With the stroke of a pen and a lost court case, Chicago’s pension liabilities for 70,000 municipal workers increased 162% putting the city’s pension and fiscal future in jeopardy. The pension liability spiked to $18.6 billion at the end of 2015 up from $7.1 billion a year earlier.
Chicago’s Mayor Rahm Emmanuel’s plan to cut benefits while increasing contributions was shut down by the Illinois Supreme Court. The City is suffering from years of underfunding of their pension plan while using too optimistic assumptions and has only 32% of assets compared to liabilities. Other than Detroit, Chicago has the lowest credit rating of any major city in the country which will only increase borrowing costs. Property taxes were recently increased.
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The Rand Institute reviewing the Chicago pension dilemma warns that changes to the Chicago municipal pension plan could have unintended consequences. By increasing eligibility ages and decreasing multipliers used to calculate pension payments, there could be higher attrition among teachers early in their careers while lower turnover for teachers toward the end. Not only is turnover costly, there will be less talent to take over in the future while older workers are most costly.
Perhaps learning lessons from Chicago and Illinois, Arizona passed pension reform moving more new hires into 401k-like plans away from pension schemes while lowering benefits to their existing DB plan. Changes included capping COLA payments and salaries used to calculate pensions from $265,000 to $100,000 as well as prohibiting municipalities from taking a “pension holiday” where payments are suspended.
Private companies that have shifted from DB plans to DC plans long ago with $2.9 billion in pension plans compare to $14 trillion in IRAs and DC plans – government entities have started to take similar steps but the damage may be too great to overcome with Stanford estimating a likely $4.8 trillion shortfall for $5.6 trillion in government DB plans. The only options appear to be increased funding, which means higher taxes, lower benefits, or bankruptcy like Detroit. In addition, it might be harder for state and municipalities to recruit qualified employees who had been willing to take lower salaries in return for better benefits.
