No. 107 - Illinois’ Public Pension Crisis: Executive Summary (html)
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Overview
This analysis finds Illinois is facing a serious public pension fund crisis due to systematic underpayment of the state’s obligations for more than 25 years. Addressing the crisis will require one or more of the following options: increase revenues to the state, divert current revenues from other spending priorities, reduce benefits for current or future state employees, or change the state’s retirement plans from defined benefit to defined contribution plans. All of those options face strong political opposition, and the legislature has not shown the willpower needed to stick with a reform plan once adopted. Changing from a defined benefit to defined contribution program is the most highly recommended reform.
1. Illinois faces a worsening public pension fund crisis.
“Without pension reform, there is no tax increase big enough for the State to find more funds for education, transportation, and other state priorities,” according to The Civic Federation. The group’s May 2005 report goes on to say, “Illinois will not be able to balance future budgets without substantial pension reforms today.” The following numbers tell a disturbing story:
- At the end of FY 2004 Illinois’ unfunded pension liability stood at $35.1 billion, a greater amount than any other state. Total liabilities stood at nearly $90 billion.
- The funded ratio--the amount of assets needed to cover liabilities--was just 60.9 percent, second-worst in the nation.
- State funding of public employee pensions has gone from about $635 million in 1996 to an estimated $2.6 billion in fiscal 2006, and could reach $14 billion by 2045.
2. Other states and private employers are also facing a pension crisis.
State governments and private employers across the country also face pension funding problems. “The U.S. economy may well be sitting on a trillion dollar time bomb, in the form of unrealistic pension return expectations,” writes Robert Arnott, CEO of First Quadrant Advisors. He goes on to estimate the net present value of the shortfall at $100 billion a year.
California Assemblyman Keith Richman, who introduced Assembly Constitutional Amendment 5 to reform California’s pension system, said, “Because of their very design, defined benefit pension plans put taxpayers on the hook for any deficit that can’t be covered by investment gains. ... Public employees have very generous benefits, and taxpayers cannot afford to keep making these generous promises.”
3. Current public pension benefits in Illinois are generous.
While most private-sector employers have moved from defined benefit programs (where retiree benefits are determined by a formula based on salary and years of service) to defined contribution programs (where the employer contributes a fixed amount per year to the employee’s privately held account), Illinois continues to offer its employees a defined benefit plan.
| Box 1 |
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| Governor Blagojevich’s Principal Pension Reforms |
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Illinois public employees who start their careers at age 25 can retire at age 55 with a pension equal to 50 percent of their base salary (computed as their highest four-year average among their final 10 years of service). Pension benefits increase automatically by 3 percent each year. Large end-of-career pay raises for teachers and school administrators have resulted in substantial increases in retirement benefits for some individuals. Early Retirement Option programs also have increased benefits.
4. Two pension reform proposals have been put forward.
Gov. Rod Blagojevich’s pension reform plan is summarized in Box 1. The governor estimates his pension reforms could reduce liabilities by $56 billion over the next 40 years. He proposes to use the long-term savings produced by his reform to reduce the state’s FY 2006 pension fund contribution by $800 million, freeing up that money for other spending priorities.
| Box 2 |
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| Governor’s Pension Commission Principal Reform Proposals |
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The Governor’s Pension Commission, composed of lawmakers and representatives of business and industry, employee unions, and civic organizations, put forward its own plan in February 2005. It is summarized in Box 2. Pension fund actuaries and Deloitte Consulting estimate the commission’s recommendations could reduce accrued liabilities over the next 40 years by nearly $146 billion.
5. Both plans seem unlikely to solve the long-term pension crisis.
The recommendations of the Governor’s Pension Commission seem reasonable and fair. However, it is doubtful that all of the commission’s recommendations would ever be enacted into law or, if enacted, would not be repealed or overridden in future years or, finally, would not be rendered ineffective by the diversion of funds to other spending priorities. Several fixes have been tried over the years and the funding problem has grown worse as elected officials failed to show sufficient willpower to avoid increasing benefits or diverting funds to other budget priorities.
