Honorable Mayor, Robert Lansing Prudence R. Beidler, Alderman First Ward Stanford Tack, Alderman Third Ward

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1 THE CITY OF LAKE FOREST SPECIAL CITY COUNCIL WORKSHOP AGENDA Monday, June 19, :00-6:00 pm City Hall City Council Chambers 220 E Deerpath Lake Forest, IL Honorable Mayor, Robert Lansing Prudence R. Beidler, Alderman First Ward Stanford Tack, Alderman Third Ward James E. Morris, Alderman First Ward Jack Reisenberg, Alderman Third Ward Timothy Newman, Alderman Second Ward Michelle Moreno, Alderman Fourth Ward Melanie Rummel, Alderman Second Ward Raymond Buschmann, Alderman Fourth Ward CALL TO ORDER AND ROLL CALL 4:00 pm 1. Pension Primer PRESENTED BY: Elizabeth Holleb, Finance Director ( ) BACKGROUND/DISCUSSION: As background for the discussion this evening, Finance Director Elizabeth Holleb will provide a pension primer. The attached presentation (page 3) is an updated version of a presentation given previously, but also provides additional data requested by the City Council Finance Committee in April. Also attached on page 20, additional background information on the topic of pensions is an April 2017 publication entitled Understanding Public Pensions A Guide for Elected Officials published jointly by the Center for State & Local Government Excellence and AARP. COUNCIL ACTION: Informational Item 2. Summary of April 30, 2017 Police and Fire Preliminary Actuarial Results PRESENTED BY: Elizabeth Holleb, Finance Director ( ) BACKGROUND/DISCUSSION: Finance Director Elizabeth Holleb will provide the City Council with a summary of the preliminary actuarial results of the police and fire pension funds as of April 30, The preliminary data will be presented in conformity with the City s existing Pension Funding Policy (page 36) and use all actuarial assumptions consistent with the April 30, 2016 valuations. This would be considered the baseline valuation from which the alternative scenarios can be presented and compared. COUNCIL ACTION: Informational Item 3. Alternative Scenarios for April 30, 2017 Actuarial Valuations and Public Safety Pension Funding Monday, June 19, 2017 Special City Council Workshop Agenda 1

2 PRESENTED BY: Jason Franken, Foster & Foster STAFF CONTACT: Elizabeth Holleb, Finance Director ( ) BACKGROUND/DISCUSSION: Jason Franken of Foster & Foster, the City s independent actuary, will present alternative scenarios for the City Council to consider for the April 30, 2017 actuarial valuations of the police and fire pension funds. As reported at the April 17, 2017 Finance Committee, Mr. Franken has recommended that the City consider the following changes: 1. Adjustment to mortality table 2. Adjustment to salary increase assumption 3. Adjustment to payroll growth assumption 4. Possible adjustment to amortization period (future change to open 15 years) In addition, Mr. Franken will present the use of percentage of pay vs. level dollar amortization as a means of addressing the unfunded liability. A copy of the presentation can be found on page 39. COUNCIL ACTION: The City Council is asked to consider whether any changes should be made for the April 30, 2017 actuarial valuations of the police and fire pension funds. Direction would be needed at this time so that the actuary can finalize the reports to meet audit deadlines. If the requested changes necessitate a change in the City s Pension Funding Policy, the changes would be brought to the City Council for formal approval at its July 17 meeting. 4. Adjournment Office of the City Manager June 14, 2017 The City of Lake Forest is subject to the requirements of the Americans with Disabilities Act of Individuals with disabilities who plan to attend this meeting and who require certain accommodations in order to allow them to observe and/or participate in this meeting, or who have questions regarding the accessibility of the meeting or the facilities, are required to contact City Manager Robert R. Kiely, Jr., at (847) promptly to allow the City to make reasonable accommodations for those persons. Monday, June 19, 2017 Special City Council Workshop Agenda 2

3 City of Lake Forest Pension Primer June 2017 June

4 Three Plans IMRF Police Fire Plan Type Agent Multiple- Employer Single Employer Single Employer Benefit Type Defined Benefit Defined Benefit Defined Benefit Provisions Participants Retirement Disability Death Employees>1000 Hrs/Yr 262 beneficiaries 198 active 177 inactive Includes Library Retirement Disability Death Police Officers 40 beneficiaries 40 active 8 inactive vested Retirement Disability Death Firefighters 38 beneficiaries 32 active 4 inactive vested 2June

5 Three Plans (continued) IMRF Police Fire Board Membership Local Representation Benefit Determinations 4 elected by employers 3 elected by participants 1 annuitant 2 Mayor appointees 2 active employees 1 retiree 2 Mayor appointees 2 active employees 1 retiree None 2 Board appointees 2 Board appointees Illinois General Assembly Illinois General Assembly Illinois General Assembly City Contribution Actuarially Determined Actuarially Determined Actuarially Determined Employee Contribution 4.5% (+ 6.2% FICA) 9.91% (no FICA) 9.455% (no FICA) 3June

