Pension Mess Again: It Actuarially is $140 Million

The City’s present and former actuaries met with City Council members recently to explain the assumptions and methods they used in calculating the City’s actuarially required contributions (ARCs) to the firefighters’ and police pension funds. Ted Windsor, the City’s former actuary, appeared before the Council on Feb. 27; Alex Rivera, a representative of Gabriel Roeder Smith (GRS), the City’s present actuary, did so on Feb. 23.

The City’s current unfunded liability to the pension funds was estimated at about $100 million by Mr. Windsor as of March 1, 2006, and at $141 million by GRS as of March 1, 2007. The pension funds must be fully funded by 2033 through annual contributions from the City.

City Manager Julia Carroll said she invited the actuaries to explain to the City Council members how each of them arrived at the unfunded liability and the ARC. Some Council members had questioned the validity of the $140 million estimate, particularly because making the ARC on that large a liability would cause an increase in the City’s portion of the property tax.

After listening to both actuaries, Council members appeared to agree that the $140 million estimate was reasonable. City Council decided to fund the pensions at the level determined by GRS.

Key Assumptions

The actuaries used different assumptions in estimating the amount of the unfunded liability in the police and firefighters pension funds. For example:

• Mr. Windsor assumed that the funds contributed to the pension funds would earn 7.5 percent on their investments. GRS assumed a more conservative 7.25 percent.

Mr. Windsor assumed that police and firemen would retire at the age of 56 years. GRS used a more conservative retirement age of 54 years, which increased the estimated pension liability.

Mr. Windsor and GRS used different mortality tables. The mortality table used by GRS predicts that the retirees will live longer, which increases the estimated pension liability.

Mr. Windsor said the changes that GRS made in the retirement age and the longevity tables made the biggest difference in the cost estimates. He said, “The most significant move [GRS] made, the one I agree with most is the change in the pattern of retirement. Looking at the past, the pattern of retirements is earlier than the old assumption appears to be.”

Overall, Mr. Rivera said Mr. Windsor used aggressive assumptions which resulted in a lower estimate of the unfunded pension liability at $100 million. He said, though, that Mr. Windsor’s estimate of the unfunded liability was within an acceptable range.

Mr. Windsor defended his assumptions. He maintained that he used moderate assumptions and that GRS used conservative assumptions, which result in a higher estimate. When pressed by Ald. Bernstein as to whether GRS’s $140 million estimate was unreasonable or within the realm of his reality, Mr. Windsor said, “I’d say that’s within my realm of reality.”

Mr. Windsor also said that he used a different payment method than the one used by GRS, and added that the change in method caused a bigger difference in the ARC than the change in assumptions. Under the method he used, he said “the payments start low and grow over time.” In other words, he said, the increase in the unfunded liability was deliberate. “It follows a state model,” he said. “Municipalities make lower payments at the start, and then their contributions become greater.”

Under the payment method used by GRS, the City will pay more up front than under Mr. Windsor’s method, but pay less than under his method as time goes on.

The Shortfall Grew Over Time

In this pension-funding problem, Evanston has a lot of company throughout the state. Since the 1980s, municipalities have been mandated to fund the police and firefighters’ pensions; the municipalities are required to make annual contributions and to have the pensions fully funded by 2033. However, state legislation over the past 15 years has increased the requirements for municipalities by expanding pension benefits without giving the communities financial help to fund these requirements. First Ward Alderman Cheryl Wollin said, “There have been four [state] bills that changed benefits – all of them disastrous for cities, in my opinion.”

In addition, it was not until the year 2000 that cities were required to put in an actuarially determined amount, the City’s former finance director Bill Stafford told the RoundTable.

As actuary for the City, Mr. Windsor calculated annually the amount the City should contribute to each pension fund. According to “Schedules of Employer Contribution, Required Supplementary Information” which are part of the City’s audited financial statements for the year ended Feb. 28, 2007, each year between 1996 and 2003 the City put in 99.5 percent or greater (108 percent in 2003) of the annual required contribution (ARC) to the firefighters’ pension fund. In 2004, the latest year for which figures are reported, the City contributed only 82 percent of the ARC.

Similarly, the City’s contributions to the police pension fund were 99 percent of the ARC or greater (110 percent in 2003) each year between 1996 and 2003. The City contributed only 75 percent of the ARC for 2004.

Even though the City contributed the amount of the ARC between 1996 and 2003 and fell short in only 2004, the unfunded liability to the pension funds grew dramatically in those years.

The City’s financial statement for fiscal year ended Feb. 28, 2007, shows that between March 1, 1997, and March 1, 2006, the City’s unfunded liability in the firefighters’ pension fund grew from $17.8 million to $43.8 million; during the same 10-year period the unfunded liability in the police pension fund grew from $30.3 million to $54 million. The total unfunded liability grew from $48.3 million in 1997 to $97.8 million in 2006. See accompanying table.

Responsibility

Mr. Rivera said, “When actuarial assumptions fall short of actual return, there is a gap in funding rates. If this continues, then there is a faulty assumption.” Yet Mr. Rivera also said Mr. Windsor had a “range of reasonable assumptions, and he was probably on the aggressive end. … He did not update the assumptions. … If you see a string of actuarial losses, what we should do is adjust the assumptions so you can dampen the losses,” he said.

Mr. Windsor said he reassessed his assumptions “every three or so years,” and he changed them once in the 15 or so years he served as the City’s actuary.

Yet, Mr. Rivera said, the string of losses, “should have been a red flag.” Later he said he felt Mr. Windsor’s “entire assumption was on the aggressive end, plus he did not consider benefits. If only one [assumption] was aggressive, we could accept that model, but his assumptions were producing losses year after year. … There was very little margin to absorb losses.”

Mr. Windsor said the increased accrued liability was planned, so that municipalities would have to make greater contributions near the end of the funding period.

Some aldermen were concerned about the mounting liabilities.

“Who should have seen this?” asked Alderman Ann Rainey, 8th Ward.

“It is the responsibility of the pension boards and the City Council,” said Mr. Rivera. “The actuary could only provide commentary. Ultimately it is up to the pension board, the City Manager and the City Council to set policy and assumptions.”

A blue-ribbon panel appointed by Mayor Lorraine Morton is forming to look for long-term solutions to the City’s pension problems.