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By: Mark Glennon*

 

If you’re not exasperated  by Chicago’s approach to pension “reform,” you haven’t been paying attention.

 

The absurdity into which it has descended is anything but “reform.” Nothing good will come out of the Illinois Supreme Court’s decision on the reform case it heard this week. In fact, upholding Chicago’s reform law could constitutionally lock in pension funding obligations far beyond what taxpayers would endure. Here’s a recap:

 

On Tuesday the Illinois Supreme Court heard oral arguments in the appeal on SB1922. That law, which a trial court earlier struck down, would reduce benefits for two of Chicago’s four pensions, the Laborer’s Fund and the Municipal Fund.

 

That same law, if upheld, will require increased contributions to those pensions, ramping up gradually to what’s misleadingly called an “actuarially required contribution” — the “ARC.”

 

But the city is already supporting legislation to reduce its annual pension payments. Even with the entire $500 million-plus new property tax designated to go entirely to the police and fire pensions, the city is about $220 million short. So, the city wants Governor Rauner to sign a pending bill to lower scheduled payments to the police and fire pensions and extend the deadline for fixing them.

 

In short, Chicago is arguing to uphold a law requiring higher contributions to two of its pensions while seeking legislation to lower contributions its contributions to its other two.

 

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On the right is the city’s estimate of scheduled, combined annual payments required from taxpayers for Chicago’s four pensions, assuming the court upholds SB1922 for the Laborers’ and Municipal pensions and the current contribution schedule stays for police and fire pensions. (It comes from Table 15 of the disclosure document filed in June by the city for it general obligation bonds.)

 

Backloading (or can-kicking, if you prefer) is obvious, especially for a city with no population growth. And that’s just the city’s own rosy projection. Backloading likely will worsen significantly and required contributions will be higher, however, for two reasons. First, Chicago may get its reduction in near term requirements for funding the police and fire pensions, deepening the annual underfunding.

 

Second, the real contribution required will be whatever-it-takes, hell-or-highwater amounts, starting in five years for the Laborers’ and Municipal Pensions. That is, full ARC payment must start in the year 2020. For police and fire pensions, a sort of modified, backloaded version of that is already in place. (See the Civic Federation’s description of that linked here.)

 

What that means is that if things don’t go the way the way the actuaries predict and they are forced to change their assumptions, taxpayers must make up for the resulting shortfall. The funds assume they will earn 7.5% – 8.0% on their investments, an assumption that’s widely ridiculed. Many other assumptions on things like how long retirees will live and numbers of new employees may also prove faulty and result in higher liabilities for the city.

 

Chicago, by the way, uses the same actuarial firm for three of its four pensions that Detroit used before its bankruptcy. After bankruptcy, Detroit’s emergency manager got reports from a new actuary saying the city’s pension liabilities were billions higher than previously thought. According to the New York Times, the firm used before bankruptcy “was sued after Detroit went bankrupt by city workers and residents who accused it of professional negligence. They complained, among other things, that the firm based calculations on the assumption that the city payroll was increasing when in fact Detroit was collapsing and its payroll was shrinking.”  It’s easy to find plenty of other news stories on that chapter in Detroit. I will have to let you look at those and decide for yourself if Chicago’s officially reported pension liabilities are realistic. UDATE, 11/21/15: A Forbes article yesterday by a prominent actuary discusses Detroit’s experience with that actuarial firm.

 

Now, keep in mind that SB 1922, the reform law being decided by the court, won’t reduce benefits or pension costs very much if it’s upheld. The annual savings on taxpayer contributions is already reflected in that schedule above. The law would reduce the unfunded liability by only about $2 billion, or 10% of the city’s total unfunded liability, according to one independent analysis, (The city has not published any scoring of the reform bill to my knowledge, and reporters never ask for it). Whoopee. That would put us back to where we were only about a couple years ago, given the rate at which these funds are deteriorating.

 

In short, the can is being kicked, big time, and there’s nothing on the table that will end it.

 

And it will get much uglier if one the city’s own legal positions is accepted.

