Jane the Actuary Retirement

Forbes post, “Will New Jersey Fund Pensions With Stealth-Taxes? An Asset Transfer Update”

Originally published at Forbes.com on July 2, 2021.

 

New Jersey, the only state to have a pension funded status worse than Illinois’s (according to Pew’s 2020 compilation based on 2018 data), is quite pleased with itself because, as the state announced in a recent press release,

“State Treasurer Elizabeth Maher Muoio announced that the Treasury Department today kicked off the start of the new fiscal year by paying the full state-funded portion of the $6.9 billion pension contribution slated for Fiscal Year 2022 (FY 2022). This marks the first time in more than 25 years that New Jersey is making the full Actuarially Determined Contribution to the Pension Fund, plus an additional $505 million contribution, and also the first time in years that the state has made a lump sum payment, rather than quarterly payments.”

And Senate President Stephen Sweeney believes he has a solution to reduce the burden of these pension payments, in the form of the Retirement Infrastructure Collateralized Holdings Fund (yes, the “RICH Fund”), as proposed in legislation being considered by the New Jersey Senate, which he promotes in a commentary at NJ Spotlight News. He writes,

“That is why we have developed legislation to enable our state and local pension systems to add revenue-generating assets like water and sewage treatment systems, High Occupancy Toll (HOT) lanes, parking facilities and real estate to provide new, diversified sources of revenue for their investment portfolios.

“Senate Bill 3637, which may be considered by the Senate Budget and Appropriations Committee this week, would create the Retirement Infrastructure Collateralized Holdings Fund — RICH, for short — as an infrastructure trust fund to hold and manage assets transferred to the public corporation by state and local governments for the benefit of New Jersey’s public employee pension funds.

“This would not only bolster the pension system, but also give state and local governments powerful new tools for preserving public ownership, improving public stewardship, and maximizing public benefit. . . .

“The state and local governments own water systems, reservoirs, real estate and parking lots that could generate stable revenue for pension systems in the same way that the Lottery system has for the past several years.”

But none of the assets listed, when publicly-owned, are intended to be profit-generating! People expect their water treatment and sewage-treatment systems to operate at cost, to provide clean water and dispose of human waste in a sanitary manner, to protect public health. We expect our government officials to manage these systems at a cost that’s as affordable as possible while still keeping systems in good repair, and all the more so for the sake of the low-income among us. To be sure, private companies are gaining market share in the United States, providing water for one in six Americans, according to The American Prospect. And while the rationale for privatization can potentially be sound — the inability of a municipality, especially a small one, to fund needed improvements, and the expectation that a large multinational can manage more effectively, generally-speaking — too often (as reported at the Philidelphia Inquirer) towns simply perceive of it as a quick cash infusion, regardless of the long-term cost to residents in the form of higher rates. (And, yes, Chicagoans will be quick to share their painful experience with parking meters, 75 years’ of revenue from which was sold to a private company for a one-time cash payment of $1.16 billion, in a 2009 transaction under former mayor Daley.)

In other words, when these components of core public infrastructure become a source of profit, it is a sign not of sound governance, but of misgovernment. Any instance in which the management of a system of infrastructure is contracted out to a private entity, should be limited to cases in which that private entity can better manage the system, and earn a profit from the savings derived from superior management. Handing over such an asset to a public fund, which would in turn need to contract with a third party to manage the asset, would not suit the bill.

What it comes down to, then, is that Sweeney is proposing to fund state pensions through a set of taxes which are hidden to the public. How many residents, after all, when they see their water bill go up, or pay more on the toll roads, will be aware that these new rates are for the purpose of funding pensions? What’s more, these sorts of revenue-raisers are far more regressive, with higher relative costs for lower-income residents, than a simple income tax. No one should be patting themselves on the back as if they have come up with an innovative solution here!

Perhaps it’s for this reason that Illinois abandoned its plan to fund pensions through asset transfers — not with a public announcement, of course, but simply by letting the task force die a quiet death, never releasing the draft report its members had prepared. At least in this respect, Illinois appears to have dodged a bullet.

Update:  the bill died so is seemingly not worth duplicating at this website; however, the “solution” appears to pop up every now and again and the general principles of why to reject it are unchanging.

