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Pension & OPEB Funding Strategies for Illinois Public Plans

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IMTA 2018 presentation on funding strategies for safety and non-safety employees

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Pension & OPEB Funding Strategies for Illinois Public Plans

  1. 1. IMTA Northern Region Meeting Mark Schulte, FSA, EA, MAAA October 5, 2018
  2. 2. 1 General background 2 Pension background 3 Pension funding 4 OPEB costs 5 OPEB funding 6 Pension and OPEB outlook 1
  3. 3.  Retirement benefits usually in two main categories  Pensions  Other Post Employment Benefits  Both are benefit promises where costs must be estimated many years in future  Cost of the promises must be disclosed in financial statements when they are earned 2
  4. 4.  Why are pension and OPEB important? 3 “The Fiscal Firebomb Looming for Small Cities in Illinois” “The bottomless pit - public pensions” “Pension debt yielding a grim outlook for local governments” “Retiree Health Care: The Brick That Broke Municipalities’ Backs” “Taxpayers on the hook for billions in hidden government-worker healthcare costs” “Taming the OPEB Beast”/“Slaying the OPEB Dragon” Pension & OPEB Headlines Pensions!
  5. 5.  Public agencies face growing pressure of retiree benefit costs which are higher than expected  Increased scrutiny on costs  Legal, logistical, and financial obstacles to reducing costs 4
  6. 6.  Pension & OPEB funding is different than accounting  GASB accounting results are a snapshot of plan’s funded status  “Funding” calculations are usually a long-term view  Different actuarial measurements can create confusion about which are the “right” numbers 5 Sample Plan GASB Funded Status “Funding” Funded Status Liabilities $41.2M $27.4M Assets 21.3M 21.1M Unfunded Liability $19.9M $6.3M Funded % 52% 77%
  7. 7. 6 $0.0 $50.0 $100.0 $150.0 $200.0 $250.0 $300.0 $350.0 Unfunded Liability ($MM) – Sample Pension Plan Unfunded Liability Accrued Liability Market Asset Value  Pension liabilities are generally fairly stable and constantly increasing. It’s up to the investments (plus employer contributions) to keep up with the liability growth.  Need a proactive funding and investment policy to be successful
  8. 8.  Investment return assumptions and volatility are key pension risk factors 7 -25.0% -20.0% -15.0% -10.0% -5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% Investment Returns – Sample Pension Plan Actual Return Expected Return (7.0%)
  9. 9.  Liability discount rate (investment return assumption) determines “present value” of future pension payments  Higher investment earnings translate to lower contributions, but the opposite is true too 8
  10. 10.  Many pension plans’ funded status has decreased in recent years  Underfunded plans can sometimes operate for many decades without running out of money – as long as actuarial contributions are made 9 Funded Ratio – Sample Pension Plan
  11. 11.  IMRF provides pensions to non-safety local employees  Agent, multiple-employer system:  Each employer responsible for their own pension costs  Over 3,300 pension plans; generally well-funded  Mandatory contribution rates, with enforcement mechanism 10
  12. 12.  Over 650 local safety pension plans  Article 3 (Police) and Article 4 (Firefighters) in pension code  Varying levels of funding sufficiency  Single-employer plans  Plan administration and investments handled locally  Each municipality responsible for calculating and paying their own pension costs 11
  13. 13.  Based on prescribed methods and assumptions in IL pension code  Mandate property tax levy to help fund contributions  State comptroller can garnish tax revenues for contribution non-compliance 12 Minimum Statutory Contribution Formula Normal Cost  Value of new benefits earned by active members this year  Cost split between Employers and Employees Plus Amortization of Unfunded Liability  Spreads out unfunded liability over several years (as % of payroll)  Statutory minimum target is 90% funded by 2040  Paid entirely by employer – i.e., employer is responsible for any unexpected pension costs attributable to active members or retirees
  14. 14. 13 Should employers be looking beyond statutory minimum pension contributions? Eventually need to pay the cost of all promised pensions Delaying contributions reduces the potential investment return available to reduce future pension costs There are several options to develop an Actuarially Determined Contribution (ADC)
  15. 15.  Basic “Normal Cost plus Amortization of Unfunded Liability” approach is still appropriate  Amortization methods and assumptions can be refined 14 Statutory Amortization ADC Alternative Target 90% funding Target 100% funding Amortize as level % of payroll Amortize as level $ amount Single amortization period ending 2040 Amortization “layers” each year Usually 10-20 year amortization periods Assumptions: ~6.5% discount rate 3.5% payroll growth Other (lower risk) investment targets? Lower or no payroll growth assumption
  16. 16.  Sample comparison of minimum contribution to ADC  Assume Liability=$100M; Assets=$70M; NC=$2M  Discount rate=6.5%; Payroll=3.5% or 0%  90% vs. 100% funding target; 23 vs 20 year amortization period 15 Statutory Minimum Alternative ADC Normal Cost $2.0M $2.0M Unfunded Liability Amortization 1.2M 2.7M Total Contribution $3.2M $4.7M
