Two articles separately highlighted the city’s overwhelming debt and crime problems, with two paragraphs in two important documents giving particular pause.
The first paragraph was tied to a New York Times article by Andrew Biggs, titled “What’s the matter with Chicago?”, in which he said, “the word bankruptcy has been hanging over Chicago like a storm cloud about to burst.”
Part of his evidence for bankruptcy was the city’s own pension actuaries warning of “potential insolvency” for the city’s biggest pension system. The Municipal Employees’ Annuity and Benefit Fund is just 22% funded and has one of the poorest liquidity positions in the country.
In its letter to the pension fund’s board members, the actuary wrote:
“Given the low funded ratio and the expected timing of employer contributions, the Fund is still at risk of potential insolvency if an economic recession or investment market downturn were to occur in the near term.”
It’s not just the municipal fund that’s in trouble. Chicago’s three other city-run pensions are in equally bad shape, and so is the pension fund for Chicago teachers. Adding up all their debts, Chicago has $53 billion in unfunded pensions. It’s one of the big reasons the city has the worst credit rating in the nation.
You can’t help but think that if you bring your business to Chicago, you’re sure to be a target of the massive tax hikes the city will pursue to stay afloat.
….
And as for pensions, Mayor Johnson’s pension working group has yet to offer a single idea – or even report back.
The Windy City needs real pension and spending reforms, tax cuts and a revamped criminal justice system that treats criminals like criminals. Until then, people will continue to leave while the companies and investments Chicago needs to revitalize itself will stay far away.
In case you missed it, the unfunded liability almost doubled from 2014 to 2023. For no year in that period did it shrink. The best they did was hover for 2020 to 2021. That’s probably because a bunch of people died early.
The piece by Andrew Biggs they link to, let me give a bit:
The word bankruptcy has been hanging over Chicago like a storm cloud about to burst. Mayor Brandon Johnson is the latest leader to attempt to close Chicago's gaping fiscal gap: He proposed a $300 million property tax increase to partly fill Chicago's $982 million projected budget deficit, only to have it be unanimously rejected by the City Council. The Council narrowly passed a budget on Dec. 16, with far less in tax increases than the mayor had initially demanded.
….
At the heart of Chicago's deficit are decades of increasingly generous retirement benefits offered by Chicago's leaders to more than 30,000 public employees, a politically powerful constituency. Today, a city employee retiring after 35 years with a final salary of $75,000 would receive combined pension and retiree health benefits of about $77,000.
The city government has failed to fund those pension promises fully and the bill has come due. Retirement benefits and debt service together made up 43 percent of Chicago's budget in 2022, the highest rate of any U.S. city. Chicago spends more on debt and pensions than it does on the police and infrastructure, according to an analysis from the Illinois Policy Institute, a libertarian-leaning policy group. In other words, Chicago is paying for the past, not investing for the future.
….
Chicago owes bondholders almost $29 billion. It also faces $35 billion in unfunded pension liabilities and almost $2 billion in unfunded retiree health benefits. And these figures do not include an additional $14 billion in unfunded benefits owed to Chicago's teachers. The watchdog group Truth in Accounting gives Chicago a grade of F for fiscal responsibility, ranking it 74 out of 75 cities. (New York City is last.)
City leaders may continue to ignore these warnings. If the pension fund does get close to insolvency, Chicago can most likely keep the pension checks flowing by suspending payments to bondholders. Illinois has no legal provision for Chicago to declare bankruptcy, meaning the state would be forced to rush legislation into place to prevent financial chaos.
The Actuarial Report in Question
The actuarial report being quoted is from May 2024. It’s for the Municipal Fund, you know, the one that was going to have run out of cash last year before Chicago finally woke up and realized “oh yeah, we’d better increase the contributions by A LOT” within the past decade.
Yes, the actuaries had been yelling about this problem for years before the politicians finally agreed that, FINE OKAY we’ll put more money into the pensions.
As for the warning about potential insolvency — and you need to understand what insolvency means in the context of public pensions: it means all the assets running out — that was placed on page 4 of the document. It wasn’t hidden.
The whole section is below:
I haven’t brought back my 80% funding hall of shame (and, in this case, it’s a 90% funding target), but Illinois in general has crap targets for funding.
If you wonder why so many of their pension funds are woefully underfunded, their awful targets are simply a part of the reason. It gives them an excuse for putting too-small contributions in. Even though the entire time the actuaries yell at them for picking the wrong targets.
The full report is 137 pages, so let us sample from a few more of the pages.
