Jane the Actuary Retirement

Forbes post, “No Hope In Sight For Chicago’s Worst-In-The-Nation Pension Plans”

Originally published at Forbes.com on August 1, 2023.

Back on July 18, the Equable Institute released the 2023 version of its annual State of Pensions report, which means that, yes, it’s time for another check-in on these infamously-poorly-funded pension plans. Among the wealth of tables is a list of the best and worst-funded of the 58 local pension plans studied, and, yes, you guessed it, the bottom five spots are Chicago plans, with the bottom three at levels far below all others:

  • Municipal employees, 21% funded,
  • Chicago police, 21.8% funded, and
  • Chicago fire, 18.8% funded.

Combined with the Chicago Laborers’ pension fund, with a 41% funded status, the pensions for which the city bears a direct responsibility have a total pension debt on a market value of assets basis of $35 billion. (This data is from the actual reports*, released in May, which doesn’t match the Equable report precisely.) Spot fifth-worst is taken up by the Chicago Teachers, at 42.4% funded, and the first non-Chicago system in their list, Dallas Police & Fire at 45.2%, is twice as well funded, percentage-point-wise, as the Terrible Trio.

If those rankings and funded ratios aren’t dismaying enough, here are some other ways to look at it:

The Police and Fire pensions aren’t targeted to be 90% funded until 2055, and Municipal, not until 2058. Even with this long delay, the Fire plan is scheduled to contribute 78% of pensionable payroll every year until that date, and the Police plan, 68%. And in terms of the overall percent of the budget, the city spends 20% of its operating budget on pensions plus 80% of the property tax revenue it receives as a separate line-item.

And future pension increases for currently clout-less groups aren’t just hypothetical and in the distant future. In 2021, despite then-mayor Lori Lightfoot’s opposition at the time, a more-generous COLA benefit previously available only to grandfathered Fire employees was made available to all in legislation passed by the state, based on the rationale that the state had been continuously changing the grandfathering date so that it was more honest to do away with it altogether. No politician questioned this false narrative: the perpetual cut-off-date changing ended in 2004, when the city and state truly got serious about pension underfunding, and only resumed in 2017, with the same individual, Robert Martwick of Chicago, pushing that change. The following session, Martwick pushed for the same change for the Police, plus additional enhancements, a bill which, as a small silver lining, was not passed, but he hasn’t given up, and this past spring had been pushing for a fix for the entire Tier 2 system, despite the lack of actuarial analysis, which he brushed off as “quite expensive.” And even though those bills didn’t get passed, reporting indicates that the police fix was merely delayed until this coming fall, and, what’s more, one of the co-sponsors of Martwick’s bill to boost Tier 2 Chicago firefighters’ pensions is now deputy chief of staff to Mayor Johnson.

So, given all this, what is the new mayor’s position?

At the moment, new mayor Brandon Johnson is hosting a series of community roundtables on the budget, which is standard procedure. Although, as the Chicago Tribune reports, budget director Annette Guzman has been cautioning her audience that “Unfortunately, it’s sort of like a zero-sum game . . . OK, there’s only so much resources that we have,” Johnson himself has been encouraging attendees to dream big: “How about a budget that creates more than enough for revenue?” And he added a special session for teens and young adults, at which, as Block Club Chicago reports, “Volunteers at each table took notes and helped move the conversation along, asking young people what ideas they had for investment.” (Yes, it is a clear red flag when ordinary social spending is elevated with the label “investment,” implying that it “pays for itself” and is therefore in a special category in which the immediate cost is not an issue.) Throughout his campaign, he promised a wide range of spending increases and tax hikes to fund them, so there is still much uncertainty as to his actual budgeting decisions when bills have to be paid and his new tax wish list is restricted by the need for state approval.

He does, at least, acknowledge the issue, and last May established a working group to discuss the issue, saying, in a statement (per the Tribune),

“As Mayor of Chicago, I am committed to protecting both the retirement security of working people, as well as the financial stability of our government so we can achieve our goal of investing in people and strengthening communities in every corner of the city . . . Together, with our state legislative partners in Springfield, I am establishing a working group to collaborate on finding a sustainable path forward to addressing existing gaps in the city’s four municipal pension systems (Firefighters, Police, Municipal, and Laborers).”

What that means, in practice, appears to be a matter of finding new tax revenues, for example, according to the reporting at WTTW. And in that regard, it is disappointing that the actual members of Johnson’s Pension Working Group are exclusively local politicians, Chicago government officials (e.g., the CFO), representatives from the affected unions and, in the case of one individual without a listed affiliation, a longtime staffer in the Pritzker administration and the Chicago Public Schools. There are no representatives of the Civic Federation, with its history of promoting good governance, or any other organization with a similar point of view.

What’s more, Ralph Martire and his Center for Tax and Budget Accountability continue to promote what he calls “reamortization” as a solution to the problem, both through an April Chicago Sun Times commentary and through the release of a report, “Understanding – and Resolving Illinois’ Pension Funding Challenges” (which is an update of a prior proposal). This proposal, which is directed at Illinois pensions but is clearly meant based on other comments to be an all-purpose fix, sounds innocuous, as merely a sort of “refinancing” as one might with a mortgage, but it’s really much more as he proposes to

  • Reduce the funded status target from 90% to 80%, based on the claim that the GAO deems this funded status to be the right target for a “healthy” plan (whether he deliberately misleads or not, he is wrong here, the National Association of State Retirement Administrators or NASRA clearly explained more than a decade ago that 100% funding is always the right target and the only significance of an 80% level is that private sector pension law requires plans funded less than 80% to take immediate corrective action rather than have a long-term funding schedule, and the American Academy of Actuaries more explicitly calls this a “myth”);
  • Issue large sums of Pension Obligation Bonds, which were questionable already when they first began promoting this but are now a terrible idea with our current high bond rates, all the more so for a low-credit-rating city such as Chicago; and
  • Move contributions from last day of the fiscal year to the first day, which he argues would be a gain of a year’s investment return while forgetting that it requires the city to have this money on Day 1 and forgo the other uses it would have.