6 Three Plans (continued) IMRF Police Fire Vesting (Tier 1) 8 Years 8 Years 10 Years Vesting (Tier 2) 10 Years 10 Years 10 Years Max Pension (Tier1) 50% Pension (Tier1) Max Pension (Tier2) 50% Pension (Tier2) Basis for Pension (Tier 1) Basis for Pension (Tier 2) 75%; 40 years; age 60 50%; 28 years; age 60 75%; 40 years; age 67 50%; 28 years; age 67 Highest total earnings for 48 consecutive months within last 10 years of IMRF service Highest total earnings for 96 consecutive months within last 10 years of IMRF service (wage cap applies) Normal Retirement: 75%; 30 years; age 50 50%; 20 years; age 50 75%; 30 years; age 55 50%; 20 years; age 55 Annual salary on last day of service Average salary for eight consecutive years prior to retirement 75%; 30 years; age 50 50%; 20 years; age 50 75%; 30 years; age 55 50%; 20 years; age 55 Annual salary on last day of service Average salary for eight consecutive years prior to retirement 6 4June 2017

7 Portability/Termination IMRF All IMRF service credit is combined for purposes of service credit and pension determinations Employees may elect to take a separation refund of IMRF employee contributions Police Pension separate and distinct funds Active member of a Police Pension Fund may: 1) apply for transfer of creditable service and related contributions in another Article 3 pension fund and 2) reinstate service in any other Article 3 pension fund terminated by receipt of a refund by paying amount of refund plus interest. (40 ILCS 5/ ) Fire Pension separate and distinct funds Firefighters have authority to combine service from multiple Article 4 pension funds and draw benefit from each. They may reinstate refunds similar to police pension members. (40 ILCS 5/ ) June

8 Public Safety Pension Investment Authority 40 ILCS 5/ through List of Permitted Investments for all Article 3 and 4 pension funds limits Investment authority rests with Pension Board of Trustees Legislative limits on certain types of investments*: Combination of: Separate accounts Life insurance companies; separate accounts insurance companies -qualified mutual funds added 2000 Prior to 1/1/98 PA Eff. 1/1/98 PA Eff. 7/1/11 PA Eff. 7/1/12 10% 10% 10% 10% June 2017 Combination of: common and preferred stocks and mutual funds through investment advisor n/a 35% 50% 55% Qualified corporate bonds n/a n/a No limit No limit 6 * Applicable to funds with net assets exceeding $10 million. 8

9 Public Safety Pension Investment Authority 40 ILCS 5/ through List of Permitted Investments for all Article 3 and 4 pension funds limits Legislative limits on certain types of investments: Net Assets => $2.5m Net Assets => $5 m Net Assets => $10 m Combination of: Separate accounts Life insurance companies; separate accounts insurance companies -qualified mutual funds added % 10% 10% June 2017 Combination of: Separate accounts life insurance companies; qualified mutual funds. Combination of: common and preferred stocks and mutual funds through investment advisor Qualified corporate bonds 35% N/A 35% 55% Allowable and no limit if managed through investment advisor 7 9

10 Investment Returns 8June 2017 This chart depicts actual investment return for fiscal year shown. Actuarial return will differ due to smoothing. 10

11 Funded Ratios Final FY2017 ratios are not yet available. 9June

12 Contribution Requirements June 2017 Public Safety pension costs have increased from $1.2 million in FY2005 to $3.1 million in FY2017. Current projections forecast another $3.6 million increase to $6.7 million annually by FY2027. Annual contributions will continue to grow through FY2040 the current projected date for full funding

13 Tier 1 vs. Tier 2 Participation Fire Pension Police Pension FY14 FY15 FY16 FY FY14 FY15 FY16 FY17 June 2017 Tier 1 Tier 2 Tier 1 Tier

14 Pension Fund Actuarial Valuations The City contracts annually for an actuarial valuation of the police and fire pension funds Results of valuations as of April 30, 2017 determine the property tax levy requirements for the 2017 Levy/FY2019 Budget IMRF provides employer contribution rates on a calendar year basis 2016 actuarial valuation determines employer contribution rate for calendar year 2018/FY2019 Budget June

15 Pension Fund Actuarial Valuations PA Lake Forest 4/30/16 Target Fund Ratio 90% 100% Deadline for Target Ratio Actuarial Valuation Method Projected Unit Credit Entry Age Normal Public Act created a new tier of benefits for public safety employees joining public safety pension funds on or after 1/1/11. It also significantly changed employer contributions. Recognizing that this could exacerbate the pension funding challenges, the City has elected to retain more conservative assumptions in its actuarial valuations, as summarized above. June

16 Plan Data IMRF Police Fire Valuation Date 12/31/16 4/30/17 4/30/17 Preliminary and Subject to Change Plan Net Position $89,262,776 $30,549,529 $34,893,971 Total Pension Liability $101,386,197 $55,490,919 $48,086,010 Net Pension Liability $12,123,421 $24,941,390 $13,192,039 Percent Funded 88.04% 55.1% 72.6% Assumed Rate/Return 7.50% 7.00% 7.00% Investment Return 8.00% 9.67% 9.69% 5-year average 8.43% 6.87% 6.47% 7-year average 11.47% 6.65% 6.79% Tax Levy Requirement $1,928,236 $1,364,837 Employer Rate 12.57% % Change Prior Year 1.13% 5.25% 5.13% 4/30/17 data for police and fire is actuarial value of assets/actuarial accrued liability pending final valuation. 16 June

