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 The state’s five pension systems collectively held nearly $139
billion of debt at the end of fiscal year 2019, according to state financial
reports.2 But that number actually undersells the size of the state’s debt
crisis. Moody’s Investors Service, a credit rating agency that uses assumptions
more in line with private sector pension accounting, estimates the true debt
burden is significantly higher than state estimates. Most recently, Moody’s
pegged total state pension debt at $241 billion at the end of fiscal year 2018.3
That debt burden equaled more than 505% of annual state revenues, the worst
pension debt-to-revenue ratio of any U.S state.4
Local government pension debt adds another $63 billion,5 bringing total state
and local pension debt to more than $200 billion, according to official
estimates. Moody’s does not provide independent estimates for all local systems.
Stock market losses related to the global coronavirus pandemic will cause those
debt burdens to increase further and faster than previously expected. That’s
because investment returns are a key source of pension fund income, accounting
for 63% of revenue from 1989 to 2018 for all public plans nationally.6 The other
two sources of public pension fund income are employee contributions and
employer contributions, the latter of which means taxpayer contributions.
In Illinois, shortfalls in investment returns must be made up with higher
taxpayer contributions in subsequent years. Employee contributions and benefits
are both fixed by state law, meaning current system design requires no shared
sacrifice from retirees or current workers to cover funding gaps.
More than 1 in 10 Illinoisans – 1.1 million, or about 11.4% of the adult
population – are members of an Illinois public pension system.7
State worker contributions typically cover only about 4 to 6% of lifetime
benefit payouts. The average lifetime payouts for members of the state
retirement systems exceeds $1 million, and employees with 30 years of service or
more can typically expect to collect more than $2 million. The only exception is
for employees of state agencies and boards – nearly all of whom also qualify for
Social Security – where the average benefit is a still generous $1.7 million
even without Social Security payments factored in.
Ultimately, this flawed system design harms every resident in
the state, including those relying on taxpayer-funded pensions for their
retirement security. The financial burden it places on businesses and private
sector workers is larger than they can bear, making the pension plans
unaffordable and unsustainable in the long run. Eventually, the funds are likely
to run out of money and be unable to pay promised annual benefits to retirees.
Even in the run-up to insolvency, public pension debt is already inflicting
great harm on Illinois through higher taxes, fewer jobs, lower economic growth,
residents moving out and cuts to public services that weaken the social safety
net.
Pension costs are already eating away at Illinois government services. Pension
costs increased by more than 500% during the past 20 years. Spending on core
services, including child protection, state police and college money for poor
students, dropped by nearly one-third since 2000.8 Pension contributions
accounted for less than 4% of Illinois’ general funds budget from 1990 through
1997 but have grown to consume more than a quarter of the budget in recent
years.9 That growth crowded out the state’s ability to spend money on programs
that provide value to residents.
To avoid a future in which taxpayers are asked to pay ever more in taxes for
fewer and fewer government services – while public servants are left with shaky
retirement systems – Illinois must enact structural reforms as soon as possible
to make pensions more resilient and affordable.
COVID-19 MARKET VOLATILITY THREATENS TO PUSH STATE PENSIONS OVER THE EDGE
Mary Williams Walsh, a New York Times reporter with experience covering
bankruptcies in Puerto Rico and Detroit, wrote that “public pensions are the
time bomb of government finances” in an article examining the impact of COVID-19
on pensions.10 In this unfortunately accurate analogy, that time bomb is also
made of highly unstable nitroglycerin. Eventually, the bomb will explode, and
the wrong shock threatens to set it off earlier than expected.
While this is a problem for many governments across the country, Illinois is
home to the worst pensions crisis and faces the greatest risk.
Whether COVID-19 will trigger the inevitable explosion remains to be seen and
will depend on how quickly financial markets are able to recover from the
downturn. Regardless, the pandemic exposed the unacceptable fragility of many
government pension systems and should serve as a wake-up call for elected
officials.
Without transformative changes to pensions, a severe economic downturn will
start a slide to insolvency and the potential collapse of government finances.
This risk was apparent long before COVID-19.
While the state’s official projections show all five state funds will reach 90%
funding by 2045, this assumes the funds are able to obtain a consistent return
on investment of between 6.5% and 7%.11 The state has regularly missed its
investment return targets in the past, even when the economy was growing,12
demonstrating how unrealistic these assumptions have been.
