Dec. 11, 2012

By Jayette Bolinski

SPRINGFIELD – A hybrid “cash-balance” pension plan proposed by a group of rank-and-file Illinois lawmakers last week is a step in the right direction, but falls short of setting the state on a course for a healthy pension system, one national expert says.

It doesn’t do anything to address the state’s crippling unfunded pension liability, and the proposal doesn’t offer cash balance to all state workers, said Bob Williams, president of State Budget Solutions, which monitors government pension debt across the country.

Converting to defined-contribution plans is the best answer to the state’s multi-billion-dollar problem, he said.

“If you’re in a hole, stop digging. Cap the existing defined-benefit problem. Don’t let it get any deeper. And then convert (employees) to an IRA or defined-contribution model,” Williams said. “But to allow the hole to just keep getting bigger every year…”

Cash balance is an idea that has caught on in some states, including Louisiana, Nebraska and Kansas. All three recently approved moving to cash-balance plans for state employees.

Cash-balance plans have some elements of both defined-benefit and defined-contribution pension plans. Illinois’ state employees, teachers and others have defined-benefit plans, which many observers see as unsustainable, particularly given Illinois’ $96 billion unfunded liability — a figure State Budget Solutions pegs at more like $200 billion.

Cash balance is a way for government employers, such as the state of Illinois, to take a step toward defined-contribution plans without going all in. Here’s how the plan works:

• Each employee has an individual account, and both the employee and the employer contribute to it.
• The employee has no say in how the money is invested. The accounts are managed in one blended fund, and employees are guaranteed a specific return on their accounts.
• Employees can receive additional money if returns are better than expected.
• Upon retirement, employees receive an annuity based on the account balance and may have additional benefit options, such as rolling some of the money into a private 401k or IRA.

Illinois’ latest pension-reform proposal, pitched last week by Democratic state Reps. Elaine Nekritz of Northbrooke and Daniel Biss of Evanston with the support of about 20 other lawmakers, includes a cash balance component only for new teachers and university employees.

Under the plan, teachers would contribute 9.4 percent of their salary. Their employers — taxpayer-funded local school districts — would pay 6.2 percent into the account. But schools would have flexibility to pay in more if they want to, as part of union negotiations, for example. Illinois’ Teachers’ Retirement System would manage the account, and members would be guaranteed a return of at least 4 percent each year.

Currently, Illinois teachers outside of Chicago pay in 9.4 percent of their salary, the school districts pay in a little more than a half percent, and the state of Illinois pays in about 28 percent of teachers’ salaries. The state’s Teachers’ Retirement System currently has an expected rate of return of 8 percent, downgraded earlier this fall from 8.5 percent.

Laurence Msall, president of the Chicago-based Civic Federation, which researches and analyzes Illinois’ budget problems, said he believes it’s important that the architects of the Nekritz-Biss plan are not just shifting the funding responsibility to the local school districts – they’re also giving districts some say in the plan.

“And allowing those local school districts to have control rather than just the Legislature determining what the specific benefits are is a step in the right direction,” he said.

The proposed cash balance could be beneficial for employees who qualify, but more analysis is needed, said Amanda Kass, a pension expert with the Chicago-based Center for Tax and Budget Accountability, also a Chicago-based organization that monitors Illinois’ budget and pension issues.

“I would like to see the data on it to see if it offers a benefit to teachers and state university members. But I also think it should be extended to all of the retirement systems that were affected by Tier 2, not just two of them,” she said.

(Illinois has a two-tier pension system, in which employees hired since 2011 receive different benefits than those hired previously.)

In contrast to Illinois’ cash-balance proposal:

• Nebraska has had a cash-balance plan since 2003, when it closed the defined-contribution plan it had offered employees from 1967 to 2002. Employees contribute 4.8 percent of their salary to the plan, and employer contributions are set at 156 percent of the employee contribution. Members are guaranteed a return of at least 5 percent each year.
• Louisiana enacted legislation earlier this year to create a mandatory cash-balance plan for most state workers and some members of the Teachers’ Retirement System. It kicks in July 1, 2013. The plan is optional for other workers. Employees contribute 8 percent of their salary. Each account will receive an employer credit of 4 percent of salary, plus interest on the account. That will be contingent upon the actuarial rate of return on investments in the retirement system but won’t go below zero.
• Kansas enacted legislation this year to replace its defined-benefit plan for most state workers and teachers with a cash-balance plan on Jan. 1, 2015. Members will contribute 6 percent to their account, and the employer will contribute from 3 percent to 6 percent, depending on the member’s length of employment. Members are guaranteed a 5.25 percent rate of return.

