The Firemen’s Annuity and Benefit Fund of Chicago (the “Fund”)

1. The Firemen’s Annuity and Benefit Fund of Chicago (the “Fund”) Navigating the legal issues surrounding funding Burke Burns & Pinelli, Ltd. OCTOBER 2019

3. “To put this into perspective, folks, for every dollar you pay to the city, 80 cents goes to pay for the cost of personnel and benefits, along with pensions. But let me be clear: I don’t see the provision of pensions or city workers as the problem. The key problem is the decades’ long failure to meet our pension obligations and fix the structural problems that have led to this crisis.” –Mayor Lightfoot “State of the City” Address

4. Statutory Background

6. Statutory Funding Prior to 2010: The “Multiplier” Historically, the City of Chicago’s required funding level to the Fund was based on a multiplier of what employees contributed two years prior. The Fund’s multiplier was 2.26. That meant that the City contributed 2.26 times the amount of employee payroll deductions made two years prior to the Fund. Multiplier contributions do not adjust according to the actual cost of providing benefits.

7. The Fund’s Funding Level Between 2000-2010 Figures provided by the Fund’s Comptroller.

8. Members’ Contributions • Members’ contribution percentage is 9 1/8% of salary allocated as follows: • 7 1/8% for firefighter’s annuity • 1 ½% for spouse’s annuity • 3/8 of 1% for the increment after retirement • 1/8 of 1% for ordinary disability benefits (this is not refundable) • A firefighter has a right to a refund of his or her contributions if: (a) he or she withdraws or is terminated before age 50; (b) he or she has less than 10 years of service and withdraws or is terminated before age 57; or (c) he or she withdraws and enters the service of another department of the city. • If a firefighter is eligible for a refund, the contributions for the firefighter’s annuity and the spouse’s annuity are improved with interest.

9. Public Act 96-1495: “ARC Funding” • In December 2010, Governor Quinn signed into legislation Public Act 96-1495. • Public Act 96-1495 created a new tier of pension benefits for public safety employees in Illinois hired on or after January 1, 2011. • Public Act 96-1495 also significantly changed the employer contributions required by the City of Chicago. • The statutory funding schedule under Public Act 96-1495 required the City beginning in 2015 to annually levy a tax upon all the taxable property in an amount when extended that will produce an annual amount equal to: • (1) the normal cost of the Fund, plus • (2) an amount sufficient to bring the total assets of the pension fund up to 90% of the total actuarial liabilities of the pension fund by the end of fiscal year 2040. • This actuarially required contribution is often referred to as “ARC Funding”.

10. “Normal Cost” An Actuarial Cost Method is a set of techniques used by the Fund’s actuary to develop required contribution levels for the Fund. The Actuarial Cost Method used in the Fund’s actuarial valuation to determine required statutory funding consistent with GASB accounting requirements is the Entry Age Normal Cost method. Under the Entry Age Normal Cost method, each participant’s projected benefit is allocated on a level percent of pay basis from entry age to assumed exit age. The Normal Cost is the present value of benefits associated with pay during the current plan year.

11. Senate Bill 777: The “Ramp” to ARC Funding Before the ARC Funding obligation under Public Act 96-1495 was required to be paid by the City, the Senate introduced Senate Bill 777 which was was signed into law on May 31, 2016. Senate Bill 777 puts the City on a longer funding plan with a five-year schedule of steadily increasing static payments (often referred to as the “Ramp”). Because the City’s Ramp contributions in FY2016-FY2020 are laid out in statute, the contributions from the City will NOT adjust should the funding needs of the Fund change due to lower than expected investment returns, changes in actuarial assumptions or other deviations from actuarial expectations (such as any additional, unfunded benefits).

12. Senate Bill 777 Cont. Senate Bill 777 also introduced a new provision that expressly subordinates required City payments to the Fund to the payments of the principal, interest, premium, if any, and other payments on or related to any bonded debt obligation of the City. In general terms, “subordination” is the act of yielding priority. The “subordination clause” covers any currently outstanding bonded debt obligation of the City or any bonded debt to be issued for which the source of repayment constitutes any funds collected or received by the City. This means that the City’s bondholders arguably have a priority over the Fund’s claim for required payments under the Pension Code.