17 Contribution Required as % of Covered Payroll for FY2018 IMRF (calendar year 2017) 12.57% (plus 6.2% FICA total 18.77%) Police Pension* 48.70% Fire Pension* 44.30% June 2017 * Based on covered payroll as of 4/30/

18 GASB 68 GASB 68 Effective for the City s April 30, 2016 financials Net Pension Liability now recorded as liability on entity-wide financial statements Previously only a footnote disclosure Efforts taken to mitigate impact of GASB 67 and 68: 4/30/13 (Fire/Police) Adjusted mortality table to RP2000 4/30/14 (Fire/Police) Reduced interest rate assumption from 7.50% to 7.00% 4/30/15 (Fire/Police) Adjusted mortality, disability, turnover and retirement rates to IDOI rates published September 2012; extended amortization period to /30/16 (Fire/Police) No changes due to actuary transition June

19 Questions? June

20 Understanding Public Pensions A Guide for Elected Officials April 2017 CENTER FOR STATE & LOCAL GOVERNMENT EXCELLENCE 20

21 Acknowledgments This guide was written by Elizabeth Kellar with contributions from Bonnie Faulk, Joshua Franzel, and Amber Snowden from the Center for State and Local Government Excellence, and Barrie Tabin Berger, AARP. Amy Mayers was the copy editor, and the guide was designed by Susan Spangler. We are grateful to the National Association of State Retirement Administrators (NASRA) for their guidance and review of this document. Contents Introduction...1 Understanding Your Pension Plan...2 Pension Plan Design...2 AARP is the nation s largest nonprofit, nonpartisan organization dedicated to empowering Americans 50 and older to choose how they live as they age. With nearly 38 million members and offices in every state, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands, AARP works to strengthen communities and advocate for what matters most to families with a focus on health security, financial stability and personal fulfillment. AARP also works for individuals in the marketplace by sparking new solutions and allowing carefully chosen, high-quality products and services to carry the AARP name. As a trusted source for news and information, AARP produces the world s largest circulation publications, AARP The Magazine and AARP Bulletin. To learn more, visit or on social media. Defined Benefit...2 Defined Contribution...3 Hybrid...3 Characteristics of Public and Private Retirement Plans...4 Balancing Stakeholder Objectives...4 Public Pension Financing...6 Funding Policy...7 Investments...8 Assumptions...8 Benefit Changes...9 Strategies for Success...10 The Center for State and Local Government Excellence (SLGE) helps local and state governments become knowledgeable and competitive employers so they can attract and retain a talented and committed workforce. SLGE identifies leading practices and conducts research on competitive employment practices, workforce development, pensions, health care benefits, and financial planning. SLGE brings state and local leaders together with respected researchers. It features the latest research and news on health care, retirement benefits, recruitment, succession planning and workforce demographics. To learn more, visit or on Twitter. 21

22 Understanding Public Pensions: A Guide for Elected Officials Introduction State and local pension plans are important in attracting and retaining well-qualified public employees. They help to facilitate the effective and efficient delivery of public services by serving as a workforce Not all changes are solutions. management tool and providing financial security in retirement. As an elected official, it is important for you to understand how public pension plans operate and the role they can play in meeting the needs of employees, employers, and taxpayers alike. A good starting point is to assess whether or not your pension plans are meeting their objectives. The purpose of this guide is to provide key facts about public pension plans, including the elected official s role in making sure they are well designed Public Plans Quick Facts Cover 14.7 million active (working) members Distribute $277.1 billion annually in benefits to 9.9 million retirees Hold $3.86 trillion in assets Financed by employer and employee contributions and investment earnings Sources: Public Plans Data (PPD) and Federal Reserve Flow of Funds and adequately funded so they can meet the goals of all stakeholders. You will quickly learn that since 2009 all states have made modifications to their retirement plans to help ensure their long-term sustainability. Every Retirement Plan Objectives Attract and Retain Employees Enable Workers to Retire in Orderly Way Provide Retirement Security Keep Costs Manageable 22

23 2 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS State and Local Defined Benefit Trust Assets Year-End, (Trillions) FISCAL YEAR Source: Federal Reserve Flow of Funds pension plan has a unique history, legal framework, and financial condition. As a result, there are no one-size-fits-all solutions from state to state or even from plan to plan to ensure that pension plans are properly financed and effectively managed to pay benefits for the long-term. Finally, you will learn that not all changes are solutions. Any modifications to a pension plan should be carefully considered to avoid unintended consequences or costs. Understanding Your Pension Plan As an elected official, you and your colleagues have important decisions to make about your government s retirement plans. An important first step is to familiarize yourself with your plan s purpose and how its design and funding mechanisms function. Sound pension plan design and financing that balance stakeholder objectives likely will produce a sustainable retirement system able to pay benefits for the long term with fewer unintended or negative outcomes. Pension Plan Design Retirement plan design can range from an employer maintaining sole responsibility for providing a guaranteed lifetime benefit to employees bearing the full responsibility to finance their own retirement savings. In plans for state and local government workers, retirement plan design falls somewhere between those two extremes. There are three major types of retirement plans in the public sector: defined benefit, defined contribution, and hybrid plans. Defined Benefit A defined benefit (DB) plan promises a specified monthly benefit at retirement, usually based on the employee s length of service and salary. Most state and local governments require both employers and employees to contribute to their defined benefit pensions while they are working. Typically, these plans are funded through a combination of employer contributions, employee contributions, and earnings from investments. Public pension assets are held in a trust and invested in diversified portfolios to prefund the 23

