Latest Chicago pension fund reports lay out frail conditions

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Warnings about the weak health and liquidity risks of Chicago’s pension system abound in the funds’ 2018 financial reports.

The net pension liabilities of the four city pension funds grew to a collective $30.1 billion in 2018 from $28 billion in 2017. The funds all recorded negative investment earnings after double-digit returns in 2017.

The city has increased contributions to all four funds in recent years as it ramps up to an actuarially based contribution next year for its police and fire funds and in 2022 for the municipal employees' and laborers’ funds based on a schedule to reach a 90% funded ratio beginning in 2055 from their current levels that range from a low of 16.57% to a high of 40.6%.

Those higher payments adopted under former Mayor Rahm Emanuel’s state-approved revamp rescued the laborers' and municipal funds from looming insolvency while easing and pushing off a state mandate to reach a 90% funded ratio in 30 years for the police and fire funds. The new schedules don’t begin to make a dent in unfunded ratios for years, leaving the funds at risk in an economic downturn that hits investments hard, several funds warn.

“The risk of insolvency for MEABF has increased due to the 2018 investment return performance combined with fixed-dollar contributions through 2022, which do not change when the fund experiences unfavorable investment performance,” the Municipal Employees' Annuity and Benefit Fund warns in bold print in its 2018 actuarial report.

“We strongly recommend an actuarial funding method that targets 100% funding where payments at least cover interest on the unfunded actuarial liability and a portion of the principal balance,” the report urges. “If the fund becomes insolvent, the employer will be required to make contributions on a ‘pay as you go’ basis, which means the employer would have to pay all benefits as they become due.”

A separate warning — also presented in bold type — lays out the challenges of managing annuity payments and investments with such a weak funded status at 25%.

“The investment return assumption is based on the fund being invested according to the target asset allocation in the investment policy statement. To the extent that the liquidation of assets to pay benefit payments and expenses requires a shift in investment allocation to more liquid, lower return asset classes, a lower discount rate will likely be required in the future,” the municipal fund’s report says.

A lower discount rate, which is a factor in calculating the unfunded liabilities, would drive the net pension liabilities up.

Mayor Lori Lightfoot and her finance team know well the situation they’ve inherited.

“It is no secret that our city faces extraordinary financial challenges, driven by a legacy of pension liabilities, mounting personnel contract increases, and growing debt service obligations — all of which have been long in the making. While these costs loom large for next year and beyond, our administration will be looking at how city government functions to develop a sustainable road-map for the future,” Lightfoot said in a letter earlier this month introducing the city’s 2018 comprehensive annual financial report.

The city’s report includes the CAFRs for all four funds and all but the police fund have posted 2018 actuarial valuation reports on their respective websites.

The most urgent demand facing the city is the need to cover rising contributions. The phase-in period is covered by higher property taxes, a 9-1-1 surcharge, and a water-sewer fee but the city must find another $283 million next year when the actuarial contribution requirement hits for police and fire and another $310 million when the municipal and laborers’ requirement hits.

All four continue to require higher annual contributions but at a more modest level. The 2018 contribution of $1.18 billion grew to $1.3 billion this year. It then rises to $1.67 billion next year, $1.78 billion in 2021, $2.13 billion in 2022 and $2.18 billion in 2023.

The path Lightfoot will take is unclear and her chief financial officer, Jennie Huang Bennett, said this month it’s too early to rule in or out any fiscal maneuvers to balance the city’s books and cover rising contributions as the city continues eyeing expense cuts and management efficiencies before raising taxes.

Lightfoot recently pitched the idea of a merger involving other local governments and/or a state pension takeover but Gov. J.B. Pritzker threw cold water on that idea, saying the state’s barely investment grade rating couldn’t afford such a move. The idea of tinkering with the funding schedule has been circulated, but any such move given the weak funded status could draw rating downgrades.

