Chicago Police Pension on the Verge of Bankruptcy?

Forbes contributing columnist Elizabeth Bauer (aka Jane the Actuary) reports on how a recent Chicago police pension forensic audit uncovered gross mismanagement which compounded underfunding:

Readers, when I first read that retirees and employees in the Chicago Police pension system were pursuing a “forensic audit,” that seemed like nothing more than wishful thinking. It seemed plainly obvious that the plan’s massive underfunding was explained by the lack of a commitment to fund the plan properly, and by years of delusion that future favorable investment returns would solve the plan’s problems. But it turns out that there are serious issues with how that plan was managed that compounded these underlying issues, as revealed in a new report released at the end of August.

The background to the report is this: after this rapid decline in pension funded status over the past two decades (the police pension was, after all, 71% funded as recently as 2000), a group of retirees, widows, and active officers formed a group called the CPD Pension Board Accountability Group in February 2020, asking for a full audit of the fund. Their requests were denied, even when they offered to pay the full cost themselves, so they hired the author, Christopher Tobe, who set about doing the research based on publicly-available information as well as through making a series of Freedom of Information Act (FOIA) requests, the largest number of which, Tobe says, were illegally denied.

Here are some of the highlights of the report:

It is reasonably well-known that the pension plan has been underfunded for years, and that the state, in setting a new funding plan, allowed a “funding ramp” in 2011 and then re-set that ramp in 2016, so that funding according to the “90% funded by 2055” target only began in 2020. However, Tobe alleges that “Chicago has consistently underfunded the plan more than the statutory amount, blatantly breaking the law, with no consequences.” 

Regarding fees and management, Tobe alleges that the pension fund has “failed to monitor and fully disclose investment fees and expenses” and that “fees and expenses could be 10 times that which they disclose” because the fund’s disclosure “omits dozens of managers and their fees.” He also reports that the Fund claimed that “hundreds of contracts for the investment managers” are exempt from FOIA, and denied him access to the fund’s own analysis of fees. He concludes that “PABF may have over 100 ‘ghost managers’ in funds of funds,” that is, the fund is required to disclose its managers but it fails to do so, even though Tobe has identified them through other sources.

Tobe also found that “pay to play” is alive and well in Chicago. A 2014 report found that “former Mayor Rahm Emanuel received campaign donations of over $600,000 from investment managers who manage accounts for the PABF and other city funds.” In addition, Mayor Lightfoot has received $200,000 in donations from firms managing Chicago pension funds. 

In addition, while poor performance is never a proof of failure in isolation, Tobe found that the pension fund had well-below-average investment performance, compared to other funds — at the 90th percentile (bottom 10%), which he attributes to the fund’s use of alternative investments, with high fees not compensated for with high returns. He also raises concerns of cooked books, but cannot confirm this because of the city’s repeated denial of records requests.  

With respect to governance, the fund violates a fundamental aspect of prudent governance because its Chief Investment Officer is not a professional with qualification in the field, but simply a trustee and active-duty policeman, and, what’s more, one who has “22 allegations of misconduct as a police officer including one for bribery/official corruption.” Further, no staff members hold the credential of a CFA charter, another marker of professionalism. Another related governance issue is the use of offshore investments, e.g., in the Cayman Islands, which lack key governance and transparency protections of US-based funds.

Finally, with respect to financial reporting, “the Chicago Police Pension has decided to stop issuing Comprehensive Annual Financial Reports,” issuing a report neither in 2019 nor in 2020 (though it has made public the actuary’s reports for those years and makes available the valuations back to 2007 on its website).

There’s more, but I’ll stop here, as this is more than enough to illustrate that there are troubling practices at the fund that only compound the already-serious funding issues. It is not possible to know how much these mismanagement issues have effected the plan’s investment returns and plan expenses, but regardless of the magnitude, none of this should be happening. The city of Chicago wants us all to believe that the corruption which has been part of the city’s legacy for so many years, is in the past — but this report calls that into question. And, regrettably, Tobe’s report has gone practically unnoticed in the local media, with, to the best of my knowledge, coverage only at the local CBS affiliate.

Take the time to read Christopher Tobe's report here, it's quite an eye-opener.

On funding, Tobe writes this:

The fund went from a mediocre 61% funding level in 2003 to a mere 22% in 2019, which ranks it as one of the worst in US Pension History. It is at by many counts the 3rd worst large public pension in US history after the smaller Chicago Firefighter’s Pension Fund and the Kentucky Employees plan.

Defunding the Police Pension has been happening for the last 17 years. Chicago city government has used the PABF like a credit card, underfunding it by approximately $300 million a year, resulting in an $11 billion balance in unfunded liabilities.

City officials have lobbied the State of Illinois so that, while the Actuarial Required Contribution for 2019 was $1.037 billion, the State allowed them to “short” the pension borrowing around $300 million. This was accomplished by allowing the City to claim the statutory required contribution was only $737 million. The amount of annual contributions defined under P.A. 99-0506 does not even cover normal cost, let alone the interest on the unfunded liability for the next 11 years. This means the unfunded liability is projected to increase to a high of $12.2 billion in 2030, when contributions are finally sufficient to start reducing the unfunded liability.

