[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
EXAMINING THE RETIREMENT SECURITY OF
STATE AND LOCAL GOVERNMENT EMPLOYEES
=======================================================================
FIELD HEARING
before the
SUBCOMMITTEE ON EMPLOYER-EMPLOYEE RELATIONS
of the
COMMITTEE ON EDUCATION
AND THE WORKFORCE
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
August 30, 2006, in Springfield, Illinois
__________
Serial No. 109-54
__________
Printed for the use of the Committee on Education and the Workforce
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
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Committee address: http://edworkforce.house.gov
______
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COMMITTEE ON EDUCATION AND THE WORKFORCE
HOWARD P. ``BUCK'' McKEON, California, Chairman
Thomas E. Petri, Wisconsin, Vice George Miller, California,
Chairman Ranking Minority Member
Michael N. Castle, Delaware Dale E. Kildee, Michigan
Sam Johnson, Texas Major R. Owens, New York
Mark E. Souder, Indiana Donald M. Payne, New Jersey
Charlie Norwood, Georgia Robert E. Andrews, New Jersey
Vernon J. Ehlers, Michigan Robert C. Scott, Virginia
Judy Biggert, Illinois Lynn C. Woolsey, California
Todd Russell Platts, Pennsylvania Ruben Hinojosa, Texas
Patrick J. Tiberi, Ohio Carolyn McCarthy, New York
Ric Keller, Florida John F. Tierney, Massachusetts
Tom Osborne, Nebraska Ron Kind, Wisconsin
Joe Wilson, South Carolina Dennis J. Kucinich, Ohio
Jon C. Porter, Nevada David Wu, Oregon
John Kline, Minnesota Rush D. Holt, New Jersey
Marilyn N. Musgrave, Colorado Susan A. Davis, California
Bob Inglis, South Carolina Betty McCollum, Minnesota
Cathy McMorris, Washington Danny K. Davis, Illinois
Kenny Marchant, Texas Raul M. Grijalva, Arizona
Tom Price, Georgia Chris Van Hollen, Maryland
Luis G. Fortuno, Puerto Rico Tim Ryan, Ohio
Bobby Jindal, Louisiana Timothy H. Bishop, New York
Charles W. Boustany, Jr., Louisiana [Vacancy]
Virginia Foxx, North Carolina
Thelma D. Drake, Virginia
John R. ``Randy'' Kuhl, Jr., New
York
[Vacancy]
Vic Klatt, Staff Director
Mark Zuckerman, Minority Staff Director, General Counsel
------
SUBCOMMITTEE ON EMPLOYER-EMPLOYEE RELATIONS
SAM JOHNSON, Texas, Chairman
John Kline, Minnesota, Vice Robert E. Andrews, New Jersey
Chairman Ranking Minority Member
Howard P. ``Buck'' McKeon, Dale E. Kildee, Michigan
California Donald M. Payne, New Jersey
Todd Russell Platts, Pennsylvania Carolyn McCarthy, New York
Patrick J. Tiberi, Ohio John F. Tierney, Massachusetts
Joe Wilson, South Carolina David Wu, Oregon
Marilyn N. Musgrave, Colorado Rush D. Holt, New Jersey
Kenny Marchant, Texas Betty McCollum, Minnesota
Bobby Jindal, Louisiana Raul M. Grijalva, Arizona
Charles W. Boustany, Jr., Loiusiana George Miller, California, ex
Virginia Foxx, North Carolina officio
[Vacancy]
C O N T E N T S
----------
Page
Hearing held on August 30, 2006.................................. 1
Statement of Members:
Biggert, Hon. Judy, a Representative in Congress from the
State of Illinois.......................................... 4
Kline, Hon. John, Vice Chairman, Subcommittee on Employer-
Employee Relations, Committee on Education and the
Workforce.................................................. 1
Prepared statement of.................................... 3
Statement of Witnesses:
Brainard, Keith, research director, National Association of
State Retirement Administrators (NASRA).................... 10
Prepared statement of.................................... 13
NASRA letter............................................. 67
Letter of support to Messrs. Grassley and Baucus......... 69
GRS letter............................................... 71
Key facts benefits information sheet..................... 75
NASRA response to Reason Foundation study................ 77
Filan, John, director, Governor's Office of Management and
Budget, State of Illinois.................................. 20
Prepared statement of.................................... 24
Article from Governing.com, Management Insights column,
``Paying for Tomorrow''................................ 49
``Report on the 90% Funding Target of Public Act 88-
0593,'' and accompanying letters....................... 51
PowerPoint slides presented during statement............. 89
Giertz, J. Fred, professor, Institute of Government and
Public Affairs, University of Illinois..................... 7
Prepared statement of.................................... 9
Jinks, Irene, president, Illinois Retired Teachers
Association................................................ 18
Prepared statement of.................................... 19
Webb-Gauvin, Joanna, director of retiree programs, Council
31, American Federation of State, County and Municipal
Employees (AFSCME)......................................... 28
Prepared statement of.................................... 30
Weiss, Lance, consulting actuary, Deloitte Consulting, LLP... 33
Prepared statement of.................................... 34
EXAMINING THE RETIREMENT SECURITY OF
STATE AND LOCAL GOVERNMENT EMPLOYEES
----------
Wednesday, August 30, 2006
U.S. House of Representatives
Subcommittee on Employer-Employee Relations
Committee on Education and the Workforce
Washington, DC
----------
The subcommittee met, pursuant to call, at 11:05 a.m., in
room 400, Illinois State Capitol, Springfield, Illinois, Hon.
John Kline [Vice-Chairman of the Subcommittee] presiding.
Present: Representatives Kline and Biggert.
Staff Present: James A. Paretti, Jr., Workforce Policy
Counsel; Steven Perrotta, Professional Staff Member; Steve
Forde, Communications Director and Michele Varnhagen, Minority
Senior Benefits Counsel.
Mr. Kline. Good morning. A quorum being present, the
Subcommittee on Employer-Employee Relations of the Committee on
Education and the Workforce will come to order.
We are meeting today to hear testimony on Examining the
Retirement Security of State and Local Government Employees. I
ask unanimous consent for the hearing record to remain open for
14 days to allow members' statements and other extraneous
material referenced during the hearing to be submitted to the
official hearing record. And I have a note that some
organizations have already submitted statements and they will
be included in the record.
Without objection, so ordered.
Let me say greetings from the great state of Minnesota. I
flew in this morning and it is a pleasure to be here and be in
the land of Lincoln and be in this absolutely beautiful
Capitol, and a pleasure of course being with my colleague Mrs.
Biggert, who served here and who gave me a little tour. It is
absolutely terrific, and you should be very proud of it.
Today's hearing will begin an examination of the retirement
security of state and local government employees, but before we
start, I think some background is in order.
Earlier this month, President Bush signed into law the
Pension Protection Act, the most comprehensive reform of the
laws governing our nation's private sector pension plans. Just
a side note, I had the great pleasure of going to Washington
and being there for that signing ceremony and I can tell you
there was great joy in the room when that was signed. This bill
was overwhelmingly approved on a bipartisan basis by both
houses of Congress and represents a culmination of years of
examination and study by this Committee, among others.
Why was the Pension Protection Act necessary? Simply put,
it was needed to ensure that workers receive the pension
benefits that they have been promised and that they have relied
upon. It was needed to ensure that businesses have clarity and
certainty as to their pension obligations so that they can
budget and plan accordingly. And it was needed to ensure that
ultimately taxpayers, through Federal pension guarantees, are
not left holding the bag for billions of dollars of pension
bailout. The Pension Protection Act takes important steps, some
in the near term, others in the longer term, to ensure that the
retirement security of private sector workers receiving
pensions is guaranteed. The bill does so by adopting tough new
funding standards that employers will have to meet to make sure
that plans are sufficiently funded with real dollars. It
requires plans to use actuarial assumptions that accurately
reflect the performance of plans and the marketplace. It
targets and adopts tougher standards for those plans whose
funding levels indicate that they are at the highest risk. And
it does so by following a simple rule. When you are in a hole,
stop digging.
The Pension Protection Act prohibits plans from increasing
or expanding benefits when the plan is already under-funded and
at risk. That's simple common sense and something I expect
anyone in this room who has ever had to follow a budget for a
company or a school or a household understands all too well.
So what has that got to do with our hearing this morning?
As most who have had the good fortune--and I use the term
``fortune'' advisedly--to dig into the policy of pension
regulation knows, pension plans in the private sector are
governed by the Employee Retirement Income Security Act, the
Federal law known as ERISA.
Now certain plans, notably plans sponsored by states or
localities or municipal governments are exempted from ERISA's
coverage. Those plans instead are governed by local and state
pension laws. One of the questions before us today is does that
exemption make sense and are state and local government
regulations enough to protect public employees' pensions.
Within the last few months, we have seen more and more
reports that states and municipalities are facing the same
crises that private employers face with their pension plans--
increased benefits, more liabilities and an expanding gap in
the funding to pay for them. Across the country, from Texas to
California to New Jersey and right here in Illinois, we are
seeing on an almost weekly basis reports that the retirement
security of some state and local workers may not be as secure
as we would hope. The facts speak for themselves. According to
the U.S. Census Bureau, major public pension programs paid out
$78.5 billion in the 12 months that ended September 2000. By
the same period in 2004, pension payouts had grown by 50
percent to $118 billion.
State and local governments currently employ 14 million
people with an additional six million retirees. It is estimated
that these workers and retirees are owed $2.37 trillion by more
than 2000 different state and municipal government entities--
$2.37 trillion is a lot to us even in Washington.
Published government estimates suggest that the largest
state and local pension funds faced a funding gap of $278
billion in 2003. An analysis by Barclay's Global Investors
places the gap at closer to $700 billion. Even those that
dispute Barclay's number recognize that the potential under-
funding we are talking about is in the hundreds of billions of
dollars. Most recently, in March of this year, Wilshire
Consulting, based in Santa Monica, California, which has been
tracking the funding levels and performance of public pension
funds for over a decade, reported that state and local pension
systems are only 85 percent funded in the aggregate, down from
103 percent in 2000.
Indeed, we are here today because the State of Illinois has
the dubious distinction of having its public pension plans
ranked among the most under-funded in the nation. Let me be
clear, we are not here today to announce that the Federal
Government wants to be or should be in the business of
regulating state and local pension plans. Nor are we here to
scare public sector employees or suggest that their benefits
are at risk today. But whether it's today or years in the
future, the looming crisis in public pension under-funding is
real. And without action on some level, will not go away.
We all have an interest in ensuring that every worker
ultimately receives the pension benefits which they were
guaranteed. Congress took bold and decisive action to protect
the welfare of private sector workers and retirees. Surely
public sector employees deserve no less.
The purpose of today's hearing is to begin to understand
the scope of the issue facing us, to ask questions, to listen
and to learn. It is not to come to the table with preformed
ideas or prejudged solutions.
The panel before us represents some of the leading scholars
and advocates involved in this issue, and I look forward to
their testimony.
Before I introduce the witnesses, without objection, I will
recognize my colleague and good friend Mrs. Biggert for her
opening statement.
[The prepared statement of Mr. Kline follows:]
Prepared Statement of Hon. John Kline, Vice Chairman, Subcommittee on
Employer-Employee Relations, Committee on Education and the Workforce
Good morning. Today's hearing will begin an examination of the
retirement security of state and local government employees. But before
we start, I think some background is in order.
Earlier this month, President Bush signed into law the Pension
Protection Act, the most comprehensive reform of the laws governing our
nation's private-sector pension plans. This bill was overwhelmingly
approved on a bipartisan basis by both houses of Congress, and
represents the culmination of years of examination and study by this
committee among others.
Why was the Pension Protection Act necessary? Simply put, it was
needed to ensure that workers receive the pension benefits that they
have been promised--and that they have relied upon. It was needed to
ensure that businesses have clarity and certainty as to their pension
obligations, so that they can budget and plan accordingly. And it was
needed to ensure that ultimately, taxpayers, through federal pension
guarantees, are not left holding the bag for billions of dollars of
pension ``bailout.''
The Pension Protection Act takes important steps--some in the near-
term, others in the longer-term--to ensure that the retirement security
of private-sector workers receiving pensions is guaranteed. The bill
does so by adopting tough new funding standards that employers will
have to meet, to make sure that plans are sufficiently funded, with
real dollars. It requires plans to use actuarial assumptions that
accurately reflect the performance of plans, and the marketplace. It
targets and adopts tougher standards for those plans whose funding
levels indicate that they are the highest risk. And it does so by
following a simple rule: when you're in a hole, stop digging. The
Pension Protection Act prohibits plans from increasing or expanding
benefits when the plan is already under funded and at risk. That's
simple common sense, and something I expect anyone in this room who's
ever had to follow a budget--for a company, or a school, or for a
household--understands all too well.
So what has that got to do with our hearing this morning?
As most who have had the good fortune--and I use the term fortune
advisedly--to dig into the policy of pension regulation know, pension
plans in the private sector are governed by the Employee Retirement
Income Security Act--the federal law known as ERISA. Now, certain
plans--notably, plans sponsored by states, or localities, or municipal
governments--are exempted from ERISA's coverage. Those plans instead
are governed by local and state pension laws. One of the questions
before us today is, does that exemption make sense, and are state and
local government regulations enough to protect public-employees'
pensions?
Within the last few months, we've seen more and more reports that
states and municipalities are facing the same crises that private
employers faced with their pension plans: increased benefits, more
liabilities, and an expanding gap in the funding to pay for them.
Across the country, from Texas, to California, to New Jersey, and right
here in Illinois, we are seeing on an almost weekly basis reports that
the retirement security of some state and local workers may not be as
secure as we would hope. The facts speak for themselves:
According to the U.S. Census Bureau, major public pension
programs paid out $78.5 billion in the 12 months that ended in
September 2000. By the same period in 2004, pension payouts had grown
by 50 percent to $118 billion.
State and local governments currently employ 14 million
people, with an additional 6 million retirees. It is estimated that
these workers and retirees are owed $2.37 trillion by more than 2000
different state and municipal government entities.
Published government estimates suggest that the largest
state and local pension funds faced a funding gap of $278 billion in
2003. An analysis by Barclays Global Investors places the gap at closer
to $700 billion. Even those that dispute Barclays' number recognize
that the potential under funding we are talking about is in the
hundreds of billions of dollars.
Most recently, in March of this year, Wilshire Consulting,
based in Santa Monica, California, which has been tracking the funding
levels and performance of public pension funds for over a decade,
reported that state and local pension systems are only 85% funded in
the aggregate, down from 103% in 2000.
Indeed, we are here today because the State of Illinois has the
dubious distinction of having its public pension plans ranked among the
most under funded in the nation.
Let me be clear: we are not here today to announce that the federal
governments wants to be, or should be, in the business of regulating
state and local pension plans. Nor are we here to scare public-sector
employees or suggest that their benefits are at risk today. But whether
it's today or years in the future, the looming crisis in public pension
under funding is real--and without action, on some level, will not go
away.
We all have an interest in ensuring that every worker ultimately
receives the pension benefits which they were guaranteed. Congress took
bold and decisive action to protect the welfare of private-sector
workers and retirees. Surely public-sector employees deserve no less.
The purpose of today's hearing is to begin to understand the scope of
the issue facing us--to ask questions, to listen, and to learn. It is
not to come to the table with pre-formed ideas or pre-judged solution.
The panel before us represents some of the leading scholars and
advocates involved in this issue, and I look forward to their
testimony.
______
Ms. Biggert. Thank you, Mr. Kline, and thank you for
chairing this important and timely hearing, and welcome to
Illinois.
For several years, you and I have joined colleagues from
both parties in a series of Education and Workforce Committee
hearings to lay the foundation for the Pension Protection Act
that President Bush recently signed into law. During that
series of hearings, we spoke with dozens of witnesses and
examined a wide array of information that pointed to a private
pension system in turmoil. We heard stories of employers and
unions making pension promises they knew they could not keep.
We learned that today's outdated Federal pension laws do not
reflect the reality of today's economy. And we were told that
without real reform to fix outdated Federal pension laws, more
companies would default on their worker pension plans,
increasing the likelihood of a massive taxpayer bailout of the
Pension Benefits Guarantee Corporation, which is the Federal
body charged with ensuring private pension plans. And so we
acted.
Today, we convene this hearing to focus and to discuss the
health of our public pension system. I'm afraid the symptoms we
are examining do not look much different than those of our
nation's traditional private plans. According to a Wall Street
Journal article published last week, the California firm,
Wilshire Consulting, reported that our nation's state and local
pension systems are only 85 percent funded, down from 103
percent in the year 2000. Moreover, four of every five public
pension plans are currently under-funded and as you noted, the
total amount of under-funding nationwide is in the hundreds of
billions of dollars.
I am troubled to say that my home State of Illinois manages
a plan for its workers and retirees that is under-funded by $38
billion, making it the worst funded state pension plan in the
nation.
This concerns me for two key reasons. First, I represent
workers and retirees who depend on the state pension plan. Do
these public servants not deserve the same pension plan
assurances as those who work for private employers? Reneging on
pension promises to retirees is one of the most shameful and
reprehensible practices, whether it is by a public employer or
a private employer.
Second, legitimate concerns were raised about a potential
taxpayer bailout of the Federal agency that insures the private
pension system. And I believe the recently enacted Pension
Protection Act will go a long way toward calming those fears.
But similar concerns can and should be raised, arguably
with a greater sense of urgency, because taxpayers dollars not
only could be used to bailout a collapsed public pension plan,
but they also serve as the primary funding source for state and
local pensions.
It is no surprise that the Wall Street Journal has been
joined by other newspapers across the country in focusing on
this escalating crisis and searching for both its causes and
its potential solutions. That search brings us today to
Springfield, inside the Capitol building, where decisions have
been and will continue to be made about the future of our state
pension system.
Before we begin, let me be clear, as a former member of our
General Assembly, I am sensitive to the fact that the Federal
Government does not and should not reach its hands into state
government matters. I would not take part in a committee
activity that would advocate otherwise. However, I believe that
public officials at all levels have responsibilities when it
comes to taxes paid and nest eggs expected by those they
represent. The public pension crisis is one that is national in
scope, so much so that two prominent U.S. Senators, one a
Republican and one a Democrat, have requested an official
Federal study of this very issue. And it is one that deserves a
much closer look, not just by our nation's newspapers and state
and local governments, but by both parties in both houses of
Congress as well.
This is precisely why we are here today, to listen and to
learn. I thank the witnesses who have joined us and agreed to
testify today, and I look forward to discussing this important
matter with them.
Thank you again, Mr. Kline, for chairing this hearing and I
yield back.
Mr. Kline. Thank you, Mrs. Biggert. I should say that I am
here because the Chairman of this Subcommittee is recovering
from surgery and, of course, we wish him well.
We have today a really distinguished panel, and I am
excited to hear from them. I would like to sort of briefly
introduce all of them to everyone in the room and then we will
start down the line.
We have Dr. Fred Giertz, a Professor in the University of
Illinois at Urbana-Champaign Department of Economics. He has
been on the faculty of the Institute of Government and Public
Affairs at the University of Illinois since 1980.
Mr. Keith Brainard serves as Research Director for the
National Association of State Retirement Administrators, for
which he collects, prepares, distributes studies and reports
pertinent to public retirement system administration and
policy.
Ms. Irene Jinks is the President of the Illinois Retired
Teachers' Association. Ms. Jinks taught mathematics for 34
years in Skokie, Illinois and served on the Board of Education
of Parkridge-Niles.
Mr. John Filan is Director of the Governor's Office of
Management and Budget. Mr. Filan previously served in state
government as a department cabinet officer and is a member of
the Governor's staff for Central Management, Employment
Security and State Pension Agencies.
Ms. Joanna Webb-Gauvin serves as the Director of Retiree
Programs for Council 31 of the American Federation of State,
County and Municipal Employees. Prior to her current position,
she spent 2 years with the Illinois Attorney General's Office
assisting the policy advisor on senior issues.
Mr. Lance Weiss is a Senior Analyst for Deloitte
Consulting, LLP in Chicago. He has over 30 years of experience
in employee benefits and retirement planning with special
emphasis on the design, funding, security, administration and
implementation of retirement programs.
Before the panel begins, I would ask that each of our
witnesses today please try to limit your oral statements to 5
minutes. Your entire written testimony will be included in the
official hearing record. So you can feel free to summarize.
In Washington, we have a light system which would alert you
to the dwindling time. We do not have such a system here and I
am reluctant to interrupt, but if it looks like it's going to
go too long, I may have to do that. Please try to limit your
statements to 5 minutes.
And we will start, if everybody is ready, with Dr. Giertz.
Sir, you are recognized.
STATEMENT OF J. FRED GIERTZ, PROFESSOR, INSTITUTE OF GOVERNMENT
AND PUBLIC AFFAIRS, UNIVERSITY OF ILLINOIS
Dr. Giertz. Thank you very much. I am really pleased to be
here and hope I can make a contribution to the issue.
First of all, I am from the University of Illinois and my
specialty is in state and local government finance, I am an
economist dealing with budget issues, but equally importantly I
served 10 years on the State University's Retirement System
Board of Directors and several years as Chair of the Investment
Committee, so I have first hand knowledge of pension systems.
Most of what I will be talking about here today is
Illinois-specific and also state specific, not too much about
local governments, and a lot about Illinois. But I think a lot
of things about Illinois have general applicability.
If there is any good news--I am not sure whether it is good
news or bad news--but our problem, and Illinois and the state
and local pension systems in the country's have a problem, but
that problem pales in comparison to the looming Social
Security-Medicare-Medicaid problems. So put in perspective,
this is a serious issue, but we have a number of other
retirement issues on the horizon that are probably of a
magnitude larger than this, so that is something that I think
we need to address first of all.
So I am going to suggest today that the pension problem,
the pension funding problem, the security problem, is really a
twofold problem. It is a problem for state and local workers,
retirees, participants, but it is equally severe a problem for
taxpayers. This is a dual problem. It is a problem for the
participants in the system, it is also a serious problem for
taxpayers who in the long run will have to deal with this issue
in equal measure.
To talk a little bit about history, the under-funding in
Illinois is not an accident. It came about largely because we
chose not to fund at the full actuarial cost of the systems as
these accrued over the years. This is not an oversight, it was
not neglect, it was explicit policy. It was easier to spend
money for other things, to not raise taxes, to give raises to a
whole host of things rather than set aside money for the
pension system. And this is not the last 5 years, 10 years, it
goes back decades.
In 1995, the State of Illinois recognized that this was a
problem that had become a serious one and was basically out of
control, and we set to right ourselves with a multi-decade
program to try to get back in balance again. The first 10
years, unfortunately, did not involve a lot of pain, it was
more sort of ramping up, getting ready for the serious problem
to come in the future. And so the first 10 years, we stayed
within the plan guidelines. But 2005 came, the hurdle moved up
in size, the contribution the State was supposed to make
increased, and we blinked. We changed our plan and did not
fulfill the obligation that we chose in 1995 and basically made
a new plan starting in 2005 with, again, not very much pain in
the early stages and most of the pain pushed back into the
later years. So neither the 1995 nor the 2005 changes really
righted our--we are going to have to have huge increases in
funding obligations in the State of Illinois in just a very few
years in the future, obligations that cannot be met within the
framework of our current budget.
We did make some adjustments, we did make some changes in
the pension obligations and the payments to future retirees,
but we actually, after even 1 year, we went back and changed
some of the ways that we were going to save money. For example,
we were going to save money by limiting end-of-career salary
increases. That only lasted 1 year, that has been modified now.
So we still face this very, very large problem, a problem that
is not really able to be addressed in the framework of our
present budget.
Now the State of Illinois has in its Constitution something
called a non-impairment clause. A non-impairment clause
basically guarantees the benefits that have been earned to
government employees. So that is why I said it is both a
taxpayer problem and an employee problem, because most of the
pain eventually is going to be felt not necessarily by the
people who are retiring, like me, but will be felt by the
taxpayers that have to pay the bill for this.
Now I do not have any--one last thing. There is in fact a
suggestion abroad that somehow the pensions have gone out of
control because of generous extension of benefits, all kinds of
changes being made to the benefit of workers. Now there have
been a few of those, but most of the changes in the benefits
have been a quid pro quo, where there has been some kind of
decrease in, for example, 1 year people had to forego a salary
increase and the State contributed more to pensions. Another
time there was an increase in the cost of healthcare to
employees and the State increased pension payments. So the
pattern was take back something that you save money today from,
but then increase pension benefits sometime in the future. You
do not have to pay today, you may have to pay years in the
future. So most of the problem is from under-funding, it is not
from a lavish extension of benefits to the workers.
Now I am not in a position to talk about solutions. Let me
just summarize now.
Douglas Holtz-Eakin was the head of the Congressional
Budget Office in Washington, he just stepped down 6 months ago
or so. He was asked about what can you do about the Social
Security, Medicaid, Medicare problem and he said ``This is a
really serious problem, but I know that we will address it
eventually because we have to address it.'' There is a famous
statement by Herbert Stein, who used to be a Council of
Economic Advisors member, he said ``Some things cannot go on
forever and eventually will end.'' Well, obviously this cannot
go on forever, it eventually has to be solved. The question is
how do we solve it. Do we solve it in an effective way or do we
solve it in a less-than-effective way? And Holtz-Eakin had two
suggestions; one is that any kind of solution has to entail
pain, there is no painless way of dealing with this. We cannot
insulate taxpayers from pain, we cannot insulate necessarily
future workers from pain. So pain has to be part of the
equation. The second suggestion he gave was that you have to
have all options on the table. You cannot say we are going to
solve this problem, but we cannot possibly raise taxes, we
cannot possibly do this, we cannot possibly do that. We need to
have all options open and then we have to address the issue.
So that is basically my suggestion, no specifics, but this
issue has to be addressed, it will be addressed and our
challenge is to do it in an effective way.
Thank you.
Mr. Kline. Thank you, sir. I think right on time. The
timekeeper is here. So thank you very much, that was a good
job.
Now, Mr. Brainard.
[The prepared statement of Dr. Giertz follows:]
Prepared Statement of J. Fred Giertz, Professor, Institute of
Government and Public Affairs, University of Illinois
The State of Illinois' pension systems are among the most seriously
underfunded in the nation. This underfunding is the result of decades
of neglect where decisions were made to use available funds for
purposes other than pensions. The so-called pension problem should be
viewed as a more general state budget problem that manifests itself in
high pension costs because the state's pension systems have been used
in the past to mask more basic budget issues. This problem continues to
this day where the state faces huge increases in pension funding costs
in the upcoming years to address past underfunding problems. The
problem is one of taxpayer ``security'' as well as retirement
``security'' for state employees.
On many occasions in the last several decades, maneuvers involving
the state's pensions systems have been used to avoid painful political
choices of either raising taxes or cutting state programs. The heart of
the current pension problem is the long-term underfunding of the
state's pension systems where funds that should have gone for pensions
have been used for other state programs. Each year, actuaries for the
pension systems calculate the normal costs of the systems-the increased
liabilities for promised future benefits created in that year. If the
contributions of the state and the employees equal this normal cost,
the pension systems will remain fully funded, assuming the actuarial
assumptions are met.
From their inception, the state has almost always chosen to fund
pensions at less than their normal cost, thus creating unfunded
liabilities that have to be made up in the future. This was done
explicitly during the austere budget days of the 1980s when the state
chose to direct the available state resources to other state programs
and underfund the pensions. This was not an oversight, but a conscious
policy decision. A case can be made to underfund pensions during lean
times with the shortfall made up during the good years. In Illinois'
case, every year was a lean year and the shortfalls were never made up.
Unfortunately for the state, the underfunding was not invested in
the portfolios of the pension systems and therefore missed out on the
phenomenal growth in the financial markets from the early 1980s through
the end of the century. Simulations for the State Universities
Retirement System indicate that had the state made its required
contributions along with the contribution mandated for employees (which
were made), the system would be fully funded at the end of fiscal 2004
with assets at nearly 110 percent of accrued liabilities even after the
decline of the stock market after 2000 and the state would only have to
contribute its share of the normal pension costs in the future-a
fraction of the costs they now face.
In 1995, the state of Illinois realized the seriousness of the
underfunding problem and set out on a course to correct it. It is safe
to say the state did not act precipitously in this regard. In fact, the
state adopted a 50-year plan to bring the various pension systems up to
a modest goal of 90 percent of full funding. Not only did the plan
stretch the catch-up over half a century, it delayed any real catching
up for a decade. The period from 1995 to 2005 was labeled a ramp phase
in which the state still contributed less that the normal pension costs
with the serious business of making up the short fall deferred 10 years
(to 2005). Note that if the state had dealt with its past budget
problems by issuing bonds in the credit market rather than by
underfunding pensions, the state would now have a bond repayment
problem, not a pension problem. In such a case, would the appropriate
policy be to default on the bonds?
Since the pension funding reform in 1995, it is alleged that the
pensions systems have provided generous benefit increases and early
retirement options. In one sense, there is an element of truth in these
statements, but these changes have, for the most part, been instigated
by the state in order to save money in other programs. For example,
there was an increase in the retirement benefit formula for those
retiring under defined benefit plans approved in 1997. However, the
increased benefits came at a cost. As a kind of quid pro quo, the state
eliminated a costly program that paid state employees for a portion of
their unused sick leave at retirement while also tightening the
eligibility requirements for state-subsidized medical insurance for
retirees. The state captured the savings in the form of lower general
fund spending while the costs were borne by increases in the unfunded
liability of the pension system.
In another case, certain state workers gave up a scheduled pay
increase in return for the state picking up a larger portion of their
retirement contributions. Here again, the state saved the forgone wage
costs while the burden was placed on the retirement systems.
Finally, early retirement programs, that have become common in
recent years, are portrayed as costly benefits for young retirees.
While a strong case can be made for limiting early retirements and
possibly raising the retirement age, most early retirement programs
were designed to help the state and school districts by moving older
workers out of their jobs and into retirement. Again the state and the
schools capture the benefits of lower wage costs while the pension
systems bear the burden of increased underfunding. It is interesting to
note that when officials bemoan the increased underfunding of the
pension systems from early retirements, they seldom mention the
offsetting savings resulting from the early retirements.
The state is severely limited in its ability to reduce the
currently-accrued pension liabilities by Article XII, Section 5 of the
State Constitution. The so-called non-impairment clause states:
``Membership in any pension or retirement system of the State, any
unit of local government or school district, or any agency or
instrumentality thereof, shall be an enforceable contractual
relationship, the benefits of which shall not be diminished or
impaired.''
The article constrains the ability of the state to directly reduce
current pension liabilities and protects current employees and retirees
from pension reductions. However, it does not protect state taxpayers
or future employees from the consequences of this problem.
As noted above, the state has a budget imbalance problem, not just
a pension problem, even though pension costs have come to play an
important role in both the problem and its solution. The problem is a
serious one and the solutions are not easy. The solutions require a
comprehensive review of state expenditures and revenues. Focusing
narrowly on pensions will lead to inferior solutions to the state's
underlying budget problem. Soon, the state of Illinois must face the
prospect either making large and painful cuts in major state programs
(not just cuts in pension benefits decades in the future) or finding
additional permanent revenue sources to fund its activities.
The 1995 legislation has not solved Illinois pension problem. In
2005 in response to a serious budget shortfall and a reluctance to
raise state taxes or make expenditure cuts, the Illinois General
Assembly and the governor targeted the state's pension system to free
up revenue by reducing funding for the fiscal years 2006 and 2007 by an
estimated $2.3 billion. The plan reduced pension benefits for new
employees that will reduce funding requirements many years in the
future, but booked the expected savings immediately. This increased the
underfunding of the state pensions systems at a time when the state
pension systems are already the most poorly funded in the nation. In
essence, the state is borrowing money from the pension systems which
will have to be repaid in future years at an expected implicit interest
rate of over 8 percent-the expected return on the pension fund
investments in future years. This resulted in large scheduled increases
in state pension cost over the next several years.
(Note: This testimony is based on material produced by the
presenter over the last several years.)
______
STATEMENT OF KEITH BRAINARD, RESEARCH DIRECTOR, NATIONAL
ASSOCIATION OF STATE RETIREMENT ADMINISTRATORS
Mr. Brainard. Chairman Kline, Representative Biggert, thank
you for the opportunity to appear before you today.
Broadly speaking, I believe the retirement security of the
nation's state and local government employees and retirees,
particularly compared with other groups, is strong. This
strength is a result of the system that features pre-funded
defined benefit plans; reasonable costs that are shared by
public employees, employers and investment earnings; flexible
plan designs that accommodate the objectives of relevant
stakeholders; voluntary defined contribution plans that
supplement defined benefit plans; exemption from most Federal
regulation, allowing cities and states to design, administer
and finance retirement benefits in concert with the unique
needs of each pension plan sponsor and within the framework of
each state's constitution, statutes, case law and political
culture; and finally, state protections of pension benefits,
many of which predate and exceed Federal regulations of pension
benefits among private employers.
Sixteen million Americans, more than 10 percent of the
nation's workforce, are employed by a state or local
government. These are public school teachers, administrators
and support personnel, firefighters, public health officials,
correctional officers, judges, police officers, child
protective service agents and myriad other professionals
responsible for performing a broad array of essential public
services. Ninety percent of these workers have a defined
benefit plan or traditional pension as their primary retirement
benefit, a figure that stands in increasing contrast to the
diminishing portion of the nation's private sector workforce
with access to a traditional pension. This pension coverage
makes a significant and cost-effective contribution to the
retirement security of not only these public employees, but
also to the Nation as a whole.
Pension plans for the vast majority of state and local
government employees are in reasonably good condition. Based on
the latest available data, pubic pensions have approximately
$2.8 trillion in assets to fund more than 86 percent of the
next 30 years of pension liabilities they have incurred. Based
on my own projections, this figure will begin rising again in
fiscal year 2006 and for the foreseeable future. Absent an
extreme downturn in investment markets, 86 percent is likely to
be the low point for the aggregate public pension funding
level.
There is nothing inherently flawed about defined benefit
plans for public employees that makes them risky or expensive
to taxpayers, and cities and states that have properly funded
their pension plans and managed their liabilities generally are
in good condition.
I want to take just a moment to explain the meaning of
under-funding in the context of a public pension plan. Most
pension benefits for public employees are pre-funded, meaning
that all or most of the assets needed to fund pension
liabilities are accumulated during an employee's working life,
then paid out in the form of retirement benefits. Pre-funding
is one way of financing a pension benefit, and it enables a
large portion of the benefit to be paid with investment
earnings rather than contributions from employees and
employers. All else held equal, a fully funded pension plan is
better than one that is poorly funded, but a plan's funded
status is simply a snapshot of what is happening at a
particular point in time in an ongoing pre-funding process. It
is a single frame, if you will, of a movie that spans decades.
There is nothing magic about a pension plan being fully funded.
