Pension changes face series of hurdles

Thursday, June 17, 2010

Two sides of Illinois’ pension systems need to be fixed to bring the state out of its retirement funding quagmire: the benefits, which some say are overly generous, and the funding, which is $78 billion in the red.
The first half got a boost last month when Gov. Pat Quinn signed changes applying to most — but not all — of the pension systems in Illinois. But the second, and more urgent, half of reform remains untouched.
Standing in the way of reducing the pension deficit is, in no particular order: a legislature unwilling to cut spending or raise taxes, the Illinois Constitution, angry taxpayers and hundreds of thousands of equally angry state employees and retirees. And the laws of mathematics.
Illinois’ first successful stab at comprehensive pension reform in more than a decade came earlier this year, when Public Act 96-0889 was whisked through the legislature in a day and signed into law April 14.
The law creates a second pension tier for public workers hired after Jan. 1, 2011. The second tier increases the retirement age from 60 to 67, caps the final salary used to calculate pension payments and trims the annual pension increase to be more in line with inflation. The changes are projected to save $200 billion over 35 years.
The law didn’t increase members’ contribution rates, which range from 7.5 percent to 11.5 percent of a worker’s salary, or change the credits for each year of service.
Quick passage, mixed support
The pension bill sailed through the legislature, but support wasn’t universal.
Both the American Federation of State, County and Municipal Employees and the Illinois Education Association opposed the reforms, saying public-sector workers shouldn’t be punished for decades of reckless pension management by the state.
By the 1950s, just a decade after most Illinois pension systems were created, legislators already were underfunding the plans. Efforts to step up funding were largely thwarted through 1995, when a 50-year funding plan was passed. But that, too, was weakened when the legislature agreed to let the payments be skipped in times of economic distress.
The average state retiree earns about $20,000 from his or her pension, according to AFSCME Council 31; reducing that benefit won’t help the state out of its funding hole.
Advocates of the reform bill said it’s past time for public-sector pensions to get more in line with their private-sector counterparts, where pensions have been largely ditched in favor of defined-contribution plans like 401(k)s. Less than a third of employees of medium- and large-sized private firms receive pensions, compared to nearly 90 percent of workers in the government sector.
Some legislators support moving to a defined-contribution system. But there’s been little motivation to make the switch because it would not erase the state’s past-due pension obligations.
Work left undone
Along with leaving alone their own pensions and those of the state’s judges, legislators left a large and vocal group of state employees out of the reform bill — local police and firefighters.
“Those are some of the worst-funded and precariously funded pensions in Illinois,” said Laurence Msall, president of The Civic Federation, a nonpartisan government research organization. “If anyone’s going to run out of money in their pension funds, those are going to be the ones that run out of money first.”
Whether more reforms to the pension systems are forthcoming is unclear. A measure to create a second tier to police and fire benefits was introduced in the Illinois House, but didn’t make it out of the Senate before the legislature adjourned last month.
A coalition of public-safety unions and the Illinois Municipal League were at loggerheads over the measure because of a clause that would force municipalities to maintain at least a 50 percent funding level for their police and fire pension funds. If they were to fall below that threshold, the local pension fund trustees would have the authority to redirect tax revenues to the pension funds.
Fix the funding
No changes in future employees’ pensions will erase the $78 billion needed to bring Illinois’ five pension systems into full funding.
The money, which should have been paid into the system over the last 60 years but was wantonly ignored by generations of legislators, can be found in only one of two equally painful ways: raise taxes or cut services.
If the state does neither, Msall said, the question of cutting benefits will be theoretical. One day, perhaps within this decade, the state will run out of money to pay retirees.
“If a judge were to find the state insolvent and that it was no longer able to pay its bills, it wouldn’t really matter about vested or nonvested pension rights. All the pension promises would be in the same unsecured position as any other creditor,” he said. “The state could be forced into a position where it would have to decide between existing critical services, like prisons or courts, versus making additional contributions, or any contributions, to the pension fund. It would be up to a judge to decide who gets priority.”
Federal law doesn’t include a provision allowing states to declare bankruptcy. If the state doesn’t have the money to pay its pensioners, or chooses not to do so, a lawsuit would be the inevitable result.
The constitutional issue
A small, but growing, group of government watchdogs is calling for cuts in pensions for state employees who already are on the payrolls or retired. But a short piece of text called Article 13, Section 5 of the Illinois Constitution is standing in their way.
It’s brief: “Membership in any pension or retirement system of the state, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”
The provision was written into the state Constitution in 1970 because of concerns regarding pension funding.
“One of the reasons for the constitutional protection was that the state was not funding its retirement benefits, and had not been funding them for some time,” said Louis Kosiba, executive director of the Illinois Municipal Retirement Fund.
Although many legal experts say the clause prevents the state from reducing retirement benefits from what current employees now earn, several law firms have written position papers stating that the state or municipalities could, in fact, change pension benefits midway through an employee’s tenure in public service.
State Rep. Dave Winters, R-Shirland, said the legislature should pass a bill modifying benefits for current employees to force the issue to a court battle.
“That’s the way it would have to happen,” he said. “But we need to ratchet benefits back to make them a bit more reasonable and a little more comparable to what you find in the current job market.”
National problem, no national solution
Illinois is far from alone in its funding straits. A February report from the Pew Center on the States said that in 2008, only four states — Florida, New York, Washington and Wisconsin — had fully funded pension systems. In 2000, slightly more than half the states could make the same claim.
The report ranked Illinois dead last in state pension funding. Illinois also was one of eight states “having failed to make any meaningful progress toward adequately funding their pension obligations,” according to the report.
Although a number of states are being pushed toward pension reform by their finances, a one-size-fits-all strategy for fixing unfunded pension liabilities is unlikely, said Lee Craig, an economics professor at North Carolina State University and author of several pension textbooks.
“In general, I don’t see the financial solution coming from cutting the benefits from people already in the pipeline,” he said. “The real solution over the next 10 years would be just robust economic growth and the return of growth to the stock market. If you’ve got those, then your tax base is expanding and your assets are growing.”