State pensions: funding shift, but funding short

State pensioners have been pushing for increased state funding of state pensions for several years. Retirees wanted better funding so that they could argue for pension benefit increases. Also seeking better funding was a handful of pension experts, who argued that by under-funding its pension system, Illinois was postponing debts onto future taxpayers. In June lawmakers approved a change in the way that Illinois goes about funding its pensions; they also approved benefit increases for retirees. But lawmakers came up with too little money to cover the changes, leaving pensions more unfunded than they were before.

First the funding changes. At issue was how much the state should contribute annually to the five pension systems it supports: those for state employees, university employees, judicial employees, down-state teachers and General Assembly members. The systems receive money from three sources: the employee contributions, which are set by law; the earnings on the money that the pension systems have invested, which are determined by the economy and the skill (sometimes the luck) of those making the investments; and the state contributions as employer, which are determined by lawmakers and the governor.

The historic benchmark for determining the state contribution has been the amount paid out in retirement benefits in any given year. Until 1982 the state had matched the amount paid out in benefits, allowing employee contributions and interest earnings to be invested and reinvested. In 1982 the state contribution was reduced to 70 percent of payout. In 1983 it was reduced again, to 60 percent of payout. And in 1988 the state share dropped to 44 percent of payout.

Clearly, 100 percent of payout was too large a state contribution. If the state were to kick in that much money each year, there would be no need for employee contributions or a state retirement system at all. The state would simply make then retirement payments each year, although at an ever-spiraling cost.

But 44 percent of payout has proved too little money. The financial health of the systems is measured by actuaries who estimate how much money the systems will have to pay out based on average life span and estimates of economic conditions. For 1988 actuaries for the five state pension systems put the liabilities (potential payout) at $20 billion and assets (estimated resources) at $12 billion. The difference, $8 billion, is the unfunded liability. And the funding ratio (asset to liability ratio) is 60 percent.

Those who criticize state funding of pensions point out there is no relation between what a pension system is paying out and what obligations are being incurred. An example. Take a fictional retirement system with 100 retirees drawing benefits and 400 active employees making pension contributions. If 200 new workers are hired who join that pension system, the payout will not increase. But with 200 new workers who will retire some ways down the road, the system will need to put aside more money to take care of those future retirees.

The shift that has been sought is a change from basing state pension contributions on payout, to basing the contributions on payroll. As part of the Omnibus Pension Bill signed by Thompson on August 23, Illinois is supposed to boost pension funding by $800 million between 1990 and 1996.

James J. Ofcarcik, manager of the debt analysis unit of the General Assembly's Economic and Fiscal Commission, finds some things to cheer about in the new bill. He likes the move from payout to payroll and approves of language in the statute that establishes the intention of moving to actuarial funding. "Around here you take your victories where you can get them," Ofcarcik says.

But lawmakers did far more than move to actuarial funding. They also boosted benefits. The first benefit change allows compounding of the annual pension increases that retirees receive. In the past if

October 1989 | Illinois Issues | 8

an individual had retired at a given pension, each year the pension would be increased 3 percent of the original pension. Say the person retired at $1,000 per month. Each year the pension would increase $30, to $1,030, $1,060, $1,090, $1,120, etc. The change enacted by lawmakers requires that the 3 percent annual increase be computed based upon the current not the original pension. In the example of the $1,000 pension the increases would be to $1,030, $1,061, $1,093, $1,126, etc.

The second benefit change made survivors eligible for annual increases and the compounding. They had received increases only through legislation granting specific increases to them.

Together the benefit changes boosted the liability of the systems by nearly $1 billion, according to an actuarial analysis done for the Economic and Fiscal Commission. "In one stroke of a pen, the accrued liability of the pension systems went up a billion dollars," Ofcarcik says. Boosting the liabilities by $1 billion also boosts the unfunded liability by $1 billion and drops the funding ratio from 60 to 57 percent.

What most worries Ofcarcik is the continued underfunding. Lawmakers added $30 million to state spending to cover the first step of the seven-year move toward actuarial funding. It would have taken $73 million, however, to cover the move and the increase in benefits. That leaves the state $43 million short going into the second year of the phase-in. And in the second year the required state contribution will jump another $101 million. Add that to the $43 million shortfall in the first year, and lawmakers will have to come up with $144 million to keep on track with pensions. In the five following years, the state needs $125 million in new money each year. The total seven-year cost is $800 million. "While we're glad to see some of the changes in there, we're concerned about the perception of setting aside $30 million, when the subsequent increases are much higher," Ofcarcik says.

The state has begun a move toward a more sound system of funding pensions. To get there will require a lot more money. Lawmakers came up with $30 million in a year that they hiked total spending $1.3 billion. In future years they will have to come up with lots more money when there is much less available.□

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