24 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS 3 cost of pension benefits. These pooled assets are professionally managed and provide economies of scale that lower fees and increase returns. Assets are then paid out in monthly installments during an employee s retired years, not as a lump sum. Typically, survivor and disability benefits are part of the financing and design of the defined benefit pension plan. Retirees also may be eligible for cost-of-living adjustments, which may be capped or dependent on the pension plan investment performance. Defined benefit plans are the most prevalent plan design in the public sector. The typical defined benefit plan places some level of responsibility and risk on both the employer and employee. This use of shared financing and shared risk as part of plan design has grown in recent years as states have modified required employer and employee contributions, restructured benefits, or both. Most state and local governments offer defined benefit pension plans to their employees, in part Defined Benefit Public Pension Plan Sources of Revenue % Investment Earnings: $4.3 trillion 26% Employer Contributions: $1.8 trillion 12% Employee Contributions: $805 billion Source: Compiled by NASRA based on U.S. Census Bureau data because public sector workers generally have accepted more modest wages in exchange for more retirement security. Retirement income also contributes to local and state economies as retirees spend their pension checks on goods and services where they live. Defined benefit plans in both the public and private sectors provide a reliable income for 24.3 million Americans. Nationwide, over $1.2 trillion in total economic output resulted from DB pension expenditures in Reliable pension income is especially important in stabilizing local economies during economic downturns. 1 Defined Contribution A defined contribution (DC) plan is a retirement savings vehicle that accumulates savings based on contributions to an employee s individual retirement account. A DC plan does not promise a specific retirement benefit. In this plan design, the employee, the employer, or both contribute to the plan, often at a certain percentage of the employee s salary. The employee will ultimately receive the balance in his or her account, which is based on contributions and any investment earnings. Defined contribution plans typically do not pool investments and employees are instead given a range of investment options they manage individually. While 401(k)s are most prevalent in the private sector, they are not common in the public sector, where 401(a), 403(b), and 457 DC plans are typically used instead. Although nearly all public employees have access to a DC plan as a supplemental savings plan, part of a hybrid plan, or as an alternative to a defined benefit plan, only a handful of states and the District of Columbia provide a defined contribution plan as their employees only retirement plan option. In a defined contribution plan employees assume all of the investment and longevity risk. Employer obligations are fulfilled annually as contributions are made. Employers have some uncertainty about orderly retirements, particularly if investment returns drop and older employees decide to delay their retirement. 24

25 4 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS Characteristics of Public & Private Sector Retirement Plans PUBLIC PRIVATE 99 percent of state and local workers have access to a retirement plan at work, and participation is typically mandatory. Additionally, most employees have access to a voluntary supplemental retirement savings plan a 403(b) or 457 plan. Roughly one-half of private sector workers have a retirement plan usually a 401(k). A minority has a defined benefit or hybrid pension plan. Pensions are in lieu of Social Security for 25 percent of the state and local workforce, including nearly half of teachers and two-thirds of public safety employees. All private sector employees participate in Social Security. Retirement benefits often include a cost-of-living adjustment (COLA). Nearly all employees are required to contribute to their retirement plan. State and local retirement systems are established and regulated by state and/or local laws and must comply with federal tax and trust laws. State and local governments follow the accounting standards set by the Governmental Accounting Standards Board (GASB). Few private sector retirement benefits include a costof-living adjustment. Private sector workers who are in defined benefit plans do not make contributions. Contributions to defined contribution plans are voluntary. Private sector retirement plans are not governed by state and local laws, but rather are regulated by the federal Employee Retirement Income Security Act (ERISA) as well as other federal laws and regulations. Accounting standards and processes are set by the Financial Accounting Standards Board (FASB). Hybrid Hybrid pension plans combine elements of both defined benefit and defined contribution plans. The two most prevalent types of hybrid plans sponsored by state and local governments are: 1. a combination of defined benefit and defined contribution plans and 2. a cash balance plan. Combination plans typically include a modest defined benefit element in combination with a defined contribution plan. Cash balance plans marry elements of traditional pensions with individual accounts into a single plan. Employers generally guarantee an annual rate of return on a hypothetical account to which the employer, employee, or both contribute. Balancing Stakeholder Objectives Employees, employers, and taxpayers have a stake in your state and local government pension plans. Pensions are important to employers because they help to attract and retain well-qualified individuals to work in government. This is important because of the investment that employers make in the training and experience of their workers. Pensions allow employers to manage the progression of their workers throughout their career to ensure that public services are delivered effectively and efficiently, even as one generation retires and new employees are hired. All stakeholders have a vested interest in retirees who are financially independent and do not require costly social services to meet their basic needs. For retirees, pensions are essential to help provide an adequate standard of living 25