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.

Jane the Actuary Retirement

Forbes post, “The Public Pension Funding Crisis And The First Law Of Holes”

Originally published at Forbes.com on January 6, 2020.

 

“If you find yourself in a hole, stop digging.”*

Many politicians in states and cities with severe levels of pension underfunding will assert that they have indeed followed this instruction.

Illinois, after all, implemented “Tier 2” pensions for workers hired in 2011 or later, with cuts so drastic, for teachers, at any rate, that, on the asset-return discount rate basis used in the valuation, new participants pay more in contributions than they receive in benefits — that is, the “employer normal cost” is negative. For state workers and university employees, there is a (positive) employer normal cost, as is also true of City of Chicago workers, but they all face lower (and noncompounded) cost-of-living adjustments, increased retirement eligibility ages, stricter vesting requirements, and pay caps which bite at a lower inflation-adjusted pay level year after year. (Conveniently, the “Tier 2” pensions legislators implemented for new legislators and judges were much more moderate in their cuts, with COLAs based on CPI and continuing to compound and with pay caps increasing at CPI.)

Various other such plans have similar “tiers” — New Jersey’s system, for example, ranges from Tier 1 (hired before July 1, 2007) to Tier 5 (hired after June 28, 2011), with tweaks in benefit accruals, retirement ages, and ancillary benefits, for each tier. Tier 1 employees were able to retire as early as age 60 without reduction (or age 55 with 25 years of service); Tier 5 employees must now wait until age 65, with early retirement of any kind contingent on 30 years of service, and requiring a 3% per year benefit reduction.

And politicians are quite willing to pat themselves on the back about these changes. Here’s Illinois State Senator Heather Steans (Democrat representing Chicago’s far north side/lakefront) speaking at a City Club of Chicago forum (see my Sept. 11 article for fuller comments):

“I get frustrated when people suggest that the Illinois Senate, the General Assembly in the state have not been doing things, however; in 2011 we implemented a Tier 2 pension system that dramatically changes pensions for employees hired as of 2011 on. That’s already done, so we’ve already made significant changes that upped the retirement age and that really changed the compounded COLA that folks get in the future. That’s been changed. It’s the legacy costs we’re dealing with.”

But a mere two months after Steans’ confident statement that everything’s been fixed but the legacy costs, the legislature, as a part of their November 2019 asset-management consolidation measure for local police and fire pensions, unwound several elements of the Tier 2 cuts, without any actuarial analysis but instead viewing the projected higher asset returns as “found money.”

Which means that the legislature hasn’t stopped digging at all. There’s simply digging a bit more slowly than before.

What would it take to truly do so?

True not-digging would require that the state of Illinois,

first, begin participating in Social Security with respect to all public employees — currently the lion’s share of direct state employees do so, but not municipal employees, teachers, university employees, or public safety workers (with respect to teachers, this places them among 15 states which are in the minority nationally); and,

second, to move to a defined contribution (401k-equivalent) or risk-sharing pension plan for supplemental benefits, so as to establish the principle that “you get what you get and you don’t throw a fit.” (Let’s call it the YGWYG public pension principle.) This means that if unions don’t approve of the state’s annual appropriation to fund their pension plans, they must fight tooth and nail to boost it, rather than preferring better raises in their here-and-now cash compensation knowing that future generations will be locked into paying their pensions regardless of the state’s efforts, or lack thereof, to fund them at the time they were accrued.

And what does “risk-sharing pension plan” mean? I’ve cited the model of Wisconsin’s public pension system in the past. There, retirement benefits are adjusted up and down as needed to reflect investment returns from year to year. What’s more, employee and employer contributions are recalculated every year based on a fixed formula (but the latter are far lower and far less variable than Illinois’).

There’s another model, too, or at least I hope there will be, soon: the “composite plan.” Never heard of it? I don’t blame you. It’s included in the Senate multiemployer pension plan rescue proposal, and has its origins in a proposal by the NCCMP (a multiemployer pension lobbying group), which aims to create a structure similar to the “Collective DC” plans of the Netherlands, in which participants receive protection against outliving their benefits by joining together, well, collectively, rather than relying on guarantees made by an employer.