So where do we head now? In a perfect world, the need to make Tier 2 changes would set the stage for a “grand bargain,” similar to Arizona’s pension reform, in which they got public support to make a very limited exception to their own constitutional pension protection clause. In the real world, in which fiscal conservatives have disappeared from Chicago or Illinois government even as a strong minority voice and in which Covid funds have filled budget holes and allowed the illusion of spending prudence, I don’t hold out much hope for such a solution.

 

*Links for the pension funds’ actuarial reports are here: Chicago Fire, Chicago Police, Laborers, and Municipal Workers.

 

Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Mismanagement Compounding Underfunding: The Chicago Police Pension Forensic Audit”

Originally published at Forbes.com on September 6, 2021.

 

Readers, when I first read that retirees and employees in the Chicago Police pension system were pursuing a “forensic audit,” that seemed like nothing more than wishful thinking. It seemed plainly obvious that the plan’s massive underfunding was explained by the lack of a commitment to fund the plan properly, and by years of delusion that future favorable investment returns would solve the plan’s problems. But it turns out that there are serious issues with how that plan was managed that compounded these underlying issues, as revealed in a new report released at the end of August.

The background to the report is this: after this rapid decline in pension funded status over the past two decades (the police pension was, after all, 71% funded as recently as 2000), a group of retirees, widows, and active officers formed a group called the CPD Pension Board Accountability Group in February 2020, asking for a full audit of the fund. Their requests were denied, even when they offered to pay the full cost themselves, so they hired the author, Christopher Tobe, who set about doing the research based on publicly-available information as well as through making a series of Freedom of Information Act (FOIA) requests, the largest number of which, Tobe says, were illegally denied.

Here are some of the highlights of the report:

It is reasonably well-known that the pension plan has been underfunded for years, and that the state, in setting a new funding plan, allowed a “funding ramp” in 2011 and then re-set that ramp in 2016, so that funding according to the “90% funded by 2055” target only began in 2020. However, Tobe alleges that “Chicago has consistently underfunded the plan more than the statutory amount, blatantly breaking the law, with no consequences.”

Regarding fees and management, Tobe alleges that the pension fund has “failed to monitor and fully disclose investment fees and expenses” and that “fees and expenses could be 10 times that which they disclose” because the fund’s disclosure “omits dozens of managers and their fees.” He also reports that the Fund claimed that “hundreds of contracts for the investment managers” are exempt from FOIA, and denied him access to the fund’s own analysis of fees. He concludes that “PABF may have over 100 ‘ghost managers’ in funds of funds,” that is, the fund is required to disclose its managers but it fails to do so, even though Tobe has identified them through other sources.

Tobe also found that “pay to play” is alive and well in Chicago. A 2014 report found that “former Mayor Rahm Emanuel received campaign donations of over $600,000 from investment managers who manage accounts for the PABF and other city funds.” In addition, Mayor Lightfoot has received $200,000 in donations from firms managing Chicago pension funds.

In addition, while poor performance is never a proof of failure in isolation, Tobe found that the pension fund had well-below-average investment performance, compared to other funds — at the 90th percentile (bottom 10%), which he attributes to the fund’s use of alternative investments, with high fees not compensated for with high returns. He also raises concerns of cooked books, but cannot confirm this because of the city’s repeated denial of records requests.

With respect to governance, the fund violates a fundamental aspect of prudent governance because its Chief Investment Officer is not a professional with qualification in the field, but simply a trustee and active-duty policeman, and, what’s more, one who has “22 allegations of misconduct as a police officer including one for bribery/official corruption.” Further, no staff members hold the credential of a CFA charter, another marker of professionalism. Another related governance issue is the use of offshore investments, e.g., in the Cayman Islands, which lack key governance and transparency protections of US-based funds.

Finally, with respect to financial reporting, “the Chicago Police Pension has decided to stop issuing Comprehensive Annual Financial Reports,” issuing a report neither in 2019 nor in 2020 (though it has made public the actuary’s reports for those years and makes available the valuations back to 2007 on its website).

There’s more, but I’ll stop here, as this is more than enough to illustrate that there are troubling practices at the fund that only compound the already-serious funding issues. It is not possible to know how much these mismanagement issues have effected the plan’s investment returns and plan expenses, but regardless of the magnitude, none of this should be happening. The city of Chicago wants us all to believe that the corruption which has been part of the city’s legacy for so many years, is in the past — but this report calls that into question. And, regrettably, Tobe’s report has gone practically unnoticed in the local media, with, to the best of my knowledge, coverage only at the local CBS affiliate.

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “The Chicago Park District’s 30% Funded Pension Plan – And More Tales Of Illinois’ Failed Governance”

Originally published at Forbes.com on June 7, 2021

 

The Illinois legislature ended its regular legislative session on May 31, in a flurry of legislation passed late into the night. One of those bills was a set of changes to the 30% funded pension plan of the Chicago Park District. Were these changes long-over due reforms, or just another in the long line of legislative failures? It’s time for another edition of “more that you ever wanted to know about an underfunded public pension plan,” because this plan illustrates a number of actuarial lessons.

To start with the basics, the Chicago Park District is a separate entity than the city of Chicago, although its commissioners are appointed by the mayor. Its liabilities are not included in the city’s accounting; if they were it would be a small sliver, only 3%. But that’s still over $800 million in debt.

