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Wednesday, January 8, 2014
“It’s a Debt Problem, Not a Pension Problem” in Illinois
Unrealistic Schedule for Repayment of Debt Owed to the Pension Systems Continues to Strain Fiscal Resources (from the Center for Tax and Budget Accountability):
“…As he did last year, Governor Quinn focused much of his budget address for FY2014 on the state’s annually increasing pension payments — required under existing law — as the primary reason behind cuts to core services. However, the Governor did not distinguish between the growth in annual pension payment caused by debt service (virtually all) versus that caused by the cost of funding benefits for current workers (virtually none). Understanding the source of growth in the annual pension payment is crucial if a sustainable solution to the pension-funding crisis is to be implemented.
“The state has the responsibility to fund five distinct public employee pension systems: TRS, SURS, SERS, GARS, and JRS. Presently, all five retirement systems are significantly underfunded. To be considered financially sound, a public pension system should have a funded ratio of at least 80 percent — meaning it has 80 percent of the assets needed to pay all obligations as they become due overtime, based on actuarial estimates. None of Illinois’ five systems is funded at even 50 percent. That means, based on actuarial assumptions and projections, the state’s pension systems have significantly less in accumulated assets than what they would need to pay all benefits earned, as those benefits come due...
“At the start of FY2013, the retirement systems had a combined unfunded liability of $95 billion, and collectively were just 40.4 percent funded. Due to a significantly back-loaded repayment schedule for debt owed to the retirement systems, the overall unfunded liability is projected to increase by at least $6 billion, meaning FY2014 will begin with the systems having an aggregate unfunded liability in excess of $100 billion. Being underfunded is nothing new for the state’s pension systems, not once in the last two decades have the systems collectively been funded at 80 percent...
“The primary reason for the significant, annual growth in the state’s pension contribution is poorly understood and is often not reported correctly in the media. It has nothing to do with increasing benefits for workers, nor any other inherent aspect of the pension systems themselves. By far and away, the main reason the state’s contributions to its pension systems are increasing so much annually is the unrealistic, heavily back-loaded schedule the legislature set back in 1995 for repaying the debt the state owes to its pension systems.
“Two compelling data points conclusively prove that debt is driving the increase in annual pension payments. First, of the roughly $5.1 billion General Fund contribution to the five pension systems estimated for FY2013, about $1.1 billion is the normal cost of funding benefits being earned by current workers, whereas well over three-quarters, $4.0 billion, is repayment of debt. Of the $6.19 billion General Fund contribution to the five pension systems for FY2014, about $1.02 billion is attributable to the normal cost of the benefits being earned by current workers, while $5.17 billion constitutes debt repayment…
“Over four out of five taxpayer dollars paid as part of the state’s annual pension contribution go to paying down pension debt, not to funding benefits being earned by current workers. Indeed, the entire 20.99 percent year-to-year growth in the pension contribution from FY2013 to FY2014 is due to increasing debt service under the existing repayment schedule.
“Second, when one considers the factors that have contributed to the growth in the state’s unfunded liability since FY1996, the amount borrowed from what should have been paid to the systems is by far the largest reason for this growth…
“The greatest cause of the state’s unfunded liability has been borrowing against the pension systems. This borrowing meant that the state’s contributions were not sufficient to pay for both benefits earned by current employees and interest on the pre-existing unfunded liability. Without sufficient contributions, an unfunded liability annually grows by a retirement system’s investment rate assumption (which ranges from seven percent to eight percent among Illinois’ five state systems).
“The state’s annual contribution to the retirement systems for debt service can be thought of as having two components: one part goes to pay down principal and the other is for interest on the principal. This is similar to paying down a credit card bill or home/car loan…
“The significant debt owed to the pension systems is the core cause of the systems’ cumulative unfunded liability—a situation that did not arise overnight. In fact, Illinois lawmakers essentially borrowed against the pension systems for decades by underfunding what was owed, and instead diverted the revenue that should have gone towards pensions to fund the delivery of current services—like Healthcare, Education, and Public Safety.
