Month: January 2020

Originally published at Forbes.com on January 28, 2020.

I’ve said it before: Illinois cannot continue kicking the can on its pensions. I’ve said repeatedly (and fellow soapbox-stander Adam Schuster repeated the message in the Chicago Tribune last week) that the state’s spending on pensions is costly, not only in terms of dollar amounts spent — over 25% of the state budget — but in terms of spending that ought to be spent on needs such as services for those with disabilities, the unemployed, students, and so on, but isn’t, because it’s going to pensions instead.

And I’ve lamented that Gov. Pritzker just doesn’t get it, most recently in an interview in which he said that stretching out the funding target was not off the table, and seemed to suggest interest in the CTBA “solution” involving Pension Obligation Bonds and a reduced funding target of 70%.

All of which prodded me to look at the largest of the state pension plans, the Teachers’ Retirement System, in more detail. This plan is, like the other main plans, about 40% funded, and its unfunded liability is 60% of the total. It is also notable in having cut the benefits for the Tier 2 workers most sharply, so that, given the valuation’s assumptions and funding method, the benefit that they accrue is, in total, less than their required contributions. (Direct state employees mostly participate in Social Security so that their pension is a supplement, not a replacement, and the State Universities System has quirks of its own, including a pure Defined Contribution option for new hires.)

And I plowed through the data in order to assess, how reasonable are these funding targets? And what can go wrong?

Now, current legislation dictates that the state must make contributions as a level percentage of pensionable pay, to reach a target of 90% funded in 2045, but the contribution schedule is actually slightly lower than this target now, and jumps up later, so in order to do my own calculations, I replicated (approximately and in a more smoothed manner) the contribution projections. There are also some finer details which I simplified but the basic concepts below should still be clear.

Chart One: what happens if there’s a run of bad luck?

I calculated three hypotheticals, in each case keeping the dollar amount of contributions unchanged:

In the first, I projected asset growth in the case that the 7% assumption turns out to be 6% instead. In the second, I assumed a long-term 6.5% return but also adjusted the liabilities to reflect the changes that’d be needed for a new valuation interest rate. And in the third, I kept the assumptions unchanged at 7%, but dropped the assets immediately by 33% to reflect a market crash.

Not good, eh? A drop to a 6.5% asset return/valuation interest rate assumption is not just reasonable but likely, and this keeps the plan from reaching anything close to its 90% objective — instead, only 62.5%.

Chart Two: Bad luck with a 70% target

The colors shift because I’ve excluded the original target to illustrate the fact that setting a 70% target produces an even greater risk of poor funded status. (Note that the CTBA’s projections look different because of their POB proposal, and recall that I am, well, anti-POB, especially with respect to anyone who promotes pension obligation bonds as a form of “refinancing”.) In the wholly-realistic 6.5% discount rate scenario, it barely budgets from the present funded status, and maxes out at 46.6%.

Chart Three: The effect on the unfunded pension liability, with a 90% target and “bad luck.”

Note that while the funded status for the two low-return scenarios was similar, they diverge in terms of absolute pension underfunding. In the actuary’s current projection, the unfunded liability peaks in 2029 at $86 billion. With a discount rate drop, it peaks at $110 billion in 2037.

Chart Four: Unfunded pension liability with a 70% funding target.

Yes, you see that right, in the scenario in which the plan targets a 70% funded level, and doesn’t adjust its contributions afterwards, the unfunded liability reaches $139 billion for the teachers’ plan alone in 2045, and has not yet peaked and begun to decline.

Are you starting to see my point?

Even with a 90% funding target, the state is at risk of liabilities growing year after year — or (not modeled here) even more money being spent on pension funding rather than daycare subsidies for low-income families, for example. And with a 70% target, of course, those numbers are even worse.

But wait, there’s more!

