Structure of IMRF
IMRF is a multi-employer agent public employee retirement system. This means we have more than one employer (2,972 at the end of 2015), and each employer funds its own employees’ retirement benefits. In addition to retirement benefits, IMRF also provides death and disability benefits.
The revenue that is used to pay retirement benefits comes from three sources:
- Investment income
- Member contributions
- Employer contributions
IMRF retirement benefits are paid under a defined benefit plan with fixed member contributions. That is to say, both member contributions and the benefits to be paid are established by state law. The difference between the cost of legislated retirement benefits and member contributions must be paid from either investment earnings or from employer contributions.
Each year, an independent actuary calculates an employer contribution rate for each employer; the calculation assumes IMRF will earn 7.5% on its investments. This rate, expressed as a percent of participating payroll, determines the employer’s contribution.
Calculating Pension Costs
To fund a future pension, you must be able to estimate the cost of that pension. This is where the independent actuary comes in. To determine the cost of the pension, the actuary needs four types of information:
- Member demographic information
- Actuarial assumptions
- Employer information
- Method for distributing the costs
This data is combined mathematically to determine how much each employer must contribute each year.
Member Demographic Information
IMRF pensions are determined by a formula which multiplies a member’s final rate of earnings by a percentage. This percentage increases each year, depending on which plan (Regular, SLEP, or ECO) is involved. Therefore, salary history and total service are required information.
While benefit amounts are not determined by gender, gender does affect longevity which determines how much money will be needed to pay a member’s pension. Therefore, gender is another important piece of information. Age is a factor as well, because it determines how much time is left before a pension will be paid. Gender and age also affect the probability of mortality, disability, separation, and marital status.
We are trying to determine the cost of future events, therefore, we need to estimate the probability of those events occurring. Actuarial assumptions are a formal set of estimates of what will happen to IMRF members. We could set rates on the assumption that all members will retire at 65 with a spouse two years younger, and that they will live for 25 years thereafter. These assumptions would be incorrect and would result in IMRF being overfunded. For example, not every member retires, some die, and some members take refunds. Some members are not married upon retirement. Some live to be 100, and some die at 67.
To ensure that the assumptions we use are as accurate as possible, every three years the actuary compares IMRF’s actual experience to our assumptions. The actuary then recommends any necessary changes in the assumptions to the IMRF Board of Trustees.
The actuary uses eight principal assumptions to determine rates.
- Investment return: Pension plans are established on the premise that investment earnings will pay part of future benefits. The investment return assumption is the estimate of what the investments will earn on average at a compound rate over the long term. The current assumption for IMRF is 7.50%. It is expected that in some years the investment return will be higher than 7.50% and in some years the investment return will be lower than 7.50%.
- Retirement age: As you might expect, this is an estimate of how many members will retire at a given age. The rates vary by age and by gender. Beginning in 2011, retirement age estimates were impacted by whether a member is in Tier 1 or Tier 2. (Public Acts 96-0889 and 96-1495 made a number of changes, one of which was to increase the normal retirement age.)
- Marital status: This provides an estimate of how many members will have a spouse eligible for a survivor’s pension. These rates vary by age and by gender.
- Mortality for active members: This is an estimate of how many active (non-retired) members will die in a given year. These rates vary by age and by gender.
- Mortality of retired members: This is an estimate of how many retirees will die in a given year. These rates vary by age and by gender.
- Disability: This is an estimate of how many active members will become disabled in a given year. Although disabled members receive service credit toward a pension while on IMRF disability, neither the employer nor the member makes contributions toward the member’s retirement during the disability period. These rates vary by age, gender and service.
- Separation: How many active members will leave employment in a given year? Employers do not make contributions toward members who terminate participation and take a refund. These rates vary by age, gender and service.
- Payroll increases: Pensions are based on an average of a member’s salary at the end of his or her career for the Regular and SLEP plans. Therefore, when the actuary calculates the benefits to be paid at retirement, future salary increases must be considered. IMRF currently estimates salary increases of between 7% and .4% per year due to merit and 4.00% due to inflation, for the Regular plan.
The actuary must know two important pieces of information about each employer: the employer’s asset balance and the amortization period for the unfunded liability. Both items have a significant effect on the rate.