Some history

The Chicago Park District pension, as with the other city pensions, has its benefit provisions fixed by state law. In addition, also by state law, it has a dedicated property tax levy sufficient to contribute to its pension 110% of employee contributions, which themselves are set at 9% of pay. Just as was the case for other state and local pensions, legislators created a Tier 2 pension benefit for those hired after 2010. And just as there were reductions to other state and state-legislated pensions for Tier 1 workers and retirees, the same was true here: regarding COLA, the retirement age, and disability benefits, as well as an increase to the required employee contribution, which the court struck down in 2018. (This was later than the ruling for other state and city pensions, because the reform legislation was passed later and park district workers waited until the court decision on the other reforms was finalized before filing their lawsuit.)

That reform legislation also contained changes to pension funding. However, unlike the other plans, those changes did not set a funding target, neither using the public-pension concept of Actuarially Determined Contribution, nor the approach of other Illinois pensions, setting a target date 30, 40, or 50 years into the future and setting contributions as that percent of payroll that would reach full (or mostly-full) funding at that date. Instead, the law merely prescribed new multipliers, in which the district would have to pay 2.9 times employee contributions until the plan was sufficiently funded.

In any case, that new funding requirement was lost when the reform law was struck down, and the plan has been on a path to insolvency in 2027 since then.

Some deeper history

In many respects, the history of this plan is similar to the Municipal Employees’ pension. In both cases, this woeful level of debt was not always so. As recently as 2001, according to actuarial reports, the plan was essentially fully funded.

This chart looks very similar to that of my 2019 Municipal Employees’ pension analysis, in which the early 2000s full funding is actually a peak after a steady climb from 45% in the early 70s. In that case, the path to full funding was explained in part by an increase in the funding valuation interest rate from 5% to 8%, and likely as well not just increases in interest rates but a shift to equities from a prior traditional fixed-income investment strategy. In the case of the Park District, older reports are not available online, so we don’t know whether the same pattern held true, and whether that near-100% funding level was a consistent one in the past or a one-time aberration due to the confluence of favorable investments and demographics.

In any case, it’s been downhill since then. What happened?

The easy answer is that the city did not make its Actuarially Required Contributions, or Actuarially Determined Contributions — the label changed in 2014 to reflect that this is merely a standardized method of calculating contributions that amortizes debt over a fixed number of years, not an amount required by law. By the time the city started making the temporarily-higher contributions as prescribed by the reform law, it was too late.

Pension plans, of course, grow in liabilities regardless of what the law says should happen regarding contributions. In fact, here’s what’s happened over the past 20 years:

Believe it or not, this twenty-year doubling of the liability is actually less steep than for the municipal plan, indicating that the bonanza of benefit provision increases in the latter plan did not take place here to the same degree.

But, again, the actuarial math remains unforgiving.

And thus we have Lesson 1:

A pension plan which promises guaranteed benefits to its recipients must be willing to make all prescribed contributions. There is no getting around this math. A plan which is not firmly committed to these contributions, however much they may swing due to market changes and demographics, or which does not have the ability to make this commitment, simply must have some flexibility in its plan design.

This is made all the worse with a disproportion of retirees. That’s true with multiemployer pensions, and that’s true with public pensions, whether that’s due to a generous early retirement age or a declining population. In the case of the Chicago park district, there are virtually identical numbers of retirees/beneficiaries and active workers.

Consider, too, this rather dramatic change in fortunes:

The 2013 pension reform’s increased multipliers did not provide any guarantees that the pension would reach full funding. However, in 2014 and 2015, actuaries calculated that the plan would reach 90% funding in 2048. But in 2016, it was a different story. At that time, the court had ordered that one of the reform changes, reductions to COLA, be un-done, even though the entirety of the law was not yet struck down. This change in itself was enough to set the pension on a path towards insolvency, declining to a 6% funded status in the last year of the report’s projection, in 2055.

And, again, to say that public pensions must be funded seems fairly obvious, but, regrettably, some people who hold themselves out as experts and gain attention as such, still manage to claim the opposite, that it’s acceptable to leave public pensions un- or under-funded as long as they can be deemed “sustainable,” with future pension payments projected to be a tolerable level of the state or local budget. That’s the claim made by Brookings scholars James Lenney, Byron Lutz, Finn Schuele, and Louise Sheiner, which has been picked up by such media as Reuters and MarketWatch.

But the speed with which a public pension can find itself in such a serious hole means that it simply is not reasonable to shrug off debts as tolerable as long as a projection determines it to be so under ideal circumstances.

And that’s not the only issue. Here’s lesson 2: a pension plan is not sustainable without proper governance and actuarial analysis.

Let’s revisit that 1.1 multiplier: this was the property tax levy prescribed by the Illinois state legislature. But the Chicago Park District was never restricted to only this contribution level. At any point, the city could have chosen to use its operating budget for higher contributions, and, in fact, in fairness, the city has done so at times. Even after the legislative mandates were ended, in 2019, the park district contributed an extra $13.1 million beyond the designated property tax levy, and in 2020, the park district had budgeted a supplemental contribution of $20.6 million. Pension funding was also an issue in a narrowly-averted park district union strike in 2019, though the specifics were never made public, except with the implication that the district was constrained in the amount of increases it could offer due to its need to fund the pension.

But at the same time, in 2004 and 2005, the Illinois state legislature authorized the park district to cut back its pension contributions, siphoning off $5 million in each year from the dedicated tax levy to ongoing operating expenses. (”Parks ‘06 budget raises flag,” Chicago Tribune, Dec. 1, 2005).

Can any local entity be trusted to fund its pension plan, when other groups are clamoring for money right now, pension benefits must be paid in the future, and the risks of population decline or other issues feel so intangible?

