Pension risk meter on the rise for Chicago and Illinois, reports warn

Pension funding-related threats to Chicago and Illinois’ fiscal health are on the rise, reports published this week warn.

Chicago and Illinois — longtime examples of outliers nationally on the size of their unfunded liabilities and funded ratios — have made progress, with Chicago now making payments more closely aligned with an actuarial calculation and both making supplemental contributions to complement scheduled payments.

But pension funded ratios remain weak and both are expected to face higher costs to raise benefits for the lower tier of benefits adopted for employees hired after 2010 to avoid violating federal rules governing public employees who don’t pay into Social Security.

“We believe pensions have an elevated probability of stressing the state and local governments’ budgets even as Illinois has made supplemental contributions above the statutorily required amounts,” S&P Global Ratings analyst Joseph Vodziak said in a Pension Spotlight on Illinois report. “The enactment of a new benefit tier in 2010 is generating significant cost savings today but recent efforts have been made to increase these benefits in an attempt to avoid violating social security’s safe harbor provision.”

“Costs will keep rising because contributions are significantly short of meaningful funding progress, plans are poorly funded, and the Illinois Pension Code allows plans to use assumptions and methodologies that defer costs,” S&P warned.

The state constitution’s pension clause protects promised benefits from being impaired or diminished and the Illinois Supreme Court has ruled that protection extends to retiree healthcare. The state covers those costs on a pay-as-you-go basis. “We expect costs will escalate, in part due to medical inflation,” the S&P report warned.

The state is amortizing its unfunded liabilities using a level percentage of payroll with payroll growth that S&P believes has not been keeping pace with assumptions. Under the current ramp, contributions are expected to rise about 2.2% annually. The state’s fiscal 2024 makes a scheduled $10 billion payment. The state has $139 billion of unfunded liabilities and the system is 44% funded.

The state is aiming for a 90% funded ratio in 2045 — another flaw as actuaries recommend targeting 100% funding. Illinois has made $500 million in additional payments with another $200 million planned for fiscal 2024. “Contributions are still short of an amount we consider indicates funding progress,” S&P said.

A report from Segal commissioned by the legislature’s Commission on Government Forecasting and Accountability put an estimated $5.6 billion price tag on bringing the state’s system into compliance with Social Security. That would add about $285 million to annual payments.

“Even with the projected changes, the savings from Tier 2 benefits would still be significant. However, we believe an unexpected increase to pension costs will make annual contributions more challenging to fit into budgets,” S&P said.

Gov. J.B. Pritzker’s office highlighted progress on paying down debt and making supplemental payments in a response to the report. “He is proud of the fiscal progress the state is making, including eight credit upgrades,” Pritzker spokeswoman Jordan Abudayyeh said in a statement.

The state budget office also noted savings from the ongoing pension buyout programs and “the governor continues to explore additional ways to manage the state’s pension commitments.” The statement also noted retiree healthcare liabilities are down 60% to $34.5 billion as more favorable rates have been negotiated.

New Chicago Mayor Brandon Johnson’s efforts to deal with rising pension costs from pending state-imposed Tier 2 changes contributes to a fresh round of headline and “potentially real credit risks” for investors, Municipal Market Analytics warned in its weekly outlook report.

Johnson has tasked a panel made up of his financial team, several lawmakers, and labor representatives to come up with a plan to tackle rising costs and improve the system’s health. The move came as state lawmakers agreed to temporarily put on hold changes to the city firefighters’ fund raising Tier 2 benefits. The previous administration warned the changes carried a $3 billion price tag.

Chicago has ramped up payments to reach an actuarially based contribution. It still falls short of the industry recommended actuarially determined calculation formula. Chicago began making a supplemental contribution sending $242 million over the statutory payment this year, which contributed to rating upgrades. With $33.7 billion of unfunded liabilities, the city targets a 90% funded ratio for each of its four funds between 2055 and 2058.    

What is “likely at the core of the mayor’s interest in generating new solutions at present, are state and local proposals that would restore prior pension benefit cuts to some Tier 2 workers and/or expand overall employee benefits to help the city refill its pandemic-depleted workforce,” MMA said. “In MMA’s view, the city of Chicago’s three potential causes of material credit backsliding remain: unexpected economic downturns; a hypothetical adversarial relationship with the state and city management mistakes. As a potential source of the last, the new working group’s efforts should be followed closely.”

MMA sees Johnson’s effort to adopt new revenue sources to address pensions and other social spending priorities as a positive but worries that some solutions won’t fully cover new spending on a recurring basis or that a fix could rely in part on pension obligation bonds.

“This would be, of course, a terrible choice for the city’s credit profile, could introduce substantial long-term risk to taxpayers and bondholders, and could bias city ratings back below investment grade if used recklessly,” MMA wrote. “Further, that the mayor’s working group specifically excludes employers and/or taxpayer representatives suggests a higher potential total cost of, and possibly more political friction from, whatever the group ultimately recommends.”

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