Employer Rates: The Hows and The Whys
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Presented by Louis W. Kosiba, Executive Director, and Mark Nannini, Chief Financial Officer, on Wednesday, October 21, 2015, "Employer Rates: The Hows and The Whys" detailed how IMRF rates are calculated and explained the various factors that affect employer rates. Attendees were invited to submit questions during the presentation, which were addressed live in the broadcast and afterward to expand on the data presented and focus on specific points.
Question & Answer Session
Q. There have been many articles about pension funds reducing their expected investment return. In our current financial environment, is IMRF considering a reduction in the 7.5% expected rate of return?
A. Louis W. Kosiba: No, we are not. We’ve used 7.5% since 1992. We’ve never increased it and right now we’re not planning on decreasing that rate. It is expected to be a long-term rate. A number of funds that have reduced assumption rates had large assumptions. In the past, funds assumed they would earn 9% on investments and they have lowered their assumptions. Actually, 7.5% is pretty average today. We were historically a bit on the low side during certain years, but now we are in the middle of the pack. If we changed our assumed investment rate, it would have a major impact on Employer Contribution Rates.
We talked about this equation: B – E = EC + ER + I. If we drop the investment income to 7.5%, benefits haven’t changed, employee contributions haven’t changed, and expenses haven’t changed. The only way you can achieve balance is by increasing Employer Contributions. If we were to decrease the 7.5% to something lower, like 7.25% or 7%, you would see an increase in Employer Contribution Rates.
Mark Nannini: We talked about the Triennial Assessment in the program that is presented to the Board. The Board consciously reviewed lowering the rate during the December 2014 Board Meeting and decided to keep the rate at 7.5%.
Louis W. Kosiba: We do look at the number; we take it seriously and we continue to evaluate it. We also have to balance that number against the effect on our employers.
Q. What percentage is a good number for an employer to be funded?
A. Louis W. Kosiba: We say 100% because that’s the long-term lowest cost for the sample year. If you have an unfunded liability, we’re effectively charging you interest. Consider the equation B – E = EC + ER + I … if we don’t have all the money we need in the employer account, we’re missing a 7.5% return. So we add that to the unfunded liability.
Q. Please explain again the one-time charge when an employee retires.
A. Mark Nannini: When a member retires, we calculate the amount of money we need to pay that member’s pension for life. First, we take all of the member’s contributions and transfer those funds into the Annuitant Reserve – the pot of money we use to pay our pensions. Any difference between the member’s contributions and the total amount we need to fund the pension for life comes from the employer’s reserve account. That’s the one-time charge you are referring to.
Louis W. Kosiba: Remember, we pre-fund our retirement benefits. It’s not like Social Security, which is a pay-as-you-go system. We aren’t concerned about the ratio of active members to retired members like Social Security. Because we prefund our retirement benefits, your employer’s pension liability ends the moment an employee retires and we transfer funds from your Employer Reserve to the Annuitant Reserve to fund the benefit.
Q. If a person wants to retire at age 55, can they draw more on their retirement until they are able to draw Social Security?
A. Louis W. Kosiba: Yes. If you retire under age 62, you are eligible to choose an optional pension. The optional pension is a lifetime pension where you receive a larger pension until age 62 but a reduced pension once you reach age 62. Some members select this option and then apply for Social Security benefits at age 62 when their IMRF pension decreases. If a member takes an optional pension, there is no additional cost to the employer.
Q. May employers pay for adjustments at the time an adjustment is sent to IMRF? For example, is there a mechanism to avoid funding adjustments on the annual rate?
A. Mark Nannini: I believe you’re referring to an accelerated payment here. IMRF will send your employer a notice of that accelerated payment. If you pay it now, you would pay less interest over the life of that funding. It’s encouraged and recommended that you make the accelerated payment upon learning the amount.
Louis W. Kosiba: There are also other adjustments. For example, if there was omitted service, if a person gets service credit, or if a person buys military service, there can be an adjustment that the employer is going to have to eventually pay. The answer is always yes, you can always pay for any adjustment. IMRF’s Finance Department Staff can calculate what that cost is to help bring down your future rates.
One thing we also encourage employers to consider is reducing their unfunded liability. We have some employers that reduce their unfunded liability and we recommend they do this by the end of the calendar year. It will not be reflected in next year’s rates but will be reflected a year after – the two-year lag in rates.
Mark Nannini: What Lou is referring to is an additional contribution. By the Pension Statue, IMRF cannot give you interest on any contribution you make during the calendar year until the first day of the following year. We recommend you make that contribution in December; you can have the benefits of holding that idle money and earning additional interest.
Q. If an employee did not receive a 3% raise in year X but received a 6% raise in the following year Y, does this create an unfunded liability or does the 0% raise year offset the 6% raise the following year?
