Chapter One

AUDITOR GENERAL’S SUMMARY                                        

 

REPORT CONCLUSIONS

On June 18, 2012, Public Act 097-0694 was signed into law which directed the Auditor General to contract with or hire an actuary to serve as the State Actuary. Cheiron was selected as the State Actuary.  The Public Act directed the State Actuary to:

 

·       Review assumptions and valuations prepared by actuaries retained by the boards of trustees of the State-funded retirement systems;

 

·       Issue preliminary reports to the boards of trustees of the State-funded retirement systems concerning proposed certifications of required State contributions submitted to the State Actuary by those boards; and

 

·       Identify recommended changes to actuarial assumptions that the boards must consider before finalizing their certifications of the required State contributions.

 

Cheiron reviewed the actuarial assumptions used in each of the five systems’ actuarial valuations for the year ended June 30, 2014 and concluded that they generally were reasonable.  Cheiron did not recommend any changes to the assumptions used in the June 30, 2014 actuarial valuations.

 

Cheiron made recommendations for additional disclosures for the 2014 valuations and recommended changes for future valuations. Recommendations included the following:

 

·       The Boards periodically should undertake a full scope actuarial audit, utilizing the services of a reviewing actuary. Such an audit should fully replicate the original actuarial valuation, based on the same census data, assumptions, and actuarial methods used by the Plan’s actuary.

 

·       Cheiron continues to recommend the Boards annually review the interest rate and inflation assumptions as opposed to waiting for the completion of a formal experience study.

 

·       The systems’ actuaries, in future valuations, should consider establishing a corridor that would limit the maximum spread between the actuarial value of assets (smoothed value) and the market value of assets so that the actuarial value of assets, in any year, would be no more than 120 percent of market value or no less than 80 percent of market value.  A move to this approach would have no impact on the 2014 actuarial valuation results as the actuarial value of assets for all five systems is currently within the 80 percent to 120 percent corridor.  The systems have indicated that the current method is prescribed in statute and that a change would require legislative action.


 

 

·       The systems should consider the use of generational mortality improvement assumptions if they are not already in place.

 

Cheiron verified the arithmetic calculations made by the systems’ actuaries to develop the required State contribution and reviewed the assumptions on which the calculations were based.

 

The Illinois Pension Code requires that the systems’ actuaries calculate the required State contribution using a prescribed funding method that achieves 90 percent funding in the year 2045. Cheiron concluded that this funding method does not meet generally acceptable actuarial principles because the systems are not targeted to be funded at 100 percent and the funding of the plans is pushed back to later years. At a minimum, future plan benefit accruals should be fully funded, to avoid continued systematic underfunding of the systems.  Continuing the practice of deferring contributions that are needed to fully fund annual benefit accruals increases the risk of the plans becoming unsustainable.

 

Based on the systems’ 2014 actuarial valuation reports, the funded ratio of the systems ranged from 42.3 percent (SURS) to 16.0 percent (GARS), based on the actuarial value of assets as a ratio over the actuarial liability.  Cheiron has concerns about the solvency of the systems if there is a significant market downturn.  Cheiron suggests the Boards always use the conservative end of any range of assumptions recommended by the actuary or other advisors due to the uncertainty and risks associated with the State mandated funding method. Cheiron also recommended stress testing be done or be expanded to demonstrate the likelihood there will be sufficient assets to pay benefits if there is a significant market downturn.

 

Information presented in this report is based on State statutes in effect at June 30, 2014 and does not take into consideration any effect of Public Act 98-0599, signed into law on December 5, 2013.  The implementation of the law was suspended in a ruling May 14, 2014 by the Seventh Judicial Circuit Court.  The Court ruled the law unconstitutional November 21, 2014.  The ruling is being appealed to the State Supreme Court. Due to the legal status of Illinois Public Act 098-0599, this report, and the valuation reports of the retirement systems, do not specifically reflect the reforms of Public Act 098-0599.

