As your editor mentioned yesterday in the piece on Karen Lewis’ six-figure compensation, Chicago is in the midst of a battle over reforming its virtually-insolvent teachers’ pension. While Lewis and the AFT local, the Chicago Teachers Union, proposes to float a $5 billion pension obligation bond and levy a so-called LaSalle Street tax on commodities trading transactions on the two exchanges located in town, Mayor Rahm Emanuel plans to offer a set of reforms that are similar to the modest changes put in place by Illinois earlier this year to address its woeful pension deficits. Emanuel would likely push to restrict cost-of-living increases to three percent on the first $25,000 in annuity payments (or up to an additional $750 in cost-of-living hikes).

transformersAs seen last month with the state legislature’s passage of a plan to shore up the Second City’s pensions for police officers and firefighters, any plan Emanuel finally proposes will end up being approved. As Emanuel’s predecessor, Richard M. Daley, can attest, getting your way is what happens when you’re the mayor of Illinois’ largest city. But the bigger question is whether Emanuel will offer a plan that effectively addresses both the pension’s insolvency and also provides teachers (especially high-quality instructors and younger teachers who are the least likely to stay around long enough to collect annuities) suitable retirement savings options. This starts with dealing accurately and honestly with the real level of insolvency. As the most-recent comprehensive annual financial report released this month by the teachers’ pension makes clear, Emanuel will need to force it into being truly transparent.

Thanks in part to a 26 percent increase in the number of teachers retiring and collecting annuities, the Chicago Teachers’ Pension Fund officially reports an underfunding of $9.6 billion as of 2013, the latest year available. That’s 16 percent higher (or $1.6 billion more) than the officially-reported level of insolvency for the previous fiscal year.

But these are just the officially reported numbers — and understated at that. For one, thanks to smoothing and other actuarial tricks ostensibly used to insulate Chicago’s budget from shocks, the number doesn’t include the unrecognized gains and losses from investments the fund has experienced. If the Chicago pension fully recognized the $2.2 billion in investment losses over the past years, it would have had to officially report an insolvency of $12 billion, 24 percent higher than what it actually stated.

Then there is the fact that CTPF still assumes a rate of return on investments of 7.75 percent, far higher than the 5.2 percent five-year return rate experienced in the market (according to Wilshire Associates) and the 4.6 percent average return the pension itself has achieved over the past five years. Because of the inflated rates of return, the Chicago pension is overstating how much its investments can generate over the long haul to address the insolvency, and ultimately, how much it has available to cover annuities.

To get to the bottom of CTPF’s insolvency, Dropout Nation uses a version of a technique developed by Moody’s Investors Service, which assumes a more-realistic 5.5 percent rate of a return on investments. [Moody’s bases its rate of return on the performance of a bond index, which can range between four and six percent.] Just analyzing the officially-reported insolvency, Dropout Nation concludes that the Chicago teachers’ pension is underfunded to the tune of $12.5 billion, 30 percent higher than the pension states.

Based on a 17-year amortization schedule, Second City taxpayers would have to spend an extra $735 million a year just to pay down the insolvency; that’s six times greater than the $120 million the city currently paid into the pension. Thanks to a so-called pension holiday granted by the state, Chicago has skipped on making full payments into the pension as it should be doing for the past 18 years; it was supposed to pay $196 million in 2013 and must contribute $613 million this year, and $684 million in 2015.

But this number is also based just on the officially-reported insolvency, not on what would have been reported if the Chicago pension actually accounted for all of its investment gains and losses the moment they occurred (as it should be doing). Accounting for the all the investment losses, Dropout Nation concludes that the pension’s underfunding for 2013 was $15.5 billion. That’s 30 percent more than the $12.5 billion the pension would have had to report if it accounted for its losses and gains on time, and 61 percent higher than the officially-reported insolvency for last year. Based on a 17 year amortization schedule, Chicago taxpayers would have to pay an extra $910 million a year just to pay down the insolvency; that’s nearly eight times greater than what the city contributed to the pension last year.

Let’s be clear about this: These numbers don’t include the unfunded retired teacher healthcare obligations that CTPF bears on behalf of the city. The pension reports an official unfunded actuarial accrued liability of $2.3 billion for 2013, a 23 percent decline over the previous year. The good news is that the pension assumes a realistic 4.5 percent rate of return for its investments dedicated to covering retiree health costs. But when adds the healthcare underfunding to the uncovered pension liabilities, the Chicago pension has an insolvency of $12.8 billion to $15.8 billion that Emanuel must ultimately address.

The problem will get worse because more Chicago teachers are heading into retirement. Between 2004 and 2013, the number of annuitants increased by 42 percent (from 19,266 to 27,440), while annuity payouts increased by a two-fold (from $594 million to $1.2 billion). Based on the pace of increases in annuitants in that nine-year period, CTPF will likely add 1,583 new annuitants (excluding deaths and other removals) to its rolls every year for at least the next decade before retirements slow down. Considering that 2,129 teachers and other school employees retired in 2013, even that average number pace is understating matters. Based on the pace of increases in average annuity payouts, the pension will also face annual increases of 4.3 percent per retiree, further increasing its insolvency.

Emanuel will have to take numerous steps to address the CTPF’s financial straits for the long haul. Restricting cost-of-living increases is a start. But the city must make full contributions to the pension as it should have been doing in the first place. The mayor must level with taxpayers — and increase contributions to $1 billion a year just to get the pension onto the path to solvency. At the same time, Emanuel must address the governance of the pension itself. One reason why it is in such dire straits is because it is effectively a division of the AFT’s Chicago local, which controls all but four seats on its 12-member board; currently, it is even further under the union’s control because Jay Rehak, the AFT honcho who presides of the board is now serving as its acting executive director. Any pension reform plan Emanuel offers must effectively put the pension under the city’s budget office, with the mayor assuming full control and responsibility for its solvency as it should be.

Emanuel must then ensure that any pension reform plan he offers doesn’t give younger teachers (and high-quality instructors, in particular) the shaft. This is particularly important because the district he controls needs to hold onto all the good and great talent it needs to continue its overhaul and improve student achievement. As with other pensions, CTPF is a particularly bad deal for high-quality new teachers, whose attrition rates are likely even higher, both because of the lack of support they get from school leaders and districts as well as because of their own desires to utilize their talents beyond classroom instruction. For these teachers, the pension doesn’t allow them to actually attain full retirement benefits unless they remain in classrooms.

So Emanuel must offer a new retirement option for younger teachers so that they can reap the full rewards of their work. This would feature a defined-contribution account toward which teachers can contribute as much of their income to retirement as they see fit (with a five percent match from the city), as well as a cash-balanced plan that guarantees an annual savings rate. Such a move, by the way, would also help the pension (and ultimately, taxpayers) by reducing the number of new annuitants that will add to its insolvency. Sure, Lewis will oppose any plan that resembles what your editor is describing. But Emanuel should then turn the tables on her rhetorically, pointing out how his plan is addressing both the city’s irresponsibility and that of the AFT local in managing the pension.

But none of Emanuel’s efforts to address the Chicago teachers’ pension’s insolvency will matter if he doesn’t get accurate numbers. And this means he must force the pension — and the AFT local — to be honest in the first place.

Photo courtesy of the Chicago Tribune.