 

If the court upholds the reform law, according to the city’s own lawyers, it will be constitutionally prohibited from ever cutting back on the new, higher, whatever-it-takes funding schedule. Pension benefits cannot be cut under the pension protection clause but they can be underfunded. Underfunding has been routine and, in some years –“pension holidays” — contributions were skipped entirely.

 

But this reform bill contains a particularly strong “funding guaranty.”  Funding guaranties attempt to assure that scheduled pension obligations get made. We’ve been writing about how insidious they are for a couple years. They are routinely stuck into pension reform bills. On Tuesday, one justice asked the city’s lawyer what would prevent the legislature from repealing the contribution schedule in the new law. He answered that the new law’s funding guaranty is so strong it would create a constitutionally protected contract right for each pensioner!

 

In other words, he said the city would be entirely waiving its claim that the city is not obligated to fund its pensions. If that claim is valid, it should have been used as the keystone of real pension reform — just stop funding the old pensions and fund, instead, a new, affordable system. Instead, we may well end up with a ruling that constitutionally forces pension contributions. Such a ruling might well apply to many other pensions.

 

Mayor Emanuel inherited a backloaded pension time bomb. However, he is making no serious effort to fix it. The “Edgar Ramp” is the term we now use for the can-kicking pension funding schedule for IllinoUntitledis state pensions signed by former Governor Jim Edgar. It became unaffordable, and it’s rightly blamed as a major cause of our state-level pension crisis.

 

 

Regardless of how the court disposes of SB1922, Chicago will face a similarly impossible ramp-up of pension contributions. If Mayor Emanuel completes his term having only extended it, expect it to become known as “Rahm’s Ramp.” If SB1922 is upheld using the city’s own rationale, expect it to become known as “Rahm’s Irrevocable Ramp.” It’s charted on the right.

 

Mark Glennon is founder of WirePoints. Opinions expressed are his own.

 

 

 

 

 

 

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there are comments on this thread about retiring outside of illinois. the reality is that with the expense of pensions, and the increased taxes they will require (barring a massive cut in govt spending) even residing inside the state and making a living here will be challenging.

Rick

Retiring outside Illinois, will become a very popular thing in the future. It will be the natural thing to do, it will be the smart thing to do. Especially when they start taxing retirement income. Retirees who do stay, even those retiring from the public sector, will only be here because of kids or other ties they can’t break right away. I’m making my plans in 5 years, and I never saw any urgency before to consider moving, now I do.

Anonymous

Simple math, For Chicago Fire and police, the math is $1.1 billion this year just to keep it equally unfunded. If http://www.wirepoints.com/an-actuary-slams-chicagos-pension-payment-bill-wp-original/

Peter Quilici
The issue now is the taxpayers’ ability to fund all this. According to Census records, household income in Chicago peaked in 2007 then declined. A bit up now but no recovery to 2007 levels. Also, the California Public Employees Retirement System, the largest gov employee pension system in the US, recently announced it is reducing its expected rate of return from 7.5% to 6.5% over 20 years. This will result in increased demands for funding from California taxpayers. Expect Illinois’ 600or so pension plans to follow, including Chicago. You can play the blame/entitlement/we’re worth it/sacred contract/constitutionally protected scenarios over and over, but it appears that the taxpayers’… Read more »
nixit71
What does funding pensions at 100% mean? It means that the citizens consuming the services provided by public sector employees pay their full share of the true cost of those services at the time of consumption. Simple as that. Anything less is dine-n-dash. A veritable can kick. Is 80% enough? Well, to paraphrase Mary Pat, are we planning to pay out only 80% of each pension? The state constitution says otherwise. Rate of return assumptions should be conservative to ensure that fair share is paid. This, of course, would mean a higher employer contribution every year. That would also mean higher taxes. Is an 8% ROR conservative?… Read more »
Anonymous

