One lesson of politics: Congratulations become condolences. This is something Chicago Mayor Rahm Emanuel already knows. Beating Jesus (Chuy) Garcia earlier this month to win a second term as chief executive of the Second City’s government now means having to deal with new woes. This includes the fallout from last week’s revelation that Chicago Public Schools Chief Executive Officer Barbara Byrd-Bennett (now on leave) is under investigation allegedly awarded a $20 million no-bid contract to her former employer, SUPES Academy.
But the biggest challenge facing Emanuel is figuring out how to deal with decades of mismanagement of its collection of pensions by predecessor Richard M. Daley and by public-sector unions who control the boards that oversee them. This includes addressing the Chicago Teachers Pension Fund, a virtual subsidiary of the American Federation of Teachers’ Chicago Teachers Union, which continues to offer less-than-honest data on its woeful fiscal condition.
The pension officially reports a shortfall of $9.5 billion for 2013-2014, a slight decline from the $9.6 billion reported in the previous year. This can be attributed to stronger-than-expected gains in the financial markets, along with a 52.7 percent year-to-year decline in the number of retirees added to the rolls.
But as Dropout Nation readers already know, those numbers do not reflect reality. For one, thanks to an actuarial trick called smoothing, which requires losses and gains to be phased in over five years instead of immediately as they should be, CTPF isn’t reporting its true financial position. In this case, the pension is failing to report $770 million in investment gains over the past few years; when added to the officially-reported numbers, the underfunding would decline to $8.7 billion.
The other reason why the officially-reported numbers don’t reflect reality? The overly-inflated assumed investment rate of return of 7.75 percent. The value of the Chicago teachers’ pension’s assets declined by eight percent on an actuarial basis between 2009-2010 and 2013-2014, and increased by only 20.9 percent (or 4.17 percent a year) on a market value basis within that period. Overly-inflated assumed rates of return are problematic because pensions can report insolvencies as being lower than they actually are during both good times and bad, which means that politicians can’t engage in honest, fiscally-sensible problem-solving of their virtual insolvencies.
To get to the heart of the matter, Dropout Nation utilizes a version of a technique developed by Moody’s Investors Service, which assumes a more-realistic 5.5 percent rate of a return. [Moody’s bases its rate of return on the Citibank Pension Liability Index, which is based on the yield for AA-rated corporate bonds.]
Let’s start with the officially-reported liability: Based on the calculation, CTPF is underfunded to the tune of $12.3 billion, or 30 percent more than officially reported. The good news is that the underfunding is 1.6 percent lower than the $12.5 billion shortfall DN determined last year. But even with this slight decline, taxpayers would have to contribute an additional $722.9 million a year over the next 17 years in order to address the shortfall; this is 123 percent more than the $585 million the city contributed in 2013-2014.
[Pension costs accounted for 10.5 percent of the $5.6 billion spent in 2013-2014 by Chicago Public Schools, whose budget is technically separate from the $8.7 billion spent by the rest of the Second City’s government; an additional $722.9 million in contributions that year would have increased the percentage of district spending devoted to pensions to 23.4 percent. If the budgets for both the schools were together on one ledger — adding up to $14.3 billion for 2013-2014 — the teachers’ pension contributions would have accounted for 4.1 percent of the overall budget; the additional contributions would have increased the percentage of expenditures dedicated to the pension to 9.1 percent. In fact, the contributions made to CTPF in 2013-2014 are greater than the $478.3 million contributed by the city to its other pensions put together.]
But what if we use $8.7 billion, which is lower than the officially-reported shortfall thanks to the inclusion of unreported gains? Based on Dropout Nation‘s calculations, CTPF is underfunded to the tune of $11.3 billion, which is 30 percent higher than the $8.7 billion number and 19 percent more than the officially-reported liability. Based on a 17-year amortization schedule, taxpayers would have to contribute an additional $664 million to the pension, also more than double what they put into the pension last fiscal year.