 

INTRODUCTION AND BACKGROUND

 

On June 18, 2012, Public Act 097-0694 was signed into law which directed the Auditor General to contract with or hire an actuary to serve as the State Actuary. The Public Act amended the Illinois State Auditing Act as well as sections of the Illinois Pension Code for each of the five State-funded retirement systems.  The five State-funded retirement systems are:

 

·       The Teachers’ Retirement System (TRS);

 

·       The State Universities Retirement System (SURS);

 

·       The State Employees’ Retirement System (SERS);

 

·       The Judges’ Retirement System (JRS); and


 

 

·       The General Assembly Retirement System (GARS).

 

Requirements of Public Act 097-0694

 

Public Act 097-0694 requires the State Actuary to conduct an annual review of the valuations prepared by the actuaries of the State-funded retirement systems.  Specifically the Act requires the State Actuary to:

 

·       Review assumptions and valuations prepared by actuaries retained by the boards of trustees of the State-funded retirement systems;

 

·       Issue preliminary reports to the boards of trustees of the State-funded retirement systems concerning proposed certifications of required State contributions submitted to the State Actuary by those boards; and

 

·       Identify recommended changes to actuarial assumptions that the boards must consider before finalizing their certifications of the required State contributions.

 

On or before November 1 of each year, beginning November 1, 2012, the boards of each of the systems must submit to the State Actuary a proposed certification of the amount of the required State contribution to the system for the next fiscal year, along with all of the actuarial assumptions, calculations, and data upon which that proposed certification is based.

 

On or before January 1, 2013, and each January 1 thereafter, the Auditor General shall submit a written report to the General Assembly and Governor documenting the initial assumptions and valuations prepared by actuaries retained by the boards of trustees of the State- funded retirement systems, any changes recommended by the State Actuary in the actuarial assumptions, and the responses of each board to the State Actuary's recommendations.

 

On or before January 15, 2013, and every January 15 thereafter, each Board shall certify to the Governor and the General Assembly the amount of the required State contribution for the next fiscal year. The Board's certification must note any deviations from the State Actuary's recommended changes, the reason or reasons for not following the State Actuary's recommended changes, and the fiscal impact of not following the State Actuary's recommended changes on the required State contribution.

 

Requirements of Public Act 098-0599

 

Illinois Public Act 098-0599 was signed into law in December 2013 to become effective as of June 1, 2014.  It made significant changes to statutes governing the statewide pension plans.  This Act modified eligibility and benefits of participants, changed the actuarial cost method used to calculate liability, expanded requirements of the State Actuary, and changed the funding method of the System.  The implementation of the law was suspended in a ruling May 14, 2014 by the Seventh Judicial Circuit Court.  The Court ruled the law unconstitutional November 21, 2014.  The ruling is being appealed to the State Supreme Court. Due to the legal status of Illinois Public Act 098-0599, this report, and the valuation reports of the retirement systems, do not specifically reflect the reforms of Public Act 098-0599.


 

 

Contracting with the State Actuary

 

On July 12, 2012, the Office of the Auditor General issued a Request for Proposals for the services of a State Actuary.  On August 24, 2012, the contract was awarded to Cheiron.

Cheiron is a full-service actuarial and consulting firm with offices in nine locations throughout the United States. Cheiron has experience working with multiple public pension plans around the country.

 

REVIEW OF THE ACTUARIAL ASSUMPTIONS

 

Cheiron reviewed each of the actuarial assumptions used in each of the five systems’ actuarial valuations for the year ended June 30, 2014 and concluded that they generally were reasonable.  Cheiron did not recommend any changes to the assumptions used in the June 30, 2014 actuarial valuations.

 

Cheiron did recommend additional disclosures for the 2014 valuations and also recommended changes for future valuations.  In their responses to Cheiron’s preliminary reports, systems indicated that they were planning to add to their 2014 valuations many of the additional disclosures recommended by Cheiron.  The systems’ responses to Cheiron’s preliminary reports can be found in Appendix C of this report.

 

Exhibit 1-1 summarizes the recommendations made to the retirement systems. At the end of each of the reports located in Chapters Two through Six is a chart summarizing the status of recommendations made by the State Actuary in the 2013 report.