And even with no changes to funding policies or plan design,
most under-funded pension plans will be able to pay promised
benefits for decades. Pension liabilities typically extend
years into the future, and it is during this time that a
pension fund can accumulate the assets it needs to pay its
future liabilities.
The critical factor in assessing the current and future
health of a pension plan is not so much the plan's actuarial
funding level, as whether or not funding the plan's liabilities
creates fiscal stress to the plan sponsor.
Under-funding is a matter of degree, not of kind. Many
pension plans remain under-funded for decades with no
deleterious consequences. The status of a plan whose funding
level declines from 101 percent in year one to 99 percent in
year two has changed from over-funded to under-funded. Although
the nomenclature describing the plan's funding condition has
changed diametrically, the financial reality of its funding
condition has changed little. Fully funded and under-funded
plans both continue to require contributions and investment
earnings.
As mentioned previously, public pensions as a group have
accumulated assets equal to approximately 86 percent of their
liabilities, a figure I project will begin to rise in the
coming months as more of the investment earnings generated
since March 2003 are incorporated into public funds' actuarial
calculations. In my view, the fact that public pension funds
have accumulated as much of their liabilities as they have
deserves praise, not condemnation. Whether one refers to the
public pension funding glass as 86 percent full or 14 percent
empty, the glass undeniably is mostly full.
This is not to suggest that there are not funding problems
among some public pension plans--there are and they need to be
addressed, but there is no national crisis and suggesting that
a plan is in crisis simply because it is under-funded is to
misunderstand the meaning of that term.
On a national basis, the cost to taxpayers of public
pensions, both as a percentage of public employee payroll and
of all state and local government spending, is lower today than
during most of the last decade. On a national basis, employer
or taxpayer pension costs for state and local government
pensions are lower today than they were during the mid-1990's.
In most cases, where employer costs have risen sharply, a major
factor contributing to that rise is that the employer allowed
its contribution rates to decline to very low levels.
For the 22 years from 1983 to 2004, three-fourths of all
public pension revenue came from sources other than taxpayers.
Unlike most corporate pension plans, most employees in the
public sector are required to contribute to their pension plan.
Five percent of pay is the median and most popular employee
contribution rate.
In addition to promoting retirement security for public
employees and the Nation as a whole, traditional pensions for
state and local government employees offer other advantages
that benefit all Americans relative to defined contribution or
401k plans. For example, traditional pensions strengthen the
ability of public employers to attract and retain the personnel
needed to perform essential public services. Taxpayers benefit
from these plans because they promote worker retention and
longevity, encouraging experienced and qualified workers to
return the investment in training and experience that has been
made in them by their public employers. Those who rely on
public services--which includes all of us--enjoy myriad
benefits that emanate, directly or indirectly, from the
provision of these services.
Americans also enjoy the economic benefits generated by
traditional pension plans for public employees. The $2.8
trillion held by public pension funds is a key source of
liquidity and stability for the nation's financial markets.
Pension assets are real, invested in stocks, bonds, real
estate, venture capital and other asset classes. Public
pensions hold in trust approximate 10 percent of the nation's
corporate equity and as institutional investors, these funds
are an important source of long-term patient capital for the
nation's publicly traded companies. Recent studies have found
that public pension funds are significant sources of economic
support and stimulus that reaches every city and town in the
nation. Public pension funds are also a key source of financing
for venture capital, which represents the seeds of the nation's
future economic growth and productivity gains.
State and local governments take seriously their legal and
civic responsibilities for paying promised benefits to their
employees and retirees. Comprehensive state and local laws and
significant public accountability and scrutiny provide rigorous
and transparent regulation of public plans and have resulted in
strong funding rules and levels. These safeguards often predate
and exceed Federal laws for private sector pensions.
Additionally, public plans are backed by the full faith and
credit of their sponsoring state and local governments. And
public plan participants' accrued level of benefits and future
accruals typically are protected by state constitutions,
statutes or case law, which prohibit the elimination or
diminution of retirement benefits. These constitutional and
statutory protections provide far greater security than are
provided to private sector pension plans under ERISA and the
PBGC.
Although any group as large as the public pension community
could benefit from some common sense reforms, a fair review
will lead a reasonable person to conclude that (a) the model
for providing retirement benefits for employees of state and
local governments is working for all stakeholders; (b) pension
benefits of working and retired public employees are safe and
assured; and (c) the model used by state and local governments
to provide employee retirement benefits contain elements worthy
of imitation by other employer groups and segments of the
economy.
Thank you.
Mr. Kline. Thank you, Mr. Brainard.
Ms. Jinks, you are recognized.
[The prepared statement of Mr. Brainard follows:]
Prepared Statement of Keith Brainard, Research Director, National
Association of State Retirement Administrators (NASRA)
Mr. Chairman, members of the Subcommittee, I want to thank you for
the opportunity to speak to you today. The membership of the National
Association of State Retirement Administrators (NASRA) and the National
Council on Teacher Retirement (NCTR) administer State, territorial,
local, university and statewide public pension systems that
collectively hold over $2.1 trillion in trust for over 18 million
public employees, retirees and their beneficiaries.
Broadly speaking, I believe the retirement security of the nation's
state and local government employees and retirees, particularly when
compared with other groups, is strong. This strength is the result of a
system that features:
a) pre-funded defined benefit plans;
b) reasonable costs that are shared by public employees, employers,
and investment earnings;
c) flexible plan designs that accommodate the objectives of
relevant stakeholders, including public employers, taxpayers, those who
rely on public services, and public employees;
d) voluntary defined contribution plans that supplement defined
benefit plans;
e) exemption from most federal regulation, allowing cities and
states to design, administer, and finance retirement benefits in
concert with the unique needs of each pension plan sponsor and within
each state's constitutions, statutes, case law, and political culture.
f) state protections of pension benefits, many of which pre-date
and exceed federal regulations of pension benefits among private
employers.
Sixteen million Americans--more than 10 percent of the nation's
workforce--are employed by a state or local government. These are
public school teachers, administrators, and support personnel;
firefighters; public health officials; correctional officers; judges;
police officers; transportation workers; child protective service
agents; and myriad other professionals responsible for performing a
broad array of essential public services.
Ninety percent of these workers have a defined benefit plan, or
traditional pension, as their primary retirement benefit, a figure that
stands in increasing contrast to the diminishing portion of the
nation's private sector workforce with access to a traditional pension.
This pension coverage makes a significant and cost-effective
contribution to the retirement security of not only these public
employees, but also to the nation as a whole.
Pension plans for the vast majority of state and local government
employees are in reasonably good condition. Based on the latest
available data, public pensions have approximately $2.18 trillion in
assets to fund more than 86 percent of the next 30 years on pension
liabilities they have incurred to-date. Based on my projections, this
figure will begin rising again in FY 2006 and for the foreseeable
future. Absent an extreme downturn in investment markets, 86 percent is
likely to be the low point for the aggregate public pension funding
level.
Figure 1. plots the current funding level of 117 public pension
plans around the country. Combined, the plans depicted in this chart
provide pension benefits for approximately 85 percent of all state and
local government employees in the U.S. The size of the bubbles in the
chart is roughly proportionate to the size of each plan. Larger bubbles
indicate larger plans, and smaller plans are indicated by smaller
bubbles. As the chart shows, most plans are funded above 80 percent,
especially most of the larger plans.
figure 1. current funding level of 117 state and local pension plans
There is nothing inherently flawed about defined benefit plans for
public employees that makes them risky or expensive to taxpayers, and
cities and states that have properly funded their pension plans and
managed their liabilities are generally in good actuarial condition.
I want to take a moment to explain the meaning of underfunding in
the context of a public pension plan. Most pension benefits for public
employees are pre-funded, meaning that all or most of the assets needed
to fund pension liabilities are accumulated during an employee's
working life, then paid out in the form of retirement benefits. Pre-
funding is one way of financing a pension benefit, enabling a large
portion of the benefit to be paid with investment earnings rather than
contributions from employees and employers. All else held equal, a
fully funded pension plan is better than one that is poorly funded, but
a plan's funded status is simply a snapshot of what is happening at a
particular point in time in an ongoing pre-funding process. It is a
single frame, if you will, of a movie that spans decades. There is
nothing magic about a pension plan being fully funded, and even with no
changes to funding policies or plan design, most underfunded public
pension plans will be able to pay promised benefits for decades.
Pension liabilities typically extend years into the future, and it is
during this time that a pension fund can accumulate the assets it needs
to fund its future liabilities. The critical factor in assessing the
current and future health of a pension plan is not so much the plan's
actuarial funding level, as whether or not funding the plan's
liabilities creates fiscal stress for the pension plan sponsor.
Underfunding is a matter of degree, not of kind. Many pension plans
remain underfunded for decades with no deleterious consequences. The
status of a plan whose funding level declines from 101 percent in year
one to 99 percent in year two, has changed from overfunded to
underfunded. Although the nomenclature describing the plan's funding
condition has changed diametrically, the financial reality of its
funding condition has changed little. Fully funded and underfunded
plans both continue to require contributions and investment earnings.
As mentioned previously, public pensions as a group have
accumulated assets equal to approximately 86 percent of their
liabilities, a figure I project will begin rising in the coming months
as more of the investment earnings generated since March 2003 are
incorporated into public funds' actuarial calculations. In my view, the
fact that public pension funds have accumulated as much of their
liabilities as they have deserves praise, not condemnation. Whether one
refers to the public pension funding glass as 86 percent full or 14
percent empty, the glass undeniably is mostly full.
This is not to suggest that there are not funding problems among
some public pension plans. There are, and they need to be addressed.
But there is no national crisis, and suggesting that a plan is in
crisis simply because it is underfunded is to misunderstand the meaning
of that term.
On a national basis, the cost to taxpayers of public pensions, both
as a percentage of public employee payroll and of all state and local
government spending, is lower today than during most of the last
decade. As shown in Figure 2., on a national basis, employer (taxpayer)
pension costs for state and local government pensions, are lower today
than they were during the mid-1990's. In most cases where employer
costs have risen sharply, a major factor contributing to the rise is
that the employer allowed its contribution rates to decline to very low
levels.
figure 2. employer (taxpayer) contributions to state and local
government pension plans as a percentage of payroll and of total state
and local government spending, 1995 to 2004
Figure 3 shows the three sources of public pension revenue for the
22-year period from 1983 to 2004 (these are the only years of this data
available from the U.S. Census Bureau.) As the figure shows, three-
fourths of all public pension revenue came from sources other than
taxpayers. Unlike most corporate pension plans, most employees are
required to contribute to their pension plan; five percent of pay is
the median and most popular employee contribution rate.
figure 3. sources of state and local government pension revenue, 1983-
2004
In addition to promoting retirement security for public employees
and the nation as a whole, traditional pensions for state and local
government employees offer other advantages that benefit all Americans
relative to defined contribution, or 401k, plans. For example,
traditional pensions strengthen the ability of public employers to
attract and retain the personnel needed to perform essential public
services. Taxpayers benefit from these plans because they promote
worker retention and longevity, encouraging experienced and qualified
workers to return the investment in training and experience that has
been made in them by their public employers. Those who rely on public
services--which includes all of us--enjoy myriad benefits that emanate,
directly or indirectly, from the provision of these services.
Americans also enjoy the economic benefits generated by traditional
pension plans for public employees. The $2.8 trillion held by public
pension funds is a key source of liquidity and stability for the
nation's financial markets. Pension assets are real, invested in
stocks, bonds, real estate, venture capital, and other asset classes.
Public pensions hold in trust more than 10 percent of the nation's
corporate equities, and, as institutional investors, public pension
funds are an important source of long-term, patient capital for the
nation's publicly-traded companies. Recent studies have found that
public pension funds are significant sources of economic support and
stimulus that reaches every city and town in the nation. Public pension
funds are also a key source of financing for venture capital, which
represents the seeds of the nation's future economic growth and
productivity gains.
State and local governments take seriously their legal and civic
responsibilities for paying promised benefits to their employees and
retirees. Comprehensive state and local laws and significant public
accountability and scrutiny, provide rigorous and transparent
regulation of public plans and have resulted in strong funding rules
and levels. These safeguards often pre-date and exceed federal laws for
private sector pensions.
Additionally, public plans are backed by the full faith and credit
of their sponsoring state and local governments, and public plan
participants' accrued level of benefits and future accruals typically
are protected by state constitutions, statutes, or case law, which
prohibit the elimination or diminution of retirement benefits. These
constitutional and statutory protections provide far greater security
than are provided to private sector pension plans under the Employee
Retirement Income Security Act (ERISA) and the Pension Benefit Guaranty
Corporation.
Although any group as large as the public pension community could
benefit from some common sense reforms, on the whole, a fair review
will lead a reasonable person to conclude that: a) the model for
providing retirement benefits for employees of state and local
governments is working for all stakeholders: public employers,
taxpayers, recipients of public services, and public employees; b)
pension benefits of working and retired public employees are safe and
assured; and c) the model used by state and local governments to
provide employee retirement benefits contains elements worthy of
imitation by other employer groups and segments of the economy.
I am happy to respond to any questions you may have about public
pension issues. Thank you.
______
STATEMENT OF IRENE JINKS, PRESIDENT, ILLINOIS RETIRED TEACHERS'
ASSOCIATION
Ms. Jinks. Thank you for this opportunity to speak with
you. I appreciate it very much. I am the President of the
Illinois Retired Teachers Association, a 31,000 member
grassroots organization representing retired educators who
taught outside the city of Chicago, because we, of course have
the state of Chicago as far as teachers are concerned, with
their own pension system.
The Teacher Retirement System, which protects all of those
who are downstate teachers, was created in 1939 to provide
members with retirement, disability and survivor benefits. As
of June 30 of 2005, there were over 155,000 active teacher-
members, or educators and 82,575 members receiving benefits. On
that date, the average monthly retirement annuity was $3043,
but there are more than 1700 annuitants in Illinois who receive
less than $1200 a month, many after a lifetime in education.
Funding for our pensions come from member contributions,
school district contributions, investment income and the State
of Illinois. Over the past 20 years, 21 percent of total TRS
income has been from member contribution and 55 percent from
investment income. Active educators are now required to
contribute 9.4 percent of their creditable earnings each year,
considerably more than you mentioned, Mr. Brainard.
Illinois is facing a pension fund crisis. In 1995,
following years of the state's failure to adequately fund
retirement systems, the General Assembly enacted a pension
reform law designed to bring the state's pension to a 90
percent funded level by 2045. Until 2005, the state adhered to
the funding schedule. Then, action by the General Assembly
reduced funding of the state's pension system by over $2
billion over a 2-year period. The TRS portion of the under-
funding is about $1 billion. Of course, IRTA opposed passage of
this bill.
The Illinois Constitution guarantees pension benefits, but
the Constitution is not inviolable. Illinois educators deserve
more than just a promise that the system will be funded. Active
teachers and school systems have upheld their responsibilities
to pay into the system regularly. The State must do the same.
For most retired Illinois educators, the TRS pension is
their only source of income. They do not receive Social
Security and even if they have contributed to Social Security
through other employment or would be eligible otherwise for a
spousal pension, those payments are reduced or even eliminated
under the Windfall Elimination Provision and the Government
Pension Offset.
IRTA is concerned about present retirees, but also is
concerned about the effect on current and future educators.
Salaries in education are not high. And we do not have the
benefits of profit sharing and bonuses of the private sector.
To ensure that we attract the best teachers to our schools, we
must protect the retirement system. We need to ensure that the
plan to fund the system to 90 percent by 2045 is met. We know
that with additional programs or increases, the State cannot
meet its pension obligations. We fear that we will be faced
with an attempt to change the current payment schedule or the
current benefit formula, a change that could create a two-
tiered benefit program, which we oppose.
Under-funding has required the Teacher Retirement System to
sell assets to meet current obligations. These assets, as well
as the interest they would have earned, are lost forever.
Without assurance of an adequate pension, people will be less
likely to remain in education long term.
I spent 37 years as a teacher and administrator, plus 8
years given as a school board member, so I have spent
considerably more than half my lifetime in education. I do not
regret 1 day of it, but I certainly hope that we do not find
ourselves in a position where people teach for a couple of
years and then move on to other things. We will have an
inexperienced and much less dedicated cadre of teachers in our
schools.
The State of Illinois must not forego its obligations. We
retired educators have served our state and the youth of our
state. We have fulfilled our obligation by paying into TRS.
Illinois must do the same.
Thank you for this opportunity.
Mr. Kline. Thank you, Ms. Jinks, for your testimony.
Mr. Filan, sir, the floor is yours.
[The prepared statement of Ms. Jinks follows:]
Prepared Statement of Irene Jinks, President, Illinois Retired Teachers
Association
Good Morning, members of the Subcommittee on Employer-Employee
Relations. My name is Irene Jinks and I am the President of the
Illinois Retired Teachers Association (IRTA). I thank you for the
opportunity to speak with you today on the important subject of the
state's retirement security. The IRTA is a 31,000-member ``grassroots''
organization, which represents retired educators who taught outside of
Chicago.
The General Assembly created the Teachers' Retirement System for
the State of Illinois (TRS) in 1939. TRS provides its members with
retirement, disability, and survivor benefits. As of June 30, 2005,
there were 155,850 active members and 82,575 annuitants and
beneficiaries receiving benefits. As of June 30, 2005 the average
monthly retirement annuity was $3,043. In addition, there are over
1,700 members who gave most of their lives to education making less
than $1,200 per month.
Funding for TRS benefits comes from member contribution,
contributions by school districts, investment income and the State of
Illinois. Over the past 30 years, 21% of the total income to TRS has
been from members, 23% has been from employers, and 55% has been from
investment income. Currently, active TRS members are required to
contribute 9.4% of their creditable earnings each year towards their
retirement.
Illinois is facing a pension fund crisis. In 1995, due to years of
Illinois failing to fund its retirement systems adequately, the General
Assembly passed a pension funding reform law, Public Act 88-593. The
law is designed to bring the State's pension funds to a 90% funded
ratio by 2045 by requiring that the state's contribution ``equal a
percentage of payroll necessary to amortize 90% of unfunded
liabilities''. Until 2005, the State met its statutory obligation by
adhering to the funding schedule. In 2005, the General Assembly passed
SB27 (PA 94-0004). This legislation reduced the funding to the state
pension systems by over $2 billion in a two-year period. The Teachers
Retirement System portion of the under funding is approximately $1
billion over the same period of time. The IRTA opposed the passage of
SB27 recognizing the additional strain it would put on the system and
the threat of jeopardizing future benefits. It should be noted during
this time of pension funding abuse; teachers and school districts never
missed a payment.
Article 13, Section Five of the Illinois Constitution states
``Membership in any pension system of the State, any unit of local
government or school district, or any agency or instrumentality thereof
shall, be an enforceable contractual relationship, the benefits of
which shall not be diminished or impaired.'' Some of our members take
comfort by this guarantee, but constitutions can be amended. The
legislature simply votes to place constitutional questions on the
ballot. They would only be voting to allow the general public to decide
the outcome.
Our members and other Illinois retired educators' deserve more than
a promise that the pension system will be funded. As previously stated,
retired teachers and school districts have upheld their responsibility
to pay into the pension system, having never missed a payment.
For most Illinois retired teachers their TRS pension is their only
source of income. Unless these retirees held other employment, they do
not receive any Social Security. Even if they did have outside
employment in which they contributed to Social Security, their payments
from Social Security have been minimized and in some cases eliminated
due to the Windfall Elimination Provision and the Government Pension
Offset. Current and future retirees have expected and planned on their
teachers' pension being there when they retire. If Illinois continues
to miss payments, this may not be the case in the future.
The IRTA is not only concerned about the well-being of current
retirees, but we are worried about the impact that this administration
will have on our current and future teachers. Educators in Illinois are
already burdened by fairly low salaries. In order to ensure that we
attract the best and brightest teachers for our future generations, we
must protect the retirement system.
The best way to do that is to ensure that the TRS is fully funded
to 90% by the previously set date of 2045. We oppose any type of two-
tier system or reduction of benefits. In order to bring pension
contributions back up to the level required by the 1995 Pension Act,
substantial ``ramp-up'' payments are required in the future years. The
first of these comes due July 1, 2007, when the state must increase
scheduled pension payments by an estimated $700 million.
Natural revenue growth in Illinois is about $1 billion. The minimum
annual education increase is about $300 million. Medicaid absorbs $200
million in revenue growth annually. With any additional programs or
increases, the numbers will guarantee that the state will be unable to
meet its pension obligation for fiscal year 2007. With this knowledge
at hand, we know that we will eventually be faced with an attempt to
change the current 2045 date or the payment formula. The IRTA opposes
any change to the current formula and believes that pensions should be
funded according to the 1995 law.
The under-funding of payments also caused the TRS to have to sell
off assets in order to make payments on time. The under-funding now
means the pension systems will not be able to invest that money and
will lose their projected 8.5% interest earnings each year. This is
just one more barrier that TRS must face as they head in a downward
spiral while still trying to serve the retired teachers of Illinois.
The State of Illinois must stop forgoing payments into the TRS.
Illinois retired teachers have served the State of Illinois by
educating our youth, they have fulfilled their obligation by paying
into TRS, and it is time for Illinois to do the same.
______
STATEMENT OF JOHN FILAN, DIRECTOR, GOVERNOR'S OFFICE OF
MANAGEMENT AND BUDGET, STATE OF ILLINOIS*
Mr. Filan. Thank you very much. Vice Chairman Kline, thanks
for coming on behalf of the Chairman today; Representative
Biggert, nice to see you in Illinois. I appreciate very much
the opportunity to appear before you today.
---------------------------------------------------------------------------
*PowerPoint slides presented during Mr. Filan's statement appear on
page 89 of this document.
---------------------------------------------------------------------------
The State of Illinois sponsors five plans covering state
employees, university employees, teachers outside of Chicago as
was just mentioned, judges and members of the General Assembly.
As many reports have indicated, Illinois state pensions
have been under-funded for more than 30 years, 30 consecutive
years I might add. As a point of clarity, recent statements
have referred to raiding Illinois state pension funds. Even the
word ``stealing'' has been used. Nothing could be further from
the truth. A look at the facts clearly show that these are
outright false statements. In fact, the statements have been
made so often by some that I can confidently say these
statements are in fact totally false.
In 2003, when Governor Blagojevich took office, the
combined assets, cash and investments, of the five state
retirement systems were approximately $41 billion. At the end
of the Governor's first two budget years, June 30, 2005, those
same cash and investments totaled $59 billion, $18 billion more
than when the Governor first took office. This represents by
far the single largest increase in pension assets in any 2
years in Illinois history. Further, according to the Retirement
Systems, those same cash and investments as of the recently
completed third budget year of the Governor, June 30, 2006, now
total $61.9 billion, a full $21 billion more, in fact 50
percent more in assets in the Retirement Systems than when the
Governor took office.
So as you can plainly see, there have been no raids, no
withdrawals, no transfers, no stealing of pension assets or
funds. Instead, there have been record deposits and increases
in assets and substantial earnings on those assets since
Governor Blagojevich took office. No Governor in Illinois
history has deposited more money, $13.3 billion, in one term,
into the retirement funds than Governor Blagojevich. In fact,
no Governor has budgeted and contributed more money into the
Retirement Systems in any one term than Governor Blagojevich.
During the 1970's, 1980's and first half of the 1990's,
state contributions were grossly inadequate. It increased the
unfunded liability every single year, every adopted budget
under-funded the pensions, without exception, during good times
and during bad times.
In 1994, the state adopted a payment schedule. That first
became effective in fiscal year 1996. However, the payment
schedule continued to under-fund each of the pension funds each
and every year. And would do so until 2034, 40 years later. At
that point in time, June 30, 1995, the plans had a total funded
ratio of 52.4 percent, that is assets to liabilities, and an
unfunded liability of $19.5 billion in 1995. At that time,
according to Wilshire, referred to earlier, they were about the
43rd worse funded system in the nation. You will see, as a
result of this plan's funding, Illinois quickly moved to the
worst funded pension system in the Nation, and it has been
there for many years.
The 1995 payment schedule was structurally and
fundamentally flawed when it was enacted. We agree that
adopting a payment policy for the state pension contributions
was definitely needed, and still is. Unfortunately, the 1995
payment schedule would not decrease the pension debt for 40
years. The $19.5 billion will not go down, but go up, over the
next 40 years. Payments were not sufficient to pay normal costs
and interest on unfunded liability until around 2034. Thus, the
state was guaranteed to experience a growing unfunded
liability.
This had the impact of deferring and increasing major debt
into the future. As a result, the unfunded liability was
originally projected in 1995 to grow from the June 30, 1995
level of $19.5 billion to more than $70 billion in 2034. The
plan was structured that way, before it finally reduces to $45
billion in 2045, the last 10 years of the plan, based on
projections done by the actuaries in 1995.
As a result, the 1995 payment schedule that was adopted
pushed the entire unfunded liability of 1995, every nickel of
it, out 40 years, to 2034. The total unfunded liability of the
state pension systems more than doubled from $19.5 billion in
1995, the year before the 50-year payment schedule was adopted,
to $43.1 billion as of June 30, 2003, the beginning of the
current Governor's term. The $43 billion unfunded liability in
June of 2003 equated to a funded ratio of 48.6 percent, less
than when the 1995 plan started. The primary drivers of the
increase in unfunded liability and consequent reduction in
funded ratio include state contributions determined in
accordance with the 1995 payment plan which were designed not
to be sufficient to fund the normal costs and unfunded
liability. This amounted to $10.9 billion worth of increase
between 1995 and 2003. Significant investment losses incurred
during the last three fiscal years amounted to $6.5 billion,
those come and go.
Most alarming though, after recognizing the liability of
1995 and how big it was, the State of Illinois adopted benefit
improvements, without a single nickel of additional funding, in
the amount of $5.8 billion between 1995 and 2002. That practice
of adopting pension benefits without a funding source was
stopped last spring under this General Assembly and this
Governor.
So what have we done about the pension problems since 2003?
We have made the pension funds more secure and better funded.
We have done it both by increasing the assets, as mentioned
earlier, to record levels, and reducing the costs and the rate
of growth in liability for the first time in Illinois history.
So we have made both immediate improvements in funding assets
and short and long term reductions in costs and liabilities. In
fact, since 2003, Governor Blagojevich has increased assets by
$21 billion, more than 50 percent, primarily due to pension
bond proceeds, additional contributions on that and earnings on
those additional contributions; increasing the funded ratio,
ratio of assets to liabilities from 48 percent to 60 percent,
primarily due to pension bonds and earnings on those additional
contributions; reducing the long term liabilities of the system
by $83 billion, according to the Retirement Systems, based on
the reforms that were adopted in the spring of 2005; and maybe
most importantly, as I said before, prohibiting by law
increasing benefits without dedicated funding.
Another way to look at the impact of the Governor's action
is to compare the unfunded liability and funded ratio of the
pension systems with and without the proceeds of the pension
obligation bonds. With the proceeds of the pension obligation
bonds, the unfunded liability and funded ratio, are $38.6
billion and 60.3 percent respectively as of June 30, 2005.
Without the proceeds of the pension bonds, the ratio would have
been--I am sorry, the liability and the funded ratio would have
been $47.6 billion and 50.4 percent respectively if we had not
adopted the pension bond policy. Again, the results are
demonstrably better than if the Governor's actions had not been
implemented.
Earlier this year, the bipartisan Commission on
Governmental Forecasting and Accountability issued a report
which compares the actual progress toward the 90 percent
funding goal in 2045 on a year-by-year basis. The Commission
engaged its own independent actuary, the same actuary developed
a year-by-year set of projections back in 1995 when the pension
plan was adopted. This year's report compared those 1995
projections to 2005. The bottom line is simple and stark: the
1995 pension payment schedule estimated the funded ratio would
be 52.5 percent in 2005, while the actual funded ratio achieved
as a result of what I just mentioned was 60.3 percent, clearly
ahead of schedule.
So as a result of the policies put in place since Governor
Blagojevich took office, the State of Illinois is well ahead of
the funding level expected and designed in the 1995 payment
schedule. If we had followed the 1995 payment plan, we would
have been even lower than the 52.5 percent because of the
adoption since the 1995 plan of $6 billion of unfunded
benefits.
A direct quote from the report just mentioned: Despite
counteractive factors such as formula increases--the $6
billion--investment gains or losses due to market volatility,
the infusion of pension bonds and funding reductions as
contained in Public Act 94.4, the total cost of the current
funding plans has not grown appreciably from what was
originally projected in 1994. The significant material increase
in the funded ratio was due primarily to the record $7.3
billion of additional contributions not called for in the plan
in fiscal year 2004 that came from the pension bond and the
$3.3 billion of earnings on that $7.3 billion through June 30,
2006, earnings that could not have been done unless they had
that additional money.
Those that accuse the Governor of raiding the pension
systems conveniently forget the additional funding that went to
the systems in 2004. In fact, the 1995 projections of the
Commission actuary estimated that the State would have
received--the pension systems, pardon me--would have received
$12.3 billion of contributions from 1996 to 2005. In fact, the
actual contributions received were $19.8 billion for that same
period, exceeding the plan's requirements by $7.5 billion. Once
again, one hell of a--once again, pardon me--well ahead of
schedule.
In closing, I know that there are a lot of numbers being
stated today. Let me repeat those findings of the Commission--
$7.5 billion of contributions more than called for in the 1995
payment plan and a funded ratio of 60.3 percent, not 52 percent
that was called for there.
I challenge anyone to refute those numbers and that result.
Specifically answer this simple question: If the funds were
raided, how can they have $7.5 billion more than required by
the funding plan and a funded ratio that is 7.8 percent more
than the actuary estimated?
Illinois has had the worst funded pension system by far for
many years--solely caused by 30 years of under-funding,
including many years of planned under-funding of the 1995 plan.
Illinois also had a practice of adding billions of dollars of
costly benefits without providing any new funding, which only
made the longstanding under-funding worse. We have put a stop
to that in Illinois, no new benefits can now be adopted without
a funding source.
Our submission to the Committee also outlines many of the
other steps we have taken and the other recommendations we have
made. Illinois has made demonstrable progress on pension
funding for the first time in decades. We still have a long way
to go and are committed to continue down that path.
By any measure, the Illinois state pension systems are
better funded and more secure than they were when the Governor
first went into office. Any statement to the contrary,
particularly statements or inferences about raiding or
stealing, are demonstrably and completely false.
Thank you so much for allowing me to speak here today.
Mr. Kline. Thank you, Mr. Filan.
Ms. Webb-Gauvin, thank you.
[The prepared statement of Mr. Filan follows:]
Prepared Statement of John Filan, Director, Governor's Office of
Management and Budget, State of Illinois
Chairman Johnson, Ranking Member Andrews, Vice Chairman Kline,
Representative Biggert, Representative Davis, and Members of the
Subcommittee, I am John Filan, Director of the State of Illinois
Governor's Office of Management and Budget. I appreciate the
opportunity to appear before you today.
Background
The State of Illinois sponsors five retirement plans covering state
employees, university employees, teachers outside of Chicago, judges,
and members of the state General Assembly. As of the date of the most
recent actuarial valuation (June 30, 2005), the plans on an aggregate
basis were 60.3% funded, up from 48% in 2003.
During the 1970's, 1980's and the first half of the 1990's, state
contributions were grossly inadequate during both good and bad economic
times. As a result, in 1994, the state adopted a payment schedule
(Public Act 88-593) that first became effective in fiscal 1996.
However, the payment schedule continued to grossly underfund each of
the pension funds. At that point in time (June 30, 1995), the plans on
a total basis were 52.4% funded, with an unfunded liability of $19.5
billion.
Unfunded Growth Since 1995
The total unfunded liability of the state pension system more than
doubled from $19.5 billion as of June 30, 1995 (the year before
implementation of the 50-year payment plan) to $43.1 billion as of June
30, 2003, the beginning of the current gubernatorial term in office.
The $43.1 billion unfunded liability as of June 30, 2003 equates to
a funded ratio of 48.6%. The primary drivers of the increase in
unfunded liability and consequent reduction in funded ratio include:
State contributions determined in accordance with the 1995
Payment Plan were designed not to be sufficient to fund the normal cost
and interest on the unfunded liability--this amounted to $10.9 billion.
In other words, the 1995 plan was flawed from the beginning.
Significant investment losses incurred during the three
fiscal years ended June 30, 2003--$6.5 billion.
Benefit improvements passed by the legislature from 1995
through 2003 with out any source of funding--5.8 billion.
A combination of consistently underfunding the pensions and
continuing to provide more and more benefits without a way to pay for
them resulted in more than doubling the unfunded liability.
The following chart shows the components of the increase in the
unfunded liability from 1996 to 2003 (numbers in billions):
Unfunded Liability at 6/30/1995................................... $19.5
Change due to:
State Contributions....................................... $10.9
Actuarial Investment Losses (Gains)....................... 6.5
Unfunded Benefit Improvements............................. 5.8
All Other Factors......................................... .4
Total Increase.......................................... $23.6
______
Unfunded Liability at 6/30/2003................................... $43.1
=================================================================
________________________________________________
Failings of 1995 Payment Schedule
The 1995 payment schedule was structurally flawed when it was
enacted. We agree that adopting a payment policy for the state pension
contributions was definitely needed. Unfortunately, the 1995 payment
schedule Governor Edgar's administration proposed would not decrease
the pension debt for 40 years. First of all, it incorporated a 15 year
ramp-up period, which increased contributions over a period of 15 years
from a starting level that was totally arbitrary and grossly less than
the amount needed to keep the unfunded liability from increasing. Thus
the state was guaranteed to experience a growing unfunded liability
from 1996 through at least 2010. This had the impact of deferring and
increasing the entire liability into the future. To make matters even
worse, contributions for years after 2010, although determined as a
level percent of pay, are also not sufficient to pay normal cost and
interest on the unfunded liability until around 2034. As a result, the
unfunded liability was originally projected to grow from the June 30,
1995 level of $19.5 billion to more than $70 billion by 2034 before it
finally reduces to $45 billion in 2045 (based on projections from the
June 30, 2005 actuarial valuation). Ultimately, the 1995 payment
schedule did nothing more than push the entire unfunded liability out
40 years to 2034.
2003/2004 Pension Obligation Bonds
In response to the enormous challenges facing the state in funding
the state pension systems, Governor Blagojevich developed, and is
currently in the process of implementing, a long-term, multi-step plan
to reform the state's pension system. The ultimate goal of this reform
plan is to develop a retirement program that is affordable for the
state, and at the same time, meets the retirement security needs of the
state's pension system participants.
The first step taken by the Governor to address these tough issues
was to provide the state pension systems with a cash infusion and
reduce the state's pension debt. During June of 2003, the state issued
$10 billion of Pension Obligation Bonds, all of which, except for $500
million which was used to cover issuance costs and initial debt service
payments, was paid into the pension systems. Of this $10 billion total,
$7.3 billion was disbursed to the pension systems as an additional
state contribution over and above any annual contribution requirements.