Williams said there are benefits and drawbacks to cash-balance plans. On one hand, the employer has more control over how the plan is doing. On the other hand, the employer is under pressure to make good rate-of-return assumptions because it’s liable for it either way.

The Nekritz-Biss plan could go to lawmakers during the Legislature’s lame-duck session in January. The reform proposal also calls for raising the retirement age by zero to five years based on an employees’ age, requiring employees to pay more into their pensions, restricting cost-of-living increases and gradually shifting teacher pension costs from the state to local school districts. It also includes language that the courts can get involved if the state fails to make required pension payments.

Ultimately, any comprehensive pension reform proposal must address how to grapple with the state’s unfunded liability, which has become a financial black hole, Williams said.

“They really have to address the (unfunded liability) problem, because eventually the state’s credit rating is going to become so low that they’re going to be paying too much money for bonds and things like that. And it probably will hit the school districts first,” he said.

“To me one of the biggest problems is in good times legislators increase benefits, because it’s good times. They don’t look at the unfunded liability. In bad times, legislators delay putting money into the pension systems, and they don’t make that up,” Williams said.

“The easy thing is they can look you in the face and say, ‘We balanced the budget without raising taxes.’ Yeah, but what did you do? You created this liability that someone has to pay off sometime.”

Illinois Comptroller Judy Baar Topinka

Dec. 6, 2012

By Jayette Bolinski

SPRINGFIELD — A proposal in the state legislature to borrow $4 billion to pay down the state’s backlog of bills could mean a double-whammy for Illinoisans who ponied up to pay off old bills as part of a 67-percent “temporary” personal income-tax hike.

The problem is that none of that tax money has gone to pay down the backlog, which now stands at a half-billion dollars more than it was two years ago.

It’s a structural issue, said state Comptroller Judy Baar Topinka.

“This is not hard to understand. If you keep doing the same thing over and over and over again, you get the same result,” she said.

“If you borrow $4 billion, you’ll pay off the backlog now, but then that cycle will start all over again, and you’ll have another backlog because the structure stays the same, and at the same time now we’ll have a $4 billion bond debt that’s been added on to what we have already.”

In January 2011, Illinois lawmakers promised to use part of a 67-percent personal income tax hike to pay down old bills — bills that amounted to $8.5 billion. Today, as they consider borrowing $4 billion — again to pay down old bills — the backlog stands at more than $9 billion.

As of Wednesday, there were 196,141 unpaid bills at the comptroller’s office, amounting to $6.9 billion. Add to that the bills that haven’t been sent to the comptroller yet, including $1 billion in Medicaid payments and $1.4 billion in employee health insurance payments.

So where did the tax money meant for old bills go? To pensions and Medicaid, experts say. That, coupled with a spending problem, is why the state is coming around again, looking for money to pay unpaid bills, said Ted Dabrowski, vice president of policy at the Illinois Policy Institute, a right-leaning think tank.

“That promise is broken. All it did was fill the coffers. It allowed the state to pay down the pensions. And that increased tax load helped them avoid reforms on pensions and allowed them just to keep spending more money,” he said.

Topinka agrees. Lawmakers may be trying to do the right thing, but borrowing to pay down the old bills is “a short-term, feel-good ‘aah’ that ends up an ‘ugh,’ she said.

“What happened to the magic tax increase that came out last session that was supposed to pay for the unpaid bills? That went totally to Medicaid and totally to pensions, and we did not get Dollar One to pay for unpaid bills,” she said. “So now they’ve still got the unpaid bills to pay and they want to borrow $4 billion.”

