Thursday, June 7, 2012

Pension Costing in Ilinois ... Normal Cost versus Unfunded Liability ... Something Smells Here!

Today my friend Sid from Illinois sent along another thought provoking and timely article about what the Illinois government is debating regarding cleaning up its unfunded and ongoing pension liabilities for public sector employees. The article, albeit interesting, begs more questions than it answers.

Illinois officials still divided on pension reform solution says this:

"Illinois officials will spend the next two weeks gathering financial information from the state’s more than 800 school districts to get a better idea of how shifting pension costs away from the state would affect those districts. After a meeting with the four legislative leaders in Chicago on Wednesday, Gov. Pat Quinn said lawmakers must approve a comprehensive pension package. “We can’t have partial solutions,” Quinn said. “That won’t get the job done.”

Senate President John Cullerton, D-Chicago, said Tuesday he believes the General Assembly could fairly easily approve reforms to the pension systems that cover state employees and lawmakers. Then legislative leaders could continue to work on stickier problems involving university employees and downstate teachers, he said.

That would show bond rating agencies that the state is willing to start tackling pension reforms, Cullerton said, even if it takes longer to negotiate a package that applies to teachers and university workers.

Speaking after the meeting, Quinn appeared to reject Cullerton’s approach.

“My goal from the very beginning was to erase completely the unfunded liability of all of our public pension systems,” Quinn said. “We have to roll up our sleeves and do it all.”

The impasse involves whether to shift the costs of future pensions for downstate teachers and university workers away from the state to school districts and universities. Many Republican lawmakers fear that shifting costs will force many school districts to raise property taxes.

Quinn had supported cost shifting, but backed off that position late in the spring legislative session. However, House Speaker Michael Madigan, D-Chicago, said he would oppose any plan that didn’t include cost-shifting, so proposed pension reform was never called for a vote in the House.

Quinn said the next two weeks will be spent collecting financial data from school districts, including “what their reserves are, what their current contracts are, what exactly they have right now as to their costs.”

“The more facts we could gather regarding what the impact would be on school districts, it would be very important facts we should know,” Quinn said.

Rep. Elaine Nekritz, D-Northbrook, who worked on pension reform legislation through the spring session and attended Tuesday’s meeting, said lawmakers in the closing days of the session got conflicting information from schools about the effects of a cost shift.

“We didn’t really have time to get them the time they needed to fully understand what normal costs might be for them,” she said. “We were hearing one district’s normal cost would be 3 percent of payroll and another’s 11 percent. That didn’t make sense.”

“Normal cost” is the total benefit accrued for active employees for the current budget year.

The leaders on Wednesday reportedly discussed the cost shift in the context of additional cuts to education spending in the new budget and the state’s chronic delays in paying bills.

Quinn said districts also need to factor in money that will be saved on pension costs if reforms are enacted. Quinn and Madigan believe school districts should be responsible for pension costs, not the state, because they are the ones that negotiate the labor contracts that ultimately determine pension benefits.

“The taxpayers of Illinois should not be just there to subsidize the retirement costs of every single school district,” Quinn said.

Quinn and the leaders will meet again June 19, 20 or 21.

Quinn reiterated that action must be taken soon on pensions for the state to avoid a possible downgrade in its credit rating.

Standard & Poor’s, one of the major ratings agencies, said Wednesday it will analyze the state’s recently passed budget and Medicaid reforms to assess progress Illinois has made on its financial problems.

But S&P also included an ominous warning.

“There was no action during the regular legislative session on pension reform, and we consider this negative from a credit standpoint,” S&P said. “Given that the pension reform legislation did not pass during this session, it will now be a much more significant challenge to implement, in Standard & Poor’s opinion, requiring a three-fifths majority if addressed in a special session in 2012.”"

Discussion and Analysis

Governor Quinn says "We can't have partial solutions. That won't get the job done. . . . My goal from the very beginning was to erase completely the unfunded liability of all of our public pension systems."  So far, so good.