Note this was the first time in the history of Illinois that payments
were made above the annual contribution requirements.
This additional cash infusion on July 3, 2003 immediately reduced
the pension system's unfunded liability, and increased the system's
funded ratio from 49% as of June 30, 2003 to over 57% literally
overnight. (With investment earnings, the funded ratio subsequently
improved to over 60% by June 30, 2005.) With this single action, the
security of the members and retirees' pensions improved significantly.
This reduction in liability exceeds the goals set out in the 1995
payment plan.
Governor's Pension Commission
The second step was the Governor's appointment of a Pension
Commission to review the pension system's funding issues, and make
recommendations focused on improving the system's financial condition
and affordability. The Commission met numerous times and issued their
report and recommendations on February 11, 2005.
The Governor then examined and considered the recommendations
contained in the Commission's report. Based on the recommendations of
the Commission, the Governor next proposed changes to the plan
provisions and funding mechanisms for the state retirement systems.
Public Act 94-4
The third step taken by the Governor to reform the pension system
was to submit the set of proposed changes to the Legislature. After
review and negotiation, several reforms to the state pension system,
known as Public Act 94-4, were adopted.
The net results of the pension reforms included in PA 94-4 is a
projected reduction in the 2045 actuarial accrued liability of
approximately $83 billion according to the independent determination of
the pension systems' actuaries, as well as a reduction in state
contribution requirements of approximately $3 billion over the next 40
years according to the independent determination of CGFA (in their
January 2006 report).
The Governor's commitment to streamline and revitalize state
government has resulted in the elimination of 13,000 non-essential
positions, reducing the state payroll to under 57,000 employees (after
decades where the payroll hovered near 70,000 employees, resulting in a
bloated and inefficient state government). In addition to the annual
payroll savings this effort has generated, the most current actuarial
valuation of the State Employees Retirement System (SERS) as of June
30, 2005 projected a savings of approximately $5 billion in state
contribution requirements to SERS between fiscal year 2006 and 2045 as
a result of this effort. This $5 billion contribution savings
represents an additional $2 billion savings over the $3 billion
discussed above.
Governor's Pension Reforms
The reforms included in Public Act 94-4 represent the first time
future liabilities and costs of the Illinois pension system have ever
been reduced.
Recent statements have referred to ``raiding'' Illinois state
pension funds. Those statements are nothing more than political
rhetoric from elected officials who, for years, voted for budgets and
benefits that drove the unfunded liability to $43 billion. If there's
something the Blagojevich administration has been deficient on when it
comes to pension funding, it's failing to aggressively halt the
attempts of those who created the problem to then re-write history and
try to pass the blame onto others.
In 2003 when Governor Blagojevich took office the combined assets
of the five state retirement funds were $40.7 billion. By the end of
the Gov's first two budget years (June 30, 2005) those assets had grown
to $58.8 billion--$18.1 billion more than when the Governor took
office. This is, by far, the single largest increase in pension assets
in any 2 year period in history.
Further, according to the retirement systems, as of June 30, 2006
those same cash and investments are in excess of $61.9 billion--a full
$21 billion more (50% more) than when Governor Blagojevich took office
in 2003.
The $21 billion increase in assets came from $12.2 billion of
deposits into the retirement funds by the Blagojevich administration
through June 30, 2006 as well as investment earnings on those deposits.
There have been record deposits and increases in assets, and
substantial earnings on those assets since Governor Blagojevich took
office--despite the rhetoric and attacks leveled by politicians seeking
to hide their own shameful record when it comes to pension funding and
benefits.
Governor Blagojevich's administration has contributed the most
funds to the state pension system of the last four administrations. The
following table illustrates state contributions to the pension system
under the last four administrations:
----------------------------------------------------------------------------------------------------------------
Contributions Average annual Percent of
Fiscal year period (millions) contribution resources
----------------------------------------------------------------------------------------------------------------
2004-2007 Blagojevich.................................... $13,300.0 $3,325.0 12.9%
2000-2003 Ryan........................................... $5,818.4 $1,454.6 6.08%
1996-1999 Edgar.......................................... $3,433.7 $ 858.4 4.30%
1992-1995 Edgar.......................................... $2,067.6 $ 516.9 3.28%
----------------------------------------------------------------------------------------------------------------
Another way to look at the impact of the Governor's actions is to
compare the unfunded liability and funded ratio of the pension systems
with and without the additional contribution of the pension obligation
bonds. With the additional contribution of the pension obligation
bonds, the unfunded liability and funded ratio are $38.6 billion and
60.3% respectively as of June 30, 2005. Without the proceeds of the
pension obligation bonds, the unfunded liability and funded ratio would
have been $47.6 billion and 50.4% respectively as of the same date.
Again the results are demonstrably better than if the Governor's
actions had not been implemented.
Advisory Commission on Pension Benefits
The fourth step in the Governor's long-term plan to reform the
state's pension system consisted of establishing an Advisory Commission
on Pension Benefits. The mandate of this Advisory Commission on Pension
Benefits (the ``Commission'') was to consider and make recommendations
concerning revenue sources, changing the age and service requirements,
automatic annual increase benefits, and employee contribution rates of
the State-funded retirement systems and other pension-related issues.
The Commission met five times between September 23 and October 27,
2005. After extensive and productive discussions of the State
Retirement Systems, the Commission crafted several recommendations. The
next step in the Governor's plans to reform the state's pension system
will be for the legislation to consider the Commission's
recommendations. Some of these recommendations were included and
adopted in the Fiscal Year 2007 budget.
Commission on Government Forecasting and Accountability (``CGFA'')
Earlier this year, the Commission on Government Forecasting and
Accountability (``CGFA'') (a bi-partisan commission whose statutory
role encompasses monitoring of the state's pension systems including
their progress toward the funding levels set forth in the 1995 pension
legislation) issued a ten year report (on the 1995 payment plan). The
report compares the actual progress toward the 90% funded goal (in
2045) on a year by year basis. CGFA engaged its own independent actuary
to track the impact of all cash contributions by the state, changes in
pension benefits such as the early retirement incentive program (ERI),
the impact of the pension obligation bond issued in 2003 and actual
investment results. The same actuary developed a year-by-year set of
projections back in 1995 when the pension funding plan was adopted.
This year's report compared those 1995 projections of where the pension
plans were projected to be (relative to the funded ratio level) in 2005
versus what the funding levels actually were at that same date.
In fact, following is a quote directly from CGFA's report in
January of 2006 ``Despite counteractive factors such as formula
increases, investment gains and losses due to market volatility, the
infusion of Pension Obligation Bond proceeds and funding reductions as
contained in PA94-4, the total cost of the current funding plan has not
grown appreciably from what was originally projected in 1994.''
The bottom line is simple and stark: the 1995 pension payment
schedule estimated the funded ratio would be 52.5% in 2005 while the
actual funded ratio achieved was 60.3%. So, as a result of the policies
put in place since Governor Blagojevich took office in 2003, the state
of Illinois is well ahead of the funding level expected and designed in
the 1995 payment schedule.
This significant and material increase in the funded ratio was due
primarily to the record additional contribution in Fiscal 2004
associated with the $10 billion pension obligation bond and earnings on
that additional contribution.
Those that accuse this governor of ``raiding'' the pension systems
conveniently forget the additional funding that went to the systems. In
fact, the 1995 projections of the CGFA actuary estimated that the state
would make $12.3 billion of contributions from 1996 through 2005. In
fact, the actual contributions for the same period totaled $19.8
billion, thereby exceeding the statutory requirements by $7.5 billion.
Once again, we are well ahead of the original 1995 payment schedule.
Conclusion
I know there's a lot of numbers being stated today but let me
repeat those findings of the independent actuary of CGFA--$7.5 billion
of contributions more than called for in the 1995 plan, and a funded
ratio of 60.3% versus only 52.5% (called for in the 1995 payment plan).
I challenge anyone to refute those numbers and that result.
Specifically, answer this simple question: if the funds were raided,
how can they have $7.5 billion more than statutorily required and the
funded ratio is 7.8% more than the independent actuary estimated?
Illinois has had the worst funded pension system by far for many
years--solely caused by 30 years of underfunding, including many years
of planned underfunding. Illinois also had a practice of adding
billions of dollars of costly benefits without providing any new
funding, which only made the longstanding underfunding worse. We have
put a stop to this in Illinois-the Governor proposed and signed into
law in 2005 a key pension reform: no new benefits without a full
funding source.
Our submission to the Committee outlines many of the steps we have
taken and the recommendations we have made. Illinois has made
demonstrable progress on pension funding for the first time in decades.
I believe that we have taken the first steps towards the pension reform
necessary to strengthen the retirement system's balance sheet, protect
taxpayers and preserve retirement security for our employees. We still
have a long way to go and are committed to continue down that path.
By any measure Illinois state pension systems for retirees and
current employees are better funded and more secure that they were when
Governor Blagojevich came into office. Any statement to the contrary--
particularly statements or inferences about ``raiding'' or
``stealing''--is not only patently false, they scream for the records
of those making those statements to be examined and the truth revealed.
Thank you for allowing me to speak to you today.
______
STATEMENT OF JOANNA WEBB-GAUVIN, DIRECTOR OR RETIREE PROGRAMS,
COUNCIL 31, AMERICAN FEDERATION OF STATE, COUNTY AND MUNICIPAL
EMPLOYEES
Ms. Webb-Gauvin. Good afternoon, Mr. Chairman and members
of the Committee. My name is Joanna Webb-Gauvin. I am the
Retiree Director for Council 31 of the American Federation of
State, County and Municipal Employees in the State of Illinois.
I am pleased to be here today representing Council 31 and
AFSCME on the subject of examining the retirement security of
state and local government employees.
I want to begin by making it very clear that our members do
not have gold-plated pensions. The average pension in the State
of Illinois is $1500 per month, which is not overly generous.
Our members, to earn their pensions, work very hard in public
service. They deserve a sound retirement plan that will let
them live with dignity and have some level of financial
security. That is why our members are deeply concerned that the
State of Illinois, for some time now, has not been contributing
enough money each year to cover the retirement system's long-
term costs. They are concerned that the irresponsibility of our
political leaders may compromise the system's ability to
protect their retirement security. Unfortunately, our under-
funding problem may have even broader implications that we are
concerned about. We are afraid it will provide an opening for
others to unfairly attack the entire concept of defined benefit
pension plans.
Council 31 represents about 75,000 working members and
about 23,000 retired members in the State of Illinois and our
international union represents 1.4 million working members and
almost 230,000 retiree members. One of our principal goals has
always been to ensure that workers receive sufficient income in
retirement. As a result, AFSCME has been a strong supporter of
traditional defined benefit pension plans and the Social
Security system. Both guarantee a steady income to retired
workers and their spouses, along with disability and survivor
benefits. Despite the strength of a defined benefit pension
plan, a handful of anti-worker groups and some politicians,
claim that public employee retirement systems are unfair and an
unaffordable expense. They say these systems must be overhauled
and that a financial crisis is looming. We do not agree that
major changes are required or that a major crisis is looming.
In fact, we feel that most of these attacks are part of a
concerted effort to dismantle pension systems around the
country and undermine the retirement security of millions of
Americans.
We believe that, for the most part, defined benefit plans
in public retirement systems across the country are well
managed and well funded. Pension systems with problems, such as
in San Diego, are the exception. Problems occur when public
employers take pension holidays or fail to pay the normal cost
of the pension system every year. Public pension plans should
not be under-funded. The same for private sector plans,
including those that have been hit by scandal, such as those at
Enron and WorldCom.
Moving from secure defined benefit plans to often risky
defined contribution plans is not the answer. While much has
been made of the growth of 401k style DC savings plans in the
United States, most Fortune 500 companies and 90 percent of
public sector employers continue to offer traditional defined
benefit plans. In fact, the ideal retirement income formula has
long been described as a three-legged stool, with one leg each
representing Social Security, a guaranteed employer-paid
pension--employer-provided--and individual savings. Because a
DC plan is a savings plan and not a guaranteed pension, it
should be viewed as a supplement to a DB pension plan, not as a
substitute. Without a defined benefit plan, the retirement
stool gets pretty wobbly. As a result, many workers are being
forced to find a third leg--continued employment. Defined
benefit plans are especially critical for public employees who,
of which a quarter of them including about half of them in
Illinois, are not covered by Social Security. And for those
employees, an employer-sponsored defined benefit plan is their
only dependable source of income in retirement.
Although there a few public sector retirement systems with
large unfunded actuarial liabilities, these shortfalls were
brought about by situations like the one involving the systems
covering state and university employees in Illinois. This is
not a recent development in Illinois. For the past 25-30 years,
State government has failed to make the necessary contributions
to plans covering its employees. In some instances, the State
has actually borrowed from what should have been plan
contributions to fund education and Medicaid programs. As a
result, the systems covering Illinois' state and university
employees are funded at an aggregate level of 60 percent. In
contrast though, because local employers have made the
necessary contributions to the Illinois Municipal Retirement
Fund, it is funded at a very healthy 94 percent level. In both
instances, however, public employees and retirees have a
guaranteed benefit that exceed whatever is provided for in
ERISA, in that those current and future accruals are guaranteed
by the State Constitution and there is no risk that the plans
will be offloaded to the PBGC as a business tactic. This lack
of an escape valve adds protections for participants, but also
makes it even more important for governments to pre-fund their
programs to keep the bulk of the costs paid by investment
income.
Workers and retirees in the United States are facing
growing economic uncertainty. Our nation is facing an
unprecedented Federal deficit and has been introduced to a new
era of greedy corporate executives infamous for gross
mismanagement of their companies' funds and stocks. Coupled
with the White House's scheme to replace guaranteed Social
Security benefits with private investment accounts, there is
now more than ever a need for certainty and stability in
retirement plans. Public sector systems remain healthy and will
continue to deliver promised pension benefits.
Government, in its dual role as employer and policymaker,
has the responsibility not only to serve as a model employer,
but to provide secure retirement benefits for a large part of
the nation's workforce. Career employees deserve an adequate
pension benefit that will not disappear in just a few short
years into retirement. Without the retirement security provided
by a defined benefit pension plan, it would be the burden of
the state and local governments to deal with the consequences
of an elderly population unable to provide for themselves in
retirement.
In closing, Mr. Chairman, I want to thank you for the
opportunity to testify on this important issue, and I would be
happy to answer any questions that you may have.
Mr. Kline. Thank you very much.
Mr. Weiss, the floor is yours.
[The prepared statement of Ms. Webb-Gauvin follows:]
Prepared Statement of Joanna Webb-Gauvin, Director of Retiree Programs,
Council 31, American Federation of State, County and Municipal
Employees (AFSCME)
Good morning, Mr. Chairman and members of the committee, my name is
Joanna Webb-Gauvin. I am the Director of Retiree Programs for Council
31 of the American Federation of State, County and Municipal Employees
in the state of Illinois. I am pleased to be here today representing
Council 31 and AFSCME on the subject of Examining the Retirement
Security of State and Local Government Employees.
I want to begin by making it clear that our members do not have
gold-plated pensions. In fact, in Illinois the average state pension is
only $1500 per month--not overly generous. To earn their pensions, our
members work very hard in the public service. They deserve a sound
retirement plan that will let them live with dignity and some degree of
financial security. That's why our members are deeply concerned that
the state of Illinois, for some time now, has not been contributing
enough money each year to cover the retirement system's long-term
costs. They are concerned that the irresponsibility of our state's
political leaders may compromise the system's ability to protect their
retirement security. Unfortunately, our under-funding problem may have
even broader implications. We're afraid it will provide an opening for
others to unfairly attack the entire concept of defined benefit plans.
Council 31 represents about 75,000 employees here in the state of
Illinois and our International union AFSCME represents 1.4 million
active members and almost 230,000 retiree members. One of our principal
goals has always been to ensure that workers receive sufficient income
in retirement. As a result, AFSCME has always been a strong supporter
of traditional defined benefit (DB) pension plans and the Social
Security system. Both guarantee a steady income to retired workers and
their spouses, along with disability and survivor protections. Despite
the strengths of DB pension plans, a handful of anti-worker groups--and
even some politicians--claim that public employee retirement systems
are unfair and an unaffordable expense. They say these systems must be
overhauled to avoid a financial crisis. We don't agree that major
changes are required or that a major crisis is looming. In fact, we
feel most of these attacks are part of a concerted effort to dismantle
pensions systems around the country and undermine the retirement
security of millions of Americans.
We believe that, for the most part, defined benefit plans in public
retirement systems across the country are well managed and well funded.
Pensions systems with problems, such as in San Diego, are the
exception. Problems occur when public employers take pension holidays
or fail to pay the normal cost of the pension system every year. Public
pension plans should not be under-funded. The same goes for private
sector plans, including those that have been hit by scandal, such as
those at Enron and Worldcom.
Moving from secure defined benefit plans to often risky defined
contribution (DC) plans is not the answer. While much has been made of
the growth of 401(k)-type DC savings plans in the United States, most
Fortune 500 companies and 90 percent of public sector employers
continue to offer traditional DB pension plans. In fact, the ideal
retirement income formula has long been described as a ``three-legged
stool,'' with one leg each representing Social Security; a guaranteed,
employer-provided pension; and individual savings. Because a DC plan is
a savings plan and not a guaranteed pension, it should be viewed as a
supplement to a DB pension plan--not as a substitute. Without a DB
plan, the retirement stool gets pretty wobbly. As a result, many
workers approaching retirement may be forced to add another leg--
continued employment. DB plans are especially critical for public
employees because a quarter of them, including about half of those in
Illinois, aren't covered by Social Security. For those employees, an
employer-sponsored DB plan is their only dependable source of income
upon retirement.
No matter what happens on Wall Street or how long an individual
lives, DB pension plans provide employees and their dependents with a
secure retirement income. This is not the case for a DC plan
participant, whose private account balance will depend on the level of
contributions and, perhaps more importantly, the investment income
earned on those contributions. All of the risk is placed on the
individual employee under a DC plan.
Look at how investment returns can play havoc with a person's
retirement savings. Assume an employee with 30 years of service had
accumulated $150,000 in her DC savings plan by the end of 1999. If she
happened to retire in 2000, she may have been able to maintain a modest
standard of living by combining her savings with Social Security. If
she waited to retire until 2002, however, her retirement security would
be in jeopardy. That's because market reverses caused average DC
account balances to decline by 30 to 40 percent over those two years.
Imagine having to get by on two-thirds of the savings you anticipated.
The fact is that retirement prospects for American workers whose
employers do not offer a traditional DB plan are poor. According to the
Employee Benefit Research Institute (EBRI), the average account balance
among DC plan participants was just $57,000 at the end of 2004 and half
of those participants had account balances under $20,000. With an
average additional life expectancy of about 20 years for an American
retiring at age 65, millions of workers will see their savings vanish
just a few years after retirement. Even more alarming is that those
averages only include employees actually participating in their
employer's plan: about one-fourth of workers who are eligible to
participate in DC plans do not do so.
It is our strong belief, that dollar for dollar defined benefit
plans are a more efficient use of taxpayer money once contributions are
made. Unlike the private sector, where employers typically pay all
pension plan costs, most public DB plans require worker contributions
as well. Public employees generally contribute between 4 and 8 percent
of their pay.
Defined benefit plans also have professional management, which
allows for a wider set of investment opportunities, leading to higher
returns than the average DC plan and much lower fee structures. All of
this makes DB plans highly desirable for both public employees and
taxpayers. There's another reason that DB plans also make sense from a
taxpayer's perspective: they help states and localities maintain a
qualified and stable workforce. The billions of dollars in public
pension systems go to work for both by earning strong returns that are
used to fund on average about 75 percent of the benefits that are paid
out. Consequently, taxpayers only pay somewhere between 10 and 20
percent of the cost of the retirement benefit.
It is also important to note that some states have been too
precipitous in changing to DC plans only to regret it later. In 2002,
the state of Nebraska recognized the numerous problems with DC plans
and scrapped its long standing DC plan in favor of a plan that more
closely resembles a DB plan. The change followed a study determining
that DC plan members had worse returns on their investments than DB
plan members and were retiring with only 25 percent of their pre-
retirement income, while DB plan participants were retiring with 60 to
70 percent of pre-retirement income. Studies have shown that rates of
return for professionally managed DB plans significantly outperform
employee-directed DC investments. The actuarial consulting firm of
Watson Wyatt found that the rates of return for DB plans exceeded those
of DC plans by about 4 percent each year over a recent three-year
period.
Defined benefit plan managers are trained in developing ongoing,
long-term investment strategies that include an optimum mix of growth
potential and risk. Participants benefit from the favorable investment
performance of pooled pension fund assets. DC plan participants, on the
other hand, are often limited to a handful of investment choices.
Furthermore, investments in a DB plan are not affected by the
retirement timing of a particular employee so the investment horizon
never has to be shortened. As a result, return prospects are enhanced
in a DB plan.
Also, of great importance to taxpayers, public pensions are an
important source of economic stimulus to every state, city, and town
across America. These systems distribute more than $130 billion
annually. Their $2.5 trillion in assets are an important source of
liquidity and stability for our financial markets. Higher returns
generated from pooled and professionally invested funds contribute an
estimated $240 billion (or 2 percent) more to GDP than if they had been
invested in private accounts.
Defined contribution plan proponents claim those plans provide
much-needed portability for a workforce that changes jobs more often
than in the past. Numerous studies, however, dispel the notion that
workers today change jobs more often than in the past. The Bureau of
Labor Statistics reports that tenure for wage and salary workers was 4
years in January 2004, compared with 3.5 years in January 1983. For
public employees, tenure is even longer, with the average public
employee having nearly 7 years on the job. Therefore, with most public
sector DB plans providing for vesting after 5 years, most public
employees will be eligible for a pension benefit commensurate with
their service.
Groups that want to eliminate traditional pensions often claim the
systems responsible for providing retirement benefits are facing a
collective financial crisis. That claim is simply not true. According
to the Wisconsin Legislative Council's ``Comparative Study of Major
Public Employee Retirement Systems,'' released in December 2005, the
average funding ratio of the 88 large plans surveyed was 85 percent,
and nearly half of the plans were over 90 percent funded. A plan's
funding ratio is simply a comparison of assets to future obligations.
Typically, a retirement system's liabilities are amortized over time--
similar to paying off a mortgage. As Fred Nesbitt, former Executive
Director of the National Conference on Public Employee Retirement
Systems, put it, ``A family that owes $200,000 on a mortgage wouldn't
say 'we're doomed,' because it knows it has 30 years to pay the bill.''
Although there are a few public sector retirement systems with
large unfunded actuarial liabilities, these shortfalls were brought
about by situations like the one involving the systems covering state
and university employees in Illinois. This is not a recent development
in Illinois. For the past 25 years, state government has failed to make
the necessary contributions to plans covering its employees. In some
instances, the state has actually borrowed from what should have been
plan contributions to fund education and Medicaid programs. As a
result, the systems covering Illinois' state and university employees
are funded at an aggregate level of 60 percent. In contrast, because
local employers have made the necessary contributions to the Illinois
Municipal Retirement Fund, it is funded at a very healthy 94 percent
level. In both instances, however, public employees and retirees have
benefit guarantees that exceed what is provided for in ERISA, in that
both current and future accruals are guaranteed by the state
constitution and there is no risk that the plans will be offloaded to
the PBGC as a business tactic. This lack of an ``escape valve'' adds
protections for participants, but also makes it even more important for
governments to pre-fund their programs to keep the bulk of the costs
paid for by investment income.
For most DB plans, the vast majority of income comes from returns
on investments. The fact that investment losses during bear markets
reduce the value of retirement systems' assets should not come as a
surprise. What is surprising is that groups attempting to dismantle
pension systems fail to account for the fact that DB pension plan
funding is structured to be carried out indefinitely. Defined benefit
plans are designed for the long haul and do not have an investment
horizon like DC savings plans that cover individual employees.
Furthermore, governments are ongoing concerns that will not go bankrupt
and leave workers unprotected.
Defined benefit plans are also good for employers. Public sector
employers must attract, and retain, a uniquely diverse workforce, such
as architects, correctional officers, librarians, social workers and
zookeepers, to name just a few occupations. Each of these jobs calls
for special skills, knowledge and abilities. More than half of all
public employees hold positions classified by the Bureau of Labor
Statistics in either the ``Education'' or ``Protective Service''
fields. These are jobs for which there is little or no private sector
equivalent, and their nature makes experience highly valuable. Defined
benefit plans have not only done a good job of attracting such a
diverse group, but those plans have also promoted retention efforts by
rewarding the hard work and dedication of career employees.
Workers and retirees in the United States are facing growing
economic uncertainty. Our nation is facing an unprecedented federal
deficit and has been introduced to a new era of greedy corporate
executives infamous for gross mishandling of their company funds and
stock. Coupled with the White House's scheme to replace guaranteed
Social Security benefits with private investment accounts, there is
now, more than ever, a need for certainty and stability in retirement
planning. Public sector retirement systems remain healthy and will
continue to deliver promised pension benefits.
Government, in its dual role as employer and policy-maker, has the
responsibility to not only serve as a model employer, but to provide
secure retirement benefits for a large part of the nation's work force.
Career employees deserve an adequate pension benefit that will not
disappear just a few short years into retirement. Without the
retirement security provided by DB pension plans, it would be the
burden of state and local governments to deal with the consequences of
an elderly population lacking the resources to provide for themselves.
In closing, Mr. Chairman, I want to thank you for the opportunity
to testify on this important issue. I would be pleased to answer any
questions you may have.
______
STATEMENT OF LANCE WEISS, CONSULTING ACTUARY, DELOITTE
CONSULTING, LLP
Mr. Weiss. Thank you. Chairman Johnson, Ranking Member
Andrews, Vice Chairman Kline, Representative Biggert and
members of the Subcommittee, my name is Lance Weiss and I am a
pension actuary with Deloitte Consulting, LLC. I very much
appreciate the opportunity to appear before you today.
Mounting public sector retirement costs pose a serious
threat to many--not all, but definitely many--state and local
governments. Public officials must confront runaway public
pension and retiree health benefit costs or risk voter backlash
as these costs hit taxpayers directly in the pocketbook and
force states to spend tax dollars on legacy obligations that
otherwise could have been used for education, services and
infrastructure.
Solving the public pension crisis requires prompt action.
Government policymakers must address this challenge by
developing sound funding policies for public pension systems
and then having the discipline to follow through on them.
Now, although each state or locality has a unique set of
factors which contributed to their own pension crisis, there
are a number of causes that are pretty consistent across many
plans.
First, there are generally no requirements forcing public
entities to fund their pension liabilities. As a result, public
pension plans are funded to varying degrees, including some
that are funded very well. Unfortunately, it also includes some
that are completely unfunded and operate on a pay-as-you-go
basis.
By contrast, private sector pension plans are now required
by the recently enacted Pension Protection Act of 2006 to reach
100 percent funding of accrued liabilities in 7 years. Most
public sector plans, by comparison, are funded over much, much
longer periods of time--30, 40 or even 50 years.
Second, flush with earnings from the bull markets that
lasted through much of the 1990's, and actually masked
significant under-funding of many plans that occurred prior to
that time, states and localities routinely added all types of
benefit enhancements to public sector retirement plans, often
justifying the increases as necessary to retain qualified
workers.
Unfortunately, as the investment markets cooled in 2000,
the bill came due for generous benefit packages accrued during
the boom years. However, instead of shoring up pension funds
with more revenues, some states and localities used revenues
that should have gone into pension funds to finance other
priorities such as Medicaid or education. Thus, making the
pension funding situation even worse.
Regrettably, there is no silver bullet for solving the
public pension crisis. Most jurisdictions will require a
combination of cost-cutting and revenue-enhancing changes to
bring their pension systems back into balance. In the short
term, jurisdictions facing large unfunded pension obligations
must stop the financial bleeding. Several strategies for
relatively quick improvement include:
First, curtail abuses by eliminating pay raises and sick
leave policies that allow pension benefits to be arbitrarily
inflated.
Narrow eligibility for costly public safety benefits to
true public safety employees.
Second, where possible, raise employee pension
contributions to better match rising total costs.
Third, explore all other revenue sources to improve pension
funding.
And last, reduce administrative costs by combining multiple
pension plans or implementing more efficient administrative
systems and procedures.
Longer-term viability of public retirement programs likely
will demand fundamental changes in pensions. Because these
reforms sometimes are difficult to apply to existing employees,
their impact often will not be felt until a new generation of
public workers is hired and some of today's younger workers
near retirement.
Pension reform for the medium to long-term include, first,
develop an appropriate pension funding policy and stick to it.
Current laws governing public sector plans allow policymakers
to shift huge retirement costs to future generations. States
should consider crafting laws that require minimum funding
levels for public retirement systems. There is no magic number
for what the funding levels should be. Funding targets may
range from 80 to 100 percent. Policymakers need to decide on a
level of pension funding that balances short-term needs with
long-term goals.
Second, consider establishing a two-tier pension program
that shifts newly hired workers into lower cost retirement
plans. This approach, which is now very common in the private
sector, reduces retirement and health benefits for employees
hired after a specific date, while maintaining agreed upon
benefit packages for existing workers and current retirees.
Third, tie cost of living increases to actual inflation
rates. This could actually produce significant savings while
still protecting retirees from rising living expenses.
Fourth, scale back generous early retirement programs. As a
huge number of aging baby boomers near retirement age, these
provisions are proving to be extremely expensive and very
poorly designed. Restructuring these early retirement programs
would save money and encourage valuable workers to stay on the
job.
In conclusion, there are no easy answers to the public
pension crisis. In the short term, jurisdictions facing large
unfunded pension obligations must stop the financial bleeding.
In the longer term, jurisdictions must develop sound funding
policies for the public pension systems and then have the
discipline to follow them. They must make the minimum required
pension contributions when times are tough. Just as important,
they must resist politically expedient pension give-aways when
times are good.
Thank you and I look forward to your questions.
[The prepared statement of Mr. Weiss follows:]
Prepared Statement of Lance Weiss, Consulting Actuary,
Deloitte Consulting, LLP
Chairman Johnson, Ranking Member Andrews, Vice Chairman Kline,
Representative Biggert, and Members of the Subcommittee, I am Lance
Weiss, a consulting Actuary with Deloitte Consulting LLP.
I have over 33 years of experience in employee benefits and
retirement planning, with special emphasis on the design, funding,
security, administration and implementation of qualified and
nonqualified retirement and post-retirement medical programs. I have
worked with large public and private corporations, coordinating
retirement benefits with other elements of total compensation programs,
as well as developing effective benefits and cost containment programs.
I am a Fellow of the Conference of Consulting Actuaries, a Member
of the American Academy of Actuaries and an Enrolled Actuary under
ERISA.
I've had the unique opportunity to work with leading public and
private sector organizations helping them navigate their way through
employee benefit challenges and opportunities. Most recently, I have
spent a great deal of my time working with public sector organizations
assisting them manage their underfunded pension programs. These
experiences led directly to my involvement as co-author of a Deloitte
Research Paper entitled ``Paying for Tomorrow: Practical Strategies for
Tackling the Public Pension Crisis.''
I think I can be most helpful to the Subcommittee today by focusing
on what I have gleaned from my own experiences with public sector
pension plans and therefore, I will be testifying on my own behalf and
not on behalf of Deloitte or any of its affiliates or clients.
Mr. Chairman, I appreciate the opportunity to appear before you and
share my perspective with the Subcommittee.
Introduction to the Public Pension Crisis
``Public Pension Plans Face Billions in Shortages'' was the title
of a front page article that appeared in the August 8, 2006 New York
Times. The first in a series that will examine actions of state and
local governments that have left taxpayers with large unpaid bills for
public employee pensions, the article states that ``By one estimate,
state and local governments owe roughly $375 billion more than they
have committed to their pension funds.''
While some public pension plans are in sound financial shape, too
many others are in crisis mode. In fact, funding public pension plans
today represents one of the most significant budget issues for many
states and local governments.
The news is similar across the nation, as many states and
localities confront the widening gap between the amount of money
collected by pension plans through employee contributions and
investments, and the amount of money these plans are committed to
paying out in the form of benefits to government retirees. Several
examples follow:
In April 2005, San Diego Mayor Dick Murphy stepped before
a crowd of news reporters and announced his resignation. Murphy,
elected to office just five months earlier, had become the focal point
of public backlash over a city pension deficit of nearly $2 billion.
Not only were San Diego's pension troubles a key factor in Murphy's
resignation, they also hindered the city's effort to complete capital
projects. San Diego's credit rating fell in 2004, hobbling the city's
ability to sell bonds to finance initiatives such as water and sewer
improvements, the Los Angeles Times reported.
In Texas, the state Pension Review Board placed 18 public
retirement plans on its watch list, a warning that the plans have
insufficient funds to meet future obligations.
In New Jersey, newly elected Gov. Jon Corzine made public
pension reform a campaign issue in his state, where taxpayers may need
to come up with nearly $400 million this year to cover skyrocketing
pension costs for municipal workers, police and firefighters. New
Jersey's state and local public retirement systems are underfunded by
as much as $35 billion--a shortfall that must be filled either by
investment gains or taxpayer contributions over the next three decades.
Cities and counties in New York State saw their pension
contributions grow by as much as 248 percent in 2004, according to
BusinessWeek. For example, the pension bill for Binghamton, N.Y.,
jumped from $1.6 million to $4.2 million, prompting Mayor Richard Bucci
to brand the increase a ``fiscal atom bomb.'' The city hiked property
taxes 7 percent in 2004--half of which went to cover pension costs--and
another 7 percent in 2005 for the same reason.
A 2006 survey of 125 state retirement systems by Wilshire Research
shows the breadth and magnitude of the problem. Of the 58 plans that
provided actuarial data for 2005, 84 percent of them were underfunded.
For those providing data for 2004, the number was even higher at 87%.
This is up from 79 percent in 2002 and 51 percent in 2001.
A report from the Reason Foundation warned that the current price
tag for unfunded pension obligations dwarfs the federal government's
bailout of the savings and loan industry in the late 1980s, which cost
taxpayers $124 billion. Today, taxpayers may be exposed to more than
five times that amount in unfunded pension obligations across the
public and private sectors.
In a recent special report, BusinessWeek magazine highlighted the
impact of exploding pension costs on several communities. One of these
is Jenison, Mich., where contributions to pensions and retiree health
care are the fastest-growing expense for the public school system. The
bill came to $1 million in 2005 and will jump to $1.5 million in 2006.
With state school funds frozen for the past three years, the district
coped with growing pension expenses by eliminating teaching positions
and instituting fees for afterschool sports and field trips.
As these impacts become more pronounced, public officials will face
growing public concern over the spiraling expense of government
retirement programs. The problem will only get worse when the huge wave
of baby boomers begins to retire.
The bottom line is the world in which retirement programs operate
has changed dramatically in recent years, and the programs must be
proactively managed in order to maintain a cost-benefit balance.