26 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS 5 throughout their retirement years. In addition, employers, employees, and taxpayers alike place a high priority on reasonable, predictable pension costs. Meeting the needs of employees, employers, and taxpayers is challenging. Changes to the retirement plan that focus on one of these goals to the exclusion of others are likely to produce negative outcomes. Generally speaking, the following retirement plan core features have been successful in balancing the objectives of workforce management, retirement security, and costs. Mandatory participation. Most state and local governments require participation in the retirement program as a condition of employment. Cost sharing between employers and employees. Public employees typically are required to contribute 5 to 10 percent of their wages to their state or local pension. Pooled and professionally managed assets. Public pension trusts can earn higher returns Nationwide Distribution of Funded Ratios for Defined Benefit Public Plans, FY % OR MORE FUNDED: 2.5% of All Plans % FUNDED: 33.3% of All Plans 60-79% FUNDED: 44% of All Plans LESS THAN 60% FUNDED: 20.1% of All Plans Sources: 2015 actuarial valuations and calculations from PPD (2015). Successful retirement plan changes follow a deliberative and informed process; engage employees and other stakeholders; keep the government competitive in recruiting and retaining employees; and rely on high quality data. with lower fees through pooled investments that are professionally managed, have greater portfolio diversity, and large economies of scale. Targeted income replacement. Most public pension policies aim to replace a certain percentage of pre-retirement wages to better assure financial independence in retirement. Lifetime benefit payouts. The vast majority of state and local governments do not allow for a lump sum distribution of benefits; rather, they require retirees to take most or all of their pensions in installments over their retired lifetimes. Most also make periodic cost-of-living adjustments to curb the effects of inflation. It is important to understand whether or not your plan is effective in balancing stakeholder objectives. You can start by gathering good data on your plan s financial condition, what changes have been made to financing and design in recent years, and how those changes have affected all stakeholders. Good resources include your pension plan administrator, actuarial reports, and audited financials (Comprehensive Annual Financial Report). Public Plans Data (PPD) is another good resource you can use to understand your plans in relation to national trend data. The PPD provides access to quick facts about public pensions at the national, state, system, and plan 26

27 6 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS 100% Average Percentage of Required Contribution Paid, FY % 60% 40% 20% 0% Sources: 2015 actuarial valuations and PPD ( ) levels, as well as data on plan contributions and assumptions ( It is important to understand if your government has been making its full actuarial contribution as well as any recent adjustments to employer and employee contributions, benefit levels, or eligibility for retirement. From 2009 to 2015, in the wake of the Great Recession, every state made meaningful changes to one or more of its pension plans. Although the market crash and the recession affected all plans, plan changes varied because of differing designs, budgets, and legal frameworks across the country. Each state or local government made modifications that were tailored to its unique circumstances. It is noteworthy that nearly every state chose to retain its traditional defined benefit pension plan and the core features that balance workforce management, retirement security, and cost containment sought by employers, employees, and taxpayers. Only five states (Michigan, Rhode Island, Tennessee, Utah, and Virginia) created combination hybrid plans. 2 The most common change to pension plans during this time was an increase in employee contributions. Increases in contributions often have applied to both current and new employees. Other plan changes, such as increasing the retirement age, typically have applied to new employees. Some plans reduced or eliminated automatic cost-of-living adjustments or reduced the amount of income replaced in retirement for each year worked. 3 Retirement plan changes that are successful in preserving a sustainable pension to pay benefits for the long term follow a deliberative and informed process, engage employees and other stakeholders, keep the government competitive in recruiting and retaining employees, and rely on high quality data. Public Pension Financing Prefunding pension benefits ensures that sufficient assets will be accumulated during an employee s working years so that benefits can be paid when the employee retires. Governments that have had success in reaching their funding goals take a long view and are disciplined about funding their required contributions on an annual basis. Although media reports draw attention to poorly-funded pension plans, there is wide variation in the funded status of defined benefit plans across the country: 36 percent are more than 80 percent funded and only 20 percent are under 60 percent funded. Overall, pensions were 74 percent 27

28 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS 7 If your pension plan is underfunded, you can t change the past, but you can change the plan s future direction. funded on average in 2015, according to funding measures used for actuarial reports. 4 Many factors can affect the funded status of a pension plan, including the government s pension funding policy, investments, assumptions, as well as legal limitations and cost implications related to benefit changes. Funding Policy Governments should have a clear pension funding policy that lays out a plan to fully fund pension benefits within a reasonable time period. A sound pension funding policy offers guidance in making annual budget decisions, documents prudent financial management practices, and provides transparency as to how and when pensions will be funded. 5 Governments that are disciplined in following such pension funding policies and make their full employer contributions every year remain well funded, even following market downturns and recessionary periods. A pension funding policy should incorporate certain general objectives to: 1. Base the employer s annual contribution on an actuarially determined contribution (ADC), calculated at least every two years. Taking Stock of Good Pension Practices and Policies Has the plan been historically well financed because the government has been making its pension payment in full each year and/or have new financing mechanisms been put into place? Gather facts and review the pension funding policy, employee and employer contribution history, changes for new employees, and current and trend data on the funded status of plans. Is the plan design meeting the human resource, financing, and retirement security needs of stakeholders? Examine elements such as benefit levels, vesting, and the minimum age and service required to receive a retirement benefit. If there are cost concerns, are they from past liabilities or new pension benefits? Verify whether the costs of the plan are primarily due to past unfunded liabilities, which cannot be erased, or to ongoing benefit accruals. Are the plan s assumptions in line with its experience? Determine if assumptions (e.g., long-term investment returns and plan demographics) are regularly reviewed to ensure they accurately reflect the plan s experience and any needed adjustments can be made in a timely way. Are benefit improvements fully funded? Ensure that any increases in benefit levels or cost-of-living adjustments do not increase the plan s unfunded liabilities. Are there legal and cost implications to pension modifications? Research whether legal restrictions may bar certain plan changes and whether they may increase plan costs or have unintended consequences. Are there inequities that create hidden costs and undermine public trust? Eliminate any practices that could allow a few individuals or employers to undermine the funding of the system. 28

