Annual Financial Analysis
The City’s Pension Funds

The City’s Pension Funds

The City contributes to four pension funds – Municipal Employees’ Annuity and Benefit Fund, the Laborers’ and Retirement Board Employees’ Annuity and Benefit Fund, the Policemen’s Annuity and Benefit Fund, and the Firemen’s Annuity and Benefit Fund. These pension funds provide retirement, death, and disability benefits to City employees. This section discusses the statutory framework, the net pension liabilities of the City’s four pension funds, recent changes to the pension system, and the resulting impact on City finances.1

Illinois law establishes retirement plans for public employees in the State, including those employed by the City. Employees and employers contribute to the retirement plan in order for employees to receive benefits when they retire. Contributions are allocated to a pension fund, which makes investments that accrue over time. The cumulative amount of the contributions and return on investments make up the total assets of a pension fund. Once an employee has served a certain number of years and reached a certain age (these requirements vary depending upon the fund and the employee’s hire date), she/he can retire and receive benefits paid out of these assets. The pension funds and the contributions and benefits under each fund are governed by the Illinois Pension Code.

The City’s annual pension contributions are funded with property tax revenues, operating revenues, and enterprise fund revenues which reflect the enterprise funds’ proportionate share of the City’s pension contributions. The contribution amounts and revenue sources are discussed in further detail below.

City employees participate in one of four such defined benefit pension plans:

  • the Municipal Employees’ Annuity and Benefit Fund (MEABF), which covers most civil servant employees of the City, as well as non-teacher employees of the Chicago Public School system;
  • the Laborers’ and Retirement Board Employees’ Annuity and Benefit Fund (LABF), which covers City employees who are members of the Laborers’ union;
  • the Firemen’s Annuity and Benefit Fund (FABF), which covers the City’s sworn firefighters and paramedics; and
  • the Policemen’s Annuity and Benefit Fund (PABF), which covers the City’s sworn police officers, captains, lieutenants, and sergeants.

The table below outlines the number of members and retirees of each City pension fund as of December 31, 2015:

Fund Name Active Members Inactive Members Retirees
MEABF 30,683 16,268 24,964
LABF 2,816 1,455 3,846
FABF 4,735 76 4,729
PABF 12,061 637 13,210

Inactive members have not yet retired, but are no longer working for the City; therefore they no longer contribute to the fund. Source: City of Chicago 2015 CAFR - Comprehensive Annual Financial Report

In recent years, the City of Chicago has worked with union leadership and Illinois lawmakers to address the City’s contributions to these funds as well as employee contributions and benefits. The City has successfully changed State law for PABF and FABF, allowing the City to stabilize and fund the pensions through increased employer contributions, while still protecting taxpayers and vital City services. Further, the City and labor leadership representing the employees who participate in LABF have agreed to a proposal that provides stable funding for LABF along with benefit reforms for new hires. The City is working with labor leaders on a pension funding reform plan for MEABF similar to the plan for LABF. All four pension funds are discussed in greater detail in the following sections.

Net Pension Liability

A pension fund is said to be ‘fully funded’ when its total assets are sufficient to cover the projected future benefits paid to current members of the fund. The net pension liability is the difference between the fund’s total pension liability and the net position of those funds. If the fund’s net position is not sufficient to cover the total pension liability, it is said to have a ‘net pension liability’. Currently, all four of the City’s pension funds carry significant net pension liabilities.

Under the Illinois Pension Code, each City employee contributes a statutorily-determined percentage of their pay to their pension during each year that they are employed by the City. The City contributes a statutorily-determined amount to all four funds each year as well. Prior to 2015, the City contributed a multiple of the employee contribution to all four funds, with the multiple or multiplier varying by each pension fund. These statutorily-determined contributions were not actuarially-determined to ensure the pension funds were fully funded. The statutory contribution, combined with economic downturns, pension benefit enhancements, and changes in the workforce led to an increasing net pension liability.

While the City has recently taken steps to address the net pension liability through increased employer contributions, the current funding status of the pension funds is the result of the historic statutory framework of the pension system and the economic factors that have acted upon that framework, as discussed further in this section.

Funding Status of City Pension Funds, as of December 31st, 2015

Fund Name (A) Total Pension Liability (B) Plan Net Position Net Pension Liability (B) as % of (A)
MEABF $23,358,869,625 $4,741,427,557 $18,617,442,068 20%
LABF $3,712,615,936 $1,238,657,245 $2,473,958,691 33%
FABF $4,826,084,038 $1,045,101,093 $3,780,982,945 22%
PABF $12,032,733,000 $3,058,949,037 $8,973,783,963 25%
Total $43,930,302,599 $10,084,134,932 $33,846,167,667 23%

The Governmental Accounting Standards Board (“GASB”) establishes financial reporting requirements for governments that provide pension plan benefits. Beginning in 2015, the new GASB 68 accounting rule requires the City to recognize its long-term obligation for pensions as a liability for the first time. The net unfunded liability is now reported as a blended discount rate of the municipal bond rate and the expected long term rate of return. The new reporting requirement increased the reported net pension liability. This new reporting requirement does not impact the statutory or actuarially determined contributions required by the City.

