A primer on obligations and assets

A year ago this month, wrangling over proposals to increase pension benefits for public employees came to a head in the Illinois Senate.

What began as an effort by three Springfield Republican lawmakers to boost benefits for state workers, a major voting bloc in their districts, suddenly included downstate teachers and university workers.

Senate Democrats wanted to block the bill, if for no other reason than to prevent one of those Republicans, Sen. Larry Bomke, from scoring a key election-year legislative victory.

But joining the Democrats were eight Republicans who voted against the pension sweeteners, though they would have been a plum for a colleague's re-election bid.

"We're trying to cover a whale of a giveaway with a sardine of a contribution," Aurora Republican Sen. Chris Lauzen said at the time. "We deserve outright scorn. Politics and pension finance don't mix."

Unfortunately in Illinois, politics and pension finance often mix.

State officials have grappled with the issue again this year. And they will in the future. Though they might want to boost benefits for public employees, finding a way to pay for the increases is another matter. There are always other things to do with the money.

That's one reason the state is sitting on a $20.8 billion pile of retirement obligations that are not covered by pension assets. That's also why, by the year 2025, it's estimated that every man, woman and child in the state will be paying $433 per year to support current and future public employee retirees. (In the 1995 fiscal year, that per capita outlay was less than $44.)

There are five public employee pension systems that receive part of their income from annual state appropriations. Those plans cover current and future retired state employees, university workers, judges, members of the General Assembly and public school teachers outside of the city of Chicago.

The largest of the systems covers retired downstate teachers. At the end of fiscal year 1996, that system had $13.8 billion in assets. The pension plan for the General Assembly was the smallest, at $42.6 million in assets.

Like any pension plan, the five systems receive their income from three sources: employer contributions (in this case, the state), employee contributions and investment income. In the budget Gov. Jim Edgar submitted to the General Assembly in March, some $138 million in state funds were allocated to increased spending for the systems. Edgar is requesting a total of $856 million for all five funds next year.

Edgar didn't make that allocation due to any inherent interest in public employee retirement benefits. He and the General Assembly are operating under the strictures of a 1994 law intended to ensure that the systems have enough assets by 2045 to cover 90 percent of the pension obligations.

In the language of pensions, this will give the five systems a 90 percent funding ratio. Collectively, they had a funding ratio of just over 53 percent at the end of the 1996 fiscal year. However, that varied widely between systems, from 33 percent in the General Assembly Retirement System to more than 59 percent for the State Employee Retirement System.

There's no standard that dictates a 90 percent funding ratio for a public pension plan. Private pension plans are supposed to have a 100 percent funding ratio because there is always the risk a private company could go out of business. That risk is virtually nonexistent for a unit of government, particularly state government.

30 ¦ May 1997 Illinois Issues

Michael Mory, executive secretary of the State Employees Retirement System, says that when the 1994 law was drafted, a survey was conducted of hundreds of public pension systems and the average funding ratio was 90 percent. That's now the goal of the five Illinois systems.

To make matters more complicated, experts say the funding ratio doesn't necessarily track with cash obligations that aren't covered by income — the systems unfunded liability. At $12.3 billion, the pension system for down- state teachers makes up nearly 60 percent of the state's accumulated debt for the five plans. The university retirement system is next highest, at $5 billion, or nearly a quarter of the debt.

Still, funding ratios and unfunded liabilities and the rest of the dense technical issues surrounding pensions will have no impact on the key issue facing current and future retirees: whether they'll get the pension check promised by the state. Pension benefits are guaranteed by the Illinois Constitution. They must be paid regardless of the financial shape of the pension systems or state government.

Of course, an adequately funded pension plan still makes financial sense for the state. Pension fund dollars are invested, which earns money for the plans to help cover future obligations. More than 64 percent of the income reported by the five pension plans in the 1996 fiscal year came from investments. So obviously, the more money the plans have available to invest, the more investment income will be earned and the better off the pension systems will be.

One way to determine how much the state should pay into the pension plans each year is to compute the figure based on such factors as current and future salaries of retirees, projected employee contributions and projected investment income. Unfortunately, for years the amount of money the state put in the pension plans wasn't based on keeping up with future obligations or any other actuarially sound system. The state simply determined how much money was needed to meet the pension payments for current retirees and put that amount in the budget.

But that method didn't take into account a growing work force that was earning higher salaries and pushing the future pension obligations into the stratosphere. Starting in the mid-1980s, the state didn't even allocate enough money to pay current benefits. The effect on the pension systems of those years of neglect was dramatic. In the 1972 fiscal year, the unfunded liability of the five systems was $2.8 billion. By 1991, it had grown to $ 11.7 billion. Five years later, it was $20.8 billion.

The reason for under funding the pension plans is simple enough. State tax dollars are always limited. And because pension payments aren't jeopardized by under funding the systems, there was little pressure to put money into them at the expense of, say, education or prisons.

However, the mounting pension debt didn't go unnoticed, particularly when efforts were made to boost benefits. Many lawmakers were reluctant to approve increases, knowing they would add to a debt that was already growing.

In 1989, lawmakers made the first attempt at repairing the mess. As with the current law, the aim then was to restore fiscal health to the systems over the long haul.

There was a critical difference between the 1989 and 1994 pension laws, however. The 1989 bill left the pension fund appropriations up to the governor and the General Assembly. So, when the financial crunch hit the state in the early 1990s, the provision for funding pensions was simply ignored. The 1994 version made pension contributions a continuing appropriation. Actuaries determine each year how much money is needed to comply with the law and it is automatically set aside in the budget. In other words, pension contributions are no longer subject to negotiations between the governor and lawmakers.

Robert Mandeville, budget director under former Gov. James Thompson and temporary head of the Pension Laws Commission, notes that the law can still be circumvented. If lawmakers decide the state cannot afford to make the required contribution some year, they can vote to ignore it.

When the bill was drafted, though, its backers were banking that legislators would be reluctant to do that because of the potential political fallout.

The will of lawmakers to abide by the law has yet to be tested. It was implemented in the 1996 fiscal year, and Mory notes it is constructed so that larger pension payments are required the longer it is in effect.

"The 1994 plan is very backloaded, but at least it's a plan," Mory says.

"The test on this is going to be when there's a tough budget year."

That hasn't happened yet, but it's clear the law will have a major impact on the state's budget in coming years, according to calculations Mandeville made for members of the Pension Laws, Commission. In the current year, about 2.2 percent of the entire state budget goes toward pensions. By 2010, Mandeville estimates, 5.4 percent of the budget will go toward pensions. It will remain at that percentage until 2045, by which time the pension systems will meet that 90 percent funding ratio goal.

Even now, the pension funding requirement affects Edgar's proposed budget for the next fiscal year. For example, of the $230 million increase Edgar is requesting for elementary and secondary education, $77 million is devoted to pensions. Edgar makes the argument that a good pension program will attract quality people to the teaching profession, thus improving the quality of education. However, the fact remains that the pension money is not available for general state aid, special education, technology improvements or the other education programs people deem priorities.

The 1994 law is based on restoring fiscal health to the five systems over a 50-year period, an eternity in state government. It will work, pension experts insist, if it is given a chance. "The law doesn't mean anything if you don't follow it," Mory says.

Doug Finke is a Statehouse reporter for The State Journal-Register in Springfield.

Illinois Issues May 1997 ¦ 31