How do we get from here to there? It’s not easy, but it involves refusing to accept claims by politicians that they have fixed everything but the legacy costs, unless they have made these changes.

(*See Wikipedia for some brief background on this adage.)

 

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.

Jane the Actuary Retirement

Forbes post, “Public Pension Funding Crisis: Why Should Today’s Workers And Retirees Pay The Price?”

Originally published at Forbes.com on January 4, 2020.

 

Here are some excerpts of interest from a May 26, 1965 Chicago Tribune story, “Police, Fire Pensions Tabled”:

“Three important police and firemen’s pension bills appeared defeated today but efforts may be made to revive one which would consolidate 335 pension systems outside of Chicago. . . .

“Robert Erickson, a spokesman for the Civic federation, Chicago taxpayers’ organization, was happy when two tax-increasing bills were tabled by their sponsors.

“One would have required a property tax boost to yield 90 million dollars in the next 10 years to build up reserves for the Chicago police pension fund. Erickson said this fund is in good shape, now 35 per cent of actuarial requirements, and steadily increasing. . . .

“Supporters of the consolidation bill for municipalities with 5,000 to 500,000 population cited figures showing how far these pension funds are lagging behind Chicago’s 35 per cent in relationship to the actuarially sound figures.

“For police pension funds, in Cicero it is 4 per cent, Decatur 6 per cent, Elgin 3 1/2 per cent, Glencoe 11 per cent, Springfield 7.4 per cent, Forest Park 8 per cent, Rock Island 8 1/2 per cent, Freeport 9 per cent, Galesburg 12 per cent, Moline 4 1/2 per cent, Quincy 5 per cent, Pekin 9 1/2 per cent, Waukegan 8 per cent, and Peoria 10 per cent.”

And the reasons why the bill failed are much the same as why the recent consolidation law only consolidates the pensions’ asset management, not the overall pension administration, that is, the fact that the high expenses of these small local pensions are due to board members, administrators, and lawyers getting generous paychecks for their work.

But here’s what’s astonishing about this article on the pensions’ funded status: the fact that the 35% funded status for Chicago’s pension plans is treated as being “in good shape” — at least in comparison to cities where there is effectively no advance funding at all, but rather, pensions were run on a pay-as-you-go basis with a nominal reserve fund.

Now, that was 55 years ago, and in the meantime, the city and the state both began to accept the concept that not just private sector but also public sector pension plans should be funded in a proper actuarial manner, that the pension fund should be more than just the single-digit percentage funds listed above. And indeed, by the time the oldest available records are available online for the Firemen’s pension fund and the Policemen’s plan, the funds had made at least some progress above this 35% (though to what extend this is due to an increase in contribution levels vs. a move to riskier assets and higher investment return assumptions isn’t possible to say).

At the same time, the pension (asset-only) consolidation wasn’t passed after so many years due to a new resolve to fund pensions but in part due to a promise of something-for-nothing (higher asset returns and lower expenses) and due to pressure placed on local communities due to the 2011 “pension intercept” law by which the Illinois comptroller withholds state funds from towns and cities which don’t properly fund their pensions to a “90% in 2040” target.

And here’s the challenge that I am working out for myself and will pose to readers as well:

It will not surprise readers that one of my objectives in writing on this platform is to play a role in making some progress, however small, towards pension reform in those states and cities (Illinois and Chicago, yes, and those others with dreadful funding as well) with atrociously-poorly funded public employee pensions.

Yet the most obvious rejoinder from any worker or retiree at risk of having their pensions cut (COLA or guaranteed fixed increases curtailed, generous early retirement provisions removed, accrual formula reduced for future accruals) is a simple one: public pensions have been underfunded by modern metrics, for generations, essentially since the inception of those pensions. (See here and here for the early history of the Chicago Teachers’ Pension Fund, which was much the same.) Why should this generation be the one to suffer from the obligation to bring the plans up to funded status — either as pensioners or participants with benefit cuts, or as taxpayers?

