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PAGE 2 - EXPLANATION OF RECoAIATION e 2. CHANGE DUE TO PAYROLL EXPERIENCE: The prior service contribution rate is closely linked to the city's payroll. An increase in payroll above the actuarial assumption reduces the contribution rate. An increase in payroll of less than the actuarial assumption, or a decrease in the payroll, will cause an increase in the contribution rate. The actuarial assumptions are based on the historical trends in the city itself, and allow the actuary to project future contributions to the retirement system. 3. CHANGE DUE TO ACTUARIAL GAINS, INCONSISTENT CONTRIBUTIONS, OR OTHER ACTUARIAL FACTORS This is a broad category and includes changes in three areas. The first area is actuarial gain. The assumptions used in the actuarial valuation process enable the actuary to project the value of the Unfunded Actuarial Liability (UAL) from the previous actuarial valuation to the current actuarial valuation. The difference between the projected UAL and the actual UAL is called an actuarial gain (a negative difference is an actuarial loss). This gain, or loss, takes into account the differences between events (investment return, deaths, retirements, disabilities, and withdrawal of member contributions) assumed on the basis of the actuarial assumptions and the corresponding real-life events that occurred between the preceding actuarial valuation and the current one. An actuarial gain reduces the prior service contribution rate, and a loss increases it. . The second area in this category is inconsistent contributions. This refers to timing of the valuation and when contribution rates actually take effect. A city's 2004 contribution rate is based on the valuation for the year ended December 31,2002. There is, therefore, a one-year period from the time the actuarial experience is recognized and the time the contribution rate is changed to reflect the actuarial experience. During this one- year lag time, 2003 in this case, the city may be contributing too little or too much as a result of the actuarial experience for the year ended December 31,2002. Therefore, the contribution rate must be adjusted to account for this one-year lag time. If actuarial experience is better than assumed, the contribution rate can be reduced. Likewise, if actuarial experience is worse than assumed, the contribution rate will be increased. The third area includes adjustments for other actuarial factors. This is usually just the effect of rounding in the actuarial valuation process. 4. INCREASE DUE TO PHASE-IN OF ACTUARIAL ASSUMPTION CHANGES: For eligible cities that chose to phase-in the effect of changes in actuarial assumptions resulting from the 5-year experience study completed in 1998. this amount is an increase in the calculated rate. The 2003 rate took into account 80% of the effect of the assumption changes. The 2004 rate takes into account 100% of the effect; thus the 2004 rate acknowledges the final 20% of the rate increase caused by changes in the actuarial assumptions. 5. CHANGE DUE TO EFFECTS OF CONSERVATIVE FUNDING: This item is the effect of conservative funding formulas used to calculate the prior service contribution rate for cities with fewer than three contributing members. These conservative funding formulas provide for funding the prior service benefits over the remaining expected working life of the contributing members.