Economic Downturns

Two major economic events significantly affected the health of the City’s pension funds. When the dot-com bubble burst in 2000, the assets of the pension funds shrank significantly due to market losses. From 2000 to 2002, the four funds went from approximately 87 percent funded to approximately 62 percent funded, due primarily to investment losses. Investment performance improved in the mid-2000s, but this growth was on a smaller pool of money due to prior losses, so even in years with high investment returns, the overall funding levels remained at around 61 to 66 percent. Then, in 2007 and 2008, the real estate-driven market crash took the City’s pension funds, collectively, from approximately 62 percent funded to approximately 38 percent funded.

Additionally, some of the City’s pension funds are now lowering the projected rate of return on investments, which impacts the funded ratio. The rate of return is an estimate of the return on investments the pension funds will experience over the next 30 years, and is used to determine the assets needed today to pay benefits in the future. The board of each pension fund has the authority to determine the projected rate of return on investments for actuarial calculations. Economic downturns over the past decade have caused many public pension funds, including Chicago’s, to lower their projected rate of return. In 2014, the PABF lowered its rate of return from 7.75 percent to 7.50 percent. Lowering the rate of return causes the net pension liability to increase.

Automatic Increases and Changes in Benefits

Over time, additional benefits have accrued under or been written into the Pension Code. Most notably, automatic annual increases written into the Illinois Pension Code significantly increased the cost of benefits. These automatic increases provide a guaranteed annual increase in pension payments regardless of the extent to which the cost-of-living actually increases. Employees hired prior to 2011 and participating in FABF or PABF receive annual increases at a simple rate (either 3.0 percent or 1.5 percent) based on the original annuity payment to the retiree. Employees hired prior to 2011 and participating in LABF or MEABF receive an annual increase at a 3.0 percent compounded rate, meaning that each year their benefits payment2 increases 3.0 percent over the prior year’s benefits payment. Legislative changes to the Illinois Pension Code also increased the total cost of benefits owed, though to a lesser degree than the automatic increases. Among other changes, the minimum pension certain retirees receive was increased and the final salary used to calculate a retiree’s pension was expanded to include more categories of pay other than annual salary.

Workforce and Retiree Demographics

The makeup of the City’s workforce and retirees has added to the net pension liability. The statutorily-set employee and employer contribution percentages did not change to account for shifts in basic demographic factors such as the lifespan of retirees. As retirees live longer, they collect benefits longer and the projected future benefit costs of the pension funds increase. Adding to this, as the City took measures to incentivize early retirement to help balance the City’s budget, employees retired and thus stopped paying into the pension funds and started collecting from the pension funds sooner than would otherwise have been expected. This affected the pension funds’ balances on both sides - contributions decreased while benefit costs increased.

Conclusion

Each year, employees and the City contributed the statutorily-required amounts into the pension funds, but these statutorily-required contributions fell far short of covering the future benefits that were accrued.

Demographics changed, benefits were enhanced, and a series of severe economic events occurred over the past 15 years and the system was not set up to automatically adjust for investment losses or the growing cost of benefits. In addition, lawmakers did not take action to address the situation with changes to benefits, increases in contribution requirements, or both.

In recent years, the City has taken significant steps to address the net pension liability of all four pension funds. The following discusses recent actions the City has taken to address growing pension liability and put all four funds on a path to long-term stability.

Pension Funding and Contribution Changes

Senate Bill 1 (P.A. 98-599) – State Pension Reform Act

In 2013, the State enacted legislation reforming four of the five State-funded pension systems for State employees. These reforms included a reduction in the automatic annual increase, a cap on pensionable salary, increased employee contributions, and increased state contributions.

In 2015, the Illinois Supreme Court found Senate Bill 1 (P.A. 98-599) unconstitutional, stating all benefits established in the Illinois Pension Code cannot be modified for current employees or retirees. Senate Bill 1 would have allowed for costs-savings and benefit reforms to the State’s largest pension plans. The decision on Senate Bill 1 impacted the City’s pension reform efforts as discussed further below.

Police and Fire Pension Funds

In 2010, legislation passed by the State, Senate Bill 3538 (P.A. 96-1495), altered the City’s contribution to PABF and FABF, starting in 2015, by removing the multiplier and replacing it with an actuarially determined amount sufficient to bring the funds to 90 percent funded by 2040, a significantly shorter timeframe than other public safety pension funds in Illinois. This legislation imposed a significant financial burden on City taxpayers as it did not provide a funding ramp that acknowledged the impact of drastically increased pension payments on City finances and its ability to provide services. Instead, this legislation would have forced the City to close the pension funding gap with a $550 million increase in contributions to PABF and FABF in one year.

