Policy procrastination: state pension systems

Always put off until tomorrow what you can do today — eventually you'll get out of a day's work! Applied to someone's daily tasks, that facetious paean to procrastination contains a certain element of truth. But when public policymakers collectively subscribe to it, then it becomes a likely invitation to future headaches. Consider, for instance, the financial condition of the state's public employee retirement systems. The five systems, which cover state workers, university faculty and staff, suburban and downstate teachers, legislators and state elected officials, and judges, currently face unfunded liabilities projected to total between $6.5 billion and $6.2 billion, depending on whose assumptions you prefer.

Because the benefits being drawn by a retired worker can be considered deferred compensation for past service rendered, failure to adequately fund retirement systems pushes a portion of today's payroll costs off onto future generations. We're asking our children and our grandchildren to pay outstanding bills we've left for them, bills for work performed and services provided long before some of them were born.

Until recent years, the state's longstanding policy has been to contribute into the systems each year an amount matching the dollars paid out in benefits. That rule-of-thumb was abandoned, however, in 1981 as the state was in the early throes of the financial crisis that ultimately led to higher taxes. Gov. James R. Thompson and the legislature shaved the funding level to 62.5 percent of payout for fiscal year 1982 and even further, to 51 percent, for fiscal 1983. For the next four budgets, the governor and the lawmakers followed a new standard — 60 percent of payout —until last summer, when Thompson carved deeply into pension appropriations to bring the legislative spending plan into line with what he said were available resources. As a result, the state's contribution this fiscal year amounts to only about 43 cents for every $1 expected to be paid in benefits.

Such cuts, of course, have not gone unnoticed by the employee groups for whom the systems are designed. Retired teachers have been particularly vocal in urging that pension systems be soundly financed. The most emotional question involved in pension funding — whether the assets will be there to pay an employee the benefits he or she earned when the employee retires — is probably one of the easiest to answer: a constitutionally guaranteed yes, underwritten by Article XIII, section 5 of the 1970 Constitution, which provides that earned pension benefits cannot be diminished or impaired.

But lobbyists for teachers, state workers and others in the system know that the funding level is important in winning new or expanded benefits; one of the first objections to any proposed pension sweetener is always its impact on a system's fiscal health. And because earned pension benefits must be paid as a matter of contract law, chronic underfunding could mean that at some future point, the allocations for pensioners' checks could cut into available revenues for schools, human services and other current programs. In fact, an analysis of long-term state obligations prepared by Illinois Economic and Fiscal Commission staff projected exactly that result. Under the study's assumptions of no major changes in current bonding practices, if state pension contributions continue to match 60 percent of payout, "nearly all of the growth in annual long-term obligations as a percent of general funds revenue from FY 1987 through FY 1995 would be attributable to pensions," the report noted. "This would lead to pressure to either increase revenues, cut program spending, or . . . reduce pension contributions."

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Payout is expected to increase about 7 percent annually, while the study projects revenue growth averaging 4 percent a year. By 2005, pension funding at the 60 percent of payout level would require about $1.5 billion, a 6.5 percent slice of the general funds pie, up from 3.7 percent in fiscal 1986.

Cost aside, there's a more fundamental reason why it's not good practice to base pension funding on a percent of payout: It's essentially an arbitrary policy because the amount required to cover this year's checks for benefits earned in the past is no reliable indicator of what will be needed in future years to pay for benefits being earned now. "There's no connection between payout and a system's funding needs as determined by the actuaries," said James J. Ofcarcik, the commission's manager of long-term debt analysis. "It's the difference between meeting expenses as they occur, or planning for them with an educated guess about the future."

A better practice, the commission study suggests, would be to base pension funding each year on the actuarially determined needs of the system. If the legislature opted for one such approach now pending in the House — the so-called level percent amortization method — it would be less costly over the long run and leave the systems fully funded to boot, the commission study shows. That method involves pegging contributions to the same percentage of payroll each year, a figure representing the future costs of benefits being earned in the year plus the pro-rata amount needed to retire the unfunded liability over a 40-year span. Under that formula, the state would be required to contribute less over the next two decades than under the 60 percent of payout approach, including a savings of more than $200 million in 2005 alone, according to commission staff estimates.

Switching to level percent amortization would require an additional $85 million in state contributions this year, probably a prohibitive price tag. But sooner or later, lawmakers must come to grips with the pension funding issue, and both common sense and the potential for long-range savings dictate that actuarially determined needs, rather than payout, should be the standard for making budgeting decisions for the state retirement systems. □

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