29 8 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS Annual Return for State and Local Pensions, Actual Annual Return % Assumed Annual Return % Source: Census of Governments. National data averages are weighted by plan size. 2. Commit to funding the full ADC each year. If a plan is significantly underfunded, this may require a transition period for some government employers to achieve. 3. Provide clear reporting to show how and when pension plans are projected to reach full funding. Investments State and local government defined benefit pension plans hold $3.86 trillion in assets in trust for current and future retirees. These assets are professionally managed and pooled, which reduces costs, allows greater portfolio diversity, reduces risk, provides economies of scale, and produces higher investment returns. Pension fiduciaries and trustees have the primary responsibility for establishing the plan s investment policy and strategy. They establish the asset allocation plan, select the investment team, negotiate fees, and monitor the strategy. Assumptions Another characteristic of well-funded pension plans is that they carefully monitor their assumptions to ensure they accurately reflect the plan s experience and that any needed adjustments can be made in a timely way. In a defined benefit pension plan, employers rely on actuarial assumptions to determine how much they need to contribute (or prefund) each year to ensure that benefits can be paid when employees retire. Actuaries base this calculation on numerous economic and demographic assumptions. Economic assumptions include inflation, salary growth and investment returns. Demographic assumptions include the age when employees retire and how long they will live, among others. Using these assumptions, actuaries develop projections regarding the level of pension fund assets required to pay future liabilities and the required contribution governments need to budget to bring the fund into balance over a fixed number of years. An actuarial experience study should be conducted at least every five years so that actuarial assumptions can be updated. These studies help to ensure that assumptions are in line with the plan s demographic and economic experience. 6 29

30 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS 9 Benefit Changes Before considering benefit changes to your government s pension plans, assess your overall goals, the effect of the various proposals on the workforce and the employees, and resulting financial impacts. Examine any legal limitations and cost implications. For example, state laws, including constitutional restrictions, statutory provisions, or case law, often protect benefits that current employees have already earned. Many also limit or prohibit changes that negatively impact future benefit accruals for current employees. You also need to gather data on the plan s funded status, the government s contribution history, what changes have been made in recent years, and whether those changes have had a sufficient chance to take effect, as well as understanding your plans in relation to national trend data. If your pension plan is underfunded, you can t change the past, but you can change the plan s future direction by realigning contributions and/or benefit levels. While there is more flexibility to modify benefit levels for new employees, such changes will not affect unfunded liabilities that have already been accrued. Placing new employees into an entirely different plan type may also have unintended consequences, including accelerating pension costs Pension Funding Checklist Budget for the full employer contribution. Adjust employer and employee contributions as needed. Evaluate benefit levels and eligibility to receive benefits. Conduct actuarial experience study. Adjust investment and demographic assumptions as needed. Pension Measures for Different Purposes Several separate pension calculations are derived in different manners for distinct purposes: Accounting: The GASB calculations used for annual financial reports. Budgeting: The actuarial calculation that determines how much the government needs to contribute to advance-fund future benefits. Bond ratings: Credit rating agencies use their own proprietary analytics to calculate pension obligations. APR_13_70.pdf in the closed (legacy) plan. There are also additional administrative costs associated with operating two types of pension plans. Workforce issues, such as the potential of increased turnover and training costs, should be carefully considered. Elected officials sometimes seek to increase pension benefit levels. When such changes are approved, be sure they are fully funded. For example, retroactive benefit and cost-of-living increases that are not fully funded will increase the plan s liabilities. Another challenge can occur if pension rules permit employees to increase their final salary to the detriment of the plan s funding (e.g., include overtime pay in the benefits formula). Such practices can disproportionately increase an employee s pensionable compensation and create inequities and hidden costs. These types of pension increases can also undermine the public s trust in the government and create a false impression of a typical public employee s retirement benefit. To change direction, start by examining the current situation. Are your pension plan benefit levels appropriate to achieve your objectives? Has the government been making the full employer contribution? Are your plan s vesting as well as age and service requirements for receiving a pension appropriate? Are there inequities that need to be 30

