Pen­sions Dog­ging Illi­nois

The Bond Buyer - - Front Page - BY YVETTE SHIELDS

CHICAGO – A warn­ing from Illi­nois’ largest pub­lic pen­sion fund of­fers a stark re­minder of the state’s most daunt­ing fis­cal threat – its $126.5 bil­lion un­funded pen­sion tab.

The Teach­ers Re­tire­ment Sys­tem said changes that re­duce the state’s con­tri­bu­tion in the cur­rent fis­cal year will only make things worse later.

Sig­nif­i­cant pen­sion changes that some be­lieve could pass state con­sti­tu­tional muster were pro­posed dur­ing the reg­u­lar ses­sion and en­joyed bi­par­ti­san sup­port but they took a back­seat as ef­forts built -- suc­cess­fully -- to break a two-year-old bud­get im­passe and stave off a cut to junk bond sta­tus.

“The 2018 bud­get may have stopped the bleed­ing, but Illi­nois faces sig­nif­i­cant struc­tural head­winds that are not go­ing away,” said Thomas Schuette, co-head of in­vest­ment re­search & strat­egy, at Gurtin Mu­nic­i­pal Bond Man­age­ment. “Pen­sions re­main the ele­phant in the room.”

The bud­get pack­age in­cluded sev­eral “re­form” mea­sures first pitched by Gov. Bruce Rauner with pro­jected bud­getary sav­ings of about $1.5 bil­lion.

They limit end-of-ca­reer pen­sion spik­ing, shift the cost of higher paid em­ploy­ers to lo­cal dis­tricts, and phase-in the im­pact of ac­tu­ar­ial changes.

The pack­age also cre­ates a Tier 3 de­fined ben­e­fit and de­fined con­tri­bu­tion pen­sion plan for some cur­rent em­ploy­ees.

The Teach­ers Re­tire­ment Sys­tem late last month re­vised the state’s fis­cal 2018 con­tri­bu­tion that had been cer­ti­fied last fall, low­er­ing it by $531 mil­lion to $4.034 bil­lion from $4.564 bil­lion to re­flect the changes in law.

That in­cludes the retroac­tive ap­pli­ca­tion of the law smooth­ing over five years the im­pact of ac­tu­ar­ial changes since 2012.

The fund has re­duced its as­sumed in­vest­ment re­turn rates sev­eral times. The smooth­ing mea­sure is ex­pected to gen­er­ate over­all state bud­get re­lief of $800 mil­lion.

“The changes en­acted this year in the pen­sion fund­ing for

mula move TRS fur­ther away from fi­nan­cial sta­bil­ity and con­tinue to kick the can down the road. Pe­riod,” the fund’s ex­ec­u­tive di­rec­tor Dick In­gram said in a state­ment. “Cut­ting the state’s con­tri­bu­tion only in­creases our con­cern that TRS will even­tu­ally be­come in­sol­vent.”

The fund ac­counts for $71 bil­lion of the state’s $126.5 bil­lion in un­funded pen­sion li­a­bil­i­ties, which TRS called one of the largest in the coun­try and said is a di­rect re­sult of decades of un­der­fund­ing by the state.

In fis­cal 2018, the state’s con­tri­bu­tion will fall $2.839 bil­lion short of what the sys­tem’s ac­tu­ar­ies say is a sound ac­tu­ar­ial fund­ing level.

“For ev­ery dol­lar that the state cuts from the TRS con­tri­bu­tion now, they will have to spend $3 down the road to re­place that rev­enue be­cause of the in­ter­est costs,” In­gram said. “A $530 mil­lion fund­ing cut to­day just puts off the in­evitable and will cre­ate a pay­ment of $1.6 bil­lion in the fu­ture.”

The newly set con­tri­bu­tion does not in­clude any po­ten­tial cost sav­ings from the cre­ation of new Tier III “hy­brid” re­tire­ment plan be­cause it’s still un­der de­vel­op­ment.

The TRS board, which over­sees the na­tion’s 37th largest pen­sion fund, last year low­ered its as­sumed rate of re­turn to 7% from 7.5%, de­spite po­lit­i­cal pres­sure to hold the rate steady be­cause of the bud­get im­pact. In 2012, TRS low­ered the rate to 8% from 8.5 % and then in 2014 low­ered it to 7.5%.

The TRS change was one of many around the coun­try in which pub­lic pen­sion sys­tems low­ered as­sumed rates as their ac­tual in­vest­ment re­turns lagged.

The pen­sion bur­den strains weigh heav­ily on Illi­nois’ rat­ings, which are low­est of any state.

It was one of sev­eral fac­tors that prompted Moody’s In­vestors Ser­vice to put the state on re­view for a down­grade in July even as law­mak­ers ze­roed in on a suc­cess­ful over­ride of Rauner’s bud­get ve­toes.

“So far, the plan ap­pears to lack con­crete mea­sures that will ma­te­ri­ally im­prove Illi­nois’ long-term ca­pac­ity to ad­dress its un­funded pen­sion li­a­bil­i­ties,” that re­port read. Moody’s later af­firmed the state’s Baa3 rat­ing and neg­a­tive out­look.

In af­firm­ing the state’s BBB rat­ing, Fitch Rat­ings said its neg­a­tive out­look re­flected the un­cer­tain­ties re­lated to suc­cess­ful im­ple­men­ta­tion of the bud­get, risks in re­duc­ing a $15 bil­lion bill back­log, and “achiev­ing near-term pen­sion con­tri­bu­tion sav­ings, partly at the ex­pense of wors­en­ing the state’s long-term li­a­bil­ity pic­ture.”

