RRB11R004 Attachment B - 24th Actuarial Valuation.pdf

Twenty-Fourth

Actuarial Valuation of the Assets and Liabilities

Under the Railroad Retirement Acts as of December 31, 2007 with

Technical Supplement

U.S. Railroad Retirement Board

Bureau of the Actuary

Chicago, Illinois

Twenty-Fourth Actuarial Valuation of the Assets and Liabilities

Under the Railroad Retirement Acts as of December 31, 2007 with by

Frank J. Buzzi, Chief Actuary with Statements of the

Railroad Retirement Board and the

Actuarial Advisory Committee

U.S. Railroad Retirement Board

Bureau of the Actuary

August 2009 i

CONTENTS

Statement of the Railroad Retirement Board v

Statement of the Actuarial Advisory Committee vii

Report of the Actuary

I. Introduction 1

II. Summary of Recent Developments and Results 1

III. Regular and Supplemental Benefits and Their Financing 3

IV. The Financial Interchange and Dual Benefits 6

V. Assumptions, Methodology, and Valuation Results 8

VI. Statement of Actuarial Opinion 14

Appendix

Outline of the benefit and financing provisions of the railroad retirement system as amended through December 31, 2008 29

General Methodology and Assumptions 38

Mortality, Remarriage and Related Experience 57

Retirement Studies 71

Withdrawal Studies 78

Employee and Beneficiary Censuses, Family Composition, and Miscellaneous Statistics 81 ii

TABLES

1. Employment, inflation and interest assumptions 15

2. Progress of the Combined National Railroad Retirement Investment Trust and Railroad

Retirement Account, and Social Security Equivalent Benefit Account 17

3. Present value of benefits in millions of dollars 20

4. Present value of benefits as a percentage of the present value of tier 2 payroll 21

5. Balance of the Combined National Railroad Retirement Investment Trust and Railroad

Retirement Account, and the Social Security Equivalent Benefit Account as of

December 31, 2007 22

6. Actuarial surplus or (deficiency) for National Railroad Retirement Investment Trust and

Railroad Retirement Account 23

7. Unfunded accrued liability 24

8. Vested dual benefit amounts and average number of beneficiaries 25

9. Supplemental annuity benefit amounts and average number of beneficiaries 26

10. Average number of railroad retirement annuitants and number of annuitants per full time employee 27

11. Transfers to railroad retirement system under financial interchange with social security system, 1937-2009 28

S-1. 2007 RRB Annuitants Mortality Table 43

S-2. 2007 RRB Disabled Mortality Table for Annuitants with Disability Freeze 44

S-3. 2007 RRB Disabled Mortality Table for Annuitants without Disability Freeze 45

S-4. 2003 RRB Active Service Mortality Table 46

S-5. 2007 RRB Spouse Total Termination Table 47

S-6. Probability of a retired employee having a spouse eligible for railroad retirement benefits 48

S-7. 1995 RRB Mortality Table for Widows 49

S-8. 1997 RRB Remarriage Table 50

S-9. 2004 RRB Total Termination Table for Disabled Children 51

S-10. Calendar year rates of immediate age retirement 52

S-11. Rates of immediate disability retirement and of eligibility for disability freeze 53

S-12. Calendar year rates of final withdrawal 54

S-13. Service months and salary scales 55

S-14. Family characteristics of railroad employees assumed for the valuation of survivor benefits 56

S-15. Mortality experience of railroad age annuitants between anniversaries of retirement in 2003 and 2006, by sex and type of retirement 58 iii

S-16. Mortality experience of railroad age annuitants between anniversaries of retirement in 2003 and 2006, by year 59

S-17. Mortality ratios for railroad age annuitants on a select and ultimate basis between anniversaries of retirement in 2003 and 2006 60

S-18. Age specific death rates of railroad disability annuitants between anniversaries of retirement in 2003 and 2006, by age and duration 61

S-19. Mortality experience of railroad disability annuitants between anniversaries of retirement in 2003 and 2006, by disability freeze status 62

S-20. Percentages of railroad disability annuitants included in the 24th valuation mortality studies who would have qualified for a benefit under the social security disability standards 63

S-21. Mortality experience of active railroad employees during calendar years 2001-2005 64 S-22. Total termination experience of spouse annuitants between anniversaries of retirement in 2003 and 2006 65 S-23. Mortality experience of spouse annuitants between anniversaries of retirement in 2003 and 2006 66 S-24. Number of retired employees and number with a spouse eligible for railroad retirement benefits, by attained age of employee on December 31, 2006 67 S-25. Mortality experience of widow annuitants between anniversaries of retirement in 2003 and 2006 68 S-26. Remarriage experience of widows between 1994 and 2006 anniversaries of widowhood 69 S-27. Total termination experience of disabled children annuitants between anniversaries of retirement in 2003 and 2006 70 S-28. Rates of immediate age retirement 72 S-29. Immediate age retirement experience of railroad employees with 5-29 years of service during calendar years 2004-2006 73 S-30. Immediate age retirement experience of railroad employees with 30 or more years of service during calendar years 2004-2006 74 S-31. Rates of immediate disability retirement 75 S-32. Immediate disability retirement experience of railroad employees during calendar years 2004-2006 76 S-33. Percentages of immediate disability retirements meeting the disability freeze standards of the Social Security Act 77 S-34. Withdrawal experience of railroad employees during calendar years 2002-2005, by attained age and years of service 79 S-35. Distribution of 2007 active employees by age and completed years of service 82 iv

