Department of Employee Trust Funds - Hot Topic
February 3, 2004

Wondering About This Year's Retiree Dividend?

The Department of Employee Trust Funds (DETF) will soon announce the annual fixed annuity dividend and variable annuity adjustment paid to retirees of the Wisconsin Retirement System (WRS). In the meantime, we’ll address some commonly asked questions from retirees about fixed annuity adjustment calculations and how they differ from rates credited to non-retired participant accounts.

Q. According to preliminary information from the State of Wisconsin Investment Board (SWIB), the fixed trust fund earned over 24% in 2003. However, DETF says there may not be a fixed annuity increase this year. Why?

A. Under current law DETF cannot grant a fixed annuity increase unless there is sufficient funding to grant all retirees a 2% increase. Even though preliminary 2003 investment returns were 24%, the fixed trust fund is still feeling the effects of investment losses from three consecutive years of declining investment markets (2000, 2001, and 2002). As a result, the preliminary investment returns of 24% are still insufficient to generate a 2% fixed dividend.

However, proposed legislation still might make it possible for the Department to pay a small fixed annuity increase in May. Assembly Bill 692 and Senate Bill 344 call for lowering the 2% threshold mentioned above to .5% (one-half percent). Under these bills, if the annual investment earnings are sufficient so that the Department’s calculation process yields a fixed annuity increase of at least .5%, the increase could be granted. If this legislation is enacted in time, there will be a small fixed annuity increase (less than 2.0%) beginning with the May 1, 2004, annuity payment.

DETF supports these bills and is closely monitoring their status. To monitor their status yourself, visit the Legislature’s Internet site.

Q. Why are the annuity adjustments (fixed and variable) always lower than the interest rates credited to non-retired participant accounts? Don’t all monies in the trust fund reap the same investment earnings?

A. The funds earn the same rate of return. The annuity adjustment is always lower because 5% assumed interest earnings must first be subtracted from the earnings actually credited to the annuity reserves (fixed and variable). Here’s why: When you retire, the Department calculates the amount of money that will be needed to fund your retirement benefit for your projected lifetime. This amount is based on an actuarial assumption that the fund will earn 5% every year. Next, the total amount needed to fund your annuity for your lifetime is transferred to the annuity reserve, the fund from which all monthly payments are paid. Consequently, only investment earnings in excess of the 5% assumed earnings are available to provide annuity increases. When investment earnings are less than the 5% assumed rate, this deficiency must be “made up” before money is available to provide annuity increases.

Q. Then why isn’t the fixed annuity adjustment rate exactly 5% less than the fixed effective rate applied to non-retired accounts?

A. Calculating annuity dividends is significantly more complex than calculating the interest rates credited to the accounts of non-retired members. The process involves factors that are only applicable to annuities. One example: changes in mortality rates for members. A dividend increase is calculated based on how much money is in the annuity reserve as of December 31, as compared to how much is needed to fund all of the benefits for the projected lifetimes of all annuitants. A small increase in annuitants’ life expectancies (as occurred in the recent three-year actuarial study) means that the annuities are now expected to be paid for a slightly longer period of time. This results in needing more money to fund those annuities, which has the effect of slightly reducing the annuity adjustment that can be granted. Other factors include funds carried over from the previous year’s calculation process; adjustments for reestablished accounts; and lump sum payments to annuitants’ beneficiaries.

Q. The variable interest rate credited to participants’ accounts is fairly close to SWIB’s actual variable fund investment earnings for the previous year. However, the fixed interest rate is normally very different from SWIB’s actual fixed fund investment earnings for the previous year. Why?

A. Variable fund gains and losses are fully distributed each year. However, to maintain stability in annual contribution rates and fixed interest crediting and fixed annuity adjustments, by law annual fixed investment returns are “smoothed” over a five-year period. One result of smoothing the fixed returns is that there may be a fixed annuity increase after a year with fixed fund investment losses. However, this generally also results in lower annuity increases for the years in which the market performs well.

Due to the significant stock market losses during 2000, 2001 and 2002, the fixed fund actually lost money in each of those years. However, because of the smoothing in the fixed fund investment returns, the Department was able to grant fixed annuity increases in 2000 (5.7%) and 2001 (3.3%). Unfortunately, over time these losses must still be applied to WRS fixed accounts and annuities. When calculating the interest crediting and annuity adjustments calculation, DETF will continue distributing the losses until they have been fully recognized.

This has the effect of reducing fixed interest crediting and annuity adjustments for five years after the last year in which a loss occurred.

Find out more about State of Wisconsin Investment Board preliminary investment returns for 2003.

Fixed and variable fund percentages.