An actuary is a financial risk expert who reviews a fund’s assets, liabilities, and future earnings.  In the case of a pension plan, a liability refers to how much the fund owes its current and future retirees.

These calculations are based on investment performance, shifting life expectancy rates, workplace risks, and a series of other factors. These variables help determine an actuary’s estimates for how much a fund needs to meet its current and future obligations.

The actuary for a fund will use many variables to predict how much revenue a fund will generate from its investments.

The actuary provides these calculations to local or state officials to determine their recommended rate of contributions into the pension fund for that year. If revenues from investments are determined to be high, the actuary may say official contributions can be lower. If revenues are determined to be significantly lower, such as during an economic recession, the recommendation will be to increase official contributions.

In years when revenue projections are lower than the average annual rate of return, policymakers have often failed to increase their contributions. This imbalance has been a primary factor to the pensions being underfunded.

Compounding interest is calculated on both the initial principal deposit into a fund, as well as the interest that has accumulated over time. Known simply as “interest on interest,” a poorly funded retirement system will likely miss out on earning this kind of revenue.

Defined benefit plans are common among public retirement systems. A portion of a worker’s salary goes into a public pension fund, in addition to the contribution made by employers. Depending on where the employee works, either the local or state government will be expected to do the same.

Upon retirement, the pension fund gives an agreed-upon percentage of their salary back to the employee. This defined percentage will depend on years of service, the employee’s final salary, and the age when they started collecting benefits.

If a retirement system is not fully funded, it will earn less revenue on investments, making it harder to accommodate future benefits. In severe cases, there may not be sufficient funds to meet the cost of current benefits.

In cases of chronic underfunding, a retirement system may seek administrative solutions, such as bankruptcy, to discharge or restructure its debt.

Unlike a private retirement account, such as a 401(k), public pension funds are not insured by an external agency. Laws like the Pension Clause in the Illinois Constitution are the only form of protection for a public retirement system.

Defined contribution plans are most common in the private sector. One type of defined contribution plan is a 401(k), and some public pension systems offer these as an alternative to a defined benefit plan.

In a defined contribution plan, each employee has an individual account, and future benefits are based on the balance of funds. The more the employee contributes over time, the higher their pension will be.

The employee sets the amount they will contribute to the account each month, which is usually a percentage of their pre-tax salary. Employee contributions are often matched by the employer in part or in full.

The balance of a defined contribution retirement account is affected by gains and losses from investments, as well as administrative expenses. Participants might choose how their funds are invested and future benefits will fluctuate on the basis of earnings.

One benefit of a defined contribution plan is that if their employer declares bankruptcy, employees are not in danger of losing any of their contributions or the contributions of their employer. Their funds will remain under their control.

The Pension Clause in the Constitution of the State of Illinois states that membership in a public retirement system is “an enforceable contractual relationship,” and the benefits cannot be “diminished or impaired.”

This law means that legislators must amend the Constitution to make changes to pensions that would lead to reductions for current beneficiaries or current employees. The state can make changes only to employees who have not yet been hired.

The Pension Intercept Law was introduced in 2010, and municipalities were given five years to comply with funding requirements before the law was rolled out in stages. The law means public safety retirement funds can ask the State Comptroller to intercept municipal revenue, if a municipality has failed to make its required contributions.

Ordinarily, the state collects revenue from sources such as taxes and fees on behalf of the municipality. The revenue is then redistributed back to local governments to pay for schools, hospitals, infrastructure, public safety, and other running costs.

If an intercept request is granted by the state, that revenue will be redirected to the public safety retirement fund which made the claim. The municipality will then have reduced resources for essential services.

In 2018, Harvey was the first city in Illinois to see the law tested. At that time, the Harvey Firefighters’ Pension Fund was only 20.13% funded, while the Harvey Police Pension Plan was 47.9% funded. Both pension boards sued the city for money owed, and an intercept was granted by the state.

However, Harvey officials went back to the Judge and said the city would need to shut down if all its revenue was lost to the intercept. The Judge required the city to negotiate a solution with the pension boards. The outcome was that the retirement funds received some, but not all, of the intercepted revenue.

Intercepts can be seen as a last resort. They may force difficult concessions between the pension funds and the municipality, while the problem of underfunding may persist.

Sometimes referred to as “salary spiking,” pension spiking is when public sector employees are granted large raises in the time immediately preceding their retirement. These extra payments artificially inflate their compensation so they qualify for pensions larger than what they were previously entitled to receive.

When an employee due to retire receives a “spike,” the amount of pension the employee will receive does not reflect the percentage of salary the employee and employer have contributed for the majority of the employee’s career.

Pension spiking is considered a significant contributor to the high cost of public sector pensions because it increases the total payments due to all retirees. This practice puts the entire fund at risk by depleting its assets, and it can put your own pension at risk too.

In 2010, a series of laws were passed that split Illinois public sector workers into two tiers. Pension benefits for Tier 1 workers (hired before January 2011) remained largely untouched, but a number of changes were made concerning how pensions would be calculated for Tier 2 workers (hired after January 2011).

Depending on their profession, changes for Tier 2 workers included: a higher age of retirement, differing years of required service, changes to how final average salary would be determined, and a cost-of-living adjustment (COLA) no longer fixed at 3%.

In 2013, a Pension Reform Bill was passed that aimed to make further changes to both tiers, including: an increase in the age of retirement for younger employees, a cap on salaries on which pensions could be based, and a reduced COLA.

These changes would have been offset by lower employee contributions, while a third tier of workers would be invited to set up private 401(k) accounts, rather than participate in the defined benefits system. Most of the 2013 bill was struck down by the Illinois Supreme Court in 2015 on the grounds it violated the Pension Clause in the Constitution of the State of Illinois.