S-36. Census of vested inactive employees in 2007 by age and completed years of service 83

S-37. Comparison between 2007 and 2004 of selected characteristics of active railroad employees 84

S-38. Census of employee and spouse annuitants on December 31, 2007 85

S-39. Census of survivor annuitants on December 31, 2007 86

S-40. Comparison of service months of railroad employees during calendar years 2003-2005 with assumptions used in the 24th valuation 87

S-41. Average creditable compensation per service month during 2007 88

S-42. Age distribution of new entrants during calendar years 2003-2006 and comparison with assumptions of the 23rd valuation 89

S-43. Family characteristics of railroad employees who died in 2003-2006 with a current connection 90

S-44. Selected employment and benefit statistics for 2004 and 2007 91

UNITED STATES OF AMERICA

RAILROAD RETIREMENT BOARD

844 NORTH RUSH STREET

CHICAGO, ILLINOIS 60611-2092

BOARD MEMBERS:

MICHAEL S. SCHWARTZ, CHAIRMAN

V.M. SPEAKMAN, JR., LABOR MEMBER

JEROME F. KEVER, MANAGEMENT

MEMBER

STATEMENT OF THE RAILROAD RETIREMENT BOARD

Section 15(g) of the Railroad Retirement Act of 1974 requires that the Railroad Retirement Board, at intervals not longer than three years, estimate the liabilities created by the Act and include the estimate in its annual report. Section 22 of the Railroad Retirement Act of 1974 requires that the Board submit to the President and the Congress, by July 1 of each year, a report containing a five-year projection of the revenues to and payments from the Railroad Retirement Account. Section 502 of the Railroad Retirement Solvency Act of 1983, Public Law 98-76, requires that the Board submit to the Congress, by July 1 of each year, a report on the actuarial status of the railroad retirement system. The 24th valuation was prepared by the Board's Chief Actuary and meets these requirements. The Actuarial Advisory Committee reviewed the valuation as to assumptions and methods as required by Section 15(f) of the Railroad Retirement Act.

The Chief Actuary's report describes the results of three valuations, each valuation differing from the others as to the employment assumption on which it is based. Cash flow problems occur only under the most pessimistic employment assumption. Even under that assumption, the' cash flow problems do not occur until the year 203 1.

Section 502 of the Solvency Act requires recommendations with respect to tax rates and whether any part of the taxes on employers should be diverted to the Railroad Unemployment Insurance Account to aid in the repayment of any debt to the Railroad Retirement Account. The Chef Actuary's report does not recommend a change in the tax rate, nor does it recommend a diversion of taxes from the Railroad Retirement Account to the Railroad Unemployment hsurance Account.

The Board Members believe that the 24th valuation presents a fair picture of the financial condition of the railroad retirement system, and we support the conclusions reached in the report.

The Railroad Retirement Board wishes to thank the members of the Actuarial Advisory Committee for their assistance in this important project.

Michael S. Schwartz &

V. M. Speakman, Jr. W

Jerome F. Kever

STATEMENT OF THE ACTUARIAL ADVISORY COMMITTEE

May 27,2009

This statement sets forth the Committee's review of the twenty-fourth actuarial valuation of the railroad retirement system. This valuation, performed as of December 3 1,2007, was completed in the spring of 2009 by Mr. Frank J. Buzzi, Chief Actuary of the Railroad Retirement Board, and his staff. In both the planning and carrying out of the valuation, the Committee has counseled with Mr. Buzzi as to the structure, actuarial methods, actuarial assumptions, and procedures of the valuation and as to the scope and content of his report. In all, the Committee has met with the Chief Actuary on August 5,2008, December 16,2008, and May 27,2009, for the purpose of reviewing and discussing the significant elements of the twenty-fourth valuation.

The Committee believes that the actuarial assumptions are reasonable and that the valuation results present a fair picture of the financial condition of the railroad retirement system.

Section 502 of the Railroad Retirement Solvency Act requires the Board to report to Congress on the actuarial status of the railroad retirement system each year. The report must include recommendations for any desirable financing changes. The Chief Actuary recommends no change in payroll tax rates under the railroad retirement system.

The Chief Actuary's report indicates that the average cost of the program over the projection period as measured by the excess of present value of tier 2 payroll taxes over the actuarial surplus ranges from 16.13% to 21.57% of payroll, depending on assumed future employment levels. This compares to a range of 14.19% to 18.63% of payroll in the twenty-third valuation.

The Committee acknowledges the valuable help of the Board, the Chief Actuary and his staff in the Committee's review of this valuation.

Respectfblly submitted, -

Albert Pike 3rd, M.A.A.A., Chair n

Peter A. Bleyler, M.A.A.A.

Maynard I. Kagen, M.A.A.A.

