CHICAGO – The bills that will come due for Chicago's underfunded pensions are weighing on city council members.
Pension funding payments are scheduled to ramp up sharply in 2020 and 2022, a familiar topic for the muni buyside and rating agencies.
But it’s the city’s 50 aldermen that must bear the political costs for imposing new taxes, fees, or fines on Chicago residents.
They’ve already had to dig deeper to cover higher contributions due under Mayor Rahm Emanuel’s funding overhaul of the retirement system that included a $543 million annual property tax hike phased in over multiple years, a new water-sewer surcharge, and a 9-1-1 fee.
The weight of meeting future funding hikes — $278 million in 2020 and $238 million in 2022 — dominated aldermen's questions to the city's finance team Monday on the first day of hearings about the proposed $10.7 billion 2019 budget. It’s the last budget for Emanuel, who isn't running for a third term.
The 2020 and 2022 funding spikes come when Chicago is scheduled to begin making actuarially based payments for pensions under Emanuel's funding overhaul.
“The thought of having to go back to the well on property taxes is just unimaginable,” Alderman Michele Smith told the finance team.
“I think people generally agree this is a very good budget but there's been a lot of concerns expressed about some of the challenges we will be facing in the next several years particularly with regard to our obligation" on pensions, said Alderman Joe Moore.
Council members quizzed the finance team for options other than tax increases, asking whether further attempts at state approved reforms could work, or the $10 billion pension obligation bond issue Emanuel is considering would solve the dilemma.
They also asked whether the city could re-amortize the funding schedule that currently sets a 90% funded ratio for two funds in 2055 and the other two in 2057, or if an asset transfer to the funds offered a fix, or if reserves can be tapped.
Chicago’s chief financial officer, Carole Brown, was clear: the Illinois Supreme Court has shot down reforms that cut benefits as unconstitutional, and some other ideas are just not fiscally sound.
"We anticipate that we would have to ask this body again for revenue increases to fund the increased pension fund contributions in 2020 and 2022,” Brown told the Budget Committee, adding that current revenues can’t cover the looming spikes without new revenue or deep expense cuts.
The pension borrowing would not eliminate the need for tax increases but it would “mitigate that need,” she said. Rating agencies and investors have been encouraged that the city has shown the “political will” to face its pension challenges and will be looking for that same will to raise the revenue to meet the pension obligation, Brown said.
When pressed, Brown said she could not say by how much a pension borrowing would reduce the needed tax revenue.
The pension bond option remains in play even as the rise of Treasury rates has dampened the potential savings from such a deal.
Brown was asked for her “tipping point” on interest rates where she would drop her support for pension bonds.
If rates the city anticipates near 7% then Brown said she would “say there’s not much value to it” but as long as the rate remains below the discount rates factored into contributions — a de facto interest rate on the unfunded liability — “we should be evaluating it.”
The city pays a discount rate of 7% to 7.5% on the funds. If it could borrow in the 5% to 5% range, savings of $5 billion to $6 billion are estimated over the life of the amortization schedule.
Two options pitched by various organizations or municipal participants include an asset transfer to the pension funds or funding re-amortization. Brown said the city’s main assets are its airports and that revenues must remain at the airport under federal rules and such transfers don't offer a long-term fix. She said a re-amortization that lowers the funding target or pushes off the timeline would be frowned up on by the market and rating analysts.
Brown noted that a complaint from rating agencies over the current funding schedule is that the city is “moving too slowly” to improve funded ratios, now collectively at 26.5%, with improvement not seen for a decade. Re-amortization would make that worse.
“I think that if a future administration chose that as a strategy it would have negative market implications,” she said.
Brown said the city views the only reform option remaining in the wake of the Illinois Supreme Court’s voiding of both city and state reforms as a “constitutional change.”
Brown said the liquidity fund established in recent years stands at $70 million, the unassigned balance is at $155 million, and reserves from the city’s asset leases total $640 million, but the city must guard against their use to meet governmental standards on liquidity to cover operations.
The city does routinely frees up in its unassigned balance an amount equal to 1% of the budget but any further use could only be done if the city structurally balances the budget so as to avoid damage to its credit and investor standing, Brown said.
DECEMBER
Emanuel intends to lay out a comprehensive pension plan before the end of the year although he and his finance team have offered scarce hints about its scope or details and whether it would fall to his successor to seek the needed approval.
“The mayor intends to present before this body in December his thoughts around pensions,” Brown told the committee. “We expect that we will have more concrete recommendations at that time.”
In a later interview, Brown called the plan a “work in progress” that will be focused on after the budget is wrapped up. Budget hearings are continuing and a vote would take place next month.
“I can say what the mayor would like to do is have a dialogue where he lays out what he encountered when took office, what worked, what’s been done and what he sees as the challenges going forward,” Brown said.
He intends to lay out options that would address the funding spikes, raise the funded ratios, and address the slow amortization of the unfunded liability. “I think his goal will be to address all of it,” Brown said.
Brown said the establishment of a stabilization fund that could be funded with a dedicated revenue source is under consideration as part of a bonding solution. It would be used to supplement contributions should they rise in any given year due to investment return levels or other actuarial changes.
BUDGET PRESSURE
Other budget pressures include the expected need to fund new contracts with key unions including the Fraternal Order of Police. Budget director Samantha Fields said based on salary deals reached with other unions the 2019 price tag could land around $46 million but it’s hard to gauge because the FOP contract is complicated by mandates tied to a proposed consent decree on policing activities.
Brown and Fields said the city has available cash from the unassigned fund balance and could look to other spending efficiencies. Brown later said in an interview that ultimately it will fall on the next administration to determine a means to cover the cost and she would urge future leaders not to return to practices like putting retroactive raises on the city's debt load.
That's among the dubious debt practices, which also include bonding for settlements and judgments, that Emanuel continued through his first term before phasing them out in his second term, along with scoop-and-toss debt restructuring.
“We think they are good fiscal policies and we hope that the next administration would maintain them,” Brown said. “Investors want to hear that city will continue to be fiscally responsible and will continue a lot of the policies put in place by Mayor Emanuel.”
The city also faces challenges on settlements. It budgeted $45 million this year but the tab so far due to some costly, high-profile settlements relating to police conduct is expected to exceed $160 million this year, Fields told Alderman Scott Waguespack.
The city has some remaining proceeds from its last general obligation sale in early 2017 that marked the final scoop-and-toss borrowing and use of debt for settlements to help “offset” the higher tab, Fields said. The 2019 budget includes $55 million for future settlements. The 2017 tab was $115 million.
Brown highlighted the city’s across-the-board stable rating outlooks and said upgrades are not likely until the city fully structurally balances its books and deals with the funding spikes or raises funded ratios. The city put its structural imbalance this year at just under $100 million, down from more than $600 million eight years ago.
"The challenge that we still have with our rating is two-fold. One, they are waiting for the city to reach structural balance,” she told aldermen. “The second issue obviously is that of our pensions."
The city carries ratings of BBB-minus from Fitch Ratings, A from Kroll Bond Rating Agency, Ba1 from Moody’s Investors Service, and BBB-plus from S&P Global Ratings.