Each employer has a reserve account with IMRF. This account is used to pay retirement benefits for the employer’s own employees. The items which increase or decrease this account are:
- Employer retirement contributions (employer contributions minus death, disability, Early Retirement Incentive (ERI), and supplemental [13th payment] contributions)
- Interest credited or charged on the opening balance at the prescribed rate
- Adjustments, if any
- Residual investment income or loss (Each year after interest is distributed to member, annuitant, and employer reserve accounts; any remaining investment income or loss is distributed among all employers. An employer’s share of the distribution is based on its assets and the present value of annuities for the employer’s retired employees)
- Employer’s share of the cost of an annuitant’s pension. (When a member retires, we calculate the present value of the member’s pension. From that amount we subtract the member’s own contributions and the interest earned on those contributions. The remaining difference is then subtracted from the employer’s account and added to the annuitant reserve. This is a one-time charge to the employer’s account when the member retires.) An employer may make payments to reduce its unfunded liability (increase employer assets). Since IMRF calculates interest on the beginning of the year balance only, we recommend remitting any such payment in December.
Generally, each IMRF employer has an unfunded liability due to prior service of employees when the employer joined IMRF. The unfunded liability is the estimated cost of retirement benefits earned to date that have not been funded. That is to say, the employer does not have enough assets with IMRF to pay those benefits.
A portion of the unfunded liability must be paid each year; the portion is determined by the employer’s structure. For most employers, the unfunded liability is amortized over a 29-year closed period beginning in 2014, reducing to 15 years, and then rolling at 15 years. Participating instrumentalities (employers without taxing authority) amortize their unfunded liability over a 10-year open period.
Methodology for Distributing Costs
After the actuary estimates the cost of future benefits, a method is developed for determining how much of the future cost will be paid each year. The possibilities are infinite. One possibility could be to contribute the whole amount when a member joins. Another possibility could be to contribute whatever is needed in the five years between ages 50 and 55. The actuarial profession has developed several widely accepted methodologies. IMRF uses the following method:
Entry age normal is the method IMRF uses to calculate employer retirement rates. 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 cost includes expected future service and salary increases. The goal is to spread the cost over the career of the member as a level percentage of payroll.
For example, assume a member begins participation in IMRF at age 25 and the average retirement age is 62. This means there are 37 years between entry age (25) and retirement (62) in which to contribute toward the pension. The cost of the future pension is distributed over the 37 years. Each year the employer pays a percentage of the employee’s salary. If everything works as planned, when the employee retires the contributions (member and employer) and the interest on those contributions is sufficient to pay the pension and survivor’s benefits.
Calculating the Present Value of Benefits
Combining all the factors described above into an employer 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 Five Parts of the Employer Rate
The actuary calculates the cost of each member’s expected future benefit, adjusts that cost for the probability that the benefit will not be received, and then determines how much of that cost must be paid each year. This cost is then translated into a rate made up of five parts:
- Death benefit contributions
- Disability benefit contributions
- Supplemental retirement contributions ("13th Payment")
- Normal retirement contributions
- Amortization of the unfunded liability contributions
Each is calculated separately and used for specific purposes designated by state law. Some employers may have an early retirement incentive (ERI) rate included in their employer rate.
Death Benefit Contribution Rate
Death benefit contributions fund the death benefit paid to beneficiaries of IMRF members who die in service. If a participating member with more than one year of service dies, his or her beneficiaries are entitled to lump sum payments equal to one year’s salary. This benefit is paid solely from employer death benefit contributions. IMRF member contributions are not used to fund IMRF death benefits.
The contributions from all employers are pooled to pay this benefit, much like life insurance. The rates are calculated separately for each employer based on the average age of its employees. Employers with older employees pay a higher rate. Employers with younger employees pay a lower rate. The average death benefit contribution rate for 2014 is .18% of participating payroll for the Regular, SLEP and ECO plans.
Disability Benefit Contributions
Disability benefit contributions are used to pay IMRF disability benefits. Members with more than one year of service are eligible for disability benefits up to 50% of their salary if they are disabled for more than 30 days. Only employer contributions are used to pay these benefits. No member contributions are used.
Like death benefit contributions, disability benefit contributions are pooled. Unlike death benefit contributions however, all employers pay the same rate. The disability benefit contribution rate for 2014 is 0.11% of participating payroll.