31 10 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS Governments that develop a credible funding plan and stick to it have the most success in achieving their pension goals. can be made in a timely way. Improving a pension plan s funded status can be achieved with discipline and commitment. 7 As more older workers retire and a younger generation moves into the government workforce, attracting and retaining well qualified individuals is more important than ever. Elected officials play a key role in balancing stakeholder objectives to produce a sustainable retirement system that is both competitive and cost-effective. corrected? Do any of your plan s assumptions need to be adjusted based on actual experience? Governments that develop a credible funding plan and stick to it have the most success in achieving their pension funding goals. Strategies for Success Every state and local pension plan has its own history, legal framework, and characteristics. That s why solutions to pension funding and other challenges must be tailored to the individual needs and circumstances of participating employers and workers. If changes are needed, keep in mind the objectives of the pension plan, including workforce management, retirement security, and costs. In examining pension plans that are well funded, certain strategies stand out. Without exception, these pension plans have been able to count on the employer contribution. These governments rarely, if ever, take a pension holiday, making their full contribution whether the stock market is up or down. If they need to make changes to their pension plan design, they do so based on good data; engage all stakeholders as changes are considered; and do not lose sight of their pension plan objectives. Some of them have increased the age and/or service requirements needed to receive a pension and many have increased both employer and employee contributions when needed. Cost-ofliving adjustments are funded whenever granted, as are benefit enhancements. Finally, they are rigorous in examining their assumptions to ensure they accurately reflect the plan s experience and that any needed adjustments Takeaways Key retirement plan objectives include attracting and retaining employees, workforce management, retirement security, and keeping costs manageable. To balance objectives, consider a retirement plan that includes the core features of mandatory participation, cost sharing, pooling of contributions, professional asset management, targeted income replacement, and lifetime benefit payouts. Before making any changes to your retirement plan, be mindful of your overall goals, the effect of various proposals on the workforce and the employees, and resulting financial impacts. Successful retirement plan changes follow a deliberative and informed process, engage employees and other stakeholders, keep the government competitive in recruiting and retaining employees, and rely on high quality data. From 2009 to 2015, nearly every state made changes to its pension plans, yet most retained a traditional defined benefit pension plan with some modifications. If your pension plan is underfunded, you can t change the past, but you can change the future direction by making the full employer contribution going forward and by realigning contribution and/or benefit levels. Retirement plan funding and solutions must be tailored to the individual needs and the circumstances of participating employers and workers. Communicate! Give employees and the public clear information about pension finances and the plan to fund them. 31

32 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS 11 PATH TO PENSION PLAN DON T GRANT COST OF LIVING INCREASES WITHOUT FUNDING THEM SUSTAINABILITY DON T PROVIDE RETROACTIVE BENEFIT INCREASES WITHOUT FUNDING THEM DON T TAKE PENSION HOLIDAYS OR FAIL TO MAKE THE FULL EMPLOYER CONTRIBUTION 32

33 12 UNDERSTANDING PUBLIC PENSIONS: A GUIDE FOR ELECTED OFFICIALS Endnotes 1. Brown, Jennifer Erin, Pensionomics 2016, National Institute on Retirement Security, p. 24, September Brainard, Keith and Brown, Alex, Spotlight on Significant Reforms to State Retirement Systems, National Association of State Retirement Administrators, p. 3, June State and Local Government Workforce: 2016 Trends, Center for State and Local Government Excellence, May Munnell, Alicia H. and Aubry, Jean-Pierre, The Funding of State and Local Pensions: , Center for State and Local Government Excellence and Center for Retirement Research at Boston College, p. 4, June Pension Funding: A Guide for Elected Officials, Report of the Pension Task Force 2013, issued by the National Governors Association; National Conference of State Legislatures; The Council of State Governments; National Association of Counties; National League of Cities; The U.S. Conference of Mayors; International City/County Management Association; National Council on Teacher Retirement; National Association of State Auditors, Comptrollers and Treasurers; Government Finance Officers Association; and National Association of State Retirement Administrators GFOA Sustainable Funding Practices for Defined Benefit Pensions and Other Postemployment Benefits (OPEB) 7. Success Strategies for Well-Funded Pension Plans, Center for State and Local Government Excellence, February FOR MORE INFORMATION Center for State and Local Government Excellence slge.org Government Finance Officers Association gfoa.org/sustainable-funding-practices-defined-benefit-pensions-and-other-postemployment-benefits-opeb National Association of State Retirement Administrators nasra.org National Conference of State Legislatures ncsl.org/research/fiscal-policy/pensions.aspx Public Plans Database PublicPlansData.org National Institute on Retirement Security nirsonline.org 33