 

 

Exhibit 1-1

RECOMMENDATIONS TO THE RETIREMENT SYSTEMS

Recommendations

TRS

SURS

SERS

JRS

GARS

Recommended Changes to Actuarial Assumptions used in the 2014 Actuarial Valuations:

Cheiron reviewed the actuarial assumptions and concluded that they were reasonable. Consequently, Cheiron did not have any recommended changes to assumptions this year.

Recommended Additional Disclosures for the 2014 Actuarial Valuations:

·   Include the statutory State contribution development in the Executive Summary

X

 

 

 

 

·   Revise the term Generally Accepted Actuarial Standards with reference to a particular funding method

 

X

 

 

 

 

·   Explain the rationale of using different assumptions between the two Tier 2 rates for COLA and pay cap increases

 

X

 

 

 

 

·   Add additional years and a narrative to a table in the valuation report that shows experience gains and losses by source

 

X

 

 

 

 

·   Demonstrate the implications of using the prior year’s data on the measurement of liabilities and plan costs

X

 

 

 

 

·   Include changes made as a result of the State Actuary review in its valuation report (rather than in a supplement)

 

X

 

 

 

 

·   Disclose whether the recommended mortality tables sufficiently cover anticipated increases through 2045

 

X

 

 

 

·   Indicate when and how stress testing will be done

 

 

X

 

 

·   Analyze and disclose liability loss due to payroll increases in the past year

 

 

X

 

 

·   Clarify the payroll basis applicable to the required State contribution rate

 

 

X

X

X

Recommended Changes for Future Actuarial Valuations:

·   Annually review the economic assumptions (interest rate and inflation rate) and adjust assumptions accordingly

 

X

 

X

 

X

 

X

 

X

·   Consider establishing a corridor around the market value of assets of 80% to 120% beyond which the actuarial value is limited

 

X

 

X

 

X

 

X

 

X

·   Include historic development of assets without General Obligation Bonds

X

X

X

X

X

·   Include a comparison of the projected contributions and funded ratios under the alternative measurements discussed in the valuation report

 

X

 

 

 

 

·   Include sample mortality rates in a tabular format

X

 

 

 

 

·   Consider the use of generational mortality improvement assumptions

 

 

X

 

X

 

X

 

X

·   Request investment consultants provide longer term market expectations

 

X

X

X

X


 

 

 

 

 

 

 

Exhibit 1-1

RECOMMENDATIONS TO THE RETIREMENT SYSTEMS

 

 

Recommendations

TRS

SURS

SERS

JRS

GARS

·   Provide evidence that the constant population assumptions and payroll assumption are reasonable

 

 

 

X

X

·   Other minor recommendations

 

 

 

 

 

·   Full disclosure of assumptions with respect to 415(b) limits and 401(a)(17) limits

 

 

X

X

X

·   Consider if additional revisions to demographic assumptions for Tier 2 members are appropriate

 

 

X

X

X

·   Consider using actual data rather than an assumption for the spousal continuance benefit

 

 

 

X

X

·   Provide additional clarity on the payrolls used to allow for a more complete evaluation by an actuary

 

 

 

X

X

Other Recommendations:

·   Periodically undertake a full scope actuarial audit in which the results of the valuation are fully replicated by a reviewing actuary

 

X

 

X

 

X

 

X

 

X

·   Use the conservative end of any range of assumptions recommended by the actuary or other advisors due to the uncertainty and risks associated with the State mandated funding method

 

X

 

X

 

X

 

X

 

X

·   Continue and/or expand stress testing of the system

X

X

X

X

X

Source: OAG summary of Cheiron’s preliminary reports to the five State-funded retirement systems.

The following sections discuss some of the key assumptions and recommendations.

Further details on the assumptions and recommendations, including those not discussed in this summary chapter, are contained in the State Actuary’s preliminary reports for each of the five systems, found in Chapters Two through Six of this report.

 

Economic Assumptions

 

Cheiron reviewed the economic assumptions utilized in the actuarial valuations for each of the five State-funded retirement systems.  The following sections discuss two of those assumptions – the interest rate assumption and the inflation assumption.