Although not part of this hearing or my testimony, it should be
noted that the financial crisis facing many public sector entities is
compounded and dwarfed when considered in combination with (1)
increasing post-retirement health plan costs and (2) the fact that the
workforces of many entities will decline as the competition for a
shrinking workforce intensifies. This will result in fewer younger
workers contributing to the plans to help fund the higher costs of
older and retired workers. Accordingly, any solutions to the pension
problems need to be considered in a broader perspective.
Causes of the Public Pension Crisis
The current public pension crisis stems from a multitude of causes,
but basically boils down to a mix of ineffective pension policy
decisions and a lack of planning, the results of which were exposed by
the stock market slide that began in 2000.
Although each state or locality has a unique set of factors
contributing to the pension crisis, there are a number of causes that
are consistent across many plans. The primary causes of the pension
crisis that are consistent across numerous plans include the following:
Lack of Prefunding Requirements
There are generally no requirements forcing public retirement plans
to fund their pension liabilities. As a result these plans are funded
to varying degrees, including some that are completely unfunded and
operate on a ``pay-as-you-go'' basis. Paying less than the actuarially
determined contribution each year increases the unfunded liability,
which may impact debt ratings for state and local governments and cause
future required contributions to be even higher.
By contrast, private-sector organizations must comply with the
Employee Retirement Income Security Act of 1974 (ERISA), as recently
amended by the Pension Protection Act of 2006, which sets minimum
funding standards for company sponsored retirement plans. In very
simple terms, private plans are now required by the recently enacted
Pension Protection Act of 2006 to reach 100% funding of accrued
liabilities in seven years. Most public sector plans are funded over
much longer periods of time--30, 40 or even 50 years.
Due to the lack of prefunding requirements, there is little
incentive for fiscal restraint. In fact, sometimes the opposite is
true--policy leaders reap political rewards for creating new benefits
for public employees or underfunding retirement systems and using the
money for other short-term goals. The bill for increasing unfunded
pension liabilities is unfortunately left for future generations.
In recent years, the economic slowdown reduced general government
revenues, leading jurisdictions to divert retirement fund contributions
toward other priorities. States such as New Jersey and North Carolina
reduced retirement fund payments to help balance their books. Now they
are struggling to reduce unfunded pension liabilities--and the rating
agencies are taking notice.
Benefit Expansions
Bolstered by the bull market that lasted through much of the 1990s,
many States and localities improved benefits in public-sector
retirement plans, often justifying the increases as necessary to retain
qualified workers. In some cases, the benefit expansions were given in
lieu of politically more difficult pay raises. For example, Texas state
lawmakers approved $14 billion in benefit enhancements for public
school employees over the past 10 years. Benefit enhancements added in
Illinois between 1995 and 2003 boosted liabilities by approximately $6
billion.
Public pension plans also expanded supplemental plan benefits over
the past 10 years. For instance, an ever-growing number of public
employees were classified as public-safety workers, thus qualifying
them for higher retirement benefits due to the hazardous nature of
their jobs. In Illinois, special benefits once reserved for police
officers now go to approximately one-third of all state workers.
Likewise, one in three California government workers now receives
public-safety pensions, up from one in twenty during the 1960s. In
addition, generous rules on selling back unused sick- and vacation-time
caused artificial raises in final year earnings. Since retirement
benefits usually are based on how much workers earn during their last
several years of employment, these income spikes resulted in bigger
lifetime pension amounts for retirees and permanently higher costs for
taxpayers.
Not only were benefit amounts rising in the 1990s but public
retirement systems were paying out higher pension amounts for longer
periods of time. Lucrative ``unreduced'' early retirement benefit
provisions had the effect of actually encouraging many employees to
retire in their early 50s. Such early retirement adds significantly to
the costs of these plans because earlier benefit commencement coupled
with constant improvements in health care (resulting in retirees living
longer) mean that retirees now draw benefits longer than ever before.
Structural Weaknesses Masked by 1990s Stock Market Boom
The increasing cost of government pensions (and the failure of many
public pension sponsors to adequately fund their plans) was totally
masked by the booming stock market of the 1990s. Thanks to historic
market gains during the ``dot-com'' era, pension fund investment
revenue easily kept pace with expanding retirement perks under the
guise of ``only spending the surplus''. Investment returns were so
good, in fact, that many governments made no contribution at all to
their retirement funds. Before 2005, local governments in New Jersey
had gone six years without paying anything toward public employee
retirement plans, the Star-Ledger reported. Some retirement systems
even gave away extra earnings to plan participants in the form of bonus
``13th'' pension checks--meaning an extra month's worth of payments--
instead of saving the money to offset periods when the market
inevitably cooled off. Although many states underfunded their public
retirement systems for years, thanks to the strong stock market, their
pension plans remained reasonably well funded. When the dot-com bubble
burst, retirement systems accustomed to earning a handsome return on
their investments abruptly found themselves in a financial bind. As
investment markets cooled, lucrative benefit packages approved during
the boom years began pushing pension contribution requirements to
unaffordable levels.
Solutions to the Pension Crisis
Since each plan has its own unique set of circumstances, there is
no single solution for solving the public pension crisis that will fit
all situations. However, there are a number of strategies that public
sector entities can adopt to improve the funded position and
affordability of their pension plans. In general, most jurisdictions
with plans in crisis will require a mix of (1) cost cutting and (2)
revenue enhancing changes. Some of the strategies that can be utilized
are described below.
1. Cost Cutting Strategies
First with regard to cost cutting, the costs of pension plans are
equal to the benefits paid, plus administrative expenses associated
with operating the plan, reduced by any investment return generated by
invested assets. Therefore, there are really only three ways to reduce
plan costs:
Reduce benefits
Increase investment return
Reduce administrative costs
Reduce Pension Benefits
One caution with regard to reducing benefits is that public pension
benefits may be very difficult to modify. Public pension benefits are
often the product of collective bargaining agreements, and they're
strongly supported by employee and union groups.
Furthermore, public employee pension benefits, once approved, are
subject to constitutional protection in some states. Experts generally
agree that governments can change or reduce benefits for employees who
haven't yet been hired, and they cannot change them for retired
employees. The gray area is whether benefits can be reduced for the
employees in between--workers who are hired, but not yet retired.
Because of the difficulty and uncertainty of reducing benefits for
current employees, providing reduced benefits for newly hired employees
may be the most practical option for paring costs. Unfortunately this
``two-tier'' approach will not produce significant cost savings for
years.
Some of the options for reducing benefits are to:
Reduce cost of living increases--automatic cost-of-living
increases are common in public-sector retirement programs. By contrast,
these provisions have become rare in the private sector because they
are extremely costly. Contractual issues will most likely make it hard
to eliminate cost-of-living provisions for public sector retirees.
Further, since public retirement systems replace Social Security
benefits in many states, it may be politically difficult and perhaps
unfair to abolish cost-of-living increases for public-sector plans when
private-sector workers receive them through Social Security benefits.
But some public retirement plans offer extremely generous automatic
increases--as high as 5 percent, regardless of inflation. Tying cost-
of-living increases to actual inflation rates could produce significant
savings, while still protecting retirees from rising living expenses.
Scale back lucrative early retirement benefit provisions--
generous early retirement provisions often allow public-sector workers
to retire with full benefits as early as age 50 or 55--instead of 65
which is typical in the private sector. In some cases, state and local
officials also viewed early retirement programs as cost-cutting
measures to reduce the size of government workforces with delayed cash
implications. As a huge number of aging baby boomers near retirement
age, these provisions are proving to be extremely expensive and poorly
designed. In some states, nearly half of the public workforce will be
eligible for early retirement within 10 years. Some jurisdictions
already have been forced to offer older workers additional incentives
not to take early retirement benefits. Restructuring these provisions
would save money and encourage valuable workers to stay on the job.
Reduce basic pension benefit--the most common two-tier
pension program strategy is to shift newly hired public employees from
traditional defined benefit plans to less risky (from an employer cost
perspective) defined contribution plans. Defined contribution plans
don't necessarily reduce employee retirement benefits, but they limit
employer and taxpayer exposure to investment risk because ultimate
retirement benefits under a defined contribution plan are determined by
the performance of an employee's retirement investments. By contrast,
defined benefit plans pay a set pension amount regardless of a fund's
investment performance, with taxpayers picking up the tab for any
deficiency. However, one word of caution--transitioning to defined
contribution plans for new hires while still providing pensions to
existing employees may actually result in higher total costs for poorly
funded pension plans.
Close Loopholes--although it may not be easy to reduce
basic benefit formulas, it may be possible to modify ancillary plan
provisions, some of which can significantly reduce plan costs. Options
include:
--Tighten the practice of granting large pay raises in the years
immediately before retirement, which can allow employees to
spike final earnings amounts.
--Tighten overly generous sick-leave policies, which also can allow
employees to spike final earnings amounts.
--Narrow eligibility for high-cost public-safety pension benefits by
limiting the categories of eligible workers.
Increase Investment Return
Overly cautious investment strategies needlessly reduce income
potential. They also often don't give the flexibility that is needed to
manage the portfolio and manage risk. Some plans' policies often place
a ceiling on equities and don't allow for hedging or alternative
investments. By limiting the types of investments and investment mix
they can actually create greater risks under certain market conditions.
Therefore, investment policies must balance profit potential with risk.
Achieving the right balance of risk and reward maximizes investment
income and limits the chance of devastating losses. Plans should
undertake a review and analysis of their investments policies to
determine if they are appropriate for the particular plans. One way for
states and localities to analyze the risk/reward relationship is to
conduct an asset and liability projection study. Finally, investment
advisors need to be given enough latitude to manage the investments
prudently but should fully understand all potential investments.
Another strategy that should be examined is pension obligation
bonds. This approach requires governments to issue bonds at low
interest rates, and then reinvest the bond proceeds into higher-
yielding financial investments. The difference between the cost of debt
service on the bonds and revenue created by investing the bond proceeds
generates income that could be used to prop up pension funds.
This strategy depends on careful market timing and therefore is
highly risky. Another problem with pension obligation bonds is that it
involves converting a soft debt (pension liability) into a hard debt
(the required bond payments), which gets the attention of the bond
rating agencies. Moreover, voters may balk at the prospect of approving
new long-term debt.
Illinois, however, used the technique very successfully in 2004,
selling $10 billion in pension obligation bonds when interest rates in
the bond market had nearly hit bottom. The move allowed the state to
basically refinance $10 billion of pension debt at approximately a 5
percent interest rate instead of an 8.5 percent interest rate. The bulk
of the bond proceeds went directly into the state retirement fund,
increasing the funding status by more than 10 percent virtually
overnight.
Reduce Administrative Costs
Savings from administrative changes probably will be small in
relation to the size of the pension funding problem. Nevertheless,
cutting plan overhead should at least be a component of any
comprehensive solution.
The biggest opportunity lies with consolidating multiple pension
plans. There are more than 2,600 public employee retirement systems
nationwide, according to the U.S. Census Bureau. In Texas, for example,
dozens of state and local public retirement plans cover government
workers, teachers, police and firefighters. Similarly, the state of
Illinois has five separate retirement boards--each with its own
workforce and infrastructure. Combining these plans where sensible
would eliminate redundant administrative staffs and functions,
producing lower operating costs and leaving more dollars available for
pension payments. Consolidating pension plans could be politically
difficult, but it's a commonsense reform that deserves consideration.
Outsourcing certain administrative tasks or automating processes
represents another opportunity to trim overhead expenses. Jurisdictions
can also benefit from a thorough review of vendors and service
providers involved in their public pension systems. Analyzing pricing
and services provided by third parties--and renegotiating contracts
when appropriate--can deliver savings. California, New York and New
Mexico are among a growing number of states deploying information
technology designed to boost efficiency in their public employee
retirement systems.
2. Revenue Enhancing Strategies
In terms of enhancing revenue, States and localities should first
consider raising the amount that employees contribute to public
retirement plans. Employee pension contributions generally have held
steady as plan costs have increased. One alternative would be to tie
employee contribution amounts to actual plan costs. So, for example, if
total pension plan costs increase by 10 percent, employee contributions
would increase by the same percentage or at least by some amount.
Such adjustments are common for employee health plans. But
instituting similar practices for pension contributions would depend on
potentially difficult negotiations with public employee unions and
consideration of constitutional provisions.
State and local governments should also look and see if they have
any untapped revenue sources that could be used to fund pension
obligations. Finding these dollars will require innovative thinking.
Illinois, for example, is exploring selling or leasing it's state
tollway system. Proceeds from the sale would be funneled into the state
pension system. Other revenue sources might include sales of unused
public properties.
Jurisdictions must develop sound funding policies for their public
pension systems and then have the discipline to follow them. Since
there is generally no governmental prefunding requirement for public
pension plans, funding decisions must be guided by sound fiscal policy.
For more than 30 years, ERISA has spelled out requirements and
responsibilities for private-sector pension and health plans. Yet the
absence of similar laws for public-sector plans allows policymakers to
shift huge retirement costs to future generations. States should
consider crafting laws that require minimum funding levels for public
retirement systems.
Finally, pension funding policies have little impact if no one
follows them. Officials must make the minimum required pension
contributions when times are tough. Just as important, they must resist
politically expedient pension giveaways when times are good.
Mr. Chairman and Members of the Committee, there are no easy
solutions to the public pension crisis. Hopefully, the information
presented in this testimony will assist the federal government (1)
better understand the unique challenges facing public sector pension
plans and (2) develop solutions designed to improve the affordability
and funded positions of public sector pension plans.
______
Mr. Kline. Thank you, Mr. Weiss. And thank all of the panel
members.
Our plan here is for each of us to ask some questions, I am
going to ask a few questions and then I will yield to Mrs.
Biggert and then probably another round. I am mindful that
people have schedules to keep, both panel members and Mrs.
Biggert and I, and I am sure most people in the audience, so we
will try not to have this go too long, but there are some
things that I feel need to be cleared up. I am not sure if we
can do it here today, but I am going to try just a couple.
Just a couple of comments. It is interesting the different
perceptions. We had several panel members talking about the
crisis in public employee pensions and other witnesses discount
that completely. So we may need to explore that a little bit. I
may need to use Ms. Jinks' mathematics skills to help me with
Mr. Filan's testimony.
[Laughter.]
Mr. Kline. That was an impressive array of numbers.
Let me just start with a couple here. I wrote so many
notes, I have got to get myself organized a little bit. It
seems to me that we have differing ways of looking at the
health of these pensions, and I am wondering--I think I will
start with you, Mr. Weiss--how much of this debate and
confusion is a function of the differing modes of accounting
and actuarial assumptions and would a more uniform or
standardized set of accounting assumptions give us a better
picture? Is that something that you can address?
Mr. Weiss. Sure. I really do not believe it is a function
of accounting or actuarial assumptions. I think, you know, if
you look at the funded percentages as it compares to accrued
liabilities, I think that gives you a pretty good, at least a
snapshot, view of the health of these plans, at least in
today's terms.
Probably more important though is to look at what is the
projected funded percentage ratios of these plans as we go
forward, based on their existing funding policies. And for too
many plans, the ratios are, in my own opinion, inadequate and
trending downward instead of upward, notwithstanding, you know,
future investment returns or expectations for investment
returns.
So I think it is really a function of looking at the funded
percentage, determining if that is appropriate, looking at the
affordability of the funding schedule required to improve the
funded percentages. So for example, for a plan that is 70
percent funded, I think we probably all agree we would like
that plan to get to 100 percent funded within a reasonable
period of time. What is the funding required to get there, is
it affordable based on the existing level of benefits?
Mr. Kline. But in determining the percentage funded, you
have got to use some basis. Are you assuming a growth of 6
percent, 8 percent, 9 percent? It seems to me that would have a
big impact on determining how well funded you are and I do not
know--we tried to grapple with that in the Pension Protection
Act, but I do not see that there is any uniformity here. Is
that of any interest to you at all?
Mr. Weiss. Yeah, it is. I think honestly most public plans
make a reasonable attempt to come up with a discount rate to
determine their liability, and that is really where it is
applicable, determining the liability.
Mr. Kline. Exactly.
Mr. Weiss. With the assets, the market value is the market
value. But it is the liability that there is some flexibility
in terms of determining the appropriate discount rate.
You are right, it might require a uniform measure of that
liability similarly to what you have done now for the private
sector via the Pension Protection Act, might make these plans
more comparable but honestly, I think the plans do a very
reasonable job in determining, you know, fairly consistent
discount rates.
Mr. Kline. OK, thank you. Anybody else have a comment? Mr.
Brainard.
Mr. Brainard. If I might.
Mr. Kline. Yes, please.
Mr. Brainard. Mr. Weiss commented that he felt that public
pension plan funding levels are trending downward. I believe
that they have reached--for the community certainly as a whole
and for most plans, they have reached their low point. Most
public pension plans phase in investment gains and losses over
several years to reduce volatility in funding levels and
required contribution rates. For most plans, they have
recognized all or most of the investment losses that we
experienced through March 2003, but very few of the investment
gains we have experienced since then. As more of those
investment gains are recognized on the books in the next few
years, those funding levels are going to begin to rise. That
coincides nicely as well with the last several years of public
pension plan liability growth which has been significantly
lower than assumed levels, where in the 1990's when there were
some benefit enhancements approved, liability growth was 8
percent, 9 percent. The last 3 years average liability growth
for the public pension community has been about 5 percent,
significantly lower than the assumed rate of 8 percent.
Mr. Kline. OK, thank you.
Let me--I am going to ask another one or two and then I
will be happy to yield to you.
Ms. Jinks, you said that the Teachers Retirement System had
to sell off assets to make the payments on time. Could you tell
us some more about that, what literally happened?
Ms. Jinks. It is my understanding that the Teacher
Retirement System was forced, during this last year, in order
to meet the current obligations of payroll, the actual monies
to be paid out to annuitants, had to sell some of its invested
stocks in one of the funds in which it was invested to use
those funds to pay the present annuitants.
Mr. Kline. And so the effect of that then obviously is you
have fewer assets that can earn a return.
Ms. Jinks. It is like spending one's bank account without a
reasonable way of replenishing those funds. They are in fact
gone.
Mr. Kline. Yes, sir? You had some more comments here? Go
ahead.
Dr. Giertz. The fact of a pension system selling assets is
really not a clear sign of either good times or bad times. A
mature system, a system that has been in operation for many
years and accumulated a lot of assets will in fact routinely
sell assets to meet its obligation. So it could be a sign of
weakness, it might not be. In this case, it probably is a sign,
but in general selling assets is not a warning sign of some
kind of major problem.
Mr. Kline. Mr. Weiss.
Mr. Weiss. Actually we did take a look at the Teachers plan
and it is more a function of how the assets are invested and
the generated cash versus investment--it is really a function
of the investment policy that required them to sell assets. The
combination of employee contributions, employer contributions
and generated investment cash was insufficient to pay the total
amount of benefits. In fact, the total assets of the Teachers
plan increased, so it is really not the fact that the fund is
having to--is being reduced to pay benefits, it is more a
function, as Dr. Giertz implied, of the maturity of the plan,
the significant dollars that are being paid out in benefits and
the investment policies.
Mr. Kline. I see.
Mr. Weiss. Most importantly, the total funds increased.
Mr. Kline. I see.
Let me yield now to Mrs. Biggert.
Ms. Biggert. Thank you, Mr. Chairman.
Congress, in the Pension Protection Act, acted to toughen
up the funding requirement for the private pension plans,
requiring a step up to 100 percent by phasing it in, and they
required sponsors of severely under-funded plans to step up the
funding requirements and probably most importantly by limiting
the benefit increases and accruals when the plans are under-
funded.
In general, are state plans, in particular Illinois'
pension plans, subject to any similar restrictions?
Dr. Giertz. I think the answer is no, but we have a kind of
odd situation constitutionally. The State of Illinois is
mandated to pay the pension benefits, but there has been a
court cases that has held that we are not constitutionally
mandated to fund the pension system. So the under-funding then
becomes a liability to the State of Illinois and the taxpayers
of Illinois. So unlike the Federal situation, a poorly funded
firm might go out of business and then some of those
obligations would fall back on the Pension Guarantee
Organization and become an obligation of the taxpayers of the
country. But in the case of the state, the funder of last
resort is in fact the state and the taxpayers. So there is in
fact an argument to be made that the state systems, and
probably less so local systems, are kind of hybrid, somewhere
between--seems like Social Security was basically a pay-as-you-
go and a purely private system should be a fully funded kind of
system. So I think it is not unreasonable to think that a
system like Illinois could operate at a 90 percent fully funded
situation continually because we have an ongoing life
expectancy, we do not expect to go out of business, we have the
fallback of the taxpayers. So 100 percent would be good, but
may not be absolutely necessary.
Ms. Biggert. Would you say that there is a certain level
that the fund should reach?
Dr. Giertz. I think the concern is--we clearly have a
source of concern, but there are many ways to fund a pension
system. The pay-as-you-go system is the worst way because you
end up not paying at the time and having to pay huge amounts in
the future. My rough calculation says if you had a fully pay-
as-you-go system, we would end up paying about 20 percent of
our salary to fund pensions. If you had a fully funded, pre-
funded, system, it would take about 10 percent of our salary
contributions. So not fully funding is a very expensive way to
do it. It could be done, we have the resources, the taxpayers
of Illinois are there, but it not a very good way to go about
it.
Ms. Biggert. It was mentioned that Social Security is a big
problem and Medicare. We tried to take on Social Security
because we thought Medicare was harder and now here we are with
the pensions. We have a lot to do, and maybe Social Security,
because it is a pay-as-you-go, has always been that way.
We heard a lot of testimony about Public Law 88-593 and the
1995 pension law that set up the plan to get Illinois pensions
up to 90 percent funding and then SB 27. In your opinion, Mr.
Giertz, is SB 27 a step forward toward better pension funding,
or a step back away from the improvement plan that the state
has been following over the last 10 years.
Dr. Giertz. Well, I think it was a temporizing kind of
measure that--it was not in a sense catastrophic, but it
increased the payback into the future. I used the analogy once
that the 1995 law was like saying I am going to go on a diet, I
am going to start by reducing my calories 10 years in the
future. Well, the 1995 law said we are going to solve our
problem, but they did not really attack the pain until a decade
later. And when that pain came along, we decided to roll back
the clock. So my problem with--Mr. Filan, I think was correct
in terms of all the money, we have had a lot of money going
into pensions and if you compare the current administration to
10, 20, 30 years ago, they might fare fairly well, the question
is what about the future. Just in 2 years, this is the 2007
budget year, 2 years from now, the State is going to have to,
according to our rules that are on the books right now, going
to have to increase pension funding by 1.3 billion, the year
after that another $2 billion. Well, $2 billion is about 7
percent, is a huge percentage of our state budget. So the
question is, where is the State, a year and a half from now,
going to come up with another $1.2 billion, where is the State
going to come up with another $2 billion. Now again, that is
not the fault of the administration, these numbers were there,
but the question is at some point we have to stop blaming
people 20 and 30 years ago and step up to the plate and deal
with the problem. That is where we are right now.
Ms. Biggert. I have read reports that say that the change
in SB 27 would allow the State to contribute $2.3 billion less
in pension contributions.
Dr. Giertz. Again, I am sure Mr. Weiss and Mr. Filan
probably have a different opinion, but it did reduce benefits
in the future, especially for new employees. But what they did
was to capture those future benefit reductions that are going
to occur years into the future and reduced by this year and the
preceding fiscal year. So again, it is a matter of reducing
benefit growth somewhat but then attributing all those
reductions to the current period, and we still have the future
demands starting in a couple of years.
The other thing which is a little bit troubling too, one of
the reforms of the 2005 law was to reduce end-of-career salary
increases that credit toward the pension. It was supposed to
save money. We passed it 1 year, the very next year, we
rescinded that and as far as I know there was no extra source
of revenue coming in to compensate for that.
Ms. Biggert. Mr. Filan.
Mr. Filan. That last statement is incorrect. The Senate
Bill 27 that indicated a number of cost reductions going
forward, that was referred to, according to the system
actuaries, will reduce the long-term liabilities, both a short
and long-term challenge, by $83 billion. The changes made this
year in what is terms unintended consequences, were minor
revisions where the State was not trying to penalize a local
school district for increases that were caused not by them but
by things such as state statute or other provisions that were
not their responsibility. But the vast majority of the end-of-
career pay increase controls that were put into place in the
law remain in place.
If I may comment just very briefly, I think the question
asked of Lance Weiss regarding accounting and economics is an
excellent question frankly, I think. I have kidded Lance a
couple of times, my background is accounting, his is actuarial
science, if we both sent our children to the best schools and
one had an accounting degree and one had an economics or
actuarial degree and you were looking at any government's
financial statements, you would find the accountant's
representation of the pension liability and that of the actuary
vastly different. In the case of Illinois, it is about half in
terms of what they assume and how they report it and how they
structure it. So I think it is a very excellent point to
pursue.
I would point out on the earlier question, no one goal or
no one act should be looked at by itself, I think it is what
happens in the entirety. And the question to Lance about the
market value of assets is a perfect example. I think for all
pension systems, including Illinois, in those four or five boom
years in the 1990's, those returns looked so wonderful that it
masked the under-funding, it masked the unfunded benefits
because the way it worked is you were booking those huge gains
as if they would last forever and they do not. And
consequently, I think a lot of people were not consciously
misled but got an unwarranted amount of comfort from doing
that.
So in this case, I think if you look at the entirety and
not just any one bill or one action, but what has happened in
this case in the last 3 years, as Dr. Giertz said, there is
improvement. We have a long-range goal. The only way we fix a
$43 billion problem ultimately is with $43 billion. And you do
not do it overnight, but it takes a tremendous amount of
discipline over many years to dig out of a hole that Illinois
has been in for three decades.
Ms. Biggert. I guess that is why we do the planning for 40
years. Mr. Weiss.
Mr. Weiss. Thank you. One other comment with regard to the
1995 funding plan. I was not involved with, you know, the State
at that point, but they had to know when they implemented that
plan that basically it was a payment plan. As Director Filan
pointed out, it really was not a funding plan so much as it
provided some discipline to the State, it required a certain
amount of payment. To me, a funding plan is a plan that
sufficiently funds the plan. This did not do it, it pushed most
of the liability--again Director Filan pointed this out--it
pushed most of the liability out into the future to future
generations. And I believe the legislators had to know at some
point that payment was going to become unaffordable.
Unfortunately it became unaffordable during Governor
Blagojevich's tenure here. And I think SB 27 was one of the
actions that the Governor took to attempt to alleviate some of
that pain and attempt to bring the plan back into balance. Now
as Director Filan pointed out, you know, in and of itself, it
is not going to do it, it has got to be part of a series of
actions designed to bring the plan back into balance.
Ms. Biggert. Thank you. I have not decided whether I want
to say I was here then or not.
Mr. Weiss. I was afraid to ask.
[Laughter.]
Dr. Giertz. Well, affordability is not a clear term. People
talk about, there are words of choice and words of necessity.
Affordability is really a question of can you do it. And
clearly we can afford to deal with the pension system in
Illinois. We chose not to because we ruled out the most
important option to be ruled out, spending cuts in other areas.
Governor Blagojevich came in saying I will not cut education
spending, I will not cut health, I will not cut public safety
and so on, and I will not raise taxes.
Well, when you make those kind of promises, almost
everything becomes unaffordable unless you do it by borrowing,
so affordability is not--it was not unaffordable in the sense
if we wanted to, it was unaffordable because we chose not to
because we ruled out most of the options that would make it
affordable.
Ms. Biggert. Thank you. I yield back.
Mr. Kline. Thank you, Mrs. Biggert. I will ask a few, and
we will come back to you in a minute.
Sort of a fairness doctrine here directs that I turn to Ms.
Webb-Gauvin, you have been sitting there as this has been going
on back and forth. I certainly have no disagreement, and I am
sure that Mrs. Biggert does not, nor does this Committee, the
Subcommittee, large Committee, that a defined benefit pension
plan is a very valuable asset. We worked very, very hard to
make sure that those defined benefit plans were fully funded
and working, would be there for the retirees in the private
sector. So it is not a question of is a defined benefit plan
important or is it good, it is a question of is it going to be
there when you need it.
And that is sort of what we are grappling with here. We
took it on in the private sector and now we are sort of asking
the question of ourselves, is there a role for the Federal
Government--and neither one of us is at all sure there is, but
is there a role for the Federal Government in making sure that
the public employee defined benefit plans are going to be there
for their employees. And so I guess my question to you is do
you or your organization, you have no concerns about the under-
funded plans that we have been talking about here?
Ms. Webb-Gauvin. By all means, we are concerned about
under-funding of pension programs, whether they be in the
private or public sector. We believe though that most of the
public pension funds are well managed and well funded. Illinois
is the exception to that. We are not as well funded as we would
like to see, our members are very concerned about that. We
think it is not a regulatory problem, it is an under-funding
problem. We had the money, we chose to spend it somewhere else
and we believe that that policy here in Illinois needs to
change.
I do not know if there is--I do not believe that there is a
uniform way for the Federal Government to come in and address
this concern. All states are different and their pension
systems are unique and they have their own unique problems. I
am not sure you could come in with a uniform policy that one
size fits all.
Here in the State of Illinois, we have a constitutional
guarantee that our members will receive their pension benefits,
and we believe that they will be there. The under-funding is a
very serious problem and it needs to be addressed. We do not
believe that a two-tiered system or reducing pension benefits
is a way to address that problem.
Again, as I said in my testimony, our pension benefits here
in the State of Illinois are not overly generous. This is
purely a funding problem, and we feel that there are other ways
that we can address that by raising revenue to address the
funding problem.
Mr. Kline. Thank you. I would say that as we looked at the
pension plans in the private sector, it was largely an under-
funding problem as well. We had the issue of masking that was
discussed earlier with the dot-com in the 1990's that looked
like there were a great many assets in these plans, and when
the dot-com bubble burst--and I am over-simplifying this a
little bit--but it turned out that the assets were not there
and private companies had not been putting payments into those
plans. So we had some very under-funded plans.
So the problems are not dissimilar in that if you do not
put enough money in the plan, there may not be enough money
there to make the payments. The difference is, of course, that
with governments, state governments, and particularly like
Illinois, where you have a constitutional requirement that
those benefits be paid, it is going to go directly to the
taxpayers and it is a policy decision.
And again, I am not really suggesting that the Federal
Government has a role here, that is something we are exploring.
We felt the Federal Government did have a role because of the
exposure of the American taxpayers in the role of the Pension
Benefit Guarantee Corporation in making sure that private
sector employers were meeting their funding requirements.
Mr. Weiss, let me turn back to you. You are the last guy in
the line here I think, but you have some expertise I want to
use to--I want to exploit for just a minute. To what extent
does a state, and it does not have to be Illinois, to what
extent does a state's deferral of pension plan payments--what
role does that play in the broader economic picture in the
state or in the country? Bond rating and so forth, what is the
impact?
Mr. Weiss. That is a very good question, and the bond
rating agencies now are taking a much, much closer look at debt
of a state, both hard and soft debt. And in talking to and
listening to some of the rating agencies, when they look at a
state and rate that state, pension debt plays a major, major
issue these days.
More importantly, I think though the rating agencies
nowadays are looking at the actions a state is taking to
address those issues. So they are not necessarily, you know,
nicking a state for past inadequacies in funding, but more
importantly, they are looking at what are you doing to address
these liabilities. You have these liabilities, these unfunded
liabilities, what are you doing to address these liabilities.
And I think it is important for these states to recognize that
they have to take some action.
As a pension actuary, I can assure you that--and you all
know this from the actions you took by implementing the Pension
Protection Act--if you do nothing, pensions that are out of
balance do not miraculously come back into balance. You have to
take some action, whether it is legislatively or funding-wise
or whatever. You have to take some action or change benefits.
So yes, these liabilities have a major impact on a state,
the economy, the economic conditions that we are operating in
have a role to play. The overall, you know, financial needs,
the revenue generation of a state all comes into play, and I
think as Dr. Giertz indicated, you know, these states and
localities have to find a balance between how much can they cut
other sources, how much do they have to fund the plan and where
is the revenue coming from, can they increase taxes. It is a
fine balance, but they have to take some action. I think the
bottom line is they need to take some action and find a fine
balance between increasing taxes, reducing benefits or if they
do not take action, the rating agencies are going to definitely
impact them in lower ratings, which has all kinds of
implications for the people living in each state.
Mr. Kline. I guess that would apply state by state or
perhaps even municipality by municipality or whatever the
governmental unit is that has the pension plan.
Mr. Weiss. Yes, absolutely.
Mr. Kline. OK, thank you.
Mrs. Biggert, I will yield to you.
Ms. Biggert. Thank you. Mr. Weiss, you talked about some of
the things that contribute to perhaps under-funding, such as
early retirements. Could you comment on a couple of those?
Mr. Weiss. Sure. Many states, similar to what the private
sector did, you know, many years ago, was to increase, improve
early retirement provisions. To the extent we are now--and it
is not universal, but in many plans, localities, states, et
cetera, employees can retire as early as age 50 with unreduced
benefits. Now it is not always 50, it might be 55, it might be
60. These provisions vary greatly across the plan. But they are
extremely expensive. By allowing an employee to retire early
with unreduced benefits, the cost of that is phenomenal. And it
also is not only costly, but then you lose all of that talent
and every projection we see, every survey we see now is
projecting a future shortage of skilled workers coming into the
workforce. So if we are losing all this talent and we do not
have the skilled workers available to replace them, it is going
to be even more of a problem.
So one suggestion we had similarly to what the private
sector has done is to tighten some of these early retirement
provisions.
Ms. Biggert. I think that happened here.
Mr. Brainard.
Mr. Brainard. Ma'am, if I might, I infer that your question
is referring particularly to early retirement windows where a
state or a plan sponsor will say that you will have an
incentive to retire until such and such a date. And the actual
cost of an early retirement window really depends on the way it
is structured and the incentives that are provided.
Particularly in down economic times, some states and
municipalities have benefited from such windows because, for
example, it can allow you to replace an employee who is making
say $65,000 with somebody who is making $35,000. So you are
generating some immediate savings. And then, of course, you
have an actuarial cost to the pension plan. It really depends
on how you structure it and how well you manage it.
Illinois offered an early retirement window a couple of
years ago that, for whatever reason, ended up costing them a
lot more than was initially projected. But by definition, an
early retirement window is not expensive and does not
necessarily have a cost to it.
Dr. Giertz. I am not a defender of early retirement. In
fact, I do not think it is a good idea in most cases, but in
Illinois it has been used in the same old pattern. What we do
is to have--if we have a budget problem, we will have an early
retirement program, window, as was mentioned here. People will
retire, the State saves money in the short run. The consequence
is that pension liabilities increase on the back end and we
never fund those. They use the money saved in the early
retirement to build a bridge in the short run and then throw
the costs onto the pension system. So it is not necessarily bad
per se, it is just bad in the way that it is financed. And we
have tended not to use the savings in early retirements to
bolster up the pension systems.