  17. 17.  What do OPEB promises look like?  Often “tiered” with different grandfathered groups  Often varies by employee group (e.g., Police, Fire, Misc) 16 Sample OPEB Subsidies Premiums  100% paid by employer  % of premium based on service at retirement  Retirees receive amount equal to active subsidy  Premium up to cap  Fixed dollar amount Premium increases  Paid by employers  Split between employer and retirees Duration  Lifetime  Pre-65  Specified period (e.g., up to 10 years)
  18. 18.  Retiree OPEB costs are often projected to extend for many years 17 - 100,000 200,000 300,000 400,000 500,000 600,000 700,000 800,000 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 2050 2052 2054 2056 2058 2060 2062 2064 2066 2068 Projected Retiree Benefit Payments Current Retirees Future Retirees
  19. 19.  Actuarial calculations estimate OPEB costs decades into the future  Many factors affect projected OPEB costs  OPEB can be very volatile compared to pensions  Benefit provisions sometimes flexible  Challenging to project health costs and utilization several decades into future  Potential changes in national healthcare system? 18
  20. 20.  Governmental Accounting Standards Board (GASB) requires measurement of the value of OPEB promises  GASB 45 shined a light on OPEB starting in 2006, but was outdated from the start  Full liability not on balance sheet  To much variation in calculation methods and assumptions  GASB 75 effective for FYs beginning after 6/15/2017  Catches OPEB up with pensions  Significant effect on balance sheet  More frequent actuarial reporting  More volatile liabilities in many cases  Alternative Measurement Method (AMM) still available, but more complex 19
  21. 21.  Direct Subsidy and Implicit Subsidy costs  Implicit Subsidy can be difficult to understand and explain, but still need to recognize under GASB 75 accounting  Is supposed to reflect the additional “hidden” cost of allowing retirees to remain on employer’s group medical plan 20 Active employee (age 40) Retiree (age 60) Total Premium 800 800 1,600 Medical Costs 600 1,000 1,600 $0 $200 $400 $600 $800 $1,000 $1,200 $1,400 $1,600 Illustration of Implicit Subsidy
  22. 22.  OPEB funding is entirely separate from accounting requirements  Many OPEB plans are unfunded, but some employers have established OPEB trusts  OPEB funding challenges  OPEB funding is usually optional, not mandatory like pensions  OPEB liability volatility  Investment objectives – stability vs. returns  Often starting from $0 21
  23. 23. OPEB Trust Considerations  Revocable vs. irrevocable trusts  Revocable trusts offer additional flexibility  Irrevocable assets better for GASB 75 accounting  Assets reflected in Fiduciary Net Position and Net OPEB Liability  Expected investment return affects liability discount rate  Consider converting revocable to irrevocable, or a combination of the two? 22
  24. 24.  Normal Cost + Unfunded Liability Amortization model is appropriate for both pensions and OPEB  Often need special adjustments to OPEB funding policy because starting from lower funding level than pensions 23 $0.0 $5.0 $10.0 $15.0 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 2050 2052 2054 2056 2058 2060 2062 2064 2066 2068 Millions Projected OPEB Costs/Contributions Employer pays 100% future payments (pay-as-you-go cost) Traditional funding policy (30 year) Phase-in to level OPEB cost ($7M)
  25. 25.  What does trust projection look like with different funding policies? 24 $0.0 $20.0 $40.0 $60.0 $80.0 $100.0 $120.0 $140.0 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 2050 2052 2054 2056 2058 2060 2062 2064 2066 2068 Millions Projected OPEB Trust Assets Traditional funding policy (30 years) Phase-in to level OPEB cost ($7M)
  26. 26.  How to coordinate OPEB trust contributions and benefit payments?  Some employers want to get “100% funded” before paying benefits from trust – is this practical?  Consider  Direct vs. implicit subsidies  OPEB liability and asset volatility  Flexible funding/spending policy  Contribution sources: employer vs. employee  Some employers end up “super-funding” their OPEB trust  Make OPEB trust contributions plus annual retiree benefits paid from general assets  Can cause an unstable contribution pattern 25
  27. 27.  IL public safety pension consolidation and reform proposals  Nationwide trend towards lowering pension plan benefits – depending on statutory protections  Additional scrutiny on actuarial assumptions/transparency  “Mark-to-market” accounting 26
  28. 28.  Focus on disclosing/communicating/mitigating pension risks 27 Solvency Liability (3.0%) 6.0% Discount Rate 7.0% Discount Rate 8.0% Discount Rate Unfunded Liability $102.1 M $47.1 M $33.0 M $21.2 M Assets $72.4 M $72.4 M $72.4 M $72.4 M Liability $174.5 M $119.5 M $105.4 M $93.6 M $ M $20 M $40 M $60 M $80 M $100 M $120 M $140 M $160 M $180 M $200 M Effect of Discount Rate on Funded Status Baseline assumption
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  30. 30. Mark Schulte, FSA, EA, MAAA marks@vaniwaarden.com Van Iwaarden Associates 612.596.5960 All information in this presentation is for general informational purposes only and should not be relied upon without the express written consent of the authors. L/D/C/R: 4/ms/sb 29

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