Supplemental Retirement Contributions
Supplemental retirement contributions are used to pay the additional “13th payment” paid in July of every year. Retirees and surviving spouses who have been receiving benefits for at least one year receive a supplemental benefit payment in July of each year. The supplemental retirement rate is set by state statute and is 0.62% of participating payroll.
Normal Retirement Contributions
Both normal retirement contributions and the amortization of the unfunded liability pay the employer’s portion of retirement benefits. However, they are calculated separately.
The normal retirement contribution, also referred to as the normal cost, is the percent of payroll necessary to fund this year’s portion of the expected total cost of future benefits for the average IMRF member. Under the entry age normal method, the actuary distributes the expected future cost over the member’s career as a level percent of payroll. That level percent of payroll is the normal cost.
Each participating employer pays a normal cost rate based on the weighted average of its Tier 1 and Tier 2 projected wages (some larger employers have the option of paying an individual normal cost rate).
For 2014 the average normal cost is 7.64% for Regular employers, 12.61% for SLEP employers, and 17.59% for ECO employers. (Eligible employers who opted to have individual rating of normal cost paid the incremental actuarial fees required of the calculation.)
If every employer had identical groups of members, benefits never changed and assumptions never changed, we could stop the process here. Since that is far from being the situation, we must also include a factor to make up the difference. That is the prior service cost or the amortization of unfunded liability.
Unfunded Liability Contributions
The unfunded liability is calculated for each employer as follows:
Present value of benefits for all employees
Future member contributions
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.
Therefore, we subtract the members’ contributions and interest, both past and estimated future. The employer retirement contributions are needed only for those employees that retire. The employer has usually already made some contributions and the employer’s asset account has earned investment income so we need to subtract those amounts. The employer’s future normal cost contributions will pay the cost of future service, so we want to subtract that as well. The remainder is the employer’s unfunded liability.
You may ask-why do I 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 so high? The reasons are many and differ from employer to employer. Some of the most common are explained below.
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. Assume an employer joins IMRF in 2000. When it joined it had employees already working. These employees were given pension credits (20% of the employee’s service up to five years) at no additional cost to them for the period of employment prior to the employer joining IMRF. The employer did not make any additional contributions at that time for this service. The cost was added to the unfunded liability.
Benefit Improvements granted after a member joins IMRF increase the unfunded liability. 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.
Past Service Adjustments increase an employer’s unfunded liability. The Pension Code defines circumstances under which a member may establish retroactive or omitted service credit by paying the member contributions plus interest. 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.
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 we use to project future costs to our actual experience. We change our assumptions to match our experience. These changes can result in additional costs that have not yet been funded, thus adding to the unfunded liability.
The Employer's Demographics compared to the demographics of IMRF as a whole can have a significant effect on its unfunded liability. We 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. As mentioned earlier, 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.
Investment Earnings less than or greater than 7.50% will have an affect on the unfunded liability. Obviously, if returns are greater than 7.50%, the unfunded will decrease. If returns are less than 7.50%, the unfunded will increase.
Based on the employer’s structure, the amortization period determines how much must be paid in a given year. This factor is determined by the actuary based on the previous year’s contributions, interest rate assumption, payroll growth, and amortization period and may vary from employer to employer. Because the actuary assumes that payrolls will increase for inflation each year, the factor is not 1/29th as you might expect. The amount to be paid is divided by the expected payroll of the employer to determine the unfunded amortization rate. An unfunded amortization rate is calculated separately for each employer based on its payroll and unfunded obligation. For this reason it is difficult to compare rates among employers.
Amortization for employers who are 120% or more overfunded on a market basis is handled differently. Overfunding occurs when the total assets exceed the actuarial obligation. The funding ratio of an employer can be found on the GASB Statement Number 50 (GASB 68 for fiscal years beginning after June 15, 2014) disclosure furnished annually by IMRF.
The primary goal of IMRF is to produce stable employer rates. However an employer that is 120% or more overfunded on a market basis will be given the option of selecting a minimum contribution amount as long as the employer remains over 120% funded on a market basis. Selecting the minimum contribution option will increase rate volatility. Some employers with limited ability to increase tax levies may want to continue with the normal amortization period since it provides more stable rates. Once overfunded amounts are used up, employer rates will increase to the normal cost rate, death, disability, and supplemental rate plus amortization of any unfunded amounts. Employers who are over 120% funded on a market basis may use the overfunding to reduce or satisfy an early retirement incentive liability.