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A 'Simple Fix' To Solve Public Pension Funding Woes? Think Again.

Forbes Online

Friday, November 9, 2018  |  Commentary  |  Elizabeth Bauer Contributor

Governor (44) , Pensions (70)
Readers, I have previously lamented that the incoming governor in the state of Illinois, JB Pritzker, has no plan with respect to the state's woeful pension underfunding, which, as a reminder, totals $130 billion over the five pension plans for which the state has responsibility, not to mention the debt of the various municipalities, most notably the city of Chicago, for their own plans.  Note, too, that this $130 billion underfunding only includes Illinois' obligation for accruals for past service, but without a change to the state's constitution, we're on the hook for pension accruals for all future service for existing employees.  What's more, this underfunding is based on valuation interest rates of about 7% (it varies by plan from 6.75% to 7.25%), set based on the plan's management's determination of future investment returns; if the plan was required to use a bond rate to measure its liabilities like a private-sector plan, the liabilities would be significantly higher.

As it happens, though, he, and the Illinois Democrats in general, think they does have a plan.  Here's the plan as spelled out by the newly-elected State Senator for my own district, Ann Gillespie, as described on her website:

Ann endorses a simple fix to fund the pension liability by amortizing the liability over a fifty year period at a set rate. This is like refinancing your mortgage to achieve a lower rate. While slightly more costly at first, it would save the state millions of dollars in the long run.

It turns out that this is a poorly-explained version of the proposal of the Chicago-based Center for Tax and Budget Accountability:

Illinois' five state pension systems face a debt crisis after years of intentional borrowing from state contributions. The crisis is compounded by a backloaded repayment plan that calls for unrealistic, unsustainable state contributions in future years, putting funding for crucial public services at risk. Because the crisis is about debt, rather than benefits being earned by current and future employees, attempts to solve the problem through benefit cuts have failed. CTBA proposes resolving the pension debt crisis by reamortizing our payment schedule, creating a sustainable, level-dollar plan that saves the state $67 billion and gets the pension systems 70 percent funded by 2045. To bridge the higher contributions called for in the first several years of the reamortization plan, CTBA suggests using bonds to ensure current services do not have to be cut.

Where do I start?

To begin with, this is not a "simple fix."  The CTBA fairly criticizes the existing amortization plan, the so-called "Edgar Ramp," which indeed backloaded the pension contributions, and which, alongside the contribution holidays of subsequent governors, contributed significantly to the current underfunding.  But its proposal's "reamortization" is nothing more than a further plan to keep the plan underfunded for longer.  In fact, its plan is to achieve 70% rather than 90% funding by 2045, and it has no intention of achieving a higher funded ratio, except (near as I can tell) to the extent that asset growth is more favorable than projected.  The only other element of "cost savings" is to issue more pension obligation bonds, to the tune of $11.2 billion, money which is meant to provide additional funding into the pension funds beyond the current contribution schedule, for the early years of the plan.  This is, again, the dream of "easy money" because of the hope for gains from investment returns higher than the interest paid out to bondholders.

There is no money "being saved" in this proposal.  There is no "lower interest rate" as in a mortgage refinance.  Pension obligations consist of payments owed to current and future retirees next year, and the year after, and the year after that, and far into the future -- obligations which should have been advance-funded by paying into the relevant pension funds the amounts needed to fund those benefits, year-by-year, as those benefits were accrued.  Every year that the state failed to do this (and every time in which they increased benefits without funding them), is a year in which legislators placed obligations on future generations, no differently than if they'd issued bonds to pay salaries of teachers and state employees.  Choosing now to continue to defer a significant portion of this debt into further into the future is not "saving money" -- it's passing that debt onto your children and grandchildren.  And it goes without saying that leaving pensions partially or wholly unfunded passes past and current compensation costs onto those same children and grandchildren to an even greater degree -- see my original "actuary-splainer" on the subject.

And, contrary to the assertions of the CTBA, this crisis is about both debt and benefits.  Up until the "Tier II" reform of 2011, Illinois had long had a practice of increasing pension benefits for short-term budget gains or to reward employees in union contract talks, and the benefits accrued by "Tier I" employees, especially given their generous retirement-age and COLA provisions, are significantly richer than the combination of Social Security and a typical private-sector retirement plan provision.

So the only question that remains, as far as I'm concerned, is this:  do Gillespie and Pritzker and the rest of the lot not understand this, or are they simply hoping that Illinoisians won't question their explanations?

UPDATE:

Crain's this morning reported on an interview with Pritzker which confirmed that he is "looking seriously" at the CTBA proposal, in particular, the plan to issue Pension Obligation Bonds, and that CTBA chief Ralph Martire is a part of his "transition financial team."