The final two of the six charts are an attempt to approximate the impact on the pension liabilities of a “repair” of the Tier 2 benefits. As it is, there is effectively no employer contribution. I modeled the impact of a 6% employer contribution (less than a Social Security contribution) and a 9% contribution, such as in a notional account plan (a “cash balance plan” in the private sector), along with the removal of the pay cap that is lowered every year in inflation-adjusted terms. This is approximative, but is a very conservative scenario.

Chart Five: Tier 2 “repairs” with a 90% target

Chart Six: Tier 2 “repairs” with a 70% target

To be clear, these are based on the baseline valuation, with “original” representing the original contributions for the 90% target.

Are these six charts enough? It was tempting to produce “worst-case” scenarios but those would be too easy to brush aside, and even these hypotheticals, intentionally made realistic, should be enough to make it clear that it’s not remotely reasonable to shrug off pension debt as something for the next generation to deal with.

Added next-day comments:

I’m often asked, “how long until the plan runs out of money?” And, in fact, that’s a fair quesiton to ask, with respect for the even-worse-funded Chicago plans, where they’re still making their way up the funding “ramp” and are so poorly funded that if they chicken out and markets have poor returns, they will become insolvent. In an article in September 2019, I explained some of the math; to take one example, if the mayor replaces the scheduled “ramp” increases for the municipal plan with inflatoinary increases instead, the plan becomes insolvent in 2027, even without adding in any “bad luck” scenarios.

But there isn’t as dramatic an answer for the state plans — the 23% vs. 40% funded status ratios do make a difference. Nonetheless, I spent so much time typing up these numbers that I might as well make the most of them: the following table illustrates the insolvency year under the valuation assumptions, and a second scenario in which assets earn only 6% and there is a market crash.

If the state continues its current contribution level — which is, yes, 48% of pensionable payroll, and, yes, that’s a lot — the plan reaches 90% funding under current assumptions and avoids insolvency in the “bad luck” assumptions; however, its funded status is very shaky, staying 27% – 28% during the entire modeling period. And if the state were to drop its contribution down to significantly lower levels, then the plan would end up insolvent in either scenario.

Sadly, though, I doubt this table will persuade any of the politicians who need to be persuaded, many of whom would likely say, if off the record, “what’s wrong with insolvency anyway? We’re paying for the benefits our fathers and grandfathers promised; why not demand the same of our children and grandchildren?”

And one final comment: none of these scenarios take into account another likely issue in Illinois, that of declining population. A contribution of 48% of pensionable payroll directed almost entirely at paying off past debt, will grow to even higher levels, as a percentage of pensionable payroll, if the number of teachers declines over time in line with the number of residents. That’s not pretty, either.

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Originally published at Forbes.com on January 22, 2020, and still relevant 4 years later.

Once more, from the top: here is why public pension reform matters.

In December, I cited a report by the Chicago Tribune that, due to lack of funding, 20,000 adults in Illinois with cognitive disabilities were on a waitlist for group homes or day programs, waiting seven years or longer, due to lack of funding.

Earlier this month, the Trib reported that, due to the end of work-requirement waivers for SNAP/food stamps, social services agencies were scrambling to place recipients in job training or volunteer programs.

Here’s a key excerpt:

“Basic processes to help with the administrative burden have yet to be put in place, state caseworkers say. For example, there is no efficient way to report volunteer or training hours completed outside of state-sanctioned programs, so people will have to do so monthly in person at benefits offices, where waits can stretch longer than two hours, said John Mitchell, an officer with AFSCME Local 2858, which represents caseworkers in northeast Cook County.

“Understaffed benefits offices also haven’t prioritized connecting people with employment services as they’ve dealt with a backlog for processing SNAP applications that was so bad that the federal government threatened to suspend funding, Mitchell said.”

Last week, the Tribune reported that the University of Illinois system was raising its tuition after having frozen it for the past six years. The increases are modest, all things considered, but here is the key paragraph:

“Residents long have complained that U. of I., the state’s flagship, is too expensive and does not offer enough financial aid. University data shows all three University of Illinois schools remain among the priciest in their peer groups, even though other schools raised their prices during Illinois’ tuition freeze.”

