Pension reforms remain on Illinois’ legislative agenda.

CHICAGO – A fix for Illinois’ $112.9 billion unfunded pension tab, which requires an $8 billion contribution next year, remains high on the minds of lawmakers in the midst of a 10-month-old budget impasse.

“Our unfunded liability is killing us and it’s just going to continue to grow” without action, state Rep. William “Will” Davis, D-Hazel Crest, said during a forum Monday on Illinois’ budget.

The state’s pension burden has contributed heavily to Illinois’ credit deterioration and status as the lowest rated state, which in turn has driven up its borrowing costs.  “Pensions remain an acute pressure on the state's fiscal operations,” Fitch Ratings wrote in its downgrade of the state’s general obligation rating last fall.

About $7 billion of the $8 billion payment – which still falls short of an actuarially based level – relies on the state’s cash-starved general fund. The state anticipates about $31.9 billion of revenues next year at current tax rates and has a current budget hole of $5 billion to $6 billion to plug. That’s due to the current budget deadlock between Gov. Bruce Rauner, a Republican, and the General Assembly’s Democratic majority.

As a budget solution languishes so has a fix for the pension system, although lawmakers have voiced hope that action on some proposals could still get done in the current session.

Reform Ideas

The Illinois Supreme Court threw out the state’s last stab at pension reforms in May, finding benefit cuts violated the state constitution’s stringent pension clause. The court suggested a potential path for reform, and elaborated on the suggestions in its opinion last month voiding Chicago pension reforms.

Bi-partisan efforts at reining in the state’s pension strains vary in the level of savings they would achieve and the time they would take to accomplish.

They include offering employees some benefit in exchange for cuts, putting a constitutional amendment to voters, borrowing to pay down the liability, and re-amortizing the current payment schedule adopted in 1995.

Rauner has endorsed the so-called “consideration” proposal developed by Democratic Senate President John Cullerton, D-Chicago. If adopted, it could trim an estimated $1 billion off future annual pension contributions and $45 billion to $50 billion off long term payments.

Current public employees would have the choice of keeping their current annual cost of living adjustment, but future pay increases wouldn’t be counted toward retirement benefit calculations, or they could take a reduced cost-of-living adjustment and continue to have pay raises counted.

Supporters believe that plan won’t run afoul of the constitution because of language in the high court’s opinions recognizing that changes can be made to a contract negotiated with individuals or unions if members are offered some form of "consideration," meaning some kind of benefit, to offset negative changes. The state’s pension clause gives contractual status to fund membership and protects benefits from being impaired or diminished.

Some believe the court might buy the argument that salary increases fall under the purview of the state to set, so it can offer up the continued accrual of raises toward pensions as fresh benefit.

Others say the proposal doesn’t stand a chance because it fails to offer members a new perk, as the benefit of having raises counted toward pensionable salaries is currently in place and thus protected by the pension clause. The plan has bipartisan support, but the timing of a vote is unclear, especially given that many lawmakers are up for re-election this November.

Another plan being explored with smaller savings offers a voluntary pension buyout in which employees would receive a cash payment in exchange for forgoing their retirement benefits. Under House Bill 4427 sponsored by state Rep. Mark Batinick, R-Plainfield, employees could take a lump sum valued at 75% of the present value of their retirement annuity.

A review estimated savings at $3.5 billion if 10% of members in the teachers fund, the largest of the state’s five funds, participate. That figure rises to $7 billion if 20% participate. The House pensions committee is reviewing the proposal, though it’s unclear how the state would fund the cash payments.

Rauner included a series of other measures in his proposed fiscal 2017 budget with estimated savings of $780 million. He wants to phase in over five years the impact of changes in actuarial assumptions to soften the near-term impact on pension contributions and restrict pension spiking that occurs with raises late in an employee’s career. The state would also shift the cost of pension payments for higher-paid employees over to local districts and universities.

Rauner and others believe ultimately a constitutional amendment limiting the scope of the pension clause – which was adopted as part of the state’s 1970 constitutional convention – is the answer.

The amendment was among the options that had support from some lawmakers participating in Monday’s forum, sponsored by the public interest groups Illinois Campaign for Political Reform and Truth in Accounting.