“At the end of FY1994, Illinois lawmakers had borrowed so much against the pension systems that combined, the five systems were just 54.5 percent funded—meaning that just over half of all liabilities were covered by assets—and had an aggregate unfunded liability of $17 billion.
“In FY1995, the General Assembly passed and Governor Jim Edgar signed into law PA 88 -593, purportedly to resolve this problem by creating a schedule to repay what had been borrowed from the pension systems. This Act mandated that the state’s annual pension contributions be made pursuant to a continuing appropriation based on a 50-year funding plan now known as the “Pension Ramp.” Under the Pension Ramp, the state’s annual contributions are calculated so that, if made in accordance with the schedule, by the end of FY2045, all five systems will be 90 percent funded.
“Even though PA 88-593 was ostensibly created to repay the debt owed to and resolve the underfunding of the pension systems, the legislation — by law — actually continued the practice of borrowing against contributions owed to the pension systems to subsidize the cost of delivering public services for 15 years after its passage...
“Despite reducing pension benefits for employees hired on or after January 1, 2011 (i.e. the creation of Tier II), the state’s required contributions nevertheless are projected to take up increasingly more of the annual General Fund budget over time. For each of the five systems to be 90 percent funded by the end of FY2045, the state’s annual payments will have to grow by accumulative average of 3.5 percent annually for the remainder of the funding schedule (FY2013 - FY2045).
“Despite these annual increases, the state’s contributions under the Pension Ramp are currently not even enough to prevent the unfunded liability from growing year-to-year. In fact, under the current back loaded payment plan, the unfunded liability does not begin to shrink until after FY2030.
“In other words, for at least the next 15 years, Illinois taxpayers will continue to pay billions of dollars without making much of a dent in the unfunded liability. To date, nearly all bills introduced to resolve this problem fail to accomplish that purpose for one simple reason: they focus on cutting benefits—which are not driving the annual cost increases—and avoid re-amortizing the debt, which is driving the increase in annual pension payments…
“One final note on using benefit reductions to alleviate the state’s pension problem… Illinois has one of the strongest constitutional protections of public worker pension benefits in the nation. Article XIII, Section 5 of the Illinois constitution plainly states that pension benefits ‘shall not be diminished or impaired.’ Legislation that reduces benefits for current employees and/or retirees—which includes… increasing retirement age, or delaying the COLA—are in all likelihood unconstitutional. If such legislation is passed, it will inevitably be challenged in court and the state will have to pay for any related court costs. Should legislation ultimately be found unconstitutional, the state will end up in an even worse fiscal situation, with the responsibility to repay any savings generated from the unconstitutional benefit cut—with interest.
“This is precisely what just happened in Arizona, which has a pension protection clause in its state constitution that is very similar to Article XIII, Section 5 of the Illinois Constitution. In 2012, a law in Arizona that increased current employees’ contribution rates was found to be an unconstitutional diminishment of pension benefits. As a remedy, the court ordered Arizona to repay its workers the dollar amount of these increased contributions, plus interest.
“Obviously, any such outcome for Illinois would only worsen the state’s already dismal fiscal condition. Instead of focusing on benefits, lawmakers should re-amortize the debt currently owed to the pension systems using a = level dollar, rather than level percent of payroll, amortization schedule. After all, the data clearly indicate the fiscal strain caused by the unfunded liability is fundamentally a debt—not a benefit—problem. Focusing on benefits ignores this fact and allows the fiscal pressure caused by the unaffordable back-loaded payment schedule under current law to remain in place…” (Center for Tax and Budget Accountability).
from ANALYSIS OF FY2014 ILLINOIS GENERAL FUND BUDGET
The Center for Tax and Budget Accountability Is “A Bi-Partisan, Data-Based Watchdog of the State’s Tax Policy, Health-Care Capacity, Education Funding, and Unfunded Pension Liability…” Please click here for more information: The CTBA.