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.”