To add insult to injury, the city even underfunds the pension more than the statutory amount, blatantly breaking the law, with no consequences. While the law has an intercept function that works for some cities, it seems deliberately rigged to let Chicago off the hook with intercepts so small they are immaterial.

Chicago is frequently considered as being the most likely major U.S. city to file bankruptcy following Detroit. Officers have already had retiree health benefits related to plan cut significantly. Retirees, disabled officers, and widows, along with currently active police officers, have valid concerns that their pension benefits could possibly be slashed by as much as half in a municipal bankruptcy.

For its part, the Retirement Board of the Policemen's Annuity and Benefit Fund of Chicago put out this statement on its website to respond to all these allegations.

Interestingly, I wasn't able to copy and paste this statement so I took a screenshot of it (you can read it here).

If you look at this section of the website, you will find two types of reports for the Fund:

  1. The Comprehensive Annual Financial Report (CAFR) contains financial results of the Fund’s operation in a fiscal year. The CAFR also includes investment, actuarial, and statistical information about the Fund for the fiscal year.
  2. The annual audit. The Fund’s management is responsible for the preparation and fair presentation of the Fund’s financial statements in accordance with generally accepted accounting principles. In compliance with 40 ILCS 5/5-188, the Fund contracts with an independent certified public accounting firm (Mitchell & Titus LLP) to perform an annual audit of the assets of the Fund and issue a financial opinion.

You'll notice that the latest available Comprehensive Annual Financial Report (CAFR) dates back to 2018 (read it here). 

I zeroed in on the funded status which was published in that 2018 CAFR:

The funding ratio of the Fund on a fair value basis, for purposes of market value funding, experienced a decrease to 22.0% at December 31, 2018 from 23.8% at December 31, 2017.

Then, I looked at the 2020 annual audit report (available here) to see where the funded status stood at the end of last year:

The funding ratio of the Fund on a fair value basis, for purposes of market value funding, experienced an increase to 23.41% at December 31, 2020 from 22.20% at December 31, 2019. During 2014, the Fund adopted GASB No. 67, which requires that projected benefit payments are required to be discounted to their actuarial present values using a single discount rate that reflects (1) a long-term expected rate of return on pension plan investments (to the extent that the plan's fiduciary net position is projected to be sufficient to pay benefits) and (2) a tax-exempt municipal bond rate based on an index of 20-year general obligation bonds with an average ‘AA’ credit rating. Using this methodology, the funding ratios of the Fund at December 31, 2020 and 2019, were 22.2% and 21.4%, respectively. Discount rates used in the GASB No. 67 valuation were 6.28% and 6.43% as of December 31, 2020 and 2019, respectively.

Let me be blunt: Chicago's police pension is on life-support and they're about to stop the ventilator.

Importantly, when a pension plan's funded status drops below 50%, it's past the point of no return; when it drops below 25%, it's dead on arrival! 

This is what happens when cities and states shirk their responsibility to properly fund a public pension and when you have poor governance that exposes a fund to potential corruption and fraud.

But forget allegations of fraud and corruption, which we all know are endemic to Chicago, the police pension plan is way past the point of no return and no hedge fund or private equity fund can save it from oblivion.

It makes my blood boil when I read these articles and reports because these are pensions of police officers working in one of the most dangerous cities in America.

Like Tobe states, these are retired police officers, disabled officers, widows, as well as active police officers who expect their pension plan to be managed properly so they and their loved ones can retire in dignity and security.

I don't want to scare these people but unless Cook County State's Attorney, Kim Foxx, intervenes to properly investigate what the hell is going on at the Chicago police pension plan, I'm afraid this is going to go from a disaster to a nuclear bomb.

Importantly, this pension is a textbook case of poor governance: lack of transparency, accountability, high fees, pay to play nonsense that should be outlawed by now, etc.

But the state and city are equally responsible for why this pension is grossly underfunded, completely disregarding their legal responsibility to properly top up this plan over the years.

In fact, I would lay more responsibility on the state and city governments than anyone else for this unfolding disaster.

Lastly, if it were up to me and I was king of the United States for a day, I'd do away with all these smaller rinky-dink local and city pension funds and amalgamate them all so they are managed by the state's public pension fund which tends to have better governance and a lot more transparency.

Not that this would make much of a difference in Illinois which is notorious for having one of the worst state pensions in the United States.

Everyone in the US needs to read a report “The evolution of the Canadian pension model; practical lessons for building world-class pension organizations” to understand how they can improve the governance at all their public pensions.

Don't hold your breath, however, there are vested interests which don't want to see state or other smaller public pensions adopt governance elements that led to success of Canada's large pensions.

But when it comes to Chicago, their brave men and women policing the streets deserve a lot better than what they're getting now in terms of how their pension is being managed.

I have a bad feeling this isn't going to end well and it will require a major state bailout and much higher property taxes (get ready Illinois!).

Anyway, I'd better stop there, enough of my Monday Tuesday rant.

Below, CBS News Chicago reports on scathing report has been issued about Chicago’s police pension fund, claiming taxpayers are paying millions of dollars more than needed in unnecessary fees. 

Financial auditor Chris Tobe released a report last Tuesday, three months after a group of retired officers hired him to review the management of the Policemen’s Annuity & Benefit Fund of Chicago.