Chicago’s Shaky Pension Funds Face Increasing Risk

As 2022 unfolded, Chicago’s long-troubled pension funds faced a new shortfall: A delay in property tax receipts left the system without enough money to pay the city’s retirees.

Pension managers contended with the difficult decision of whether to sell off pension assets to raise cash quickly. Instead, they got an advance from Mayor Lori Lightfoot’s administration to plug the gap. In the end, Chicago funneled in at least $512 million that was earmarked for payments later in the year and early 2023.

The payout was the largest advance ever in one year in Chicago, a sign of just how fragile the pension system is, especially at a time when markets are headed for their worst annual return since 2008. Looking ahead, pensions for employees of the third-most populous U.S. city could take an even deeper hit in 2023 if the market rout continues to erode returns and the looming recession, which economists are warning of, hurts Chicago’s revenue.

“Downturns are never good, and systems like Chicago don’t have much wiggle room,” said Jean-Pierre Aubry, director of state and local research at the Center for Retirement Research at Boston College. “Other pension funds will weather it. Chicago may have to react more aggressively and more quickly.”

How Chicago arrived at this point is easy to understand and hard to fix. Put simply, it fell behind on contributions for its retirees—including cops, firefighters, laborers, and other municipal employees—year after year as officials shortchanged payments. Now, the unfunded liability for Chicago’s four pension systems is $33.7 billion, more than twice the size of the city’s annual budget.

Chicago’s pensions have enough assets to cover only about 25 percent of what they owe, while funding ratios for U.S. state and local pensions, on average, hover around 70 percent, according to research at Boston College.

These underfunded pensions are weighing on the city’s ability to pay for much-needed services. About $1 of every $5 in Chicago’s budget goes toward pensions, a challenge in a city where revenue often falls short of expenditures, 17 percent of the population lives in poverty, and crime continues to rise—all factors that also could tip the scales on Lightfoot’s chances for re-election in February, when she could face as many as 10 mayoral candidates.

City Budget Challenges

The city has faced calls for more mental-health clinics, increased funding to help the homeless, and greater resources to reduce environmental hazards such as air pollution that have been reported to disproportionately hurt poor neighborhoods.

The fact that markets are headed for their worst annual gains in 14 years has made 2022 a more challenging year for pension funds. U.S. stocks are down 19 percent, and the benchmark 10-year Treasury bill is off 12 percent.

All of this comes even as a key rating agency recently lifted Chicago’s credit rating out of junk status, praising Lightfoot’s efforts to increase and accelerate payments into the pension funds. But the problem continues to challenge the city’s ability to pay for much-needed services.

Now, the threat of a recession in 2023 raises questions about Chicago’s ability to provide advances—such as the half-billion dollars given from September through November—because a slowdown could reduce tax revenue as economic activity slows. Chicago’s Purchasing Managers Index, a barometer for the region’s economic health, is already starting to send out recession warning signals. The index fell to 37, below expectations and at a level that historically has indicated an economy in recession.

Already, rising inflation undercut one of Lightfoot’s proposals to fill the gap. The mayor persuaded the City Council in late 2020 to tie annual property tax increases to the consumer price index (CPI), but for 2023 decided to forgo that bump up given the highest inflation in four decades.

On top of that, annual property tax bills that were expected roughly around August didn’t go out until early December. The months-long delay meant that one of the biggest sources of funding for the pension funds was stalled.

After long failing to make enough contributions into the pensions, the city—under both Lightfoot and former Mayor Rahm Emanuel—has increased taxes on property and services such as water and sewer, with a goal of ramping up pension contributions to the state-required 90 percent level in about four decades. The city’s annual contributions rose by $1 billion over the past three years, and it’s trying to do more than the minimum by providing advances and paying an additional $242 million for pensions in the 2023 budget.

The city’s residents have raised concerns about property tax increases that they don’t see reflected in new or expanded services. Roughly 80 percent of the city’s property taxes go to pensions, and 10 percent pay for other debt.

Still, the increased contributions led to the city’s first credit-rating upgrades in a decade, pulling Chicago out of junk territory. But the future of its ratings, which affect the city’s cost of borrowing, could hinge on the health of those very retirement systems. Pensions remain a credit risk for Chicago, and the unfunded portion is its most significant long-term liability, according to Moody’s Investors Service.

“When we save the pension funds, we save the city,” said Melissa Conyears-Ervin, Chicago’s treasurer, who oversees about $10 billion in city assets.

Not the Time to Sell Assets

The city’s pension funds have long turned to some desperate measures: selling off assets to pay current expenses. The Municipal Employees’ Annuity and Benefit Fund, the biggest of Chicago’s four funds, sold about $321.3 million in assets last year, $366.3 million in 2020, and $471.1 million in 2019, according to financial statements.

Having to sell assets in a market downturn would increase the likelihood that the funds would endure a loss on their investments, and a smaller asset base would mean future gains may be lower as well, according Boston College’s Aubry.

To tap another revenue source, this month the City Council gave its final approval for Bally’s Corp. to build Chicago’s first casino as part of an entertainment complex. The company provided $40 million up front, and the city expects $200 million annually in revenue once the permanent casino opens. The casino revenue will be funneled to the police and fire pension funds, but the Illinois Gaming Board still needs to sign off on the project.

“One of the critical factors is that the city adheres to the new funding policy and continues at this strong level,” said David Levett, an analyst at Moody’s, which in November raised the city’s rating by one level to Baa3, freeing Chicago from its one below-investment-grade rating for the first time since 2015.

Another problem Chicago faces is that the ratio of fixed costs, including debt and retirement benefits, to city revenue is much higher than that of its peers. In 2020, Chicago’s fixed-cost ratio was 41.6 percent, compared with a median of 12 percent for peer cities, according to the latest comparable data from Moody’s. In 2021, Chicago’s fixed-cost ratio declined to 36.5 percent.

Jennie Bennett, Chicago’s CFO, noted that property taxes didn’t go up for nearly two decades, even as costs increased. Property taxes began rising starting in 2015. Bennett said that the city will continue to monitor the performance of the funds, and that Chicago is planning to stick to its new policy to add funds to keep the unfunded liability from growing, but she’s not committing to advances at the same level as this year.

“Part of the challenge of our pension funds is you are always climbing an uphill battle,” said Bennett.

 

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