To be sure, the politicians repeating over and over again “pensions are a promise” don’t explicitly say this. When Mayor Lightfoot acknowledges that the city will be hard-pressed to make its required payments in to the pension funds and still reach her other goals for city services, but can’t voice any solution other than stumbling around various ways of saying, “this is hard” (for instance, back in August), this is surely what’s underlying her statements (or lack of meaningful statements): “it’s unfair that the rating agencies now think pensions should be funded.”

And I’ve written in the past on why it actually does matter to pre-fund pensions, but it is admittedly not easy to persuade, well, anyone, that the right thing to do with whatever tax money you can scrape up is to put it in a pension fund, when you’ve got people clamoring for it to be spent on education or mental health or housing or any number of other items on a wishlist.

Prizker regularly says that there’s no point in expending political capital on a pension reform amendment because it wouldn’t have the public support it needs ot pass, and I regularly complain that his willingness to expend not just political capital but also cold hard cash on his graduated tax amendment shows that it’s really about his priorities, but it also does fall to the rest of us, in those states and cities with these woefully-underfunded pensions, to make the case that it does indeed matter.

 

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.

Jane the Actuary Retirement

Forbes post, “A Modest Proposal To Solve Illinois’ Pension Woes”

Originally published at Forbes.com on August 7, 2019.

 

It’s easy-peasy, really.

There’s a way to reduce the Illinois and Chicago pension liabilities by half, with no constitutional amendment required, no hard political truth-telling or compromises, no cuts at all.

And considering that Chicago’s pensions are 23% funded, and Illinois’, 40%, this is not a minute too soon.

Here’s the scoop:

The basic structure of Illinois’ and Chicago’s pensions are the same. In general, Tier I employees/retirees, those hired before 2011, receive a pension based on final pay and service with a fixed 3% per year Cost-of-Living Adjustment; whenever inflation is lower than this (the last ten years, it’s averaged 1.8%, the last 20 years, 2.2%), they come out ahead, to the extent that some retirees get pension checks greater than any paycheck they ever received. Tier II employees, on the other hand, keep the same benefit formula, but averaged out over a longer period of time, receive pseudo-COLAs at half the rate of inflation, without compounding, and have their pensionable pay capped at a level that (unlike, for instance, the Social Security ceiling) doesn’t rise based on average wage growth or even inflation but at half the rate of inflation, so that, to take the teachers as an example, any teacher who earns above-average pay levels will be affected as soon as 2027, based on current inflation projections and average wage data.

Now, the value of any pension without a true CPI-based cost-of-living adjustment will be eroded over time due to inflation, and eroded in very short order in instances of high inflation. And in countries with a history of inflation, employer-sponsored pensions are more likely to include true cost-of-living increases. In some cases, the entire actuarial valuation is done on a “real” basis, evaluating all of the inputs on the basis of “value in addition to inflation” — that is, using the assumed salary increase in excess of inflation and the interest rate in excess of inflation. When both these hold true – true-CPI increases and assumptions all relative to inflation, in principle, neither the liabilities nor the pension benefits’ real value are affected by fluctuations in inflation. (Random trivia: in Brazil, the government even issues its bonds on a “real” basis.)

At the same time, back in the spring, the latest buzzword was Modern Monetary Theory (here’s an explainer), which was the means by which various progressive politicians promoted the idea that there was an awful lot more room for government deficit spending than appears to be the case; concerns about inflation were waved away with the assurance that the government would be able to tack as needed by increasing tax rates.

You see where I’m going with this, don’t you?

If the United States were to hit a period of high inflation rates, sustained over a long period of time, these liabilities would shrink considerably — and I’m not even speaking, snarky photo aside, of hyperinflation. Based on my calculations (and yes, these are real calculations, using real data for this plan collected for another project, not merely back-of-the-envelope estimates, however unlikely the very even numbers make it appear), an inflation rate of 10%, and assumptions for interest rate/asset return rate and salary increases over time which reflect the same net-of-inflation rates as at present, would halve the pension liabilities of the Illinois Teachers’ Retirement System.

Sounds preposterous, I know. And admittedly, beyond all the ill-effects of high inflation, individual state governments don’t control monetary policy anyway. But is it really any worse a proposal than the idea of selling the Illinois Tollway to a private firm which would do the dirty work of raising tolls so as to indirectly fund the pensions by making the tollway an attractive and profitable purchase? Or more ill-conceived a notion than the notion that public pensions can function perfectly well as pyramid schemes in which each cohort of employees funds their predecessors’ benefits?

