Chicago Police Sergeants' Association
Pension News
By: John J. Gallagher, Jr.
Executive Director
The Retirement Board Policemen’s Annuity and Benefit Fund – City of Chicago.
Purpose and Importance of Actuarial Evaluations
There are many service organizations that impact the Policemen’s Annuity and Benefit Fund, perhaps none more importantly than the actuary. This Fund employs Gabriel, Roder Smith and Company as it’s actuarial firm and has for some time. For most people, actuarial studies are beyond our normal range of understanding, but hopefully this article will remove some of the mystery surrounding the work an actuary does.
Measuring assets of the Fund is usually quite easy. The Police Fund invests mostly in publicly traded securities, which can be valued on a daily, weekly or monthly basis exactly at a point in time by the marketplace. But liabilities are quite difficult to value. There is no “market price” for life expectancy or future salary rates so we turn to the experts in liability projection and management, professional actuaries. Actuarial science applies mathematical and statistical methods to arrive at an actuarial valuation of a defined benefit plan to, at a point in time, provide the trustees, staff, members, plan sponsors and outside users of information an accurate assessment of its liabilities.
The purpose of an actuarial valuation is to develop the minimum actuarially determined contribution for the next plan year for the liabilities (benefits) incurred and to measure the funded status of the plan at that point in time. The most important actuarial concept is referred to as the Present value of a future sum, which was developed in the late 17th century for the life insurance business and is the cornerstone concept of a valuation. There are several methods used by an actuary to execute this concept and the Fund has adopted the Entry Age Normal Method. This method assumes that each participant’s benefits are funded by annual installments, equal to a level percentage of compensation, payable from the date of participation to assumed retirement. To arrive at the normal cost and actuarial accrued liability numbers the actuary must make both demographic and economic assumptions. The demographic assumptions used are active service turnover, retirement, disability and post retirement mortality. Significant economic assumptions are investment return, pay increases for active personnel and inflation. The total Normal Cost is the sum of the current years annual installments determined for all the active participants of the plan. The Actuarial Accrued Liability is the excess of the discounted value of projected benefits over the discounted value of the normal costs determined for future years of service. So if projected benefits are greater than the normal costs, on a present value of a future sum calculation, there results an unfunded liability. The benefits earned were not funded at the appropriate level.
Actuarial science is not perfect. It relies on reasonable assumptions to statistically project liabilities to better able members, sponsors, trustees and management to understand how much in assets a fund will need to be able to meet all of its obligations, current and future, at a point in time. Each year, the actuary determines the actuarial gain or loss, which helps the Fund determine if the actuarial assumptions are reasonably measuring liabilities or if perhaps one or more may need revision based on actual experience. It has been our experience that the assumptions used by this and by our prior actuaries were reasonable and justifiable and the assumptions have been consistently applied year after year. This gives us confidence that the actuary, using widely accepted methods and models, are accurately projecting liabilities according to actuarial methods called for by the industry and approved by the Governmental Accounting Standards Board, or GASB.