What’s Worse Funded Than Teamsters’ Central States? Chicago’s Pensions

view of Chicago’s skyline from rear of train backing into station.Getty

Before the Christmas holidays, I focused extensively on the problems facing Taft-Hartley multi-employer pensions and the PBGC multi-employer pension fund.  Although I’ll be returning to the topic, with a Chicago mayoral election coming up soon (February 26th, no incumbent candidate, 15 candidates, April 2 runoff election if needed), I am taking some time to address the pension issues that next mayor will have to face.

To begin with a comparison:

The Teamsters/Central States’ pension plan, projected to become insolvent in 2025, is 38% funded at a 5.5% valuation interest rate.

The four city of Chicago-controlled pension plans, in total, are funded at a rate of 27%, using a valuation rate of 7% (which, as a reminder, means that on an apples-to-apples basis, they’d be even more poorly funded).  (An Illinois Policy Institute article from October 2018 gives an overview of the numbers; there are additional Chicago pension funds for teachers, park district and transit workers that are not included as city of Chicago funds.)

Of course, one might say that Chicago has the ability to tax its residents, and the Teamsters do not.  But in the same way as the Teamsters cannot simply increase the contributions required of its participating employers without creating genuinely intolerable burdens, so too, Chicago can’t readily solve its troubles with taxation. In 2018, Chicago’s contribution to these funds totaled $1.02 billion and that figure is scheduled to increase to $1.2 billion in 2019 based on a contribution schedule agreed on in 2017.  For reference, the city’s total 2019 spending plan is $10.7 billion.  Do the math:  that’s 10% of the city budget being spent on pensions.

But it doesn’t stop there:  as part of a contribution plan which is meant to ensure the city’s pension plans achieve 90% funding by 2058, and which enables them to use the more advantageous expected-return-on-investments valuation interest rate, contributions are slated to double in five years’ time, reaching $2.1 billion in 2023 and continuing thereafter at the level percentage of payroll necessary for each plan to reach that 90% funding target.  If one assumes that the city budget increases at the same inflation rate that it assumes for its valuations, 2.5%, then this means that in 2023, 18% of city spending will be on pensions .  Where will that extra money come from?  Or, alternatively, what city spending will be cut in order to fund those pensions?

And, lest one think that the city can simply pare back its funding ambitions, those contributions are not simply necessary to meet some arbitrary future funding requirement.  Looking specifically at the largest of these plans, the Municipal Employees’ Annuity and Benefit Fund, funded coincidentally at the same 27% as the city plans in total, if the city were to keep contributions at their current level, increasing them only with inflation, based on the data in the most current actuarial report, and ignoring this past year’s market downturn, this plan would become insolvent in 2027, depleting the pension fund entirely and becoming a “pay as you go” plan, that is, paying benefits directly out of city funds.

But wait, there’s more!

One might be tempted to shrug this off:  Chicago.  Machine politics.  It was ever thus and will always be, and indeed, reviewing past actuarial reports (to their credit, available online as far back as the 80s), for most of the plan’s history, the Municipal Employees’ plan’s funding level was mediocre.  But the plan had made significant strides in the 1990s, and, as recently as 2000, the plan was 94% funded (using, of course, the expected-investment-return method of valuation interest rate determination).

What happened?

Here’s a simple progression of funded status over the past two decades ending at the 2017 actuarial report.  (Note that the figures are hand-typed from the relevant valuation reports; I will of course correct any errors readers might notice.)

MEABF funded status 1997 – 2017own calculations

Why the funded status dropped so dramatically is best viewed by looking at the progression of assets and liabilities —

MEABF assets and liabilities, 1997 – 2017own work

as well as the plan’s contributions (the dip in 2014 is not a typo on my end but reflects benefit cuts which were restored in 2015 when the Illinois Supreme Court declared these changes to have been unconstitutional).

MEABF contributions, 1997 – 2017own work

To do some math, the plan liabilities increased by a factor of three over two decades’ time, at a point when the relevant inflation factor was only 1.5.  But until the implementation of the new funding plan in 2017, contributions stayed level, beginning and ending this two-decade period at $157 million.

And those liabilities did not increase due to some unavoidable misfortune.  Yes, there’s an extent to which assumption changes, in particular, the decline in valuation interest rates from 8% in 1997 to 7% in 2017 (both with the same net-of-inflation assumption, since the inflation assumption likewise dropped from 3.5% to 2.5%), played a role.  And assets have decreased, but not due to a sustained investment loss so much as because those assets were being used to pay benefits.

But that’s only a small part of the explanation.

At present, all employees hired before 2011, are eligible to retire at age 55 with 10 years of service, for the “money purchase” formula, or as young as age 50, with 30 years of service, for the traditional formula, which accrues benefits at the rate of 2.4% per year of service up to 80% pay replacement after 33 years of employment, in either case with a guaranteed 3% compounded annual benefit increase, plus benefits for spouses and children upon death, and disability benefits, and a special extra-generous formula for elected officials, in exchange for an employee contribution of 8.5% of salary (with 3% extra for elected officials), which essentially replaces their FICA contribution but for considerably larger benefits.

But the actuarial report contains a litany of benefit increases.   In 1983, the guaranteed 3% benefit increases were added.  In 1985, accrual factors of 1.8 – 2.0 – 2.2 – 2.4% by years of service replaced existing lower factors.  In 1986, benefit caps for survivor benefits were removed.  In 1987, the penalty factors for early retirement were halved, and exemptions added for long-service employees.  In 1990, the accrual rate was changed to a uniform 2.2% for all years of service that would have previously accrued at 1.8 or 2.0%, the service requirements to be exempt from early-retirement reductions were made more generous, and the more generous elected officials’ benefits were added.  In 1992, a special early-retirement incentive was created with extra benefits for a half-year period.    In 1997, eligibility for early retirement was extended again, minimum benefit levels were increased, and another half-year early retirement incentive was created.  In 1998, the 3% increases were extended to certain groups which had previously been ineligible, and survivor benefit provisions were increased.  In 2002, the accrual rate was increased from 2.2% to 2.4% for all service years, and the maximum benefit increased from 75% to 80% of final pay.  In 2004, another early retirement incentive plan was created.  Only after 2004 did the repeated benefit increases come to an end.  It is whiplash-inducing to see the full list of increases, which continued to grow the liabilities year after year even after the spending spree of increases had come to an end.

All of which means that, while blame can’t be assigned to “contribution holidays” as happened at the state level, none of these increases should have been legislated without the city increasing contributions at the level needed to fund them.

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