At the same time, the legislature’s reform attempts repeatedly fall short.

Consider, again, the Tier 2 reform, in which state and local pensions in Illinois provide lower benefits for those participants hired after 2010. I’ve discussed in the past the issues facing the Illinois Teachers’ Retirement System, in which the Tier 2 changes pared away benefits so much that the state likely faces a lawsuit in the future for failing to provide benefits even at the level of Social Security itself for some teachers.

For the Chicago Park District, the Tier 2 benefits are, for the workers as a total group and based on all the plan assumptions, pretty much equal to the contributions the workers pay. The sole benefit those workers receive is due to the guaranteed nature of the benefit, in the form of, basically, a guaranteed 7.25% investment. But benefits are highly unequal; because all workers must have 10 years of service to receive Tier 2 benefits, based on the plan’s valuation assumptions, only about 30% of Tier 2 workers will ever collect a retirement benefit at all. In fact, turnover in the first few years is so high that even for Tier 1 workers, nearly half aren’t eligible for retirement benefits — and in either case, all they get back is their employee contributions without even earning any interest on them.

No actuary would have designed a plan like this. And no private-sector plan would be legally allowed to have such a strict vesting requirement as 10 years; ERISA requires the private-sector DB plans vest after 5 years, and 401(k)s after 3 years.

And now, finally, we get to the last-minute legislative changes, with the legislative text filed on the 19th, passed by the State Senate on the 27th, and passed by the State House on the 31st, the last day of the session. There are three major provisions: a new funding schedule, authorization of pension bonds, and a new Tier 3 group of participants. None of these appear to have been based on actuarial analysis (inquiries to the Pension Board and to the office of sponsoring state senator Robert Martwick were not responded to).

Most egregiously, the Tier 3 benefit simply increases employee contributions by 2 percentage points, from 9% to 11%, and reduces the retirement age two years, from 67 to 65. As it happens, this is similar to the Tier 3 for the Chicago Municipal Employees’ pension, but there are two key differences: first, employees in the latter system only pay contributions at this higher rate until funded status improves, and, second, employees are guaranteed to pay a contribution rate that is no higher than the normal cost (annual benefit accrual) rate, so that they are not obliged to subsidize other employees. This new Tier 3 has no such provisions, and it is wholly unknown whether new employees will benefit or merely subsidize the system.

Second, the plan provides for a new contribution schedule: the amounts necessary to reach 100% funding in the year 2058. For the years 2021, 2022, and 2023 (in each case, paid a year later), there is a “ramp” in which only 1/4, 1/2, and 3/4 of the amount otherwise due must be paid. In addition, not later than November 1, 2021, another $40 million must be paid, though the law specifies that this sum “shall not decrease the amount of the employer contributions required under the other provisions of this Article.” (Does that mean that the projected employer contributions to 2058 must be done as if this $40 million didn’t exist?) This, it turns out, is a lot of money — approximately the equivalent of 60% of payroll or 25% of the total budget (making some estimates based on valuation data). It is the inevitable consequence of past failures to fund and of poor plan design — but I wonder how many of the legislators who cast their votes truly knew what they were voting for.

And, finally, the bill authorizes pension obligation bonds, in the amount of $250 million in total, or $75 million in any one year, and, like the additional $40 million in 2021, the law specifies that “Any bond issuances under this subsection are intended to decrease the unfunded liability of the pension fund and shall not decrease the amount of the employer contributions required in any given year under Section 12-149 of the Illinois Pension Code.” Does this mean that the park district would be required to make contributions on a schedule as if the bonds didn’t exist, so that they would accelerate the funded status of the plan to a point earlier than 2058, while being paid off outside the plan? It is again wholly unclear, and this legislation was passed without any discussion on how these pension bonds would actually work.

This is not how to pass pension legislation. Regardless of whether it’s the $230 billion in liability of the five Illinois state systems ($137 billion unfunded) or the comparatively small $1.2 billion in liability here, no such legislation should be passed without actuarial analysis laying out the impact of the changes, and without making this available to the public.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Chicago Firefighters Pension Update: Why Did Pritzker Boost Benefits?”

Originally published at Forbes.com on May 10, 2021.

 

About a month ago, Illinois governor JB Pritzker signed legislation that boosted pension benefits for a group of Chicago firefighters, despite the urging of Chicago mayor Lori Lightfoot not to do so, because of the cost to the already-woefully-underfunded plan. As I wrote back in January, this change could drop the funded status from 18% funded down to an even-worse 16%. Each dollar that is spent on this benefit improvement is a dollar that must be extracted from taxpayers or found by cutting other needs.

As the Chicago Sun-Times reported,

“A Wall Street rating agency that alone gave Chicago a junk bond rating on Friday branded as ‘credit negative’ a bill Gov. J.B. Pritzker signed over Mayor Lori Lightfoot’s objections boosting pensions for thousands of Chicago firefighters.

“’The legislation is credit negative for the city of Chicago,’ said the advisory from Moody’s Investors Service, ‘because it will cause the city’s reported unfunded pension liabilities, and thus its annual contribution requirements, to rise.’

“With pension contributions consuming 17% of the city’s operating revenue and total liabilities pegged at $46.6 billion in 2019, pensions are the ‘largest credit challenge facing Chicago,’ Moody’s said.”

Why, then, did Pritzker sign this bill?

In his press release, Pritzker claimed that “HB 2451 creates a system that gives all firefighters certainty and fair treatment.”

And the promoters of this bill, most notably State Senator Robert Martwick, had claimed that, despite all appearances, the bill was actually prudent and responsible, because it removed a “birth date restriction” that, as the Sun-Times reported, “Martwick has . . . already has been moved five times as a way of masking the true cost to the pension fund.”

