Another Chicago Pension Fund Reduces its Assumed Rate of Return on Investment

September 16, 2016

Decisions by two of the largest State of Illinois pension funds to reduce their expected rates of return on investment have garnered headlines, but they were not the only funds to change their assumptions recently. On May 11, 2016, the Retirement Board for the Firemen’s Annuity and Benefit Fund of Chicago voted to reduce the expected rate of return on investment for the fund to 7.5% from 8.0%, in addition to changes to the inflation and wage inflation assumptions. Together the changes produced a $188.2 million higher estimate of the unfunded liability.[1]

As previously noted on many occasions on this blog, the discount rate or expected rate of return on investment is an important actuarial assumption to estimate the present value of future benefit payments. Reducing the rate increases the estimated present value because more money must be set aside now to pay future benefits. This present value, known as the actuarial liability, is compared with the value of pension assets to determine the funded status of pension plans and the level of State contributions. Public pension funds generally use the long-term assumed rate of investment return to discount liabilities for funding purposes.

In contrast to the State funds, where the reduction to the discount rate is projected to result in significant increases in statutorily required state pension contributions in the upcoming budget year, the change to the Fire Fund discount rate will not immediately result in increased contributions by the City of Chicago. This is because for the next several years, under the provisions of Public Act 99-0506, the City’s contributions to the Police and Fire Funds are laid out specifically in statute and will not adjust to account for deviations from actuarial assumptions or changes to those assumptions such as the reduction to the discount rate approved by the Fire Board in May. After the end of the ramp the City will be required to fund the Police and Fire Funds at an annually calculated amount that will produce a funded ratio of 90% by 2055. Therefore, it is likely that the City will face significantly increased contributions in FY2021, the first year after the ramp.

The Fire Fund’s actuary, Gabriel Roeder Smith & Company, notes in its actuarial valuation for FY2015 that the statutory funding method under P.A. 99-0506, with its five-year ramp and 40-year plan to get to 90% funded, “generates a contribution requirement that is less than a reasonable actuarially determined contribution.” Instead of the statutory funding, the actuary recommends the development and implementation of a funding mechanism that would incorporate an annual normal cost payment combined with an amortization payment to pay off 100 percent of the unfunded liability within a 15-20 year closed period.[2] While the actuary did not disclose how much such an annual payment would be, it would certainly be significantly higher than the $208 million payment scheduled to be made by the City of Chicago to the Fire Fund in FY2017 under P.A. 99-0506.

[1] Firemen’s Annuity and Benefit Fund of Chicago, Actuarial Valuation Report as of December 31, 2015, p. 3.

[2] Firemen’s Annuity and Benefit Fund of Chicago, Actuarial Valuation Report as of December 31, 2015, cover letter.