on Employer Funding Status, Employer Reserves, and Future Employer Contribution Rates
February 12, 2008
We encourage each Authorized Agent to share this memorandum
with the unit of government’s chief financial officer, other officials,
and governing body members.
Executive Summary
This preliminary information is based on unaudited investment return data and projected actuarial information. Finalized information will be available by early May 2008.
The estimated 2007 investment return for IMRF is .5%. This return translates into investment income of approximately $1.8 billion and, on an estimated basis, allows IMRF to retain its 100% plus funded status on a market value basis.
IMRF’s returns for the 2007-2003 period were 8.5%, 13.9%, 8.7%, 12.4%, and 22.6%. While IMRF earned 8.5% on a market basis in 2007, its actuarial return, which is the return that impacts employer contribution rates, was 8.8%. This is higher than the actuarial investment return assumption of 7.5%.
Background
As a defined benefit plan, investment return fluctuations have no impact on the benefits payable to active or retired IMRF members. All member benefits are guaranteed. Also, as a defined benefit plan, IMRF is designed to be pre-funded. The lump sum needed to pay a lifetime pension should be available when a member retires. This differs from “pay-as-you-go” plans—like Social Security—where money collected today is used to pay benefits owed to current retirees.
While investment return fluctuations do not impact member benefits, they do impact funding status, individual employer reserve balances, and employer contribution rates.
IMRF, as a defined benefit plan, is designed to be 100% funded. The Illinois Pension Code [40 ILCS 5/7-172(b)(2)] requires the amortization of any unfunded liabilities over the remainder of the period allowable under generally accepted accounting principles.
Investment Returns
As noted above, IMRF’s estimated 2007 investment return on a market basis is 8.5%. However, for actuarial purposes, IMRF uses a common pension industry practice of five-year averaging of actual market returns to arrive at the actuarial return of 8.8%.
The actuarial return is used to determine employer contribution rates and actuarial funding status. This averaging technique, which is employed to moderate fluctuations in employer contribution rates, delays the recognition of market returns that either exceed or fall short of the assumed actuarial return of 7.5%.
For 2007, IMRF will be adjusting its assumed investment income of $1,604 million (a 7.5% return on the beginning of the year actuarial value of IMRF investments) by one-fifth of the excess of the market value returns over the assumed actuarial returns for the past three years.
Thus, for actuarial purposes, IMRF’s investment return will be approximately $1,892 million. IMRF will begin 2008 with $865 million of unrecognized gains for actuarial rate-setting purposes, which will be recognized over the next four years. These unrecognized gains provide a cushion against future employer contribution rate increases should investment returns drop below 7.5%.
Employer Funding Status
IMRF’s 2007 overall funded status on an actuarial basis is expected to increase from 95.3% as of year-end 2006 to 96.9% at year-end 2007. This increase is due to the fact that on an actuarial basis, IMRF earned more than its assumed return of 7.5%.
However, on a market value basis (which does not reflect the five-year averaging technique), IMRF’s funded status is projected to increase from 100.1% to 100.5%, which reflects the 8.5% market return in 2007.
If IMRF earns its actuarial assumed investment return of 7.5% over the next four years, it will also reach its 100% funding goal on an actuarial basis by 2010. If actual returns exceed 7.5% over the next four years, IMRF will reach 100% funding on an actuarial basis sooner.
Most individual employers can expect that their Regular plan funded status will improve modestly on an actuarial basis and only slightly on a market basis.
In April, we will furnish each employer its annual GASB 27 footnote information which will disclose the actuarial and market value funded status for all plans.
Impact on Employer Reserves
By statute, IMRF must credit member and retiree reserves with 7.5% interest (approximately $898 million for 2007). After providing for these credits and covering administrative and direct investment expenses, approximately $871 million will be credited to employer reserve balances.
IMRF will credit beginning of the year positive employer reserve balances with 7.5% interest (approximately $735 million for 2007). The remaining amount of investment income (approximately $136 million) will be distributed to all employers as residual investment income.
On average, employers will receive a credit of approximately 8.3% based on their beginning of the year balance. The additional residual income return beyond the normal 7.5% interest credit reflects the fact that, as a member of a defined benefit plan, IMRF employers share all the risks and rewards of investment returns.
IMRF employers have received significant financial benefits over the last five years from the distribution of residual investment income—$136 million in 2007, $1,269 million in 2006, $188 million in 2005, $814 million in 2004, and $2,060 million in 2003.
Employer Contribution Rates
Employer contribution rates consist of as many as six parts:
- Normal retirement costs,
- Death in service benefits,
- Temporary disability benefits,
- Supplemental retirement benefits (13th payment),
- Amortization of over- or underfunding, and
- Early retirement incentives (employer option).
The ongoing cost of the IMRF benefit package for the Regular plan covering normal retirement costs, death in service benefits, temporary disability benefits and supplemental retirement benefits, is 8.38% of payroll in 2008. Put another way, for each dollar of service an employee renders, the employer also incurs a pension cost of 8.38 cents. To the extent an employer was overfunded, the 8.38 cents is reduced to amortize its surplus. To the extent an employer was underfunded, the 8.38 cents is increased to collect the shortfall.
The average employer rate for the Regular plan for 2008 is 9.47% and reflects the fact that the Regular plan is currently less than 100% funded on an actuarial basis.
The impact of 2007 investment returns on individual employer contribution rates is difficult to forecast, since each employer has a unique rate affected by its own demographics and funded status. Since IMRF’s actuarial return was 8.8% in 2007, more than the 7.5% assumed return, the average employer rate for the Regular plan is expected to decrease to 8.99% in 2009. If IMRF is able to earn a market return of 7.5% or more in 2008, the average rate for the Regular plan will continue to decrease in 2010.
The average employer rate for the Regular plan was 9.72% for 2007 and will be 9.47% for 2008, a decrease of 25 basis points or 2.6%. A rough estimate of the average employer contribution rate for the Regular plan for 2009 is 8.99%, a decrease of 48 basis points, or 5.1%.
The impact on individual employers will vary widely. As individual employers’ overfunding is depleted, there will be non-proportional rate increases not factored into the estimated average rate for 2009.
IMRF Meetings
In order to discuss the potential impact on individual employers in 2009 and beyond, as well as the underlying concepts driving funding levels, reserve balances, and contribution rates, IMRF will schedule a series of meetings throughout the state. These meetings will give IMRF the opportunity to answer any specific questions you or any other representatives of your unit of government might have.
These meetings will also provide an opportunity for IMRF to discuss certain initiatives and other matters that are taking place at your retirement plan. The dates and locations will be provided in a subsequent General Memorandum.
The meetings will be held after you receive your 2008 Advance Rate Notice and 2007 Reserve Statement. Reserve Statements will be available in March 2008 and Advance Rate Notices will be available in early April 2008. You will be advised when your Reserve Statement and Advance Rate Notice are available online in the Employer Document Archive of Employer Access. Employers who do not have internet access will be mailed paper copies.
Questions?
If you have any questions regarding the information presented in this memorandum, please call or e-mail Chief Financial Officer Richard DeCleene at (630) 368-5345 or rdecleene@imrf.org.