As a result of overly optimistic expectations for investment growth, taxpayer
contributions to the systems have grown much faster than official projections
suggested they would. From 2010 to 2019, taxpayers were forced to pay $7.6
billion more than the state estimated they would, compared to projections five
years prior to each payment. On average, taxpayer costs were 15% higher than
expected during the past decade. But despite being asked to pay
more each year and more than expected, taxpayers still cannot keep up with
growing pension debt. A major hit to investments would start an inevitable slide
to insolvency.
An actuarial stress test of the systems commissioned by the Illinois Policy
Institute in fall 2019 shows if state-run pension funds lose 20% of their asset
value as a result of a recession – the same loss experienced in 2009 – and the
average return on investment matches the roughly 4.6% the funds experienced in
the 10 years after the last recession,13 the state’s major retirement systems
will run out of money in fewer than 30 years.
Under the stress test scenario, the State Universities Retirement System would
be the first to reach insolvency, and by 2039, the fund would be unable to pay
full benefits with assets on hand. The other systems would see their funding
ratios – the amount of money on hand to pay promised benefits – decline each
year despite constantly increasing employer contributions. Retirement systems
for teachers, state employees and elected officials would run out of money
between 2046 and 2048.
In the early days of the pandemic, the above scenario seemed poised to become
reality.
Moody’s estimated on March 24 that if market losses continued along their
downward trajectory at the time, the average pension fund would see annual asset
losses of 21% in fiscal year 2020.14 The estimate is based on a representative
sample of 56 large pension funds that account for roughly half of total U.S.
pension assets and liabilities. Moody’s uses publicly available market indices
that closely match the investment portfolio makeup of these funds to estimate
losses in real time.
Unfortunately, most pension funds, including those in Illinois, do not supply
even quarterly data on their investment performance. Actual annual results may
not be available until December, months after the June 30 end of fiscal year
2020.
More dire predictions came from The Pew Charitable Trusts, which in a report
April 24 estimated overall state pension debt would increase by $500 billion.15
That is a nearly 42% jump in one year.
However, market conditions have improved substantially since March. Pension
investment losses will likely be less severe than Moody’s snapshot estimate.
Using Moody’s same methodology, market indices point to an average loss of 0.13%
as of the end of the fiscal year on June 30.16 But Illinois pensions will still
almost certainly miss their optimistic target rates of return. This will drive
debt and taxpayer contributions higher than pre-pandemic projections, though
losses of this size are unlikely to trigger the total collapse that appeared
possible in March.
Regardless of whether COVID-19 triggers the day of reckoning for Illinois
pensions, it demonstrates how fragile the current system is. This should be used
as an opportunity to fix the problem before it’s too late by building broad
consensus around the need for reform.
Illinois’ pension status quo not only harms taxpayers and vulnerable state
residents, but it also harms the state and local government employees relying on
these systems for their retirement security. The Illinois Constitution’s pension
clause has been interpreted as preventing any reduction in benefits, including
future growth for work not yet performed. That strict reading will not matter if
there’s no money.
Legal scholar and pensions expert Amy Monahan has argued even ironclad legal
provisions preventing benefit cuts cannot be used to force states to pay full
benefits if funds become insolvent.17 Simply put, if there’s no money, benefits
can’t be paid without impairing the state’s ability to exercise the basic
functions of government, and courts cannot force legislatures to spend money or
incur debt.
LOCAL PENSION DEBT WILL CONTINUE TO DRIVE CITY SERVICE CUTS AND PROPERTY TAX
HIKES
Pension debt poses financial risks to many Illinois cities at least as severe as
the risk to the state – and in some cases worse. Mayors and other local elected
leaders have been saddled with pension systems created by state law and have
virtually no options to reduce costs or improve sustainability on their own.