The governor’s own proposal is more politically feasible, but even his allies admit his estimate of savings lacks credibility. The governor’s plan also has a critical flaw: Rather than use the savings to begin to repair the broken pension system, the governor proposes to use $800 million of future pension savings now to plug the FY 2006 budget hole.
6. A pension fund reform proposal from Rhode Island could be a model for Illinois.
The Rhode Island Public Expenditure Council, a nonpartisan citizens organization somewhat similar to Illinois’ Civic Federation, makes the following suggestion:
... [C]onsideration be given to a five-year program to move the savings resulting from the pension benefit changes away from the operating budget and into the retirement funds to increase assets and to reduce the projected unfunded liability. ... RIPEC proposes to have an 80/20 distribution of the savings in year one, where 80 percent of the savings derived from the changes go to support the needs of the operating budget and 20 percent be allocated to the pension. Year two would have a 60/40 distribution, year three 40/60, year four a 20/80 distribution and year five and thereafter have the entire savings from the pension changes allocated to the pension system.
The RIPEC report concludes, “There is no question that this will make it difficult for the State to meet its operating needs, but it will force the State to begin addressing the unfunded pension liability issues it currently faces.” Exactly the same could be said of why Illinois ought to consider the same arrangement.
7. Plans in Michigan and California to move to defined contribution retirement benefits could also be a model for Illinois.
The Governor’s Pension Commission recommended additional study of a plan to replace all or part of the state’s defined benefit plans with defined contribution plans. Advantages of such a transition would include giving employees control over how much of their earnings to deposit in the plan, private and individual ownership of the accounts so legislators could not “borrow”or steal from a worker’s retirement savings, and account portability, enabling vested employees who change jobs or become self-employed to take their entire account with them.
In the 1990s, the State of Michigan began putting new state employees into a 401(k) plan. All new state employees hired after March 31, 1997, and new public school employees hired after July 31, 1997, have been offered only the 401(k) option. Employees hired before those dates have the option of staying in the defined benefit pension system or switching to the defined contribution plan.
In California, voters may get to vote on a constitutional amendment initiative to do this. Assembly Constitutional Amendment 5 would close the public employee pension program to new hires beginning July 1, 2007. New public employees would be offered the same type of 401(k) program provided by most private employers. With a 401(k) program, the state’s obligation would end when the matching contribution is made. Pension benefits to current employees and retirees would remain unchanged.
8. True reform isn’t on the table yet in Illinois.
No one denies that Illinois faces a public pension funding crisis, but no one has shown the political willpower to put a reform plan on the table that is likely to fix the long-term problem. The plans put forward by Governor Blagojevich and the Governor’s Pension Commission would seem to be “steps in the right direction,” but there is no reason to believe future legislatures will take additional steps in that direction rather than raid the pension funds at the next available opportunity.
The Rhode Island plan of diverting some of the savings from pension reform to the current budget while setting aside some of it for improving the relative funding ratios of the pension funds should be good politics and good policy. Much better would be shifting from defined benefit to defined contribution plans, a solution that significantly lowers costs and is fair to employees.
As fierce as union opposition has proven to be to the smaller and temporary reforms proposed by the governor and his commission, legislators ought to seriously consider adopting a policy that will end the pension crisis once and for all.
Based on Heartland Policy Study #106, “Illinois’ Public Pension Crisis,” by Steve Stanek. Copies are available from The Heartland Institute for $10 each. The report is also available online at http://www.heartland.org.
Copyright 2005 The Heartland Institute. Nothing in this Executive Summary should be construed as reflecting the views of The Heartland Institute, nor as an attempt to aid or hinder the passage of any legislation. Permission is hereby given to reprint or quote from this Executive Summary; please send tearsheets to The Heartland Institute, 19 South LaSalle Street #903, Chicago, Illinois 60603. Questions? Call us at 312/377-4000 or visit our Web site at http://www.heartland.org.
