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Retirement Planning > Saving for Retirement

Chicago’s pension woes threaten city

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There’s an ill wind blowing in Chicago that could take the city down. That’s because the Windy City threatens to become the next Detroit if it doesn’t find a way to fund its pension obligations.

Already downgraded by Moody’s by a surprising three notches – it’s only four slots above junk – Chicago has also seen its S&P outlook cut to negative. That could mean a downgrade within the next couple of years.

The cause? Unfunded pension obligations to its five plans. Chicago has been stalling on pension contributions for many years, a problem fueled in part by the economic downturn and helped along by a state formula that allowed woefully inadequate pension contribution levels by the city given its commitments.

The problem is so bad that the city’s underfunding amounts to a total of $100 billion in pension liability, the worst in the nation.

According to a report from the Pew Charitable Trusts, out of the country’s five biggest cities, Chicago stands out as having contributed the least to its pension commitments, with city documents revealing the level of funding at the end of 2012 at only 36 percent. Even funding at 80 percent is not considered adequate, and Chicago is a long way from there.

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Looking at the issue in another way, among the 50 local governments with the most debt, Chicago has the most ground to make up on its pensions. The city’s pension liabilities, according to Moody’s calculations, were equal to 678 percent of its revenues as of 2011, and Cook County (which contains Chicago and some of its suburbs) comes in next, with pension liabilities that equal nearly 382 percent of its revenue. 

The shortfall will cost Chicago in more ways than one: not only is it considering cutting retirement benefits, something that will not endear it to its public servants, but the hit to its credit means that it will likely pay much more to borrow money. The twin possibilities of having to cut services and raise taxes have incensed everyone, though Mayor Rahm Emanuel has so far refused to consider a tax increase.

Instead, he’s advocating measures that have exponentially increased tension in the city — and in the state as well. He’s pushing to raise the retirement age for state workers, make them contribute more heavily toward their own pensions and freeze, at least temporarily, the level of benefits paid to current retirees, thus eliminating inflation adjustments. That choice is generating not just bad feelings will but fury among union members, who paid into their retirement system for years in expectation of secure benefits.

The reaction from union members — not just in Chicago, but across the country — is understandable, since many union members do not participate in Social Security and thus have no other retirement income. They say the city and state are at fault, and therefore workers and retirees should not be the ones to pay for the city’s, and the state’s, poor planning. They also say that if the state’s formula was inadequate, the city should have compensated for it on its own so that it could honor its obligations.

The problem will become seriously worse in 2015, when Chicago will be required by the state to increase its contributions to those five different pension plans by a huge margin — a questionable action given the city’s failure to meet previous contribution commitments.

According to David Draine, senior researcher at Pew, while Chicago’s problem is a complex legal and political one, “One of the challenges is that when you skip payments, it’s like making the minimum payment on a credit card. The cost is still there when the bill finally comes due.”

And it didn’t have to be this way — or at least, not this bad, he said. However, in 2010, Chicago made the equivalent of a minimum payment, instead of putting in a $1 billion payment that it should have.

And the state isn’t getting off without blame, too. There has been no progress to speak of in the state legislature, where Democratic politicians find themselves pitted not just against Republicans in favor of cuts, but also against former supporters from unions who are protesting the loss of benefits promised under legally binding contracts. Not only that, but there is a provision in the Illinois constitution that protects the retirement benefits of state employees — protection that the public employees’ unions have pointed out is not conditional on whether the state or city made required payments to fund those benefits or chose to skip contributions.

The impasse became so pronounced that in July, Illinois Gov. Pat Quinn decided to spur state lawmakers to solve the pension crisis by holding back their paychecks. Democratic leaders in the legislature responded by suing Quinn, who is also a Democrat. They pointed to other parts of the state’s constitution that protect legislators’ pay. In September, Quinn lost the battle when a judge ruled the governor’s order to withhold legislators’ pay unconstitutional, and ordered checks to be cut for legislators’ back pay, with interest.

Legislators, for their part, say they have been busy working on a plan. But provisions that include changing the COLA calculation and tying it to the rate of inflation and cutting employee contributions toward their retirement have been underwhelming, and with so much bad blood, a viable plan doesn’t look likely to emerge any time soon.

Draine said Chicago has to come up with a solution soon. “It either has to find new resources or do something else; right now it’s not sustainable.”

Saddled with huge debts of all sorts, Detroit today is in bankruptcy. While a municipal bankruptcy “is clearly something that is extremely rare,” Draine said, “(and) Chicago and other major cities are not anywhere near that, (that’s) the impact that continued failure to fund these benefits can have on taxpayers and workers.”

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