Thursday, September 27, 2012

The Unfunded Pension Liability (and the “Pension Ramp”) from Center for Tax and Budget Accountability

“The 50-Year Funding Plan: The state attempted to address its unfunded pension liability in 1994, pursuant to a change in Illinois law created under Public Act 88-0593, which became commonly known as the ‘Pension Ramp.’ Intended to force increased allocations to the pension over time, this reform established a time frame during which Illinois was required to fund the current pension contribution the state owed for existing employees (the ‘Normal Cost’), plus make up unpaid contributions and the return thereon for prior employees, amortized over 50 years with a target of funding 90% of total actuarial liabilities by 2045.

“Given that the total unfunded liability had grown so large [because of legislators’ incompetence and irresponsibility], the legislation created a framework that established a 15-year-ramp period, during which the newly mandated contributions Illinois had to make for current and past employees increased in gradual increments. Since these makeup payments increased annually, they became known as the ‘Pension Ramp’; that is, they ‘ramp-up’ over time.

“The ‘Pension Ramp’ became operative in Fiscal Year 1996. Under the plan, if Illinois satisfied its obligations under the ‘Pension Ramp,’ the state's pension systems would have achieved a Funded Ratio of 90% by the year 2045. The initial 15-year ‘ramp-up’ period was designed to allow Illinois to adapt to its increased financial obligations, because there simply was not enough revenue to move immediately to the appropriate level percentage of payroll to fund the pensions systems or to amortize the liability over a shorter period.

“Since it passed, Illinois funded the ‘Pension Ramp’ as required every year, except FY2006 through 2007. However, the annual increases in the required contribution under the intended ‘Pension Ramp’ vastly outpace natural growth in the state's tax revenue. This reality, coupled with the constitutional requirement that Illinois balance the budget, meant the state would have to cut spending significantly on services to fund the ‘Pension Ramp,’ particularly in out years. The net result, Illinois' fiscal system simply could not accommodate the significant contribution increases contemplated under the ‘Pension Ramp.’ The first major threat to the ‘Pension Ramp’ was averted with the sale of $10 billion of pension obligation bonds. Then, reverting to past poor fiscal practices, the state significantly underfunded pensions in FY2006 and FY2007, to maintain, and in some cases expand, services” (the Center for Tax and Budget Accountability).

According to Amanda Kass, Research and Policy Specialist for Pensions and Local Government of the Center for Tax and Budget Accountability (April 2012): “the issue is that Illinois lawmakers designed a system – the way the employer cost is calculated (what the state pays) – [that is] inconsistent with rules set by the Government Accounting Standards Board (the rules are non-binding and are for reporting; public retirement systems can fund themselves however they so choose).

“The way GASB specifies that systems should be funded is generally referred to as the ARC (annual required contribution). According to GASB, the employer’s ARC should be the normal cost (which is calculated using the cost method) plus an amount to amortize an unfunded liability over 30 years. The 30-year time period is an open system, [in other words] those 30 years don’t count down. In systems in which there is no unfunded liability, the employer’s ARC would just be the normal cost. [It is important to note that] in Illinois, what the state has historically paid was less than the employer’s ARC (as calculated according to GASB rules).

“[To reiterate,] there were years like 2006 and 2007 in which lawmakers passed legislation that lowered the contributions for those years to an amount that was below the pension ramp (those amounts were already less than the employer’s ARC).  In addition to a revenue problem, the pension ramp was designed in such a way that it’s unfeasible. Even if Illinois’ revenue issue was addressed, the pension ramp would still likely be an issue” (the Center for Tax and Budget Accountability).

The current “Pension Ramp” does not work for the five public pension systems. The “Ramp” entails larger payments today as a result of the 1995 funding law – Public Act 88-0593 – to pay the pensions systems what the state owes. There needs to be a required annual payment from the state to the pension systems; the debt needs to be amortized for a longer frame of time (a flat payment) just like a home loan that is amortized; though the initial payment will be more painful in the beginning, over the long term it will become a reduced cost and a smaller percentage of the overall Illinois budget as it is paid off throughout the years.

“Given that the current repayment schedule is a complete legal fiction - a creature of statute that doesn't have any actuarial basis - making this change is relatively easy. Simply re-amortizing $85 billion of the unfunded liability into flat, annual debt payments of around $6.9 billion each through 2057 does the trick. After inflation, this new, flat, annual payment structure creates a financial obligation for the state that decreases in real terms over time, in place of the dramatically increasing structure under current law. Moreover, because some principal would be front- rather than back-loaded, this re-amortization would cost taxpayers $35 billion less than current law” (Ralph Martire, Executive Director of the Center for Tax and Budget Accountability, updated January 16, 2013).

The State of Illinois has a pension debt problem; the State of Illinois also has a revenue problem. Pension reform will not address either one of these serious problems prolonged and disseminated by the Illinois General Assembly and its Big Business partners. Pension reform is an attack on the Illinois Constitution and the state’s public employees. Pension reform will also adversely affect the economy of the entire state and, thus, its citizenry.

Please also review: “Unrealistic Schedule for Repayment of Debt Owed to the Pension Systems Continues to Strain Fiscal Resources” (from Center for Tax and Budget Accountability):

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