The borrowing proposal, House Bill 6240, has 17 co-sponsors, all Democrats. But bill sponsor Rep. Esther Golar, D-Chicago, facing opposition to the plan, asked for more time before a committee vote. The Legislature returns Jan. 3 for its final “lame-duck” session, and it could come up then, but its future is uncertain.

Phone calls and an email to Golar’s office this week were not returned.

Ultimately, more borrowing is out of the question, Topinka said, and that means vendors will have to continue to wait, at least until the economy improves and revenue picks up.

“The state really cannot afford to do this because we might be able to pay them this time around, but if they are doing work with the state the next time around, we will be in the same hole, if not worse, because now we will have the interest payment on a greater debt load we have to pay,” she said. “So it doesn’t solve the problem.”

Until the state changes its ways, its debt will continue to mount, vendors doing business with Illinois will have to wait months to be paid, and taxpayers will be on the hook for even more, the experts say.

Topinka said she believes the economy is improving and, given time, will enable the state to pay down the backlog in a more reasonable manner.

Most vendors, she added, probably would tell her to borrow the money so they can be paid, but that only stands to make the state’s finances worse.

“They (the vendors) have not done anything wrong here. They need to be paid,” she said.

Dec. 5, 2012

By Jayette Bolinski

SPRINGFIELD — Two Illinois pension experts are divided on the merits of a new reform proposal that seeks to cut pension costs but does little to address the state’s pension borrowing issues.

The plan is either a dramatic step toward rescuing the state from financial ruin or a potentially unconstitutional failure that lacks teeth, depending on who you ask.

“We question why so much time and political capital is being expended on a policy initiative that doesn’t address or solve the problem,” said Ralph Martire, executive director of the Chicago-based Center for Tax and Budget Accountability. “It doesn’t solve the problem created by the unfunded liability. In fact, it’s sort of more of the same. It’s a mishmash of some of the proposals that have been on the table.”

But Laurence Msall, president of the Chicago-based Civic Federation, said the proposal is reasonable, sensitive to lower-paid employees and those close to retirement, and shares the pain of digging the state out of debt among all stakeholders — the government, state employees and taxpayers.

“The greatest concern for most employees is they want to know they are going to receive the benefit they’ve been promised,” Msall said.

The plan, put forth by Rep. Elaine Nekritz, D-Northbrook, and Rep. Dan Biss, D-Evanston, has bipartisan support from 21 other lawmakers — an early show of solidarity that other pension plans have not enjoyed.

It is unclear if enough other lawmakers will be willing to move it through the Legislature by Jan. 9, the final day of the General Assembly’s “lame-duck” session and the date Gov. Pat Quinn set as the deadline for comprehensive pension reform. Nekritz and Biss said it’s a framework that’s up for discussion.

Illinois has a $94.6-billion in unfunded pension liability, the worst of any state in the nation. The Teachers’ Retirement System alone has unfunded liabilities of $52.1 billion. Investment houses are watching Illinois and may lower its credit rating if the Legislature takes no meaningful action soon.

Cost savings from the latest proposal are unknown because the pension systems’ actuaries have not analyzed it, officials said.

Illinois Watchdog spoke with Msall and pension expert Amanda Kass from the Center for Tax and Budget Accountability and asked them to weigh in on some of the main points of the Nekritz-Biss plan, which is in House Bill 6258.

Increases the pension contribution of workers hired before 2011 by 1 percent the first year, 2 percent after that.

Msall: “We’re glad to see that. All of the changes that are proposed in this have a financial impact on the state’s unfunded liability and the cost of the pension program going forward. So it’s good they’re including that. What we don’t know is how significant that savings is, and until you see the actuarial study and calculation you can’t say whether the state can actually afford to continue to make those contributions.”

Kass: “It would generate savings for the state because the employees and the state share in the cost of the benefits, so if you increase employees’ contribution rates you generate savings for the state. But I don’t think it’s constitutional. Arizona passed legislation a few years ago increasing employee contributions, but it was overturned a year after it was passed. The state then had to refund all the money back to the employees from their over-contribution.”

Increases the retirement age for employee as follows: no increase for those 46 and older, one year for those 40 to 45, three years for those 35 to 39 and five years for those 34 and younger.