Ms. Biggert. Dr. Giertz, going back to the changes in
Senate Bill 27 from the former law, which allowed the State to
contribute less, $2.3 billion less in pension contributions for
fiscal year 2006 and 2007, will this end up costing more in the
long run, you know, over a period of years?
Dr. Giertz. Again, there were two parts of the bill, the
part of the bill that is to reduce future pension benefits will
save money. And the next question was how do you allocate those
savings over time, and we chose to allocate a lot of the
savings early, early on. So the fact that we are not making
those contributions to the pension system means that those
funds are not going to be generating revenue in the future, so
it is going to be somewhat more costly. But you have to be
careful and not compare directly future versus current cost and
benefits, because of the value issue. But there is at least a
modest cost in moving up the savings in the early years.
Ms. Biggert. So did most of this increase take place in
fiscal year 2004?
Dr. Giertz. Most of the----
Ms. Biggert. The increase of the payback?
Dr. Giertz. I mean, we were scheduled to have some large
increases, according to the 1995 law, that would have taken
place in fiscal year 2006 and 2007. Then we passed this new law
which sort of recalibrated the payment schedule and what we did
was reduced what we would have paid and we had substantial
reductions in funding for last year and this year, and the
consequence is we will have higher payments in the future.
Ms. Biggert. Well, like in fiscal year 2004 then, the ratio
went up to 60.9 percent and then it fell to 57.7 in fiscal year
2007?
Dr. Giertz. Right. There were several things happening, but
it went up hugely when we put in the 7.5 or $10 billion pension
bonding proceeds and then the market also took off at that
time, so we did very well, but then this last year, the lower
contributions did have an impact on funding. For example, with
SERS, my understanding is that SERS earned about 11 percent
plus for this last fiscal year, which is really great
performance, 3 percentage points above our benchmark. But our
funding ratio did not improve at all because of the lack of
state contributions. So again, that hurt us, but the State is
supposed to make that up in the future.
Ms. Biggert. Thank you.
Mr. Kline. OK, thank you very much.
I would like to thank the panel. Really a terrific panel of
witnesses, a great level of expertise and coming at it from
different angles. Because we have just come through this
experience of the Pension Protection Act, I think we are more
keenly aware on this Committee of the dangers of an under-
funded plan and all the problems that that can lead to.
So I want to thank everybody here today for coming to this
beautiful room in this beautiful building to participate with
us. I want to thank the witnesses for their very valuable time
and testimony. I would like to thank my friend and colleague,
Mrs. Biggert.
And if there is no further business, the Subcommittee
stands adjourned.
[Whereupon, at 12:42 p.m., the Subcommittee was adjourned.]
[Additional submissions for the record follow:]
[Article submitted by Mr. Filan follows:]
[Article from Governing.com, Management Insights column, July 12, 2006]
Paying for Tomorrow
By William D. Eggers
When Rod Blagojevich began his first term as governor of Illinois
in January 2003, he had a host priorities he wanted to address:
Improving schools, investing in the state's underfunded infrastructure,
increasing access to health care and so on. There was only one problem:
A few months into office, he learned that the state's public employee
retirement system was starting at an unfunded liability of $43.1
billion (with a funding ratio of under 50 percent).
If things continued on their path, annual state payments into the
system would have to jump from $1 billion in 2006 to $4 billion in 2013
and $16 billion in 2045. ``Unless we reform the way we fund our
pensions,'' explained the governor, ``we will never eliminate the
structural deficit that takes money away from education, from health
care, from law enforcement, from parks, and from everything else we
care about.''
Illinois has a lot of company. More than 87 percent of state
pension systems are underfunded, dwarfing the much-publicized corporate
pension problems. In New Jersey alone, state and local public
retirement systems are underfunded by as much as $35 billion.
Meanwhile, the bill for paying future medical benefits for state and
local employees who retire could top $1 trillion. And the problem will
only get worse with the impending huge wave of baby boomer retirements.
So what's to be done?
Some experts say the solution is to transition public pension
systems from defined benefit to defined contribution 401(k)-style
retirement programs. While this may be the right thing to do for the
long term, it's unfortunately not a solution to managing today's near-
term runaway retirement costs. Reason: Governments must phase in
defined contribution pension plans gradually as new workers enter the
system, meaning they may not see significant relief for 20 to 30 years.
In fact, thanks to transition costs, defined contributions would likely
increase costs in the near term.
So if that's not the answer, what is? From an actuarial
perspective, the ``solutions'' are quite simple--costs must either be
reduced to solve the problem or deferred to postpone the problem. And
continuing to defer the problem to future generations is both unfair
and irresponsible.
That leaves one option: reduce costs. This brings us back to
Illinois. Facing one of the most underfunded public pension plans in
the country, resulting from decisions made long before he took office,
Blagojevich has methodically gone about taking out costs and
liabilities from Illinois' five state retirement systems.
Loopholes and abuses have been curtailed. School districts, for
example, had routinely approved generous salary increases for teachers
in their final years of employment, producing inflated pension amounts
that became the responsibility of state taxpayers when teachers
retired. No more. School districts must now pick up the tab for pension
increases triggered by pay raises in excess of 6 percent.
Another big cost driver in Illinois was expensive special benefits
once reserved for police officers for risking their lives in the line
of duty, which over the years had somehow spread to one-third of all
state workers. Eligibility for these benefits was cut back to those
they were originally intended for: public safety workers.
To avoid making the same kinds of mistakes again that got Illinois
into the trouble it's in now, the governor convinced the legislature to
mandate that all future benefit enhancements will expire after five
years unless they are renewed by the governor and the state
legislature. In addition, every future benefit increase is required to
have a dedicated revenue source.
Illinois offers important lessons for other states and localities
embarking on fixing their pension systems. The first is to gain a firm
understanding of your current pension situation. What are your real
pension costs? How big is the problem? If your fund is only 65 percent
funded, say, you'll first have to stop the bleeding. Once that is
accomplished, you can focus attention on longer-term reforms.
Second, involve stakeholders. Pension reform often involves
difficult and politically sensitive changes. Involving political
officials, business leaders, labor unions and other stakeholders helps
build support and buy-in for these initiatives.
Once reform proposals are developed, you'll need a broad education
campaign to explain their value to constituents. Illinois state
officials launched an extensive communications campaign to promote the
governor's pension-reform plan. They met with most members of the state
legislature and with union representatives. They also met with almost
every major newspaper in the state and sent letters to teachers and
other retirement plan participants.
Third, while it's true that public-pension-plan underfunding is a
financially driven crisis, it should not be viewed purely through a
financial prism. Pension issues cannot be divorced from their impact on
talent acquisition and management. The underlying plans are, after all,
``employee benefit'' plans that were designed, even if flawed, to
attract, retain and motivate talented individuals to seek and remain in
employment. All financial decisions are also human-resource decisions
that may have significant workforce consequences.
Lastly, Illinois teaches us that few of the pension-reform options
are painless. Indeed, all of them demand strong political leadership
and the willingness to confront entrenched interests. Yet, the stakes
are too high to ignore--and the time for action is now.
William D. Eggers is the co-author of ``Paying for Tomorrow:
Practical Strategies for Tackling the Public Pension Crisis,'' to be
published by Deloitte Research in mid-July.
______
[Commission report submitted by Mr. Filan follows:]
Report on the 90% Funding Target of Public Act 88-0593
Commission on Government Forecasting and Accountability,
703 Stratton Office Building, Springfield, IL 62706
January 2006
commission co-chairmen
Representative Terry R. Parke Senator Jeffrey M. Schoenberg
senate
Don Harmon Christine Radogno Steven Rauschenberger
David Syverson Donne Trotter
house
Mark H. Beaubien, Jr. Frank Mautino Robert Molaro
Richard Myers Elaine Nekritz
executive director
Dan R. Long
deputy director
Trevor J. Clatfelter
author of report
Dan Hankiewicz
office assistant
Briana Stafford
Executive Summary
This report looks at the financial status of the State retirement
systems in Illinois. The following is a summary of the findings:
P.A. 88-593 requires the State to make contributions to
the State retirement systems so that total assets of the systems will
equal 90% of their total actuarial liabilities by fiscal year 2045. The
contributions are required to be a level percent of payroll in fiscal
years 2011 through 2045, following a phase-in period that began in FY
1996.
P.A. 88-593 also requires the Commission on Government
Forecasting and Accountability to make a periodic evaluation of whether
the 90% target funded ratio continues to represent an appropriate
funding goal for State-funded retirement systems in Illinois.
The funded ratio places the unfunded liabilities in the
context of the retirement system's assets. Expressed as a percentage of
a system's liabilities, the funded ratio is calculated by dividing net
assets by the accrued actuarial liabilities. The result is the
percentage of the accrued liabilities that are covered by assets.
At the end of FY 1995 (the year before the implementation
of P.A. 88-593), the systems' total unfunded liabilities were almost
$19.5 billion. By the end of FY 2005, the liabilities totaled $38.6
billion, an increase of 97% from the FY 1995 level.
Investment returns performed above expectations in the
early years of the current funding plan, however Fiscal Years 2001 and
2002 saw significant investment losses when compared to actuarial
assumptions. Investment losses were also recorded in Fiscal Year 2003.
The five State-funded retirement systems have benefited significantly
from the upturn in the financial markets over the last two fiscal
years.
P.A. 93-0002 authorized the State to issue $10 billion in
general obligation bonds for the purpose of making required
contributions to the five state-funded retirement systems.
P.A. 94-0004 (SB 27) contained several important reforms
that are expected to reduce the rate of growth of the accrued
liabilities of the five State-funded retirement systems.
Commission staff analyzed projected contributions based on the 1994
actuarial valuations of the five State-funded retirement systems and
compared them with the most recent actuarial forecasts. This analysis,
shown on pages 16 and 17, shows that the total cost of the current
funding plan has not grown appreciably from what the 1994 forecasts had
predicted (this despite counteractive factors such as formula
increases, investment gains and losses, the infusion of pension
obligation bond proceeds, and the funding reductions and reforms
contained in P.A. 94-0004). While the current pension funding plan will
continue to present significant challenges from a budgetary
perspective, the Commission believes that the goal of reaching a 90%
funded ratio by 2045 as called for in P.A. 88-593 should be maintained.
I. Public Act 88-593
Public Act 88-593 amended the State-funded retirement systems'
Articles of the Pension Code to require annual appropriations to the
systems as a level percent of payroll, beginning in FY 2010, following
a 15 year phase-in period which began in FY 1996. The goal of P.A. 88-
593 is to attain a 90% funding ratio by FY 2045. After FY 2045, the
State must contribute the annual amount needed to maintain a 90%
funding ratio.
P.A. 88-593 requires the Board of Trustees of each retirement
system to certify the required State contributions for each fiscal year
by the preceding November 15th. The Act contains language authorizing a
continuing appropriation of the required State contributions, which has
removed the contributions from the budgeting process and ensures the
certified contributions will be made.
The General Provisions Article of the Pension Code was amended by
Public Act 88-593 to state that the General Assembly finds that a
funding ratio of 90% is an appropriate goal for the State-funded
retirement systems in Illinois. The Act further states ``that a funding
ratio of 90% is now the generally-recognized norm throughout the nation
for public employee retirement systems that are considered to be
financially secure and funded in an appropriate and responsible
manner.''
P.A. 88-593 requires the Commission on Government Forecasting and
Accountability (CGFA), in consultation with the retirement systems and
the Governor's Office of Management and Budget, to make a determination
every five years as to whether the 90% funding ratio continues to
represent an appropriate funding goal.
Rationale for 90% Funding Target
According to the June 1994 Survey of State and Local Government
Employee Retirement Systems, prepared by the Public Pension
Coordinating Council (PPCC), the value of assets as a percentage of the
Pension Benefit Obligation averaged 90.2% for the retirement systems
surveyed by the PCCC in the summer of 1993. It can be assumed that P.A.
88-593 was referring to this survey when it stated ``that a funding
ratio of 90% is now the generally recognized norm throughout the nation
for public employee retirement systems.'' A snapshot of national trends
in the funding status of public pension funds is shown at the end of
Section II. While the volatility in the financial markets in recent
years has clearly had a negative impact on the funding status of public
pension systems nationwide, the Commission reaffirms the endorsement of
a 90% funding target contained in P.A. 88-593.
II. National Overview
The chart below reflects data contained in the 2005 Wilshire Report
on State Retirement Systems. The chart provides an overview of the
financial condition of 64 State Retirement Systems which provided
actuarial values for fiscal years 2000 through 2004. The chart also
shows that at the end of FY 2004, 84% of these 64 state pension
systems, or 54 systems, have liabilities that exceed assets. Also, the
average funded ratio for all 64 state systems was 83 % at the end of FY
04.
FINANCIAL OVERVIEW OF 64 STATE RETIREMENT SYSTEMS
[$ in Billions]
----------------------------------------------------------------------------------------------------------------
2000 2001 2002 2003 2004
----------------------------------------------------------------------------------------------------------------
Total Pension Assets:
Market Value.................................... $795.0 $730.1 $669.1 $681.7 $778.9
Total Pension Liabilities........................... $727.4 $792.7 $850.1 $889.4 $942.3
Average Funded Ratio................................ 109% 92% 79% 77% 83%
Underfunded Plans................................... 39% 69% 92% 97% 84%
----------------------------------------------------------------------------------------------------------------
III. Calculating the Funded Ratio
The Funded Ratio
The funded ratio places the unfunded liabilities in the context of
the retirement system's assets. Expressed as a percentage of a system's
liabilities, the funded ratio is calculated by dividing net assets by
the accrued liabilities. The result is the percentage of the accrued
liabilities that are covered by assets. At 100%, a fully funded system
has sufficient assets to pay all benefits earned to date by all its
members. Of course, in order to calculate the funded ratio, the accrued
actuarial liabilities must be calculated and the actuarial value of
plan assets must be determined.
Determining the Actuarial Accrued Liability
Various actuarial cost methods have been devised to allocate
systematically to employers and employees the expenses incurred under a
pension plan as employees earn benefits. In other words, an actuarial
cost method determines how much money should be set aside each year so
that, when the employee retires, the system will be able to pay the
earned benefits. An actuarial funding method is also used to determine
the contributions needed in order to meet the costs of currently
accruing benefits and improve or stabilize the system's financial
condition. The state-funded retirement systems calculate accrued
liability based on the projected unit credit method, as explained
below.
Projected Unit Credit Method
The pension benefit obligation (PBO) is the actuarial accrued
liability calculated using the projected unit credit actuarial method.
The PBO is the sum of the present value of:
benefits payable to current retirees;
benefits that will become payable to inactive vested
members;
accrued benefits of active vested members;
accrued benefits of active employees who are likely to
become vested; and
benefits due to future salary increases.
Calculation of Actuarial Assets
There are four different methods that can be used to determine the
actuarial value of plan assets. Assets may be valued at the original
purchase price or at the market value on the date of the actuarial
valuation. Two methods of valuing assets which smooth short-term market
fluctuations are the smoothed market method and the blended method. The
smoothed market method uses a moving average to smooth market
fluctuations, while the blended method uses the average of the cost and
market value of assets. The State-funded retirement systems currently
determine the actuarial value of their plans' assets using the market
value of the assets on the date of the actuarial valuation.
The Significance of Actuarial Funding Ratios
The ratio of assets to liabilities in a defined benefit pension
plan, commonly known as the ``funding ratio,'' is a widely utilized
method for gauging the health of a retirement system. If a pension
plan's assets are equal to its liabilities, the plan is considered to
be fully funded (or funded at 100%). If a plan has a shortfall of
assets to liabilities (or a funded ratio of less than 100%) then the
plan carries an unfunded liability. Hence, such a plan would be
considered underfunded. If a pension plan is underfunded, that does not
mean that the plan cannot pay the benefits that its current employees
and retirees have earned. Indeed, virtually all underfunded defined
benefit public employee pension plans, including the five State-funded
plans, continue to meet their current obligations.
All pension plans, whether fully funded or not, depend on employee/
employer contributions and investment income in order to remain
financially solvent. The primary difference between a fully funded plan
and an underfunded plan is that the underfunded plan requires
contributions to pay for benefits that are currently being accrued as
well as to eliminate the shortfall between assets and accrued
liabilities. A fully funded pension plan has no such shortfall and
therefore only requires contributions to pay for benefits that are
currently being accrued. This does not mean that no future
contributions will be required for a fully funded plan, but rather that
the actuarial value of the plan's assets equal its accrued liabilities
at that moment in time.
It should be stressed that the funded ratio is merely a snapshot
based on an assortment of long-term financial and demographic
assumptions. It is merely a way of attempting to ascertain what the
fund's obligations would be if the plan ended as of the actuarial
valuation date and all of the plan's future obligations became payable
at once. However, all of the plan's future obligations are not payable
at once, but rather they are payable over many years into the future.
This period of years allows the plan the necessary time to accrue the
assets needed to pay future obligations.
Achieving full funding of a pension plan is not unlike a mortgage,
in which a homeowner has a long period of time--usually 30 years--to
amortize the mortgage. If the homeowner makes all of his or her
scheduled payments, the mortgage would be considered fully funded at
the end of the 30-year period. At any point during the 30-year
amortization period, the outstanding amount of the mortgage is akin to
a pension fund's unfunded liability.
IV. The Financial Health of the State Retirement Systems Under P.A. 88-
593
The following table provides a summary of the financial condition
of each of the five State retirement systems, showing their respective
liabilities and assets as well as their combined unfunded liabilities
and funded ratios, as of June 30, 2005.
SUMMARY OF FINANCIAL CONDITION: STATE-FUNDED RETIREMENT SYSTEMS
[June 30, 2005; $ in Millions]
----------------------------------------------------------------------------------------------------------------
Accrued Unfunded Funded
System Net assets liabilities liability ratio
----------------------------------------------------------------------------------------------------------------
TRS................................................ $34,085.2 $56,075.0 $21,989.8 60.8%
SERS............................................... 10,494.1 19,304.6 8,810.5 54.4%
SURS............................................... 13,350.2 20,349.9 6,999.7 65.6%
JRS................................................ 565.0 1,236.5 671.5 45.7%
GARS............................................... 83.3 212.9 129.6 39.1%
------------------------------------------------------------
Total........................................ $58,577.80 $97,178.90 $38,601.10 60.3%
----------------------------------------------------------------------------------------------------------------
Changes in Funded Ratios and Unfunded Liability since
Passage of Public Act 88-593
Several factors influence the unfunded liabilities of a retirement
system. For the purpose of determining the reasons for the changes in
the unfunded liabilities (and the funded ratios) these factors have
been grouped in six categories, as follows:
1) Salary Increases. The actuary assumes an average rate of growth
of employees' salaries, based on historical figures. Because pension
benefits are calculated as a percentage of employees' wages, salary
levels are an important factor in determining an employee's future
level of benefits. If actual salaries increase more than assumed, the
unfunded liabilities also increase. Conversely, if actual salary
increases are less than assumed, the unfunded liabilities decrease.
2) Investment Returns. Based on historical averages, the actuary
assumes an annual rate of return on assets. If actual returns are
greater than the assumed rate, the unfunded liabilities decrease. If
actual returns are less than assumed, the unfunded liabilities will
increase.
3) Employer Contributions. A widely applied measure of the adequacy
of funding compares an employer's actual contributions to the
actuarially recognized standard of ``normal cost plus interest.'' Under
this funding method, an employer makes contributions sufficient to
cover the cost of all benefits earned by employees during the year (the
normal cost) plus makes an interest payment on the unfunded liabilities
of the retirement system. This funding method attempts to freeze the
unfunded liabilities without reducing them in total. If employer
contributions are insufficient based on this measure, a system's
unfunded liabilities grow. If contributions are equal to or greater
than required by this method, the system's unfunded liabilities either
remain constant or diminish.
4) Benefit Increases. Under the State Constitution, pension
benefits cannot be lowered for current employees, but are often
increased for a variety of reasons. Any improvement in benefits causes
an immediate rise in the unfunded liabilities of the system.
5) Changes in Actuarial Assumptions. Actuaries periodically revise
previous assumptions based on recent experience which they feel more
accurately reflects what may occur in the future. These changes could
relate to investment returns, salary increases, mortality rates, staff
turnover, and many other factors. Some changes, such as a decrease in
the assumption on investment returns, cause an immediate increase in
the unfunded liabilities. Other changes, such as a reduction in the
assumed rate of salary growth, cause a decrease in the unfunded
liabilities.
6) Other factors. This factor encompasses all other events that do
not fall into one of the previous categories. These factors include a
change in the actuarial assumptions, or elements that had previously
been overlooked but now must be considered.
This section of the study focuses on how these six factors have
affected the unfunded liabilities, and therefore the funded ratios, of
the State funded retirement systems since the implementation of P.A.
88-593.
State-Funded Retirement Systems, Combined
At the end of FY 1995 (the year before the implementation of P.A.
88-593), the systems' total unfunded liabilities were almost $19.5
billion. By the end of FY 2005, unfunded liabilities totaled $38.6
billion, an increase of 97% from the FY 1995 level. The following table
shows how six factors affected the combined unfunded liabilities of the
State-funded retirement systems between FY 1995 and FY 2005.
TABLE 1.--STATE-FUNDED RETIREMENT SYSTEMS: CHANGE IN UNFUNDED LIABILITIES FY 1996-FY 2005
[In millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Salary Investment Employer Benefit Actuarial Other
increases returns contributions increases assumptions factors Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
1996........................................................ $278.1 ($950.4) $1,648.4 $17.8 ($781.7) $316.7 $528.9
1997........................................................ (174.6) (1,718.0) 1,571.6 179.1 (6,629.2) 456.3 (6,314.9)
1998........................................................ (113.2) (2,788.1) 984.2 2,250.2 0.0 275.7 608.7
1999........................................................ 77.1 (988.6) 883.4 33.9 125.2 893.5 1,024.5
2000........................................................ 154.5 (1,307.1) 902.6 3.0 0.0 471.6 224.6
2001........................................................ 64.2 6,610.6 887.5 652.1 2.5 1,261.0 9,478.0
2002........................................................ 134.4 5,575.4 1,624.1 234.1 1,377.7 1,020.2 9,966.0
2003........................................................ 125.6 2,071.5 2,426.0 2,425.0 0.0 1,110.1 8,158.2
2004........................................................ 135.8 (3,841.7) (4,713.1) 0.0 0.0 408.5 (8,010.5)
2005........................................................ 35.0 (1,033.6) 2,393.9 0.0 26.4 2,085.6 3,507.3
-------------------------------------------------------------------------------------------
Total................................................. $716.9 $1,630.0 $8,608.7 $5,795.2 ($5,879.1) $8,299.1 $19,170.8
--------------------------------------------------------------------------------------------------------------------------------------------------------
As Table 1 shows, the failure to make employer contributions at a
normal-cost-plusinterest level over the ten-year reporting period was
the most significant catalyst in the increase in unfunded liabilities
of all five State-funded systems. A change to a market valuation of
assets in FY 1997 served to mitigate the total actuarial loss over this
period. Despite strong investment returns during the first half of the
reporting period, two years of very poor returns in FY 2001 and FY 2002
contributed to an overall actuarial loss in that category. Pension
Obligation Bond (POB) proceeds in FY 2004 had a positive actuarial
impact on both investment returns and employer contributions. Because
of the POB proceeds, FY 2004 was one of only two years in which the
systems' overall actuarial liabilities decreased to a significant
degree. Benefit increases and other miscellaneous factors also
contributed to the increase in liabilities.
Teachers' Retirement System
The unfunded liabilities of the Teachers' Retirement System have
increased by over $10 billion since the end of FY 1995. Table 2 details
the factors that caused the increase in unfunded liabilities.
TABLE 2.--TEACHERS' RETIREMENT SYSTEM: CHANGE IN UNFUNDED LIABILITIES FY 1996-FY 2005
[In millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Salary Investment Employer Benefit Actuarial Other
increases returns contributions increases assumptions factors Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
1996........................................................ $400.4 ($577.3) $966.0 $17.8 $0.0 $166.5 $973.4
1997........................................................ (59.1) (830.9) 992.4 0.0 (2,944.7) 88.8 (2,753.5)
1998........................................................ (46.0) (1,417.7) 776.2 1,000.3 0.0 71.2 384.0
1999........................................................ 44.0 (389.0) 677.4 33.9 125.2 533.9 1,025.4
2000........................................................ (33.4) (450.4) 723.6 0.0 0.0 197.3 437.1
2001........................................................ (10.3) 3,089.8 733.9 0.0 0.0 632.7 4,446.1
2002........................................................ 4.9 2,696.2 1,074.4 0.0 694.7 360.0 4,830.2
2003........................................................ 171.8 827.4 1,415.6 53.8 0.0 658.5 3,127.1
2004........................................................ 217.3 (2,168.9) (2,811.5) 0.0 0.0 357.2 (4,405.9)
2005........................................................ 236.7 (682.3) 1,299.8 0.0 26.4 1,706.2 2,587.1
-------------------------------------------------------------------------------------------
Total................................................. $926.3 $96.9 $5,847.8 $1,105.8 ($2,098.4) $4,772.3 $10,651.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
The leading causes of the increase in unfunded liabilities of TRS
were insufficient employer contributions and other miscellaneous
factors (such as waiving ERO payments for teachers with 34 years of
service). Over the ten-year period, years of strong investment returns
in the first half of the reporting period were offset by two
particularly poor years in 2001 and 2002. The POB proceeds in FY 2004
served to offset the overall actuarial losses in both investment
returns and employer contributions.
State Universities' Retirement System
Table 3 shows the factors that caused the unfunded liabilities of
SURS to increase approximately $2.3 billion from the end of FY 1995 to
the end of FY 2005.
TABLE 3.--STATE UNIVERSITIES RETIREMENT SYSTEMS: CHANGE IN UNFUNDED LIABILITIES FY 1996-FY 2005
[In millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Salary Investment Employer Benefit Actuarial Other
increases returns contributions increases assumptions factors Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
1996........................................................ ($70.5) ($105.4) $456.0 $0.0 $0.0 $86.8 $366.9
1997........................................................ (44.0) (312.3) 424.8 179.1 (3,342.4) 198.5 (2,896.3)
1998........................................................ 5.2 (765.7) 158.8 0.0 0.0 48.1 (553.6)
1999........................................................ 44.3 (273.3) 147.2 0.0 0.0 314.9 233.1
2000........................................................ 171.5 (587.5) 162.0 0.0 0.0 13.7 (240.3)
2001........................................................ 70.3 2,068.5 141.4 0.0 0.0 266.7 2,546.9
2002........................................................ 90.8 1,568.7 313.9 63.0 485.3 155.6 2,677.3
2003........................................................ 10.3 583.0 549.4 0.0 0.0 328.4 1,471.1
2004........................................................ (62.9) (950.5) (846.0) 0.0 0.0 41.2 (1,818.2)
2005........................................................ (19.4) (218.0) 536.8 0.0 0.0 208.0 507.4
-------------------------------------------------------------------------------------------
Total................................................. $195.6 $1,007.5 $2,044.3 $242.1 ($2,857.1) $1,661.9 $2,294.3
--------------------------------------------------------------------------------------------------------------------------------------------------------
The leading causes of the increase in unfunded liabilities of SURS
were investment losses, driven mainly by two years of particularly poor
returns in FY 2001 and FY 2002, and also insufficient employer
contributions over the ten-year time period (with the exception of the
Pension Obligation Bond proceeds in FY 2004). Offsetting the increase
in unfunded liabilities somewhat was the changeover to valuation of
assets at market value in FY 1997, which caused a decline in the
unfunded liabilities of SURS of over $3.3 billion.
State Employees' Retirement System
Table 4 shows the elements that caused the unfunded liabilities of
SERS to increase by more than $5.7 billion from the end of FY 95 to the
end of FY 05.
TABLE 4.--STATE EMPLOYEES' RETIREMENT SYSTEM: CHANGE IN UNFUNDED LIABILITIES FY 1996-FY 2005
[In millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Salary Investment Employer Benefit Actuarial Other
increases returns contributions increases assumptions factors Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
1996........................................................ ($63.8) ($251.4) $196.6 $0.0 ($781.7) $47.1 ($853.2)
1997........................................................ (65.1) (541.6) 121.7 0.0 (379.9) 152.9 (712.0)
1998........................................................ (62.0) (568.8) 9.4 1,249.9 0.0 148.7 777.2
1999........................................................ (12.5) (307.0) 21.0 0.0 0.0 32.9 (265.6)
2000........................................................ 14.6 (252.7) (21.8) 0.0 0.0 250.2 (9.7)
2001........................................................ (8.0) 1,368.8 (29.4) 652.1 0.0 310.0 2,293.5
2002........................................................ 52.0 1,247.3 186.9 171.1 168.1 496.2 2,321.6
2003........................................................ (28.3) 629.5 404.5 2,371.2 0.0 97.8 3,474.7
2004........................................................ (22.3) (679.7) (944.1) 0.0 0.0 6.8 (1,639.3)
2005........................................................ (166.5) (123.1) 503.5 0.0 0.0 144.1 358.0
-------------------------------------------------------------------------------------------
Total................................................. ($361.9) $521.3 $448.3 $4,444.3 ($993.5) $1,686.7 $5,745.2
--------------------------------------------------------------------------------------------------------------------------------------------------------
The unfunded liabilities of SERS increased by over $5.7 billion
from FY 96 through FY 05, driven primarily by benefit increases in FY
98 (retirement formula increase) and FY 2003 (the 2002 Early Retirement
Incentive). The actuarial loss in investment returns over the ten-year
period was due in large part to two years of poor returns in FY 2001
and FY 2002. Also adding to the overall increase in unfunded
liabilities were insufficient employer contributions in each year over
the ten-year period (with the exception of the POB proceeds in FY 2004)
and other miscellaneous factors.
Judges' Retirement System
The unfunded liabilities of the Judges' Retirement System increased
by $362.0 million between FY 1995 and FY 2005. Table 5 details the
factors that caused this increase in unfunded liabilities.
TABLE 5.--JUDGES' RETIREMENT SYSTEM: CHANGE IN UNFUNDED LIABILITIES FY 1996-FY 2005
[In millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Salary Investment Employer Benefit Actuarial Other
increases returns contributions increases assumptions factors Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
1996....................................................... $10.0 ($13.7) $24.5 $0.0 $0.0 $14.9 $35.7
1997....................................................... (7.7) (28.1) 27.2 0.0 37.9 15.3 44.6
1998....................................................... (10.2) (30.5) 34.1 0.0 0.0 7.2 0.6
1999....................................................... 0.5 (16.5) 32.5 0.0 0.0 8.8 25.3
2000....................................................... 2.2 (14.1) 33.2 3.0 0.0 8.3 32.6
2001....................................................... (7.5) 61.8 35.8 0.0 0.0 17.0 107.1
2002....................................................... (11.8) 54.5 42.2 0.0 28.4 8.6 121.9
2003....................................................... (26.4) 27.2 49.3 0.0 0.0 18.9 69.0
2004....................................................... 6.3 (36.7) (92.3) 0.0 0.0 (2.0) (124.7)
2005....................................................... (15.1) (8.9) 46.4 0.0 0.0 27.5 49.9
--------------------------------------------------------------------------------------------
Total................................................ ($59.7) ($5.0) $232.9 $3.0 $66.3 $124.5 $362.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Insufficient employer contributions, along with changes in
actuarial assumptions and miscellaneous other factors caused the
unfunded liabilities to increase over the FY 1995 levels. Investment
income and slower-than-anticipated salary growth both served to offset
a portion of the increase.
General Assembly Retirement System
As shown in Table 6, the unfunded liabilities of the General
Assembly Retirement System increased by more than $50 million from the
end of FY 95 to the end of FY 05.
TABLE 6.--GENERAL ASSEMBLY RETIREMENT SYSTEM: CHANGE IN UNFUNDED LIABILITIES FY 1996-FY 2005
[In millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Salary Investment Employer Benefit Actuarial Other
increases returns contributions increases assumptions factors Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
1996....................................................... $2.0 ($2.6) $5.3 $0.0 $0.0 $1.4 $6.1
1997....................................................... 1.3 (5.1) 5.5 0.0 (0.1) 0.8 2.3
1998....................................................... (0.2) (5.4) 5.7 0.0 0.0 0.5 0.5
1999....................................................... 0.8 (2.8) 5.3 0.0 0.0 3.0 6.4
2000....................................................... (0.4) (2.4) 5.6 0.0 0.0 2.1 4.9
2001....................................................... (0.6) 10.1 5.8 0.0 0.0 1.3 16.7
2002....................................................... (1.5) 8.7 6.7 0.0 1.2 (0.2) 15.0
2003....................................................... (1.8) 4.4 7.2 0.0 0.0 6.5 16.3
2004....................................................... (2.6) (5.9) (19.2) 0.0 0.0 5.3 (22.4)
2005....................................................... (0.7) (1.3) 7.4 0.0 0.0 (0.2) 5.2
--------------------------------------------------------------------------------------------
Total................................................ ($3.7) ($2.3) $35.4 $0.0 $1.1 $20.4 $50.9
--------------------------------------------------------------------------------------------------------------------------------------------------------
The increase in the unfunded liabilities of the General Assembly
Retirement System from FY 96 through FY 05 was caused primarily by
insufficient employer contributions (with the exception of the FY 04
POB proceeds) and other miscellaneous factors. Some of the factors that
mitigated the overall increase were actuarial gains realized from
lower-than-expected salary increases and higher-than-assumed investment
returns.
V. Original and Current Projections of State Contributions and Funded
Ratios
This section of the study compares the original 1994 estimates of
annual required contributions (and the resulting funded ratios) with
the current projections of annual required contributions, which are
based on the June 30, 2005 actuarial valuations for each system.
Original Projections (1994 Projections)
The original projections of required annual contributions for the
funding plan created by Public Act 88-593 were based on the June 30,
1994 actuarial valuation. The first year of the funding plan was FY
1996 and the contributions for FY 1996 were certified in November 1994.
At that time, the assets of the retirement systems were valued at cost,
the actuarial assumptions of the systems were more conservative, and
the benefit formulas of the 3 large retirement systems had not yet been
increased.
Current Projections (2005 Projections)
The current projections of required annual contributions are based
on the June 30, 2005 actuarial valuation. These projections take into
account changes in actuarial assumptions, the valuation of assets at
market value, Pension Obligation Bond proceeds and changes contained in
P.A. 94-0004 such as the elimination of the Money Purchase program in
SURS for new hires and the modification of the Early Retirement Option
in TRS, as well as the funding reductions in FY 2006 and FY 2007.
State-Funded Retirement Systems, Combined
Table 7 compares the original estimate of the required annual
contributions to all of the State retirement systems with the current
estimate, as prepared by the retirement systems. Also shown are the
original and current projections of the funded ratios. The original
contribution column includes the FY 1996 certified appropriations and
the estimated contributions for selected fiscal years for the remainder
of the funding plan. The current contribution column includes the
actual State contributions for FY 1996 through FY 2005, the actual
appropriation amounts for FY 2006, the certified contributions for FY
2007 (per P.A. 94-0004), and estimated contributions for selected
fiscal years for the remainder of the funding plan.