And Martwick’s own statement at the time?

“If we ever hope to right our financial ship, we must finally put an end to the irresponsible behavior that put us here in the first place . . . . This law simply ensures that the city confronts the true costs of its pension obligations and makes the difficult decisions it needs to make today.”

But, again, as I explained back in January, this is misleading, to put it nicely. This restriction was imposed in 1982 and changed in 1995 and 2004 — then the benefit boosts stopped as the city and the state both finally recognized that pension funding mattered, with Tier 2 benefits implemented in 2011 and an attempted reform in 2013. Only in 2017, in a bill sponsored by Martwick himself, as a state representative, was the benefit boosted again by a further moving of the birthdate restriction, and after he succeeded in getting this bill passed, he set about getting the birthdate restriction eliminated, with a bill in 2018 which died in 2019, before re-introducing it for its final passage now. For Martwick to point to this past history to claim that the moving of the birthdate restriction is somehow inevitable and out of anyone’s control is, well, chutzpah at its finest.

But why, then, would Pritzker have signed into law a bill when the central claim of its advocate — that the state had an unalterable practice of benefit boosts that needed to be recognized honestly — was demonstrably not true, with the barest amount of research required to understand this?

Plainly, there are three possibilities.

First, that Pritzker truly believed Martwick’s claim that the legislature would always boost benefits, so the only option was to recognize this fact.

Second, that Pritzker was unwilling to stand up to legislators who, themselves, did not hesitate to support this bill, because, after all, no one is going to blame an individual legislator for going along with the rest of the party, with the safety in numbers it affords. “Fiscal responsibility” offers a plausible cover for what is, in the end, the action of a coward.

Or, third, that he knows full well that Martwick’s claim is absurd, but simply doesn’t care, because he himself, however much he claims otherwise, doesn’t particularly care about pension funding, and will take any opportunity available to boost benefits in an environment in which this is otherwise out-of-the-question. A statement becomes a purposely misleading, even if others think it’s the truth, if you have access to information to the contrary.

Does it matter?

Pritzker signed this bill a month ago. In the meantime, immediate fiscal crises in Illinois and Chicago have been lightened by the $7.5 billion in American Rescue Plan funds to the state and $1.8 billion to the city. Pritzker announced that, as a result, the state’s contribution to public schools would increase by $350 million and state Comptroller Susana Mendoza announced that the state’s bill backlog had shrunk down to $3.5 billion. Lawmakers are working on budget negotiations, with a May 31 deadline. The redistricting battle is also underway, with its own June 30 deadline, and with the Illinois GOP accusing Pritzker of breaking a campaign promise to support an independent redistricting commission. And Pritzker, as well as new House Speaker Chris Welch, want Illinoisans to believe that, regardless of the state’s past history of corruption that gave it its second-most-corrupt ranking, the state is “under new management” and is now being ethically and responsibly governed.

Can Pritzker be trusted? Can legislators and their leadership be trusted? Not only is the Democratic party in full control of the state, but there are no factions within the party arguing for different directions; bill after bill is passed wholly on a party-line basis, because legislators are expected to simply vote as they’re told to.

Actions like Pritzker’s decision in the firefighters’ bill seem small, but they add up, one signature after the next. And each decision matters, each one is a decision in favor of good governance and fiscal responsibility, or against it. This decision, and countless others like it, matter, even if Pritzker may choose to believe otherwise.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “The Story Behind Illinois’ Latest Public Pension Liability Boost, And Why It’s So Very Illinois”

Originally published at Forbes.com on January 13, 2021

 

In the Chicago Sun Times on Monday, a headline: “Illinois Senate passes firefighter pension bill over mayor’s strenuous objections.”

“With the spotlight focused elsewhere [Illinois’ General Assembly is in the midst of its 5 day lame duck session], such as the Mike Madigan saga and the Black Caucus push for criminal justice reform, the Illinois Senate voted Monday to raise retirement benefits for 2,200 Chicago firefighters in a way that would saddle beleaguered city taxpayers with $850 million in added costs by 2055. The bill already had passed the Illinois House and now awaits Gov. J.B. Pritzker’s signature or veto.”

As a reminder, the Chicago Firefighters’ Pension Fund is 18% funded, with assets of $1.1 billion, and liabilities of $6.3 billion, according to its most recent actuarial report. If that $850 million represented an actuarial present value (that’s unlikely), it’d drop the funded status down to 16%. So what possible rationale could there be for this?

The bill was introduced by Sen. Robert Martwick, D-Chicago, at a point at which he was still a member of the state House. The bill removes a date of birth requirement in the provisions for COLA benefits, in which Tier 1 plan participants born before 1966 and meeting certain other requirements receive a COLA of 3% (noncompounded), and those born after, 1.5%.

The Sun Times reports that, although Mayor Lightfoot opposed the bill, Martwick’s rationale was sound, even adhering to actuarial principles:

“In late February, Martwick argued the ‘birth date restriction’ has already been moved five times as a way of masking the true cost to a firefighters pension fund with roughly 25% of assets to meet its future liabilities.

‘Remember, they have traditionally given that 3% simple COLA [Cost-of-living adjustment] to these firefighters. They’re going to get that. This just writes it into law. It’s really not adding cost. It’s making that cost transparent,’ Martwick said then.

‘If we don’t change the provision and we give them the more generous, 3% simple COLA, then payment on the back end will be enormous. There’s no doubt that would make the mathematical calculation of their payment go up. But what it will do is prevent us from kicking the can and making a huge disaster down the road. It’s making the law comply with what the actual practice is.’”

The article further cited a firefighters’ union spokesperson, Rob Tebbens:

“This is potentially an age discrimination issue because you’re basing the benefit off of an individual’s age and not their years of service. Based on their age, they’re gonna get a benefit that is less than a Tier 2 benefit.”

