*By: Mark Glennon*

 

The significance is enormous but rarely discussed. It runs contrary to a widely accepted assumption in the municipal bond and pension communities that Chicago is liable to pensioners if the pensions run dry. We now have a very firm opinion from a respected lawyer. I’ve looked at the law and the briefs further and I think he’s right. Here’s what John Schmidt wrote in an opinion piece yesterday in the Chicago Tribune:

The city is not legally obligated to pay pensions beyond its statutory obligation to make contributions to the pension funds — an obligation Chicago has always fulfilled. This is not ambiguous, not a lawyer’s argument about what is implicit. The law governing city pensions says, in so many words, that there is no city obligation to the beneficiaries beyond the amount that the city is obligated to contribute to the funds.

Schmidt is a partner at Mayer, Brown, served as an Associate U.S. Attorney General, Harvard Law grad, etc.

 

It sure looks like he’s right. The state could not have been more clear about it in the Illinois Pension Code that established Chicago’s pensions. Here is the statute Schmidt is referring to:

Any pension payable under [the Pension Code] shall not be construed to be a legal obligation or debt of the State, or of any county, city, town, municipal corporation or body politic and corporate located in the State, other than the pension fund concerned, but shall be held to be solely an obligation of such pension fund, unless otherwise specifically provided in the law creating such fund. 40 ILCS 5/22-403.

Unions have a different view. They’ve argued that the constitutional pension protection clause, which was enacted after that statute, overrides the statute. You can find that and their other reasoning in their earlier brief, starting on page 15. The city’s contrary argument regarding two of its pensions (MEABF and LABF) is on page 6 of their earlier pleading in the court challenge to the reform law to those two pensions. In the trial court decision last month invalidating that reform law, the judge seemed to agree with the unions, though the opinion is garbled on that point.

 

The city undoubtedly will be challenging that vigorously in its appeal. It’s possible, however, that the Illinois Supreme Court will sidestep the issue. Even if it doesn’t, you can’t trust the Illinois Supreme Court to apply the law, anyway.

 

Personally, I did think the Illinois Supreme Court reached the right decision earlier this year when it invalidated SB-1, the reform law for the state pensions. The constitutional pension protection clause means what it says, I think. But I also think that the statute quoted above means what it says. I don’t find the arguments against it convincing. The pension protection clause has nothing to do with who is liable for them. When the legislature wanted a particular unit of government liable for the pensions it had to do that expressly, which it did with the state pensions.

 

The consequences are enormous because this opens a clear path to real pension reform. Yes, Chicago is obligated to pay annual amounts to the pensions set by state law. But state law could be changed to allow the city simply to stop funding the existing pensions and begin funding a new replacement in amounts that are reasonable and affordable. The replacement could be a traditional defined benefit plan, 401(k)-style, a hybrid or whatever is decided. If the city is not liable, a bankruptcy proceeding covering just a pension would also be more viable. The city, however, is using the argument as part of its reasoning that the reform bill before the court  is valid. To heck with it and other reform bills that have gotten through the legislature. They wouldn’t accomplish much and would still leave us with a rotten system.

 

We’ll have to wait to see if we get the right result on this issue.

 

Update: For a good summary of Chicago’s pension problems, read this brief filed earlier this year.

 

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

 

 

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Jim Palermo

I would think more active workers in public sector defined benefit plans would be demanding their employers change to a defined contribution plan. When you consider that nationally, hundreds of thousands of workers are in plans where the annual plan benefits exceed the combined employer and employer contributions; where there are nearly as many retirees as there are active workers (and sometimes more in actives than actives); and where the liabilities due the inactives exceeds plan assets, the astute DB must realize that he could have greater retirement security if he were in a DC plan.

mark glennon

Can you imagine being a Tier 2 participant in paying into, say, the Chicago police or fire pensions, that are in fact something like 20% funded? Crazy. I would want all my contributions going into my own DC plan.

Tough Love

It continues (to the extreme detriment of the newer/younger officers) because the oldest, longest service workers control the Unions.

The younger/newer Officers don’t seem to “get it’ that their older “brothers” don’t really give a damn about THEM and want … all that they were “promised” ….no matter how costly and now impossible it is to honor the (absurd) promises.

Mike
What happens next in the City of Chicago MEABF and LABF pension reform case? It’s being appealed to the Illinois Appellate Court? What’s the current status and next steps? The case being: Mary J. Jones et al. v. MUNICIPAL EMPLOYEES’ ANNUITY AND BENEFIT FUND OF CHICAGO and BOARD OF TRUSTEES OF THE MUNICIPAL EMPLOYEES’ ANNUITY AND BENEFIT FUND OF CHICAGO and CITY OF CHICAGO (Defendant-Intervenor) and STATE OF ILLINOIS (Defendant-Intervenor) Case No. 2014 CH 20027. and Jeffrey Johnson, et al. v. MUNICIPAL EMPLOYEES’ ANNUITY AND BENEFIT FUND OF CHICAGO and LABORERS’ & RETIREMENT BOARD EMPLOYEES’ ANNUITY AND BENEFIT FUND OF CHICAGO and CITY OF CHICAGO (Defendant-Intervenor) and… Read more »
mark glennon

Yes, that’s the case in which the issue is being argued by the city. It’s going up on direct appeal to IL Sup. Ct. Oral arguments in November.