34 Board Of Directors Robert J. O Neill, Chair Senior Vice President, Public Finance, Davenport & Company; Fellow, Joseph P. Riley, Jr. Center for Livable Communities, College of Charleston; Former Executive Director, ICMA Robert P. Schultze, Vice Chair President and Chief Executive Officer, ICMA-RC Donald J. Borut Former Executive Director, National League of Cities Gregory J. Dyson Chief Operating Officer, ICMA-RC Jeffrey L. Esser Executive Director, Government Finance Officers Association The Honorable William D. Euille Founder, Principal, and CEO, The Euille Group; Former Mayor, City of Alexandria, Virginia Peter A. Harkness Founder and Publisher Emeritus, Governing Magazine Scott D. Pattison Executive Director and CEO, National Governors Association William T. Pound Executive Director, National Conference of State Legislatures Antoinette A. Samuel Deputy Executive Director, National League of Cities Raymond C. Scheppach, PhD Professor, University of Virginia Frank Batten School of Leadership & Public Policy; Former Executive Director, National Governors Association SLGE Staff Joshua M. Franzel, PhD President and CEO Elizabeth K. Kellar Senior Fellow Amber Snowden Communications Manager Bonnie J. Faulk Operations Manager Gerald W. Young Senior Research Associate 34

35 Helping state and local governments become knowledgeable and competitive employers 777 N. CAPITOL STREET NE, SUITE 500 WASHINGTON DC AARP enhances the quality of life for all as we age. We champion positive social change and deliver value through advocacy, information and service. 601 E STREET, NW WASHINGTON DC member@aarp.org 35

36 City of Lake Forest, Illinois Pension Funding Policy I. Introduction The purpose of this policy statement is to define the manner in which the City of Lake Forest, Illinois funds the long-term costs of benefits promised to plan participants and defines the calculation of Lake Forest s annual required contribution (ARC) to its pension funds. II. Background and Scope The financial objective of a defined benefit pension plan is to fund the long-term cost of benefits provided to the plan participants. In order to assure that the plan is financially sustainable, the plan should accumulate adequate resources in a systematic and disciplined manner over the active service life of benefiting employees. This Pension Funding Policy applies to the pension funds in which employees of the City of Lake Forest are enrolled. The specific funds covered by this policy include: Lake Forest Fire Pension Fund Lake Forest Police Pension Fund Illinois Municipal Retirement Fund (IMRF) III. Objectives a. Actuarially Determined Contributions - Ensure pension funding plans are based on actuarially determined annual required contributions (ARC) that incorporate both the cost of current benefits and the amortization of the plan s unfunded actuarial accrued liability. b. Funding Discipline A commitment to make timely contributions to the pension funds to ensure that sufficient assets will be available to pay benefits as promised. c. Intergenerational Equity Annual contributions should be reasonably related to the expected and actual cost of each year of service so that the cost of employee benefits is borne by the generation of taxpayers who receive services from those employees. d. Contributions as a Stable Percentage of Payroll Manage contributions so that employer costs remain consistent as a percentage of payroll over time. e. Accountability and Transparency Clear reporting of pension funding to include an assessment of how and when the City will ensure sufficient assets will be available to pay benefits as promised. APPROVED City Council 8/3/15 36

37 IV. Ethics and Conflicts of Interest Officers and employees involved in the pension funding process shall refrain from personal business activity that could potentially conflict (or appear to conflict) with the proper execution and management of the pension funding program or that could impair their ability to make impartial decisions. V. Annual Required Contribution The City of Lake Forest will determine its Annual Required Contribution (ARC) using the following principles: The ARC will be calculated by an enrolled actuary. The ARC will include the normal cost for current service and amortization to account for any under or over-funded amount. Police and Fire Pension Funds: o The normal cost will be calculated for the police and fire pension funds using the entry age normal level of percentage of payroll actuarial cost method using the following assumptions: o Investment rate of assumption 7.0% per year o Salary increase assumption 5.5% per year o Non-economic assumptions such as rates of separation, disability, retirement, and mortality shall be determined by City management in consultation with the actuary to reflect current experience. o The difference between the accrued liability and actuarial value of assets will be amortized to achieve 100% funding in 2040 based upon a level percentage of payroll. o Actuarial assets will be determined using a five-year average market valuation. Illinois Municipal Retirement Fund: o The normal cost calculation, actuarial assumptions, amortization period and valuation of actuarial assets shall be determined by IMRF. The City will make its actuarially determined contribution to the Police and Fire pension funds as property tax collections are receipted. Contributions will be made to IMRF on a monthly basis. VI. Reporting Funding of the Lake Forest pension funds shall be transparent to vested parties including plan participants, annuitants, pension board trustees, the City Council and Lake Forest residents. To achieve transparency, the following data shall be distributed: A copy of the annual actuarial valuation shall be made available to the City Council and applicable Board of Trustees. The City s annual budget shall include the City s contribution to the City pension funds. The City s Comprehensive Annual Financial Report (CAFR) shall be published on its web site. In this report, the City will make all required APPROVED City Council 8/3/15 37

38 disclosures in accordance with Governmental Accounting Standards Board (GASB) guidelines. VII. Future Amendments Funding a defined benefit pension plan requires a long-term horizon. Assumptions and inputs into the policy should focus on long-term trends, not year-to-year shifts in the economic or non-economic environment. The City will review this policy at least every five years to determine if changes to this policy are needed to ensure adequate resources are being accumulated. The City reserves the right to make changes to this policy at any time if it is deemed appropriate. VIII. Effective Date This policy shall be effective immediately upon approval by the City Council. APPROVED City Council 8/3/15 38

39 LAKE FOREST POLICE AND FIRE PENSION PLANS Presented By: Jason L. Franken, FSA, EA, MAAA June 19,