13. Comparing the Revisions to Section 6-165 of the Illinois Pension Code for ARC Payments Public Act 96-1495 Senate Bill 777 “Beginning in 2015, the city council shall levy a tax annually at a rate on the dollar of the assessed valuation of all taxable property that will produce when extended an annual amount that is equal to (1) the normal cost to the Fund, plus (2) an annual amount sufficient to bring the total assets of the Fund up to 90% of the total actuarial liabilities of the Fund by the end of fiscal year 2040, as annually updated and determined by an enrolled actuary employed by the Illinois Department of Insurance or by an enrolled actuary retained by the Fund or the city.” “Beginning in tax levy year 2015, the city council shall levy a tax annually at a rate on the dollar of the assessed valuation of all taxable property that will produce when extended an annual amount that is equal to no less than the amount of the city’s contribution in each of the following payment years: for 2016, $199,000,000; for 2017, $208,000,000; for 2018, $227,000,000; for 2019, $235,000,000; for 2020, $245,000,000. Beginning in tax levy year 2020, the city council shall levy a tax annually at a rate on the dollar of the assessed valuation of all taxable property that will produce when extended an amount that is equal to no less than (1) the normal cost of the Fund, plus (2) an annual amount sufficient to bring the total assets of the Fund up to 90% of the total actuarial liabilities of the Fund by the end of fiscal year 2055, as annually updated and determined by an enrolled actuary employed by the Illinois Department of Insurance or by an enrolled actuary retained by the Fund or the city.”

14. The City’s Contributions During the “Ramp” Period

16. The “Ramp” Payments • The Five Year “Ramp” period includes static amounts the City must contribute to the Fund between FY2016 and FY2020. • FY 2016: $199,000,000 • FY 2017: $208,000,000 • FY 2018: $227,000,000 • FY 2019: $235,000,000 • FY2020: $245,000,000 • As of December 31, 2016, the City contributions for payment year 2016 was $192,653,466.28. • As of December 31, 2017, the City contributions for payment year 2017 was $201,199,905.45. • As of December 31, 2018, the City contributions for payment year 2018 was $219,136,850.11.

17. City Contributions for 2016-2018 Section 6-165 states that the “city council shall levy a tax annually at a rate on the dollar of the assessed valuation of all taxable property that will produce when extended an annual amount that is equal to no less than the amount of the city’s contribution in each of the following payment years: for 2016, $199,000,000; for 2017, $208,000,000; for 2018, $227,000,000; for 2019, $235,000,000; for 2020, $245,000,000.” Based on the City’s contributions for 2016, it was the Fund’s position that the City continued to owe the Fund $1,782,783.25 for required contributions in 2016. Based on the City’s contributions for 2017, it was the Fund’s position that the City continued to owe the Fund $1,557,419.75 for the required contributions in 2017. Based on the City’s contributions for 2018, it was the Fund’s position that the City continued to owe the Fund $7,863,149.89 for the required contributions in 2018.

18. Comptroller Intercept Relief • The Pension Code provides for 2 areas of relief in the event the City fails to pay the required contribution in a given payment year. • First, the Fund is required to certify to the State Comptroller the amounts of the delinquent payments, and the Comptroller must deduct and deposit into the Fund the certified amounts from State grants owed to the City. • On September 4, 2018, the Fund certified to the State Comptroller the amounts of the delinquent payments for payment years 2016 and 2017. On March 1, 2019, the Fund certified to the State Comptroller the amounts of the delinquent payments for payment year 2018. • As of today’s date, the Fund has received the total delinquent payments for payment years 2016, 2017 and 2018 through the Comptroller’s intercept and deposit of State grants owed to the City. • The other 3 Chicago public pension funds have followed the Fund’s direction in filing intercept proceedings with the Comptroller’s office.

