Department of Employee Trust Funds - Hot Topic
October 10, 2002

What Effect Will Market Declines Have on Future Fixed Annuity Dividends?

Wisconsin Retirement System (WRS) annuitants have historically received positive fixed annuity dividends – there has never been a negative fixed annuity adjustment (dividend) in the WRS. Over the past ten years, fixed annuities have gone up an average of 6.5%. However, a Department of Employee Trust Funds (ETF) analysis shows that these relatively high rates will most likely not be repeated for at least several years. In fact, depending on future market experience, it is possible to have no fixed dividends or even negative fixed adjustments in some years. How is this possible and how will it affect your WRS annuity?

Let us reassure you that the law provides that your fixed annuity benefit will not drop below the final fixed monthly amount computed at retirement -- only previously earned dividends could be taken back. For example, if there is a negative fixed dividend as a result of 2002 investment returns, past fixed dividends will be reduced for future payments as necessary to adjust for any loss.

During the 1990s, dividends have been higher because the markets have performed beyond expectations. Eligible annuitants also saw increased dividends from 1999 Wisconsin Act 11 (Act 11) of 9.6%. However, recent market experience, combined with the costs ($4 billion transfer, actuarial assumption changes and benefit changes) resulting from Act 11, may result in no fixed annuity dividend or even negative adjustments in the future. Some provisions of Act 11 had the effect of reducing the protective financial cushion for annuitant dividends in times of declining markets.

Please keep in mind that the Department is not predicting a loss at the end of 2002. However, the investment markets have been in a prolonged downward slump and we are concerned about the impact this will have on your benefits. The State of Wisconsin Investment Board (SWIB) investment returns for 2002 as measured on December 31 are used to determine the effective rates (interest on active and eligible inactive accounts) and annuitant dividends. As of September 30, 2002, SWIB reported the following returns: Fixed Trust –13.2% Variable Trust –27.6%

Does the ETF Board have the authority to reduce dividends?
Yes. If there is a deficit in the fixed annuity reserve, the ETF Board has the authority under law (s. 40.27 (2) (c)) to reduce all or part of past granted dividends, as to future payments.

Under what conditions are fixed dividends paid?
Fixed dividends are paid when investment income, adjusted to reflect mortality experience among annuitants, is greater than the 5% set by law, but only when it would result in at least a 2% dividend for all annuities. In 2003, the Department will announce the fixed and variable annuity dividends in February, effective March 1.

The Department has developed the following hypothetical scenarios using projected positive and negative SWIB investment returns through 2008.

ETF Projections:

ETF calculated the following fixed annuity dividend scenarios using two factors:

1. 2002 SWIB Fixed Fund investment returns of –10%, -5%, 0%, and 8%
2. Investment gains of 8% in subsequent years (which currently is the long-term investment earnings assumption used by the WRS actuary).

Note: Under current law, fixed fund dividends are only awarded when it would result in at least a 2% dividend for all annuities. These figures are projections only. Actual results will reflect actual investment experience (keep in mind that investments include not only stocks but also bonds, real estate, and several other asset classes).

If SWIB recorded a 10% loss for 2002 and 8% gains each year through 2008:

Example: For an annuitant with a $1,000 monthly annuity, a negative .3% would result in an annuity of $997.00 (a $3.00 loss).

If SWIB recorded a 5% loss for 2002 and 8% gains each year through 2008:

If SWIB recorded a 0% return for 2002 and 8% gains each year through 2008:

Once again, please keep in mind that these are hypothetical scenarios and actual investment experience could vary significantly from these projections. A significant increase in investment earnings beyond the 8% assumed rate in future years would have a positive effect on dividends. Similarly, continued years of investment earnings of less than 8% would require greater reductions than noted and also increase contribution rates for active employees.