Home BUSINESS No, Lightfoot’s Chicago Budget Does Not Make An ‘Actuarial’ Pension Contribution

No, Lightfoot’s Chicago Budget Does Not Make An ‘Actuarial’ Pension Contribution

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No, Lightfoot’s Chicago Budget Does Not Make An ‘Actuarial’ Pension Contribution

In late September, Chicago Mayor Lori Lightfoot delivered her 2022 budget address to the City Council. It was filled with a long list of new spending programs, including $400 million for community safety/violence reduction plans, $52 million for increased mental health services, $240 million for subsidized housing programs, $20 million for artists, and the list goes on. And among the achievements she lists is the following:

“In 2022, with the Budget we are proposing, we will climb our pension ramp, which means that for the first time in our city’s history, and all four pension funds will be paid on an actuarially determined basis. This is huge.”

Now, what she identifies as an “accomplishment,” having finished the climb up the pension ramp, is actually a state law that left her no choice in the matter. But that’s not the only incorrect part of her statement. Even having finally left the ramp behind, the plans are not funded on an “actuarially determined basis.” They are funded based on the Illinois legislature’s decision of a funding schedule which, for the police and fire plans, is sufficient to attain 90% funding in the year 2055, and for the Municipal and Laborers’ plan, not until 2058. Yes, if you do the math, that’s 34 and 37 years from now.

In fact, the plans’ actuarial valuations calculate a figure that’s labelled the Actuarially Determined Contribution. For the Fire plan (19% funded), the city’s contribution was only 79% of the ADC; for the Police plan (23% funded), the city’s contribution was only 75% of the ADC. And these are the two plans which reached the top of the ramp last year!

But, as it happens, there’s more to the story.

The Actuarially Determined Contribution is a figure that’s used for purposes of financial reporting, and it’s common enough to report on whether a plan is contributing at least as much as the ADC, as a way to eyeball whether a plan is being funded properly. But financial reporting for public pension plans actually works differently than for private-sector plans; public plans have historically had a great deal of latitude as to how they “determine” the actuarially-determined contribution. In fact, the method of determining the contribution is not decided by actuaries at all but by the Retirement Board for the respective plans! (See, for example, the Municipal actuarial report.)

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And, as it turns out, the particular calculation method used, a “rolling” amortization period, is one which is, in the long term, not any better than the current 37-year funding policy. It’s the equivalent of refinancing your home mortgage every year and resetting the balance to a new 30 year payoff period. Or, to put it a different way, it’s a 30 year version of Zeno’s Paradox, in which the runner travels half the distance, then half the remaining distance, and so on, never reaching the goal, but this time it’s 1/30th of the distance each time.

A more appropriate method of determining the ADC is what’s called a “fixed amortization,” which, as its name implies, is like a true 30 year mortgage, in which contributions are set to actually pay off the debt after 30 years from the start of the funding plan.

Here’s a comparison of the three methods for the 23% funded Municipal pension plan, using their current actuarial report and recalculating the projected funded status under the three funding methods, assuming everything else remains as projected.

Under a true “closed” ADC, the plan would be 90% funded in 2048, and 100% funded in 2050, at a point where, in the existing funding plan, it would be only 47% funded. Under the “rolling” ADC, even as late as 2069 (the final date of the actuary’s projection), it would only be 57% funded.

And there’s even more to the story.

As it turns out, the “rolling” ADC is generally acknowledged by the actuarial profession to be an inappropriate calculation. A 2014 White Paper by the the Conference of Consulting Actuaries Public Plans Community labelled this as an “unacceptable practice,” as acknowledged in a 2015 presentation by a Segal actuary — the very firm that the Municipal Employees’ Pension engages for its valuations.

In fact, the accounting standard that governs public pension plans, GASB 68, simply states that the Actuarially Determined Contribution must be determined “in conformity with Actuarial Standards of Practice.” And the relevant Actuarial Standard of Practice, ASOP number 4, states (3.14) “When selecting an amortization method, the actuary should select an amortization method that is expected to produce total amortization payments that are expected to fully amortize the unfunded actuarial accrued liability within a reasonable time period or reduce the unfunded actuarial accrued liability by a reasonable amount within a sufficiently short period” — a requirement that is interpreted as prohibiting the use of these long rolling amortization periods.

Now, there’s one further wrinkle, and that’s that the passage I just cited comes from the Third Exposure Draft, as this Standard of Practice is in the process of being revised, having last been revised in 2013. In addition, in 2015, the ADC, in the GASB requirements, replaced what had been called the Actuarially Required Contribution, and in the old standard, the 30 year rolling amortization was considered acceptable, or at least not unacceptable. This means that when the new Standard of Practice is finally finalized, the city will have to change its ADC calculation. And what that means, is that gap between the city’s actual contribution and the ADC will be even wider, in the short-term, with the payoff that the debt is paid off much sooner. (Note that in the graph, there is a jump in employer contributions in 2062 when the employee contribution decreases.)

So what’s this all add up to, besides a short lesson in pension finance?

It is clear from reading Mayor Lightfoot’s speech that, unlike the early days of her tenure, pension funding is the furthest thing from her mind — and, indeed, the now-customary reporting on Monday mornings counting the number of weekend shootings makes it clear that there are many issues which rightly should be on her mind. But the mayor’s extensive spending plans are based on short-term federal money which will disappear soon enough. It will require prudent decision-making. However determined Lightfoot may be to enhance spending on the needy now, it is wishful thinking to believe that having good intentions is enough to resolve longstanding issues of city debts.

Source: Forbes


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