Illinois Pensions and Intergenerational Theft

How union bosses and politicians protected themselves at the expense of our children and grandchildren.

When it comes to pensions, it is easy to manipulate public expectations, and therefore public beliefs, because the whole process is so complicated and esoteric almost no one on the outside understands it. A few very knowledgeable insiders can make an improbable financial future look like a sure thing, unthreatening and moderate when in fact it is disaster waiting to happen, the Titanic with the lifeboats reserved for the politically connected and their minions. The only casualties are the taxpayers, three generations of them in Illinois’ case.

It is an example of a new breed of corruption – legal corruption. Why do you think most politicians are lawyers? So they can pass laws mealy-mouthed enough to escape any courtroom punishment yet flexible enough to be manipulated for political purpose.

How to keep pension contributions low and everybody happy – for a while.

If you are a union boss it is a plus if you can tell your members “We have a great pension plan and it won’t cost you much.” Ditto if you are a politician except you keep two groups happy – unions contributors and taxpaying voters.

How is this low-cost legerdemain accomplished – justifying $130,000 pensions at 56 for public employees as reasonable while having to admit $21,000 pensions at 62 for Social Security paying private sector employees is on an unsustainable course?

Well, it’s simple second grade math really. There are only three sources of income that can be used for paying pensions:

  1. Employee contributions
  2. Employer contributions (that’s us – the taxpayer)
  3. Income on invested assets – ROI (Return On Investment)

So total Pension Income = 1 + 2 + 3.

If you want to make 1 and 2 very low you simply need to make 3 high. Problem solved. And that’s what they did by assuming that assets would return 8.5% per year forever. Compare this to Social Security’s assumption of 4.5%.

Unfortunately for us 8.5% ROI has not come to pass. In the last 10 years the ROI has been about 2%. Since the employee’s contribution (#1) is fixed (about 8.4% of salary on average) the shortage in investment return (#3) has to be picked up by increasing the employer’s (#2 – taxpayer’s) contribution. And that is what happened since currently our portion is about 30% of salary. As a comparison the employer’s portion of Social Security is 6.2%.

In 1995 we were told the employer contribution (the taxpayer portion) would be about 8%; that promise has ballooned to about 30% now, payable by future generations.

And that is a Best Case Scenario, one that assumes pension assets ROI will make up for the recent $25 billion in losses and earn 8.5% on top of that. A very unlikely outcome in my opinion.

Using the Best Case Scenario the current $78 billion deficit is the lowest it will be until 2044.

Using the Best Case Scenario, we will pay $230 billion in pension taxes from now until 2034 when we will pass on to our children a pension deficit almost twice what it is now – $142 billion.

Using Best Case Scenario, we owe $4 billion in pension taxes this year our children will owe $15 billion in 2034.

And in the likely event the Best Case Scenario does not occur? Our children inherit a politically induced bankrupt state unable to provide even the most basic state services.

This, ladies and gentlemen, is Intergenerational Theft Example 1.

Actuarial methods can rob our children too.

There are two basic actuarial methods that can be used to charge pension costs to the taxpayers.

The first is called level. In this case if you hired a new employee in 2011 for $50,000/yr you would contribute about $1,000 the first year and each year thereafter for 35 years until he retires. In the second method you would charge less early in his career and more in later years. Using the same example as above you would pay about $200 the first year and about 100 times that amount or $20,000 in the 35th year.

Guess which method Illinois uses? Right, the second method whereby you look good by having low pension costs the first 10 years with accelerating costs thereafter culminating in a mind-boggling 100 times cost in year 35. The problem is that 35th year is going to be paid by our children and grandchildren and maybe great-grand children.

Of course if you are a politician or a union leader, who cares? You are either dead or retired by then.

However you are, in effect, stealing $20,000 from future generations 35 years after you initiated the plan.

This, ladies and gentlemen, is Intergenerational Theft Example 2.

Pension Obligation Bonds and Interest Only sub-prime loans have something in common.

One of Rod Blagojevich’s greatest sales jobs (and there were many) was in 2003 when he convinced the state legislature to saddle the Illinois taxpayers with a $10 billion financial millstone called Pension Obligation Bonds. Of course we didn’t get the whole $10 billion, about $900,000 or so went to various and sundry Blago hangers on, contributors, sycophants and boot-lickers including the well know Kjellander, Kelly, Rezko and Levine. But I digress.

The nature of the bonds was like sub-prime lending because they were sold as less than interest only in the first four years and less than interest only plus .5% of principal in the next four years.

The end result is 76% of the principal of the 2003 Pension Obligation Bonds are due in the last 10 years of the 30-year bond from 2024 to 2033. Just when your kids will be paying taxes.

This, ladies and gentlemen, is Intergenerational Theft Example 3.

Three strikes and our children’s future is out.

Notice how all three items end up costing a lot more during the period 2025 – 2040. This means if you have teenagers now they and their children will be picking up these huge tabs left to them by the politicians of the last decade or so.

More pension obligations, more pension costs and more bond payments, all funds going into the insatiable maw of the Illinois public pension system.

This, ladies and gentlemen, is Intergeneration Theft of the first magnitude.

What the next governor should do.

The next governor needs to use the bully pulpit to educate the public on the nature of this Intergenerational Theft in order to drive fundamental and thorough pension reform through the legislative system.

The need for reform and the support for reform are there; it only requires courage and political leadership to move it forward.

So who will lead?

Bill Zettler is a free-lance writer and consultant specializing in public sector compensation. He can be contacted at this email address.