The Causes of Illinois Police and Fire Pension Underfunding

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Illinois COGFA Study Perspective

Last year, the Illinois Commission on Government Forecasting and Accountability conducted its first biennial study of the underfunding issues plaguing the Illinois police and fire pension systems. The report reviewed the following six Illinois municipalities and their police and fire pension underfunding issues: Arlington Heights, Bellwood, Champaign, Springfield, and Wilmette. Obviously, a number of the causes cannot be controlled by the municipalities, including past investment return and employee benefit increases which are set at the state level. However, the municipalities’ own insufficient contributions and failure to reduce the future rate of return has increased the UAL as well. The municipalities must correct their own contribution issues, especially now when many of these funds have only approximately 50% of the assets needed to pay the pension benefits already earned.

Even though it may not surprise many individuals given how the stock market has performed in the past three years, inadequate investment return was a significant cause of the UAL increase for all of the municipalities’ police and fire plans. Investment return alone caused 33% of the UAL increase for Arlington Heights and 31% of the UAL increase for Bellwood. In fact, investment return caused 51% of the UAL increase in Springfield with nearly two-thirds of that amount caused by a reduction of the plan’s assumed future rate of return from 8% to 7%. This reduction was required because it was determined that the plan going forward could not earn an 8% rate of return. Although this issue may correct itself for the municipalities after the economy has recovered, there is no guarantee.

Unfortunately, the investment return may continue to cause problems for Illinois police and fire pension plans unless the municipalities lower the plans’ expected rate of return to a reasonable rate. All of the six municipalities have an expected rate of return between 7% and 7.5%. This is the rate of return the actuary assumes the plan will earn each year. If this rate of return is not earned, the plan will have fewer assets than expected and the UAL will increase. In comparison to the 7% expected rate of return, the actual rate of return earned from 1997 to 2008 was in the 5% range for five of the six municipalities. Wilmette actually had a rate of return of 3.3%.

Although these figures may be misleading because the stock market had a steep decline in 2007 and 2008, the municipalities should reduce the expected rate of return going forward unless there is some indication that the plans will be able to begin earning those types of returns again. Otherwise, the municipalities’ contributions are held artificially low because the actuary assumes the plan assets will increase at a much higher rate than what will occur. If this continues, the municipalities will be able to make lower-than-needed current contributions to the police and fire plans and delay paying their obligations these plans.

The unfunded accrued liability (UAL) of all of the police and fire pension funds in the study increased due to insufficient employer contributions as well. With Champaign having only 6% of the UAL increase caused by the insufficient employer contributions and Arlington Heights with 19%, all of the municipalities had issues with employer contributions. Although there may be larger causes of the UAL increase, the cities are only worsening the police and fire plans’ underfunding issues by their own contributions.

Although there may be other causes of the UAL increases, the two causes that deserve the most attention are the employer contributions and future investment return. For employer contributions, these municipalities should be required to contribute an amount that will decrease the UAL, instead of increasing it, especially given the 2033 Illinois deadline to fully fund pensions. There is no reason why the municipalities’ contributions should increase the UAL for police and fire pension plans. For future investment return, the pension plans have been devastated by the recent or present recession, and the market declines of 2007 and 2008. It has been nearly three years since the beginning of this recession and it is still uncertain when the economy will return to its pre-2007 condition. With such a high level of uncertainty, the actuaries should decrease the expected rate of return so that the UAL actually reflects the true amount the municipalities owe to the police and fire pension plans and the municipalities begin paying the proper amount owed to the police and fire plans.

Although municipalities cannot control every cause of the UAL increase, the municipalities should support the financial stability of these police and fire pension plans and make the contributions needed to make these plans financially stable. Otherwise, the municipalities are just passing off even larger problems and debts to the future citizens of these municipalities. Since pension benefits are constitutionally guaranteed in Illinois, there is no basis for cities trying to delay or escape their funding responsibilities.

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