REPORT OF THE ACTUARY

I. INTRODUCTION

Section 15 of the Railroad Retirement Act of 1974 requires that the Railroad Retirement Board, at intervals of not more than three years, prepare actuarial valuations of the railroad retirement system.

Section 22 of the Railroad Retirement Act of 1974 requires the Railroad Retirement Board to prepare an annual report containing a five-year projection of revenues to and payments from the Railroad Retirement Account and to submit the report to the President and the Congress by July 1.

This report must also contain a five-year projection of the account benefits ratio and average account benefits ratio. If the five-year projection indicates that funds in the Railroad Retirement Account will be insufficient to pay full benefits, (1) representatives of railroad employees, railroad carriers and the President must submit proposals to the Congress to preserve the financial solvency of the Railroad Retirement Account, and (2) the Railroad Retirement Board must issue regulations to reduce annuity levels during any fiscal year in which there would be insufficient funds to make full payments.

Section 502 of the Railroad Retirement Solvency Act of 1983 requires the Railroad Retirement Board to prepare an annual report on the actuarial status of the railroad retirement system and to submit the report to the Congress by July 1. The report must contain recommendations for any financing changes which might be advisable, including (1) changes in the tax rates, and (2) whether any part of the taxes on employers should be diverted to the Railroad Unemployment Insurance Account to aid in the repayment of any debt to the Railroad Retirement Account.

This report, the 24th actuarial valuation, is intended to meet these three requirements for 2009.

II. SUMMARY OF RECENT DEVELOPMENTS AND RESULTS

Recent actuarial reports have discussed in detail the importance of the level of railroad employment to the railroad retirement system's financial stability. The payroll tax on railroad employment has been the major source of income to the system since its establishment in the 1930s. It is clear that the fewer railroad workers there are, the less money the retirement account collects in payroll taxes, and the more likely the system is to require additional funds. Declines in railroad employment over a long period, coupled with inflation and subsequent benefit increases, required legislation to strengthen the system's financial condition in 1974, 1981, 1983, and 1987.

The 23rd valuation (2006 actuarial report) projected a surplus of 0.33 percent of tier 2 payroll and an average tier 2 tax rate of 16.52 percent under the intermediate employment assumption. Although employment experience has been favorable, large investment losses have resulted in lower trust fund balances, which in turn have produced higher projected taxes due to the tier 2 tax rate schedule. The average tier 2 tax rate has increased to 18.97 percent, and the surplus has increased to 0.35 percent of tier 2 payroll. The combined effect of a 2.45 percent of payroll increase in projected future tier 2 tax rates net of a 0.02 percent of payroll increase in projected surplus results in an overall decline equal to 2.43 percent of tier 2 payroll. If the same rates of decline in freight employment were used in the 24th valuation as in the 23rd, the measured decline in financial position would have been somewhat greater.

Legislation enacted since the 23rd valuation liberalizing benefits payable under court ordered partitions, expanding eligibility for divorced spouse benefits and increasing the disability earnings limit has not had a significant impact on the system’s financial stability.

The 24th valuation has been prepared under three assumptions as to the future behavior of railroad employment. These employment assumptions are similar to the employment assumptions used in the 23rd valuation, differing mainly because of lower rates of decline assumed for freight employment. Employment assumptions I and II assume stable passenger employment and different rates of decline in freight employment. Employment assumption III follows the structure of assumptions I and II, except that it has declines in passenger employment and steeper declines in freight employment than employment assumptions I and II. Employment assumptions I, II and III are intended to provide an optimistic, moderate and pessimistic outlook, respectively. The specific results of the projections made in this report of the railroad retirement system's financial condition are as follows:

1. Under employment assumption I, the average tier 2 tax rate is 16.51 percent, and an actuarial surplus of 0.38 percent of tier 2 payroll exists as of December 31, 2007. There are no cash flow problems during the 75-year projection period, and the tier 2 payroll tax rate ranges from 8.2% to 20.0%.

2. Under employment assumption II, the average tier 2 tax rate is 18.97 percent, and an actuarial surplus of 0.35 percent of tier 2 payroll exists as of December 31, 2007. There are no cash flow problems during the 75-year projection period, and the tier 2 payroll tax rate ranges from 8.2% to 27.0%.

3. Under employment assumption III, the average tier 2 tax rate is 21.54 percent, and an actuarial deficiency of 0.03 percent of tier 2 payroll exists as of December 31, 2007. Cash flow problems arise in 2031 and remain to the end of the 75-year projection period. The tier 2 payroll tax rate ranges from 16.0% to 27.0%.

The average tier 2 tax rate is calculated by dividing the present value of tier 2 payroll taxes by the present value of tier 2 payroll as of January 1, 2008. The surplus or deficiency figures given above represent the change in the average tier 2 tax rate which would produce a balance of zero in the combined National Railroad Retirement Investment Trust, Railroad Retirement Account and Social Security Equivalent Benefit Account at the end of the 75-year projection period.

The conclusion is that, barring a sudden, unanticipated, large drop in railroad employment or substantial investment losses, the railroad retirement system will experience no cash flow problems during the next 22 years. The long-term stability of the system, however, is not assured. Under the current financing structure, actual levels of railroad employment and investment return over the coming years will determine whether additional corrective action is necessary.