And Rep, Niekritz said this, "We didn't really have time to get them (school districts) the time they needed to fully understand what normal costs might be for them. We were hearing one district's normal cost would be 3 percent of payroll and another's 11 percent. That didn't make sense."

"Unfunded Liability" ...  A Single Lump Sum

So here's the problem. The unfunded pension liability is represented to be about $85 billion. If so, that's approximately what taxpayers owe to fully fund the pensions promised to public employees. In any case, the estimated amount of unfunded liability is at least tens of billions of dollars to fund the promises made. 

And that's the elephant in the room.  Billions of dollars of an elephant. So whether the money comes from the state, the cities, the school districts, local property taxes, employee contributions, reduced benefits or later eligibility for those benefits or otherwise such as higher investment returns on money invested, it's a whole lot of money indeed.

"Normal Cost" ... An Ongoing Annual Sum 

Normal cost is the amount it costs to fund the benefits earned in a specific year. There should be no mystery about that amount, whether in a particular school district or for the entire state.

Simply put, that's what actuaries do --- estimate the costs to fund liabilities for a group based on fundamental actuarial assumptions. For example, If 100 people are working and paid at an average rate of $200 annually, actuaries expect that there will be future employee turnover, salary raises and even deaths before reaching retirement age for the group as a whole.

These same actuaries also predict that those reaching retirement age will live for another X years after retirement. They further calculate what monies contributed to the fund and invested will earn on average and over time. 

All that is factored into the actuarial calculation and out comes an amount which will have to be contributed to fund the benefits earned for that year. That work is not done by school districts but by actuaries acting on behalf of either the state or its various components, perhaps including school districts. 

The point is that the specific information almost certainly exists, regardless of what Rep. Niekritz says.

Summary ... Illinois Has a Simple Factual But Not Easy Financial Pension Funding Problem to Solve

So Illinois government has two really simple math problems: (1) how to fund the estimated $85 billion unfunded liability; and (2) how to keep that liability from growing by fully funding the normal costs each year.

It won't be easy to get the money to pay the pensions, of course, but the amount required is not hard to calculate. Taxpayers Beware!

But let's acknowledge that simple and easy are not the same thing. Illinois government has a simple but not easy problem to solve in order to meet pension promises made to public sector employees. 

It's not easy because it's extremely expensive and especially since most taxpayers have no idea as to the magnitude of the overall amount of money that will be required to solve the problem. Raising local property taxes won't do the trick. Not even close.

Although I obviously don't know exactly how much the $85 billion estimate is over or understated, I do know it's a huge number. And that huge number is in essence a debt of the state that either has to repaid or which amount has to be reset by changing the amounts of benefits and the time those benefits will be paid.

In other words, if already promised benefits are reduced and/or people have to wait longer to draw those benefits, the $85 billion will be reduced.  Similarly, if investments earn more or less than assumed, the $85 billion number will change as well. 

It Smells

Why this all smells to me is that all these numbers, even if unknown, are eminently knowable. The actuaries know the numbers, the accountants know the numbers and lots of state officials know the numbers as well.

What isn't known is what the Governor and legislature will do about changing the benefits to be able to pay whatever sums the taxpayers will actually pay to public employee beneficiaries. Or how employees, taxpayers, courts, bond rating agencies, lenders and public sector unions will react to all that.

In sum, something really is rotten in Illinois politics, as usual, because the pension issue is really a simple math problem. If there's an $85 billion debt that has to funded and if, for example, annual payroll costs are another 7% (midpoint between 3% and 11% mentioned by Rep. Niekritz), that's a knowable amount for sure.

Then who pays, how much, when they retire, receive raises, increase or decrease staffing, at what rate is interest on the debt paid, assumed investment return, employee contributions and so forth are all the blanks that need filling in, of course.

And if the employee retiree benefits are going to change from what's been promised or if the investment return assumptions on money contributed will change, that's just a simple alteration in how the various amounts are calculated, too.

So that's why this all smells to me. How about you?

And finally, what is simple to know will be by no means easy to do in this case. It hardly ever is.

Thanks. Bob.

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