At least one state in the US is acting on the need for epic reform of its pension system, but the political difficulty associated with such reform – something all states are wary of – was demonstrated in the violent outburst by Illinois representative, Mike Bost, last week (see video) and the inability of representatives to agree to the reform package before the state assembly broke last week for summer.
Pension reform is the reform of our lifetime, according to Illinois governor, Pat Quinn, who is determined to fundamentally change the system.
“We must enact bold reform that eliminates the unfunded liability,” he says.
The state is facing $83 billion in unfunded liabilities and Quinn is worried about ratings-agency suggestions they will lower the state’s credit rating if the state assembly doesn’t take action.
The reform agenda includes increasing employer contributions so the funding ratio will reach 100 per cent in 2042. It also proposes that members increase their retirement age to 67.
The eruption of Mike Bost in the Springfield assembly last week is indicative of the frustration that policy makers, fund trustees and staff are experiencing with regard to the dire pension situation in the US.
Bost, who reacted strongly to the amount of time he had to discuss a pension-policy reform agenda, launched into a soliloquy about the adverse control of the state speaker and the inability to effect reform.
“I feel like someone escaping from Egypt: let my people go,” he yelled in the assembly last week. “I’m trapped by the rules being forced down my throat. We live in a democracy, but not here. The speaker has too much control.”
A few days after his outburst, the Illinois House of Representatives broke for the summer but pension reform was not passed due to disagreement on a provision to shift the pension costs from state to local school districts.
Now the governor is calling for a special legislative session in the summer to deal with the reform.
“We are racing the clock,” he said.
The Illinois State Board of Investments manages the $11.5 billion in assets of the pension funds and has a fairly aggressive allocation: US equities 30 per cent, international equities 20 per cent, fixed income and cash 20 per cent, private equity 5 per cent, real estate 10 per cent, infrastructure 5 per cent, hedge funds 10 per cent.
While the state politicians could not agree on the “reform of our lifetime”, they did pass a law called the “skin tax”, which will charge strip-club patrons $3 each – the money going to sexual-assault-prevention services.
Who would be a politician?
Fair enough: contribution holidays were not a smart idea.
But if liabilities are compounding at 8.5 percent, does that not suggest contribution rates were too low to start with.
You can only earn 8.5 percent if you put 100 percent in equity like instruments
Let’s be clear the current pension problem has little to nothing to do with benefits it is instead caused by decades of governors and lawmakers from both political parties who have chosen to spend available revenues on other state programs rather than sock enough away to pay for the pension benefits workers were earning. The dollars not put into the retirement kitty in turn did not earn any return on investment or compound over the years, so the gap has grown ever increasingly larger.
The partial pension payment holidays (SB 27) taken in FY 2006 and FY 2007 is only one example of how dramatically not contributing the required state contributions can lead to increasing the state’s unfunded liability in this case by $7.1 billion in only three years. During that period, no retirement benefits were increased but because interest on the unfunded liability compounds at between 8.0% and 8.5%, any payment shortfall, such as the pension holiday, quickly increases the unfunded liability.
“The deadly combination of nearly 30 years of systematic state underfunding of its employer contributions to the pension systems, followed by the cataclysmic decline in asset values caused by the national meltdown in financial markets over the last year, has combined to create an all-time high in the state’s unfunded pension liability,”
To know how to fix the problem we must first know what caused the problem. The problem has been caused by drastic underfunding of all state pensions except one, IMRF which, wait for it, has a mandatory funding provision.
The answer lies in 1. Re-setting the actuarial clock to 100% funded in 40 years using sound actuarial assumptions of level payments. 2. Mandatory funding like the IMRF pension fund enjoys. 3. Negotiate with labor to participate in some reduction in benefits and or increases in employee contributions. The road will be rough for all but it is obtainable if all parties will look at what the problem is and then how to fix it.