As mentioned earlier, this report is intended to meet the requirements of Section 502 of the 1983 Solvency Act. Section 502 requires recommendations with regard to (1) the tax rates and (2) whether any part of the taxes on employers should be diverted to the Railroad Unemployment Insurance Account to aid in the repayment of its debt to the Railroad Retirement Account.

1. This report recommends no change in the rate of tax imposed on employers and employees.

The tier 2 tax rate schedule maintains a close balance between the present value of future income and expenditures. Although future financing problems are projected to occur under employment assumption III, as discussed above, the absence of projected cash flow problems for at least 22 years under each employment assumption indicates that an immediate change in the tax rate schedule is not required.

2. No diversion of taxes from the Railroad Retirement Account to the Railroad Unemployment Insurance Account is recommended. As of May 27, 2009, there are no loans outstanding from the Railroad Retirement Account to the Railroad Unemployment Insurance Account.

Section V of this report presents details of the valuations under the three employment assumptions.

III. REGULAR AND SUPPLEMENTAL BENEFITS AND THEIR FINANCING

The Appendix contains a detailed description of the provisions of the current law. Sections III and IV provide a more general summary of the law.

Amounts available for payment of railroad retirement benefits are held in four Accounts: the National Railroad Retirement Investment Trust (NRRIT), the Railroad Retirement (RR) Account, the Social Security Equivalent Benefit (SSEB) Account, and the Dual Benefits Payments Account.

Because of their intertwined nature, the NRRIT, RR Account and SSEB Account are discussed together in this section. Dual benefits and the Dual Benefits Payments Account are discussed in a separate section, Section IV.

Amounts held in the NRRIT, RR Account and SSEB Account are mainly used to pay monthly benefits to retired or disabled employees, their spouses, and survivors. The various types of benefits and their eligibility requirements are described in the Appendix. The Accounts also pay out relatively small amounts in lump sums to employees and their survivors in certain cases. The monthly benefits consist of three components, known as tier 1, tier 2 and supplemental annuity.

For all categories of recipients, the gross tier 1 benefit is generally equivalent to the benefit that the social security system would pay if all the employee's earnings (railroad and non-railroad) had been covered under the Social Security Act. Any benefit actually received from social security is subtracted to determine the net tier 1 benefit payable. Section IV explains the logic behind this determination. The cost-of-living increase paid to social security beneficiaries automatically carries over to the tier 1 component of railroad retirement annuities.

There are some differences between social security benefits and tier 1 benefits. The most significant are as follows:

1. An employee may not retire before age 62 under the social security system. Under the railroad retirement system, an employee may retire at age 60 with 30 years of service. A spouse of a 30-year employee may also retire at age 60. If the employee retired after 2001, there is no age reduction in either case.

2. Railroad retirement pays an occupational disability benefit under tier 1 and tier 2. Social security requires total and permanent disability. A five-month waiting period applies under both systems.

3. Widow(er)s who retire at age 60 or 61 under railroad retirement are deemed age 62 in the computation of the tier 1 benefit, resulting in a smaller age reduction than under social security.

4. From the start of the railroad retirement system through 1984, earnings up to a monthly maximum amount were taxed and credited for benefit computation purposes. Social security has always used an annual earnings limit. The 1983 Solvency Act changed railroad retirement to an annual earnings limit for 1985 and later years, but benefit computations for new beneficiaries will reflect the pre-1985 use of a monthly limit for many years into the future. All benefits awarded before 1985 reflect a monthly limit exclusively.

The formula used to compute the tier 2 component of railroad retirement is comparable to a private pension formula. Under the formula adopted in 1981, the employee tier 2 benefit is equal to 0.7 percent of the employee's average monthly railroad earnings for the 60 months of highest earnings, multiplied by the number of years of railroad service, less 25 percent of any vested dual benefit.

Unlike private pensions, tier 2 benefits (1) provide automatic cost-of-living increases, and (2) are paid to spouses and survivors without any reduction in employee benefit for the payment of these auxiliary benefits.

The tier 2 benefit for spouses is equal to 45 percent of the employee's tier 2 benefit. The survivor's tier 2 benefit is a specified percentage of the employee's tier 2 benefit. The Appendix lists the percentages and describes an initial minimum widow(er)’s amount which became payable beginning in calendar year 2002.

The tier 2 cost-of-living increases for employees, spouses and survivors are equal to 32.5 percent of the percentage increase which is used in computing social security increases (and tier 1 increases).

The increase is paid at the same time as the tier 1 cost-of-living increase.

The portion of tier 1 benefits which is considered equivalent to social security benefits is subject to Federal income tax under the rules that apply to social security benefits. Tier 2 benefits, the portion of tier 1 benefits in excess of social security benefits, supplemental annuity benefits, and vested dual benefits are subject to Federal income tax under the rules that apply to private pensions.

A railroad retiree may receive a supplemental annuity in addition to his regular annuity if (1) the retiree has a "current connection" with the railroad industry at the time of retirement, and (2) the retiree has attained age 65 with 25 years of railroad service, or attained age 60 with 30 years of railroad service. A current connection is generally defined as at least 12 months of railroad service in the 30 months preceding retirement.