And this week, Chicago Mayor Lori Lightfoot announced plans for an anti-poverty summit “to marshal resources from the city, business community and philanthropic groups to rescue Chicagoans ‘trapped in the throes of generational poverty,’” as reported at the Chicago Sun-Times. How’s she funding this?

“The $250 million earmarked for Lightfoot’s ‘Invest South/West’ program is ‘re-prioritized money already in the pipeline’ from tax increment financing; the moribund $100 million Catalyst Fund; the Small Business Improvement Fund; and the share-the-wealth Neighborhood Opportunity Fund generated by developers paying a fee for permission to build bigger and taller buildings downtown.”

But at the same time, the city of Chicago issued its new “refinancing” bonds, in which the city found $210 in cash up front due to lower rates — and, it turns out, those rates were not favorable solely because of a lower interest rate environment, in general, but because the city legally committed the right to future sales tax revenue it has coming from the state, so that investors will receive their money even if the city goes bankrupt and has to default on other loans and cut city services. And it was only possible to do so because of a last-minute back-room provision inserted into the 2017 budget in the literal last hours of the legislative session. (See this Wirepoints report for details.)

The list goes on: insufficient spending on childcare subsidies for low/moderate-income parents . . . insufficient state spending on education, placing the burden on local property tax payers . . .

These are all areas where there is widespread agreement that the State of Illinois falls short.

At the same time, of course, however eager the Democrats currently in power in Illinois (that is, controlling the governorship and State House and State Senate, with supermajority control over the General Assembly, as Illinois labels it) are to raise taxes through a graduated income tax, skeptical voices caution that it simply isn’t possible to raise taxes however much you’d like to boost spending however much you’d like — even if you claim those increases will be limited to “the rich” (which is always defined as “everybody with more money than your audience at any given point in time). Not only will it raise the ire of those taxpayers, but increasingly many of them will find somewhere else to live.

And, yes, one would like to imagine that there’s an easy solution to these woes, whether it’s the perennial pledge to cut wasteful spending or the dream to find new sources of free money (in Illinois’ case, pot and gambling). But Illinois politicians have believed in the promise of free lunches for far too long.

And this is why public pension reform matters: 25.5% of Illinois’ spending is going to its state pension funds. Once the city has made it up to the top of its funding ramp, it will be spending 18% of its revenue on pension contributions, assuming its revenue projections are not overly optimistic. (See here for the contribution schedule — $2.2 billion in 2022 — and here for the revenue projection which I’ve increased by two years’ worth of inflation.) And these percentages could go higher if the state and city are forced to unwind the “Tier 2” pension cuts as a result of court cases or political pressure.

It should be obvious: pension reform is not about trying to fleece public employees and retirees.

Instead, it’s quite simple: had the state not promised more in pension benefit accruals each year than they funded through contributions at the time, that money would be available to spend on all these needs. And if Gov. Pritzker, the General Assembly, Major Lightfoot, and public union leaders were to forge a consensus for an amendment which would permit pension reforms, some portion of that 25.5% and the 18% would be freed up to spend on these needs.

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Once again, Pritzker talked about pensions in an interview.  Once again, he doesn’t get it.

Originally published at Forbes.com on January 15, 2020.

On twitter, I joked that I was drafting an article I was tempted to call, “Beating a Dead Horse Into The Ground: More Historical Context On Pensions Than Any Reader Is Remotely Likely To be Interested In.” But — I’m sorry to disappoint you — I suspect this will not be the last time I address the context of the pension clause, especially as it drives my conviction that it is indeed necessary to amend the Illinois constitution before pensions can be reformed, but that, no differently than the flat-tax-only provision of the Illinois constitution, the path is cleared for legislation if that happens.

