Sunday, June 5, 2011

Sustainability of the Teachers' Pensions

Lately, I have been asking questions related to the so-called “unsustainability” of the teachers’ pensions and its conjoined twin, “unfunded liability.”  What is an unfunded liability?   It’s a “calculation of the current value of future liabilities minus the available value of assets.”  What is the problem or debate regarding sustainability and public pensions?  It’s how the current value of future liabilities should be measured and addressed.  What is also behind the push for a radical, “surgical” pension reform in Illinois besides the Civic Committee of the Commercial Club of Chicago, et al?  It’s HR 567, a federal bill sponsored by U.S. Congressmen Devin Nunes and Paul Ryan that would require the state and local governments to report pension liabilities to the Federal Government using the “riskless rate” (or Treasury-Bond rate at 3-4 percent). 

Even without the passage of such a Bill, some state legislators are using this lower “riskless rate” for purposes of measuring the unfunded liability of pension funds.  According to The Center on Budget and Policy Priorities (May 2011), legislators believe that the amount of money needed for pension plans should be larger than the amounts necessary.  Recently, in Illinois, we have witnessed an insensitive and reactionary attempt to change the teachers’ pension system, as evident in the recent proposed SB 512 by elected Representative Tom Cross and House Speaker Michael Madigan, and the “unelected” Tyrone Fahner of the Civic Committee of the Commercial Club of Chicago.
It‘s true that the State of Illinois confronts a greater challenge than most states because of past-elected officials who had blatantly disregarded their legal and fiduciary responsibilities to fully fund the State’s public pension systems for several decades.  Now add to this fiasco the Market crash of 2008-09, the prior practice of “spiking” public-employees’ salaries in their last four years of service, the previous “special-interest” deals made by both sides, and wealthy businessmen writing and endorsing legislative bills in Illinois and we have a disastrous calculation precipitated by fiscal irresponsibility, incompetence, avarice, corruption, officiousness, and bad luck.   
It seems obvious that many current legislators do not want to uphold the State’s constitution. As a friend of mine said to me, “Legislators do not want to be in the pension-funding business anymore.” Why not?  One answer is that some legislators have used the Commission on Government Forecasting and Accountability report (2010) and the Buck Consultants’ valuation report of pension benefits (June 30, 2010) which predicts that the State contributions to the pension funds will exponentially increase despite an 8.5 percent Market rate of return and; thus, some legislators want to renege on the constitutionally-guaranteed contract (explicitly stated in Article XIII, Section 5 of the Illinois State Constitution) to avoid the anticipated increased payments in the future.

Despite the claim that Illinois is the worst state in the country regarding unfunded liabilities (and we know why it is), an essential question to ask is whether the State is in an imminent danger of a financial collapse?  The answer depends upon which recent analysis is used as proof.  According to the Center for Retirement Research at Boston College (May 2011), “The outlook for pension funding is mixed.  First, one concern is that states and localities are falling behind in their annual required contribution [ARC] payments.  They are generally covering normal costs but are not making the amortization payments required to fully fund their pensions.  Paying 100 percent of the ARC should be a priority for all plan sponsors.”  In Illinois, that also includes payments for an exorbitant debt service to the Teachers’ Retirement System (TRS) that is the result of not fully funding the pension system.
Is the only way to “save the pension system” through pervasive and uncompromising reform such as in destroying the existing defined-benefit plan?  The recent, unprecedented response to the spring legislative session proved enlightening, and perhaps an answer to this question is a perspective from the Center for Retirement Research: since actuaries use “smoothing” or the averaging procedure that includes both gains and losses over a five-year period, to determine funding data, why not wait a few more years before drawing further conclusions about what needs to be done to the teachers’ pension system?  

In other words, allow the State’s revenue to recover from the economic downturn of 2008-09.  After all, Illinois does not face an urgent liquidity crisis (because pension fund liabilities are long-term)!   Why not re-evaluate three or four years from now to see whether the economy and Market have recovered; furthermore, continue to use the accounting methods of the Government Accounting Standards Board (GASB).  The GASB actuarial model uses an eight percent discount rate which is more realistic and comparable to the average return of TRS investments since 1982 (at 9.83 percent).  

Moreover, Fitch Ratings states in its February 2011 report, “Enhancing the Analysis of U.S. State and Local Government Pension Obligations,” that “a funded ratio of 70 percent or above [and not 90 or 100 percent is] adequate” (National Conference on Public Employee Retirement Systems, May 2011).  Incidentally, the funded ratio for TRS has increased since 2010 and is approximately 50 percent.
Most states have enough assets (from investment returns, membership and “fully-funded” state contributions) for at least 30 years according to recent studies. Nevertheless, as stated by a report in March, 2011 from the Center for Retirement Research, “the exhaustion date for the state-local sector as a whole is 2023 with returns of six percent and 2033 with returns of eight percent.”   However, Bob Lyons, a TRS trustee, points out that no one knows with certainty how much the Illinois State budget will be in the future or how easy or difficult it might be to make a payment to the pension funds by the State. Most definitely, analyses must include an estimation of assets from State and federal funds, the State’s debt service on pension obligation bonds, the Market rate of return, membership contributions, and the rate of inflation, to name just a few variables.

It’s unfortunate that the State of Illinois has been pressured to address its more challenging unfunded liabilities ill-advisedly.  Indeed, it’s true that the “Pension Clause” guarantees that “benefits will be paid because they are contractual obligations of the employer,” even if the money must come out of a state’s general revenues.  Though a sobering inference to draw is perhaps that without a more scrupulous and reasonable solution for the problem from our “elected” legislators and the IEA’s and IFT’s leadership and their actuaries, the State’s general revenue fund may become the last source of income for retirees. 
One thing to remind these stakeholders is that it’s dishonest, illegal, and costly to ruthlessly amend an existing defined-benefit plan until it becomes unaffordable. Furthermore, teachers need to understand that switching to a defined-contribution savings plan offers no retirement guarantee and; therefore, it is a foolish and risky choice to make without having the needed pool of “fully-funded” financial resources of both State and employee contributions, professional investment managers, and several decades of the types of diversified investments that are not available for an individual retirement account.

The Center for Retirement Research (April 2011) maintains that “meaningful defined-benefit plans could remain as a secure base for the typical public employee, and defined-contribution [savings] plans could be ‘stacked’ on top to provide additional retirement income for those at the higher end of the pay scale. Such an approach would ensure a more equitable sharing of risks…” Three states already use a capped defined-benefit plan in combination with a defined-contribution savings plan for new employees; however, these states do not have constitutionally-protected pensions.
On a final note, it’s appalling to accuse teachers of not wanting to contribute to their pension fund when they have consistently subsidized it since 1939, despite the fact that annual contributions have increased seven times but not by more than one percent each time.  Yes, teachers have always paid their share and the State has not, and now some of our elected officials (and self-appointed, greedy businessmen) believe that “current contributions don’t cover the costs, [and] they also want to reduce the amount of the state budget that goes to funding pensions” (Chris Wetterich, Gate House News Service, June 3, 2011).  

-Glen Brown

1 comment:

  1. Questions to ask before thinking about raising the contribution rates for current teachers are whether the current 9.4 percent contribution rate is enough to cover the “normal costs” to the pension system, and whether all teachers want to pay off the State’s debt service (as in the Tier-Two plan)? After June 30th, the funding projections for the teachers’ retirement system will also change. The FY 2010 projections and reports from the Commission on Government Forecasting and Accountability, the Pew Center on the States, the Center for Retirement Research, the Center for State and Local Government Excellence, the Center on Budget and Policy Priorities, and Buck Consultants, et al will be updated to reveal new assumptions.