Or maybe the politicians of Illinois have some better idea? If so, I’m all ears.

 

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.

Jane the Actuary Retirement

Forbes post, ” More Cautionary Tales From Illinois: Tier II Pensions (And Why Actuaries Matter)”

Originally published at Forbes.com on June 7, 2019.

 

Earlier this week, I shared with readers the ill-fated attempt to reform Illinois pensions by requiring local school districts to pay the added costs of their teachers’ pensions when they boost their salaries beyond 3% per year; this measure was slipped into last year’s last-minute budget and removed (restoring the old 6% limit) in this year’s last-minute budget, in a demonstration of the intractability of Illinois’ pension woes so long as the guarantee of future accruals and future increases remains in the state constitution.

As it happens, that’s not the first time that legislators have cobbled together reforms which fail to accomplish their objective.

Readers who are employed by large corporations and have been around for a while likely have experienced the joy of being told that their employer is changing the terms of their retirement benefits program, either switching to a “cash balance” benefit, reducing the generosity of a defined benefit program going forward, being offered the opportunity to switch to a 401(k), or simply being told that the pension plan is being frozen and replaced by a 401(k).  (Have less seniority? Ask your older co-workers.)  From an employee perspective, this might appear to come out of nowhere, but these changes would invariably have been preceded by extensive modeling and calculations by a plan’s actuaries, to calculate the impact on pension accounting and funding requirements and the impact on participants’ projected retirement income.  Yes, even if employees might not like the outcome and even if the results of the calculation were to determine that the new formula’s retirement income, while smaller, was tolerable enough, it remains the case that the actuaries did the math.

But these calculations did not occur in advance of Illinois’ implementation of its two prior reform attempts, the Tier 2 and Tier 3 plan changes to the benefit provisions for new hires.  Each of these was rushed through the state legislature without any consideration of its impacts, and offered short-term gains but at the risk of posing a “pension time bomb” that may turn out to have been no real solution at all.

The Tier 3 changes date to 2017.  The intent was to create a hybrid defined benefit/defined contribution system for new employees, but as Ted Dabrowski at Wirepoints reported in October 2018,

Tier 3 was shoved into the state’s omnibus budget bill back in July of 2017. It was one of the token gifts given to Republicans in exchange for their help in overriding Gov. Bruce Rauner’s veto of the 2018 budget.

Now, nearly a year and a half later, the Tier 3 hybrid plan hasn’t been implemented. And there’s little sign of any action on it. The law that originally created the plan needed lots of fixes for it to work, according to the state’s retirement systems. But the bill that makes those fixes has been stuck for months in the House Rules Committee. That’s where bills go to die.

The Tier 2 system dates further back; it covers all employees hired after 2010.  The precise details of the Tier 2 benefit program differ for each of the 5 state retirement systems (for teachers, state employees, university employees, judges, and legislators), and variations exist for the retirement programs for City of Chicago employees, and other public employees in Illinois, but there were three key changes in the Tier 2 benefits:

  • Retirement age and minimum vesting service were increased;
  • The Cost-of-Living adjustment was reduced from a fixed 3% per year to half the rate of inflation, and is additive rather than compounded (that is, if CPI is 3% for four years, your original benefit is increased by 4 times 1.5% rather than 1.03 x 1.03 x 1.03 x 1.03); and
  • Pensionable pay is capped at a level that sits at $113,645 in 2018, but increase at a rate of half the rate of inflation.  (The legislators, not surprisingly, chose to apply neither this provision nor the COLA reduction to themselves or the judges.)

For the teachers, the impact of these provisions is harshest, especially bearing in mind that Illinois teachers (unlike those of 35 other states) do not participate in Social Security.  Illinois teachers do not vest in their benefits until reaching 10 years of service.  Their normal retirement benefit is not available until age 67; while they are eligible to retire at age 62, their benefit is reduced by 6% per year prior to age 67.  They contribute 9% of pay towards their benefits (though, roughly half the time, their local school district pays the cost as part of their contract), but (unlike the statutory requirements for private-sector plans which require employee contributions) they do not earn interest on their contributions, which comes into play for teachers who leave the state or leave teaching without a full career, and do not vest or have only a small vested benefit.

