Prichard’s Perspective on Pension Reform

November 29, 2013

Express Your Views about the Pension Reform Proposal

After years of contentious discussions about pension reform and countless proposals, the legislative leaders have agreed to a plan they intend to bring to a vote in the General Assembly on December 3.  Numerous working and retired state employees have been calling and sending e-mails opposing the plan before it was unveiled. I encourage all citizens to review the actual proposal in the next few days, thoughtfully consider its trade-offs in light of the state situation, and then send me your comments that I might consider before the vote. Compromises are never easy and I would have liked for this proposal to have been crafted by all affected parties.  This is the plan we have before us.

Why Reform is Necessary

Changes must be made to preserve the pension system that state employees have earned. There are many reasons why pension reforms are necessary even beyond the private sector groups that have been calling for reforms.  First, the present defined benefit public pension plan with inflationary adjustments was developed without accurately determining the long-term costs.  The current benefit levels are not sustainable even if the state had made regular payments.  Next, the repayment schedule created by law in 1995 to pay the unfunded liabilities is consuming too large a share of state revenue.  Currently about 22 percent of general revenue is used to pay pensions while other Midwestern states pay less than 3 percent of their general revenue.  This means there is less revenue for schools, social services, unpaid bills, roads and other important state priorities. 

Another reason changes are necessary is to improve the down-graded Illinois’ credit rating, now the lowest in the nation.  Bond houses lowered Illinois’ ratings over 13 times in just the last few years in large part due to the pension obligations.  This low rating results in higher interest payments not only for the state but also for schools, cities and counties when they borrow funds.  Then there is the growing unpaid pension liability even when the state makes the employer’s share of the payment. Employee and employer payments are not sufficient to cover the actual annual pension cost adding millions of dollars to the unfunded liability each day. While it’s fortunate that retirees are living longer, the annual compounded adjustment to pension payments–the so-called cost of living adjustment or COLA–adds significantly to the state’s pension liability.

Some retirees say just raise income taxes to pay for the pension obligation even though most state retirees pay no taxes on their pension income. Others want an end to tax credits and incentives for businesses–so called tax loopholes–that were intended to create jobs and stimulate business activity.  As you recall, the recent major tax increase that expires in 2014 has been used to pay the pensions, not the $8 billion or so in unpaid state bills.  Many believe further tax increases in the current economy with high unemployment will only damage Illinois’ business climate and ability to attract and keep jobs.

Here Are the Proposed Reforms

• Retired employees will have more assurance that they will continue to receive their pensions

• Funding schedule and method for certifying contributions: Establishes an actuarially sound funding schedule to achieve 100 percent funding no later than the end of FY 2044. Contributions will be certified using the entry age normal actuarial cost method (EAN), which averages costs evenly over the pensioner’s employment and results in level contributions.

• Supplemental contributions: The State will contribute (i) $364 million in FY 2019, (ii) $1 billion annually thereafter through 2045 or until the system reaches 100 percent funding, and (iii) 10 percent of the annual savings resulting from pension reform beginning in FY 2016 until the system reaches 100 percent funding. These contributions will be “pure add on,” which means State contributions in any year will not be reduced by these amounts.

• Funding guarantee: If the State fails to make a pension payment or a supplemental contribution, a retirement system may file an action in the Illinois Supreme Court to compel the State to make the required pension payment and/or supplemental contribution set by law each year.

• Employee contribution: Employees will contribute 1 percent less of their salary toward their pension.

• Annual annuity adjustment (COLAs): Future COLAs will be based on a retiree’s years of service and the full CPI. The annual increase will be equal to 3 percent of years of service multiplied by $1,000 ($800 for those coordinated with social security). The $1000/$800 will be adjusted each year by the CPI for everyone (retirees and current employees). Those with an annuity that is less than their years of service multiplied by $1000/$800, or whatever the amount is at the time of retirement, will receive a COLA equal to 3% compounded each year until their annuity reaches that amount.

• Additionally, current employees will miss annual adjustments depending on age: employees 50 or over miss 1 adjustment (year 2); 49-47 miss 3 adjustments (years 2, 4, and 6); 46-44 miss 4 adjustments (years 2, 4, 6, and 8); 43 and under miss 5 adjustments (years 2, 4, 6, 8, 10). 

• Pensionable salary cap: Applies the Tier II salary cap ($109,971 for 2013), which is annually adjusted by the lesser of 3% or ½ of the annual CPI-U. Salaries that currently exceed the cap or that will exceed the cap based on raises in a collective bargaining agreement would be grandfathered in.

• Retirement age: For those 45 years of age or under, the retirement age will be increased on a graduated scale. For each year a member is under 46, the retirement age will be increased by 4 months (up to 5 years). 

• Effective rate of interest (ERI): For all purposes, the ERI for SURS and the rate of regular interest for TRS will be the interest rate paid by 30-year U.S. Treasury bonds plus 75 basis points.

• GARS Tier 2 fix: Brings GARS Tier 2 salary cap and annual adjustment in line with other Tier 2 benefits. 

• Pension abuses:Prohibits future members of non-governmental organizations from participating in IMRF, SURS, and TRS. Prohibits new hires from using sick or vacation time toward pensionable salary or years of service (applies to SERS, SURS, TRS, IMRF, Cook County, and Chicago Teachers).

• Defined contribution plan: Beginning July 1, 2015, up to 5% of Tier 1 active members have the option of joining a defined contribution plan. The plan must be revenue neutral and employee contributions will be equal to those for the defined benefit plan. If a member chooses to opt into the defined contribution plan, benefits previously accrued in the defined benefit plan will be frozen.

• Collective bargaining: All pension matters, except pension pickups, are removed from collective bargaining.

• Healthcare payments:Prohibits the State pension systems from using pension funds to pay healthcare costs.

Consider these reforms and let me know your considered opinions before December 3.

Bob
bob@pritchardstaterep.com