A. Louis W. Kosiba: If your employer is not going to grant you 3.5% pay raises and the actuary is assuming that there will be 3.5% pay raises, that’s going to be reflected immediately in the data we have. The actuaries look at that data every year. Because of the two-year lag between the actuarial data and the rates being set, you will probably see a little higher funding level for your organization and you will see a trend down in your Employer Contribution Rate.
Q. What is the average funding level for all employers in 2015?
A. Mark Nannini: As of the end of 2014, the total funding under a market value is 93.1%. Under the actuarial value, the amount is 87.3%.
Louis W. Kosiba: It’s important to note that we’re talking about the aggregate average here and no two employers have the same funding level or the same contribution rate. If they do, it is not by design; it’s more by accident. If your funding level is more or less than the average, there are specific reasons why.
Mark Nannini: A lot of these topics can be addressed by visiting IMRF’s website, www.imrf.org. Go to the search bar, enter your topic, and you will find multiple result items. If it’s still unclear, you can always call 1-800-ASK-IMRF and speak to one of our representatives. If you are an Authorized Agent, you can talk to your Field Representative who can help you locate the information or directly provide the answer.
Q. How is the return on investment doing this year?
A. Mark Nannini: So far it’s mediocre, but we don’t know what tomorrow will bring. We were well over 7.5% at the middle of the year. Right now, we’re below that, but we don’t know what the last two months of the year will bring.
Louis W. Kosiba: I would say challenging. If we don’t make our 7.5% assumption this year, it will raise employer rates slightly but that won’t happen until 2017. We close the year on December 31, 2015. In spring 2016, the actuaries will work through the calculations and in April 2016, we will advise what the 2017 rates will be.
Q. If an employee wishes to retire a few months short of the retirement age, can the employer and employee “purchase” additional months of service credit?
A. Louis W. Kosiba: The answer is no. If you want to retire at age 55 and you have 7 years and 10 months of service credit – which means you’re short of vesting – you cannot purchase two additional months of service credit.
Mark Nannini: This is stated in the Illinois State Pension Code.
Q. Regarding your comment on employer liability ceasing for separation/refunds by terminated employees … is that employer liability reestablished should the employee choose to reinstate that service at a later date?
A. Mark Nannini: Yes, it is and that’s what we addressed in the presentation – it’s called purchasing past service. If an employee is working, takes a refund, and then decides to return to an IMRF employer, they have the option to purchase past service by paying back what contributions they’ve received plus interest for every year they were out of the pension fund.
Q. How are the additional contributions from members invested?
A. Louis W. Kosiba. Voluntary Additional Contributions (VAC) by members are invested along with IMRF’s other funds; they’re pooled together. It works the same way for additional contributions made by an employer; we pool that money together to make the best investment we can. If you look at our website, www.imrf.org, you’ll see the asset allocation as well as the returns by different classifications of assets. You will see what our logic is, what our approach is, and that our intent is to earn a return of 7.5% or more over long periods of time.
Q. Can you please show the slide with the components that make up the employer contribution rate?
A. Louis W. Kosiba: What the actuary wants to do is formulate your cost for your unit of government – how much does the employer have to contribute to fund the cost for that year. As you can see from the slide, we’re looking at Tier 1 and Tier 2. Normal cost for Tier 1 is about 40% more than Tier 2. If you have no Tier 2 employees, your normal cost is going to be 7.29%. If your employer joined IMRF after January 1, 2011, and no employee has service credit with another IMRF employer, the normal cost for all employees is going to be 4.41%.
But that’s not the case for 99% of our employers. What we see is a mix of the two. The actuary is going to weigh the value of those payrolls based on how many people are in Tier 1 and how many are in Tier 2.
Q. Could you talk about smoothing of gains and losses.
A. Mark Nannini: Smoothing of gains and losses is allowed for actuarial purposes only, not accounting purposes. Smoothing is spreading investment gains or losses over a five-year period for rate-setting purposes. For example, IMRF earned 20% on its investments during 2013. But for rate-setting purposes, we only recognized 1/5 of that gain in 2015. The idea, as the name implies, is to smooth out the returns so we don’t see the rate volatility from year to year.
Q. Are losses from the Voluntary Additional Contribution (VAC) not meeting the 7.5% interest rate added to the employer's unfunded liability?
A. Louis W. Kosiba: It is not directly added to anyone unfunded liability. The money to fund the VAC comes from investment returns. If we don’t make 7.5% interest, it is deducted from our investment returns before we make distributions to employers. If IMRF makes more than 7.5%, the "excess earnings" are returned by employers.
Q. Can you clarify the unfunded liability?
A. Mark Nannini: Unfunded liability is basically what funds you do not have to meet the present value of your benefits. How do we get there? In a straight formula, we consider your employer’s assets and we add your members’ contributions plus the projected 7.5% interest. The difference between that sum and what your total liability, based on the age and service of the census population for your employer, is the unfunded liability. Each year's contribution rate includes a percent to pay down the unfunded liability over the remaining amortization period.