Quinn: Pension Reform Will Save $400 Million in 2011.
Zettler: Pension Deficit Will Increase More than $50 Billion by 2014.
Governor Pat Quinn signed the pension reform bill and immediately claimed the new law would save $400 million from the 2011 budget. Why are politicians ignoring the $10’s of billions in new taxpayer costs going down the pension toilet while claiming a measly $400 million savings? That’s the kind of accounting that caused this problem to begin with.
The new pension system will save substantial sums over the coming decades but not nearly as much as claimed. Early on it will have little impact because no employees will be in it until Jan 1, 2011 and even then there will be very few. Keep in mind that many, many employees have been laid off in the last 12 months and new hiring (thankfully) will be limited for the next several years especially if Bill Brady is elected governor.
In addition a large percentage of future new hires will be “re-hires” of former employees who were laid off not new hires that would be enrolled in the new pension system. Those former employees are grandfathered into the old system and therefore will not save the system any money initially.
However, when it comes to the old system there are potentially big problems looming over the next five years. If I am right and the pension deficit (unfunded liability) doubles by the end of the next governor’s first term in 2014 then the $400 million savings claim is just another example of Illinois corruption. It seems honesty is not the best policy when it comes to Illinois politics.
So let’s start with the official unfunded pension liability (pension deficit) of $62 billion and see how easily it doubles by 2014.
STEP ONE: $62 billion becomes $78 billion by using real numbers rather than fudged ones.
Officially the pension deficit (unfunded liability) as of July 1, 2009 is $62 billion but that number is only possible by fudging the numbers in a process called “smoothing.” This allows any loss in investments to be spread out over 5 years rather than recognized for what it is: a loss for one year. In real life the five state pension funds lost $16 billion in asset value in 2009 leaving total assets available for investment at $48 billion. But the board of trustees of the pension funds required the actuaries to use smoothing, which results in a book asset value of $63.3 billion in 2009 vs. $64 billion in 2008 i.e. no loss shown.
By the way the actuaries objected to this method but were forced to use it by the pension trustees. Being a trustee is a cushy job; hanging on to them for another 5 years is worth the fudge.
The only people who benefit from the fudging” are the public employees, the trustees and staff of the pension funds, the politicians who created this mess and the outside investment advisors who managed to pull in $250 million in fees from the pension funds over the last 2 years while “advising” the funds on how to lose $25 billion. One can only imagine how many political donations will find their way back to politicians from those $250 million in fees.
STEP TWO: $ 78 billion becomes $105 billion under reasonable 6.5% investment return assumptions.
Actuaries say under the best scenario the pension deficit will be $95 billion in 2014. Even this number is most certainly too low because it assumes the funds will earn more than 8.5% per year on investments between 2009 and 2014. Considering the fact that interest rates are the lowest in history, virtually zero at their source, it is safe to assume rates will be much higher in 5 years than they are now. And higher interest rates means lower bond values and lower stock market values.
The reason the 8.5% rate is needed is because from a cash flow basis payouts to pensioners are greater than contributions therefore some of the investment return each year must be used for cash flow purposes and not retained for investment in subsequent years.
An example would be 2011 when pay-outs are expected to be $7.7 billion while pay-ins will be $6.1 billion ($1.6 from employees plus $4.5 from taxpayers) leaving $1.6 billion that must come from assets. This negative cash flow continues to infinity and thus underlines the importance of the assumed rate of return since part of that assumed return must always be used to pay the bills.
STEP THREE: $105 billion becomes $137 billion when GASB (Government Accounting Standards Board) changes hit in 2011-2012.
The Government Accounting Standards Board is the agency charged with establishing regulations for public sector accounting. Virtually all public entities, including Illinois pensions, are required to adhere to these standards (regulations). GASB is currently reviewing the way pension funds determine their liability for future pensions. This involves using a lower interest rate (or discount rate) to calculate a Pension Benefit Obligation based on that assumed rate. The Pension Benefit Obligation is the amount we the employers need to have in the bank to pay off all the pension obligations if we were to terminate the pension fund right now. For Illinois the Pension Benefit Obligation, using an 8.5% rate, is $126 billion in 2009 growing to $161 billion in 2014.
Simply put the lower the interest-rate the higher the Pension Benefit Obligation and thus the taxpayer liability. For example if you need $8.50 to retire on and you can get an 8.5% CD at the local bank then you need $100 in the bank. However if you can only get 7% on a CD then you need $121 in the bank to get the same $8.50 (7% times $121). If you can only get 4.5% (called the risk free rate) you need $188 in the bank to get $8.50 (4.5% times $188).
So when, not if, GASB requires a maximum 7% interest rate to be used for calculating pension liability the Pension Benefit Obligation for Illinois taxpayers will instantly grow by at least 20%, or $32 billion (20% of $161 billion) in 2014. That makes the total 2014 pension deficit $137 billion or more than double the $62 billion claimed today.
We need an adult to stand up and say: “We cannot pay this bill.”
As bad as these numbers look it is even worse when you include the public employee health care liability (called OPEB) which will be at least $30 billion under the new GASB rules. Remember state employees including university employees pay nothing for health care while they are working or when they retire. Premium costs per member have increased by 73% since 2003 all of which has been picked up by the taxpayer. We could save $2 billion a year and $30 billion long-term liability by dropping coverage and paying the employer fine to put them under ObamaCare.
The problem is simple: Public employees’ wages are too high, fringe benefits are too high, pensions are too high and contributions to pensions and health-care are too low. So the problem with the structural budget deficits is directly attributable to excessive public sector compensation. The next governor needs to lower the public sector head-count and the public sector compensation by whatever means possible. Otherwise the state will be bankrupt and political unrest will be of epic proportions. The 95% of Illinois workers who are not part of the state system do not want to, and have no obligation to, pay this tab for the 5% who are.
So the question is: are there any adults in the audience?
SOURCES:
Office of the Auditor General, “Supplemental Digest To Retirement Systems’ Audit”
Commission on Government Forecasting and Accountability – “Five State Systems Combined”
Teachers Retirement System Actuarial Report June 30, 2009
State University Retirement System Actuarial Report June 30, 2009
State Employees Retirement System Actuarial Report June 30, 2009
Bill Zettler is a free-lance writer and consultant specializing in public sector compensation. He can be contacted at this email address.