The Civic Federation of Chicago, whose president Laurence Msall served as forum moderator, has endorsed the option. “The proposed amendment should specify that the pension protection clause applies only to accrued benefits, giving the state legislature the discretion to make adjustments to future benefits for existing employees,” the group recommends in its 2016 legislative priorities.

Several panelists said they believe the Center for Tax and Budget Accountability’s proposal to re-amortize the current payment schedule offers a partial solution.

The center – whose executive director Ralph Matire also served as a forum moderator – says the state could limit its annual payments to a fixed sum under $8 billion. That would require adopting a schedule that relies on level annual payments over a revised amortization period with the goal of reaching a more modest funded ratio of, say, 80%, instead of the current’s plan’s 90%.

Panelist member Sen. Matt Murphy, R-Palatine, called the re-amortization a “reasonable” idea to consider as part of a package of reforms as well as the cash-out option.

“The Supreme Court has made it pretty clear that under this constitution you are not going to do a whole heck of a lot more than that,” said Murphy, who supports a constitutional amendment giving the state the ability to limit future benefits for existing employees.

“The key thing is we need to come up with something that will pass legal muster and I think we need all hands on deck,” said Rep. Frank Crespo, D-Hoffman Estates.

The consideration and other proposals probably face a fight, so market participants are cautious about the state curing its pension ills any time soon.

“Any proposal will have a long road to approval and withstanding any legal challenges,” said Michael Johnson, head of research at Gurtin Fixed Income Management LLC. “Overall, what we want to see is an implemented solution that lowers the state's liability and maintains an affordable annual contribution.”

Borrowing

Talk has also circulated about additional pension borrowing to pay down the liability. The Government Finance Officers Association recommends state and local governments refrain from issuing bonds for retirement benefits as it’s a risky arbitrage play.

Illinois’ past pension borrowing has carried a hefty price tag, with total repayment costs of $30.8 billion for $17.2 billion of principal. In addition to its contribution to the pension funds, the state paid $1.8 billion in interest and principal on pension borrowing in fiscal 2015. The tab for this year is $1.4 billion.

Illinois 2003 $10 billion taxable deal – which matures in 2033 – carries an overall cost of $22 billion. About $7.3 billion of the proceeds went to bring down the unfunded liability with the remainder covering a portion of the state’s 2003 contribution and all of its fiscal 2004 contribution.

The play of arbitrage that gambles on earning more in investment returns than bond repayment remains a risk, but so far has worked in the state’s favor.

Investment returns, although in negative territory in some years, have ranged from 7% to 8% on an annualized basis between 2004 and 2015, exceeding the true interest cost on the bonds of 5.047%, according to the legislature’s Commission on Government Forecasting and Accountability’s March overview of the system.

Though the practice is frowned upon as signaling an issuer’s distress, the state again borrowed to help cover its pension payments in fiscal 2010 and fiscal 2011. The 2010 sale totaled $3.5 billion and was retired in 2015 at a total cost of $3.8 billion. The 2011 sale for $3.7 billion will be retired in 2019 with a total tab of $5 billion.

The Numbers

The state’s unfunded obligations have ballooned by $86 billion between fiscal 2001 and 2015, according to the report from the commission on government forecasting and accountability.

“The main factors for this increase in unfunded liabilities were actuarially insufficient employer contributions, changes in actuarial assumptions and lower-than-assumed investment returns over five years, along with other miscellaneous actuarial factors,” the report reads.

The growth illustrates the flaws in the payment adopted in 1995. It puts the state on a path to a 90% funded ratio in 2045. The contributions are required to be made at a level percent of payroll from 2011 through 2045, a figure that is not tied to an actuarially required level.

The Securities Exchange Commission brought fraud charges in 2013 – which were simultaneously settled by Illinois – for failing to disclose that the plan significantly underfunded pension obligations and increased risk to its overall financial condition.

Contributions will rise to nearly $8 billion in 2017, a dramatic increase given that contributions didn’t hit the $2 billion mark until 2009. Payments continue to climb but at a slower clip. The funded ratio currently at 40.9 % is slow to gain momentum. Payments rise to $9.9 billion in 2026 for a funded ratio of just 50.6%. They hit $14 billion in 2036 for funded ratio of 63%. The funded ratio now at 41% doesn’t hit 70% until 2040. Payments reach $17 billion in 2045 when a 90 % ratio is achieved.

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