But Martwick is being disingenuous in his statements. Here’s some history:

There were indeed multiple increases to the age cut-off for the higher COLA, though I’m at a loss as to how there were five separate instances. Based on the plan legislative history in the valuation report, the age differential first came about in 1982, when the COLA was increased to 3% for all employees born in 1930 or earlier. In 1995, the birth date cut-off was raised to 1945; in 2004, to the present 1955.

Then, for 13 years, no further changes were made, perhaps finally recognizing that it was indeed not acceptable to boost benefits of such an underfunded plan. The years after 2004, after all, were a period when Illinois actually tried to restrain its pension costs, with the implementation of the Tier 2 pension system for workers hired beginning in 2011 and with an attempt at pension reform, later ruled unconstitutional, in 2013.

But in 2017, that effort at cost control ended. In that year, the birth date was adjusted to 1966 and retroactive benefits were given. And who was the sponsor of this legislation?

Why, then-Rep. Martwick. In fact, this bill was designed exclusively to provide this boost. The bill was passed by the House and Senate on July 1, 2017, vetoed by then-governor Bruce Rauner on September 22, 2017, and overridden by both houses on November 7, 2017. And there was so little notice taken of it that I can find no reference to it in either the Chicago Sun Times or the Chicago Tribune at the time.

But Martwick wasn’t finished. In 2018, he introduced a bill eliminating the age restriction, which died in 2019. And the bill which is now awaiting Gov. Pritzker’s signature was introduced immediately thereafter, in 2019. In both the 2017 bill and the new one, the benefit increase is retroactive for those who have already been receiving their pensions.

And the best part? The 2017 bill’s text includes this nugget:

“The changes to this subsection made by this amendatory Act of the 100th General Assembly are a declaration of existing law and shall not be construed as a new enactment.”

This is wholly undetached from reality, and suggests that even in 2017, they knew that this increase was unjustified and inappropriate for such a seriously underfunded plan.

It would be funny if it wasn’t so serious — a legislator claiming that “they’re going to do it anyway,” when it’s he himself who had been spearheading the increase, is exactly the sort of action that is, compounded over and over, the reason why Illinois is in exactly the straits it is in.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Chicago Is Considering Issuing A Pension Bond – And Taking A Gamble”

Originally published at Forbes.com on September 15, 2020.

 

How is Chicago going to solve its budget crisis? Two weeks ago, when Mayor Lightfoot gave her budget forecast address, she spoke of dreams for a “world-class” entertainment district surrounding a Chicago casino, the revenues from which are slated to fund the police and fire pension funds. But, it turns out, that may not be the only way in which Chicago attempts to use gambling to resolve its pension woes.

Let’s recap:

Chicago, we learned in late August, is facing a serious budget hole as it ends 2020, and an even worse one in 2021, to the tune of $1.2 billion — or, expressed differently, 25% of the total corporate budget. Mayor Lightfoot hopes to find some coins in the metaphorical couch cushions by refinancing debt, and is urgently pleading for more federal money. Why, their plight is so serious that they may even go to extremes such as reducing payrolls or cutting pay. (Yes, that’s right – unlike elsewhere, neither Illinois nor Chicago has yet made any spending reductions.)

Now we learn, according to Bloomberg (via Yahoo on September 3), that the city is once again considering a pension obligation bond.

“Chicago is looking to the $3.9 trillion municipal-bond market for options to close its ballooning budget deficits, Chief Financial Officer Jennie Huang Bennett said.

“Options on the table include selling pension obligation bonds, as well as refinancing general obligation and sales tax-backed bonds, Bennett said in a telephone interview on Wednesday. . . .

“The city has mulled pension obligation bonds in past years. Former Mayor Rahm Emanuel had considered issuing $10 billion of them to cover rising costs of public employee retirement funds. The pension costs have weighed on the city’s credit rating for years with Moody’s Investors Service giving the city a junk rating in 2015. The city’s unfunded retirement liability stands at about $30 billion. ‘Everything is on the table,’ Bennett said. ‘We’ve spent time analyzing a pension obligation bond, what the pros and cons are and have had a number of conversations about what that could mean for the city.’ . . .

“Any discussion about pension obligation bonds should be paired with potential reforms for how the city pays for retirement costs and what benefits are provided, she said. Bennett declined to comment on specifics for reforms but said the city plans to have conversations with groups including beneficiaries.”

Of course, without a amendment to the state constitution, the hands of state and local government are so tightly tied that it’s hard to imagine what sort of reforms Bennett has in mind.

But there’s a bigger question with the prospect of issuing pension bonds: how would they actually solve the city’s short-term cash flow problems?

After all, neither of the two usual pitches for pension obligation bonds promises short-term cash flow savings.

The first is a straight arbitrage game: giving the pension fund an immediate boost in funded status and, in the long run, earning more in investment returns than you pay in interest on the bonds. It’s as if you used a cash-out home mortgage refinance to invest in the stock market — and, indeed, there have been experts (or people with a credential or a title sufficient to gain publication) calling for cities and states to do exactly this, considering the time to be exactly right for a stock market rebound and low rates on the bonds themselves. (It’s important to know that interest rates are not spectacularly low for these types of bonds because, unlike public works, these are just as taxable as corporate bonds.)

This is, in part, what the state of Illinois did in its historic-at-the-time $10 billion bond sale in 2003, under Gov. Rod Blagojevich, selling bonds, plowing the money into the state’s retirement systems, and using some of the money otherwise earmarked for retirement contributions to cover the debt service payments on those bonds.