Cook County Treasurer Maria Pappas told The New York Times that in the COVID-19
era, the condition of local pensions is “like a rubber band that’s been
stretched too thin” and warned “the rubber band is about to break.”18 Local
pension funds include eight Chicago funds, two for Cook County, the Illinois
Municipal Retirement System, and nearly 650 police and firefighter systems for
cities outside of Chicago.19
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Chicago’s eight pension funds alone have more debt
than 44 U.S. states, at more than $46 billion.20 Even before the
pandemic, annual pension contributions from the city budget were
expected to grow by $1 billion from budget year 2019 through 2023.21
Accounting for likely 2020 investment losses and the expected
increase in taxpayer contributions, Chicago residents are likely to
be hit with higher taxes, reduced city services or both to keep up
with pension costs. Chicago Mayor Lori Lightfoot has
already made clear a property tax increase is on the table to deal
with a city budget deficit of at least $700 million.22 Higher than
expected pension contributions resulting from investment shortfalls
make a significant property tax increase more likely.
Many cities across the state face pension crises similar to
Chicago’s. Unfunded pension liabilities in downstate public safety
pension funds, which provide retirement benefits for municipal
police officers and firefighters, have grown nearly 140% since
before the 2008 financial crisis, ballooning to $12.3 billion in
2018 from $5.2 billion in 2007.
The overall public safety funding ratio has never recovered from the
Great Recession, despite a decade of strong financial markets and
economic growth. Illinois cities had only about 55 cents saved for
every $1 in current and future pension benefit promises as of 2018,
the most recent data available for all systems.
Gov. J.B. Pritzker and the Illinois General Assembly did take a
small step toward addressing the rising debt and costs of local
pensions in December 2019 by enacting a bill to consolidate the
state’s nearly 650 public safety pension funds into just two, one
each for police and firefighters.23 Combining small pension funds
can help reduce administrative costs and enable higher investment
returns because larger asset pools can generally diversify their
investments more effectively and attract more professional
investment managers.
However, a number of factors will limit the effectiveness of
Pritzker’s pension consolidation measure.
First, the governor stopped short of proposing full-scale
consolidation, electing instead to pool investment assets but leave
in place various administrators for each local system. Failing to
consolidate benefit administration means the state is forgoing $7
million in annual savings, according to a 2018 estimate from the
Anderson Economic Group.24
Second, enhanced benefits for workers hired in 2011 or later were
added into the pension consolidation bill late in the legislative
process. While the task force created by Pritzker publicly claimed
these benefit sweeteners would cost between $14 million and $19
million more per year – compared to their estimate of between $160
million and $288 million in higher returns – this was not based on
any publicly available methodology or professional actuarial
analysis.25 The benefits of consolidation could be wiped out if the
cost of the pension sweeteners is higher than expected, as tends to
be the case with official Illinois estimates for pension costs, or
if estimates for additional investment revenues prove overly
optimistic.
Lastly, the actual process of consolidating the funds is not
expected to be completed until July 1, 2023.26 Downstate pension
funds will not reap the benefits of pooling investment assets in
time to help offset losses stemming from COVID-19.
Mid-sized Illinois cities whose pension funds were troubled prior to
the crisis will be at particular risk of service crowd-out and tax
hikes going forward. Even after consolidation is complete, assets
and debt for each pension fund will be accounted for separately and
belong only to the corresponding local government. Generally
speaking, a pension funding ratio of 60% or less means a plan is
deeply troubled, while a funding ratio of 40% or less indicates a
pension fund cannot recover without significant structural reforms.
The 20 cities listed below represent deeply troubled pension funds
in municipalities with populations of roughly 25,000 or more.
Pension debt per resident of these cities ranges from around $1,800
in Carbondale to nearly $5,600 in Melrose Park. That’s on top of
$16,680 in state debt per person as of 2018, which translates to
more than $44,000 per household.27 Each of these 20 troubled cities
has at least one public safety pension fund with less than 50 cents
saved for every $1 in future payouts. Such low funding ratios mean
these funds are at risk of insolvency just like the state funds if a
recession causes major asset losses.
Additionally, the losses caused by COVID-19 will almost certainly be
worse for local public safety funds than for statewide funds. A
report from Pritzker’s task force on fund consolidation compared
average investment returns of downstate public safety funds to
larger Illinois funds. From 2012 to 2016, downstate police and fire
pension funds averaged a return of just 5.06% while all other funds
averaged 6.89%.28 This gap means taxpayer costs will likely rise
faster in local pension systems compared to the state funds,
straining city budgets and potentially driving higher property
taxes.