So here are three key pieces of historical context to keep in mind with respect to this clause in the Illinois constitution which forbids any action which would “diminish or impair” pensions. (See “What The Illinois Supreme Court Said About Pensions – And Why It Matters” for a catch-up on the topic.)

First, the pensions clause was bipartisan. It’s easy to think of Illinois as a “blue state” in which the Democratic party has a lock on governance, but that clause, debated on over only the course of a single day, was principally sponsored by four Republicans — two judges, a lawyer, and a land developer — with 15 co-sponsors (yes, including Chicago Mayor Richard M. Daley) from both parties. Some sponsors believed, however mistakenly, that the clause would be the impetus for moving pensions towards full funding — that is, believing that, if legislators knew that future generations couldn’t escape pension funding by reneging on promises, they’d be more responsible about funding (I know, you can resume reading after you’re done laughing and I apologize if you’ve gotten coffee on your keyboard); others had no such illusions.

(For more historical context, an undated page at the Illinois Senate Democrats’ website provides links to multiple sources of further information, including a 2013 Chicago Tribune article, and a 2014 report which provides background on the 1970 clause and funding history since then.)

Second, although the five state systems had more or less the same funded status then as now (41.8% in 1969, according to that 2014 report, and 40% in 2019), the magnitude of the unfunded liability, the debt accrued as a result of promising benefits without funding them, has grown at an incredible rate in the past 50 years.

That same 2014 report cites an unfunded debt of $1.46 billion in 1970.

In 2019, the debt stands at $137 billion.

That’s an increase of 9,078%.

Is that perhaps a bit of an unfair comparison, because of inflation?

If we take into account inflation, that’s an increase of 1,354%.

Even if we take into account the increase in GDP in Illinois in this period, that’s an increase of 578%. Or if we look at increases in total personal income in Illinois, it’s an increase of 553%.

In other words, even in the most charitable way of massaging the numbers, the degree of unfunding is far, far higher than it was in 1970. (CPI data comes from the Bureau of Labor Statistics and economic data from the Bureau of Economic Analysis.)

What’s more, this is not merely due to failures to fund, or to demographic changes. Plan benefits were regularly increased, over and over again, until the legislature finally realized that fixes were necessary in 2011.

Consider the Teachers’ Retirement System. In 1971, the basic benefit formula was increased, the maximum benefit was increased from a range of 60 – 70% by age, to 75%, and early retirement reductions were eliminated for retirees with 35 years of service. In 1972, the cola was increased to 2% and in 1978, it was increased to 3%. In 1979, an early retirement program was established, the provisions of which changed and were renewed periodically in the coming years. In 1984, credit for up to one year’s accrual via sick leave was implemented and in 1988, employees could use sick leave credit from former employers. In 1991 and 1993 early retirement incentives were implemented. In 1998, the basic benefit formula was increased again. In 2003, teachers were permitted to use two years of sick leave to count towards pension accruals. In other words, the pension benefits being guaranteed in 1970 were considerably less than now.

And, third, legislators utterly lacked an understanding that pension liability is a real form of debt. In this, they weren’t alone. The landmark law requiring funding for private sector plans, ERISA, was passed in 1974. It took until 1985 for the FASB to issue regulations governing accounting for private sector pensions, in the form of FAS 87 and FAS 88.

As the 2014 report I cited earlier describes, for many years following the 1970 constitution, Illinois’ funding policy, if you can call it that, was to fund the benefits being paid out in any given year, a dreadful pyramid-scheme that only works if you’re indifferent to the consequences for future generations, or believe that economic and population growth mean that those future generations can easily manage the bills that will come due. Turns out, if those delegates and politicians in 1970 had believed that future population growth meant that there was no need to worry, that was about the last point in time in which they could reasonably believe this, as the decade from 1960 to 1970 was the last decade of meaningful population growth.

So, no, the Illinois pensions clause wasn’t meant to be a suicide pact. But it will turn out to be if we don’t change it.

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.