But the second pitch is a claim that, like refinancing, this is a way to save on interest expense. Rather than “paying” interest at the rate of 7% in the actuarial valuation, you pay the bond’s interest rate, at, say, 4 or 5%. But I’ve put the word “pay” in quotes in connection to the actuarial valuation, because that savings is illusory. The valuation interest rate is an artificial rate determined for the purpose of measuring the liabilities, at a specific point in time, of all the benefits to be paid out in the future. The real cost is those future benefits and using a Pension Obligation Bond is simply a means of making the current year’s financial reporting look better. (See here for more details and examples.)

This means that, if your concern is the city’s debt, and financial reporting, and bond ratings, then a pension obligation bond might be an attractive way to try to game the system.

But the math around the city’s required annual contributions to the pension fund is a different matter.

Here’s a refresher:

The city of Chicago has four different pension systems (parks, teachers, transit, etc., workers are separate entities). The Municipal plan (23% funded, $16.8 billion in liability) and the Laborer’s plan (41% funded, $2.7 billion in liability) are both on a “ramp” of fixed contributions up until 2023, and thereafter contribute a level percentage of payroll to achieve 90% funding in 2058. The Police (22%, $13.3) and Fire (17%, $6.3) each are in the last year of fixed contributions now, then have a funding target of 90% in 2055.

This means that, in total, the plans had a dramatic jump in contributions of 29% in 2020, and will have further future jumps of 7% in 2021 and 25% in 2022. What’s more, there are even more dramatic jumps in the impact on the city’s budget, because they pay the marginal additional contribution after certain portions are already covered through other dedicated taxes. In the city’s current budget and its projections, contributions increase from

  • $335.5 million in 2020, to
  • $426.9 million in 2021, to
  • $685.3 in 2022, and
  • $859.1 in 2023.

(There are also differences in timing between plan years and when contributions are actually made.)

But what happens if a pension obligation bond is added? Would the city reduce its actual cash flow rather than financial reporting?

That, it turns out, depends on the city’s decision-making.

Here’s one example of a way that the city could manage pension bonds to — if you jump past all the warnings not to issue bonds in the first place — improve its funded status immediately and its contributions over the long term: issue bonds of $5 or $10 billion for the Municipal plan, and $5 or $7.5 billion for the Police plan, pay the bonds of in an amortized (level payments) fashion, recalculate the annual contributions according to the same formula but the new-and-improved funded status, and enjoy a growing level of savings over time. In the case of the Municipal Employees’ plan, a $5 billion bond would boost the funded status to nearly 50%, a $10 billion bond to a bit over 75%. For the Police plan, $5 billion would be a boost to almost 60%, and $7.5 billion, almost 75%.

And the effect on contributions over time would look something like the following charts, if, hypothetically, the assets returned exactly the plans’ forecasted investment returns each year:

(I’m basing all my calculations on the 2018 Municipal Employees’ actuarial report issued in 2019 and the same year for the Police; an updated version exists for the Muni and Police but had not when I first worked through similar calculations in March of this year, and plan actuaries would generate somewhat different numbers as I’m without access to the particulars of timing and calculation methods and am taking certain shortcuts in my math. And I’ve just taken these two as examples because they’re the largest.)

For the Municipal Employees’ plan, the city’s contributions right now are still on the “ramp” and artificially low; for illustration purposes the hypothetical “with bond” contributions assume that the ramp is gone in a new contribution (because, honestly, the math is messier otherwise).

Why doesn’t the state see immediate savings? Two reasons: a 30 year bond is a shorter amortization period than the current time ‘til 90% funding, 39 years for the Municipal plan and 35 years for the Police plan. And the current contributions increase each year at the rate at which pensionable pay increases; in my example, as with a mortgage you or I might have, the payments are level.

But that doesn’t seem to be what the city has in mind.

Regrettably, there is precedent for the city simply issuing bonds for the sole purpose of making its required contributions and, once again, putting future taxpayers in debt to pay current obligations — that is, in 2003, only $7.3 of the state’s $10 billion in bonds was used to boost the pension funding levels. The remainder was simply used to fund part of the 2003 and all of the 2004 statutory pension contributions. Again, in 2010 and 2011, under Gov. Pat Quinn, the state issued bonds solely to cover its statutory contributions.

And a report issued by Chicago’s City Council Office of Financial Analysis in February of this year (that is, before covid) provided more insight on the method by which Chicago might issue bonds, which aims to be more responsible than simply covering annual contributions but places the city at risk, instead.

And, yes, if you’ve read this far, this is where the city moves from questionable decision-making to gambling, or, in more neutral actuary-speak, unacceptable risk-taking.

Chicago, after all, has a credit rating that’s literally junk grade. Only formerly-bankrupt Detroit is worse. In order to manage to borrow money at rates that aren’t so high as to wholly defeat the purpose of a pension bond, the city would have to provide collateral — specifically, by promising the city’s portion of the state sales tax, because doing so is believed to ensure that those revenues are thus guaranteed to the bond buyers even in the event of bankruptcy (though it hasn’t actually been tested yet). To provide further assurance that the funds would be used for pensions, the city would create an entity, the Dedicated Tax Securitization Company, which would be responsible for managing the entire process: it would issue 30-year bonds with interest-only “coupon” payments, invest the money, and, each year for 30 years, earn 6.3% in investment income (according to the report’s assumptions, pay 4.62% in interest to bondholders (again, according to assumptions), and use the leftover investment income to reduce the amount of the city’s annual contribution, keeping the principal untouched to pay back in 30 years.

A $10 billion bond could generate $168 million in free money per year.

Right?

Of course not.

Each year that the investment returns exceed the interest rate, the city has money to use to reduce the annual pension contributions.

Each year that the investment returns are lower than the interest rate, the city has to pay more to make up the difference.