In recent years, many cities have already been forced to either lay
off current workers, raise taxes or both to keep up with the cost of
these pension systems. For example:
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Jerome,29 Geneseo,30 and Norridge31 raised
property taxes to pay for pension costs in 2018.
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The south Chicago suburb of Harvey in 2018 laid
off one-quarter of its police officers, more than half of its
other police department personnel, and 40% of its firefighters
after the state intercepted money bound for the city under a
pension law intended to force cities to make required pension
contributions.32
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In 2019, the pension intercept law was also
triggered in North Chicago and East St. Louis.33 The resulting
increase in pension costs for the cities’ budgets resulted in
$1.3 million of cuts in North Chicago, including layoffs for
three firefighters, and nine firefighter layoffs in East. St
Louis.
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Peoria, which in 2018 eliminated 38 first
responder jobs and 27 municipal jobs,34 has already been forced
to cut an additional 45 jobs in 2020 after COVID-19 exacerbated
the city’s pension-driven budget woes.35
The cost of local pensions is the chief cause of
Illinois’ high property taxes, driving the state’s property tax
burden from around the national average in 1996 to the nation’s
second highest 20 years later.36 Without true pension reform that
reduces overall pension liabilities in downstate police and fire
funds, Illinoisans in troubled cities will continually be asked to
pay more in taxes in return for reduced city services.
CONCLUSION: REFORMING PENSIONS FOR RESILIENCY AND AFFORDABILITY
WOULD BENEFIT EVERY ILLINOISAN
Illinois’ pension crisis is the most severe public policy issues
facing the state. Pension debt can be directly linked to high taxes,
reductions in government services, low home values and lagging
economic growth. Market volatility linked to COVID-19 will
exacerbate these problems and, by exposing the risk of total pension
collapse, should be seen as an opportunity to build consensus for
needed reforms.
However, the political hurdles to reform remain high. Amending the
state constitution’s pension clause, a necessary first step for any
successful reforms initiated at the state level, will require
approval from three-fifths of both chambers of the Illinois General
Assembly, along with supermajority ballot approval from voters in a
general election. Building the required consensus for change will
require political courage from lawmakers, honest dialogue with
public employees whose long-term retirement security is at risk and
widespread public acknowledgement of the problem.
For that to happen, politicians and residents will need to stop
looking to false solutions that double down on past mistakes. Higher
tax revenues are a self-defeating strategy in a high tax state that
already spends more on pensions than anywhere else. Further tax
hikes will only harm the state economy, preventing the sustainable
growth in government revenues that comes from a prosperous private
sector.
Pritzker’s proposed “fair tax” amendment – which would scrap the
flat tax protection in the constitution in favor of a progressive
tax system – cannot fix the pension crisis. The initial rates
attached to his proposal would fall far short of the revenues needed
to make a dent in the debt,37 making it highly likely that further
tax increases are to follow if voters approve his plan in November.
A progressive tax hike that would actually raise enough money to pay
off the pension debt, using the same bracket proportions as
Pritzker’s initial rates, would have to raise taxes on all taxpayers
by around 21%. A tax hike of this size would cost the state economy
nearly 127,000 jobs and $21.8 billion in economic output.
There is a much better option available. Amending the constitution
to allow for reductions in the future growth of pension liabilities,
without taking away a single dollar of already earned benefits,
could solve the problem in a way that’s fair and beneficial to every
Illinoisan.
An actuarial analysis commissioned by the Illinois Policy Institute
shows very modest reforms similar to those in a law passed in 2013 –
before it was thrown out by the Illinois Supreme Court – can solve
the pension crisis while leaving public workers with generous
retirement benefits that are more secure than the status quo.
Reforms that replace 3% compounding post-retirement raises with a
true cost-of-living adjustment pegged to inflation, that slightly
raise retirement ages for younger workers and that temporarily
freeze annual benefit increases for some of the state’s largest
pensions to bring them back in line with inflation can save the
state more than $2 billion per year while fully eliminating the debt
by 2045.38
COVID-19 was a dress rehearsal for the inevitable collapse of
Illinois pensions in the absence of reform. Unfortunately, state
elected leaders have no clear plan to prevent or manage this coming
crisis. For the sake of all Illinoisans suffering under the broken
status quo, it’s time to defuse the pension bomb before it’s too
late.
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