19. Mandamus Relief A second area of relief is that the Fund may file a mandamus action in the Circuit Court of Cook county to compel the City to make the required payment. On September 19, 2018, the Board filed a mandamus complaint against the City seeking the funding payments required from the City under Section 6-165 (the lawsuit was filed prior to receiving any monies under the Comptroller intercept). The City has responded that the case involves the “loss in collection” amount related to the City’s collection of the property taxes it levies. The City alleges that it has historically never added a “loss in collection” factor to its property tax levy for the Fund. The City has requested that the Court declare that it has fulfilled its statutory contributions obligations and that the Fund should be required to return the monies intercepted by the Comptroller. A ruling is expected on November 22, 2019.

20. The City’s Contributions After the “Ramp” Period

22. Required “ARC” Payments In FY2021, the City must contribute an amount that is actuarially calculated in order to have the Fund be 90% funded by 2055 (pushing back the requirement to be 90% funded from 2040 that was in Public Act 96-1495). The Fund’s actuaries have determined that the City will be required to contribute $372,701,000.00 in 2021 under Section 6-164 of the Illinois Pension Code. This represents an increase in the City’s contributions of approximately $127 million dollars from the required 2020 “Ramp” contribution. “While we are working toward balancing this year’s revenue with this year’s costs, two years from now—in 2021—we will have to figure out how to pay for the increased annual cost of over $200 million for public safety services. Followed by another increase of $400 million for our municipal and labor pensions the year after that. In other words, no matter what we do for this coming budget, Chicago will be on the hook for over half-a-billion in new pension obligations over the next three years.” --Mayor Lightfoot

23. A Chicago Casino The revisions to Section 6-165 in SB 777 also provide that any proceeds received from a new casino in Chicago would go toward the City’s payment of its Police and Fire pension fund obligations. On June 28, 2019, Governor Pritzker signed a gambling legislation package that provides the pathway for Chicago to establish a casino. Following the passage of the legislation, the City of Chicago selected 5 potential sites for a Chicago casino. As required under the Act, an independent consultant was hired by the Illinois Gaming Board to review the feasibility of those potential sites. On August 13, 2019, the Feasibility Study was released. It concluded that the current “regulatory construct, namely the highest effective gaming tax and fee structure in the U.S., makes any [Chicago] casino project—regardless of location-generally not financially feasible.” “And importantly, we are pursuing a Chicago casino that creates a dedicated revenue stream to pay for our pension costs. If we get the tax structure right, this will represent a structural solution to address long-term problems, not a one-time fix.” —Mayor Lightfoot

24. Funding Caselaw

26. People ex rel. Sklowodski v. State, 182 Ill. 2d 220 (1998) Plaintiffs from the State pension systems sued the State and the General Assembly arguing that the State failed to comply with the funding requirements of the Illinois Pension Code. The Illinois Supreme Court confirmed that the pension protection clause of the Illinois Constitution “served to eliminate any uncertainty as to whether state and local governments were obligated to pay pension benefits to the employees,” and it “demands that the ‘benefits’ of that relationship shall not be diminished or impaired.” Sklowodski further stated, however, that annuitants are NOT entitled to a particular funding mechanism and found that the Plaintiffs failed to prove that the Funds were on the “verge of default or imminent bankruptcy” such that benefits are in immediate danger of being diminished.

27. Litigation Brought by Fund Members to Compel Funding In 2015, the Illinois Supreme Court affirmed in In re Pension Reform Litig., 2015 IL 118585, 32 N.E. 3d 1,9, that although the specific mechanisms of funding are left to the other branches of government to work out, a direct action could be brought by pension system members to compel funding if a pension fund were “on the verge of default or imminent bankruptcy.” In order to prove that a pension fund is on the verge of default, the allegations must demonstrate more than “only an opinion that present funding levels are insufficient…to meet the accrued future obligations of the funds.” Importantly, in reviewing the State’s argument regarding utilizing its “police power” to modify pension benefits, the Supreme Court confirmed that when legislation has been directed at reducing pension benefits, the Supreme Court has expressly held that such reduction is “not defensible as a reasonable exercise of the State’s police powers”.