None of this, by the way, includes the unfunded retired teacher healthcare obligations that CTPF bears on behalf of the city. The good news is that pension assumes a more-realistic 4.5 percent rage of return on the investments dedicated to covering those costs. Even better, the unfunded actuarial accrued obligation of $1.9 billion in 2013-2014 is 19 percent lower than the previous fiscal year. But when added on top of the pension insolvency, Emanuel must ultimately address insolvency of between $13.2 billion and $14.2 billion. This is a tall order, especially given the liabilities of the city’s other pensions.
Given that Chicago skipped out on contributions to CTPF over the previous 18 years thanks to an Illinois law allowing it to do so, no one can feel sorry for the city government on this front. It should have been doing the responsible thing and making those payments. But it isn’t just the fault of the city alone. The AFT’s Second City local, which controls the majority of seats on the pension, has also aided in the pension’s mismanagement. Between years of silence over the failure of Daley and other politicians to properly contribute to the pension, to allowing it to use overly inflated rates of return, CTU has done as much as city officials to poorly serve teachers, taxpayers, and children.
For the pension, it won’t get better anytime soon. Fewer Baby Boomers in the Chicago district’s classrooms retired in 2013-2014 than in previous years. Still, the pension can expect 1,550 teachers to retire every year (based on data for the previous 10 years). With each retiree collecting an average annual annuity of $45,792, CTPF can expect to add at least an additional $71 million a year in additional annuity payments, exacerbating its insolvency. In fact, new retirees in 2013-2014 received an initial average annual annuity of $70,539.89, 54 percent more than the average.
Another factor lies with the lawsuit filed by AFT’s Illinois affiliate and other public-sector unions to stop the modest pension reforms implemented by the Prairie State last year as part of Senate Bill 1; Emanuel’s own plan to address CTPF’s insolvency (and that of the city’s other pensions) is based on the state’s plan. A state court judge has already halted the implementation of S.B. 1, leading to speculation that the state supreme court will rule the reforto halt the implementation of S.B. 1 and the possibility that the state supreme court will rule the measures unconstitutional, Emanuel has little room to maneuver. Certainly the city could address the pension insolvencies by filing for bankruptcy, something that Detroit did with great success over the last two years. But no politician wants to make such a drastic move unless it is unavoidable.
Then there’s the traditional district’s fiscal woes aside from the pension. As the Chicago Sun-Times noted on Saturday, a downgrade in CPS’s credit rating may force it to pay off $228 million in interest rate swaps. Given that the district has already seen its cash on hand decline by 79 percent (from $1.1 billion to $227 million) within the last year, and that it is struggling mightily with pension payments, any pension reform plan will have to involve tapping the coffers of the main city government. With the other pensions also in trouble, Emanuel has a massive problem on his hands.
No matter what happens with S.B. 1 or with CPS’ financial position, Emanuel will have to take numerous steps to address the CTPF’s financial straits for the long haul. Making full contributions is a key part of the solution. So is addressing the governance of CTPF itself; this includes convincing legislators in Springfield to significantly reduce the eight seats controlled by CTU, and effectively giving the mayor full control of the teachers pension (along with the city’s other retirement funds). Restricting increases in cost-of-living adjustments (a key reason for increases in the pension’s virtual insolvency) is also critical.
As Dropout Nation advised last year, Emanuel’s pension reform plan must both restrict increases in cost-of-living adjustments (a reason for increasing insolvency) and also allow younger teachers to reap the full rewards of their work. 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.
But the first and most-important step lies with getting accurate numbers on the level of CTPF’s shortfall. Emanuel should lean hard on the pension to downwardly revise its assumed rate of return in order to get a more-realistic assessment of the pension’s woes. He must also lobby state legislators to end smoothing techniques that further obscure the pension’s true financial condition. These two key steps will ultimately help Emanuel level honestly with Second City taxpayers about what needs to be done to get the pension and the municipality on the path to solvency. And if he succeeds, will mark his second term as a well-earned success.