Except for federal and trust funds paid to SERS, the contributions
include only State appropriations from the General Revenue Fund, Common
School Fund, and State Pensions Fund. Employer contributions from
school districts and all other sources are excluded.
TABLE 7.--STATE-FUNDED RETIREMENT SYSTEMS, COMBINED
[Original and Current Projected Contributions and Funded Ratios; $ in Millions]
----------------------------------------------------------------------------------------------------------------
1994 Projection P.A. 88- 2005 Projection P.A. 88- Difference (2005-1994)
593 593 --------------------------
FY ------------------------------------------------------
Funded Funded Contribution Funded
Contribution ratio Contribution ratio ratio
----------------------------------------------------------------------------------------------------------------
1996........................... $607.2 52.3% $609.1 54.9% $1.9 2.6%
1997........................... $718.7 52.6% $712.2 70.1% -$6.5 17.6%
1998........................... $839.6 52.0% $881.5 72.2% $41.9 20.3%
1999........................... $970.4 51.6% $1,122.6 73.0% $152.2 21.3%
2000........................... $1,109.4 51.4% $1,224.7 74.7% $115.3 23.3%
2001........................... $1,256.8 51.0% $1,346.6 63.1% $89.8 12.1%
2002........................... $1,419.3 51.5% $1,469.3 53.5% $50.0 2.1%
2003........................... $1,591.7 51.7% $1,628.3 48.6% $36.6 -3.1%
2004........................... $1,776.5 52.1% $9,178.5 60.9% $7,402.0 8.9%
2005........................... $1,967.6 52.5% $1,638.0 60.3% -$329.6 7.8%
2006........................... $2,172.3 52.9% $935.6 58.8% -$1,236.7 6.0%
2007........................... $2,390.3 53.4% $1,372.2 57.7% -$1,018.1 4.3%
2008........................... $2,623.8 54.0% $1,981.3 57.2% -$642.5 3.2%
2009........................... $2,871.4 54.7% $2,662.0 57.2% -$209.4 2.5%
2010........................... $3,140.4 55.4% $3,401.2 57.7% $260.8 2.2%
2011........................... $3,271.7 56.2% $3,641.3 58.2% $369.6 2.0%
2012........................... $3,411.1 56.9% $3,774.3 58.7% $363.2 1.8%
2013........................... $3,536.7 57.6% $3,938.6 59.1% $401.9 1.5%
2014........................... $3,709.1 58.3% $4,097.5 59.5% $388.4 1.2%
2015........................... $3,881.6 59.0% $4,262.0 59.9% $380.4 0.9%
2016........................... $4,062.9 59.7% $4,435.4 60.3% $372.5 0.6%
2017........................... $4,253.1 60.4% $4,617.1 60.6% $364.0 0.2%
2018........................... $4,452.8 61.1% $4,808.7 61.0% $355.9 -0.1%
2019........................... $4,662.7 61.9% $5,010.6 61.3% $347.9 -0.6%
2020........................... $4,898.2 62.5% $5,223.7 61.7% $325.6 -0.8%
2021........................... $5,146.2 63.0% $5,448.1 62.1% $301.9 -0.9%
2022........................... $5,407.2 63.5% $5,683.9 62.5% $276.8 -1.0%
2023........................... $5,681.8 64.0% $5,932.2 62.9% $250.4 -1.1%
2024........................... $5,969.2 64.6% $6,193.9 63.4% $224.8 -1.2%
2025........................... $6,271.3 65.2% $6,464.7 63.9% $193.4 -1.3%
2026........................... $6,568.1 65.8% $6,747.8 64.5% $179.7 -1.3%
2027........................... $6,920.2 66.5% $7,040.5 65.1% $120.4 -1.4%
2028........................... $7,269.1 67.2% $7,351.4 65.7% $82.3 -1.5%
2029........................... $7,635.7 68.0% $7,676.9 66.5% $41.1 -1.5%
2030........................... $8,020.8 68.8% $8,018.8 67.3% -$2.0 -1.5%
2031........................... $8,425.1 69.7% $8,377.0 68.1% -$48.2 -1.5%
2032........................... $8,849.2 70.7% $8,752.2 69.1% -$97.1 -1.6%
2033........................... $9,294.9 71.5% $9,145.3 70.1% -$149.7 -1.4%
2034........................... $9,763.6 72.6% $9,558.3 71.2% -$205.4 -1.3%
2035........................... $10,255.5 73.7% $9,989.9 72.4% -$265.7 -1.2%
2036........................... $10,772.0 74.8% $10,442.1 73.7% -$329.9 -1.1%
2037........................... $11,314.2 76.0% $10,916.1 75.1% -$398.1 -0.9%
2038........................... $11,884.7 77.3% $11,414.9 76.6% -$469.8 -0.7%
2039........................... $12,485.1 78.6% $11,937.4 78.2% -$547.7 -0.4%
2040........................... $13,115.8 80.0% $12,485.7 79.9% -$630.1 -0.1%
2041........................... $13,778.9 81.5% $13,058.9 81.7% -$719.9 0.2%
2042........................... $14,475.3 83.1% $13,659.9 83.6% -$815.4 0.5%
2043........................... $15,208.2 84.8% $14,289.7 85.6% -$918.5 0.8%
2044........................... $15,978.3 86.6% $14,947.9 87.7% -$1,030.4 1.2%
2045........................... $16,786.6 90.0% $15,636.4 90.0% -$1,150.2 0.0%
--------------------------------------------------------------------------------
Total.................... $312,872.4 ......... $315,142.3 ......... $2,269.9 .........
----------------------------------------------------------------------------------------------------------------
The factors that have contributed to the changes in overall
projected contributions are detailed system-by-system on the following
pages.
Teachers' Retirement System
Table 8 provides a summary of the original projected annual
employer contributions and funded ratios, per P.A. 88-593.
TABLE 8.--TEACHERS' RETIREMENT SYSTEM
[Original and Current Projected Contributions and Funded Ratios; $ in Millions]
----------------------------------------------------------------------------------------------------------------
1994 Projection P.A. 88- 2005 Projection P.A. 88- Difference (2005-1994)
593 593 ---------------------------
FY ------------------------------------------------------
Funded Funded Contribution Funded
Contribution ratio Contribution ratio ratio
----------------------------------------------------------------------------------------------------------------
1996.......................... $324.3 54.3% $324.3 57.8% $0.0 3.5%
1997.......................... 390.8 53.4% 378.0 64.5% (12.8) 11.1%
1998.......................... 463.1 52.7% 460.4 66.8% (2.7) 14.1%
1999.......................... 541.6 52.3% 567.1 67.0% 25.5 14.7%
2000.......................... 623.8 52.0% 634.0 68.2% 10.2 16.2%
2001.......................... 712.1 51.9% 719.4 59.5% 7.3 7.6%
2002.......................... 807.0 52.0% 810.6 52.0% 3.6 0.0%
2003.......................... 909.1 52.2% 926.0 49.3% 16.9 -2.9%
2004.......................... 1,018.5 52.6% 5,358.7 61.9% 4,340.2 9.3%
2005.......................... 1,128.9 53.0% 903.9 60.8% (225.0) 7.8%
2006.......................... 1,247.0 53.4% 531.8 59.5% (715.2) 6.1%
2007.......................... 1,372.4 53.9% 735.5 58.6% (636.9) 4.7%
2008.......................... 1,505.9 54.5% 1,049.8 58.2% (456.1) 3.7%
2009.......................... 1,647.1 55.1% 1,418.6 58.4% (228.5) 3.3%
2010.......................... 1,801.9 55.7% 1,814.4 59.1% 12.5 3.4%
2020.......................... 2,757.6 58.8% 2,739.5 63.9% (18.1) 5.1%
2030.......................... 4,477.4 62.1% 4,261.8 70.2% (215.6) 8.1%
2040.......................... 7,268.6 75.0% 6,658.6 81.7% (610.0) 6.7%
2045.......................... 9,261.1 90.0% 8,371.6 90.0% (889.5) 0.0%
----------------------------------------------------------------------------------------------------------------
Contributions to TRS are generally expected to be lower than
originally projected for the remainder of the funding plan. This is due
primarily to the infusion of over $4.0 billion in Pension Obligation
Bond proceeds in FY 2004 and the reforms contained in SB 27 such as the
Modified Early Retirement Option (ERO), the elimination of the Money
Purchase Option for new employees, the shifting of costs to school
districts for end-of-career salary increases, and requiring school
districts to pay the normal cost for granting sick leave in excess of
two years.
State Universities' Retirement System
Table 9 compares the original and current projections of estimated
annual contributions and the resulting funded ratios for SURS. The
current contributions column includes the annual employer contributions
to the accounts of participants in the Self-Managed Plan (detailed
below Chart 9).
TABLE 9.--STATE UNIVERSITIES' RETIREMENT SYSTEM
[Original and Current Projected Contributions and Funded Ratios; $ in Millions]
----------------------------------------------------------------------------------------------------------------
1994 Projection P.A. 88- 2005 Projection P.A. 88- Difference (2005-1994)
593 593 ---------------------------
FY ------------------------------------------------------
Funded Funded Contribution Funded
Contribution ratio Contribution ratio ratio
----------------------------------------------------------------------------------------------------------------
1996.......................... 123.9 50.1% 123.9 50.1% $0.00 0.0%199
7............................. 154.1 49.6% 159.5 79.4% $5.40 29.8%
1998.......................... 186.9 49.3% 201.6 85.8% $14.70 36.5%
1999.......................... 222.5 49.3% 217.6 85.3% ($4.9) 36.0%
2000.......................... 261.3 49.4% 224.5 88.2% ($36.8) 38.8%
2001.......................... 303.3 49.7% 232.6 72.1% ($70.7) 22.5%
2002.......................... 348.6 50.0% 240.4 58.9% ($108.2) 8.9%
2003.......................... 397.5 50.5% 269.6 53.9% ($127.9) 3.4%
2004.......................... 450 51.1% 1,743.7 66.0% $1,293.7 14.9%
2005.......................... 506.5 51.8% 270.0 65.6% ($236.5) 13.8%
2006.......................... 567.3 52.5% 166.6 63.9% ($400.7) 11.4%
2007.......................... 632.5 53.3% 252.1 62.5% ($380.4) 9.3%
2008.......................... 702.5 54.1% 357.9 61.5% ($344.6) 7.4%
2009.......................... 777.3 55.1% 456.5 60.7% ($320.8) 5.6%
2010.......................... 857.8 56.2% 572.4 60.3% ($285.4) 4.1%
2020.......................... 1,393.40 70.0% 1,021.9 58.1% ($371.5) -11.9%
2030.......................... 2,336.40 77.6% 1,636.7 58.0% ($699.7) -19.6%
2040.......................... 3,909.40 85.2% 2,667.7 72.6% ($1,241.7) -12.6%
2045.......................... 5,054.40 90.0% 3,407.9 90.0% ($1,646.5) 0.0%
----------------------------------------------------------------------------------------------------------------
Due to the Pension Obligation Bond proceeds, FY 2004 was the only
year in which contributions to SURS significantly exceeded projections.
Contributions are expected to be significantly lower than projected
when P.A. 88-593 was enacted due to the changeover to a valuation of
assets at market value in FY 1997 and, to a lesser extent, the
elimination of the Money Purchase option for new members after July 1,
2005 as contained in P.A. 94-0004 (SB 0027).
State Employees' Retirement System
Table 10 provides a summary of the current projected State
contributions to SERS, as well as the original projected contributions
and corresponding funded ratios, per Public Act 88-593, based on the
June 30, 1994 actuarial valuation.
TABLE 10.--STATE EMPLOYEES' RETIREMENT SYSTEM
[Original and Current Projected Contributions and Funded Ratios; $ in Millions]
----------------------------------------------------------------------------------------------------------------
1994 Projection P.A. 88- 2005 Projection P.A. 88- Difference (2005-1994)
593 593 --------------------------
FY ------------------------------------------------------
Funded Funded Contribution Funded
Contribution ratio Contribution ratio ratio
----------------------------------------------------------------------------------------------------------------
1996........................... $144.5 56.1% $146.4 70.1% $1.9 14.0%
1997........................... 157.5 55.4% 158.2 80.1% 0.7 24.7%
1998........................... 171.3 54.8% 200.7 75.6% 29.4 20.8%
1999........................... 185.9 54.4% 315.5 79.9% 129.6 25.5%
2000........................... 201.5 54.0% 340.8 81.7% 139.3 27.7%
2001........................... 216.1 53.7% 366.0 65.8% 149.9 12.1%
2002........................... 235.7 53.5% 386.1 53.7% 150.4 0.2%
2003........................... 254.2 53.4% 396.1 42.6% 141.9 -10.8%
2004........................... 273.9 53.3% 1,864.7 54.2% 1,590.8 0.9%
2005........................... 294.7 53.3% 427.4 54.4% 132.7 1.1%
2006........................... 316.9 53.4% 203.8 52.6% -113.1 -0.8%
2007........................... 340.5 53.5% 344.2 51.4% 3.7 -2.1%
2008........................... 366.4 53.6% 520.0 50.8% 153.6 -2.8%
2009........................... 393.5 53.9% 718.0 51.0% 324.5 -2.9%
2010........................... 422.4 54.2% 929.0 51.9% 506.6 -2.3%
2020........................... 659.8 60.4% 1,328.0 59.1% 668.2 -1.4%
2030........................... 1,065.6 68.2% 1,912.0 65.1% 846.4 -3.1%
2040........................... 1,707.5 80.7% 2,836.0 78.4% 1,128.5 -2.3%
2045........................... 2,177.4 90.0% 3,454.0 90.0% 1,276.6 0.0%
----------------------------------------------------------------------------------------------------------------
Contributions to the State Employees' Retirement System are
projected to be appreciably greater than the original assumptions under
P.A. 88-593. The increased funding requirements in future years are due
in large part to reductions in contributions of $974.0 million in both
FY 06 and FY 07 as contained in P.A. 94-0004. The additional funding
obligations created by the 2002 Early Retirement Incentive and the
steep market downturn in Fiscal Years 2001 and 2002 have also driven up
future contributions pursuant to the current funding plan.
Two significant benefit increases have contributed to the increased
cost as well: P.A. 90-065 provided a new flat-rate regular SERS formula
of 1.67% of final average salary per year of service for members
contributing to Social Security (coordinated), and 2.2% of final
average salary per year of service for employees not contributing to
Social Security (non-coordinated).
P.A. 92-0014 increased the alternative retirement formula to 3.0%
of final average salary per year of service for employees not
contributing to Social Security and 2.5% for employees contributing to
Social Security.
Judges' Retirement System
Table 11 compares the original and current projections of estimated
annual contributions and the resulting funding ratios for the Judges'
Retirement System.
TABLE 11.--JUDGES' RETIREMENT SYSTEM
[Original and Current Projected Contributions and Funded Ratios; $ in Millions]
----------------------------------------------------------------------------------------------------------------
1994 Projection P.A. 88- 2005 Projection P.A. 88- Difference (2005-1994)
593 593 --------------------------
FY ------------------------------------------------------
Funded Funded Contribution Funded
Contribution ratio Contribution ratio ratio
----------------------------------------------------------------------------------------------------------------
1996........................... $12.1 40.7% $12.1 48.0% $0.0 7.3%
1997........................... 13.6 39.5% 13.7 44.7% $0.1 5.2%
1998........................... 15.3 38.4% 15.7 47.7% $0.4 9.3%
1999........................... 17.1 37.5% 18.7 48.4% $1.6 10.9%
2000........................... 19.1 36.7% 21.4 48.5% $2.3 11.8%
2001........................... 21.3 36.2% 24.3 40.7% $3.0 4.5%
2002........................... 23.5 35.9% 27.5 33.7% $4.0 -2.2%
2003........................... 26.0 35.9% 31.4 30.7% $5.4 -5.2%
2004........................... 28.7 36.2% 178.6 46.2% $149.9 10.0%
2005........................... 31.6 36.6% 32.0 45.7% $0.4 9.1%
2006........................... 34.6 37.3% 29.2 44.7% -$5.4 7.4%
2007........................... 37.9 38.1% 35.2 43.4% -$2.7 5.3%
2008........................... 41.4 39.1% 47.1 42.8% $5.7 3.7%
2009........................... 45.2 40.3% 60.9 42.9% $15.7 2.6%
2010........................... 49.3 41.6% 75.6 43.9% $26.3 2.3%
2020........................... 80.7 53.6% 118.3 54.3% $37.6 0.7%
2030........................... 130.9 65.0% 183.8 65.7% $52.9 0.7%
2040........................... 213.6 80.1% 284.4 80.4% $70.8 0.3%
2045........................... 272.6 90.0% 355.6 90.0% $83.0 0.0%
----------------------------------------------------------------------------------------------------------------
The estimated annual contributions based on the current actuarial
valuation are larger than those estimated in the original projections
for the remainder of the funding period. This is due in large part to
insufficient employer contributions, funding reductions contained in
P.A. 94-0004, and two years of negative investment returns in FY 2001
and FY 2002.
General Assembly Retirement System
Table 12 compares the original and current projections of estimated
annual contributions and the resulting funded ratios for GARS.
TABLE 12.--GENERAL ASSEMBLY RETIREMENT SYSTEM
[Original and Current Projected Contributions and Funded Ratios; $ in Millions]
----------------------------------------------------------------------------------------------------------------
1994 Projection P.A. 88- 2005 Projection P.A. 88- Difference (2005-1994)
593 593 ---------------------------
FY ------------------------------------------------------
Funded Funded Contribution Funded
Contribution ratio Contribution ratio ratio
----------------------------------------------------------------------------------------------------------------
1996.......................... $2.4 33.2% $2.4 40.4% $0.0 7.2%
1997.......................... 2.7 31.3% 2.8 39.4% $0.1 8.1%
1998.......................... 3.0 29.3% 3.1 41.7% $0.1 12.4%
1999.......................... 3.3 27.4% 3.7 41.5% $0.4 14.1%
2000.......................... 3.7 25.6% 4.0 41.6% $0.3 16.0%
2001.......................... 4.0 23.7% 4.3 34.9% $0.3 11.2%
2002.......................... 4.5 22.2% 4.7 29.3% $0.2 7.1%
2003.......................... 4.9 20.8% 5.2 25.3% $0.3 4.5%
2004.......................... 5.4 19.6% 32.9 40.1% $27.5 20.5%
2005.......................... 5.9 18.7% 4.7 39.1% -$1.2 20.4%
2006.......................... 6.5 18.1% 4.2 37.2% -$2.3 19.1%
2007.......................... 7.0 17.6% 5.2 34.4% -$1.8 16.8%
2008.......................... 7.6 17.3% 6.5 31.9% -$1.1 14.6%
2009.......................... 8.3 17.3% 8.0 30.1% -$0.3 12.8%
2010.......................... 9.0 17.6% 9.8 28.8% $0.8 11.2%
2020.......................... 14.5 26.8% 16.0 25.7% $1.5 -1.1%
2030.......................... 23.5 44.9% 24.5 37.0% $1.0 -7.9%
2040.......................... 38.3 72.2% 38.0 67.5% -$0.3 -4.7%
2045.......................... 48.9 90.0% 47.3 90.0% -$1.6 0.0%
----------------------------------------------------------------------------------------------------------------
The estimated annual contributions to GARS based on the June 30,
2005 actuarial valuation track closely with the original projections
under P.A. 88-593.
VI. Commission Funding Recommendation
Commission Recommendation
P.A. 88-593 requires a periodic evaluation of whether the 90%
target funded ratio represents an appropriate goal for the five State-
funded retirement systems. As evidenced by the national overview on
page 2, the average funded ratio of 64 state retirement systems at the
end of FY 2004 was 83 %. While the average funded ratio for all the
systems in the survey fell considerably from FY 2001 through FY 2003
due to the downturn in the financial markets, it can be assumed that
the average funded ratio for these 64 systems will approach or exceed
90% by the end of FY 2006. Therefore, the Commission believes that a
90% funding target is appropriate in light of national trends. In
addition, despite multiple benefit increases and the aforementioned
bear market years, the current projections of future contributions are
generally on course with the original projections based on the June 30,
1994 actuarial valuations of each of the five State-funded systems.
Furthermore, the Commission believes that adhering to an explicit and
well-defined funding schedule will produce stable, predictable results
for both the state and retirement system members and annuitants.
Office of Management and Budget Letter Concerning 90% Funding Ratio
Governor's Office of Management & Budget,
Executive Office of the Governor,
Springfield, IL, December 22, 2005.
Senator Jeffrey Schoenberg,
State House, Room 218-B, Springfield, Illinois.
Representative Terry Parke,
State House, Room 220, Springfield, Illinois.
Re: Review of Public Act 88-593
Dear Senator Schoenberg and Representative Parke: Public Act 88-593
established a 50-year payment plan for the live state pension systems.
This payment plan was adopted to address the State's inability to pay
normal cost and interest on the unfunded liability each year since
1978. The basic principal of this 50-year payment plan is to attain a
90% funded ratio by the end of fiscal 2045 and maintenance of that 90%
funded ratio thereafter. The Act also requires the Office of Management
and Budget, every five years, to consider and determine whether the 90%
funding ratio continues to represent an appropriate goal for state
sponsored retirement plans in Illinois.
Following are the findings and recommendations of the Office of
Management and Budget with regard to continued appropriateness of the
90% funding ratio.
Illinois Pension System Challenge
Funding of the State's past pension debits, accumulated over three
decades, represents the greatest financial challenge for the State of
Illinois.
The unfunded liability of the State pension systems more than
doubled from $19.5 billion as of June 30, 1995 (the year before
implementation of the 50-year payment plan) to $43.1 billion as of June
30, 2003 (with a funded ratio of 48.6%). Due primarily to infusion of
proceeds of the 2003 Pension Obligation Bonds (POB), and associated
earnings, the unfunded liability is currently at $38.6 billion as of
June 30, 2005 (as a funded ratio of 60.3%).
The primary drivers of the increase in unfunded liability between
1995 and 2003 include:
Slate contributions determined in accordance with the 50-
year payment plan that were designed to underfund the normal cost and
interest on the unfunded liability, thus increasing the liability.
Significant investment losses incurred during the free
fiscal years ended June 30, 2003.
Unfunded benefit improvements adopted between 1995 through
2002.
Total required State contributions to the pension system,
determined in accordance with the 511-year payment plan, are projected
to increase from $609 million for fiscal 1996 to $15.6 billion in 2045.
(Reduced from a projected 2045 contribution of $16.8 billion determined
when the 50-year payment was first implemented.)
Appropriateness of 90% Funded Ratio
Public Act 88-593 requires the Office of Management and Budget to
consider and determine whether the 90% funding ratio continues to
represent an appropriate goal for state sponsored retirement plans in
Illinois.
For comparison purposes, please note that the private sector has no
equivalent percentage funding target, but is subject to additional
minimum contribution requirements if the funded level falls below 90%.
Adopting a statutory payment plan for the state pension systems was
needed. The 50-year payment plan, however, was structurally
unaffordable when it was enacted though. First of all, it incorporated
a 15 year ramp-up period, which increased contributions over a period
of 15 years from a starting level that was arbitrary and significantly
less than the amount needed to keep the unfunded liability from
increasing, thereby further increasing the unfunded liability. Thus the
state was guaranteed to experience a growing unfunded liability into
the future.
Contributions for years after 2010, although determined as a
percent of pay, are also not sufficient to pay normal cost and interest
on the unfunded liability until around 2034. Therefore, as a result of
the 50-year payment plan, the unfunded liability was actually projected
to grow from the 6/30/95 level of $19.5 billion to as much as $78
billion by 2034 before it finally begins to reduce to $53 billion in
2045.
The fact that the 50-year payment plan called for continued
underfunding for 40 years until 2035, with the underfunding being paid
back at an 8.5% interest rate, caused the annual contribution schedule
to quickly become unaffordable. Both the payment plan structure and
high interest cost of the liability required a full examination of how
to resolve this decades long structural issue.
The 90% funded target for a state pension plan represents a
reasonable and appropriate funding target. The Office of Management and
Budget concurs with the majority report of the Advisory Commission on
Pension Benefits (established by Public Act. 94-4) which recommends a
series of changes needed to attain a 90% funded ratio for state pension
systems. (See recommendations of Advisory Commission Report below.)
Governor's Pension Reform Plan
The first step taken by the Governor to address these structural
issues was to provide the state pension systems with a cash infusion
and reduce the states pension debt. During June of 2003, the state
issued $10 billion of Pension Obligation Bonds, all of which, except
for $500 million which was used to cover issuance costs and initial
debt service payments, was paid into pension systems. Of this $10
billion total, $7.3 billion was disbursed to the pension systems as an
additional state contribution over an above any annual contribution
requirements. This additional cash infusion on July 3, 2003 immediately
reduced the pension system's unfunded liability from $43 billion to
approximately $36 billion, and increased the system's funded ratio from
49% as of June 30, 2003 to over 57% literally overnight. (With
investment earnings, the funded ratio actually improved to over 60% by
June 30, 2005.)
With this single action, the security of the members and retirees'
pensions improved significantly. This reduction in liability was never
anticipated or included in the 50-year payment plan.
Public Act 94-4
Deloitte Consulting LLP, (the consulting actuary to the Governor's
Pension Commission and the Governor's Office of Management & Budget)
reports that, of several estimates prepared by different actuaries, the
most appropriate, reasonable and complete estimate of the net savings
associated with Public Act 94-4 is a projected reduction in the 2045
actuarial accrued liability of approximately $44 billion (or 8%), as
well as a reduction in state contribution requirements of approximately
$53 billion over the next 40 years.
The Governor's management and budgetary actions have resulted in
the reduction of headcount to its lowest level in more than 30 years.
In addition to the annual payroll savings this headcount reduction
effort has generated, SERS, in their 6/30/05 actuarial valuation,
recognized savings of approximately $5 billion in state contribution
requirements between fiscal year 2006 and 2045 as a result of this
effort. This $5 billion contribution savings is in addition to the $3
billion discussed above.
Governor's Pension Reforms
The reforms included in Pubic Act 94-4 represent the first time
future liabilities and benefits of the Illinois pension system have
ever been reduced.
In addition to the changes included in Public Act 94-4, payments to
the State's pension systems have substantially increased in each of the
last four year periods since fiscal 1992.
The following table illustrates payments for the State's pension
systems in four year periods between fiscal year 1992 and 2007:
----------------------------------------------------------------------------------------------------------------
Percent of general
Fiscal year period Payments (billions) Average annual revenue fund
payment resources
----------------------------------------------------------------------------------------------------------------
2004--2007....................................... $7,497 $1,874 7.29%
2000--2003....................................... $5,818 $1,455 6.08%
1996--1999....................................... $3,433 $858 4.30%
1992--1995....................................... $2,067 $517 3.28%
----------------------------------------------------------------------------------------------------------------
Note: Payment numbers DO NOT include the additional infusion of $7.317 billion from the June 2003 Pension
Obligation Bonds. If included, the $7.497 billion payment for the period 2004 through 2007 would be increased
by an additional $5.829 billion ($7.317 billion net of debt service of $1.488 billion).
Advisory Commission on Pension Benefits
As required under Public Act 94-4, the Governor's established an
Advisory Commission on Pension Benefits. The mandate of this Advisory
Commission on Pension Benefits (the ``Commission'') was to consider and
make recommendations concerning changing the age and service
requirements, automatic annual increase benefits, and employee
contribution rate of the State-funded retirement systems and other
pension-related issues.
The Commission met five times between September 23 and October 27,
2005 and recommended the following be considered by an agreed bill
process:
The Commission recommends that the State adopt means by
which to dedicate revenues in excess of a specific target percentage of
growth towards the additional funding of the pension systems when those
targets are met, and establish a minimum when those targets are not
met.
The Commission recommends that if the State sells certain
assets, then 100% of the resulting revenues should be dedicated towards
reducing liabilities, including the Pension Systems' unfunded
liabilities, as a component part of a broader plan to reduce those
unfunded liabilities.
The Commission recommends that the General Assembly
consider creating incentives for employees to continue working beyond
the year when they achieve maximum pension percentage as a means to
reduce the State's pension costs.
The Commission recommends that the General Assembly
consider the issuance of Pension Obligation Bonds as quickly as
practicable as a financing instrument to reduce the State's pension
costs, as long as (1) there are favorable market conditions and (2) the
issuance of such POBs is a component part of a broader plan to reduce
the Pension Systems' unfunded liabilities.
The Commission recommends that the General Assembly should
explore new revenue sources dedicated to reducing the Pension Systems'
debt, as a component part of a broader plan to reduce the Pension
Systems' unfunded liabilities.
The Commission affirms the significance of the benefit
reforms achieved in the 2005 Spring legislative session, and also
affirms that, at the present time, most SERS, TRS and SURS benefits and
employee contributions are comparable to other public pension systems
in the United States. The Commission further recommends that the
General Assembly should regularly review, as part of the agreed bill
process as well as their normal budgetary review process, the
affordability of the Pension Systems' plan provisions regarding
benefits and make an affirmative determination thereon.
In conclusion, the 90% funded target for a state pension plan
represents a reasonable and appropriate funding target. The Office of
Management and Budget concurs with the majority report of the Advisory
Commission on Pension Benefits (established by Public Act. 94-4) which
recommends a series of changes needed to attain a 90% funded ratio for
the state pension systems.
Sincerely,
John Filan,
Director.
______
Executive Office,
State Retirement Systems,
Springfield, IL, December 30, 2005.
Senator Jeffrey Schoenberg,
Co-Chairman, CGFA, Evanston, IL.
Representative Terry Parke,
Co-Chairman, CGFA, Schaumburg, IL.
Dear Senator Schoenberg and Representative Parke: Public Act 88-
0503 established a funding goal for the five state pension systems with
a 90% funding ratio by the year 2045, and to maintain the funding ratio
thereafter. This Act also called for the 90% funding goal to be
reviewed every five years by the Systems and the Governor's Office of
Management and Budget.
It is not certain why the 90% target was initially included in the
legislation, but in view of the length of the funding plan and the
consensus of the public funds, we would recommend this goal be raised
to 100%. We believe the long term funding target should equal the total
obligations, over 40 years, the increased contributions should be
relatively small.
Very truly yours,
Robert V. Knox,
Executive Secretary, State Retirement Systems.
Jon Bauman,
Executive Director, Teachers' Retirement System.
Dan Slack,
Executive Director, State Universities Retirement System.
Appendix I. Legislative Overview
This section of the report summarizes the major legislative actions
that have significantly impacted the State-funded retirement systems
since the Commission last reported on the appropriateness of the 90%
funding target.
2002 Early Retirement Incentive (ERI)
Public Act 92-0566 (HB 2671) created an Early Retirement Incentive
(ERI) Program for certain members of the State Employees' Retirement
System (SERS) and State employees covered by the Teachers' Retirement
System (TRS). To be eligible for the ERI, members must have been,
during June 2002: in active payroll status; on layoff status with a
right of recall, or receiving a disability benefit for less than 2
years. Members were required to file the ERI application with the Board
of Trustees prior to December 31, 2002 and leave employment between
July 1, 2002, and December 31, 2002.
According to SERS, 11,039 members elected to participate in the
ERI. Of these, 10,301 were eligible to retire immediately (Option 1),
while 738 members elected to terminate employment and receive benefits
at a later date (Option 2). The average number of ERI months purchased
was 58 and the average age at termination was 57 for Option 1
participants and 48 for Option 2 participants. According to the System,
the average cost of purchasing the ERI service credit was $11,624 per
participant and the average total monthly benefit of all ERI
participants was almost $2,505.
Pension Obligation Bonds
On April 7, 2003, Governor Blagojevich signed House Bill 2660 into
law as Public Act 93-0002. The legislation authorized the State to
issue $10 billion in general obligation bonds for the purpose of making
required contributions to the five state-funded retirement systems.
After payment of fees, commissions, and interest, a total of $9,477.3
million was deposited into the newly-created Pension Contribution Fund
(PCF). The act specified that the first $300 million was to be used to
reimburse the General Revenue Fund for a portion of the FY 2003 State
contributions to the retirement systems. In addition, the next $1,860.0
million was reserved to reimburse GRF for all of the FY 2004 employer
contributions to the State-funded retirement systems. The remainder of
the POB proceeds, $7,317.3 million, was distributed to the retirement
systems in proportion to their unfunded liabilities, as outlined in the
chart below.
PENSION OBLIGATION BONDS
----------------------------------------------------------------------------------------------------------------
Pre-POB Post-POB Funded ratio Funded ratio
System unfunded POB proceeds unfunded before POB after POB
liability liability proceeds proceeds
----------------------------------------------------------------------------------------------------------------
TRS............................. $23,809.0 $4,330.0 $19,478.0 49.3% 58.5%
SERS............................ 10,092.0 1,386.0 8,706.0 42.6% 50.5%
SURS............................ 8,311.0 1,432.0 6,879.0 53.9% 61.8%
JRS............................. 746.0 142.0 604.0 30.7% 43.9%
GARS............................ 147.0 27.0 120.0 25.3% 39.1%
-------------------------------------------------------------------------------
Combined.................. $43,105.0 $7,317.0 $35,787.0 48.6% 57.3%
----------------------------------------------------------------------------------------------------------------
P.A. 94-0004 (SB 0027)
On June 1, 2005, Governor Blagojevich signed SB 0027 into law as
Public Act 94-0004. The Act makes several changes to the Illinois
Pension Code, including a reduction in the required FY 2006 and FY 2007
State contributions to the State-funded retirement systems, as shown in
the chart below:
CERTIFIED AND PROJECTED CONTRIBUTIONS VS. PUBLIC ACT 94-0004 CONTRIBUTIONS
[In millions $]
--------------------------------------------------------------------------------------------------------------------------------------------------------
FY 2006 FY 2007
-----------------------------------------------------------------------------------------------
System Certified Projected
contributions P.A. 94-0004 Reducation contributions P.A. 94-0004 Reduction
--------------------------------------------------------------------------------------------------------------------------------------------------------
TRS..................................................... $1,058.5 $534.6 $523.9 $1,233.1 $738.0 $495.1
SERS.................................................... 690.3 203.8 486.6 832.0 344.2 487.8
SURS.................................................... 324.9 166.6 158.2 391.9 252.1 139.8
JRS..................................................... 38.0 29.2 8.8 44.5 35.2 9.3
GARS.................................................... 5.5 4.2 1.3 6.3 5.2 1.1
-----------------------------------------------------------------------------------------------
Total............................................. $2,117.1 $938.4 $1,178.7 $2,507.9 $1,374.7 $1,133.2
--------------------------------------------------------------------------------------------------------------------------------------------------------
P.A. 94-0004 changes the funding plan created in 1994 by Public Act
88-0593 by setting the State contribution levels for FY 2006 and FY
2007, rather than requiring the State to make contributions based on
actuarial calculations. In addition, the separate funding of the
liability created by the 2002 SERS Early Retirement Incentive was
eliminated.