28. Jones/Johnson v. MEABF, 2016 IL 119618 (March 24, 2016) In 2016, MEABF and LABF participants alleged that a revision to State law reducing their automatic annual increases (“AAIs” also known as COLAs) was unconstitutional. The revisions included: (1) reducing the value of the AAIs; (2) eliminating those increases entirely for certain years; (3) postponing the time at which they begin; and (4) eliminating the compounding component of the AAIs. The Supreme Court held that those changes “unquestionably diminish the value of the retirement annuities the members of the MEABF and LABF were promised when they joined the pension system.” Accordingly, the Supreme Court concluded that those revisions contravened the Pension Protection Clause’s prohibition against the diminishment of pension benefits. The Supreme Court in Jones/Johnsonalso rejected the City’s contention that funding provisions in the Pension Code are a “benefit” because participants only had a right to the money available in the Fund upon retirement. The Supreme Court confirmed that the Illinois Constitution mandates that members of the Fund have a “legally enforceable right to receive the benefits they have been promised—not merely to receive whatever happens to remain in the Funds.”

29. Bd. of Trustees of the Harvey Firefighters’ Pension Fund v. City of Harvey, 2017 IL App (1st) 153074 (2017) In 2010, the City of Harvey’s Fire Pension Fund filed a lawsuit against the City and its City Council stating that the City failed to comply with Section 4-118 of the Illinois Pension Code. Specifically, the Board argued that the City of Harvey must be required to adequately contribute to the Fund because the Fund is on the verge of default or imminent bankruptcy and “will become insolvent without judicial intervention.” Pension Fund was NOT declaring bankruptcy and participants continued to receive monthly annuities. This is the first “real world” case involving the analysis of whether a fund is on the “verge of default or imminent bankruptcy”.

30. City of Harvey Contribution Rates Source:Bd. of Trustees of City of Harvey Firefighters' Pension Fund v. City of Harvey, 2017 IL App (1st) 153074, ¶ 191

31. City of Harvey Contribution Rates vs. FABF *Estimates provided by the Fund’s actuary that may be subject to revision

32. Harvey cont. • According to the most recent actuarial valuation at the time of the case, the Pension Fund was only 27.18% funded as of May 1, 2014 and the Pension Fund’s unfunded accrued liability had increased to nearly $30 million. • The City of Harvey contributed less than 10% of the annual actuarial requirement six out of nine years analyzed by the Court. • Expert testimony during trial stated that the Pension Fund had approximately 5 years before it would be “completely insolvent.” • Court found that the Pension Fund was on the verge of default, which establishes a valid constitutional right to funding, based on: • Precarious financial position of the Pension Fund based on multiple experts in relevant fields; • The constant declarations by the City of Harvey that it has not contributed to the Pension Fund’s poor financial condition; and • The continued lack of financial responsibility shown by the City over a significant period of time.

33. Harvey cont. The Appellate Court found that the Pension Fund was on the verge of default and imminent bankruptcy. The Appellate Court affirmed the trial court’s ruling that the City of Harvey violated Article 4 of the Pension Code and assessed damages against the City for $15,071,089.15. Subsequent to the Appellate Court ruling, the Pension Fund filed intercept forms with the State Comptroller pursuant to its authority under Article 4 of the Illinois Pension Code. The State Comptroller promptly intercepted nearly $3.3 million dollars. The City was forced to lay off nearly 40 employees, including nearly half of its active firefighters and police force. The Pension Fund and the City subsequently entered into a repayment agreement in July, 2018 that requires the Comptroller to distribute 35% of the State tax revenues earmarked for Harvey directly to the Pension Fund until the debt is paid in full (approximately 6-8 years).

