The method used by IMRF to calculate employer retirement rates is called Entry Age Normal funding. This method is also used by IMRF employers to report pension liabilities in accordance with the Governmental Accounting Standards Board Statement Number 50 (GASB 50).
Under this method, the cost of each individual’s pension is allocated on a level percent of payroll between the time employment starts (entry age) and the assumed retirement date. The goal is to spread the cost over the career of the member as a level percentage of payroll.
Through 2014, IMRF will continue to use the Annual Required Contribution (ARC) calculation embedded in GASB Statement No. 27 to determine employer contribution rates. This approach is consistent with actuarial best practices, supports IMRF’s 100% funding goal, maintains intergenerational equity, and minimizes disruptions to employers.
Beginning in 2015, in accordance with GASB 68, this calculation will be disclosed as Actuarially Determined Contribution (ADC), which is determined by the actuary.
Because IMRF members also contribute, the required contributions from employers are reduced in anticipation of expected member contributions. Employer contributions are also reduced because of interest and other returns on IMRF investments.
Combining all the factors described above into an employer contribution rate is a two-step process. First, the actuary calculates the present value of benefits for each member using the demographic data and the actuarial assumptions at the date of the valuation.
The calculation is extremely complex but a simple example may help to demonstrate the process. Assume we have a female active member, who is 40 years old, has five years of service and a current salary of $30,000. All the steps required to calculate the present value of benefits for an active member will not be shown in the interest of brevity.
First, we calculate the pension she has earned to date. IMRF members earn 1.667% of their final rate of earnings for every year of service through the first 15 years and 2% for each year after that. Our sample member has earned a pension equal to 8.34% (1.667% times 5 years) of her final rate of earnings.
In real life, the actuary would also estimate her final rate of earnings assuming merit and inflation increases up to her expected retirement date. For our example, we will use her current salary.
Current salary |
$30,000.00 |
Multiplied by pension credits earned |
.0834 |
Estimated annual pension earned to date |
$ 2,502.00 |
The next step is to calculate the present value of benefits at retirement. Her annuity pension will be paid for her lifetime and increased by 3% of the original amount each year. Upon her death, the survivor’s benefit will be paid to her spouse for his lifetime. However, because the annuity will be paid monthly over many years, we do not need all the money available at retirement. We calculate the present value of the life annuities for our member and her spouse. This calculation includes three estimates: the member’s life expectancy, the spouse’s life expectancy, and the estimated long-term investment earnings rate.
Annual pension earned to date |
$ 2,502.00 |
Multiplied by the present value factor for a joint and survivor life annuity with a 3% annual increase payable monthly at a 7.25% discount rate using the 1994 Group Annuity Mortality Table. |
14.8125 |
Estimated present value of benefits at retirement |
$37,060.88 |
However, our member is not ready to retire yet. Assume she will retire at age 60. IMRF has 20 more years to invest the money at 7.25% before she is ready to retire. We need to calculate the present value of her retirement benefits as of today.
Estimated present value of benefits at retirement. |
$37,060.88 |
Multiplied by the present value factor for 20 years assuming an investment return of 7.25% |
.2354 |
Estimated present value of benefits at age 40 |
$ 8,724.13 |
The estimated present value of benefits at age 40 is the amount of money that must be set aside now and invested at a 7.25% compound rate in order to pay this member’s pension. However, there is no guarantee that she will stay another three years until she is vested. To be more accurate, the present value must be adjusted for the likelihood that she will stay for three more years and vest. The actuary multiplies the estimated present value by the probability of vesting. This probability is .920, that is, out of a group of 1,000 females 40 years of age with five years of service, 920 will stay another three years.
Estimated present value of benefits at age 40 |
$8,724.13 |
Estimated probability of vesting |
.920 |
Adjusted present value of benefits |
$8,026.20 |
In this simplified example, the present value was adjusted only for the probability of termination. In real rate calculations, it also is adjusted for the probabilities of death, disability, marital status, and future salary increases. As you might expect, the present value of benefits is complex.