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A report from Gabriel Roeder Smith (GRS), the City’s actuary, that was presented to City Council on June 21 estimates that the total unfunded liability in the City’s firefighters and police pension funds was $174.7 million as of March 1 of this year – an increase in the unfunded liability of almost $16 million from March 1, 2009.

These pension funds are valued on March 1, the beginning of each fiscal year, to determine the amount of their assets, the percent at which each is funded, and the City’s unfunded liability. Under present state law, each pension fund must be fully funded by the year 2033.

The firefighters pension fund was about 43 percent funded as of March 1 of this year. Its unfunded liability as of March 1, 2010, was $77.5 million, according to GRS.

The police pension fund was about 42 percent funded on March 1. Its unfunded liability was pegged at $97.2 million as of March 1, again according to GRS.

GRS calculates the City’s annual required contribution, or ARC, which is figured into each fiscal year’s budget. Their recommendations were a contribution of $8.8 million to the police pension fund and $7.1 million to the firefighters pension fund by the end of the present fiscal year.

The ARC represents both the amount of funds to be used in the current year for pensions and their associated benefits, as well as an “amortization” amount, to help offset the unfunded liability, said Amy Williams of GRS.

The combined value of the assets in the pension fund increased by about $5.1 million last fiscal year, according to a memo from Steve Drazner of the City’s finance division, but the actuarial liabilities increased by $20.9 million. According to GRS, about $8.6 million of the increase in actuarial liabilities is a result of the decrease in the assumed rate of investment return from 7.25 percent to 7.0 percent.

Amy Williams of GRS said the decrease in asset value also reflected a four-year “smoothing” of the losses incurred by the pension plans in 2008 – in other words, the losses accrued during the economic downturn will be reflected in this and the following three years’ calculations. The same would be true of any gains that exceed losses, she said.

GRS and City staff cautioned that at least two assumptions used in estimating the ARC and the unfunded liability should be reviewed: the rate of return on investments and the average salary increases.

Ms. Williams said GRS’s analysis of each pension plan showed that the average annual rate of return on investment in the last four years was below the assumed 7 percent rate of return: The average rate of return was 2.5 percent for the police pension fund and 3.2 percent for the firefighters’ fund.

GRS suggested that the City annually review the “investment policy, including the asset allocation, risk/return profile to the individual asset classes, inflation assumption and liquidity requirements … to ensure that a nominal investment return assumption of 7 percent, net of expenses, can be supported in the future.”

Ms. Williams and her colleague, Lance Weiss, said that the assumption of a rate of return was not intended to reflect the increase over a two-year or even five-year period but over 30, 40 or 50 years. For that reason, they said, if the assumed rate of return were to be reduced, a decrease of .25 percent – down to 6.75 percent – would be reasonable.

A reduction in the assumed rate of return will have the effect of increasing the amount of the unfunded liability, Ms. Williams said.

GRS also questioned whether the assumption for salary increases should remain at the 5-percent level, where it has been for the past four years. “The salary increase [for police officers] has averaged 5.8 percent over the last four years,” according to GRS, and the average increase for firefighters has averaged 6.49 percent. Ms. Williams said if the assumption about salary increases is raised to a higher level, that will similarly have the effect of increasing the amount of the unfunded liability.

Timothy Schoolmaster, who sits on the police pension board, suggested that City Manager Wally Bobkiewicz and Assistant City Manager Martin Lyons meet jointly with the pension boards to agree upon assumptions for the future. Mr. Bobkiewicz suggested that the Council take no action in regard to changing assumptions until that meeting. He said they would report to City Council at the July 26 meeting.