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 benefits upon retirement, death or disability to members and their beneficiaries. 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 of Chicago. Employees and employers contribute to the retirement plans 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 contributions and return on investments are the total assets of a pension fund. The benefits available under the pension funds accrue throughout the time an individual is employed by the City and certain age and service requirements must be achieved by an employee to generate a retirement or survivor’s defined benefit payment upon retirement from the City. 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 currently 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 Board of Education;

• the Laborers’ and Retirement Board Employees’ Annuity and Benefit Fund (LABF), which covers City and Board of Education employees who are employed in a title recognized by the City as labor service;

• 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, 2016:

Fund Name Active Members Inactive Members Retirees
MEABF 30,296 16,876 25,236
LABF 2,822 1,476 3,769
FABF 4,760 88 4,777
PABF 12,177 606 13,394

Inactive members have not yet retired, but are no longer working for the City; therefore they no longer contribute to the Funds. Source: City of Chicago 2016 CAFR - Comprehensive Annual Financial Report

In recent years, the City of Chicago worked with union leadership and Illinois lawmakers to address the City’s contributions to these funds as well as employee contributions and benefits. State law changed for all four pension funds in 2016 and 2017, allowing the City to stabilize the pensions through increased employer contributions and other reforms, while still protecting taxpayers and vital City services. The specific legislative changes and funding sources for 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’.

While the City has recently taken steps to address the net pension liability through increased employer contributions, the current funded status of the pension funds is the result of the historic statutory framework of the pension system coupled with economic factors, demographic and workforce changes, and certain enhancements to pension benefits. These factors taken together have grown the net pension liability of all four funds and are discussed further in this section.

Funding Status of City Pension Funds, as of December 31st, 2016

Fund Name (A) Total Pension Liability (B) Plan Net Position Net Pension Liability (B) as % of (A)
MEABF $23,291,271,396 $4,436,227,596 $18,855,043,800 19%
LABF $3,693,645,301 $1,167,740,724 $2,525,904,577 32%
FABF $5,149,258,197 $1,019,013,793 $4,130,244,404 20%
PABF $13,113,091,689 $2,865,018,804 $10,248,072,885 22%
Total $45,247,266,583 $9,488,000,917 $35,759,265,666 21%

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. 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 reporting requirement increased the reported net pension liability. This reporting requirement does not impact the statutory or actuarially determined contributions required by the City.

Funding Formulas

Employees are required to contribute to their respective pension fund as set forth in the Pension Code. The provisions of the Pension Code also mandate the amounts the City must contribute to the pension funds. Prior to the legislative changes enacted over the last two years, the City contributed to all four pension funds an amount determined by a funding formula which required the City to contribute a statutory multiple of the amount contributed to a pension fund by the employees who are members in that fund two years prior to the year in which the property tax used to generate the contribution was levied. The multiplier varied by each pension fund. The City’s employer contributions were not actuarially-determined to ensure the pension funds were fully funded, which helped to drive the growth in the net pension liability.

As discussed further below, legislation was passed recently to put all four of the City’s pension funds on a fixed contribution ramp over five years that then reaches actuarial-required contributions (ARC) in the sixth year and 90.0 percent funded in 40 years.

Workforce and Retiree Demographics

The makeup of the City’s workforce and retirees added to the net pension liability. The historic, 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. Reductions to the overall size of the City’s workforce have also resulted in employee contribution reductions to the City’s four pension funds.

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 87.0 percent funded to approximately 62.0 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 61.0 to 66.0 percent. Then, in 2007 and 2008, the real estate-driven market crash took the City’s pension funds, collectively, from approximately 62.0 percent funded to approximately 38.0 percent funded.

Additionally, some of the City’s pension funds are now lowering the assumed investment rate of return, which impacts the funded ratio. The assumed investment 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 some of Chicago’s pension funds, to lower their projected rate of return. The PABF lowered its rate of return from 7.75 percent to 7.50 percent in 2014 and again in 2016 from 7.50 percent to 7.25 percent. In 2015, the FABF lowered its rate of return from 8.0 percent to 7.5 percent. Lowering the rate of return causes the net pension liability to increase because it is an assumption of lower long-term investment income.