Chicago’s stable rating outlook for its BBB-plus rating reflects “progress in stabilizing its pension funds and placing them on a path to actuarial funding as well as its narrowing budget gap and steps to more structurally align its budget,” S&P Global Ratings lead Chicago analyst Carol Spain said in a recent report that warned of a potential downgrade if “the city backslides on its progress toward structural alignment on full actuarial pension funding.”

The city’s GO bonds are rated BBB-minus by Fitch Ratings, A by Kroll Bond Rating Agency and junk-level Ba1 by Moody’s Investors Service. All assign a stable outlook.

The municipal employees' fund saw a market return of negative 4.9% last year, according to the results prepared by Segal Consulting. It assumes a 7% positive return.

The actuarially funded ratio dropped to 25% from 27.4% a year earlier. The net pension liability rose to $12.89 billion from $11.7 billion a year earlier. “The increase in the NPL is primarily due to the lower than expected market value investment return,” the report says.

The city’s 2019 contribution of $421 million is far short of an actuarially determined contribution the fund estimates at $1.12 billion. “Each year there is a contribution deficiency leads to an increased deficiency in all future years,” warns the report.

The phase-in period calls for contributions of $344 million, $421 million, $499 million, and $576 million leading up to an ARC in 2022 with the target of a 90% funded ratio in 2057.

The Laborers' & Retirement Board Employees' Annuity & Benefit Fund of Chicago saw a negative 6.36% return on assets in 2018. It assumes a 7.25% rate of return.

The actuarial funded ratio fell to 40.6% from 48.2% a year earlier. The net pension liability rose to $1.6 billion from $1.36 billion in 2017.

The city’s phase-in to a 2022 actuarial contribution for payments of $48 million, $60 million, $72 million, and $84 million in the years leading up to 2022. The 2019 contribution of $60 million compares to the $148 million that would be actuarially based.

“While the new statutory funding policy is an improvement over the prior funding policy, it does not comply with generally accepted actuarial standards for the funding of retirement plans, and therefore we recommend strengthening the policy,” says the report from Gabriel, Roeder, Smith & Co.

The Policemen’s Annuity and Benefit Fund of Chicago saw a loss on investments of 5.36% last year. It assumed a 7.25% rate of return for 2018. The funded ratio held steady at 23.8% from 23.7% in 2017. The net pension liability also held steady at $10.4 billion compared to $10.3 billion in 2017.

The phase-in cycle called for statutorily set contributions of $464 million, $500 million and $557 million in the last three years and $579 million this year. It rises to $737 million next year when the actuarially based contribution hits with modest increases then projected between $20 million and $30 million in future years, according to the comprehensive annual financial report for 2018 prepared by Mitchell & Titus LLP.

The separate actuarial valuation that has not yet posted was prepared by Gabriel, Roeder, Smith & Co.

The Firemen's Annuity and Benefit Fund saw a negative 5.2% return in 2018, when it assumed a positive 7.5% return. Its funded ratio fell to 16.57% from 19.6% and the net pension liability rose to $5.2 billion from $4.6 billion in 2017.

The city’s statutory ramp called for contributions over the last three years of $208 million, $227 million, $235 million and $245 million this year, leading up to an estimated ARC contribution of $371 million next year. The $245 million contribution this year falls short of an actuarial contribution of $442 million.

“The funding policy…significantly defers contributions” from a previous state mandate for all public safety funds across Illinois, the report warns. The unfunded liability is projected to continue to rise until 2027 when expected ARC payments will begin to bring down the tab down.

“We continue to recommend that the plan sponsor seriously consider making additional contributions to ensure that there are sufficient assets available in the fund in all years to pay for promised benefits,” reads the report.

“This is a severely underfunded plan. The funded ratio is only 16.8%” using market value of assets and it’s “not projected to even reach 50% funded for another 26 years,” warns the valuation report prepared by Gabriel, Roeder, Smith & Co.

The report further warns that if payments are not timely the fund “may not have enough liquidity to continue making all the required benefit payments without changing its investment portfolio to one comprised of a larger percentage of short-term investments.”

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Public pensions Pension reform State and local finance Budgets City of Chicago, IL Illinois