Pension challenges widespread among Illinois local governments

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CHICAGO — Illinois municipalities outside Chicago are looking for relief from their considerable pension burdens as Gov.-elect J.B. Pritzker and the new legislature get to work in the coming weeks.

Chicago and the state government get the lion's share of attention for their pension liabilities, but the weight of retirement burdens has dragged down the ratings of local governments across Illinois, driving up property tax bills and prompting some to look for alternative revenue sources to meet growing payment demands.

Downgrades have stretched from governments in the Quad Cities region on the banks of the Mississippi and Peoria in central Illinois to both wealthy and impoverished Chicago suburbs. They’ve struck both home-rule and non-home rule governments that range on the ratings scale from high to low-grade.

Since 2017, Moody’s Investors Service has stung more than three dozen local governments with downgrades in which pension burdens were cited as a primary driver.

The latest came Dec. 21 when Moody’s lowered Elgin, a city of more than 100,000 35 miles northwest of Chicago, to Aa2 from Aa1. The downgrade that affects $77 million of debt “is based on the city's high pension burden and incorporates likelihood of further growth given current contribution practices,” Moody’s said.

On Dec. 4, the Chicago suburb of Hoffman Estates and its $90 million of debt suffered a cut to Aa3 from Aa2 over “the village's high pension burden that will likely continue to grow given current contribution practices.”

The affluent Chicago suburb of Buffalo Grove is increasing contributions but that couldn’t stave off the loss of its Aaa rating in October when Moody’s lowered its $14.4 million of debt to Aa1 due to a “the village's high pension burden that is expected to remain elevated relative to other Aaa rated local governments despite increased pension contributions.”

In November, Moody’s dropped Rock Island and its $63 million of general obligation debt to A2 from A1, a move that "reflects the city's elevated leverage from debt and pensions, which remain well above sector medians given current contribution practices, as well as the rising risk of budgetary pressure related to growing fixed costs.”

Some governments are at risk of losing their investment-grade status.

In October, Moody’s cut the Chicago suburb of Oak Lawn's $75 million of debt to Baa3 from Baa2 and left the outlook at negative “based on heightened operating risk associated with the village's high and growing pension burden. The outlook also considers the direct risk to liquidity created by current funding levels given the village is not in compliance with state law.”

In 2018, Illinois Comptroller Susana Mendoza’s office began enforcing a law that allows pension funds to intercept a local government’s share of state-collected taxes if the government's annual contribution falls short of actuarially required levels. State law requires most local governments to reach 90% funding by 2040 on their public safety funds.

The impoverished Chicago suburb of Harvey was the first to be hit such an intercept request and a handful of others including Chicago have since faced such collection measures.

While a flood of requests has not occurred, many municipal market participants are watching closely because such diversions could hurt a distressed government’s ability to provide critical services or push it to raise taxes to a level that drives residents out. Local governments can’t file Chapter 9 in Illinois.

When Harvey was hit with the diversion, it cut its public safety staff. The city already levies high property tax rates and has poor collection rates. It eventually reached a court settlement with its police and firefighter funds that eased the diversion’s impact.

The escalating pressures mostly stem from obligations owed to local government public safety funds. Most local municipalities with the exception of Chicago participate in the Illinois Municipal Retirement Fund but manage their own public safety funds.

The IMRF is 89% funded and most local governments are up-to-date on actuarial payments. While the fund can now intercept state collected taxes like the public safety funds, it has long had the ability to enforce the payment of actuarial contributions by intercepting a single revenue source.

In comparison, the 656 downstate and suburban firefighter and police funds are only 57.6% funded, according to pension data compiled for fiscal 2016 by the Illinois Department of Insurance.

The state analysis reported that the combined shortfall for the funds of more than $9.9 billion had doubled from $4.8 billion a decade ago. Chicago’s net pension liabilities are $28 billion and Illinois’ are at $133.7 billion.

