Illinois State Actuary Releases First Report on the Chicago Teachers’ Pension Fund

Public Act 100-0465, which overhauled the State of Illinois’ school funding formula and made significant changes to how Chicago teachers’ pensions are funded, also required the State Actuary to review the actuarial assumptions and valuation of the Chicago Teachers’ Pension Fund (CTPF) as it does annually for the State’s five retirement systems. The Auditor General released the State Actuary’s analysis to the public on December 28, 2017 and the recommendations have already had an impact, persuading the CTPF Board to reduce its expected rate of return on investment to 7.25% for its FY2017 financial reporting rather than reducing it to 7.5% from the previous level of 7.75%. As of the publication of this blog, the CTPF Board has not yet released the final FY2017 actuarial analysis on its website, so the impact of the change in funding levels is not yet publicly known. This blog post will be updated when the actuarial report becomes available.

The expected rate of return on investment—also called the discount rate or interest rate assumption—is a key assumption in estimating the value of pension obligations. It is the interest rate used 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 therefore how much must be contributed by Chicago Public Schools to the fund. Public pension funds generally use the long-term assumed rate of investment return to discount liabilities for funding purposes.

According to the State Actuary, at the CTPF’s October 19, 2017 Board meeting, the Fund’s own actuary recommended that the CTPF lower its investment assumption to 7.25% from 7.75%. However, the CTPF Board instead opted to wait for a scheduled study of the Fund’s assumptions due in 2018 and lowered the assumption to 7.5% and the general inflation assumption to 2.5% from 2.75%. The Board pledged to make an additional reduction in the investment assumption in 2019. However, upon reviewing the materials provided by the CTPF actuary, the State Actuary found that lowering the discount rate to 7.5% would leave the CTPF with an “overly aggressive set of economic assumptions.”

The State Actuary was concerned that the real rate of return assumption of 5% the CTPF Board was proposing to use, or the discount rate assumption minus the inflation assumption (7.5%-2.5%) was overly aggressive for the current low interest rate environment. The Actuary then provided an explanation of why:

There has been emerging actuarial practice throughout the country to reduc[e] the discount rates even below the level that the investment consultants believe is achievable. This is because of the very low interest rate environment we are currently in. The lower the interest rate environment, the greater the investment risk that must be taken to achieve an assumed rate of return. For example, in 1995 the yield on ten-year Treasury bonds (a proxy for a risk free investment) was 6.21%. As of November 2, 2017 these yields are now 1.87%. This means, back in 1995 in order to achieve 7.50%, a system only had to earn 1.29% more than the ten-year treasury yields (“risk free” rates), whereas today a system would have to earn 5.63% above this “risk free” rate.[1]

The State Actuary also recommended that the salary increase assumption for the Fund be lowered by 0.25% to match the decrease in the inflation rate assumption. The CTPF Board adopted both the change to the expected rate of return on investment and the salary increase assumption at its December 14, 2017 meeting. The State Actuary found the CTPF’s other actuarial assumptions and demographic assumptions to be reasonable.

As with its analysis of the five State pension funds, the State Actuary also evaluates the proposed State contribution to the Chicago Teachers’ Pension Fund. As part of the new school funding law, the State of Illinois will contribute $221.3 million to the CTPF in FY2018 and starting in FY2019 will contribute an amount equal to the employer normal cost plus an amount for health insurance costs, in addition to the previous small statutory contribution of 0.544% of teacher payroll. The State Actuary verified the calculations that went into the CTPF actuary’s projection of the State of Illinois’ FY2019 contribution to the Chicago Teachers’ Pension Fund at $227.99 million.

In its report, the State Actuary provides an additional section of analysis of funding adequacy for the Chicago Teachers’ Pension Fund to supplement that provided by the plan’s own actuary. The State Actuary offers funding adequacy measures and trends to highlight the fund’s challenges, including a trend analysis of the plan’s funded status by membership group, a comparison of the statutory contribution rates to a “tread water” contribution, the sources of changes to the unfunded actuarial accrued liability (UAAL) and a net cash flow analysis. The Civic Federation will look at the State Actuary’s findings on funding adequacy in a future blog post, along with the results from the CTPF FY2017 actuarial report, once it is publicly released.