The 1981 amendments added the requirement that an employee must have worked in the railroad industry before October 1, 1981, to receive a supplemental annuity. This provision results in phasing out the supplemental annuity over a long period. The last supplemental annuity check will probably not be paid until after 2060.

The monthly supplemental annuity benefit is $23, plus $4 for each year of service in excess of 25, with a maximum benefit of $43. No cost-of-living increases are applied. Spouses and survivors do not receive a supplemental annuity.

If the recipient of a supplemental annuity receives a private pension from his railroad employer, the supplemental annuity is reduced by the portion of the private pension that is attributable to the employer's contributions. This reduction is not made if the private pension is reduced for receipt of the supplemental annuity.

Benefits paid from the NRRIT, RR Account and SSEB Account are financed by the following sources of income:

1. Payroll tax. Employees and employers pay a tax at the social security rate on earnings in a year up to the social security, or tier 1, earnings limit. (The Medicare hospital insurance portion of this rate is not subject to an earnings limit.) This tax is called the tier 1 tax. In addition, employers and employees pay a tier 2 tax equal to a percentage of the employee's earnings up to the tier 2 earnings limit. The tier 2 earnings limit is what the social security limit would be if the 1977 social security amendments had not been enacted. The 2009 earnings limits are $106,800 and $79,200 for tier 1 and tier 2, respectively.

Tier 2 taxes on both employers and employees are based on a 10-year average of the ratio of certain asset balances to the sum of benefits and administrative expenses (the average account benefits ratio). Depending on the average account benefits ratio, the tier 2 tax rate for employers will range between 8.2 percent and 22.1 percent, while the tier 2 tax rate for employees will be between 0 percent and 4.9 percent. This calculation is described in the Appendix.

2. Income tax. The tax on tier 1 benefits up to the social security level is credited to the SSEB Account and then to social security through the financial interchange. Revenue derived from taxing RR Account benefits (tier 2 and the excess of tier 1 over the social security level) is transferred to the RR Account.

3. Investment income.

4. The financial interchange with the social security system. This extremely important arrangement, which will be discussed in detail in Section IV, has resulted in the large annual lump sum transfers of money from social security to railroad retirement shown in Table 11.

5. Advances from general revenues related to certain features of the financial interchange.

Financial interchange transfers are made in a lump sum for a whole fiscal year in the June following the end of that fiscal year. For example, the transfer reflecting transactions which occurred from October 2006 through September 2007 (fiscal year 2007) took place in June 2008. At any time, therefore, there are between 9 and 21 months' worth of financial interchange transfers that are, in a sense, owed to the railroad retirement system. Railroad retirement receives interest on this money, so this practice does no long-term harm to the financial condition of the railroad retirement system. The lag in the transfers, however, could cause short-term cash flow problems.

In order to avoid the cash flow problems caused by this lag, the 1983 Solvency Act provided for monthly loans to railroad retirement from U.S. Treasury general funds. Each loan is equal to the transfer the Railroad Retirement Board estimates railroad retirement would have received in the preceding month, with interest, if the financial interchange with social security were on an up-to-date basis. Railroad retirement must repay these loans when it receives the transfer from social security against which the money was advanced.

The 1983 Solvency Act created the SSEB Account, effective October 1, 1984. Before that date, all tier 1 benefits, tier 2 benefits, lump sums and administrative expenses had been paid from the RR Account, and all the income described above had been credited to the RR Account. Since then, the SSEB Account has paid the social security level of benefits and the administrative expenses allocable to that level of benefits. The tier 1 portion of the payroll tax, the income taxes on the social security level of benefits, the income from the financial interchange, and the advances from general revenues are credited to the SSEB Account. Repayment of the advances is made from the SSEB Account.

The Railroad Retirement and Survivors’ Improvement Act of 2001 created the National Railroad Retirement Investment Trust to manage and invest amounts collected in the RR Account and SSEB Account. The portion of the RR Account that is not needed to pay current administrative expenses and the balance of the SSEB Account not needed to pay current benefits and administrative expenses must be transferred from time to time to the NRRIT in such manner as will maximize investment returns to the Railroad Retirement system.

IV. THE FINANCIAL INTERCHANGE AND DUAL BENEFITS

In the early 1950s, an arrangement known as the financial interchange was established between the railroad retirement and social security systems. The purpose of the financial interchange is to place the social security trust funds in the same financial position they would have been if railroad employment had always been covered under social security. If railroad employment had been covered under social security, social security would have collected taxes on railroad employment, and it would have paid benefits based on railroad employment. Under the financial interchange, the railroad retirement system gives the social security system the taxes social security would have collected, and the social security system gives the railroad retirement system the additional benefits social security would have paid to railroad workers and their families over what it actually pays them.

The word "additional" in the preceding sentence is important, because it is possible for a railroad employee to be covered under both railroad retirement and social security. The social security coverage may be based on earnings from moonlighting while in a railroad job or from coverage under the two systems at different times. Fulfilling the purpose of the financial interchange requires deducting from social security's fund only the difference between what social security would have paid had it covered railroad employment and what it actually pays the person based on his non-railroad employment. Under the financial interchange, therefore, social security subtracts an employee's social security benefit from the amount it would otherwise give to the railroad retirement system.