Msall: “I think their proposal to not impact the people closest to retirement age right now at the state of Illinois (who) have less time to adjust their savings and planning for their retirement is a sensitivity to what the impact these changes might be on future retirees. I think it’s positive.”

Kass: “I think it’s probably unconstitutional. You generate savings because essentially you’re reducing people’s benefits and making them pay more by requiring them to work longer.”

Cost-of-living adjustments will apply only to the first $25,000 of a worker’s pension ($20,000 for those eligible for Social Security). And they’re delayed until the worker turns 67, or five years after retirement, whichever comes first.

Msall: “Tying it to only the first $25,000 of someone’s retirement benefit is something they’ve done in Rhode Island. It is something that has been discussed,” he said. “I think it certainly shows a sensitivity of this coalition and of the legislators to try and protect the people who are the most vulnerable, the people with the lowest pensions, the people with the most difficult situations in terms of reliance on a pension that’s already been earned.”

Kass: “I think it’s problematic for a couple different reasons. I first wonder why they picked $25,000 because that’s not the average benefits for the majority of people in the five systems,” she said, noting that changing the COLA also may be considered unconstitutional because it affects retirees. “For the five state systems, about 80 percent of the people aren’t coordinated with Social Security, so their state benefit is kind of their sole source of retirement income. The cost of living adjustment’s really important to ensure the benefit keeps pace with inflation over time.”

Shifts pension costs from the state back to local school districts at a rate of a half percent of payroll each year.

Msall: “It’s not so much the politics of the cost shift, it’s the fiscal reality of the state having $8 billion in unpaid bills and paying such a large portion of its operating budget to the pension. Having raised the income tax and all of the money going into the pension and not significantly reducing the unpaid bills makes it a financial and mathematical reality that the state is going to continue to look for ways to shed its responsibilities and obligations.”

Kass: “You have to look at what the state contributes to education overall. In Illinois, the state contributes about 27.6 percent of education funding from the state. The national average is at 46.7 percent. So Illinois’ education funding is predominantly reliant on property taxes, and doing that cost shift wouldn’t change that. It probably would just exacerbate it.”

The proposal also includes a guarantee that the state could be sued if it fails to make its required pension payments, and it plans for the state to achieve 100-percent funding of its pension systems in 30 years. It also would require that money used to pay off pension obligation bonds would be used to pay down the unfunded liability once the bonds are paid off.

What’s missing from the plan?

Msall: “There’s nothing in that right now for city of Chicago, County of Cook, the downstate police and fire pension funds, all of which leaders have been asking to be included as part of the pension reform. That should be included. The same challenges and the same problems all were created by the Illinois Legislature when they created these pension funds, so they’re creating enormous financial pressures on our local governments.”

Kass: “I think the real aspect that needs to be fixed is the debt repayment, how they’re amortizing the unfunded liabilities. This legislation doesn’t flatten that out, so every year the state’s contribution increases significantly. It’s a back-loaded repayment schedule. This isn’t fundamentally redoing that. Instead, it cuts benefits for retirees and current employees. That ostensibly makes it possible to reduce payments, but without seeing the data it’s unclear what kinds of savings are actually generated.”

Does the plan appear to be constitutionally sound?

Msall: “Basically the constitutionality of any pension change or any significant employment benefit is always the likely subject to a lawsuit. This will certainly be litigated if it is enacted, but the hope would be that the courts would recognize the dire financial condition of the State of Illinois.”

Kass: “I don’t think the majority of it is constitutional.”

What are the chances of the proposal making it through the Legislature in January?

Msall: “If this type of reform does not make it through the legislature, two things are at great risk: one, the state’s financial stability going forward, its credit rating and its credit worthiness, and two, the solvency of the major pension funds. I can’t predict how they will get to 60 votes. This appears to be a larger group and more diverse group of state representatives than have ever spoken out jointly in support for a package and a comprehensive approach for the pension changes that need to occur.”

Kass: “I’m not sure. I know there’s a lot of talk that some pension legislation is going to have to pass this year. I know there’s a lot of pressure from bond rating agencies. I’m not sure if it’s going to be this piece of legislation or another piece of legislation, but I wouldn’t be too surprised if a piece of legislation gets passed this year. If it’s January or this spring, I’m not sure.”