Jerry D. Davis

The author’s point makes “a distinction without a difference”. The employer is required to pay the annually-calculated actuarial contribution, which necessarily takes into account the cost of all benefits accrued to date. Sure, it’s the trustees who face the direct obligation to pay benefits, but in all cases I’m familiar with, they have the legal authority to mandate all required contributions, If they neglect the necessary steps to collect the funds due, they are personally liable for the consequences of that neglect..

Jerry Davis
former Chairman/CEO, New Orleans Employees’ Retirement System.

Tough Love

I guess you missed the NJ Supreme Court’s recent ruling …. “funding” of NJ’s pension cannot be forced by NJ’s Courts. The Legislature (now Democratic and “in the Public Sector Unions’ pocket”) must fight it out with the Governor (Christie, a Republican who rails at the grossly excessive and unaffordable promises of NJ’s pension Plans and demands pension benefit Celle reductions, NOT further tax increases).

Bravo to Christie, but even better …. Scott Walker for President !

mark glennon
Mr. Davis, with all due respect, I have to say that’s an example of so many wildly incorrect things I see being said even by professionals in the pension system, as you apparently were. The employer in Illinois, like most places, is required only to pay in what the legislature sets. Here, as in so many other places, that number has not been set anything close to annually actuarially required contribution. For Chicago’s pensions, the contributions have been set at only about 1/4 of ARC. And trustees have no liability or power to collect anything beyond what is set by statute. I would also be curious to… Read more »
Jerry D. Davis
The funding for NOMERS, which reached 105% during my tenure, began to collapse when the new mayoral administration announced an across-the-board cut in funding for every city agency, resulting in the pension plan being stiffed that year (2010) to the tune of $7 million. The Louisiana Trust Code, supplemented by the Louisiana Constitution, required me to sue to collect those funds. The case still pends, though the City has offered no relevant response – in defiance of all law and precedent, the court system has simply declined to issue a ruling after the trial was held. Meanwhile, after I retired in 2011, the mayor has gained a… Read more »
Mike

New Orleans Municipal Employees Retirement System (NOMERS) Annual Actuarial Valuations and Annual Independent Auditor’s Reports are in non searchable image pdf format (as opposed to searchable) on the NOMERS website.

NOMERS has a searchable copy.

Why does NOMERS not provide taxpayers with a searchable copy?

The Actuarial Valuations reveal a more complete picture of NOMERS than described by Mr. Davis.

Basically Mr. Davis is saying over the decades the government can jack up benefits and salaries and force the taxpayers to fund the hikes.

