January 17, 2013 2:31 pm

Illinois lawmakers fall into pensions gap

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After the previous legislature failed to pass crucial fiscal reforms, Illinois’ new lawmakers sworn in this month have been handed a huge problem: how to close a $96bn unfunded pension liability.

A Moody’s downgrade last year gave Illinois the lowest credit rating in the nation and Fitch downgraded its outlook to negative last week on pension reform inaction. After years of short-changing public pension funds, filling the pensions gap will be difficult, with state and local tax revenues amounting to only about $55bn.

“This is not an opportunity in search of a crisis, this is a crisis in search of a leader [and] a reasonable compromise by our government,” said Laurence Msall, president of the Chicago-based budget watchdog group The Civic Federation.

Illinois’ pension system is just 35 per cent funded, according to Boston College’s Center for Retirement Research. A “healthy” pension system, meanwhile, is generally defined as being 80 per cent funded. In 2010, 34 states were below the 80 per cent threshold, up from 31 states in 2009 and 22 in 2008.

In fiscal 2010, the most recent data available for all states, the state pension gap in the US hit $757bn, according to a report from the Pew Center on the States. That figure nearly doubles, to $1.38tn, with the inclusion of retiree health benefits.

“This is a problem across cities and states,” said David Draine, senior researcher at Pew. It was caused by state governments “failing to make the contributions necessary to fund pension promises, raising benefits without funding them and [making] actuarial assumptions that just simply didn’t pan out.”

Some states are in better shape than others, both in terms of funding their pension systems and in taking steps to address the gaps. Pension systems in North Carolina, Florida, Georgia, Texas and Wisconsin are all well funded, while Rhode Island and Kentucky are seen as taking action to fix their woefully underfunded systems.

But reforms are often piecemeal or insufficient in the face of stiff political opposition. Between 2009 and 2011, 43 states enacted benefit cuts, increased employee contributions or both. Some of the changes states are trying to roll out have faced or will face legal challenges brought by unions.

Henry Bayer, executive director of the Illinois chapter of The American Federation of State, County and Municipal Employees (AFSCME), said the failed bills floated by the state’s governor and a bipartisan group of legislators in the recent session, which would cut benefits employees have already contributed towards, would elicit a lawsuit. Mr Bayer’s union instead proposes that its members contribute more towards their pensions, among other measures, while the government closes corporate tax loopholes to generate more revenue.

“If they pass anything like they’re talking about, it won’t be settled because there will be a lawsuit and we’ll be right back where we are now,” he said. State constitutions, including Illinois’, generally protect deferred compensation, resulting in litigation.

Indeed, Rhode Island – often cited as a prime example of how a state can fix its pension system – now finds itself in court. The state will cut benefits for new and existing employees, has created a new plan that will involve greater contributions from workers and has cut the annual assumed rate of return on pension assets from 8.25 per cent to 7.5 per cent.

That has cut $3bn from the state’s pension bill. But Joshua Rauh, finance professor at Stanford University, said the assumed rate of return remains far too high and if states calculated the cost of benefits based on a more appropriate rate, such as those of government bonds, it would become clear that the actual nationwide unfunded state pension liability is closer to $4.5tn.

“They have calculated the contributions they need to make on the basis of that flawed accounting and are contributing much less than is necessary,” he said. “One of the other consequences of the measurement problem is that it distorts the calculation [and efficacy] of the reforms.”

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