By: Mark Glennon*
UPDATE 7/17/17: A new Forbes article linked here written by a pension actuary details how irrational accounting standards allow this deception to happen.
Chicago is bragging about reducing its unfunded pension liabilities and progress shown in its new financial statements. In fact, the city merely changed assumptions used to measure its pension debt. That change covered up what otherwise would have been another very bad year.
The assumption changes had a whopping impact of about $7.7 billion on the pensions, supposedly reducing their unfunded liabilities from $35.7 billion to $28 billion. And that $7.7 billion helped cover up losses on the city’s overall position. However, there was little or no economic logic or common sense supporting the new, rosy assumptions.
Here are a few headlines from last week on Chicago’s CAFR for 2017 — its annual, audited financial statements — that might have cheered Chicagoans up:
From the Chicago Sun-Times.” City audit shows improving financial picture, declining pension obligation,”
From the Chicago Tribune headline.”Mayor Emanuel cuts Chicago pension debt but hit to future taxpayers are still expected.”
Even The Bond Buyer had a positive headline, “Chicago makes headway on digging out from fiscal hole.”
What actually happened is that two Chicago pensions simply increased the discount rate used to calculate the health of two of its four pensions, the Municipal Fund (MEABF) and the Laborers Fund. The discount rate assumption is key because it basically represents how much the pensions are expected to earn on the investments they hold.
That change in assumptions allowed the city to say, as reported by the Tribune, that as of the end of 2017 Chicago “was about $28 billion short of what’s needed to cover future pension payments to retired city workers. That debt was about $7.7 billion less than at the end of 2016.” (The Tribune did, however, discuss the accounting gimmicks to some extent.)
In fact, the assumption changes account for the entire $7.7 billion of supposed reduction in the city’s unfunded pension liabilities. That’s despite a banner year in the stock market, which most pensions enjoyed in 2017. Chicago’s pensions earned over 14%.
And those supposed pension improvement feed into the bottom line on the current and future financial statements. Consequently, the loss Chicago suffered for the year would have been much larger without the assumption change — much worse than they have typically been over the last ten years.
Wait, you might say if you’ve been following the pension crisis. Aren’t pensions everywhere cutting their discount rate to reflect more realistic assumptions about how much their investments will earn?
Yes, and here’s how Chicago justifies doing the opposite. MEABF and the Laborer’s Fund already cut their discount rate heavily in 2016, which had a huge, negative impact on their position. Reporting at the time properly attributed the pensions’ loss to the assumption change (driven by a change in accounting rules), as we did here.
But this year MEABF increased its rate from 3.91% to 7% and the Laborers Fund increased is rate from 4.17% to 7%, close to where the rates were originally.
What was their justification for that? The new taxpayer contribution schedule that became law, say the accountants in the CAFR.
We’ve written about that schedule before. Rahm’s Ramp, as we called it, provides for gradually increasing contributions by the city to the pensions, ultimately going to a sort of ARC payment, which is the supposed actuarially required contribution.
But does it make any sense to change the assumed rate of return on investments because of that? Does a new ramp mean the pensions now are $7.7 billion better off? No. Nothing about the pensions really changed. Pension promises were not reduced. The rationale wasn’t that the pensions have more assets on hand or rosier expectations about the markets.
The justification was only based on a new ramp, and up-ramps in scheduled pension contributions are routinely busted. Both Chicago and the State of Illinois have regularly gotten the law changed to kick the can by pushing ramps out further when the time comes to pay up. Now, somehow, the city, its accountants and actuaries think a new ramp justifies what is effectively a $7.7 billion write-up for the pensions.
And Chicago certainly hasn’t told anybody how it intends to fund those ever-higher contributions. Though some tax and fee increases have been passed, the bulk of the future bill remains to be addressed. Rahm admitted that last November, saying he will deal with it when the time comes.
Now, let’s turn to the bottom line of the financial statements for the city as a whole.
The city’s loss for the year would have been much worse but for the assumption changes, because those supposed pension improvements were partially used to prop up the bottom line.
Chicago reported what is basically a net loss of $938 million for the year on an accrual basis. It’s call Change in Net Position. That’s a bit lower than losses reported for most of the past nine years, which have typically been a little over $1 billion (although the losses were much worse in 2015 and 2016, mostly because of the pension assumption changes going in the opposite direction from 2017). On the surface, therefore, 2017 looks like improvement.
But the $7.7 billion of supposed improvement in the pensions pulled up the bottom line. It gets spread out over five years for purposes of calculating Change in Net Position. So, the loss would have been $1.5 billion worse but for the pension assumption changes, taking the city’s loss for 2017 to about $2.4 billion.
That’s hardly good news. It’s worse than the ten-year trend, which was already awful.
And the city will use another $1.5 billion for another four years to likewise cover up losses.
Wait once again, you might say. Didn’t Chicago tell us its 2017 budget was balanced, as the law requires? Yes, of course it did. Rahm’s gleeful press release on that is linked here. This is just another example of how governments can bleed red ink even when operating under supposedly balanced budgets.
For those interested in seeing the numbers and details yourselves, go to the one line that matters most in the 228-page CAFR. It’s the Assumption Changes line on page 91. MEABF and the Laborer’s fund are assumed to have improved drastically.
The Bond Buyer article includes some discussion of the impact of the assumption change. “This is more of an accounting change than an actual multimillion-dollar benefit,” says Howard Cure, director of municipal bond research at Evercore Wealth Management LLC in the article.
Cure added another hugely important point about how badly Chicago’s pension underfunding will continue even under the new ramp: “Additionally, the measure also includes a 40-year amortization period to reach a 90% funded ratio. This locks the city into negative amortization for many years as contributions into the plan won’t even cover the interest on the unfunded liability, causing it to continue to grow over that horizon.”
In other words, even under the new ramp Chicago’s pension hole will continue to grow. We don’t know when true improvement would actually occur under the new ramp because the city has never shared full projections.
Even with the assumption changes, all of Chicago’s pensions remain in horrible condition. As of the end of last year, the funding ratios for MEABF, the Laborer’s Fund, police and firefighters’ funds are 28%, 48%, 23% and 20%, respectively.
Chicago has claimed other areas of progress it says are reflected in it’s CAFR, though none has nearly the magnitude of the pension progress it claims. Maybe those other positive developments are real or maybe they are not. I haven’t checked them out.
Personally, however, I don’t trust anything the city says unless it’s independently scrutinized, given chapters like this in its history with budgets, pensions and financial reports. Especially with a mayoral election coming up.
–Mark Glennon is founder and executive editor of Wirepoints.