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. Most recently, P.A. 99-095, further clarified by P.A. 100-023 extended a 3.0 percent annual cost of living adjustment to participants in the PABF and FABF born before January 1, 1966. Previously, the 3.0 percent cost of living adjustment was only available to those born before 1955. Also in 2016, the minimum benefit for widows was increased to 125.0 percent of the Federal Poverty Level and P.A. 99-0906 increased the minimum benefit for certain annuitants to 125.0 percent of the Federal Poverty Level. These changes increased the net pension liability for FABF and PABF by a total of $833.4 million and will thereby increase the required City contributions.

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 payment increases 3.0 percent over the prior year’s benefits payment. Note that 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. The minimum pension certain retirees receive has also increased and the final salary used to calculate a retiree’s pension has been expanded to include more categories of pay other than annual salary.

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.

Demographic changes, benefit enhancements, 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 quickly address the situation with changes to benefits, increases in contribution requirements, or both as the issues presented themselves.

Prior Pension Reforms

Pension funding and pension reform has been an ongoing issue in the State of Illinois in recent years. There have been multiple attempts by the State of Illinois, the City of Chicago, and other municipalities to achieve pension reform that ensures the solvencies of the pension funds without sacrificing services or forcing unsustainable contribution increases. In some cases, the Illinois Supreme Court ruled these reform plans unconstitutional, forcing government entities to identify alternative paths. The following describes prior pension reform legislation that informs the City’s current contribution structure and employee benefits.

Senate Bill 3538 (P.A. 96-1495) & Senate Bill 1946 (P.A. 96-0889) – Establishment of Tier Two Benefits Legislative reform efforts passed in 2010, created a “tier two” benefit structure. Members of all four City pension funds hired after January 1, 2011 are considered part of this benefit tier. This reform changed the annual cost of living adjustments to the lesser of 3.0 percent or one-half of the consumer price index increase, simple. Additionally, this legislation capped pensionable earnings and extended the retirement age to 67. This tiered structure remains in place with certain additional changes to MEABF and LABF beneficiaries hired after July 6, 2017. This change along with reforms to funding structure outlined in P.A. 96-1495 for FABF and PABF are discussed below.

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 P.A. 98-599 unconstitutional, stating all benefits established in the Illinois Pension Code cannot be modified for current employees or retirees.

Senate Bill 1922 (P.A. 98-641) – In June of 2014, Senate Bill 1922 (P.A. 98-641) was enacted, adjusting benefits and increasing both the employer and employee contributions. Under P.A. 98-641, LABF and MEABF retirees would have received an annual cost-of-living adjustment of the lesser of 3.0 percent or half of CPI, simple, 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 11.0 percent, phased-in over a five year period.

P.A. 98-641 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 P.A. 98-641 was unconstitutional because it included a reduction in benefits for current employees and retirees.

Pension Funds Going Forward

The chart and details below provide information on the historic annual pension contributions to all four pension funds as well as discuss the recent pension reforms achieved for all four funds and the future of these funds.

Police and Fire Pension Funds

As discussed above, the State passed P.A. 96-1495, which along with reforming pension benefits for city employees hired on or after January 1, 2011, also altered the City’s contribution to PABF and FABF. P.A. 96-1495 required, that beginning in 2015, the City’s contributions each year for PABF and FABF equal the amount necessary to achieve a funded ration of 90.0 percent in PABF and FABF by the end of fiscal year 2040. The General Assembly subsequently modified P.A. 96-1495 with the enactment of P.A. 99-0506. P.A. 99-0506 extends the year from 2040 to 2055 for which the unfunded liabilities of PABF and FABF must reach the 90.0 percent funded ration and institutes a five year phase-in period to allow for a more gradual increase in the City’s required contributions than originally required in P.A. 96-1495. From 2015 through 2019, the City will contribute over $3.6 billion to the PABF and FABF pension funds and then begin making actuarial determined contributions in 2020.