 

Interest Rate Assumption

 

The interest rate assumption (also called the investment return or discount rate) is the most impactful assumption affecting the required State contribution amount. This assumption is used to value liabilities for funding purposes.  The retirement systems use varying interest rate assumptions. Exhibit 1-2 shows the interest rate assumptions for each of the five State-funded retirement systems. As can be seen in the exhibit, three of the systems lowered their interest rate assumption for this year’s actuarial valuation.


 

 

 

Exhibit 1-2

INTEREST RATE ASSUMPTIONS

FOR THE FIVE STATE-FUNDED RETIREMENT SYSTEMS

June 30, 2014 Valuation

 

System

Interest Rate

 

Notes

Teachers’ Retirement System

7.50%

Lowered from 8.00% for the June 30, 2014 actuarial valuation

State Universities Retirement System

7.25%

Lowered from 7.75% for the June 30, 2014 actuarial valuation

State Employees’ Retirement System

7.25%

Lowered from 7.75% for the June 30, 2014 actuarial valuation

Judges’ Retirement System

7.00%

Lowered from 8.00% for the June 30, 2010 actuarial valuation

General Assembly Retirement System

7.00%

Lowered from 8.00% for the June 30, 2011 actuarial valuation

Source: Retirement system actuarial reports and experience studies.

In last year’s report, Cheiron concluded that it was not comfortable with the interest rate assumptions used by three of the systems (TRS, SURS, and SERS) and urged the Boards to lower the interest rate assumption for the June 30, 2014 actuarial valuation. Each of the Boards lowered the interest rate assumption:

 

·       TRSLowered its interest rate assumption from 8.00% to 7.50%.  The Board, along with the TRS actuary, made this change based on a measured and documented process conducted this past spring.  TRS’ actuary issued a report to TRS in May 2014 on economic assumptions and recommended changes in a subsequent letter dated June 17, 2014.

 

·       SURSLowered its interest rate assumption from 7.75% to 7.25%.  In June 2014, SURS’ actuary presented an Economic Assumption Review covering the period July 1, 2009 through June 30, 2013.  In that review, the actuary provided the Board with a recommendation, based on detailed expectations from eight investment consultants, to lower the rate to either 7.00% or 7.25%. The Board elected to lower the rate to 7.25%.

 

·       SERSLowered its interest rate assumption from 7.75% to 7.25%.  In April 2014, SERS’ actuary presented its Experience Review covering the period July 1, 2009, through June 30, 2013.  In that review, the actuary provided the Board with a recommendation, based on detailed expectations from eight investment consultants, to lower the rate to either 7.50% or 7.25%. The Board elected to lower the rate to 7.25%.

 

More detail on the analysis used by each of the systems in deciding to lower their rates can be found in Chapters Two through Four. Cheiron supports the lowering of the interest rate assumptions and continues to recommend that the Boards for all five systems review


 

 

the economic assumptions annually.  Cheiron offered several rationales for supporting lowering the interest rate assumptions.  These included:

 

·       The federal government, which promulgates minimum funding standards for corporate pension plans, already requires corporate pension plans to utilize interest assumptions that are based on short-term and mid-term bond rates, which are very low.

 

·       Moody’s, an organization that provides bond rating information for private investors, compares the financial viability of public sector pension plans by using interest rate assumptions significantly lower than the assumptions used by most public sector pension plans.

 

Cheiron also discussed the nationwide movement among pension plans to lower the interest rate assumption.  The National Association of State Retirement Administrators (NASRA) conducts the Public Fund Survey which is an online compendium of key characteristics covering 126 public pension plans.  Exhibit 1-3 shows the change in the interest rate assumptions, since the inception of the Public Fund Survey in 2001, for 126 public pension plans.

 

The exhibit shows the shift to lower interest rate assumptions.  In 2001, 104 of the 126 plans (83%) used an interest rate assumption of 8.0 percent or higher. The most recent data


 

 

shows that this number has dropped to only 45 of 126 plans (36%) that use an interest rate of 8.0 percent or higher.  The median assumption has fallen below 8.0 percent. Also, four plans have adopted a rate below 7.0 percent.