In May of 2015, the General Assembly approved Senate Bill 777 (P.A. 99-0506), which extends the date for 90 percent funding from 2040 to 2055. In May 2016, Senate Bill 777 (P.A. 99-0506) became law. Senate Bill 777 puts Chicago on a similar annual required contribution (ARC) schedule as other public safety pensions throughout Illinois. Fixed amounts will be contributed each year from 2015 until 2019, after which the City contribution will be actuarially determined to achieve 90 percent funding by 2055. Under SB777, the City still doubles its pension contributions to PABF and FABF in 2015 and nearly triples its employer contributions over five years. Beginning in 2015, the contributions increase from $300 million to $619 million, $672 million in 2016, $727 million in 2017, and $792 million in 2018. A small additional increase of $32 million is required in 2019.

To meet this increase in contributions, the City passed a four year property tax increase to provide a source of revenue consistent with the Illinois Pension Code. Beginning in 2020, the City’s contributions will be actuarially determined.

Municipal and Laborers’ Pension Funds

In June of 2014, Senate Bill 1922 (P.A. 98-641) was enacted, adjusting benefits and increasing both the employer and employee contributions. Under Senate Bill 1922, LABF and MEABF retirees would have received a simple cost-of-living adjustment of the lesser of 3.0 percent or half of CPI applied to their original annuity. In addition, there would have been three pause years in which retirees would not receive a cost-of-living adjustment. Employees would have increased their contributions from 8.5 percent of their pensionable pay to 11 percent over a five year period.

During this same five year period, the City’s employer contributions would have increased year over year, reaching ARC contributions by 2019. The City’s employer contributions would have increased from $177 million in 2014 to $620 million in 2019.

Senate Bill 1922 was challenged in December of 2014 and found unconstitutional by the Circuit Court of Cook County in July of 2015. In March of 2016, the Illinois Supreme Court affirmed the decision of the lower court that Senate Bill 1922 was unconstitutional because it included a reduction in benefits for current employees and retirees.

In May 2016, the City and the labor leaders representing the employees who participate in LABF reached an agreement in principal to address the net pension liability of the fund in a manner that secures the retirements of employees and retirees, while protecting Chicago taxpayers from bearing the full amount of future pension costs.

This new agreement, which must be passed into law by the Illinois General Assembly, provides that LABF employees hired on or after January 1, 2017, will contribute 11.5 percent of their annual salary and are eligible for full pension benefits at age 65. Current employees hired after January 1, 2011, may choose to start receiving full pension benefits at age 67 and maintain an 8.5 percent employee contribution or to start receiving pension benefits at age 65 with an 11.5 percent employee contribution. This change will help to decrease future employer contributions to LABF.

The City’s employer contributions will increase on a funding ramp that will lead to actuarially based contributions no later than 2022. The City’s employer contributions will increase by no less than 30 percent per year over a five year period, starting with the 2017 contribution, payable in 2018. As a result of these reforms, LABF is expected to reach 90 percent funded by 2057.

The City will use additional corporate fund revenue available as a result of the increase in the 911 surcharge to make these increased pension contributions. The 911 surcharge was increased from $2.50 to $3.90 in the summer of 2014 as part of the funding plan intended to support the increased employer contributions required under Senate Bill 1922.

As of July 29, 2016, labor leaders representing the employees who are members of MEABF and the City are working to develop a funding and reform proposal consistent with the agreement reached for LABF.

Laborers’ Pension Fund

Without Senate Bill 1922, the employer and employee contributions required under state law are insufficient to maintain the long-term, financial viability of LABF.

Thus alternative funding plans and benefit reforms are critical. The 2016 contribution to LABF is $15 million. If the employer and employee contributions continue at this rate, only growing with salary increased, LABF will become insolvent in 2027.

Municipal Employees’ Pension Fund

The 2016 contribution to MEABF is $162 million. If the employer and employee contributions continue at this rate, MEABF will become insolvent in 2025.

  1. All projections are based on actuarial assumptions regarding future conditions, which are subject to numerous legislative, economic, and other factors; while reported projections are the best estimates available at this time, these should be viewed as approximate. The historic contributions presented in this chart differ slightly from amounts presented in prior years’ Annual Financial Analysis as a result of differences in the accounting documentation of these contributions. 

  2. In 2010, the State enacted changes to the benefits for employees hired on or after January 1, 2011. These benefit changes impact retirement age and replace the automatic annual increase with an inflation adjusted cost of living adjustment.