The state of the State

Public pension funds: Asset or liability?

WHEN STATE OR LOCAL governments run short of cash — as in the case of New York City — covetous eyes turn toward a fiscal resource not listed in the usual treasury report: the assets of public employee pension funds. But these funds, with assets in the billions of dollars in a state such as Illinois, are themselves potentially in difficulty because of failure to provide sufficient funds to pay future pensions as they become due.

In Illinois there are 455 state and local government pension systems with over one-half million participants, $4.2 billion in assets — but accrued liabilities of almost $10 billion. Thus their unfunded liabilities — the amount not now available to meet eventual pension obligations — exceeds $5.7 billion.

It is no secret that the money is not in the pension funds for future obligations, but the future looks a long way off when government has immediate and pressing needs for education, public aid, etc.

Commission deplores 'deficits' The Illinois Public Employee Pension Laws Commission in its biennial reports to the governor and General Assembly has regularly called attention to what it terms "deficits." Two years ago, the commission said the "rise in this obligation has been steady, persistent and at a considerably greater rate than the increase in membership" of pension systems. The commission added:

The larger proportionate rise in the unfunded liability [in 1974] was due principally to the inadequacy of governmental contributions to meet the requirements on account of new members. Another contributing factor was increased salaries. Salaries have a direct relationship to pension cost. Increases in salaries during recent years created additional pension obligations for which no provision was made. The increase in obligations, at least during the last several years, cannot be attributed to low rates of employee contributions. These rates have been increased progressively since the year 1945 upon recommendation of this Commission and are now among the highest for public pension funds in the United States.

The commission contends that pension costs should be integrated with salary costs, arguing that the "accruing cost of pensions is properly a part of the employee's compensation for services rendered. "The failure to provide currently for the governmental shares of pension reserves has been a constitutional and political issue in Illinois. The 1970 Constitution provides that membership in a public pension system is "an enforceable contractual relationship, the benefit of which shall not be diminished or impaired" (Art. XIII, sec. 5). However, Gov. Dan Walker in 1974 used his reduction veto to cut $187 million from the appropriations for three pension systems (universities and Chicago and downstate teachers). The Illinois Supreme Court upheld his action in People ex rel. v. Lindberg (March, 1974). The Supreme Court said that the funding provisions established no vested right. The opinion (see June 1975) quoted a delegate as saying during the convention that the provision "was not intended to require 100 per cent funding or 50 per cent or 30 per cent funding or get into any of those problems. . . ." The U.S. Supreme Court in October refused to review the case, and the Illinois decision now stands as the law.

Too many small systems? Table 1 identifies the 15 major systems, showing assets and unfunded liabilities of each. The fact that there are 440 small local police and firemen's pension funds has regularly drawn Laws Commission for the consolidation of these small systems to permit better management and administration and to spread the risks over larger systems, Half of the 440 systems have fewer than 25 members, a fourth of them fewer than 15 members. Each of these small systems is administered by its own board of trustees, consisting of fund participants and local officials. The insurance department noted such deficiencies in their operation as errors in computing and benefits granted, maintenance of large cash reserves (instead of investing the money), failure to hold regular board meetings, failure to maintain adequate membership records, and inadequate or loosely maintained accounting systems.

Management of investment portfolios calls for expert advice. In the case of three of the state funds (the judges, General Assembly, and state employees), a State Board of Investment manages investments. "This method ... offers several advantages among them being: the ability to retain top level investment management personnel,

day-to-day monitoring and evaluation of the results achieved, and the economies of administration provided through utilization of a single management facility," the insurance report notes.

The small police and fire funds are limited by law to investment almost entirely in government securities — primarily because of the lack of investment expertise and the small size of the funds. The report notes that rates of investment have been satisfactory in recent years, but this may not always be so.