 

Inflation Assumption

 

The inflation assumption primarily impacts the salary increase assumption.  The five State-funded retirement systems use inflation assumptions ranging from 2.75 percent to 3.00 percent.  TRS lowered its inflation assumption from 3.25% to 3.00% for the June 30, 2014 actuarial valuation.  Exhibit 1-4 shows the inflation assumptions for each of the five systems.

 

Exhibit 1-4

INFLATION ASSUMPTIONS

FOR THE FIVE STATE-FUNDED RETIREMENT SYSTEMS

June 30, 2014 Valuation

 

System

Inflation Rate

 

Notes

Teachers’ Retirement System

3.00%

Lowered from 3.25% for the June 30, 2014 actuarial valuation

State Universities Retirement System

2.75%

Lowered from 3.75% for the June 30, 2011 actuarial valuation

State Employees’ Retirement System

3.00%

Lowered from 3.50% for the June 30, 2002 actuarial valuation

Judges’ Retirement System

3.00%

Lowered from 4.00% for the June 30, 2011 actuarial valuation

General Assembly Retirement System

3.00%

Lowered from 4.00% for the June 30, 2011 actuarial valuation

Source: Retirement system actuarial reports and experience studies.

Cheiron concluded that the inflation assumptions used by the five State-funded retirement systems were reasonable.  Cheiron’s rationale for concurring with the inflation assumptions included:

·       The 2014 Old-Age, Survivors, and Disability Insurance Trustees Report projects that over the long-term (next 75 years) inflation will average somewhere between 2.0% and 3.4%.

·       Cheiron’s comparison of other public sector retirement systems’ inflation assumptions as shown by a study published by the National Conference on Public Employee Retirement Systems (NCPERS).  The study shows that the 3.0% assumption used by four of the five State-funded systems is a prevalent assumption while the 2.75% assumption, which SURS uses, is on the lower end of inflation assumptions.  The average rate amongst the 187 systems who responded to the study was 3.2%.


 

 

Demographic Assumptions

 

The retirement systems utilize a number of demographic assumptions such as mortality rates, disability rates, and termination rates.  Cheiron reviewed the demographic assumptions and concluded that they were reasonable. Cheiron did, however, make a number of recommendations for additional disclosures for the 2014 valuations and recommended changes for future valuations concerning various demographic assumptions.

 

Cheiron made recommendations involving the mortality assumptions for all five systems.

Cheiron recommended SURS disclose in its 2014 valuation whether the mortality tables sufficiently cover anticipated increases through 2045. For TRS’ future valuations, Cheiron recommended the specific table used for active mortality be disclosed in the report to comply with the Actuarial Standards of Practice. For SURS, SERS, JRS, and GARS, Cheiron recommended the systems consider the use of generational mortality improvement assumptions.

 

Cheiron added additional analysis in its reports on each of the five systems.  Cheiron collected data from past valuation reports dating back to 2009 and presented a historical review of past demographic and salary increase experience gains and losses. Results were presented in a chart which showed the pattern of annual gains and losses attributable to different sources.

These charts can be found in Chapters Two through Six.  Different measures were used for each system depending on the information available but sources used included:

 

·       Active and retiree mortality;

·       Disability;

·       New entrant;

·       Benefit recipient;

·       Salary increases;

·       Retirement; and

·       Terminations.

 

An examination of these trends can be used to determine if adjustments need to be made to assumptions or if additional disclosures need to be made in the actuarial valuation reports. As shown previously, Exhibit 1-1 summarizes the recommendations made for the various retirement systems.  Additional details on the demographic assumptions examined can be found in the chapters for each of the five State-funded retirement systems.


 

 

 

PROPOSED CERTIFICATION OF REQUIRED STATE CONTRIBUTION

 

As required by Public Act 097-0694, each of the five State-funded retirement systems submitted to the State Actuary a proposed certification of the amount of the required State contribution for that system.  Cheiron verified the arithmetic calculations made by the systems’ actuaries to develop the required State contribution and reviewed the assumptions on which the calculations were based.  Exhibit 1-5 shows the amounts of proposed State contributions submitted by the systems for Fiscal Year 2016.