"We have already observed pressure from rising pension costs for many of the issuers that we rate, as demonstrated by more frequent structural budget deficits, large tax hikes, and budget cuts that in many cases limit future operational flexibility, as well as reliance on reserves and other one-shot measures to address budgetary imbalance," S&P wrote in a report about the potential credit impact of the intercept law.

About 34% of municipalities’ contributions are materially below actuarially sound levels and rising payments are expected to absorb a larger share of Illinois municipal budgets over time that will require higher taxes, spending cuts, or a combination.

Some governments are looking for alternatives, including Alton, which is selling its wastewater treatment system to bolster pensions. The increased funding didn’t stave off a rating cut to A from A-plus from S&P in September.

"While we recognize the sale presents a measure of budget predictability in the near term, the city will still have a significantly high pension liability and exposure to escalating pension contributions, and we believe it will need to devise a long-term plan to stabilize its policemen's and firefighters' pension funds," S&P analyst Helen Samuelson warned.

The Illinois Municipal League and Chicago Civic Federation believe public safety pension fund consolidation would help.

“IML’s top priority is working with the General Assembly to pass legislation to consolidate the more than 650 downstate public safety pension funds for the purpose of creating efficiencies, improving processes and reducing administrative and investment costs,” the league says on its website.

Six proposals have been developed so far, according to the league. A seventh proposal, not yet in bill form, would maintain all current characteristics of each local pension fund, extend the amortization period to 2050 and reduce the required funded ratio target to 80%, and direct a study to examine the costs and benefits of full consolidation.

Some proposals call for the various funds to be merged into the IMRF with differing levels of control and changes and others would establish a single police fund and a single firefighters’ fund.

Consolidation is among reform proposals the Chicago Civic Federation will advocate for as part of its 2019 legislative priorities.

“While these funds may enjoy local control over investing and disability decisions, the federation believes that overall investment performance and administrative efficiency generated by economies of scale would greatly improve if funds were consolidated,” the federation wrote.

The federation also supports putting a constitutional amendment before voters in 2020 seeking to ease the state constitution’s stringent constitutional provision that prohibits any benefit cuts.

Consolidation isn't universally popular.

The Illinois Public Pension Fund Association released a study last week that contends consolidation poses a risk and recommends easing investment guidelines for the state’s smallest funds.

The study, performed by Anderson Economic Group LLC, contends 228 of the state’s smallest funds with less than $10 million in assets would average as much as 5% to 6.8% annually if the restrictions were eased, and this action would increase average annual pension fund returns statewide by at least $418 million over 20 years.

“Expanded investment authority is the least cumbersome and most effective way to ease the local contribution responsibility,” IPPFA President James McNamee said.

The study concluded consolidation would require asset liquidation and reinvestment fees of up to $155 million which would increase the pension funds' unfunded liability. The timing also poses risks if it occurs during a period of stock market growth and the local pension funds miss out on the resulting dividends.

“There's also the issue of local control,” McNamee said. “A consolidated fund means community residents have much less input on how their tax dollars are spent.”

While heavy pension burdens have damaged the credit quality of many Illinois cities, towns, and villages in recent years, some have managed to withstand the pressure and maintain their “exceptional credit quality” despite the rising costs, according to a recent report from Moody’s.

“Such cities typically have drawn on their strong legal revenue-raising flexibility and high median family incomes to support increased pension contributions while maintaining strong reserves,” Moody’s said.

That flexibility stems from the home rule status of most cities which gives them broad revenue raising options and many benefit from strong income levels.

Among the 13 Aaa-rated cities in Illinois, 11 have home rule authority. Home rule status is determined by population or a municipality can vote for home rule. Among all rated Illinois cities, 69% have home rule status.

Most Illinois cities with exceptional credit quality are exceeding state required minimum pension payments and are doing it without draining reserves. The median Moody's adjusted net pension burden liability for Aaa cities in Illinois is 2.7 times revenues, compared with 1.5 times for Aaa cities nationwide.

Worries persist. “If Illinois cities with large unfunded pension liabilities do not continue to absorb growing pension contributions—including costs that could arise should pension plan investment performance fall short of plan assumptions—these cities could face credit pressure,” Moody’s wrote.

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