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Report: Illinois Local Governments Face ‘Service Insolvency’ Over Pension Funding

May 6, 2019

Pension costs could require cutbacks in core services

Paying for pensions and other retiree benefits for former government employees could leave many Illinois local governments without the ability to provide basic services, a new report states.

“[P]ension and other post-employment benefits ... reduce budgetary resources available for core government services,” writes Marc Joffe, a senior policy analyst at the Reason Foundation, in an analysis published on February 6.

“In extreme cases, this crowd out effect can lead to a municipal bond default or a bankruptcy filing,” Joffe states. “More often, crowd out results in a condition known as service insolvency in which the government entity continues to pay its bills but is unable to provide public services at the level residents might reasonably expect.”

Pension plans managed by many local governments in Illinois have funded less than half of the benefits they have promised public employees, based on analysis of the latest available data from the Illinois Department of Insurance, Joffe states in his article.

Numerous Problems

Pension underfunding in Illinois and across the nation has been driven by a few key factors, says Leonard Gilroy, director of government reform at the Reason Foundation.

“These factors include underperforming investment returns, the global drop in interest rates, inadequate methods of amortizing and paying down unfunded liabilities, unrealistic actuarial assumptions, and, in some cases, governments failing to make their full actuarially determined contributions to pensions in one or more years,” Gilroy said.

Multiple parties are responsible for pension underfunding, Gilroy says.

“The reality is that pension underfunding is the byproduct of many years of many different types of decisions made by policymakers, pension boards, professional actuaries, and other stakeholders,” said Gilroy. “We didn't get where we are overnight, and it will take a long time to wind out of the problem in many places.”

Promises, Promises

The fundamental problem is that the pension systems were not designed with an eye toward what is fair and affordable, says Adam Schuster, a budget and tax researcher at the Illinois Policy Institute.

“Benefits were overpromised compared to what's affordable and what retirees in the private sector can expect,” Schuster said.

This overspending includes providing retirement benefits to people who are far below the retirement age for most workers, says Schuster.

“For example, while the full retirement age for Social Security is 67, public sector workers have been able to retire as early as 50 or 55,” said Shuster.

In addition, public pensions in Illinois increase at a rate well above inflation, a benefit other retirees don’t receive, says Shuster.

“While private sector workers [may] get an annual cost of living adjustment [COLA] that just keeps pace with inflation, ... Illinois government workers have a guaranteed 3 percent compounding COLA regardless of how fast prices are rising,” Shuster said.

Unrealistic Assumptions

Another problem is that pension plan managers assume investments will earn unrealistic profits, Schuster said.

“For example, Illinois pension funds assume an annual investment rate of return between 6.75 and 7.25 percent, but the 10-year average actual rate of return is only about 4.6,” Schuster said.

The people responsible for this problem are the politicians who guaranteed these excessive retirement incomes, says Schuster.

“Government workers are not to blame,” Schuster said. “Pension reform is not about breaking promises to retirees; it's about protecting government workers’ retirement security from irresponsible politicians.”

Calls for Constitutional Amendment

The solution to Illinois’s pension crisis must start with an amendment to the state constitution to create a distinction between past and future benefit accruals, says Schuster. An Illinois Supreme Court ruling in 2015 decreed the state could not ever change employees’ retirement plans once they are hired.

“Everything a retiree has earned to date can be protected, but increases going forward should be subject to reasonable changes for current workers and retirees,” said Shuster. “This is an idea that has received bipartisan support in the past,” Shuster said.

“Pension reform passed a General Assembly controlled by Democratic supermajorities in 2013 and was signed by a Democratic governor,” Shuster said. “Unfortunately, the courts struck down that reform in 2015, which is why we now need a constitutional amendment.”

Other States Reforming

Reform can reduce the long-term liabilities of pension systems, though governments won’t escape their established obligations, says Gilroy.

“So long as you ensure you continue to pay down legacy unfunded liabilities, there is a lot of discretion for creative thinking around plan design,” said Gilroy. “For most places, the unfortunate reality is that there is no solution that will not require additional resources to be dedicated toward pensions. It will be impossible for plans to simply grow their way out of solvency problems.”

Other states have solved their state and local pension challenges, says Gilroy.

“We've seen some real progress in the states on pension reform in recent years, in states like Colorado, Michigan, and Arizona, where very thoughtful, nuanced, and bipartisan reform proposals have been successfully enacted since 2016 to bring targeted solutions to fruition,” said Gilroy.

“Reform need not boil down to an antiquated and false ‘pensions versus defined contribution’ binary choice,” Gilroy said. “Each of those states has one or more major categories of public worker that are now, as part of reform, offered a choice of retirement plan designs for the first time.”

Ashley Herzog (aebristow85@gmail.com) writes from Avon Lake, Ohio.

Internet Info:

Marc Joffe, “Underfunded Pensions Heighten Risk of Service Insolvency for Local Governments in Illinois,” Reason Foundation, February 6, 2019:

https://reason.org/commentary/underfunded-pensions-heighten-risk-of-service-insolvency-for-local-governments-in-illinois/

Author
Ashley Herzog writes from Avon Lake, Ohio.
aebristow85@gmail.com