Yes, I am almost done (for the time being) writing about Chicago’s pensions, but before I close out this set of articles, I’ve got one more set of graphs to share.
In my prior article on the causes of the collapse in Chicago’s pension funding, I wrote that there were multiple factors at play: it is inherent in the nature of this sort of plan, with a comparatively high discount rate and using risk-taking investments, for the liability to grow substantially from year to year. For a fully-funded plan, f everything continues as predicted — if asset returns are as expected, assumptions are stable, there are no plan benefit increases, appropriate contributions are made to cover new benefit accruals, and so on — then asset growth will keep pace with liabilities. If not, then such a plan is very vulnerable to dramatic collapses in funded status, unless there are mechanisms to adjust liabilities built into the plan.
But there’s another characteristic of this plan that’s also important to understand, illustrated by another chart:
In 2001, benefit payments were about 50% higher than contributions (combining both employer and employee contributions, because both these go into the fund), and 150% higher than new accruals. In 2016 (before the ramp started), benefit payments were 200% higher than contributions, and in 2017, they were 250% higher than new accruals. This imbalance means that, on the one hand, liabilities grow less than they otherwise would, because each year, the benefit payments during the year reduce the end-of-year liability, and the new accruals increase it. But at the same time, this imbalance is a headwind making it all the more difficult for pension funds to recover from asset losses.
How does this compare with the other Chicago pension funds? And how much of this is ordinary inflation having an effect?
Here’s the growth in the pension benefits for the Firemen’s pension fund, shown both in current dollars (unadjusted) as well as adjusted for inflation, based on the Chicago-specific inflation rates published in the actuarial report itself.
and here’s the same graph for the Policemen’s plan:
Or, viewed another way, here’s the relative inflation-adjusted increase over time:
Why did the benefits grow so much? There are a number of reasons: the number of pensioners grew over time (even though the population declined). Salaries increased at rates higher than inflation. Guaranteed post-retirement adjustments exceeded inflation in most of these years. And the benefit formula increased for these plans over time as well.
And by way of comparison:
The Laborers’ plan was 113% funded on a solvency basis in 2002, 48% in 2017.
The Police plan was 71% funded in 2000, 24% in 2017.
The Fire plan was 59% funded in 2000, 20% in 2017.
And the Municipal Employees’ plan, 94% vs. 27% funded.
Now, I should say, in defense of my profession, again, that the actuaries did their jobs properly in calculating the plans’ liabilities based on best-estimate assumptions. I see nothing that suggests they were violating any norms of actuarial practice. But, again, the key word is vulnerability; using a rate-of-return interest rate (as prescribed by those norms) and investing in risky assets, leaves a plan vulnerable to funded status drops or high and escalating contribution requirements whenever liabilities increase due to assumption changes, new benefit accrual, or the like, or whenever assets drop due to market declines. In fact, the profession has become increasingly aware that a “best estimate” actuarial valuation doesn’t provide a full understanding of the plan’s financial picture, and actuaries are far more likely to provide illustrations of the impact of market downturns or other events.
Thoughts? Comments? Please visit JaneTheActuary.com, where you will also find links to related articles.