Section 1: Actuarial Valuation Summary Highlights
Page 10: Risk of asset death spiral
Okay, that’s not what it says. It says they may have to liquidate assets for present cash flow needs (aka, we gotta pay the benefits right now.)
MEABF has a very low funded ratio. The employer contributions (in cash) don’t necessarily come in at times convenient - that is, when the benefits need to be paid. So they might have to liquidate assets to pay for those benefits, instead of letting them sit there, accruing investment returns.
If you have to liquidate assets prematurely, you may have to sell at a less-than-advantageous price. This is called liquidity risk.
As is usual practice for Chicago and Illinois funds (excepting IMRF), they undercontribute. It’s written into law.
And yes, that’s $1.2 billion with a b that should have been contributed. Instead, by statute, the employers would contribute only $940 million instead.
They have been told the contributions are inadequate. They’ve been told for decades. They don’t care. They assume the benefits will always be covered. By magic, I suppose.
Note that I am taking screenshots from the PDF. All the emphasis is in the original document. While I tend to make pointed emphasis by bolding things, this is not usual in actuarial reports. I copied these two bits because they stood out in the original report.
Section 2: Actuarial Valuation Results
There is a variety of stuff in this part. I wanted to highlight a few items myself.
History of cashflows:
2022 and 2023 were the first years in which contributions were higher than benefits paid. This is not necessarily a bad thing — if the assets had been sufficient to throw off enough investment income to cover benefits in prior years. But they weren’t.
I mainly want to point out the rapid growth rate in contributions, which was absolutely necessary to prevent the assets from going into a death spiral of being completely liquidated.
The problem is that Chicago really can’t afford to keep up the growth in contributions needed to make sure that MEABF is well-funded. It’s not going to happen. Chicago is cash-strapped.
Development of liability by cause:
This one can be difficult for many to follow, but let me try.
Numbers in parentheses are boosts to the size of the pension liability. Regular numbers are actually reductions to the liability.
Let me focus on 2023: (the leftmost column)
Due to turnover, the pension liability decreased $14.6 million, then due to new retirements, it increased $39.0 million.
I don’t like the euphemism “pay status experience”, but it includes beneficiaries and not only the retirees, so I get it… but let me make it simple. Because a certain number of people died in 2023 and pension benefits stopped, the liability decreased $10.2 million.
The next item is the bloody giveaway: because of union salary increases, the pension liability increased $112.0 million.
Due to new entrants to the pension system, aka new employees, the liability increased $25.9 million.
The OPEB liability change is minimal — OPEB is non-pension retirement benefits like healthcare and other ancillary benefits. Then there’s a miscellaneous catch-all item.
Notice in this table that the “salary” row tends to have the largest effect. That might give you an idea of what one of the most important valuation assumptions here is.
Low-Default-Risk Obligation Measure (LDROM)
This is the ASOP 4 (Actuarial Standard of Practice 4) item I had been waiting for, and had forgotten about, what with my preoccupation w/ Stu and all the 2024 stuff.
I am copying over all the verbiage on this one.
In December 2021, the Actuarial Standards Board issued a revision of Actuarial Standard of Practice No. 4 (ASOP 4) Measuring Pension Obligations and Determining Pension Plan Costs or Contributions. One of the revisions to ASOP 4 requires the disclosure of a Low-Default-Risk Obligation Measure (LDROM) when performing a funding valuation. The LDROM presented in this report is calculated using the same methodology and assumptions used to determine the Actuarial Accrued Liability (AAL) used for funding, except for the discount rate. The LDROM is required to be calculated using “a discount rate…derived from low-default-risk fixed income securities whose cash flows are reasonably consistent with the pattern of benefits expected to be paid in the future.”
The LDROM is a calculation assuming a plan’s assets are invested in an all-bond portfolio, generally lowering expected long-term investment returns. The discount rate selected and used for this purpose is the Bond Buyer General Obligation 20-year Municipal Bond Index Rate, published at the end of each week. The last published rate in December of the measurement period, by The Bond Buyer (www.bondbuyer.com), is 3.26% for use effective December 31, 2023. This is the rate used to determine the discount rate for valuing reported public pension plan liabilities in accordance with Governmental Accounting Standards when plan assets are projected to be insufficient to make projected benefit payments, and the 20-year period reasonably approximates the duration of plan liabilities. The LDROM is not used to determine a plan’s funded status or Actuarially Determined Contribution. The plan’s expected return on assets, currently 6.75%, is used for these calculations.