Yes, in the long term, on average, returns will exceed the interest rate. But can the city really afford to have its costs bounce up and down each year in this way?

The report acknowledges this risk and proposes that in years of positive net returns, the city reserve some for a rainy day, but acknowledges:

“This would greatly reduce the City’s exposure to short-term downturns, but might not fully protect it if a downturn occurred in the early years of the POB, before an adequate investment capital cushion had grown.”

Now recall that this report was issued on February 7, and former Mayor Emanuel first discussed bonds a year before then, and try to imagine Chicago’s budget shortfall if, in addition to all the other financial woes, the city had to find the cash to top up its pension bond debt service.

So here’s the bottom line: the city really has no particularly good options. But the city risks making a bad situation even worse, if it looks for solutions that promise a free lunch rather than making hard choices.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Defund The Police, Cut Pension Liabilities? The One Weird Trick That Just Might Work For Chicago”

Originally published at Forbes.com on June 8, 2020.

 

Minneapolis wants to dismantle its police department. On Sunday, as CNN reported,

“Nine members of the Minneapolis City Council on Sunday announced they intend to defund and dismantle the city’s police department following the police killing of George Floyd.”

What exactly that means, and how that might play out, as CNN clarifies, and the Minneapolis Star Tribune fleshes out, is far from clear, as “defund” advocates want to prioritize social services but the city’s charter actually requires that it fund a police force.

Separately, Chicago Mayor Lori Lightfoot announced a 90-day reform initiative. Turns out, the city was already supposed to have reformed its police department as a result of a consent decree in the aftermath of the Laquan McDonald shooting in 2014 — but city officials learned that implementing reform in the face of resistance and bureaucracy is actually harder than it looks. In particular, as Ed Bachrach and Austin Berg note in a Chicago Tribune commentary, that consent decree, and the disciplining of police officers in general, were made subordinate to police union collective bargaining agreements.

But it turns out there is a useful model for successful “defund the police” reform: the city of Camden, New Jersey, in which their police department was so irredeemable dysfunctional, not in terms of police brutality/racism but in their competence in basic police work, that it was indeed shuttered — not to leave its residents at the mercy of criminals, but with the county taking over policing duties.

Is this the right model for cities where prior attempts at reform have failed? I can hardly answer that question – not with any particular expertise.

But I nonetheless asked myself, “what would happen to pensions if the city of Chicago followed that same model?” Of course, that would be contingent on Cook County being able to step in as a more competent successor entity, but hypothetically let’s imagine that this is true, for the sake of argument.

Now, there are some unique characteristics to pensions in Chicago and Illinois.

In the first place, Illinois binds all of its pensions to the requirement that they be “neither impaired nor diminished” and the state Supreme Court has ruled that this requirement is very broad, encompassing future as well as past accruals, retiree medical benefits, and any form of benefit related to retirement.

In addition, most pension plans in Illinois have reciprocal agreements: individuals who move between the Chicago Teachers’s Pension Fund and the Teachers’ Retirement System, for example, can use their total years of service to qualify for benefits and have their highest average pay from either system used to calculate benefits from both systems. The same is true for Chicago and Illinois municipal workers, state employees, university employees, Cook County workers, and miscellaneous Illinois public employees.

But neither the police and fire plans for the city of Chicago, nor those plans for other Illinois municipalities, are included in these reciprocity agreements.

What’s that mean?

If the Cook County Sheriff’s Office took over policing in the city of Chicago, then, logically enough, no police officers would be employed by the Chicago Police Department, because it wouldn’t exist any longer.

That doesn’t mean that cops and retired cops would lose their pensions — the city of Chicago would still be liable. But for currently employed cops, they would only be liable for a “frozen” benefit — that is, based on their salary at the time of the take-over, without the benefit of the pay increases they would have gotten up to retirement, and without any service-based benefit improvements (such as early retirement benefits) that they would have earned in the future. In the private sector, this would be called a “curtailment,” because, logically enough, benefits were curtailed.

How much would that cut liabilities?

Here are the basic numbers, at year-end 2019 (I don’t wish to hazard a guess as to the post-covid-crash values):

Assets (market value, not smoothed): $3,162 million

Liability: $14,270 million.

Funded status: 22%.

The liability splits out into $5,725 million for active employees, and $8,931 for inactive participants (retirees, survivors of deceased employees, and vested terminations).

So what happens if the liability for the active police drops by, say, one-third due to these curtailment effects?

The new funded status would be — are you ready for it? — 25%.

Why such a small impact? That’s because the inactives’ liability makes up such a large fraction of the total — 65%.

But at the same time, in terms of actual dollars saved, it would work out to $1.9 billion. Turns out, that’s more than the entire CPD spends in a year, which amounts to $1.78 billion — but, of course, this would be a one-time reduction rather than an annual savings.

To be clear, this is a result that’s somewhat unique to Chicago. Most states’ police pensions are a part of a larger pension system, so that none of the above is relevant to them — for example, in Minneapolis, police officers participate in the PERA Police and Fire Plan alongside all other Minnesota pubic safety workers.

And, considering the bigger picture, actuary Mary Pat Campbell crunches the numbers and concludes that the chorus calling for the cutting of police department spending and reallocating the savings to social services misses the fact that, as a percentage of total state and local spending, police spending amounts to only 4% of the total. Her data source also reports that public welfare spending (e.g., Medicaid) amounts to 22%; elementary and secondary education, 21%; and higher education and health/hospitals, 10% each.

So nothing’s simple, and the impact of reform on police pensions — or, to the contrary, the impact of police pensions on the effectiveness of intentions to reform — is only a small tangent in a bigger story, but, as an actuary, it’s an interesting wrinkle nonetheless.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.