RiskOctober 23, 2019

Chicago Moves to Consolidate More than 650 Pensions

Task force cites lower overhead costs and access to larger pools of capital as benefits to the potential mergers.

Reported by Steffan Navedo-Perez

Illinois Gov. J.B. Pritzker’s Pension Consolidation Feasibility Task Force formally issued a report explaining the benefits, procedures, and reasons to consolidate about 650 municipal pension funds throughout the state.

By working as independent and relatively small entities, the pensions are mitigating their investment opportunities and paying for respective overhead costs that could be vanquished under consolidation. Some of these retirement funds are small, only clocking in about $2,000 in assets under management in some cases. This serves as a huge obstacle for the funds to access relatively expensive asset classes outside of the traditional equity and bonds.

Consequent to their scale, the suburban and downstate police and fire pension plans generate significantly lower returns than their larger peers, on average pulling 2 percentage points less than the state municipal employees’ fund.

The task force performed an analysis that simulated the aggregate pensions’ return profile in a hypothetical scenario that takes advantage of economies of scale similar to a fund the size of the Illinois State Board of Investment or the Illinois Municipal Retirement Fund.

The simulation calculated their returns between 2004 to 2013, and found that if they were conjoined, they would have returned between 6.73% to 7.62%, a 112 to 201 basis-point increase (above the 5.61% generated during that period), and would have netted an estimated $160 million to $288 million annually.

“The larger pooled systems tend to operate more efficiently in terms of investments fees and expenses than smaller ones,” the task force report’s read.

Pritzker earlier this year denounced the idea of consolidating the downstate pensions into the state’s funds, citing that the state’s credit rating was already sitting just above junk status and was very sensitive to being degraded.

Forfeiting the opportunity to unlock these returns encapsulates the state and taxpayers in a never-ending cycle of property tax hikes and increased employee contribution rates to meet their pension obligations, the task force asserted.

“The greatest financial issue facing these systems is that the growth in liabilities has been consistently diverging from the growth in assets. … A fixed 90% funded level target date, market experiences vastly different from actuarial assumptions, and insufficient contributions into the system, have compressed remaining unfunded actuarial accrued liabilities into a shorter and shorter timeframe,” the task force said. “This has led to unsustainable growth in required employer contributions and has consistently increased the burden on state and local government operating revenues.”

The characteristics of each pension fund were surprisingly modest. Some only have one active beneficiary and $2,000 in assets under management, with only 3% of the plans having assets exceeding $100 million. Consequently, this leads to liquidity concerns around smaller plans bearing larger risk, and therefore lower returns.

The average number of plan participants per plan is 67 individuals, with 24 plans having only one active participant. Only five plans have more than 500 active members. The funded ratio for the average suburban and downstate police and fire pension plan is 55% funded.