My question is very simple. Its a question for “its the math” crowd. If the math does not allow pensions to be funded at 100%. What % of funding does the math then suddenly work? Answer this question. Otherwise your its the math becomes simply a naked talking point. You assert its the math… than please like a good math student does….show your work. AT WHAT PERCENTOF FUNDING DOES THE MATH SUDDENLY WORK?

nixit71
Actually, the math works at all percentages of funding levels. The question is how much you want to deduct from the overall employee compensation package to make up for the shortage of funding. Each state employee has an overall compensation package. It is comprised of many elements, such as wages, health benefits, and of course, pension benefits. The pension is comprised of many elements, one of which is the 7.5-8% assumed rate of return. All these components work together to provide one fixed amount (let’s call it X) that is your total compensation. So if you’re not going to fully fund the pension upfront with today’s dollars… Read more »
Anonymous

Simple math, full payment is $2.6 billion
for all 4 Chicago pensions, fire police muni workers and laborer’s. http://www.wirepoints.com/why-chicagos-500-million-property-tax-increase-wont-solve-much-wp-original/

Anonymous

Newsflash: They tried to privatize north riverside expensive fire department to cut costs.
Unions stopped them. Jc

Anonymous

Th contact expired, unions are delaying in court, waiting for election, to vote out officials that don’t kiss union *ss

Anonymous

Something about a contract that needed to be honored if I rember right. When the collective bargain expires then privatize away. But not in the midst of it. Simple.

nixit71

Would that be the contract that expired 18 months ago?

nixit71

What amazes me is how locked-in the employee contribution % is to the state constitution. You would think over the decades, the employee contribution would be adjusted upward/downward based on actuarial assumptions, market changes, etc. But the employee contribution rate cannot be raised unless the govt gives something in return (like raise COLA, increase the service years multiplier, etc). The employee contribution rate used today is still based on assumptions made generations ago. That is crazy.

Dr X

That`s not including the cost of health care for retiree`s which is in the court system now as well.

Anonymous
Newsflash: paying for govt. services is not cheap. If you dont want as many teachers or police. Then cut the ranks of the teachers and police. Simple. If you do want teachers and policemen, in the desireable quantity and quality, then you must fairly compensate them for thier labor. Pensions are part of the compensation. What is irrational is to think that we can get quality govt. services and get them without paying market value for that labor (welcome to tier 2:lower compensation will lead to lower quality labor leading to lower quality teachers, police, et al.) I can remember 3-4 years ago when Wirepoints and company… Read more »
mark glennon

There is no “us,” or “them” or “you” or “they” in this.

It’s math. Just math.

It will take another six or seven years to know who fails, and whether Illinois fails along with them. You can then tell your kids and grandkids what you stood up for, and I will tell mine something different.

100% correct re the math. You can be a partisan hack all you want, but you can’t fight math.

Anonymous
Ok…I will bite. Its simply the math. Pensions cannot be funded at 100% level. Then we are reduced to the simple question: at what % of funding does the math suddenly work? Is that at 99%? Or is that at 01%? Or somewhere in between. If ya “know the math” and its a ” math” problem then the answer can be computed. Or allready has been calculated. And in the “math” problem…..the all important question….who else ( bondholders?) takes a haircut in the “math” problem? State assets? Its a math problem has become the new talking point mantra of the pension reform crowd. Otherwise known as the… Read more »
Jim Palermo

If sound actuarial assumptions had been used for investment returns and mortality; and if sound practices had been used for funding schedules, it would have been apparent that the benefits were more costly than the taxpayers would tolerate. Instead, politicians have for years dreamed up ways to postpone the contributions to fully fund the plans. But labor bears responsibility here too; its actuaries should have predicted how costly the plans would have been if full contributions were made. Had all this been done, our state wouldn’t have scores of local and state pension plans nearing insolvency

Anonymous
You make sense Jim. But we are here now. And for the mathmaticians in the know who spew out “Its math. “Its just the math” then to them I ask the simple question again: at what percentage level of funding does the equation ballance and the “math” now work? Not a difficult question if you truely indeed “know the math”. Does the math work at 01% of funding? Does the math work at 50% of funding? What is the sweet spot where the “math” works? Or do we simply spew out a talking point “Its the math” without actually knowing the math….or without stating what does(pension reductions)… Read more »
mark glennon

There are hundreds of articles linked on this site from people who know the math, from Nobel Prize winning economists on down, showing why this system is broken.

