Chicago muni pension confronts uncertainty on asset commingling

19 September 2016

by Andrew Scurria

 

The City of Chicago’s largest pension system may be unable to rely on active employee contributions to cover retiree benefit obligations as insolvency nears, said Kim Nicholl of Segal Consulting at a legislative hearing today.

 

“It’s unclear to us” whether the Municipal Employees Annuity and Benefit Fund (MEABF) will need to segregate active workers’ payroll deductions as the system spends down its assets, which will be gone by 2025 if the State of Illinois does not change the current MEABF funding statute, according to Nicholl, the system’s actuarial consultant. At that point, the city may have to fund pensions on a costly pay-as-you-go basis.

 

Existing law ties the city’s contributions to a payroll multiplier instead of actuarial requirements, a discredited funding scheme that has proven insufficient to tame the MEABF funding gap.

 

“By continuing a static multiplier that has no relation to the solvency of the fund, there is a large probability that the fund will continue to plummet in value,” said MEABF Executive Director Jim Mohler.

 

And if active workers’ contributions cannot be commingled to pay for retirees’ benefits, the date of insolvency would arrive not in 2025 but in “2022 or sooner,” Nicholl told the Illinois House Personnel & Pensions Committee. The Illinois panel was considering a bill designed to shore up the system and restructure the city’s statutory employer contributions.

 

Crafted by MEABF and sponsored by State Representative Elaine Nekritz (D), the proposed legislation would convert the system’s funding to an actuarial method and provide an enforcement mechanism should the city default.

 

MEABF’s bill, which the city does not support, establishes a base funding mandate sufficient to bring the system up to a 90% funding ratio within 40 years; the city would phase in those actuarially determined contributions (ADC), similar to the Senate Bill 777 reform of Chicago’s police and fire pension funds. The city would pay 60% of the ADC in FY17 and ramp up an additional 10% every year until it pays 100% of the ADC starting in 2021.

 

Chicago’s preferred alternative relies on five years of fixed, but rising, payments funded by a new utility tax before the city toggles over to an ADC. The city recently passed a water and sewer tax to shore up the fund in the hopes that state lawmakers would nix the multiplier method, as reported.

 

Chicago’s proposal also requires the state’s approval; the city has not yet released a bill. The ramp in MEABF’s bill is “too severe,” said Chicago CFO Carole L. Brown.

 

The Chicago Federation of Labor (CFL) supports what the city has proposed over MEABF’s bill, said CFL Director of Legislative and Political Affairs Bridget Early.

 

“Our specific concern … is that if we jump to a steeper payment schedule, that impacts services,” Early said.

 

Whether the city can absorb the jump to ADC payments depends in part on how its pension investments perform in the interim, as reported. MEABF assumes a 7.5% rate of investment return, a figure analysts have criticized as overly rosy.

 

As MEABF nears insolvency, that 7.5% investment rate of return assumption will likely prove untenable and “would have to be modified,” Nicholl said. As assets dwindle, the need for liquidity begins competing with investment performance in asset allocation decisions.

 

Negative cash flows can force pension plans to shift away from high-performing asset classes to preserve liquidity in their investment portfolios, a dynamic also facing underfunded retirement systems in the State of Kentucky and the City of Dallasas reported.

 

MEABF last year paid USD 841m in benefits against USD 289m in employee and employer contributions, producing USD 552m in negative cash flows “that the fund had to either liquidate assets for or keep investments in more liquid assets in order to pay these benefits,” Mohler said.

 

Cutting the 7.5% rate assumption would further balloon MEABF’s net pension liability, which clocked in at USD 18bn as of 31 December 2015. Because of new Government Accounting Standards Board rules that penalize systems with a projected insolvency date MEABF calculated its funding gap based on a 3.7% discount rate, rather than 7.5%.

 

A discount rate 100 bps lower would hike the net pension liability to USD 22.2bn, according to MEABF’s FY15 audit. MEABF’s bill keeps employer contributions at their current 8.5% of payroll, while Chicago has proposed raising contributions to 11.5% for new hires who would create a new benefit tier.

 

A USD 90m tranche of 5% Series 2015C general obligation refunding bonds maturing in 2038 last traded today at 106.375 yielding 4.163%, according to Electronic Municipal Market Access. Moody’s Investors Service rates the city Ba1/negative, while Fitch Ratings pegs it at BBB-/negative and S&P Global Ratings has them at BBB+/negative.