Memo From Senator Biss: Important Vocabulary (see below)
Very recently, Senator Daniel Biss of Skokie has identified an opportunity to be found in a leak of information from the Pension Committee of Ten, on which he serves. His comments follow:
“This brings me to my second topic: a leaked media report about some of the committee’s deliberations. On Friday, August 23, several news outlets published a list of items under consideration by our committee…
These ideas are in fact all under discussion by the conference committee, but nothing has been finalized yet and our conversations remain in a state of flux. That means that this is an ideal moment for you to share your feedback on these items, as well as any other thoughts you have on the pension issue. I look forward to hearing your thoughts as we hopefully enter the late stages of our deliberations, and I very much hope that we will be able to reach a compromise that, while painful, will be manageable for all stakeholders and will put our pension systems on a clear path to stability” (http://senatorbiss.com/).
Pension funding terminology can be as arcane as the mind-numbing attempt to understand even a small bit of it. Several terms come to the forefront of this leaked information, and terms reiterated by the Senator beg some simplification for those of us in the classroom, involved in daily life, or trying to live after retirement. Below is an explanation of the concept of “cost methods” in predicting actuarial costs. Other terms will be necessary to understand before one can assess the improvement such a change might be. They are included here.
I will make some effort this week to elucidate the other terms as well. This post will try to explain Normal Age Entry Cost Method.
ARC (a.k.a. Annual Required Contribution)
Two Types of Actuarial Funding Methods
Noun: the annual amount necessary to fund a state pension plan by the employers (in our case, the State of Illinois) and to sufficiently match employees contributions and, thus, achieve a 100% funding level each year
Nota Bene: As usual, what might sound simple become multiple shades of gray when considering how such promises are ultimately carried out in actuarial terms. Actuarial mathematics is a complex and difficult task at best, a labyrinthine attempt to hit multiple targets based upon present versus estimated future costs. You’ll note that even estimates of the State of Illinois’ unfunded liability vary widely and are serviceable to political spin and bias. Complicating such variable reporting, the Governmental Accounting Standards Board has no real authority to enforce its recommendations; therefore, its proposals may be helpful but not necessarily followed.
A Quick History: The Governmental Accounting Standards Board (GASB) emerged in the 1980’s and endeavored to generate a common language providing some likeness in the communication of pension information from various states. Because each of the states had its own system of computational determiners, uniformity was difficult to attain; however, in the 1990’s GASB presented a structure for mathematical presentation by which to find commonalities. For example, GASB created a singular language to express needs in accomplishing funding over three to four decades, a determination of what it would take to cover the cost of benefits in a current year, and what it would also take to pay the unfunded future actuarial liability. In short, a state (employer) can pay out a matching contribution based upon what a current retiree will receive OR based upon what a projection of future payments of that same employee might be expected to be. Future payments would include such variables as longevity of life, increased salary, inflation, etc. Such factors would make a significant difference in the amount that a state pays in its ARC as a matching contribution each year.
What are these very different two actuarial methods?
Age-Entry Normal Actuarial Cost Method: This pension funding method recognizes “a larger accumulated pension obligation for active employees and generally requires larger annual contributions.” Like the Illinois Municipal Retirement Fund, an age-entry actuarial payment means that the cost of the benefit earned in that particular year is recognized and funded at the time the worker performs the service, not (later) when the pension is paid in retirement. Age-Entry Cost Methods take into consideration future variables and increasing expenses – added longevity of life, cost of living changes, future salary increases of current workers. In short, it is a more expensive and accurate estimate of present and future costs. The State of Illinois does not use this method. It uses the projected-unit credit actuarial cost method. In addition, Illinois also uses the practice of smoothing market gains and losses over a five-year period since 2009.
Projected-Unit Credit Actuarial Cost Method: “…plans that use a projected-unit credit costing method are 28 percentage points more likely to miss their ARC payment” (Center for State and Local Government Excellence, Why Don’t Some States and Localities Pay Their Required Pension Contributions? May 2008). Why? Unlike the projected unit credit method, “…up to the point of retirement, the entry-age method recognizes a larger accumulated pension obligation for active employees and requires a larger contribution than the projected-unit credit. Thus, given comparable funding ratios, plans using the entry-age normal method have recognized more liabilities and accumulated more assets than those using the projected-unit credit” (Center for State and Local Government Excellence, The Funding of State and Local Pensions: 2009 – 2013, April 2010).
It would seem the Committee of Ten is moving forward one step. On the other hand, other information suggests a series of backward steps as well. I trust your school year has started well.