What’s more, the $113,645 pensionable pay cap may seem generous, but the effect of the below-inflation growth over time are damaging; the 2018 actuarial report uses a CPI assumption of 2.5% and an assumed wage growth of 4% (that is, with seniority- based and other increases stacked on top of this baseline).   What’s this mean?

  • In 2018, the cap stood at $113,645, the average teacher’s wage was $71,845 and the average wage for teachers at retirement age (65 and up) was $89, 994.
  • In 2027, the cap is projected to grow to $127,088, reaching a level below the average wage for teachers at retirement, which is projected to grow to $128,090.
  • In 2035, the cap is projected to grow to $140,367, reaching a level essentially equal to the average wage for all teachers, at $139,946.
  • And by 2050, the cap will have grown so slowly relative to teachers’ pay that it will only cover 67% of the average teacher’s salary, and 53% of the average for near-retirees.

All of these items, taken together, mean that the Tier 2 teachers, with their 9% contributions, and using the plan’s valuation assumptions, are actually subsidizing everyone else.  The actuaries calculate what’s called an “employer normal cost” — the present value of the coming year’s benefit accruals as a percent of pay, after subtracting out the employee contribution.  (You can find this on page 83 of the report.)  If you participate in a 401(k) plan with an employer contribution, you can compare these values.

In 2020, the employer normal cost for Tier 2 teachers was -1.75%.  Yes, that’s a negative sign.

Now, that number is a bit unfair, because Tier 2 teachers are younger, on average, than the group as a whole, and as they get older, due to the magic of Time-Value of Money, the value of their annual benefit accruals will increase.  In 2046, the final year of the actuary’s projection, this value improves to -1.04%.  What’s more, this calculation is based on a valuation interest rate of 7%.  If a more conservative bond rate were used (for example, 4%), the total normal cost, and the employer’s share, would both increase — a back-of-the-envelope calculation suggests that the total normal cost would increase by 50%, from 8% to 12%; subtract out the 9% employee contribution and you’ve got an employer normal cost of 3%.  Yes, this is better than nothing.  But, for a plan that’s supposed to be replacing Social Security and providing additional benefits besides, this is not sustainable.

So what’s this mean?

One the one hand, it’s a win for the state’s coffers.  The contribution schedule that is targeted at reaching a 90% funding level in the year 2045 relies in part on the plans’ liabilities growing more slowly than they otherwise would, due to the coming retirements of Tier I participants and the increasing growth in the Tier 2 workforce.  This leads to a bizarre situation in which the state of Illinois contributions, in the short term, do not even exceed the amount needed to hold the plans’ unfunded liabilities steady, yet the funded ratio increases steadily.  Taking all five plans together (page 111 of the consolidated report issued in April), unfunded liabilities that are forecast to reach $136,842 at the end of 2019, continue to climb to a peak of $145,860 in 2026 before finally beginning to decline year by year.  (Other factors are also at play, such as a contribution schedule that’s still phasing in to 50% of payroll, on average across plans.)

But here’s why this situation is called a “time bomb”:  in order for a public pension plan to opt out of Social Security, minimum benefit requirements must be met.  Here’s a News-Gazette report from this past March:

The concern, however, is that Illinois teachers do not participate in Social Security. Federal law allows state and municipal governments to do that, as long as the benefits they pay out are at least equal to what Social Security pays, a law known as the “safe harbor” provision.

But Andrew Bodewes, TRS’ legislative director, told the panel that because of the small cost-of-living increases built into Tier 2, those pensions soon are likely to fail to meet the federal adequacy test.

 “So that means once the Tier 2 teachers are retiring, each and every school district will have to perform a test on that member to see if they get a benefit at least as good as Social Security,” he said. “And if they don’t, they (the school districts) will have to enroll in Social Security. They’ll have to enroll going backwards.”

That means school districts would have to make as much as 10 years’ worth of back payments into Social Security.

That article expressed hopes for reform legislation this year — which, of course, did not happen in the May legislative frenzy, and continues to be deferred.  And, again, improving benefits for Tier 2 employees with no means of modifying the Tier 1 benefits will simply further increase costs.