http://www.nola.gov/nomers/about/annual-reports

Steve-Oh
Mr. Davis: Anyone associated with decisions in New Orleans over the last 20 years should be ashamed of themselves, with respect to pensions for the govt ees. Pensiontsunami.com had an article a few months ago about the N.O. Firefighters pension, and the irresponsibility of decision-makers was staggering. A fireman retiring with 30 years of service was given a pension of 3.33% of pay per year, making 100% of Final4AvgPay as the pension. When the formula did NOT say 3.33% for all years. And COLAs were given for 15 years up to 2012 of 3% and 5% each year to retirees. The pensions and DelayedRetmtOption plan are SO… Read more »
Jerry D. Davis
As one of the principal implementers of DROP, I do understand fully its financial implications, which is why I persuaded the City Council to approve annuitizing the DROP payments, which created a net benefit to the City AND the employees. I had no part in the Firefighters pension debacle, other than advising the City Council, which declined the advice, that the Pension Obligation Bond method would be a disaster. It was, and it is – costing the City an extra $150 million as the assets raised disappeared through investment fees and probable kickbacks to consultants, as well as paying pensions for the original cash-basis pension system. The… Read more »
Steve-Oh
No Jerry: But it does make it look less horrific. Thanks to Mike linking the Actuarial Report for 1/1/14, I see the Liabilities at 7.5% discount rate. But assets have only earned approx net 5.5% this century (15 years since 1/1/00) and likely to do that badly the next 20 years. Then LIabs would be 30% higher. So even the NON-ACTIVES would have LIabs of not 360M, but more like $450M, and assets are just 360M. That means there’s not enough put away for the Non-Actives, and that means ZERO available for the 1,000 Actively employed participants. In my books, that’s a disaster. And what do you… Read more »
Jerry D. Davis
As I read the report, it seems clear that the assets have earned 7.52%, not 5.5%. As for your opinion on the next 20 years, I can only look at my own experience as a private investor since I retired in 2011 – my personal portfolio has earned an average of 10.4%. Granted, with hundreds of thousands rather than hundreds of millions, I can be more agile, but unless the consultants and trustees deliberately screw it up, a pension fund with professional investment advisors should certainly manage 7.5%. As market history shows, there will ALWAYS be double-digit returns somewhere among the investable products. Flexibility and attention to… Read more »
Steve-Oh
Jerry, my comment was about this century, since 1/1/00. And as I (very quickly) look at it, it seems the plan assets have earned LESS than 5.5% compounded in the 14 years shown, 1/1/00 to 1/1/14. I’ll prove it later. But the real returns have been atrocious, and are a large part of the actuarial losses that result in ginormous unfunded liabilities — basically Mark is exactly right, and I’m exactly right — the benefits are simply too large and paid too early, to have ANY chance of funding them sufficiently. Even with the 7.5% assumed ROR, the liabilities of the non-actives are same size as assets,… Read more »
nixit71
Jerry – I appreciate your input here, but I have to disagree on the assumed actuarial ROR. It’s great that your assets have indeed earned 7.52% over the long-term, but isn’t it risky for the actuaries to assume that average for future returns for hundreds of thousands of state retirees? Shouldn’t those actuarial assumptions be on the conservative side, like Steve-Oh’s 5.5% rate above? IL was assuming 8% ROR for a long time in their state pensions, a practice that is being heavily scrutinized by actuaries and citizens alike. And high ROR assumptions tend to mask the true cost of the benefits offered, leading to shortfalls future… Read more »
Jerry D. Davis
Regarding the 7.5% assumption: among the many associated responsibilities of trustees is the basic need to run the fund efficiently and keep it affordable. Some risk is necessary: if the actuarial assumption is lowered, the immediate consequence is the increase in the required employer contribution – that is simply the mathematics of it. If you assume lower investment earnings in order to ‘be conservative’, the unfunded liability will rocket higher because you’ve just said you’re assuming less money will be earned over time. And no, you can’t just lower the benefits when you lower the assumption; there’s a little thing called the US Constitution, where the Contracts… Read more »
Steve-Oh
Jerry: I just calc’d the net inv return on NOMERS assets from 1/1/00 to 1/1/14, and it’s worse than I guesstimated 5.5%. Those 14 years shown near the end of the Valn Report on the page of detailed asset flow…….show an arithmetic average of 5.7%/year, but more importantly/correctly/precisely, the compounded return for the 14 years has been 4.7%/year, compounded. And “no”, I was not saying that a lower long-term more reasonable, more conservative ROR assumption such as 5.5% on the assets would imply “just lower the benefits” as a result…….but it certainly WOULD imply that the plan benefits are unaffordable, completely, totally unaffordable for the private sector… Read more »
Tough Love

Jerry, When (not If) Plan assets run out and it becomes (theoretically) a pay-as-you-go system for retiree payouts to continue to be made, NO’s Elected Officials will quick realize that there is ZERO possibility that taxes can be sufficiently increases to support ongoing pension payments.

There is NO QUESTION that very material pension reductions for retirees as well as actives will result … and it’s LESS THAN 5 years away

Steve-Oh
Mark/Mike: What I described above at 6:56am is the DelayedRetmtOptionPlan (DROP) — it’s part of the pension plan of course, but say someone gets 30 yrs of svc at age 54 or 56 or whatever age w/ 30……they can collect their 83% of avg pay prior 4 yrs…..AND keep working…..in other words, they start making 183% of pay for the next couple yrs, generally 5. Howz that for a sweet deal. And Jerry pretends he helped the situation by “annuitizing” the DROP pension payments rather than saving them as many DROPlans do and paying lump sum of the “unpaid” pension pymts which can be rolled to IRA.… Read more »
mark glennon

Mr. Davis- Interesting, and thanks for that explanation. The law on funding mandates is obviously different for you compared to Illinois.

mark glennon

Exactly. And with each day that passes without reform, those two Chicago pensions go another $2M in the hole. It’s the pensioners ultimately who will be hurt by opposing reform. Read that brief linked at the end of the article. http://www.suaa.org/assets/pdf/2015/AmicusCityOfChicago.pdf. It’s a great summary of how horrible the Chicago situation is.

Jim Palermo

For many years some public pension plans sought to reduce employer pension contributions and boost wages by using flawed actuarial assumptions on mortality and investment returns, relying on the state constitution to guarantee underfunded pension benefits. If Mr. Schmidt is correct, and I believe he is, the retirement security of thousands of Illinois public employees has become more tenuous.. I feel badly for the retirees and active workers, but it was the greed of ambitious politicians and labors leaders, seated on the same side of the negotiating table, that caused this debacle.

Tough Love

The workers were promised pensions (AND benefits) FAR greater than necessary, just, fair (to the Taxpayers paying for almost all of it), and clearly unaffordable.

There is ZERO justification for the Taxpayers (whose own pensions are TYPICALLY 1/4-1/3 in value at retirement) should fund this gross excess.

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