When you ask for precise numbers on how to fix this system you are asking critics of the system to pretend that one of its fundamental flaws isn’t there, and that the system should be kept. That is, this system promises fixed, certain benefits but its built on sand — assumptions about unknowable variables like returns on assets, life spans and many other things.

Anonymous
Mark wirepoints does a fine job of linking resources. Resources with numbers and resources with analysis. I thank you for your effort towards the quality of wirepoints. I also enjoy reading your viewpoint and sometimes provide a counterpoint. Nobody should expect presise numbers and I would not ask for that regarding the math. Lord knows the learned actuarials havent been presise. But “the math” certainly should put us in the “the ballpark of numbers…an approximation if you must. At what percentage (approx) does “the math” switch from not working (currently) to working(future)? With an eye towads a solution for our pension problems many feel unions should walk… Read more »
nixit71

Agreed. The moral, ethical, and philosophical principles all got thrown out the door anyway with the first 20% pension spike.

mark glennon
It’s when the tax burden to fund those pensions becomes so large that you are not generating the jobs, growth and revenue needed to honor promises made and other obligations to the population. Opinions vary on when that happens, It depends on which entity we are talking about and other factors. I will be writing a piece shortly about taxes in the south suburbs, most of which are far past that point. For the state, in my opinion, Illinois could probably withstand some additional tax — perhaps expansion of the sales tax to services and a small increase in the income tax, IF that’s combined with other… Read more »
Anonymous

Maybe when people say its the “the math” thier ready to sacrifice many of thier principles and are throwing out a term that really is quite nebulous.

Advocate

All of the anonymous posts here have been posted by me up to this time.. I just noticed the request for a nickname. I will use one from here on out.

nixit71
“lower compensation will lead to lower quality labor leading to lower quality teachers, police, et al.)” Good point. So should we tell these folks to head back to the employment line at Fermilab now? Federal funding can be tricky, though, so I suggest they submit their updated resumes to Abbott Labs and Takeda first, lest their lab coats be taken away before they’re even put on. Then again, why do either of those if they’re already sitting on awesome MCAT scores? The world anxiously awaits all the medical, science, and liberal arts contributions these folks have to offer. After all, we wouldn’t want them commiserating with those… Read more »

How does one validate that any of the cit services mentioned are actually doing a good job??? That these are the best of the best. It is cronyism run amok.

Anonymous

Bet you thought the “Manhatan” project was not a govt. operation. The govt. run space industry as well. But more seriously. You get what ya pay for. Pay cheap tier 2 get cheap professional’s in your govt. ranks. Simple.

nixit71
Don’t be so sure. My hometown still gets piles upon piles of applications for all police, fire, teacher, and various municipal job openings. Many qualified citizens and each one a would-be Tier 2 employee. Me thinks these govt salary and benefits, in general, stack up pretty well when compared to other opportunities available to those applicants. So is every hire since Tier 2 was created in 2011 one of “low quality” as you imply? I wouldn’t say that. But tell you what…let me forward your comment to IEA, SEIU, AFSCME, IFT, or any of the other local union affiliates that represent those “low quality” members and ask… Read more »
nixit71
Yes, I’m saying the overall compensation package compares fairly well even with the lesser pension, especially when compared to equivalent positions in the private sector (queue S Moderation Douglas and his States Attorney stories of woe). There’s no question Tier 2 needs to be modified for the employee benefit. The pendulum shifted way to far in the other direction. I’m merely questioning the logic that govt will suddenly be occupied with cro-magnon employees because of Tier 2. Because it’s not like Tier 1 was attracting the best and brightest across the board, as evidenced by the mounds of debt, byzantine processes, and overall malaise. I would wager… Read more »
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