To meet the increasing contribution amounts established in P.A. 99-0506, the City passed a four year property tax increase starting in 2015, providing a sustainable and dedicated revenue source to make the ramp contribution amounts through 2018. Additional details on the property tax increase can be found in the property tax sections of this document.

The City’s 2016 budget included the second year of ramp funding for the PABF and FABF pensions totaling $672 million, including $464 million for Police and $208 million for Fire. These contributions were funded through $21.8 million from the Aviation funds and $650.2 million from property tax collections. The 2017 budgeted contributions increased to $500 million for PABF and $227 million for FABF for a total contribution of $727 million. This includes $23.7 million from the Aviation funds and the remaining $703.3 million from property tax collections.

Municipal and Laborers’ Pension Funds

Based on the Illinois Supreme Court’s decision to strike down P.A. 98-641, the City worked with its labor partners to reach a new reform agreement to prevent the pending insolvencies of MEABF and LABF in 2025 and 2027, respectively. This joint agreement is reflected in Senate Bill 42, which became law in July 2017 (P.A. 100-0023).

With P.A. 100-0023, the City will contribute fixed amounts on a ramp each year from 2017 through 2021. After which, the City’s contributions will be actuarially determined to achieve 90 percent funding by 2058. Additionally, new employees hired on or after July 6, 2017 (the effective date of the public act), will be required to contribute 11.5 percent of their salary to their respective pension fund, which is an 3.0 percent increase from the 8.5 percent current employees contribute, and these employees are eligible for benefits at age 65. Employees hired between January 1, 2011 and July 6, 2017, may elect to increase their employee contributions to 11.5 percent from 8.5 percent in order to be eligible to receive pension benefits at age 65 instead of age 67. The reforms to employee contributions and benefits were based on the Illinois Supreme Court’s decision, which indicated benefits may be adjusted for new hires and current employees can be given a choice to exchange a lower retirement age for a higher employee contribution rate.

In 2016 – the final year of the multiplier formula based contribution – the City’s budgeted contributions for Municipal and Laborer’s pension funds were $161.5 million and $15.0 million respectively. This includes $11.6 million in corporate funds, $12.4 million from the Aviation funds, $16.7 million from the Water and Sewer funds, and $135.8 million from property tax collections. The first year of ramp funding for the Municipal and Laborer’s pensions is included in the City’s 2017 budget, increasing the budgeted contribution to both funds by $126.5 million for a total contribution amount of $303.0 million. In order to meet these growing contributions under the ramp and into ARC funding, the Chicago City Council passed dedicated revenue sources for its pension funds in recent years.

In 2014, the City adopted a 911 surcharge increase (from $2.50 to $3.90), generating an additional $40 million annually for the City’s 911 emergency operation, which is funded with both the proceeds from the City’s 911 fee as well as other general tax revenue. The 911 surcharge has been insufficient to pay for the full cost of the City’s 911 and emergency response preparedness activities. The increase in the 911 surcharge was dedicated to these expenses, allowing corporate fund resources previously appropriated for 911 operations to be dedicated to funding increases outlined in P.A. 98-641.

In order to fund the increasing contributions to MEABF, the City passed a water-sewer utility tax in September 2016. In 2017, Chicago residences and businesses began paying a water-sewer tax totaling $0.59 per 1,000 gallons of water and sewer usage ($0.295 for water and $0.295 for sewer). This tax will incrementally increase over four years, ending with a total assessment of $2.51 per 1,000 gallons of water and sewer usage in 2020 and the rate will stay the same in 2021. MEABF annual employer contributions will be funded with revenue from the water-sewer utility tax in addition to existing property tax, corporate fund resources, and the enterprise funds’ proportionate share. In 2017 though, all water-sewer utility tax revenues collected in that year will be set aside in escrow in order to help make the 2022 contribution, which is the first year that the City’s contribution will be actuarially determined. Additionally, a portion of the water-sewer utility tax revenues will be escrowed in 2018 through 2020 for the same purpose.

The 2017 budgeted contributions to LABF and MEABF are $303 million combined, which includes $24.6 million from Aviation funds, $34.0 million from the Water and Sewer funds, $108.6 million from the corporate fund, and $135.8 million from property tax collections.

  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.