Shaky Chicago pension funds face another blow from impending downturn

(Bloomberg) – As 2022 unfolded, struggling Chicago pension funds faced a new shortfall: A lag in property tax revenue left the system without enough money to pay retirees from the city.

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Pension plan managers have been faced with the difficult decision of whether or not to sell pension assets to raise cash quickly. Instead, they secured an advance from Mayor Lori Lightfoot’s administration to fill the gap. Ultimately, Chicago funneled at least $512 million that was intended for payouts later in the year and in early 2023.

The payout was Chicago’s largest-ever one-year advance, a sign of the fragility of the retirement system, especially at a time when markets are heading for their worst annual performance since 2008. Looking ahead, the third America’s most populous city pensions could be hit even harder in 2023 if the market rout continues to erode yields and the looming recession economists are warning Chicago’s incomes.

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

How Chicago got to this point is easy to understand and hard to fix. Simply put, it has fallen behind on contributions from its retirees — including cops, firefighters, laborers and other city workers — year after year as officials cut back on payments. Today, the unfunded liabilities of Chicago’s four retirement systems are $33.7 billion, more than double the city’s annual budget.

Chicago pensions have enough assets to cover only about 25% of what they owe, while on average, US state and local pension funding ratios hover around 70%, according to a study by the Boston College.

These underfunded pensions strain the city’s ability to pay for much-needed services. About $1 out of every $5 of Chicago’s budget is spent on pensions, a challenge in a city where income often falls short of expenses, 17% of the population lives in poverty and crime continues to rise – all factors that could also tip the scales on Lightfoot’s chances for re-election in February, when she could face up to 10 mayoral candidates.

Increased funding

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

And the fact that markets are heading for their worst annual gains in 14 years has made 2022 a tougher year for pension funds. US stocks are down 19% and the benchmark 10-year Treasury note is down 12%.

It all comes even as a key ratings firm recently upgraded the city’s credit rating, praising Lightfoot’s efforts to increase and speed up payouts to pension funds. But the problem continues to challenge Chicago’s ability to pay for much-needed services.

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

Tax invoices

Already, rising inflation is undermining one of Lightfoot’s proposals to close the gap. The mayor persuaded the city council at the end of 2020 to link annual increases in property tax to the consumer price index, but for 2023 he decided to waive this increase in view of inflation the highest for four decades.

On top of that, the annual property tax bills that were due around August or so weren’t released until early December. The months-long delay meant that one of the main sources of funding for pension funds had come to a standstill.

After long failing to pay enough pension contributions, the city led by former mayor Rahm Emanuel and Lightfoot has raised taxes on goods and services such as water and sewer to raise pension contributions to the level of 90% required by the state in about four decades. The city’s annual dues have increased by $1 billion over the past three years, and it’s trying to do more than the minimum by giving advances and paying an additional $242 million for pensions in the 2023 budget.

City residents have expressed concerns about property tax increases that they don’t see reflected in services. About 80% of the city’s property taxes go to pensions and 10% to pay other debts.

Still, the increased contributions led to the city’s first credit rating improvement in a decade, lifting Chicago out of undesirable territory. But the future of its ratings, which affect the city’s cost of borrowing, could hinge on the health of those same pension systems. Repos remain a credit risk for Chicago, and the unfunded portion is its largest long-term liability, according to Moody’s Investors Service.

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

The city’s pension funds have long turned to desperate measures: selling their assets to pay for current expenses.

The Municipal Employees Annuity and Benefits Fund, the largest of Chicago’s four funds, sold approximately $321.3 million in assets last year, $366.3 million in 2020 and 471, $1 million in 2019, according to financial statements.

Sell ​​assets

Having to sell assets during a market downturn increases the likelihood that funds will suffer a loss on their investments, and a smaller asset base means future gains could also be lower, according to Boston College’s Aubry .

To tap into another revenue stream, this month City Council gave final approval to 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 in revenue per year once the permanent casino opens. Revenue from the casino will be funneled to police and fire department pension funds, but the Illinois Gaming Board has yet to approve the project.

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

Another problem Chicago faces is that the fixed costs, including debt and retirement benefits, relative to its income are so much higher than those of its peers. Chicago’s fixed cost ratio in 2020 was 41.6%, compared to a median of 12% for the cities, according to the latest comparable data from Moody’s. In 2021, Chicago’s fixed cost ratio fell to 36.5%.

Jennie Bennett, Chicago’s chief financial officer, noted that property taxes haven’t increased in nearly two decades, but costs have increased. Property taxes began to increase from 2015.

Bennett said the city will continue to monitor fund performance and plans to stick to its new policy of adding funds to prevent unfunded liabilities from growing, but it is not committing to advances at the same time. level than this year.

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

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