This arrangement gave rise to problems that became acute in the early 1970s. The problems arose from the weighting in the social security formula in favor of low-earning, short-service workers. A railroad employee's non-railroad earnings usually added little to the benefit social security would have paid on combined railroad and non-railroad earnings (called gross tier 1 today). However, the employee might qualify for the minimum social security benefit, receiving much more from social security than his non-railroad earnings added to his gross tier 1 benefit.

In order to improve the system's financial condition, the Railroad Retirement Act of 1974 provided that the tier 1 component of the railroad retirement annuity be reduced by any social security benefit. This essentially integrated the two systems and eliminated the advantage of qualifying for benefits under both systems.

It was generally considered unfair to eliminate this advantage entirely for those already retired or close to retirement when the 1974 Act became effective. The 1974 Act, therefore, provided for a restoration of social security benefits that were considered vested at the end of 1974. The restored amount is known as the "vested dual benefit." This benefit was available to qualifying spouses and survivors as well as to qualifying employees.

For employees retiring in 1975 or later, the vested dual benefit was to be equal to

(1) a social security benefit based on social security earnings, plus

(2) a social security benefit based on railroad earnings, minus

(3) a social security benefit based on combined railroad and social security earnings.

Social security or railroad earnings after 1974 were not to be included in this calculation. The "social security benefit" referred to in (1), (2) and (3) is the one which would have been calculated at the end of 1974. The resulting amount was to be increased by all the automatic social security cost-of-living adjustments between 1974 and the date the employee retired.

For spouses and survivors, the formulas were different and more complicated than those for employees.

The 1981 amendments made significant changes regarding vested dual benefits. Spouses and survivors were not to be awarded vested dual benefits after August 13, 1981, though they would continue to receive these benefits if they were awarded before that date. Also, vested dual benefits awarded to employees would take into account cost-of-living increases only through 1981, rather than through the date of retirement.

Since October 1981, vested dual benefits have been paid from a segregated Dual Benefits Payments Account, and appropriations have been made to that account. This means that, starting in fiscal year 1982, each annual appropriation is to be sufficient to pay the benefits for that year. If the appropriation for a fiscal year is less than required for full funding, the Railroad Retirement Board must reduce benefits to a level that the amount appropriated will cover.

The appropriation for vested dual benefits in fiscal year 1982 was less than required for full funding, resulting in a cutback in benefits during that year. Full funding was restored for the last two months of fiscal year 1982. The appropriation was less than required in fiscal year 1986, resulting in a cutback during April-September of that year. The appropriation was again less than required in fiscal year 1988, which resulted in a cutback during April-September. Benefits were cut back in January 1996 due to a lapse in government funding and then restored later that same month.

For years other than those mentioned, full benefits have been paid.

V. ASSUMPTIONS, METHODOLOGY, AND VALUATION RESULTS

A. Assumptions and Methodology

Average railroad employment is assumed to be 234,000 in 2008 under each of the three employment assumptions. This is the estimated average for the year (subject to later adjustment) and is equal to the number assumed for 2008 under employment assumption I contained in the 2008 Section 502 report.

Employment assumptions I and II, based on a model developed by the Association of American Railroads, assume that (1) passenger employment will remain at the level of 43,000, and (2) the employment base, excluding passenger employment, will decline at a constant annual rate (0.5 percent for assumption I and 2.0 percent for assumption II) for 25 years, at a reducing rate over the next 25 years, and remain level thereafter.

Employment assumption III differs from employment assumptions I and II by assuming that (1) passenger employment will decline by 500 per year until a level of 35,000 is reached and then remain level, and (2) the employment base, excluding passenger employment, will decline at a constant annual rate of 3.5 percent for 25 years, at a reducing rate over the next 25 years, and remain level thereafter.

The assumed rates of decline in freight employment are 0.5% lower during the first 25 years under each employment assumption than those assumed in the 23rd valuation.

Because inflation has been fairly stable at relatively low levels in recent years, only one set of earnings and price inflation assumptions was used in this valuation. The ultimate earnings increase, cost-of-living increase and investment return assumptions are the same as those used in the 23rd valuation. Table 1 shows the employment, inflation and investment return assumptions used in the 24th valuation. A comparison of historical and projected employment is illustrated in Figure 1.

Only one combination of non-economic assumptions (for example, rates of mortality, disability, retirement, and withdrawal) was used in this valuation. These assumptions, some of which were changed from the 23rd valuation to reflect recent experience, are discussed in the Technical Supplement to this report.

Projections were made for the various components of income and outgo under each employment assumption for the 75 calendar years 2008-2082. The projections of these components were combined and the investment income calculated to produce the projected balances in the combined NRRIT and RR Account and in the SSEB Account separately for each year. The results are summarized in Table 2. Present values of the various components of NRRIT and RR Account income and outgo were calculated by discounting amounts in each projection year to December 31, 2007, using a constant 7.5% interest rate. The present values were combined to calculate the NRRIT and RR Account actuarial surplus or deficiency. The derivation of the surplus or deficiency appears in Table 6.

