Conservatives are calling for a total transformation of Illinois’ public pension system in the wake of Democratic Gov. Pat Quinn’s failure to reform the program, which is nearly $100 billion in debt.
Bob Williams, president of State Budget Solutions (SBS), says Illinois will be the first of many states to fail if something is not done to quell rising retirement costs for state employees and teachers.
SBS, a conservative nonprofit, has studied the fiscal problems of all 50 states and sees one common denominator to curbing pension shortfalls: Converting defined-benefit retirement plans in which employees receive set benefits regardless of a state’s financial health to the defined-contribution plans common in the private sector.
"The only solution is a 401(k)-type, defined-contribution system," Williams said. "These defined-benefit systems are underfunded woefully, and unfortunately, too many states aren’t waking up to reality."
Illinois already supplies defined contribution plans to state university employees through its TIAA-CREF program. That retirement system is the healthiest in the state since lawmakers are forced to match employee contributions in a timely manner even as they have ignored and delayed full contributions to the defined benefit systems.
Illinois has the lowest credit rating of any state and is in danger of being reduced to junk bond status because its pension liabilities are 39 percent funded. That is less than half of what accounting professionals consider healthy. The TIAA-CREF system, by contrast, enjoys the highest credit rating from each of the four major rating agencies.
"The higher-ed system has performed very well because members are involved directly," Williams said. "If the legislature did not fully fund its contribution, the faculty would immediately know about it. Whereas in a [defined-benefit] plan, they assume the money is going to there—it’s obviously not."
Williams’ proposal is gaining steam among some political insiders in Illinois but reform-minded Democrats, including Gov. Quinn, are cool to the idea. The governor has proposed a number of smaller reforms to cut back on the system’s $97 billion debt to no avail. Democrats, who hold super majorities in both legislative branches, refused to vote on his lame duck push to create a super-committee to resolve the crisis.
Conservative activists from the Illinois Policy Institute, a state think tank, opposed Quinn’s plan because he seemed unwilling to push for major reforms.
"It’s clear that Pat Quinn does not understand the full scope of the problem. He’s just flailing around," said Jonathan Ingram, IPI’s director of health policy and pension reform.
"Defined-benefit plans are outdated, virtually unheard of in private sector and for good reason. They assume that you can predict what the [stock] market’s going to look like in 30 years, what the life expectancy is going to be; there are too many variables to account for."
Unions have fought against defined-contribution reforms, a major reason Quinn has not entertained the idea. Anders Lindall, spokesman for the politically powerful American Federation of State, County, and Municipal Employees, said conservatives are trying to exploit the crisis by blaming employees rather than politicians for the funding shortfall.
"They won’t be happy until no worker has a defined-benefit pension," he said. "They want everyone to have private 401(k) accounts that have failed to provide an adequate retirement savings for the American middle class."
Defined benefit systems cut costs to taxpayers since pooled money can be managed at a cheaper cost than individual retirement accounts, according to Lindall. The accounts also protect employees by putting their money in the hands of professional investors.
The average 401(k) for households of people ages 45-54 lost about 7 percent of its value during the Great Recession, while households with younger people (ages 35-44) more prone to risky investments lost about 20 percent of their savings, according to U.S. News and World Report.
Public pensions were not immune from the downturn. The Teacher’s Retirement System, the largest in the state, lost 5 percent of its value in FY 2008 followed by a 23 percent decline in 2009 before rebounding with a 13 percent gain in 2010.
Ingram said the decline is indicative of the risks inherent in underfunding the system. Illinois assumed its system would grow by 8.5 percent every year for decades. Such optimistic assumptions allow lawmakers to pay less into the system but also force state money managers to invest in more volatile assets, such as stocks, rather than lower yielding but less risky fixed income assets.
"They’re forced to reach for higher and riskier terms; there’s no security," Williams said.
The investment losses led Illinois to reduce its assumed rate of return to 7.75 percent in four of the state’s five systems—teachers reduced their rate to 8 percent. The lowered rates are still 22 percent higher than the average return of the best performing private sector pension systems at the start of the recession.
Reformers should rely on bluntness to counteract union influence and political timidity, Williams said.
"We have to be honest with the workers and let them know that as things stand, there won’t be any money left for them down the road," he said. "There’s only so much you can get from taxpayers."