So it’s a cautionary tale — reform is great.  But for Pete’s sake, do the math first!

 

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.

Jane the Actuary Retirement

Forbes post, “Hidden In the Legislate-A-Thon, Illinois Restores Pension Spiking”

Originally published at Forbes.com on June 4, 2019.

 

Illinois readers will already be aware of the flurry of activity due to a May 31 deadline for the regular legislative session in Illinois: legalizing pot, passing a budget, and funding a massive infrastructure construction plan with tax boosts and a near-doubling of gambling positions in the state, along with some 300 other bills that sailed under the radar in the last days of the session.  And — sadly, but not surprisingly — the details of these bills were largely hammered out in backroom deals, without any transparency.  It’s a discouraging story, and readers elsewhere can choose whether to take this as a cautionary tale or revel in schadenfreude.

Hidden in the details of the newly-approved budget is something that had been on the teachers’ unions wishlist ever since, well, pretty much exactly a year ago, when, in the prior legislative session, the 2019 budget contained a cost-saving measure prohibiting pension spiking.  Specifically, to cite, yes, my own article at the time:

Illinois has long had issues with pension spiking — with local school boards raising pay for their teachers in the years just prior to their retirement to significantly boost their pension benefits at comparatively little cost to the local school board.  This was partially reined in with a reform law in 2005, but not completely:  back in 2015, the Chicago Tribune reported that the penalties local school districts were supposed to be paying whenever they continued to engage in the practice, were regularly being waived, and in 2017, the Northwest Herald reported that districts were taking maximum advantage of the remaining degree of spiking permitted.

The 2005 reform bill did not prohibit excessive pay increases but required that local school districts pay for the increase in pension liability due to pay hikes greater than 6% per year in the pre-retirement averaging period, and the 2018 budget increased the local school district’s cost responsibility to include the pension liability effect of pay hikes of more than 3%.  This was projected to save $22 million per year.

The Illinois Education Association (that is, the state teachers’ union) had a campaign, “Repeal the 3%,” and there was separate State House and State Senate legislation pending to remove this provision and restore the ability to spike pay up to 6%.  And their complaints were not unreasonable, that the move from 6% to 3% meant that not only were spiking-related pay hikes being prevented, but that routine increases for cost-of-living plus any additional duties undertaken or new certifications obtained, would be impacted, and that school districts would refuse increases rather than pay for the long-term impact on pensions.  And they got their wish in a provision tucked into the budget, with a restoration of the ability to pension-spike up to a level of 6%.

Now, you’d think there’d be a reasonable middle-ground here, allowing for districts to increase pay, but simply excluding those excess pay increases from being included in the pension calculation.  But such is the straightjacket that Illinois is in, due to its constitutional prohibition of any changes to future pension accruals of existing employees, that this simply isn’t possible.  The plan provisions specify a fixed definition of pay, and that definition must be retained.

And, yes, even though the legislature placed onto the 2020 ballot an amendment permitting a graduated income tax, in order to hike taxes on (what’s currently promised to be only) the upper middle class and wealthy taxpayers, pleas to put a reform amendment up for a vote alongside the graduated income tax amendment are continually falling on deaf ears.

Now, in the grand scheme of things, a $22 million annual savings is a drop in the bucket compared to the $134 billion in unfunded pension liabilities (measured at a generous expected-investment-return basis rather than bond rates) owed by the state of Illinois, and the failure of this attempted reform, both in terms of the degree to which it was well thought-out in the first place, and the speed with which it was repealed, simply points to the intractability of Illinois’ pension problem as long as all state and local pensions (yes, Chicago’s too!) are locked into a guarantee of future accruals, and guarantees of future COLAs, with no room for sensible changes.

And, of course, Illinois isn’t the worst in the nation:  Kentucky and New Jersey have worse funded ratios and New Jersey has a higher per-resident debt, according to Bloomberg’s 2018 calculations.  Connecticut is nearly as troubled as well, and, heck, there are plenty of other poorly funded state plans (not to mention the local plans!), but Illinois stands alone among these in being so constrained in its ability to remedy the situation due to its constitution.

 

 

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.