The legislation also contained several reforms that the Commission
has discussed in previous meetings. These changes are expected to
curtail the rate of growth in liabilities which may result in lower
required annual State contributions over the life of the funding plan.
Background
The Commission on Government Forecasting and Accountability (CGFA),
a bipartisan, joint legislative commission, provides the General
Assembly with information relevant to the Illinois economy, taxes and
other sources of revenue and debt obligations of the State. The
Commission's specific responsibilities include:
1) Preparation of annual revenue estimates with periodic updates;
2) Analysis of the fiscal impact of revenue bills;
3) Preparation of ``State Debt Impact Notes'' on legislation which
would appropriate bond funds or increase bond authorization;
4) Periodic assessment of capital facility plans;
5) Annual estimates of public pension funding requirements and
preparation of pension impact notes;
6) Annual estimates of the liabilities of the State's group health
insurance program and approval of contract renewals promulgated by the
Department of Central Management Services;
7) Administration of the State Facility Closure Act.
The Commission also has a mandate to report to the General Assembly
``* * * on economic trends in relation to long-range planning and
budgeting; and to study and make such recommendations as it deems
appropriate on local and regional economic and fiscal policies and on
federal fiscal policy as it may affect Illinois. * * *'' This results
in several reports on various economic issues throughout the year.
The Commission publishes several reports each year. In addition to
a Monthly Briefing, the Commission publishes the ``Revenue Estimate and
Economic Outlook'' which describes and projects economic conditions and
their impact on State revenues. The ``Bonded Indebtedness Report''
examines the State's debt position as well as other issues directly
related to conditions in the financial markets. The ``Financial
Conditions of the Illinois Public Retirement Systems'' provides an
overview of the funding condition of the State's retirement systems.
Also published are an Annual Fiscal Year Budget Summary; Report on the
Liabilities of the State Employees' Group Insurance Program; and Report
of the Cost and Savings of the State Employees' Early Retirement
Incentive Program. The Commission also publishes each year special
topic reports that have or could have an impact on the economic well
being of Illinois. All reports are available on the Commission's
website.
These reports are available from:
Commission on Government Forecasting and Accountability, 703
Stratton Office Building, Springfield, Illinois 62706. http://
www.ilga.gov/commission/cgfa/cgfa--home.html
______
[NASRA letter submitted by Mr. Brainard follows:]
National Association of State Retirement Administrators,
National Council on Teacher Retirement,
July 14, 2006.
Hon. Charles E. Grassley,
Chairman, Committee on Finance, Hart Senate Office Building,
Washington, DC.
Hon. Max Baucus,
Ranking Member, Committee on Finance, Hart Senate Office Building,
Washington, DC.
Dear Senators Grassley and Baucus: On behalf of the National
Association of State Retirement Administrators (NASRA) and the National
Council on Teacher Retirement (NCTR), we are writing in reference to
your letter dated July 10, 2006, to the Government Accountability
Office (GAO) requesting a study of the funding status of public pension
plans. The membership of NASRA and NCTR collectively administers State,
territorial, local, university and statewide public pension systems
that hold over $2.1 trillion in trust for over 18 million public
employees, retirees and their beneficiaries.
We appreciate your interest in the general financial health of
State and local government defined benefit (DB) plans. We are
concerned, however, about some of the statements made in the letter to
the GAO, particularly those that could be misleading or are factually
inaccurate regarding the governance, protections and financial
condition of public employee retirement systems. It is extremely
important that an accurate point of departure is used and proper
metrics are employed. We welcome the opportunity to work closely with
you and the GAO as you examine the areas outlined in your letter, and
hope the factual points noted below and future discussions will better
ensure a balanced study.
For example, when discussing pensions in the private sector, the
letter may be correct in stating that ``retirees and workers who 'play
by the rules' all their careers now find themselves with far lower
actual or future retirement income on which they had counted.''
However, that statement definitely does not apply to participants (both
active employees and retirees) in the public pension plans represented
by our two associations. Public DB pension plan promises made are
promises kept. Accordingly, we do not understand the basis for the
letter's suggestion that public employees need ``help'' in ``avoid[ing]
the benefit losses and reduced accruals experienced by their private
sector counterparts.'' We know of no participant in our members' plans
who has or may ever lose any part of his or her existing retirement
benefit.
Indeed, unlike the private sector in which only the participant's
accrued benefit to date is protected, in the State and local DB plan
world the benefit formula itself is typically protected from such
cutbacks by state constitutions, statutes, or case law that prohibit
the elimination or diminution of a retirement benefit once it is
granted. Thus, State and local DB plans typically guarantee not only
the participant's accrued level of benefit but also protect future
benefit accruals from being cut back. The implication that lack of
coverage by the Pension Benefit Guaranty Corporation (PBGC) renders
government employees at greater risk is a misnomer, and only serves to
unduly alarm the participants in our members' systems. Even though
public plans may not have the PBGC as a ``back-up source for guaranteed
benefit payments,'' the full faith and credit of State and local
governments has provided insurance far greater than what is provided by
the PBGC. In fact, public employees may actually find increased comfort
in knowing that there is no ``escape hatch'' from pension obligations
once they are promised in the public sector. It is a misconception that
PBGC coverage will provide any added value to the benefit protections
already in place for State and local government employees.
We also wish to take exception to the statement in the letter to
GAO that ``many'' public sector DB plans are ``even more poorly
funded'' than their private sector counterparts, and the implication
that an untenable burden will fall on taxpayers and public employees.
As a group, public pension plans have funded 86 percent of their
liabilities, a figure that is expected to begin rising in the near
future as investment gains since March 2003 are more fully incorporated
into funding calculations. This figure is also reflective of the
funding levels of plans covering the substantial majority of public
pension participants. Unlike private sector plans that must rely on
uneven employer contributions, State and local DB plans receive a
steady stream of both employer and employee contributions that
typically is mandated by statute. In addition, State and local
government DB plans are long-term investors, whose portfolios are
professionally-managed and designed to withstand short-term market
fluctuations while still providing optimal growth potential. When
placed in context, required contributions to public pension plans
continue to be well within State and local governments' budgetary
means, and even represent historically low amounts as a percentage of
total state and local government spending and payroll.
Finally, we are concerned with the letter's co-mingling of pension
benefit funding with the issue of health benefits and the ``funded
status'' of retiree health plans. We agree that adequate health care is
essential to overall retirement security, and that health benefit
commitments are placing significant and increasing pressure on
government resources. However, meeting the fiscal and other challenges
in providing healthcare benefits must not be confused with the funding
of DB retirement plans. Retiree health benefits are handled separately
and independently and often are not administered or funded as part of a
government's retirement system.
NASRA and NCTR appreciate the strong record of support that each of
you have maintained for State and local government employee retirement
programs. We share your interest in keeping commitments to providing a
secure retirement for American workers, particularly those who spend a
career delivering vital services to the public and whose retirement
security the members of our associations guarantee. We welcome the
opportunity to work closely with you and the GAO and hope future
discussions and consultation will provide an objective and factually
accurate study.
To this end, we have attached comments recently sent to the
President of the Federal Reserve Board of Chicago. These comments are
intended to constructively promote sound public policy regarding issues
with far-reaching ramifications affecting millions of working and
retired Americans.
We look forward to working with the GAO and are confident that when
its study is complete, you will be reassured that the status of public
pension plans and their funding condition is sound. Please feel free to
call upon either one of us. We would be happy to assist you at any
time.
Sincerely,
Jeannine Markoe Raymond,
Director of Federal Relations, National Association of State
Retirement Administrators.
Leigh Snell,
Director of Governmental Relations, National Council on Teacher
Retirement.
______
[Letter of support to Messrs. Grassley and Baucus submitted
by Mr. Brainard follows:]
National Conference of State Legislatures (NCSL),
American Federation of State, County and Municipal
Employees (AFSCME),
National Association of State Treasurers (NAST),
American Federation of Teachers (AFT),
National Association of Counties (NACo),
Communications Workers of America (CWA),
National Association of State Auditors Comptrollers and
Treasurers (NASACT),
Fraternal Order of Police (FOP),
United States Conference of Mayors (USCM),
International Association of EMTs and Paramedics (IAEP),
National League of Cities (NLC),
International Association of Fire Fighters (IAFF),
International City/County Management Association (ICMA),
International Brotherhood of Correctional Officers (IBCO),
Government Finance Officers Association (GFOA),
International Brotherhood of Police Officers (IBPO),
International Public Management Association for Human
Resources (IPMA-HR),
International Union of Police Associations, AFL-CIO (IUPA),
National Association of Government Defined Contribution
Administrators (NAGDCA),
National Association of Government Employees (NAGE),
National Association of Nurses (NAN),
National Association of Police Organizations (NAPO),
National Association of State Retirement Administrators
(NASRA),
National Conference on Public Employee Retirement Systems
(NCPERS),
National Council on Teacher Retirement (NCTR),
National Education Association (NEA),
National Public Employer Labor Relations Association
(NPELRA),
Service Employees International Union (SEIU),
August 2, 2006.
Hon. Charles E. Grassley,
Chairman, Committee on Finance, Hart Senate Office Building,
Washington, DC.
Hon. David M. Walker,
Comptroller General of the United States, U.S. Government
Accountability Office, Washington, DC.
Hon. Max Baucus,
Ranking Member, Committee on Finance, Hart Senate Office Building,
Washington, DC.
Dear Gentlemen: On behalf of the 28 national organizations listed
above--representing state and local governments and officials, public
employee unions, public retirement systems, and over 20 million State
and local government employees, retirees, and their beneficiaries--we
are writing in reference to a July 10, 2006 letter between your offices
regarding a study into the financial condition of State and local
government defined benefit pension systems. The interests of our
numerous organizations may be widely diverse, but we share in the
desire to ensure such a study is done accurately and results in a
balanced report, and stand ready to work with you to ensure its highest
possible quality.
Indeed, such a study may go a long way to correcting the many
misperceptions that appear to exist with regard to State and local
government retirement systems. We hope you will call upon our
collective expertise as this study ensues, as there are fundamental
differences between governments and businesses that result in critical
distinctions between plans in each sector and the way in which they are
accounted for and measured. These distinctions are often unknown or
misunderstood. A factual study into the health of public plans must
ensure appropriate metrics are used and must not employ a private plan
yardstick to measure government retirement systems.
Public plans are in sound financial condition and State and local
governments take seriously their responsibility for paying promised
benefits to their employees and retirees. Comprehensive State and local
laws, and significant public accountability and scrutiny, provide
rigorous and transparent regulation of public plans and have resulted
in strong funding rules and levels. Public plans are backed by the full
faith and credit of State and local governments. Additionally, a public
plan participant's accrued level of benefits and future accruals
typically are protected by state constitutions, statutes, or case law
that prohibits the elimination or diminution of a retirement benefit,
providing far greater protections that what is provided by ERISA and
the PBGC. A greater understanding of the protections put in place by
the governments ultimately responsible for funding these plans may
serve to build support for these arrangements and address the erosion
of confidence in retirement security in general.
We also hope you will keep in mind that retiree health benefits are
handled separately and independently and often are not administered or
funded as part of a government's retirement system. While adequate
health care is essential to overall retirement security, and health
benefit commitments are placing significant and increasing pressure on
government resources, fiscal and other challenges in providing
healthcare benefits should not be confused with the funding of state
and local government retirement plans. It is crucial that retiree
health care benefits are clearly distinguished from any study into the
financial health of public pension plans.
When you look at State and local government pension plans, you will
find there is a good story to tell. It is our hope that a factual and
objective analysis might ultimately serve to strengthen retirement
programs and build on the success many in the public sector have had in
not only enduring market fluctuations and providing security to
retirees, but providing stability to our financial markets, and
distributing consistent and inflation-protected revenue streams to
local communities as well. We are pleased to share the following
current facts about state and local plans, which we hope you will keep
in mind as your work progresses:
Public pension plans are in good financial condition. As a
group, public pension plans have funded 86 percent of their
liabilities, a figure that is projected to begin rising in the near
future as the three-year market shock earlier this decade is more fully
offset by strong investment gains. This figure also is consistent with
funding levels of plans covering the substantial majority of public
pension participants. Unlike the contribution volatility that may exist
in a private plan setting, State and local plans receive a steady
stream of both employer and employee contributions that typically is
mandated by statute.
The bulk of public pension funding is not shouldered by
taxpayers. When placed in context, required contributions to public
pension plans continue to be well within State and local governments'
budgetary means, and even represent historically low amounts as a
percentage of total state and local government spending and payroll.
This is because the vast majority of public plan funding comes from
investment income. Employer (taxpayer) contributions to state and local
pension systems over the last two decades have made up only one-fourth
of total public pension revenue. Earnings from investments and employee
contributions comprise the remainder. This ratio has improved over
time. In 2004, investment earnings accounted for 77 percent of all
public pension revenue; employer contributions were 15 percent.
State and local retirement plan assets are professionally-
managed and provide valuable long-term capital for the nation's
financial markets. The $2.8 trillion held in plan portfolios are an
important source of stability for the marketplace and are designed to
withstand short-term fluctuations while still providing optimal growth
potential.
State and local pension plans fuel national, state and
local economies. Public plans distribute more than $130 billion
annually (an amount greater than the total economic output of 22
states) in benefits to over 6 million retirees and beneficiaries, with
an average annual pension benefit of roughly $19,500. These payments
are steady, continuous, in great part adjusted for inflation and
provide a strong economic stimulus to local economies throughout the
nation.
Public plans are subject to comprehensive oversight. While
private sector plans are subject solely to federal regulation, state
and local government plans are creatures of state constitutional,
statutory and case law and must comply with a vast landscape of state
and local requirements, as well as industry accounting standards. These
plans are accountable to the legislative and executive branches of the
state; independent boards of trustees that include employee
representatives and/or ex-officio publicly elected officials; and
ultimately, the taxpaying public.
Public retirement plans attract and retain the workforce
that provides essential public services. Active public employees
comprise more than 10 percent of the nation's workforce, and two-thirds
are employed in education, public safety, corrections, or the
judiciary. Retention of experienced and trained personnel in these and
other positions is critical to the continuous and reliable delivery of
taxpayer services.
We share your continued interest in providing a secure retirement
for American workers, particularly those that have spent a career in
public service--protecting the homeland, caring for the sick, and
educating our children. We believe many public sector systems indeed
are innovative models that could be emulated to ensure responsible and
prudent pension funding and management of assets. We welcome the
opportunity to work closely with the Committee and the GAO as you
examine State and local government defined benefit plans, and hope you
will consult with us as this study moves forward. Please feel free to
call upon our legislative representatives:
Gerri Madrid-Davis, NCSL,
Ed Jayne, AFSCME,
Dan De Simone, NAST,
Bill Cunningham, AFT,
Daria Daniel, NACo,
Rosie Torres, CWA,
Cornelia Chebinou, NASACT,
Tim Richardson, FOP,
Larry Jones, USCM,
Steve Lenkart, NAGE/IBPO/IBCO/IAEP/NAN,
Alex Ponder, NLC,
Barry Kasinitz, IAFF,
Robert Carty, ICMA,
Barrie Tabin Berger, GFOA,
Tina Ott Chiappetta, IPMA-HR,
Dennis Slocumb, IUPA,
Susan White, NAGDCA,
Bill Johnson, NAPO,
Jeannine Markoe Raymond, NASRA,
Hank Kim, NCPERS,
Leigh Snell, NCTR,
Alfred Campos, NEA,
Hope Tackaberry, NPELRA,
Allison Reardon, SEIU.
______
[GRS letter submitted by Mr. Brainard follows:]
GRS,
March 15, 2006.
Mr. Michael H. Moskow,
President and CEO, Federal Reserve Board of Chicago, Chicago, IL
Dear Mr. Moskow: We are writing because we share your concern about
the future of public retirement plans. Together, the authors of this
letter have over 35 years of experience conducting surveys and other
research related to state and local government retirement plan
administration, benefit design, investments, actuarial valuations, and
plan funding. Paul Zorn is Director of Governmental Research for
Gabriel, Roeder, Smith & Company, a consulting firm that specializes in
state and local benefit plans and provides actuarial and other services
to over 400 public sector clients. Keith Brainard is Director of
Research for the National Association of State Retirement
Administrators (NASRA), a non-profit organization for directors and
administrators of statewide retirement systems currently covering 16
million working and retired employees.
We read with interest your remarks to the State and Local
Government Pension Forum on February 28. We recognize your concerns
about public pension funding and the potentially large liabilities
related to retiree health care benefits. We also share your concerns
about the future of retirement benefits for millions of public
employees, including teachers, police officers, firefighters, judges,
and other public officials. However, we respectfully disagree with
several of your conclusions. Our comments below are intended
constructively, in support of sound public policy relating to an
important issue with far-reaching ramifications affecting millions of
working and retired Americans.
Growth of Public Pension Unfunded Liabilities
The speech characterizes the funding of state and local retirement
plans as a problem that will grow rapidly and ultimately reduce the
ability of governments to fund other public programs. With regard to
public pension plans, we believe this characterization does not
accurately reflect the current financial status of plans that cover the
vast majority of public employees, nor does it accurately reflect the
reasons for the recent decline in the plans' funding condition.
For the most part, state and local retirement plans in the U.S. are
in good financial shape. According to the Public Fund Survey, the
average funded ratio of large public retirement plans in the U.S. was
88 percent in 2004, with 7 out of 10 plans at least 80 percent
funded.\1\ While a handful of large plans do have funded ratios below
60 percent, the overall financial health of the retirement plans
covering the vast majority of public employees is good. To characterize
the current state of public pension plans as ``a mess'' is to misstate
the problem.
The dramatic decline in domestic equity markets that occurred from
2000 through 2002 is the single largest factor influencing the recent
growth in unfunded liabilities for public pension plans. Prior to 2000,
the vast majority of public plans were well funded and there was no
talk of a pension crisis. Then, from 2000 through 2002, domestic stocks
lost about 40 percent of their value, the largest market decline since
the Great Depression. As a result, public plan funded ratios fell, on
average, from a little over 100 percent to about 88 percent now. Even
at this level, because of the way the calculations are made, accrued
benefits based upon salary and service to date are most likely to be
fully funded. Moreover, public plans weren't the only ones affected:
the declines in asset values created problems for all retirement plans
alike--public and private, defined benefit and defined contribution.
Growth in Employer Contributions
Increased unfunded actuarial liabilities are usually amortized
through increases in employer contribution rates. Consequently, the
declines in the equity markets caused employer contribution rates to
rise. To dampen the immediate impact of large, short-term market
fluctuations on employer contributions, most public plans use asset
smoothing techniques to gradually recognize investment gains and losses
over three to five years. Consequently, even after the investment
markets improved in 2003, employer contributions continued to increase.
The good news is that the investment gains from 2003 through 2005
are also being smoothed into the value of assets, and will likely cause
employer contributions to stabilize. This is echoed in the recent
Standard & Poor's report which observes, if ``funds produce adequate
investment returns in fiscal 2006, then we may see funded ratios begin
to stabilize.'' \2\
Moreover, when viewed in the context of total state and local
government spending, governments (and thus taxpayers) spent less on
public pension plans in 2004 than they did during the mid-1990s. From
1995 through 1997, state and local government contributions to pension
plans were about 3.0 percent of total state and local government
spending annually. By 2002, this had fallen to 1.9 percent, due partly
to the smoothing in of investment gains earned during the late 1990s.
After 2002, government contributions increased and reached 2.2 percent
in 2004, still lower than the 3.0 percent paid in the mid-1990s.\3\
Measuring the Unfunded Liability
The speech uses Barclays Global Investors' $700 billion estimate of
public pension plan unfunded liabilities. We believe this figure
significantly overstates public pension unfunded liabilities and that
the best measure of these liabilities is provided in the actuarial
valuations done for the plans. Using this measure, we estimate total
current unfunded liabilities for all state and local pension plans to
be about $385 billion, roughly half of the Barclays' estimate.
The Barclays' estimate is based on a present value discount rate
reflecting fixed-income securities, whereas most pension portfolios are
composed of a diversified mix of equity and fixed-income investments,
including public and private equities. The problem is that the present
value calculation is intended to reflect the amount needed today that,
when invested, would be sufficient to pay future benefits. A discount
rate based solely on fixed-income investments would systematically
overstate the long-term cost of benefits. Moreover, under the
Governmental Accounting Standards Board's rules, the discount rate
should reflect the expected long-term rate of return on plan
investments for determining the cost of pension benefits reported in
governmental financial reports. As discussed in GASB Statement No. 25,
the GASB considered but rejected using the long-term bond rate as the
discount rate for governmental pension plans.\4\
In addition, for an unfunded liability figure to truly have
meaning, it must be measured in the context of available assets. For
the fourth quarter of 2005, the Federal Reserve reported that public
pension plans held assets of $2.72 trillion,\5\ a figure that has
surely grown in the ensuing period and that far outweighs estimates of
unfunded liabilities. Even if policymakers made no changes to public
pension plan designs (including to contribution rates), most public
pension plans still would have assets sufficient to continue paying
their promised benefits, at a minimum, for decades into the future.
Applying ERISA Rules to Public Plans
The speech suggests that a solution to public plan funding would be
to make the plans subject to standards similar to those in the Employee
Retirement Security Act of 1974 (ERISA), on the grounds that this would
make it more difficult for governments to increase pension benefits
without identifying adequate funding. While we agree on the importance
of funding promised benefits, we disagree that federal legislation like
ERISA would be a solution.
First, the current problems with private-sector pension plans
demonstrates the weaknesses of ERISA in ensuring plan funding. As the
GAO has pointed out, the ``current funding rules do not provide
adequate mechanisms for maintaining adequate funding of pension
plans.'' \6\
Second, the cost of satisfying ERISA's complicated rules is
considered one of the reasons for the decline in private sector pension
plans. In 1997, the Employee Benefits
Research Institute published a report on the rise of defined
contribution plans in the private sector. In its discussion of the
impact of ERISA and other legislative changes, the authors observe:
``Many argue that new laws and regulations have raised the DB
administrative costs enough to make DC plans more attractive to plan
sponsors.'' \7\
It is true that a handful of large public plans are facing funding
difficulties and that in several cases this is a result of employers'
unwillingness to fully fund the plans. However, to remedy this, changes
to state laws would be more appropriate than the imposition of a one-
size-fits-all set of federal regulations. Indeed, a strong argument can
be made that state and local government pension plans have, for the
most part, flourished in the absence of federal controls, operating
instead under governance structures prescribed by state constitutions,
statutes, and case law.
A resolution approved by NASRA in 1996 states, in part, ``public
employee retirement systems already have in place full disclosure,
reporting, accounting, and fiduciary standards set by state and local
governments and, further, these systems have significantly improved
their funding, disclosure, administration and investment management
over the past decade; * * * federal regulation that would mandate
certain standardized reports, actuarial and accounting analyses, and
disclosure * * * would needlessly duplicate what is already required of
state and local government retirement systems.'' \8\
Moving to Defined Contribution Plans
The speech also suggests that moving to defined contribution plans
could be a way to reduce government costs while better meeting the
needs of workers. While we agree that defined contribution plans can be
a useful vehicle to supplement pension benefits by encouraging
additional employee retirement savings, we disagree that replacing
defined benefit plans with defined contribution plans is a way to
reduce government costs or to better meet the needs of workers.
First, as you point out, many state and local governments have
strong legal protections on retirement benefits--often based in the
state's constitution. Consequently, a defined benefit plan would still
need to be maintained (and funded) for currently covered workers. The
new defined contribution plan would be established for newly hired
workers at an additional cost to the government. Moreover, because the
defined benefit plan would be closed to new hires, stricter accounting
standards would apply, effectively increasing the annual required
contributions to the defined benefit plan. Any savings that would
result from this change would take 10 to 15 years to be realized.\9\
Second, defined contribution plans have not been particularly
successful in providing adequate retirement benefits, for a number of
reasons, including: (1) most DC plan participants don't contribute
enough; (2) they tend to invest conservatively which results in lower
long-term rates of return than professionally managed assets; (3) they
take money out when they change jobs; and (4) they spend it too quickly
in retirement. A recent Congressional Research Service study found that
only half of older workers in 401(k) plans had saved enough to provide
an annual benefit of at least $5,000 from their account.\10\ By
comparison, public retirement plans paid an average annual benefit of
about $19,800 in 2004.\11\
Third, defined benefit plans can be flexibly designed to meet a
broad array of objectives for all stakeholders, including public
employers, taxpayers, and public employees. As indicated in a 2003
NASRA resolution expressing support for state and local defined benefit
plans, such plans can have ``progressive changes * * * that accommodate
a changing workforce and better provide many of the features advanced
by defined contribution advocates.'' \12\ Indeed, many public pension
plans have and continue to incorporate flexible features into their
benefit structures.
Other Postemployment Benefit (OPEB) Plans
While we believe most public pension plans are well-funded, we
recognize this is not the case for most public OPEB plans, including
plans for retiree health care. However, we also believe that the issues
related to public pension and OPEB benefits should be treated
separately. The issues surrounding OPEB funding are substantially
different than the issues surrounding pension funding. In most cases,
retirees and beneficiaries share in the ongoing costs of retiree health
care through deductibles and co-pays. Moreover, in many cases,
employers reserve the right to change the retiree health care benefit,
and have done so by changing eligibility provisions and by requiring
retirees to pay a greater portion of the premiums.
Consequently, retiree health care benefits are not guaranteed in
the same way as the pension benefits for many governments.
Unfortunately, this will likely mean that more of the health care costs
will be shifted to retirees, at a time when they are least able to
afford them. However, if health care costs continue increasing at
current rates, it won't be long before no one will be able to afford
them. Controlling the growth of health care costs is the key to
affording these benefits. This is an issue that goes beyond state and
local governments.
Broader Economic Implications
The discrepancy in retirement benefits paid through defined benefit
and defined contribution plans raises an even broader public policy
question: What will happen to the U.S. economy as more people retire?
Over the next 25 years, the U.S. population age 65 and older is
expected to double, from 37 million in 2005 (12% of total population)
to 70 million (20% of total population) by 2030.\13\ It is likely that,
as a result of the movement to defined contribution plans, the income
of many of these retirees will be significantly less than their pre-
retirement income. Consequently, demand for goods and services will
likely be significantly lower or governmental intervention of some type
may be needed. Lower incomes could mean less economic stimulus for the
economy, possibly for many years.
By providing sufficient and sustainable retirement income, state
and local defined benefit plans help to support the U.S. economy over
the long-term. Moreover, they act as financial engines by investing
employer and employee contributions to generate investment earnings
that provide income to retired public employees over their lifetimes.
Since 1982, state and local retirement plans' investment earnings have
amounted to over $2.0 trillion, compared with total employer
contributions of about $825 billion and total member contributions of
$400 billion. During this period, taxpayer dollars paid 25 percent of
the cost of public retirement benefits, with the remaining 75 percent
coming from investment returns and member contributions.
A 2004 working paper prepared for the Pension Research Council at
the Wharton School estimated that the higher investment returns
generated by public pension funds, relative to defined contribution
returns, creates an economic stimulus of 2.0 percent of GDP, or more
than $200 billion, annually. This stimulus is continuous and steady, as
the dollars produced by the higher returns are distributed to retired
public employees and their beneficiaries in every city and town across
the nation.\14\
Steps to Improve Public Plan Sustainability
While we believe most public plans are in good financial condition,
we also believe there are steps that plans can take to improve their
sustainability, especially in light of a more volatile investment
environment. First, to reduce downside investment risk, plans should
review their asset allocations in light of likely investment returns
and the duration of their liabilities. Second, governments should avoid
providing benefit increases based on plan ``overfunding'' or ``excess
assets.'' Third, governments should consistently contribute the amounts
necessary to fund their pension plans and, if feasible, should
establish reserves to help ensure contributions are made during
cyclical economic declines.\15\ Finally, to the extent benefits cannot
be sustained, new benefit tiers should be established to provide more
sustainable pension benefits to new hires.
Mr. Moskow, as President of the Federal Reserve Board of Chicago,
you are in a unique position to support sound public policy with regard
to retirement benefits. We hope the information offered in this letter
will be useful to you. Please let us know if you have any questions or
would like additional information.
Respectfully,
Keith Brainard,
Director of Research, National Association of State Retirement
Administrators.
Paul Zorn,
Director of Governmental Research Gabriel, Roeder, Smith & Company
endnotes
\1\ The Public Fund Survey is currently the broadest and most
detailed survey of public plans. Sponsored by the National Association
of State Retirement Administrators and the National Council on Teacher
Retirement, it presents information on the benefits, funding levels,
actuarial assumptions, and investments of 127 of the nation's largest
public plans, covering approximately 88 percent of all public employees
covered by state and local retirement plans.
\2\ Standard & Poor's, ``Rising U.S. State Unfunded Pension
Liabilities Are Causing Budgetary Stress,'' February 22, 2006, p. 5.
\3\ U.S. Census Bureau, ``State and Local Government Retirement
Systems,'' and ``State and Local Government Employment and Payroll.''
\4\ Statement No. 25, Financial Reporting for Defined Benefit
Pension Plans and Note Disclosures for Defined Contribution Plans,
Governmental Accounting Standards Board, paragraphs 135--137.
\5\ Board of Governors of the Federal Reserve System, ``Flow of
Funds Accounts of the United States,'' Fourth Quarter 2005.
\6\ U.S. General Accounting Office, ``Private Pensions: Changing
Funding Rules and Enhancing Incentives Can Improve Plan Funding,''
October 29, 2003, Summary.
\7\ Employee Benefit Research Institute, ``Defined Contribution
Plan Dominance Grows Across Sectors and Employer Sizes, While Mega
Defined Benefit Plans Remain Strong: Where We Are and Where We Are
Going,'' 1997, p 30.
\8\ National Association of State Retirement Administrators,
Resolution 1996-04, available at: http://www.nasra.org/resolutions.htm
\9\ Los Angeles County Employees Retirement Association,
``Proposals to Close Public Defined Benefit Plans,'' March 16, 2006.
The study estimated that the County's DB plan annual contribution rate
would increase by 3.66% ($206 million) if employees hired after July 1,
2007, were required to join a DC plan. While the contribution rate
would gradually decline over time, the County would have to wait until
2018 to see any savings in DB plan costs as a result of the change.
\10\ Patrick J. Purcell, ``Retirement Savings and Household Wealth:
A Summary of Recent Data,'' Congressional Research Service, December
11, 2003.
\11\ U.S. Census Bureau, ``State and Local Governments Public
Employee Retirement System Survey,'' 2004. Average calculated by
authors.
\12\ National Association of State Retirement Administrators,
Resolution 2003-08, available at: http://www.nasra.org/resolutions.htm
\13\ Board of Trustees, Federal Old-Age and Survivors Insurance and
Disability Insurance Trust Funds, 2005 Annual Report, p. 77.
\14\ Gary Anderson and Keith Brainard, ``Profitable Prudence: The
Case for Public Employer Defined Benefit Plans,'' PRC Working Paper
2004-6, Pension Research Council, The Wharton School, 2004.
\15\ For a concise summary of steps that state and local
governments can take to help ensure their plans are properly funded,
see the Government Finance Officers Association's recommended practice:
``Funding of Public Employee Retirement Systems'' at: http://
www.gfoa.org/documents/persfundingrp.pdf
______
[Key facts benefits information sheet submitted by Mr.
Brainard follows:]
Key Facts Regarding State and Local Government Defined Benefit
Retirement Plans
Public Pension Plans are in Good Financial Condition. As a group,
state and local pension systems have nearly 90 cents for each dollar
they owe in liabilities. These assets are professionally managed and
invested on a long-term basis using sound investment policies. As shown
on the chart below, the $2.6 trillion (in real assets, not IOU's) held
by these plans are an important source of liquidity and stability for
the nation's financial markets.
The Bulk of Public Pension Benefit Funding is NOT Shouldered by
Taxpayers. Employer (taxpayer) contributions to state and local pension
systems over the last two decades have made up only one-fourth of total
public pension revenue. Earnings from investments and employee
contributions comprise the remainder. This ratio has improved over
time. In 2004, investment earnings accounted for 77 percent of all
public pension revenue; employer contributions were 15 percent. Unlike
corporate workers, most public employees are required to contribute to
their pension plans. The chart below summarizes the sources of public
pension revenue from 1983 through 2004.
Public Retirement Plans Attract and Retain the Workforce
That Provides Essential Public Services. There are more than 20 million
working and retired state and local government employees in the U.S.
Retired public employees live in virtually every city and town in the
nation (90 percent stay in the same jurisdiction where they worked).
Active public employees comprise more than 10 percent of the nation's
workforce, and two-thirds are employed in education, public safety,
corrections, or the judiciary. Retention of experienced and trained
personnel in these and other positions is critical to the continuous
and reliable delivery of public services.
State and Local Pension Plans are an Integral Component of
National, State and Local Economies. Public plans distribute more than
$130 billion annually (an amount greater than the total economic output
of 22 states) in benefits to over 6 million retirees, disabilitants and
beneficiaries, with an average annual pension benefit of roughly
$19,500. These payments are steady and continuous and provide a strong
economic stimulus to local economies throughout the nation. A 2004
study for the Wharton School Pension Research Council found state and
local government pension distributions contribute 2.0 percent more to
GDP (over $200 billion) than if they had been invested in self-directed
401(k)-type retirement accounts.
State and Local Plans are Subject to Comprehensive
Oversight. While private sector plans are subject solely to federal
regulation, state and local government plans are creatures of state
constitutional, statutory and case law and must comply with a vast
landscape of state and local requirements, as well as industry
accounting standards. These plans are accountable to the legislative
and executive branches of the state; independent boards of trustees
that include employee representatives and/or ex-officio publicly
elected officials; and ultimately, the taxpaying public.
State and Local Pension Funds Earn Competitive Investment
Returns. For the 3- and 10-year periods ended 6/30/05, public pension
funds generated strong investment returns of 9.67% and 9.15%, closely
tracking returns generated by corporate pension plans.
______
[NASRA response to Reason Foundation study submitted by Mr.
Brainard follows:]
NASRA Response to Reason Foundation Study,
``The Gathering Pension Storm''
Abstract
The Reason Foundation recommends terminating defined benefit plans
for public employees because, Reason contends, it is inherent in DB
plans that policymakers, operating solely in their own political
interest, will approve higher pension benefits for their own selfish,
short-term political gain while deferring the cost of those benefits to
future generations. NASRA believes the Reason study makes its case by
1) distorting the true financial condition of public pensions in
general; 2) mistakenly extrapolating a handful of public pension
problems onto the entire public pension community; 3) failing to
consider the many negative consequences that would result from
terminating DB plans; and 4) advancing arguments that reflect an
incomplete understanding of public pension issues. Rather than
terminating DB plans (which would have negative consequences for all
stakeholders), solutions are available to the public pension problems
Reason cites, chiefly by working through normal political processes at
the state level.
