Chicago faces test to reverse insolvency trajectory for its pension plans

Chicago's woefully underfunded pension plans face insolvency unless the city sticks with a new contribution schedule that makes actuarially determined payments for the first time in its history.

Of the four Chicago pension plans, the plans for firefighters, general employees and police officers all had funding ratios hovering just above 20% as of Dec. 31, 2021, according to their most recent actuarial valuation reports. The funding ratios, which have plummeted over the last decade even during a record-long bull market, have forced them to liquidate invested assets just to pay benefits.

The worst funded was the $900 million Chicago Firemen's Annuity & Benefit Fund, at 20.9% on an actuarial value, followed by the $3.2 billion Chicago Municipal Employees' Annuity & Benefit Fund at 22%, the $3 billion Chicago Policemen's Annuity & Benefit Fund at 24% and the $1 billion Chicago Laborers' Annuity & Benefit Fund at 48.2%.

Until 2016, the city of Chicago made statutory required contributions that fell below the contributions that actuaries have said were necessary in order to keep the funding ratios from falling, said Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research at Boston College, in a phone interview.

"For years, they were able to kind of mask their funding problems by pointing to the statute which essentially had a fixed contribution rate that set the employer rate at some multiple of the employee contribution," Mr. Aubry said. "They were doing what the statute required knowing for some time this was not going to be sufficient."

Cesar Rodriguez, spokesman for Chicago Mayor Lori E. Lightfoot, declined to comment for this story.

For example, according to its most recent actuarial valuation, the city's statutory contribution for Chicago Municipal Employees' Annuity and Benefit Fund for 2021 was $576 million. However, the actuarially determined contribution requirement based on the board's funding policy was $1.2 billion. The result was that the pension fund had to liquidate a total of $321 million in invested assets during 2021 in order to pay benefits, even during a year that saw the pension fund return a net 13.6%. The previous two years, the pension fund had to liquidate $366 million and $471 million, respectively, in invested assets.

David Draine, Washington-based senior officer, public sector retirement systems at The Pew Charitable Trusts, said in a phone interview: "There's no way for pension plans to invest their way out of their challenges."

The gravity of Chicago's funding challenges means the pension funds cannot simply "muddle along" as many underfunded public sector plans are able to do, Mr. Aubry said.

For most public pension funds, with "the structure of their cash flows and the pile of assets they currently have, they can essentially exist as a somewhat underfunded system in perpetuity, neither picking up ground nor losing ground … Things are going to just muddle along as they are without any really catastrophic outcomes," Mr. Aubry said.

With Chicago's pension funds, "that model is a little less certain because each period the benefit outflows make up such a large portion of their assets, they need a high percentage return on those assets higher than the average plan, or a large infusion of contributions in order to maintain their current asset base," Mr. Aubry said.

In 2022, the city paid the actuarially determined contribution rate — amounting to $2.3 billion — to the four pension funds for the first time in the city's history. The city passed an ordinance in 2017 that called for contributions to the pension funds to be increased every year until reaching actuarially determined contribution amounts in 2022.

Also, the city council in November approved a new funding policy of advancing future pension contributions, which also resulted in credit rating upgrades for the city from Moody's Investors Service to Baa3 from Ba1. Ms. Lightfoot announced the first advance payment of $242 million in January.

Chicago's 2023 budget calls for a total of $2.6 billion in contributions to the four pension funds.

Mr. Aubry cited a 2020 study by the Center for Retirement Research that came up with three different potential scenarios specifically regarding the municipal employees' pension fund. If the city continues to make the actuarially determined contributions to the pension fund that are intended to bring it to a 90% funding ratio by 2058, the possibility of asset exhaustion is zero.

However, if the city maintains the 2022 contribution rate going forward with payrolls growing by 2.5% each year or maintains the 2022 dollar amount going forward, there is a 32% and 68% chance, respectively, that the municipal employees' pension fund will run out of money.

"I think a lot rests on whether they can make this jump and maintain it over time, and that remains to be seen," Mr. Aubry said. "The system should be on good footing going forward or at least can muddle through."

Challenges do remain. Actuary Segal Group, in its actuarial valuation report for the municipal employees' pension fund, said "the fund is still at risk of potential insolvency if an economic recession or investment market downturn were to occur in the near term" and strongly recommended 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." If any of the pension funds ran out of assets, the city would be required to contribute the full amount of benefits paid since participants' benefits are protected under the Illinois Constitution.

This past year was also a challenging one for public equity and fixed-income markets, and the Chicago firemen's, laborers' and municipal employees' pension funds all posted double-digit negative returns for the fiscal year ended Dec. 31.

They were hardly alone. For the year ended Dec. 31, the Russell 3000 index and Bloomberg U.S. Aggregate Bond index returned -19.2% and -13%, respectively.

The damage to the pension funds' funding ratios had yet to be determined. On the corporate side, pension funds' poor performance for the past year hurt far less because funding ratios barely budged. For example, Boston-based General Electric Co.'s primary pension plan posted a return of -20.5% for the fiscal year ended Dec. 31, but its funding ratio fell only to 93.5% from 93.7% a year earlier.

For corporate pension plans, "their discount rate is based on fixed index corporate bonds or some sort of objective outside the system," Mr. Draine said.

As a result of rising rates, GE Pension Plan's discount rate was 5.53%, nearly double the discount rate of 2.94% the year before. The higher the discount rate, the lower the liabilities.

However, public pension plans in determining their discount rates use their assumed rates of return. The Chicago funds also utilize the municipal bond rate.

According to research firm Equable Institute, the average assumed rate of return among public pension plans in 2022 was 6.9%.

As of Dec. 31, 2021, the municipal employees' pension fund used a discount rate of 7%; laborers, 6.77%; firemen, 6.75%; and policemen, 6.26%.