B. Valuation Results

This section sets forth the results of the valuation in the form of a discussion of the tables in which the results appear. Because it is desirable for the discussion of a table to be reasonably self-contained, there is some repetition between tables and between this section and preceding sections of this report.

Table 2. Progress of the Combined National Railroad Retirement Investment Trust (NRRIT) and Railroad Retirement (RR) Account, and the Social Security Equivalent Benefit (SSEB) Account.

Projections were made for the various components of income and outgo under each employment assumption for the 75 calendar years 2008-2082. The projections of these components were combined and the investment income calculated to produce the projected balances in the combined NRRIT and RR Account, and the SSEB Account at the end of each projection year. The results are summarized in Table 2.

Table 2 consists of three tables, one for each of employment assumptions I, II, and III. The tables show, for the SSEB Account and the combined NRRIT and RR Account for each projection year,

(1) the various elements of income and outgo, (2) the account balance on December 31, and (3) the account benefits ratio, average account benefits ratio and combined employer and employee tier 2 tax rate.

The balances of the RR Account and NRRIT are combined because amounts not needed to pay current administrative costs are transferred from the RR Account to the NRRIT for investment. The SSEB Account is assumed to maintain a target balance of approximately 1.5 months of benefit payments in order to meet benefit obligations and contingencies, and to transfer any excess to the

NRRIT.

Table 2 indicates that no cash-flow problems arise under employment assumptions I and II (Tables 2-I and 2-II).

Under employment assumption I, the combined account balance declines through 2021 and then grows through the end of the projection period. The combined employer and employee tier 2 tax rate increases to 20% in 2022-2032, decreases to 8.2% in 2053-2064 and then increases to 10.0% in 2065-2082.

Under employment assumption II, the combined account balance declines through 2023, and grows thereafter through the end of the projection period. The combined employer and employee tier 2 tax rate increases to 27% in 2026-2032, and then decreases until reaching the minimum rate of 8.2% in 2071-2082.

Under employment assumption III, the combined account balance declines until the balance becomes negative in 2031. Negative after-transfer balances indicate the amount that would be owed, including interest, if unreduced benefits were paid by borrowing from some unknown source.

The combined account deficit grows until 2068, when the balance reaches -$81,990 million. The balance then begins to improve, but remains negative through the end of the projection period. The combined employer and employee tier 2 tax rate increases to 27% in 2023 and remains at that level through the end of the projection period. Under this assumption, the tax rate mechanism does not respond quickly enough to avoid cash flow problems.

Table 3. Present value of benefits in millions of dollars. This table shows, for each employment assumption, the present value of tier 2 benefits, supplemental annuity benefits and the portion of tier 1 benefits which exceeds the social security level of benefits. The portion of tier 1 benefits in excess of the social security level is referred to as "tier 1 liability." The most important components of this liability were described in Section III. Supplemental annuity benefits are included with tier 2 benefits in this table. The present values are shown separately by type of beneficiary (employee, spouse, survivor) and by employee status on the valuation date (retired, retired and deceased, active, inactive, future entrants).

Table 4. Present value of benefits as a percentage of the present value of tier 2 payroll. The format for this table is the same as for Table 3. Each number in Table 4 was obtained by dividing the corresponding number in Table 3 by the appropriate present value of one percent of tier 2 payroll.

The payroll figures are shown in Table 6.

Table 5. Balance of the Combined National Railroad Retirement Investment Trust and Railroad Retirement Account, and the Social Security Equivalent Benefit Account as of December 31, 2007.

This table derives the balance in the accounts as of December 31, 2007. No accrual adjustments are made either for financial interchange amounts due and unpaid on that date or for benefits due on

January 2, 2008, because these amounts are included in the projected future cash flows. For the purpose of the present value calculations, an adjustment is made for calendar year 2008 market value losses as discussed in Table 6 below.

Table 6. Actuarial surplus or (deficiency) for National Railroad Retirement Investment Trust and Railroad Retirement Account. The top half of Table 6 expresses the asset and liability components of the actuarial balance as present values in dollars. The bottom half expresses these components as a percentage of tier 2 payroll. The actuarial surplus or deficiency was calculated for the NRRIT and RR Account, but not for the SSEB Account, for the following reason.

The SSEB Account pays the social security level of benefits and administrative expenses allocable to those benefits, and it receives as income the social security level of taxes. If there were no other source of income or outgo during the course of a year, a surplus or deficiency would build up, depending on whether taxes exceeded or were less than benefits. However, the SSEB Account also receives or pays any financial interchange transfers. The financial interchange transfer, subject to qualifications described in the next paragraph, should be enough to offset any surplus or deficit for the year. Furthermore, this would be the case even if the social security level of benefits or taxes are raised or lowered. The SSEB Account can thus be regarded as automatically funded, the financial interchange being the mechanism for correcting any surplus or deficiency. Therefore, the concept of actuarial balance is not meaningful when applied to the SSEB Account.

