To: Illinois Governor Candidates
From: Bill Zettler
Pension gimmicks: just because it is legal does not mean it’s not corrupt.
On Tuesday Feb. 23, 2010 Illinois Auditor General William Holland released the much anticipated audit of the Illinois pension systems. As reported in the Daily Herald and other newspapers the pension deficit was reported as $62 billion when in reality it is $78 billion.
How is that possible? By using an actuarial legal but corrupt practice of “smoothing” $16 billion in losses incurred in 2009 over 5 years thereby making the 2009 look much better than it really is. In reality the pensions combined lost $16 billion in 2009 but are only reporting $3 billion of those losses. The other $13 billion will be reported as losses of $3 billion over each of the next 4 years putting each of those years in the hole before they even start.
Even the actuaries do not like it as can be seen in the following quote from TRS 2009 Actuarial Report:
“With the introduction of five-year smoothed asset value in 2009, Schedule XIIA thru XV can no longer serve as a realistic projection…”
In other words what the 2009 report shows for future taxpayer costs is certainly understated.
How bad will it be?
CALPERS (California Public Employee Retirement System) is considering adopting a ROI (Return On Investment) rate of 6% versus their traditional 7.75% rate. This is at the recommendation of several outside advisors including Lawrence Fink, Chairmen of BlackRock Inc. who told the CALPERS board “You’ll be lucky to get 6%”.
Since Illinois current rate is 8.5% if CALPERS is right the Illinois deficit will exceed $100 billion by the end of the governor’s first term.
Why is “You’ll be lucky to get 6%” important?
It’s simple: the lower the ROI the higher the taxes.
The rate of return determines how much more taxpayers will have to pay. So if state pension systems only earn 6% instead of their projected 8.5% the deficit goes from $77 billion to $100 billion. That extra $23 billion has to be paid in its entirety by the 95% of Illinois workers who are not in the state pension system.
On the other hand the 5% of Illinois workers (public employees) benefitting from the pensions pay nothing, nada, zero towards this $100 billion.
A 6% ROI means $1 trillion in taxpayer costs over the next 35 years.
The 95% of Illinois households who are not part of the state pension and health care system should plan on paying, on average, $5,000/yr in taxes every year for the next 35 years to pay for the pensions and health care of the 5% of Illinois workers who are part of the state system.
So that $5,000 you were thinking about putting into your own 401K or IRA will instead have to go to other peoples retirement not your own.
Punish the innocent (the taxpayer) and protect the guilty (everyone else involved).
So who benefits from this manipulation of the data?
- The pension members themselves. Pressure is mounting for radical changes and they are attempting to ride it out. The thought of Social Security and working until you are 65 is sending shivers up their spine.
- Politicians. This problem is soooooo big they are attempting to do what Illinois politicians always do when faced with a big problem – stall and mumble a lot so no one can understand what you are really saying. But it will not work this time it will only get worse and fast.
- Pension trustees. They have been bragging about their investment prowess for years and to have to admit they are lost and confused might mean huge changes in how pensions are run. The fact is the investment returns they have garnered in the past were directly due to the .com and the housing bubbles. There is no future bubble on the horizon to bail them out. However the funds history of corruption precedes them and there is nowhere to hide. Think Levine and Rezco.
- The politically connected vendors providing the asset management that led to this $16 billion loss ($25 billion over the last 2 years). That list of brokers, advisors, investment managers, etc. exceeds 200 just for TRS. It’s not as long as Mike Madigan’s donor list but it’s better than even money they are on the donor list. After all the TRS paid out $325 million for their sage investment advice over the last 2 years. Advice that lost $25 billion over the last two years.
If public employees salaries and pensions were like private employees there would be a pension surplus not a deficit.
According to state actuaries public employees (the 5%) average between 5.5% and 7% per year in salary increases over their career. According to Social Security Administration those of us on Social Security (the 95%) average 4%/yr.
Also state employees (the 5%) contribute an average of about 8.4% of their pay for pension and retiree health care to retire at age 55 while the rest of us (the 95%) contribute about 12.4% Social Security and 401K to retire at age 65.
If you redo the actuarial calculations from 1990 to 2009 and assume 4% salary increase (instead of 7%) and 12.4% contributions instead of 8.4%, and the assumed 8.5% ROI had actually been achieved then the Teachers Retirement System would show a surplus over that time period.
In other words the pension problem is political not financial. Salaries were too high, ROI assumption was too high and contributions were too low. All of those items are controlled by the political system of the state not by the taxpayers.
This bill cannot be paid.
Traditionally, Illinois politicians have tinkered around the edge of this problem. That won’t work anymore. We need to take a meat cleaver to the problem or the state will implode.
We cannot pay 56-year old music teachers $189,000 per year let alone the $130,000/yr pension associated with that salary.
The gravy train is not just over; it needs to be backed up. Otherwise bankruptcy for Illinois is just around the corner. And the pension systems will take the biggest haircut when that happens.
Bill Zettler is a free-lance writer and consultant specializing in public sector compensation. He can be contacted at this email address.