 

Exhibit 1-5

AMOUNTS OF STATUTORILY REQUIRED STATE CONTRIBUTIONS

 

System

State Contribution (for Fiscal Year 2016)

Teachers’ Retirement System

$ 3,742,702,194

State Universities Retirement System

1,601,480,000

State Employees’ Retirement System

2,044,877,000

Judges’ Retirement System

132,060,000

General Assembly Retirement System

16,073,000

Total

$7,537,192,194

Source: 2014 retirement system actuarial valuation reports.

Cheiron noted that, in accordance with 30 ILCS 5/2-8.1, its review does not include a replication of the actuarial valuation results.  Given the size of the Plans (TRS, SURS, and SERS), the Plans’ low funded ratios, the recent changes in legal requirements, and guidance issued by the Government Finance Officers Association, Cheiron recommended that the Boards periodically undertake a full scope actuarial audit, utilizing the services of a reviewing actuary.  Such an audit should fully replicate the original actuarial valuation, based on the same census data, assumptions, and actuarial methods used by the Plans’ actuaries. While some systems have had limited scope audits in the past, these audits did not include independent calculations by individual member to confirm the accuracy of the valuation results.

 

ACTUARIAL METHODS

 

Actuarial methods consist of three components: (1) the funding method, which is the attribution of total costs to past, current, and future years; (2) the method of calculating the actuarial value of assets (i.e., asset smoothing); and (3) the amortization basis of the Unfunded Actuarial Liability (UAL). The amortization basis is discussed under the State Mandated Funding Method in the next section.

 

Funding Method

 

All of the five State-funded retirement systems use the Projected Unit Credit (PUC) cost method to assign costs to years of service.  This method is required under the Illinois Pension Code.  Cheiron had no objection to using the PUC cost method as it is an acceptable method that is used by other public sector pension funds. However, Cheiron would prefer the Entry Age


 

 

Normal (EAN) funding method as it is more consistent with the Pension Code’s requirement for level percent of pay funding.

 

Public Act 098-0599 amended the Illinois Pension Code to require the five State-funded plans to calculate the required State contribution using the entry age normal actuarial cost method beginning with the Fiscal Year 2016 State contribution. However, the Illinois Circuit Court granted a temporary restraining order and a preliminary injunction stopping the implementation of Public Act 098-0599.  Consequently, the systems continued to calculate the required State contribution as the law existed prior to Public Act 98-0599.

 

Under the PUC method, the benefits of active participants are calculated based on their compensation projected with assumed annual increases to ages at which they are assumed to leave the active workforce by any of these causes: retirement, disability, turnover, or death.

Only past service (through the valuation date but not beyond) is taken into account in calculating these benefits.  The cost of providing benefits based on past service and future compensation is the actuarial accrued liability for a given active participant. Under the PUC cost method, the value of an active participant’s benefits tends to increase more sharply over their later years of service than over their earlier ones.

 

As a result of this pattern of benefit values increasing, while the PUC method is not an unreasonable method, more plans use the EAN funding method to mitigate this effect.  It should also be noted that the EAN method will be the required method to calculate liability for the new Governmental Accounting Standards Board Statements 67 and 68.

 

Asset Smoothing Method

 

The actuarial value of assets for the systems is a smoothed market value.  Unanticipated changes in market value are recognized over five years in the actuarial value of assets. The primary purpose for smoothing out gains and losses over multiple years is that the fluctuations in the actuarial value of assets will be less volatile over time than fluctuations in the market value of assets.  Cheiron concurred with the use of the asset smoothing method noting that smoothing the market gains and losses over a period of five years to determine the actuarial value of assets is a generally accepted approach in determining actuarial cost.

 

Another aspect of asset smoothing methods is whether or not to limit the maximum spread between the actuarial value of assets (smoothed value) and the market value of assets. Many public sector pension plans limit the actuarial value of assets to be in any year no more than 120 percent of market value, or no less than 80 percent of market value.  In fact, the Internal Revenue Service (IRS) mandates this "corridor" for private sector pension plans (a 90%-110% corridor is mandated).  Even though it is not mandated for public plans, Cheiron believes that the use of this type of corridor is a much sounder actuarial practice. According to Actuarial Standard of Practice No. 44 Selection and Use of Asset Valuation Methods for Pension Valuations 3.3(b)(1), the actuarial value of assets should ". . . fall within a reasonable range around the corresponding market values."