Stan­dard & Poor’s rates Illi­nois BBB-mi­nus with a sta­ble out­look.

Democrats and Repub­li­cans agree that ac­tion is needed to rein in both the grow­ing an­nual pen­sion con­tri­bu­tion costs and the un­funded li­a­bil­i­ties. There’s sup­port for the so-called “con­sid­er­a­tion” model first de­vel­oped by Senate Pres­i­dent John Culler­ton, D-Chicago.

“The bud­get is un­bal­anced by more than $1 bil­lion. The gov­er­nor re­mains com­mit­ted to seek­ing bi­par­ti­san so­lu­tions to help balance the bud­get and to pass re­forms to put Illi­nois on a path to sound fis­cal foot­ing,” Rauner spokesman Ja­son Schaum­burg said in a state­ment. “Those re­forms should in­clude pen­sion re­form. He has asked the Gen­eral Assem­bly to help achieve that this fall.”

House Mi­nor­ity Leader Jim Durkin, R-Western Springs, hopes the re­cent bi­par­ti­san com­pro­mise leg­is­la­tion that over­hauled school fund­ing for­mu­las can be par­layed into agree­ments on pen­sions and in­fra­struc­ture.

Some be­lieve a cap­i­tal pack­age could have an eas­ier time ahead of an elec­tion year as mem­bers can re­turn to their base with projects in hand.

“We need to be able to pick and choose” ar­eas where there “is bi­par­ti­san agree­ment” and there’s a need to “go back in and ad­dress our pen­sion prob­lems” as well as in­fra­struc­ture, Durkin said dur­ing an ap­pear­ance on WBBM’s ra­dio po­lit­i­cal pro­gram At Is­sue. “I know those are ar­eas that we can find bi­par­ti­san sup­port.”

De­spite the talk, deep ac­ri­mony re­mains be­tween the two sides over the bud­get im­passe.

The loom­ing 2018 elec­tion and a po­ten­tial fis­cal 2019 bud­get fight could get in the way.

“Without po­lit­i­cal sta­bil­ity, we be­lieve there is lit­tle oxy­gen for ma­jor pen­sion re­forms which will de­mand com­pro­mises,” Schuette said. “Both sides may wait things out to see if they have a bet­ter dance part­ner for pen­sion re­form after Novem­ber 2018.”

The state faces a tough road on re­forms. Law­mak­ers pre­vi­ously en­acted re­forms that cut ben­e­fits and raised em­ployee con­tri­bu­tions but the Illi­nois Supreme Court voided the changes in May 2015 as a vi­o­la­tion of state con­sti­tu­tional pro­vi­sions that pro­tect ben­e­fits from be­ing im­paired or di­min­ished.

Un­der Culler­ton’s con­sid­er­a­tion model, em­ploy­ees would be asked to forgo com­pounded cost of liv­ing in­creases and other COLA changes.

In ex­change, salary in­creases would con­tinue to count to­ward their pen­sion­able salary upon re­tire­ment. The changes could trim $1 bil­lion off what this year was sup­posed to be an $8.8 bil­lion con­tri­bu­tion to all the funds be­fore the fis­cal 2018 bud­get changes.

Sup­port­ers ar­gue the plan can pass a le­gal test be­cause they be­lieve fu­ture count­ing of salary in­creases to­ward the pen­sion cal­cu­la­tion is not pro­tected by law and em­ploy­ees.

Unions say that ar­gu­ment is flawed be­cause ei­ther choice rep­re­sents a re­duc­tion in ben­e­fits so there is a not choice of­fer­ing a new ben­e­fit and it’s a co­erced choice not a vol­un­tary one.

Left unchecked the un­funded li­a­bil­i­ties keep ris­ing. They rose to $126.5 bil­lion in fis­cal 2016 from $112.9 bil­lion a year ear­lier and the funded ra­tio de­te­ri­o­rated to 39.2% from 40.9%. They have bal­looned by $86 bil­lion since fis­cal 2001.

Un­der the fund­ing sched­ule es­tab­lished by law­mak­ers in 1995, the state is re­quired to make con­tri­bu­tions as a level per­cent of pay­roll in fis­cal years 2011 through 2045. The con­tri­bu­tions are re­quired to be suf­fi­cient, when added to em­ployee con­tri­bu­tions, in­vest­ment in­come, and other in­come, to bring the to­tal as­sets of the sys­tems to 90% of the ac­tu­ar­ial li­a­bil­i­ties by fis­cal year 2045.

The sched­ule has faced sting­ing crit­i­cism for its back­loaded struc­ture. The state set­tled fraud charges brought by the Se­cu­ri­ties and Ex­change Com­mis­sion for mis­lead­ing in­vestors over the health of the pen­sion funds be­cause of flawed sched­ule. Each sys­tem cer­ti­fies an an­nual pay­ment amount in mid-Novem­ber for in­clu­sion in the next state bud­get.

The Chicago Civic Fed­er­a­tion, which tracks Illi­nois fi­nances, has also sug­gested other mea­sures to help the ail­ing sys­tem. It has rec­om­mended sup­ple­men­tal pay­ments be made tap­ping rev­enue that will be­come avail­able after ex­ist­ing pen­sion bonds and pro­posed cash flow bor­row­ing is re­paid. The or­ga­ni­za­tion also has rec­om­mended a con­sti­tu­tional amend­ment lim­it­ing the pen­sion pro­tec­tion clause to ac­crued ben­e­fits. ◽

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