34. Cranston Police Retirees Action Comm. v. City of Cranston, 208 A.3d 557, 567 (R.I. 2019) In 1996, the City of Cranston, Rhode Island passed two ordinances creating a two-tiered pension system and providing a 3% compounded COLA to employees of the Cranston Police and Fire departments. In 2011, the Rhode Island General Assembly passed the Rhode Island Retirement Security Act. The Act stated that a pension plan would be in “critical status” if its funded percentage for a plan year was less than 60%. If a City was deemed to be “critical status”, the Act required the City to give notice to plan participants and to submit a funding improvement plan to emerge from the status. In 2013, the City of Cranston was deemed to be in “critical status” under the Act. In response, the City enacted an ordinance requiring a 10-year freeze on COLA adjustments for employees of the Cranston Police and Fire departments. The Police Retirees subsequently sued the City alleging that the 2013 ordinance violated the Contract Clauses of the United States and Rhode Island Constitutions.

35. Rhode Island Cont. • The City’s Mayor testified that he felt if the City did not address the financial crisis, Chapter 9 bankruptcy “could be a very real possibility.” • In June, 2019, the RI Supreme Court found that the COLA suspensions did not violate the United States or Rhode Island Constitution. • In reaching the holding, the RI Supreme Court reviewed whether the 2013 ordinances were reasonable and necessary to fulfill an important public purpose. • In reviewing the 2013 ordinances, the Court emphasized that the ordinances were narrowly tailored to address the City’s financial problem and that the impairment was temporary and prospective in nature because the 2013 ordinances suspended a future COLA benefit for a finite period of time. • The City also concluded that a portion of the City’s financial problems were outside the City’s control. • “However, the evidence at trial demonstrates that the City’s predicament grew out of more than its continued contractual obligations under CBAs and its failure to adequately fund the pension system. Rather, the difficult economic climate, a ruinous flooding situation, and the reduction in state aid compounded the initial underfunding issue.”

36. Rhode Island Cont. Rhode Island Case Illinois The Rhode Island Supreme Court reviewed the 2013 ordinances suspending the COLA benefits and the 1996 ordinances that originally provided the COLA benefit to retirees. Retirees alleged that the COLA benefits were protected under the 1996 ordinances by the contract clause of Rhode Island Constitution and the United States Constitution. COLAs are provided under the Illinois Pension Code. Illinois caselaw emphasizes that ordinances do not maintain the same protections as a pension benefit under the Illinois Pension Code. COLAs are protected by the Pension Protection Clause of the Illinois Constitution. Illinois caselaw protects COLA benefits from being diminished. SeeIn Re Pension Reform Litig., 2015 IL 118585. (automatic annual increases are “unquestionably a ‘benefit of contractually enforceable relationship resulting from membership’.”)

37. The Fund’s Current Funding Status

39. The Fund’s Funding Level Figures provided by the Fund’s Comptroller.

40. The Fund’s Cash Flow Position Figures provided by the Fund’s Comptroller.

41. Negative Cash Flow Position A negative cash flow simply means that the Fund pays out more than it takes in before investment earnings. In 2019, it is estimated that for every $1.00 of contributions that is received by the Fund, the Fund pays out $1.25 dollars in benefits. Operating with a negative cash flow position requires the Fund to utilize the corpus of the Fund’s assets and investment earnings in order to pay benefits. This contributes to an even lower funding level. A negative cash flow position also limits the ability of the Fund to invest in income generating investments as the Fund must maintain liquidity to pay benefits. A negative cash flow position combined with a low funding level may also contribute to the Fund’s actuaries recommending a reduction in the Fund’s investment return assumption.

42. Conclusion

43. Questions/Concluding Remarks • What can you do? • Monitor pending legislation. Monitor veto session for revisions to Casino legislation and how it may impact the Fund. • Contact your legislative leaders to remind them of the importance of ARC Funding. • Monitor the Fund’s negative cash flow position to ensure it does not dramatically increase. • Be wary of increased benefits, especially during the remaining years of the “Ramp” period that fail to be simultaneously funded. • Utilize Pension Fund educational and newsletter materials that discuss funding levels. • Review pension updates in other States (Ohio COLA example).

44. “But as I made clear many times, pension obligations are a challenge we must meet. Dedicated city workers have fulfilled their careers with the agreement that they will retire with the dignity and the certainty pensions afford. Our obligations are not optional. And I will take every action necessary to fulfill the promise we made.” -Mayor Lightfoot