Illinois Pension Crisis
Illinois has five state run pension systems: State Universities Retirement System, Teachers Retirement System, State Employees Retirement System, General Assembly Retirement System, and the Judges Retirement System. Each has unfunded liabilities, with the Teachers Retirement System being by far the largest. In 1997, the State of Illinois Comptroller Loleta A. Didrickson reported that the unfunded pension liabilities had reached over $20 billion. At the time, the growth was seen as astronomical. According to Comptroller’s office the growth was due to a change in the state contribution formula to keep contributions artificially low. In a January 1997 article of Fiscal Focus, Didrickson’s office reported1:
“By basing the employer contribution on benefits paid out instead of an actuarial calculated cost of the systems, the state funding policies allowed the unfunded liability to grow from $2.8 billion in fiscal 1972 to $11.7 billion in fiscal year 1991, an increase of almost $9.0 billion in a 20-year period … the unfunded liability grew by another $9.0 billion from fiscal year 1991 through fiscal year 1996. What had taken 20 years to accumulate under the prior funding policies, was matched in just the last five years.”
Today, According to the Chicago Tribune, the unfunded Pension Liabilities sit at $130 billion, with an annual required contribution of $8.8 billion. That’s more than 25% of the overall state budget, or about $730 for each person in Illinois. Remember, that is per year According to Moody’s Investor’s, the state has actually $250 billion in pension debt. On June 1, 2017 the credit rating agency downgraded the state of Illinois’ credit rating to Baa3, just one blip above “junk”. It’s no wonder people are fleeing Illinois. There are many reasons why Illinois faces the greatest pension crisis in the nations, but they all come down to same thing – shortsightedness.
This article will hopefully give you some good background information on the Illinois Pension Crisis and it’s causes.
Part 1. What is an unfunded Pension Liability?
Understanding what an unfunded pension liability is key to understanding Illinois Pension woes. A fully funded pension would have enough investments to cover current and future liabilities. For example, when you or I do retirement planning we identify how much we will need invested in order to live off the earnings without dipping into the principle. Few of us have that much investments. So it is with public pensions. Most public pensions have a portion of the liability that is unfunded. This portion needs to be contributed by the state. For example, assume, the total liabilities for a fund are $1 billion, and the total investment of the fund is $10 billion. If we assume an 8% annual return on investments, then the investments are funding $800 million of the liabilities. That leaves $200 million unfunded. This would be an 80% funded liability.
Today, the Illinois pension is only 37% funded. That means our investments will pay for only 37% of the liabilities each year. 63% of it has to come directly from the tax payers. Of the anticipated $14 billion in pension obligations annually, $8.8 billion of it must come from the tax payers. While $5.2 billion will come from the investments owned by the fund. The only long term solution to the problem is to increase the assets of the pension until it reaches a recommended 90% funding. This is not something that can be avoided, it must be done for Illinois to remain fiscally solvent and avoid a “junk” rating on it’s bonds. Unfortunately, this will require an ever increasing obligation of state funds over the next 30 years until the pension is fully funded. Yet, Illinois can not afford these annual payments which are approaching $10 billion.
So how do we get out of this mess? How do we reduce our current $8.8 billion annual payment? We can either reduce the liabilities, or increase the investment earnings. By liabilities, we primarily mean retirement income owed to state employees. According to the 1970 constitution, we can not diminish the contracts, so short of a constitutional amendment the liabilities will stick. So, then we must increase the investment earnings. The obvious way to do that would be to sink more money into the investments. But, there is one other more devious way. With a sleight of hand, politicians can just increase their “expectations” of future earnings. With a promise of better earnings in the future, they can lower today’s contribution. I know this sounds like building a straw house on sand or just kicking the can down the road, but it is what our politicians have been doing for years. But, if those better earnings are not realized, the unfunded pension just grows even larger, making future contributions even higher. For years, the expected earnings were set artificially high at 8%, and now when pension overseers proposed that it be lowered to 7%, our Governor and House Speaker both balked. Worried, that doing so would raise our required contribution higher and further expose the problems, they delayed this downgrade of expectations for 5 years2. They kicked the can down the road, like Illinois has been doing since 1971 (which incidentally is when Michael Madigan first became a member of the Illinois House).
Part 2. Rising Pension Costs
While the bulk of the blame for the rapid growth of the unfunded pension liabilities is due to delayed or reduced payments, there have been a number of events over the years which increased the costs of the Pensions. Each of these events drove up the pension liabilities by billions of dollars. Overall, Illinois state workers have built up a combined liability of over $200 billion. Since, more than 63% of this is unfunded, the State must make annual payments to the pension systems of over $8.5 billion in 2017 to meet these commitments.
