7.20 C. Unfunded Liability

The unfunded liability is calculated for each employer as follows:

Present value of benefits for all employees

Less:

Member assets

Future member contributions

Employer assets

Future employer normal cost contributions

The actuary calculates the present value of the expected retirement benefit for each IMRF member. The sum of the expected benefits for all of an employer’s members is the present value of benefits for that employer.

The present value assumes that some employees will retire, some employees will take refunds, and some employees will die.

Members’ contributions and interest, both past and estimated future, are subtracted from the present value of benefits for all employees. The employer retirement contributions are needed only for those employees who retire. Usually, the employer has already made some contributions and the employer’s asset account has earned investment income, so those amounts are subtracted from the present value for all employers. The employer’s future normal cost contributions will pay the cost of future service, so that amount is subtracted as well. The remainder is the employer’s unfunded liability.

Some employers ask why they have an unfunded liability. If the actuary has made all these complex calculations, which are supposed to accurately predict the future, why is the unfunded liability so large? The reasons are many and differ from employer to employer. Some of the most common are explained below.

  1. Prior Service

Prior service is a common reason for employers who have joined IMRF in the last 40 years. Prior service is service credit granted to employees for employment prior to the date the employer joined IMRF. For example: assume an employer joined IMRF in 1990. When it joined, it had employees already working. These employees were given pension credits (at no additional cost to them) for the period of employment prior to 1990. The employer did not make any additional contributions at that time for this service. The cost was added to the unfunded liability.

  1. Benefit Improvements

Benefit improvements granted after a member joins IMRF increase the unfunded liability. Under Entry Age Normal funding, the actuary calculates the expected cost of a member’s benefit and spreads it evenly over the expected career of the member. If benefits change during the member’s career, the actuary’s original calculation will be inaccurate. The actuary can adjust the normal cost for future years to reflect the new benefits. The additional cost for years for which service was already granted is added to the unfunded liability.

  1. Past Service Adjustments

Past service adjustments also increase the unfunded liability for an employer. The Pension Code defines circumstances under which a member may establish retroactive, omitted, or other past service credit. When the service is established, the employer is not asked to make any contributions. The employer’s cost for this service is added to the unfunded liability.

  1. Changes in Actuarial Assumptions

Changes in actuarial assumptions can cause the unfunded liability to increase or decrease depending on how the assumptions change. Every three years the actuary compares the estimates used to project future costs to actual experience. The assumptions are changed to match the experience. These changes can result in additional costs that have not yet been funded, thus adding to the unfunded liability.

  1. Employer Demographics

An employer’s demographics compared to the demographics of IMRF as a whole can have a significant effect on the employer’s unfunded liability. Actuaries calculate the normal cost on IMRF as a whole. To the extent that an employer’s employees differ from the average IMRF member, that employer’s unfunded liability will vary to make up the difference. The actuary assumes payroll increases will be 4% a year plus merit increases.  To the extent that individual employers grant payroll increases more or less than the actuarial assumption, the unfunded liability will be impacted.  

  1. Investment Earnings

Investment earnings less than or greater than the current assumed rate of return will have an effect on the unfunded liability. If returns are greater than the current assumed rate of return, the unfunded liability will decrease. If returns are less than the current assumed rate of return, the unfunded liability will increase.

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