State of the State Pensions Part 1: What is the magnitude of the problem?

State of the State Pensions: What the Next Governor Needs to Say to the People of Illinois. A four part series.

Over the last several months we have presented Champion News readers with a variety of options of how to deal with the looming pension debacle. We have explained how we got here and what has to be done to restore financial viability to Illinois. Hopefully, if nothing else, we have convinced many people of the magnitude and immediacy of the problem.

This is not an intellectual exercise that can be discussed endlessly in the media and political establishment. It is the most serious issue extant in determining whether Illinois’ financial recovery will be viable or end in de facto or de jure bankruptcy. The immediacy of the problem will not be denied by political procrastination that has historically been the answer to this problem – kick the can down the road. The road is at a dead end and the can is squashed flat.

It is time to act.

State of the State pensions: Overview of the 4 part series.

Part 1: What is the magnitude of the problem?

In Part 1we we discuss the huge numbers surrounding the state pensions systems and explain why they are going even higher and why they punish future generations.

Part 2: What are the sources of the problem?

In Part 2 we delve into the 5 main reasons the pension system is in trouble including: salaries too high, pensions too high, ROI assumptions too high and retirement age too low.

Part 3: Is the system fair to taxpayers?

In Part 3 we cover issues of fairness Vis a Vis state employees benefits vs. taxpayers benefits. What are the legitimate questions regarding the 95% of Illinois workers who are not in the pension system having to pay for superior benefits for their peers in the public sector? How would a “Fairness in Compensation Act” rebalance this compensation difference? What is a fair interpretation of the supposed Constitutional guarantee?

Part 4: What is the solution?

In Part 4 we put forward a 10-point plan to eliminate the deficit in a fair and just manner and restore Illinois financial viability going forward. As a final point we emphasize the urgency of the project.

State of the State Pensions Part 1: What is the magnitude of the problem?

>We think it is imperative that the taxpayers of Illinois really know the facts concerning the state of the state pensions.

The first issue of course is the magnitude of the problem. How big is it and where is it headed from here based upon the current rules and assumptions?

We all are familiar with the unfunded pension liability of $78 billion. However our analysis shows many deeper problems going forward. Under the “best case” scenario outlined by the Commission on Government Forecasting and Accountability report prepared in September 2009 for the Governor’s Pension Reform Committee, that $78 billion unfunded liability will increase every year until it reaches $142 billion by 2034. Also in 2034 taxpayer’s annual contribution to pensions will equal an impossible 33% of employee payroll. And remember this is “best case”.

That $142 billion unfunded liability in 2034 assumes an 8.5% interest rate of return on investments plus what we consider to be an unconscionable taxpayer contribution of about $230 billion over the same period. So taxpayers pump an unfathomable $230 billion into the pension system and if we are lucky enough to get what most financial analysts think is an impossible 8.5% return on investment we will still owe 85% more than we do today! The employees, on the other hand, will pay only $60 billion into the fund about 25% of what taxpayers pay in. This is a recipe for financial disaster that will leave our children and grandchildren with a debt they will be unable to pay.

In addition the Government Accounting Standards Board (GASB) has initiated a study into the interest rate assumptions used by government pension funds. The initial report released in June states that rates being used by pension funds are too high and need to be reduced to more reasonable levels consistent with the risk ratios of the investment portfolio and the level of unfunded liability. These new rules, instituting new interest rate assumptions, will be official by summer of 2012 and are required by law to be used by all Illinois pensions. Outside experts estimate the new rules will lower interest rates from 8.5% to the 6-7% range. In Illinois’ case a reduction to even 7% would mean an overnight increase in unfunded pension liability to over $100 billion. If we cannot pay the tab under “best case” scenario then we have no chance under the new rules to be in effect in 2012. Keep in mind the GASB changes, increasing taxpayer liability, are not a matter of if but when.

Furthermore our analysis shows that for the 10 year period 2000-2009 taxpayers have contributed more than twice as much into the TRS and SURS pension systems as the employees have and even at that rate the funding has gone backwards instead of forwards. We think twice as much is more than a fair share.

As for the so-called “shortage” of payments by the state, actuaries say the NPO (Net Pension Obligation) for the pension funds is about $20.5 billion or 26% of the total unfunded liability. NPO is defined as the cumulative difference between the annual employer’s pension cost and the amount actually paid into the plan. This also means that 74% of the unfunded liability has nothing whatsoever to do with short payments in the past.

In the following three parts we emphasize TRS (Teachers Retirement System) and SURS (State University retirement System) because they represent about 75% of the covered employees, 80% of the unfunded liability, 94% of the Top 100 pensions and 84% of all pensions in excess of $100,000. This is not to imply there are no problems with SERS (State Employees Retirement System), GARS (General Assembly Retirement System) or JRS (Judges Retirement System). It simply means if we deal with the biggest problems, the rest will follow in due course.

Up next: Part 2.

Bill Zettler is a free-lance writer and consultant specializing in public sector compensation. He can be contacted at this email address. Click here to read more by Mr. Zettler.