Guest Essay: Pension reform needed to help solve the state's messy financial situation

Thursday, August 05, 2010

The Evanston Review reported July 28 that the director of the union-backed Illinois Retirement Security Initiative (IRSI) recently told an Evanston audience that reforming the state's pension system would "... jeopardize the state's ability to hire the best people for public sector positions." ("Speaker: Pension bloat overblown")

Your readers should make up their minds based on the facts.

Illinois' fiscal affairs are imploding. Its annual revenues are approximately $27 billion. Its real, embedded annual deficit -- the difference between revenues and costs -- is $14 billion to $15 billion.

The effects of the deficit are rippling into the budgets of cities, school districts, universities and social-service agencies throughout the state.

Why is the deficit so large?

Illinois incurs huge retirement costs each year for members of state pension funds.

If you work for the state of Illinois, with enough years of service you can retire at age 55 with a full pension of about 50 percent of your final average salary. You then receive a pension each year for the rest of your life. After 12 years (ages 55 to 67), the pension grows (3 percent per year) to about 71 percent of final salary.

You also receive Social Security, so that by age 67 you could be earning more each year than your salary the last years that you worked. (In Chicago, the retirement age is 50).

Also, when you retire at 55 you receive Cadillac-style retiree health care (no managed care) -- any doctor, any procedure, any place, any time -- and the state pays, in effect, 100 percent of the premium cost.

As a result, the annual cost of the pensions and the retiree health care to the state or its pension funds now exceeds $10 billion per year.

The unfunded liability for the pensions -- using the state's numbers -- is roughly $80 billion. Professor Joshua Rauh of Northwestern University's J. L. Kellogg Graduate School of Management says the state funds use the wrong discount rate, and that a more accurate estimate of the unfunded liability exceeds $200 billion.

The unfunded retiree-health liability adds another $40 billion.

So -- the system isn't fair, and Illinois can't afford it.

Illinois must reform the system, not just as to "new" employees -- who haven't even started to work for the state yet -- but also for current employees. That's where the savings are.

This can (and must) be done without reducing any benefits that the employees have already earned.

But the state can -- and should -- prospectively require that people have to work longer to receive future benefits.

The fittest answer

The best solution would be to freeze the current benefits and move -- prospectively -- to a defined contribution system. Alternatives are hybrids or cash-balance plans -- or even pared-back defined-benefit programs where employees make larger contributions to cover the cost of the plans.

The IRSI says the state won't be able to attract and retain people if we reform the pensions. Let's find out. The private sector long ago shifted from defined pension plans to defined contribution plans.

Virtually nobody in the private sector has a defined-benefit plan like that of the state -- one that lets you retire with a full pension at 55.

The state pension funds are now only about 41 percent funded. Some of the funds may run out of money in 10 years or so, depending on the performance of the assets. If the fund for state employees runs out of money, the retirees may well be stuck.

Neither the state Constitution nor any statute makes the state the guarantor of the pension obligations.
It will be an awful mess, and it's a mess that can be avoided if we act in time. What is needed is reform and adequate funding.

Reform is a key component -- otherwise the cost will be too great. The increased state taxes needed to pay for continuing the present, unreformed retirement programs would be far beyond what any state political figure is willing to admit.

The longer we postpone the needed reforms, the greater risk that these pensions will bring down the entire state's financial house of cards.

R. Eden Martin lives in Glencoe and is president of the Civic Committee of the Commercial Club of Chicago, a member of the nonpartisan Illinois is Broke campaign (www.IllinoisIsBroke.com).