 

Therefore, Cheiron recommended that the Boards consider moving to this approach in future valuations. Cheiron also noted that a move to this approach would have no impact on the


 

 

2014 actuarial valuation results as the actuarial value of assets for all five systems is currently within the 80 percent to 120 percent corridor.  The systems have indicated that the current method is prescribed in statute and that a change would require legislative action.

 

OTHER ISSUES

 

Cheiron raised two other issues in its reports to the retirement systems. The first issue related to the State mandated funding method and the second issue related to the State mandated projection method.

 

State Mandated Funding Method

 

The Illinois Pension Code requires that the systems’ actuaries base the required contribution using a prescribed funding method that achieves 90 percent funding in the year 2045.  In the actuarial valuation reports, the systems’ actuaries discuss their concerns with this funding method.

 

·       In TRS’s June 30, 2014 Actuarial Valuation Report, TRS’ actuary offers commentary on the statutory funding method from an actuarial point of view.  It describes two alternatives to the statutory funding method: one intended to represent more generally accepted practices and the other targeted specifically to ensure the unfunded liability does not increase.  It contrasts these methods with the current statutory method and notes that the statutory policy produces a back-loaded contribution projection, where contributions are significantly deferred into the future.

 

·       In SURS’ June 30, 2014 Actuarial Valuation Report, SURS’ actuary comments that the current funding policy defers funding which puts the system at risk that benefit obligations will not be met.  They recommend a funding policy based on 100 percent funding by 2045 or earlier.

 

·       In the actuarial valuations for SERS, GARS, and JRS, the actuary advises “strengthening the current statutory funding policy” and provides the following examples:

 

o   Increasing the 90 percent funding target;

o   Reducing the projection period needed to reach 90 percent funding;

o   Separating the financing of benefits for members hired before and after December 31, 2010; and

 

o   Changing to an Annual Required Contribution based funding approach with an appropriate amortization policy for each respective tiered benefit structure.

 

Cheiron concluded that the Pension Code funding method does not meet generally acceptable actuarial principles because the systems are not targeted to be funded at 100 percent and the funding of the plans is pushed too far into the future. At a minimum, future plan benefit


 

 

accruals should be fully funded to avoid continued systematic underfunding of the systems. Continuing the practice of deferring contributions that are needed to fully fund annual benefit accruals increases the risk of the plans becoming unsustainable.

 

Based on the systems’ 2014 actuarial valuation reports, the funded ratio of the systems ranged from 42.3 percent (SURS) to 16.0 percent (GARS) based on the actuarial value of assets as a ratio to the actuarial liability.  Cheiron has concerns about the solvency of the systems if there is a significant market downturn.

 

Cheiron suggests the Boards always use the conservative end of any range of  assumptions recommended by the actuary or other advisors due to the uncertainty and risks associated with the State mandated funding method. The potential for continued underfunding of the plan during the projection period increases the uncertainty and inherent risks in determining the State required contributions to the systems and the measurement of plan obligations.

Actuarial Standards of Practice requires consideration of the plan’s funding policy and the uncertainty or risk inherent in the measurement of pension obligations and these should be factors when selecting actuarial assumptions.

 

Cheiron also recommended stress testing be done or be expanded to demonstrate the likelihood there will be sufficient assets to pay benefits if there is a significant market downturn.

 

State Mandated Projection Method

 

Cheiron noted that under the Pension Code, the actuarial methodologies utilized in performing the 2045 projection of the systems’ funded status assume that the future earnings rate is applied to the actuarial value of assets (smoothed value) rather than the market value of assets. Cheiron believes that basing the projected future earnings of the System on starting market values of assets (rather than a smoothed value) would provide a more realistic expectation of the future direction of the contribution level.

 

RESPONSES TO THE RECOMMENDATIONS

 

Each of the five State-funded retirement systems provided responses to Cheiron’s recommendations contained in the preliminary reports. The systems generally agreed with Cheiron’s recommendations.  The complete responses are in Appendix C.