The qualification mentioned above arises because, in a relatively small number of cases, the railroad retirement system does not pay benefits when social security would pay benefits. In these cases, mainly dependent children of retired railroad employees, the SSEB Account collects an amount through the financial interchange but does not pay a corresponding benefit. This imbalance between outgo and income is transferred from time to time to the NRRIT. The value of these transfers, or amounts available for transfer, is included as an asset in Table 6 as “Available from SSEB Account.”

Revenue derived from taxing NRRIT and RR Account benefits (tier 2 and the excess of tier 1 over the social security level) is transferred to the RR Account. The present value of these transfers is shown as an asset in Table 6 as “Income taxes on benefits.”

Although the actual return of the trust funds during calendar year 2008 was approximately -31.1%, this rate is not used in the present value calculations because the large negative rate of return distorts the present values of income and expenditure. Instead, the present value calculations use 7.5% as the rate for 2008, as well as for the remaining 74 years of the projection. This avoids having present values that would be over 50% higher, thereby facilitating comparison with other years. In order to properly measure the surplus, however, the calendar year 2008 loss must be taken into account, which is done by adjusting the beginning asset value for the anticipated loss. The adjusted balance as of December 31, 2007, is calculated so that, assuming a 7.5% rate of return for 2008, the combined RRA, NRRIT, and SSEBA balance projected on December 31, 2008, is equal to the actual balance on that date.

The cost of the system to the railroad industry may be considered as the excess of “Retirement taxes” over “Actuarial surplus or (deficiency).” Table 6 shows that the cost of the system is much more stable when expressed in dollars than when expressed as a percentage of payroll. For example, the cost of the system under employment assumption III is $53,817 million, or 21.57 percent of payroll, whereas the cost under employment assumption I is $59,885 million, or 16.13 percent of payroll. Using employment assumption III as the base, the percentage cost variation in dollars between the two valuations is 11.28 percent. As a percentage of payroll, the percentage cost variation is 25.22 percent.

Table 7. Unfunded accrued liability. The railroad retirement program is a social insurance program rather than a private pension plan. A private pension plan should build up funds in an orderly way over the working lifetimes of the participants. With a fully funded program, the value of the accumulated assets will be sufficient to discharge all liabilities for the accrued benefits. Pay-as-you-go funding, where the pension costs are charged to the retirement years as the benefits are paid, is not acceptable for a private pension plan because of a lack of participant security. Because private pension plans can terminate, they should, ideally, be fully funded to protect the rights of active and retired participants.

For a social insurance plan, however, the situation is different, and full funding is not necessary.

The program is expected to operate indefinitely. Because the program is compulsory, new entrants will constantly be entering the program, and they and their employers will be paying taxes to support the program.

Unlike some other social insurance programs, the railroad retirement program relies on payroll taxes from the employers and employees of a single industry. Although the railroad retirement program is not subject to the funding standards of a private pension plan, it is still of interest to calculate the normal cost and the accrued liability for the plan.

Table 7 illustrates what the funding requirements would be for the railroad retirement system as of December 31, 2007, using the entry age normal actuarial funding method. The present value of future benefits and the present value of future administrative expenses for former and present employees are shown on lines 1 and 2, respectively. The portion of the actuarial present value of benefits assigned to a particular year is called the normal cost. For the entry age normal actuarial funding method, the normal cost rate is the average cost expressed as a level percentage of payroll (line 4) that would fund the average employee’s benefits, including dependent benefits, and expenses over the employee’s working lifetime. The accrued liability for the program, shown on line 6, is equal to the difference between the present value of benefits and administrative expenses for former and present employees and the present value of future normal costs. Then the unfunded accrued liability (line 8) is the difference between the accrued liability and the funds on hand as of December 31, 2007 (line 6 minus line 7). This is the amount needed, in excess of funds on hand and future normal costs, to fund combined NRRIT and RR Account benefits and expenses for former and present employees. Line 10 shows the level tax rate that would be required to fund the unfunded accrued liability and meet the normal costs for the next 30 years. The level tax rate after 30 years if all assumptions were realized is shown on line 11.

Table 8. Vested dual benefit amounts and average number of beneficiaries. This table shows a projection of vested dual benefit payments for every fiscal year from 2010 through 2030. After 2030, the amounts become insignificant. The amounts shown assume that the benefits are fully funded. Fiscal years are shown because vested dual benefit appropriations are made on a fiscal year basis. The table also indicates the average number of vested dual beneficiaries in each fiscal year.

The table applies to all the employment assumptions discussed in this report.

The revenue derived from taxing pre-October 1988 vested dual benefits was transferred to the RR Account. The revenue derived from taxing vested dual benefits in fiscal years 1989 and later is transferred to the Dual Benefits Payments Account, and it reduces the amount of the appropriation by the same amount. Therefore, the amount available for the payment of vested dual benefits is unaffected by income tax revenues derived from these benefits.

The 1981 amendments removed much of the uncertainty from projections of future vested dual benefit payments. The volatility caused by inflation is gone, since future awards take into account cost-of-living increases from 1975 through 1981, rather than through the date of retirement. Also, awards of these benefits to spouses and widow(er)s ceased after August 13, 1981.