As of December 31, 2023, the LDROM for the system is $29,752,140,183. The difference between the plan’s AAL of $19,368,874,758 and the LDROM can be thought of as the increase in the AAL if the entire portfolio were invested in low-default-risk securities. Alternatively, this difference could also be viewed as representing the expected savings from investing in the plan’s diversified portfolio compared to investing only in low-default-risk securities.
ASOP 4 requires commentary to help the intended user understand the significance of the LDROM with respect to the funded status of the plan, plan contributions, and the security of participant benefits. In general, if plan assets were invested exclusively in low- default-risk securities, the funded status would be lower and the Actuarially Determined Contribution would be higher. While investing in a portfolio with low-default-risk securities may be more likely to reduce investment volatility and the volatility of employer contributions, it also may be more likely to result in higher employer contributions or lower benefits.
No problem; I’m going to give some commentary.
After all, this is the whole reason I wrote this post in the first place.
There is a $10 billion difference between the AAL (using a 6.75% discount rate to value the liability) and the LDROM (valuing at a low-default risk rate of 3.26%.)
In the official report, the explanation being given is that the $10 billion-higher value of pension liabilities is if you invested solely in low-default-risk securities such as U.S. Treasuries (though, that may be pushing certain assumptions as well.)
I have an alternative interpretation.
We already know that the liabilities are being valued by pretending that assets returning 6.75% to provide those benefits as a sure thing — that’s how the AAL is calculated. Well, 6.75% is no sure thing, to be sure, and if nothing else, we know that Chicago certainly doesn’t have the assets on hand to provide the benefits already accrued so it’s a bit rich to pretend you have the non-risk-free assets on hand to cover those benefits by which you’re going to make that valuation.
“But we plan on having those assets at some point” doesn’t even make much sense, given this is Chicago. I mean, would you trust that basis of valuation?
The concept of the LDROM is what the value of the liability should be, if we could really depend on that liability being paid. It would have to be something with low default risk, right?
That’s not Chicago, that’s for sure. And not assets that aren’t there.
Maybe there needs to be a “probability of default” metric, especially given there is no backstop for public pensions.
Yes, yes, yes, I know various public finance folks would like to argue a different interpretation of LDROM, but it would come better from those with better-funded pension funds.
Frankly, it doesn’t matter much if one calls MEABF 22% funded or 10% funded.
I can understand if much better-funded plans might get annoyed if they look close to fully-funded, but under LDROM they look poorly funded. That’s a different matter. I will be looking to see how other plans deal with this disclosure requirement. Most plans are in much better funded status.
But with MEABF, they suck under either measure. There’s no getting around that. It is under danger of running out of asset given its very low-funded situation, as it can need to liquidate assets to cover benefits, just given the timing of cashflows.
Given the lack of ability of both the current mayor Brandon Johnson and the governor Pritzker (who can’t deal with money, either), Chicago may finally come to its crisis. It’s not like there is anybody with any competency around in Illinois politics anymore.
STUMP - Meep on public finance, pensions, mortality and more is a reader-supported publication. To receive new posts and support my work, consider becoming a free or paid subscriber.
Nice article. Thanks for discussing LDROM, and noting how incorrect it is to describe it as a hypothetical liability if assets were invested differently, rather than, to put this how I might have, the economically meaningful liability that should always be the focus of funded status and funding analyses. It burns me when it's described as they do.
You're right, of course, that essentially zero assets means a 0% funded status no matter what the liabilities are. But $10 billion of missing liabilities is nothing to sneeze at. This is a good example of why dollar deficits are important to focus on as much as funded percentages. I like dollar deficits (real ones, not based on AAL) divided by number of taxpayers or population.
The question is what happens next in this totally hopeless situation -- a Federal bailout? That would be some precedent. Looks like Chicago is going to be the Studebaker of public pensions -- we'll see what happens.
Nice article. Thanks for discussing LDROM, and noting how incorrect it is to describe it as a hypothetical liability if assets were invested differently, rather than, to put this how I might have, the economically meaningful liability that should always be the focus of funded status and funding analyses. It burns me when it's described as they do.
You're right, of course, that essentially zero assets means a 0% funded status no matter what the liabilities are. But $10 billion of missing liabilities is nothing to sneeze at. This is a good example of why dollar deficits are important to focus on as much as funded percentages. I like dollar deficits (real ones, not based on AAL) divided by number of taxpayers or population.
The question is what happens next in this totally hopeless situation -- a Federal bailout? That would be some precedent. Looks like Chicago is going to be the Studebaker of public pensions -- we'll see what happens.
Thanks again -- look forward to the next one.