Cola Increases – 1989 3 4 5
In 1989, Governor Games Thompson agreed to establish a compounding 3 percent cost of living increase for pensions. This pension increase applied to all government employees including law makers such as Governor Thompson himself, and the Assemblymen who supported it like Madigan and Cullerton. At 3% compounding, the pension salaries can really add up. Let’s take Madigan for example, who as been in the Illinois House since 1971. If he retired this year, his annual pension payment would include an increase of 60% to $130,000 plus an additional 3% increase each year.
The 3% compounded increase is annual, automatic and compounded. So regardless of the current rate of inflation or the value of a retiree’s pension, it will increase by 3%. Consider the average age and pension of a 30 year teacher who retired in 2013. That teacher’s starting pension is $71,000, but would double in 25 years. In the 1970s, this type of increase was needed, but remember that for the last 25 years, there have been only 5 years when inflation reached 3% or higher. In three years, it was below 1%. Many of us saw this stagnation reflected in our own salaries, but not in the state pensions. These laws have consequences with more than 700,000 downstate teachers, state workers and university employees, providing retirement security is the greatest financial challenge the state has ever faced. These increases really add up, today, there are now more than 10,000 educator pensions at more than $100,000 annually.
Early Retirement Plan – 2002 6 7 8
How many of you out there would like to retire at age 60 or 55. How about age 50? Imagine if you were given the option to purchase early retirement without losing any real benefits. Would you jump on it? Well that is exactly what happened in 2002 when Governor George Ryan signed House Bill 2617. On June 25th, 2002 with a promise to save tax payers money, Governor George Ryan signed HB 2617 allowing some state workers to retire early by purchasing years of service. Government officials boasted that the plan would save $165 million in salaries over the next two years, but were quiet about the cost of the higher pensions to those retired workers. The bill passed the General Assembly allowing members to purchase up to five years of service and age requirements, effectively reducing the retirement age to 55 with as few as 20 years of service. In 2002, the bill was estimated to save tax payers $600 million in salary reductions, but by 2004 it was learned that the number was a sham. So many members took advantage of the early retirement option, that the cost of increased pensions was expected to balloon to $2.4 billion. In 2013, Illinois Policy reported that 71% of all members of the Teachers Retirement System retired before the age of 60 with an average salary was $70,491 for these with at least 35 years of service. Over all, across the five state retirement systems more than 60% of Illinois pensioners retired before the age of 60.
“Pension Protection Act” upheld in the Supreme Court – 2015
In 2013, with Illinois facing a massive $105 billion in unfunded pension liabilities, Democratic Governor Pat Quinn signed a state law that would stop the automatic, compounded annual cost of living increases for retirees, and extend the retirement ages for current state workers. It was a desperate attempt to save the pension system and halt the crumbling of the state’s finances. Employee unions sued that this amounted to a break in the contractual agreement that could not be “diminished or impaired”. In 2015, the Illinois Supreme Court ruled in their favor, arguing that the law violated Article 13, Section 5 of the 1970 Illinois Constitution also known as the “Pension Protection Act”. The “Pension Protection Act” is Article 13, Section 5 of the 1970 Illinois Constitution. Back on December 15, 1970 the People of Illinois voted to adopt a fourth version of the Illinois constitution. The first Constitution was adopted in 1818, followed by one in 1848, another in 1870 and the current version in 1970. The 1970 Illinois Constitution went into effect on July 1, 1971. Article 13, section 5 protected the pension and retirement benefits of government employees.
PENSION AND RETIREMENT RIGHTS
“Membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired”.12
Part 3 – Failed Pension Reform
Since the early 1990’s, Illinois politicians have been looking for ways to reduce our Pension Contributions. With each plan, they fooled us with short term savings that caused the unfunded liabilities to balloon. Each time, Illinois tax payers sold a promise, but shackled with more long term debt.
The Edgar Ramp – 1994
During his reelection campaign of 1994, Governor Jim Edgar laid out his pension plan. The goal was to pay off over time the then $14.1 billion unfunded liability in the State’s pension funds. His plan would increase state contributions over the next 50 years, beginning with $82 million and growing until 2045 when his calculations would have the pension funded at 90%. His Democratic challenger Dawn Clark Netcsch argued for higher payments, saying that Edgar was putting the pension debt on “the state’s credit card”, Gov. Edgar responded, “Most of us who aren’t married to millionaires know that when you buy a house, you’ve got to pay for a long period of time.”13 The plan became known as “The Edgar Ramp”. The plan kept the payments artificially low in the 1990’s, but they accelerated dramatically in 2012 continue to rise year after year. The plan might have been Edgar’s but he got significant and surprising help from the top House Democrat, Michael Madigan. As of November 2016, Illinois new funded portion stood at 41%, a far cry from the 90% goal in 2045. For fiscal year 2018, the proposed State Pension contribution in Illinois is $8.8 billion, 100 times more than the $82 million that Edgar planned to start with in 1994.