Investment of funds

About four-fifths of the assets of all 455 funds have been invested in securities. An assets analysis in the insurance report shows the following distribution in percentages:

Securities                          Per cent
Governmental bonds                  18.0
Corporate bonds                       60.2 
Corporate stocks                       15.2
Other securities (mortgage loans,
savings and loans, short-
term notes, etc.)                           6.6
                                                100.0

The commission has been concerned with the temptation to use pension funds for other governmental purposes. Condemning such proposals, the commission noted, "In some States, pension fund reserves are being applied to investment in bonds of the particular governmental units serviced by the pension funds at lower interest rates than are obtainable on eligible securities such as corporate bonds. In others, pension funds have been applied to finance church mortgages, the building of plants to help bring industries into the State, or for construction of office buildings." As another questionable practice, the commission cited the use of pension fund reserves to help municipalities market their bonds at low interest rates.

The report emphasized that pension trustees are obligated to administer the funds for the benefit of those who will eventually look to them for retirement income and that a trustee "must refrain from placing himself in any position which may give rise to a conflict with his duties as trustee."

Over 100,000 draw benefits

Consolidating all systems to illustrate the broad situation, Table 2 shows almost 416,000 public employees are active participants in the systems and drawing salaries totaling $4.5 billion per year. More than 100,000 persons are drawing benefits from the funds — benefits totaling almost $340 million. The table indicates that the average annual benefit per individual was $3,270 per year. Pensions are supplemented in many cases by Social Security checks and beneficiaries may continue to work — but not, of course, for the government from which they are drawing a pension.

One of the most serious problems for beneficiaries of all pensions is the dwindling buying power of pensions in times of inflation. The recommendation of the Pension Laws Commission for an automatic increasing annuity plan to deal with this problem has been implemented by legislation. This provides for an automatic increase in pensions after retirement equal to two per cent per year. It is financed by additional employee and employer contributions of one-half of one per cent of salary.

What do employees put into a pension system and what may they expect eventually to receive? The state teachers' retirement system (applicable to public school systems outside Chicago) is the largest system and is one example:

Teachers pay 7 per cent of their salary toward a retirement annuity and another 1 per cent for a spouse's and survivors' annuity. The approximate obligation of the employer, paid by the state, is 9.3 per cent. A teacher may retire and draw an annuity at age 55 with 20 years service, or at age 60 with 10 years service, or at age 62 with only 5 years service. The amount of the annuity is based on average final salary multiplied by 1.67 per cent for each of the first 10 years, 1.9 per cent for each of the second 10 years, 2.1 per cent for each of the third 10 years, and 2.3 per cent for each year in excess of 30. There is some reduction if the teacher retires under age 60. Thus after 20 years' service and at age 60, a teacher would draw a pension of 35.7 per cent of the salary base; after 30 years, the pension would equal 56.7 per cent of the salary base. The maximum pension payable to teachers is 75 per cent, which would be reached after teaching 38 years. There are also provisions for spouse's, survivors' and parents' annuity and disability benefits.

The benefits under the state employees' and universities' systems are similar to the above. The systems for judges and legislators call for greater contributions but the payout is greater, too. Legislators pay in 10 per cent of salary (8 per cent for retirement, 2 per cent for spouse's annuity). After 8 years of service (four 2-year terms) at age 55, they can begin to draw a pension; after 4 years of service, they can draw at age 62. The pension is 3 per cent of the salary base for each of the first 8 years of service, 4 per cent for each of the next 4 years, and 5 per cent for each year above 12. Thus after 14 years of service, a legislator at the appropriate age could qualify for a pension at 50 percent of his salary base.

Legislators do not, of course, ordinarily make a long-term career of service in the General Assembly, so a system that pays out for fewer years of service is necessary. That is the case also with the judges whose system requires membership contributions of 11 per cent. A judge with 10 years on the bench can retire at 60, and for that 10 years he gets a pension of 35 per cent of his salary base. He gets 5 per cent of the base for each year over 10. If he has served for 20 years, his pension is 85 per cent of his salary base (the maximum pension allowed for judges). With fringe benefits of this kind, legislative or judicial service can be very attractive./ W.L.D. �

Table 2 Active participants, beneficiaries, and fiscal data