Despite reforms, professor says Illinois pensions are still in crisis

Tuesday, April 27, 2010

When the Illinois Legislature agreed to reduce pensions for future state employees, Gov. Pat Quinn called it “a political earthquake.” Wall Street Journal editorialists called it “a minor miracle.” Josh Rauh, an associate of finance at Northwestern University’s Kellogg School of Finance, isn’t so easily impressed.
Writing on Kellogg’s Everything Finance blog, Rauh says that the changes are too little, too late:
Newly hired workers are generally decades away from retiring with a large pension. By the time this bill is likely to make any real difference in actual benefit cash flows, I predict an Illinois pension crisis will have forced more drastic measures.
Rauh argues that the state’s pension funds undervalue their liabilities, because they discount them at too high an interest rate. The state uses 8.5 percent; he argues that it should use current Treasury rates, which are in the neighborhood of 4.5 percent. Making that change for the three largest pension funds would increase their funding gap to $166 billion, or $34,000 per Illinois household. Adding in underfunded municipal plans brings the unfunded liability to $200 billion, or $40,000 per household.
To solve the mess, Rauh argues, Illinois will have to force current workers to share the pain. Here’s are his suggestions:
If the Illinois defined benefit systems are to be maintained, then benefit factors need to be reduced for all future service performed, including future service performed by existing workers. It is also time for Illinois and other states to consider freezing plan benefits entirely at their current levels. To compensate workers for these measures, the state could establish defined contribution plans for future service and bring more Illinois state workers into the Social Security system.