Blagojevich borrowing plan – 2003
In 2003, Governor Blagojevich rushed through the Illinois legislature a plan to borrow $10 billion to ease the budget shortfall. Rather than make the $1.9 billion required contribution to the pension plan, the governor’s plan was to sell up to $10 billion in bonds and place the money in the pension funds where it would be invested. Blagojevich promised that by selling bonds at an average rate of 6 percent, and earning an average long-term investment of 8 to 8 1/2 percent, the state would come out ahead. This was very optimistic, especially given the volatility of the financial markets in 2003. While most of us were looking for ways to save money, our state was borrowing against our future. While hindsight is always 20/20, there were signs of potential losses at that time. In 2003, the Chicago Tribune warned, “if the market does not perform well, the state will be saddled with diminishing pension assets and all that debt. Pension fund investments performed very well during the go-go 1990s. But the value of state pension system assets dropped by $5.7 billion between 2000 and 2002, while the systems’ liabilities increased by $13.7 billion.” 14 Sure enough, 5 years later we all watched in despair as the market crash. Illinois would not see a long term return of 8 1/2 percent and the pension debt continued to grow.
Pension Holiday – 2005 9 10 11
In 2005, Governor Rod Blogojevich worked out a deal with House Speaker Michael Madigan and Senate President Emil Jones to skip the $1.1 billion pension contributions for the next two years. Democrats all got behind this so-called pension holiday so that the money could be used to pay for education, healthcare and the bail out of the Chicago Transition Authority. The Republicans, who were in the minority of both the house and the senate at the time declared the bill to be fiscally irresponsible. The concerns were that the bill as drafted, would not only skip pension payments in 2006 and 2007, but would also reduce the contributions in 2008 and 2009. House Minority Leader Tom Cross suggested that in those two years an additional $1.3 billion reduction would occur, bringing the total reduction in contributions to be $3.5 billion over four years. Since this was an election year, Blogojevich and the Democrats were accused of basing their decisions on the election, rather than sound fiscal policy. Democrats fired back. House Majority Leader Barbara Flynn Currie, a Democrat dismissed that notion, claiming that in 2005, the unfunded pension liability just wasn’t the immediate problem.
Nevertheless, along with Blogojevich’s plan to borrow $10 billion to increase the funded portion of the pension, Madigan and the Democrats approved the pension holiday. The legislation was even backed by the Service Employees International Union, the Illinois Federation of Teachers and the Illinois Education Association. The labor unions and the Education Association saw it as a way to pay for more social services including earmarking $300 million more to schools. The Commission on Government Forecasting and Accountability (CFGA) warned that skipping payments could increase contribution in later years, but never did any calculations or reporting to give actual numbers. When the legislation was sent to Gov. Blogojevich, he signed it in a heartbeat, telling the people of Illinois that it contained the “most significant structural pension reforms in state history.” Blogojevich claimed that the pension holiday along with his plan to pump $10 billion of borrowed money into the pension would save $30 billion over 40 years, but when the CFGA finally released their analysis the story was much different. The CFGA reported that pension costs would increase by $4.7 billion rather than decrease by $35 billion. According to Crain’s Chicago Business, the chief Senate Sponsor of the pension holiday law, Jeff Schoenberg now regrets the actions that were taken. He reported that they did not fully understand the effect of deferring financial obligations. Schoenberg said, “At the time, it appeared to be a prudent course of action, I can’t say that I’d recommend going down that path today.”
Pension Reforms – 201715 16
This year, facing a $130 billion unfunded Pension crisis, Governor Bruce Rauner and the Democratic run Assembly battled over how to fix the pension crisis. In the last session, the General Assembly and Gov. Rauner approved three partial pension reforms which are reported to save the State $1.5 billion. The first reform allows some state workers to participate in a hybrid contribution plan. The second shifts some pension costs form the state to local college, University, and school districts. The third phases in some changes to the actuarial/investment return assumptions. Unfortunately, these so-called savings were used to reduce the payments into the pension system in fiscal year 2018, rather than reduce the actual pension debt. Once again, our state is choosing to kick the can down the road by finding creative ways to reduce our current contributions at the expense of higher future contributions.
It was all part of this year’s budget battle. After 736 days, the Illinois legislature finally passed a budget over Gov. Rauner’s veto. The veto-override budget raises the corporate tax rate to 7 percent, raises the individual income tax rate to 4.95 percent, and promises to generate $5 billion in revenues combined with another promise of $3 billion in budget cuts. Yet, it does nothing to reduce the exploding pension contributions that Illinois must face until the year 2045. Even with these tax increases, Moody’s Investor Services continued to warn Illinois that it still may face a “junk” downgrade due to it’s unfunded pension liabilities. According to Moody’s, the unfunded pension is not $130 billion as commonly reported, but a staggering $250 billion. So, while we face higher taxes today, it may be peanuts to what our children will forced to pay. That is, assuming they choose to continue living in this state.