1

Annual Rates of Inflation

-4%

0%

4%

8%

12%

16%

20%

19

46

19

51

19

56

19

61

19

66

19

71

19

76

19

81

19

86

19

91

19

96

20

01

20

06

Pe

rce

nt

Ch

an

ge

in C

PI

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Average Inflation RateGraph 2

Average Inflation Rate

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

1970

1975

1980

1985

1990

1995

2000

2005

Ave

rag

e A

nn

ual

Infl

atio

n

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Inflation Spike: 1974-1982Graph 3

Rate of Inflation 1974-1982

0%

4%

8%

12%

16%

20%19

74

1975

1976

1977

1978

1979

1980

1981

1982

Perc

ent C

hange in

CP

I

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Average Inflation after Removing Spike

Graph 4Average Inflation Rate after Removing 1974-1982

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

1970

1975

1980

1985

1990

1995

2000

2005

Avera

ge A

nnual I

nflation

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Inflation Assumptionsin 37 Act Systems

Graph 5Inflation Assumptions Adopted by CERL Systems

4

3

6

3 3

1

0

3

6

9

3.50% 3.75% 4.00% 4.25% 4.50% 4.75%

Inflation Assumption

Nu

mb

er o

f S

yste

ms

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Average Inflation Assumptionsin 37 Act Systems

Graph 6Average Inflation Assumptions Adopted by CERL Systems

4.43%4.38% 4.38%

4.28%

4.08% 4.12%4.01%

3.5%

4.0%

4.5%

1999 2000 2001 2002 2003 2004 2005

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Inflation Assumption

• Current4.00%

• Reasonable Range 3.00% - 4.50%

• Recommendation: 4.00%

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Investment Return

Inflation

Real Investment

Return

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Real Investment Return

• Over 90% of Real Investment Return due to asset allocation

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FCERA Allocation Targets

Stocks – Domestic 38%

Stocks – International 18%

Bonds – Global 3%

Bonds – Core (and cash) 30%

Private Markets 11%

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Average Annual Real Returnsby Asset Class

(1/1/1926-6/30/2006)

Large Company Stocks 7.2%

Small Company Stocks 9.5%

Long-term Corporate Bonds 2.7%

Long-term Government Bonds 2.3%

Intermediate-term Government Bonds 2.2%

US Treasury Bills 0.6%Ibbotson Associates, Inc.

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Real Investment Return in 37 Act Systems

1

3

1

3

4

3

4

1

0

3

6

3.25% 3.66% 3.75% 3.90% 4.00% 4.16% 4.25% 4.50%

Real Investment Return Assumption

Num

ber

of S

yste

ms

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Average Real Investment Assumption

3.90%

3.98%3.96%

3.80%3.81%3.82%

3.73%

3.50%

3.75%

4.00%

1999 2000 2001 2002 2003 2004 2005

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Real Investment Return

• Current 4.16%

• Reasonable Range 3.50% - 4.50%

• Recommendation 4.16%

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Nominal Investment Returnin 37 Act Systems

Graph 7Investment Return Assumptions Adopted by CERL Systems

4 4

5 5

2

0

2

4

6

7.75% 7.90% 8.00% 8.16% 8.25%

Investment Return Assumption

Nu

mb

er o

f S

yste

ms

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Average Nominal Investment Return in 37 Act Systems

Graph 8Average Investment Return Assumptions

Adopted by CERL Systems

8.15%8.20% 8.19%

8.07%8.04%

8.00% 8.00%

7.75%

8.00%

8.25%

1999 2000 2001 2002 2003 2004 2005

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Nominal Investment Return

• Current8.16%

• Reasonable Range 7.50% - 8.50%

• Recommendation: 8.16%(8.00% compounded semi-annually)

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Questions