Introduction
In June 2005, the Reason Foundation published a study titled ``The
Gathering Pension Storm: How Government Pension Plans Are Breaking the
Bank and Strategies for Reform.'' The study is critical of defined
benefit (DB) plans for employees of state and local government and
calls for the replacement of DB plans with 401k-style defined
contribution (DC) plans.
A resolution approved in 2003 by the National Association of State
Retirement Administrators (NASRA) states that NASRA ``supports * * * a
defined benefit program to provide a guaranteed benefit and a voluntary
defined contribution plan to serve as a means for employees to
supplement their retirement savings * * * and NASRA supports
progressive changes within this prevailing system of retirement
benefits in the public sector, either within the defined benefit plan
or through supplementary plans, that accommodate a changing workforce
and better provide many of the features advanced by defined
contribution advocates.'' \1\
Flexibility of design is a central feature of DB plans. A DB plan
can be designed to achieve myriad stakeholder objectives, while
retaining core DB plan features--a benefit that cannot be outlived,
investment risk that is borne entirely or partly by the employer, and a
benefit that reflects the employee's salary and length of service.
Working within existing legislative and political processes, this
flexibility can be incorporated into the design and governance
structure of any public pension plan to achieve desired objectives of
all relevant stakeholders: public employers, employees, and recipients
of public services and other taxpayers. Indeed, design features already
in place in public pensions around the U.S. demonstrate this
flexibility, providing ample illustration that DB plans can attain
objectives advanced by advocates of DC plans, while continuing to
advance the overarching public policy objective of promoting the
nation's retirement security.
Summary of Reason's Argument
Reason's overarching complaint regarding DB plans for public
employees is that they are a ``moral hazard.'' According to Wikipedia:
In law and economics, moral hazard is the name given to the risk
that one party to a contract can change their behavior to the detriment
of the other party once the contract has been concluded.\2\
For public pensions, according to Reason, this moral hazard allows
lawmakers to grant higher pensions for current workers while deferring
the cost of those enhanced benefits to future generations of taxpayers.
Reason insists that state legislators and other policymakers cannot
be trusted to make decisions regarding pension benefits, because
elected officials will operate in their own selfish political interest
while ignoring the long-term effects of their decisions. Reason bases
this view chiefly on two criteria: 1) the purported poor financial
condition of public pensions, and 2) several examples of alleged
abusive pension practices, including pension spiking, deferred
retirement option plans, ``air time'' purchases, and ``public safety''
employees' benefits expansion.
The Reason study specifies the following examples (accompanied by
its title from the study) of alleged public pension abuses to
illustrate what Reason contends is the hazard of public DB plans:
San Diego: A ``Perfect Storm'' of Financial Mismanagement
Illinois: Mired in Pension Debt
California: The Politics of Increasing Benefits and
Managing Portfolios
West Virginia: Banking on Pension Obligation Bonds
Los Angeles County: Suffering from Pension Obligation
Bonds and ``Chief's Disease''
Detroit: Rising Pension Costs and a Declining Revenue Base
Orange County, California: Ignoring the Lessons of the
1994 Bankruptcy
Houston: Lavish Benefits and Bad Assumptions
Contra Costa County, California: The Costs of Unreasonable
Assumptions
NASRA Analysis and Response
The issue of retirement benefits for employees of state and local
government is no small matter: state and local governments in the U.S.
employ 16 million workers--more than 10 percent of the nation's
workforce.\3\ These employees perform a broad range of essential public
services, such as teaching at and supporting public schools and
universities, policing streets, fighting fires, guarding prisons and
jails, and protecting public health. At the end of September 2005,
state and local retirement funds held assets of $2.66 trillion,\4\ and
they distribute more than $130 billion annually to over six million
retired public workers and beneficiaries.\5\
If Reason's chief recommendation--to supplant DB plans with DC
plans--were implemented, NASRA believes the ability of public employers
to attract and retain qualified workers would be impaired, as would the
retirement security of millions of state and local government
employees.
NASRA believes the arguments Reason presents in favor of
terminating DB plans are flawed in at least four ways:
1. Reason distorts the true financial condition of public pensions
in general and the ramifications of pension plan ``underfunding.''
2. Reason mistakenly extrapolates a handful of public pension
problems onto the entire public pension community.
3. Reason fails to consider the many negative consequences that
would result from terminating DB plans.
4. Reason advances arguments that reflect an incomplete
understanding of public pension issues.
As elected officials operating within the framework of the U.S. and
state constitutions, federal regulations, and case law, state
policymakers are entrusted with responsibility for drafting and
approving laws to establish, govern, and administer pension benefits
for employees of state and local government. Reason's belief that
elected officials cannot be trusted to make decisions regarding public
pension benefits is an indictment of our nation's entire governance
structure, one that is based on representative democracy. If, as Reason
alleges, our own elected officials are so beholden to narrow special
interests that they cannot be trusted to make decisions for the greater
good, then our system of government is imperiled.
State legislators and governors are elected to make decisions that
have long-term consequences. Such decisions include those regarding
development of roads and highways, establishment of educational
institutions, taxation and spending, the purchase and sale of real
property, protection of natural resources, hiring public employees, and
others.
The nation's founders provided processes, within the legal and
political framework, to correct problems such as some of those in the
public pension community identified by Reason; and for use when
citizens believe their elected officials are not making prudent
decisions. These processes include:
amending state constitutions and laws affecting retirement
benefits and governance;
elections, to vote out elected officials perceived to be
making decisions not in the public interest, and to vote in others;
and, in some states,
initiative and referendum, whereby citizens and lawmakers
can change state constitutions and laws.
One desirable attribute of a pension benefit is that its cost, as
much as possible, should be paid by the current generation of
taxpayers, a concept known as ``intergenerational equity.''
Acknowledging Reason's concern regarding the potential conflict between
the long-term nature of pension liabilities and the shorter time
horizon of elected officials, Michael Peskin argues that pension costs
can be made transparent and borne by the current generation of
taxpayers:
The solution to this political imbalance is to adopt a
rigorous and disciplined framework within which to calculate
liabilities and assets, and to establish policies. Such a
framework must make the price of options and transfer of costs
or risks to future generations transparent. It thus includes a
comprehensive stochastic model of the plan going forward many
years with explicit modeling of investment, funding and benefit
policies. The core economic cost is the present value of
contributions to fund the appropriate level of benefits. It is
possible to reduce the present value of contributions with
appropriate investment and funding policy and tightening of
benefit policy to avoid the provision of expensive options.\6\
An arrangement such as one described by Peskin exists in the State
of Georgia, whose constitution requires that public retirement plans
remain actuarially sound:
It shall be the duty of the General Assembly to enact
legislation to define funding standards which will assure the
actuarial soundness of any retirement or pension system
supported wholly or partially from public funds and to control
legislative procedures so that no bill or resolution creating
or amending any such retirement or pension system shall be
passed by the General Assembly without concurrent provisions
for funding in accordance with the defined funding
standards.\7\
Pursuant to this clause, Georgia statute requires that:
Pension legislation with a fiscal effect may be introduced
only in the regular session of the first year of the term of office in
the General Assembly, and passed only during the regular legislative
session of the second year of the term of office of General Assembly
members.\8\
Retirement legislation with a fiscal effect may not leave
its committee or be considered by the House or Senate unless its
actuarial cost has been determined.\9\
First-year funding for retirement bills with a fiscal
effect must be appropriated in that year, or the bill becomes null and
void.\10\
The state must maintain minimum funding standards for its
pension plans and each year must contribute the pension plan's normal
cost plus the amount needed to amortize the unfunded liability.\11\
The Employees' Retirement System and Teachers' Retirement System of
Georgia are among the best-funded public pension plans in the nation,
with costs and benefits near the national median.\12\
I. Reason Distorts the Financial Health of Public Pension Plans
The Reason study points to public pension funds' combined unfunded
liabilities--currently around $340 billion--as evidence of an ``ominous
storm cloud'' of public pension costs. Yet Reason never places this
figure into context. As another form of government debt, the absolute
dollar value of an unfunded liability, by itself, does not reveal much.
To have real meaning, an unfunded liability must be compared with the
resources--current and future--available to retire the obligations.
These resources usually take the form of assets and future revenue
streams of state and local governments that sponsor pension benefits.
Based on these measures, as a group, public pension funds are in
reasonably good condition:
According to the most recent available information, public
pension plans in the U.S. have combined actuarial assets of
approximately $2.48 trillion and actuarial liabilities of $2.82
trillion, for an aggregate funding level of around 88 percent. Although
this funding level is lower than it was several years ago, it is higher
than it was for most of the last 25 years of the 20th century.\13\
70 percent of public pension plans are funded at 80
percent or higher.\14\
Funding a pension benefit takes place over a long period of time,
and by itself, an unfunded liability is not necessarily a sign of
fiscal distress: Not every public employee will retire tomorrow or next
year, and pension liabilities usually extend years into the future.
This extended time frame gives pension plans time to amortize their
unfunded liabilities, through a combination of investment earnings and
employer and employee contributions.
In ``The Gathering Pension Storm,'' Reason refers to sharply rising
costs of pension plans. But as shown in Figure A, state and local
governments spent approximately the same in FY 04 (the latest year for
which data is available) on public pensions than they spent in the mid-
1990's, measured both as a percentage of employee payroll and as a
percentage of total state and local government spending.
Pension costs for some employers have risen sharply in recent
years. In many cases, a root cause of these sharply rising contribution
rates is the plan's design, and can be remedied with one or more design
changes. But the idea that state and local government pension costs for
the entire nation are spiraling out of control is not accurate.
Although the majority of public pensions are in fairly good
financial condition, some plans do face serious unfunded liabilities
that will require corrective action. Unfortunately, by painting the
entire public pension community as awash in crippling unfunded
liabilities that are the product of self-serving legislators, Reason
ignores the reality of the current public pension funding picture. In
so doing, Reason's recommendation to terminate DB plans for public
employees is based on a distorted picture of the public pension funding
situation.
Of those public pension plans that face serious funding problems,
most result from legislative failure over extended periods to remit
required contributions. States that chronically failed to remit
required contributions enjoyed the savings that were generated by
diverting pension contributions to other priorities. Contribution rates
in some states declined in recent years to unprecedented levels,
including as low as
zero. Combined with the decline in equity values, very low or
nonexistent contribution rates contributed to the decline. It would be
disingenuous to call for the elimination of DB plans because they are
expensive, in cases when a major factor contributing to their cost is
the diversion of contributions over a period of years, or sharp
reductions in contributions due to favorable investment gains.
II. Reason Mistakenly Extrapolates a Handful of Public Pension Problems
Onto the Entire Public Pension Community
The Reason study purports to illustrate the flaws inherent in DB
plans, in part on the basis of nine examples of alleged abuse or
excess. According to the U.S. Census Bureau, there are more than 2,000
public pension plans in the U.S., that provide pension and other
benefits for more than 14 million active and 6 million retired public
employees. Any community this large is likely to have its share of
abuse and excess, and Reason's use of nine examples (of which five are
in one state) to demonstrate the fundamentally flawed nature of DB
plans, seems to lack proportionality. Every state sponsors at least one
statewide retirement system; most states sponsor two or more. Hundreds
of cities and towns and counties sponsor public retirement systems.
Reason does not mention the hundreds of public pension plans that
are working well on behalf of millions of working and retired public
employees, public employers, and recipients of public services and
other taxpayers. The highly diffuse and diverse regulatory structure
overseeing the public pension community creates an environment in which
states and cities can experiment with, design and maintain cost-
effective pension plans that meet the multiple objectives of public
employers. For every case of public pension abuse and excess cited by
Reason, there are many more cases of pension plans assisting, in a
cost-effective and responsible way, public employers in providing
essential public services. In cases of actual pension abuse and excess,
the answer is not to get rid of the plan, but to change the plan's
governance structure and benefit design. If necessary, this can be
achieved through changes to the constitution, statutes, and elected
officials.
Reason makes sweeping conclusions about the entire public pension
community on the basis of a rather small subset of that community, a
subset that is quite limited geographically and politically.
III. Reason Ignores Many Likely Effects of Its Recommendation to
Terminate DB Plans
Like other employers, public employers must compete in the labor
market for a limited pool of talent, and a DB plan has long been a
central component of the compensation package for most public
employees. Removing the DB plan from public workers' compensation would
have consequences for all stakeholders: employers, employees, and
taxpayers. Yet Reason pays little heed to these consequences, making
its recommendations in a vacuum, as if switching from one plan type to
another would be seamless and without consequence. In fact, switching
plan types would involve costs and have consequences.
A majority of public sector positions are best served when those
who occupy them are career-oriented or lat least remain in them for ten
years or longer. Two-thirds of public employees are classified by the
U.S. Census Bureau as judicial, firefighters, police officers and
support, corrections, or educational.\15\ The taxpaying public is well-
served when individuals remain in these positions for an extended
period--long enough to enable the employer and taxpayers to realize the
investment made to train the employee and to serve the public through
their knowledge and experience. Moreover, taxpayers are well-served
when public sector positions are filled with skilled and qualified
personnel, rather than inexperienced workers who are learning on the
job. Retention of qualified workers is a primary reason that public
sector employers continue to offer a DB plan--it creates an incentive
for career-oriented workers to remain in their position.
Unfortunately, Reason's study does not acknowledge the role DB
plans play in attracting and retaining public employees; nor does the
study consider the effects on public employers of implementing Reason's
main recommendation: the replacement of DB plans with DC plans.
Reason also does not contemplate the effects on public employers--
school districts, police departments, fire departments, etc.--of losing
what may be the strongest incentive for public workers to stay on the
job. In the absence of a DB plan, public employers will be required to
make adjustments in their compensation package. Such adjustments might
include improved working conditions, better benefits, or higher pay. It
is unrealistic to think that the behavior of current and future public
employees will not change in the wake of a change to their compensation
package. All else held equal, if the DB plan is taken away, other
compensation costs would need to rise.
The Reason study does not acknowledge the improved financial
security enjoyed by millions of working and retired public employees
from having a DB plan. Studies have documented the crisis the nation
faces as millions of workers approach retirement with savings far short
of required levels. Many Americans face the real prospect of outliving
their retirement assets. Some indigent elderly will turn to the state,
as the provider of last resort, to meet their basic needs. Yet the
Reason study is silent on this scenario, which is a real possibility
were Reason's recommendation to be implemented.
A 2004 Pension Research Council paper identified the economic
effects of public pension funds. These effects include the investment
of pension fund assets in venture capital projects; the added liquidity
and stability added by public pension assets to financial markets; and
the stimulus provided to the nation's economy as a result of the
additional assets produced by higher investment returns generated by
public pension funds.\16\ If public DB plans were terminated, the
economic stimulus they provide to every city and town in the nation
would diminish, slowly but surely, as the effects of higher investment
returns from professionally-invested DB assets fades away. A generation
of public employees relying on self-directed retirement accounts would
result in fewer assets available for retirement and declining salutary
effect on local economies.
In an analysis of public employers exploring switching to DC plans,
bond rating agency Standard & Poor's recognized the potential risks of
closing off DB plans in favor of DC plans:
The decision on pension plan design for a governmental entity
should include a very long-term view of the welfare of
employees: They must be given the tools to build sufficient
resources to live during retirement, including the combined
resources of pensions, Social Security (if applicable), and
personal savings. If this strategy fails to meet expectations,
the result could be that government retirees will require some
form of public assistance at a point in the future. These
unanticipated increased employer costs to make up for below-
average retiree wealth could offset, partially or totally, the
earlier direct benefits from lower, more predictable
contribution rates gained through a DC conversion.\17\
S&P concluded its analysis by warning that converting to a DC plan
is no silver bullet for challenges facing state and local governments:
From a credit perspective, a DC conversion plan cannot be
automatically considered a positive factor in that the effects
must be weighed over a very long time period. The benefits of a
conversion to a government's cost structure in the early years
could be undone in the later years if retiree income
expectations are not realized and unexpected costs show up
elsewhere. While the private sector has had some success with
the DC model, the historical experience in the public sector is
really too new to prove that it will be effective. When
employers are considering the DC option, overall public
policies concerning the well being of employee citizens and
fiscal policies must be integrated into a monolithic policy for
long-term retirement income stability.\18\
IV. Reason Advances Arguments That Reflect an Incomplete Understanding
of Public Pension Issues
Many arguments advanced in the Reason study indicate an incomplete
understanding of public DB plans. Following are some statements made by
Reason in its study, followed by a NASRA clarification or correction.
Reason on employer contributions to public pension plans:
``Ballooning pension obligations necessarily draw resources away from
other quality-of-life priorities like transportation, education, and
public safety. In California, for instance, the state's obligations to
its government-employee pension system have skyrocketed from $160
million to $2.6 billion annually just since 2000.''
NASRA: Reason's reference to ``ballooning'' pension obligations is
based on a highly selective use of statistics which does more to
confuse than clarify the issue of employer contributions. Figure B
(above) depicts a longer and more comprehensive data set of the
employer contribution rate for the largest group of California state
employees. This rate is representative of employer contribution rates
for other large groups of CalPERS participants.
As the chart shows, due chiefly to robust investment earnings, the
contribution rate fell sharply in fiscal year 1999, remaining well
below historic averages through fiscal year 2003, when the effects of
the decline in equity markets and the cost of recent benefit
improvements were more fully recognized actuarially. Yet to make its
argument that pension obligations are ``ballooning,'' Reason pointed
only to the low and what is likely to be the high points of California
state contributions to CalPERS. Reason excluded other information that
would have presented the issue in a more complete and accurate context.
Presenting this issue in a fuller and more fair context would
mentioned the savings enjoyed by plan sponsors--the state and many of
its political subdivisions--when contribution rates were low.
Unfortunately, to make its point that benefit obligations are
``ballooning,'' the Reason study focuses exclusively on two narrowly-
captured data points, while ignoring other relevant data.
A defining attribute of DB plans is that their design can be
modified to reach any of multiple objectives. To reduce volatility in
its contribution rates, the CalPERS Board of Administration in 2005
changed its method for calculating the actuarial value of assets, by:
increasing the period over which investment gains and
losses are recognized (a recommendation made by Reason in its study)
and,
widening the permissible corridor of the actuarial value
of assets to market value of assets.
Criticism of CalPERS contribution rates should be tempered by the
fact that for several years, California taxpayers contributed
relatively little, on a historic basis, to the pension plan for state
employees and for many employees of local governments in the states.
The reforms implemented by CalPERS are intended to smooth future year-
to-year changes in the contribution rate.
Other changes public pensions have effected in recent years to
moderate contribution rates include:
Modifying the plan design to reduce pension ``spiking,''
which occurs when an employee's salary rises sharply in the period
immediately preceding retirement, resulting in a higher pension
benefit? Several states in recent years have implemented anti-spiking
provisions.
Establishing a minimum contribution rate. This prevents
contribution rates from declining to extremely low levels, including
zero, which occurred at a number of plans around the nation in the wake
of investment market gains during the late 1990's.
Placing a limit on the annual increase in contribution
rates, such as to one percent, a policy in effect for pension plans in
Iowa and Kansas.
Establishing floating amortization periods. This moderates
the funding level by extending the amortization period during times of
underfunding and shortening it as the funding situation improves.
Linking cost-of-living adjustments to investment returns.
Establishing a relationship between COLA's and investment earnings
allows all participants--employers, actives, and annuitants--to benefit
when investment returns exceed assumptions and to bear some of the
burden of lower-than-expected market returns, either through higher
contribution rates or by a smaller COLA.
Reason on participant access to retirement funds: ``Under defined-
benefit plans, employees have limited ability to access their money if
they terminate employment before the regular retirement age. Also,
benefits cannot be ``rolled over'' if the employee switches jobs, and
usually cease upon the retiree's death.''
NASRA: Reason is correct in saying that DB plans restrict
employees' access to their retirement savings. The purpose for
providing a retirement plan is not to serve as a source of ready cash,
but to save money for retirement. A retirement plan that allows
participants to spend retirement savings before retirement is falling
short of its purpose, and Reason's criticism of DB plans in this way
seems bizarre.
One of the chief shortcomings of DC plans is the amount of assets
that leave the system prior to retirement. Studies consistently show
that many DC participants borrow against their retirement savings; or
``cash out'' when switching jobs, leaving the employee financially
unprepared for retirement. Although Reason cites the limited access
employees have to their retirement savings as a problem, NASRA believes
this restriction is actually one of many advantages DB plans have over
DC plans.
Reason on the ability of public workers to ``roll over'' their
retirement funds: ``(DB plan) benefits cannot be ``rolled over'' if the
employee switches jobs, and usually cease upon the retiree's death.''
NASRA: Reason's statement about the ability to roll over DB plan
benefits, is simply incorrect. Most public DB plan participants are
required to contribute to their pension benefit, and terminating
employees are entitled to their contributions, usually with interest.
Some public plans also allow entitle participants to some or all
employer contributions made on the worker's behalf.
Moreover, many public DB plans allow workers to purchase service
accrued with another public employer and to transfer their assets and
service credit from other plans. Those states and cities that do not
allow service purchase may do so if they wish; contrary to Reason's
assertion, there is nothing systemic in a DB plan that prevents DB plan
sponsors from allowing the purchase or transfer of service accrued at
another plan.
Reason's contention that benefits usually cease upon the retiree's
death is at best misleading and in the case of most plans, simply
wrong. Public pension plans allow retirees to designate a beneficiary,
such as a spouse, who continues to receive a benefit, should they be
preceded in death by the retiree. In fact, it is not uncommon among
public pension plans to require married pension participants to secure
the written consent of their spouse to request an annuity benefit that
does not include a benefit for the surviving spouse.
Reason on the cause of the recent decline in public pension funding
levels: ``(T)he central causes of the (pension) crisis are poor
planning and decisionmaking. At the heart of the pension crisis is a
set of incentives which create a ``moral hazard.''
NASRA: What ``poor planning and decisionmaking'' represent to
Reason is not clear, but it may be safe to infer that Reason is saying
is that benefit enhancements approved by self-serving legislators are
the primary cause of the decline in pension funding levels after they
reached their peak in 2000.
An analysis by consultant Gabriel, Roeder, Smith \19\ strongly
suggested that the chief cause of the decline in public pension funding
levels after 2000 was the decline in equity values. The combined value
of state and local government pension funds declined from 12/31/00 to
12/31/02 by more than $360 billion, or nearly 16 percent.\20\ Although
benefit enhancements for public employees were approved during the past
decade, there is no evidence that these enhancements are the primary
factor contributing to these declines. (Public pension fund values rose
to $2.66 trillion in September 2005, an increase of nearly 38 percent
above their low point at the end of 2000.) \21\
In addition, benefit enhancements for many public employees often
are approved in lieu of salary increases. Had salary increases been
approved instead of pension benefit enhancements, pension funding
levels might have been marginally higher, but current salary
obligations for public employers would be greater, possibly leaving
public employers worse off than they otherwise would have been.
Reason on compensation levels in the public and private sectors:
``Supporters of pension benefit increases routinely argue that they are
needed to attract a high-quality workforce that is paid less than their
private-sector counterparts. Unfortunately, this claim is simply not
true. According to the Bureau of Labor Statistics, the average wage for
state and local government employees is $23.52 per hour, compared with
$16.71 per hour for private-sector employees. When benefits (including
pensions) are included in the calculation, state and local government
employee compensation jumps to $34.13, compared to total private-sector
compensation of $23.41. In other words, even when private employees'
benefits are included, they still make less than the raw wage of state
and local government employees.''
NASRA: Some public sector workers earn salaries that are higher
than their private sector counterparts; many earn salaries that are
lower. Broad comparisons of private and public sector salaries and
benefits often overlook the fact that most public employees work in
professional positions that require higher levels of education or
physical risk than those in the private sector workforce. For example,
more than one-half of all state and local government employees work in
education. These are school teachers and administrators, librarians,
college professors and higher education staff. Many other public
employees work as firefighters, police officers, and correctional
officers, whose responsibilities entail significant physical risk and
have few comparable positions in the private sector.
When possible, most positions in the public sector--education and
public safety in particular--should be filled with career-oriented
workers. It makes good public policy to encourage professionals such as
these to remain in their positions long enough not only to realize a
return on the investment public employers have made in their training,
but also to enjoy the benefits of their experience and qualifications.
Allowing qualified public employees to leave their position due to
compensation shortfalls is disruptive to the orderly and effective
delivery of public services and results in added costs to train new
workers.
Finally, the BLS study cited by Reason does not acknowledge that
most public employees are required to contribute to their pension
benefit; the median contribution rate for Social Security-eligible
public employees is five percent. State and local government employee
contributions account for approximately 12 percent of all public
pension revenue.
Reason on the effects of changing corporate pension policy: ``The
enactment of ERISA and the 1978 Revenue Act would prove to be a pivotal
change in pension history. Since their passage, the private sector has
seen a steady trend toward ``401(k)'' and similar ``defined
contribution'' plans * * * and away from defined-benefit plans. Now
even government pension systems are re-evaluating defined-benefit plans
in favor of defined contribution plans.''
NASRA: Despite good intentions to strengthen corporate DB plans,
the passage by Congress of ERISA in 1974 and subsequent changes to the
tax code, has contributed to the steady decline in the percentage of
American workers with a DB plan. Many of these DB plans have been
abandoned in lieu of DC plans. Unfortunately, as workers' reliance has
shifted from DB to DC plans, the nation's overall retirement security
has declined.
Yet advocates of supplanting DB plans with DC (like Reason) justify
their view partly on the basis that relatively few DB plans remain in
the private sector.
Although many corporate DB plans have been frozen or terminated, a
majority of the Fortune 1000 continue to provide a DB plan to their
workers.\22\
More importantly, the relevant issue is not whether the public
sector should abandon DB plans because many in the private sector have
done so, but rather, whether it is prudent for state and local
governments to pursue a policy that is known to diminish the retirement
security of its employees and the nation as a whole. A DC plan, by
itself, is a poor vehicle for delivering retirement assets and
promoting retirement security. In fact, the primary DC plan type in the
U.S., the 401(k) plan, was created not as a retirement savings tool,
but as a tax shelter that was subsequently adopted by private sector
employers (and a few in the public sector).\23\ The mere fact that many
employers in the private sector have embraced a DC plan does not mean
that switching public sector workers to a DC plan is a good idea.
Reason's statement that, ``even government pension systems are re-
evaluating defined benefit plans in favor of defined contribution
plans,'' paints a distorted picture of reality. Although some states
have given some groups of public employees the opportunity to choose a
DC plan, and two states (Alaska and Michigan) limit retirement coverage
to large groups of their public workers to DC plans, far more
legislative activity in recent years has surrounded modifications to
existing DB plans, rather than incorporating DC plans.
Indeed, states and other sponsors of public pension plans are
taking advantage constantly of the remarkable flexibility offered by DB
plans to achieve key employer objectives.\24\ This flexibility takes
the form of hybrid pension plans, service purchase options, increased
portability features, return-to-work provisions, and others. Despite
extensive consideration given to which type of retirement plan they
should use, most public employers have recognized that they are better
off continuing to work within the prevailing framework of DB plans than
to switch to a retirement benefit structure that is unreliable in terms
of delivering retirement benefits and retaining qualified workers.
Reason on investment return assumptions: ``Pension systems have
become underfunded, in part, because investment returns are not meeting
expectations and thus contributions are not covering costs. Moreover,
over-optimistic expectations are not confined to just a few state and
local governments. According to the Public Fund Survey, a survey of
government pension plans conducted by the National Association of State
Retired Administrators and the National Council on Teacher Retirement,
the median investment return assumption for fiscal year 2003 was 8
percent. Unfortunately, nationwide, the median government pension has
only grown an average of 4.1 percent over the past five years.''
NASRA: Reason's use of a five-year period, to the exclusion of
other data, is selective and exclusive and borders on the disingenuous.
According to investment consultant Callan Associates, as shown in
Figure C, for the 10-year period ended June 30, 2005, the median public
pension fund investment return was 9.15 percent,\25\ well above the
public pension community's standard investment return assumption of 8.0
percent.
For the 20-year period ended June 30, 2005, the median public fund
return was 10.01 percent.\26\ Pension plans are long-term operations,
and investment returns over longer time periods, like 10 and 20 years,
are more representative of public funds' actual results than the single
5-year period cited by Reason (which happens to incorporate the first
time stocks have declined 3 consecutive years since the Great
Depression).
Reason on pension obligation bonds: ``The idea of issuing one debt
to pay another, particularly when issuing bonds to pay an annual
operating expense, is poor fiscal policy. Pension obligation bonds are
a short-term solution to a long-term problem--this is effectively the
same as a family using a credit card to pay utilities because they
don't have enough money at the end of the month and, in the process,
run up credit debt with increasing minimum payments. Not only has the
credit bailout not addressed the underlying mismatch in revenues and
expenditures, it has also contributed to higher minimum payments (in
the case of pension bonds, this is new debt service). At the end of the
day, the family that follows this strategy is actually worse off.
Elected officials must abandon the idea of pension obligation bonds and
learn to make difficult decisions to meet their pension obligations.''
NASRA: Reason's characterization of pension bonds as issuing one
debt to pay another, is misleading and misrepresents the benefit of
using pension bonds. An unfunded pension liability is a form of public
debt. Issuing pension bonds to reduce or eliminate an unfunded pension
liability can be a responsible course of fiscal action, as it can
enable a pension plan sponsor to take advantage of low borrowing rates
to reduce long-term pension liabilities.
Issuing a pension bond is analogous to a homeowner who takes
advantage of lower interest rates by refinancing her mortgage. A family
that refinances their mortgage with a lower rate of interest is
normally better off, not worse. With interest rates in recent years at
historic lows, reducing or eliminating an unfunded pension liability
through the use of pension bonds may well be a prudent course of
action. Reason's characterization of pension bonds as using a credit
card to pay utilities falsely represents the way they have been used in
most cases. In an analysis of pension bonds, credit rating agency
Standard & Poor's said:
While no panacea, POBs (pension obligation bonds) are
basically an arbitrage play based on the premise that, as a
result of the bond proceeds being invested at an expected yield
above the cost of the bonds, net savings will be achieved by
the sponsor over the life of the bonds. In other words, after
the issuance of the POB, combined debt service plus pension
contribution costs will be lower than they would have been
without a POB. The success of this formula depends on the
realization of a certain investment return, which is in no way
guaranteed. Whether a POB succeeds or fails cannot fully be
evaluated until the final maturity of the bond, and it is a
given that some years will be winners and others losers. The
bad years may add short-term fiscal stress to the POB issuer
(pension sponsor), which could be significant based on the
amount of leverage the POB exerts. With most POBs having been
issued over the past 10 years or so, it would be premature to
pronounce them an unqualified success (or failure). The best
that can be said to date is that POB results have been mixed,
with some having met or exceeded expectations while others have
come up short based largely on the vicissitudes of market
timing.'' \27\
Reason on public employee preferences for pension plan types:
Referring to Nebraska's shift from a DC plan to a cash balance plan,
Reason says: ``Tellingly, however, there has not been an exodus from
the defined-contribution plan. In fact, approximately 70 percent of the
members of the defined-contribution plan chose to remain under that
plan when the cash-balance plan went into effect. If the defined-
contribution plan was so disastrous, as critics claimed, many more
people would have switched out of the plan. Apparently, people value
the freedom to make their own retirement investment decisions.'' Also,
referring to choice in the Florida Retirement System, Reason says,
``(N)ew employee participation in the defined contribution plan has
increased from 8 percent in mid-2003 to 19 percent for the first half
of 2004.''
NASRA: Just as there was no exodus from Nebraska's DC plan, neither
was there an exodus from DB plans in any of the five states Reason does
not identify that have extended to some of its workers the opportunity
to switch from a DB to a DC plan. Once again, Reason selects its
comparative examples carefully, to the exclusion of other relevant
examples.
Two common themes have emerged in each state where employees have
been given a choice of retirement plans: 1) Most employees do not
actually make a choice of retirement plan unless required to do so; and
2) of those who do express a preference, the vast majority elect the DB
plan. Contrary to Reason's reasoning, Nebraska's experience of most
workers not making a decision does not indicate employee preference to
``make their own retirement investment decisions.'' Rather, this result
is consistent with results in other states, which suggest employees--
for whatever reason(s)--do not make a decision regarding their
retirement benefit.
In Michigan in 1996-97, during a period of rising stock markets,
fewer than six percent of state employees elected to switch to the DC
plan. Similarly, in Florida in 2001-02, when given a choice,
approximately five percent elected to participate in the DC plan. New
workers in Ohio, like those in Florida, are permitted to choose their
retirement benefit. Since the inception of choice in 2001, around five
percent have elected the DC plan. South Carolina and Montana
experienced similar results. No empirical evidence exists to support
Reason's contention that a meaningful percentage of workers prefer a DC
plan over a DB plan; in fact, just the opposite appears to be the case.
What Are the Real Issues?
The issue of retirement benefits for public employees is not
whether there are excesses or problems with DB plans. Any community
this large, with this much money involved, is bound to have some
problems. The real issue is how best to resolve these problems, how to
avoid them in the future, and what retirement plan design best meets
the multiple and sometimes conflicting objectives of public employees,
public employers, and recipients of public services. Reason's
solution--to terminate DB plans and replace them DC plans, is not only
simplistic but also is likely to create more problems than it solves,
problems that the Reason study largely ignores.
NASRA's response to the Reason study has attempted to clarify some
of the issues raised by Reason's paper and to identify solutions that
will yield better results than if Reason's recommendation--to supplant
DB plans with DC plans public employees--were implemented. Our nation's
legislative and political structure, complete with mechanisms to change
and correct existing policies, enables those who wish to do so to
address Reason's concerns, without threatening the retirement security
of the nation's public employees or the ability of public employers to
attract and retain qualified workers.
Rather than eliminating DB plans for public employees, the focus of
the retirement plan debate should center on such issues as:
What type of pension plan can best meet the objectives of
key stakeholders--public employers, recipients of public services,
taxpayers, and public employees?
How can policymakers increase public pension
intergenerational equity and increase transparency of public pension
plan costs?
How can the many positive attributes of defined benefit
plans be extended to workers outside the public sector?
NASRA believes that a fair and factual analysis of these questions
will lead to some form of a DB plan.
endnotes
\1\ National Association of State Retirement Administrators,
``NASRA Standing Resolutions No. 2003-08.''
\2\ Wikipedia, www.wikipedia.com
\3\ U.S. Bureau of Labor Statistics, ``The Employment Situation,''
December 2005
\4\ U.S. Federal Reserve Board, ``Flow of Funds,'' Third Quarter
2005
\5\ U.S. Census Bureau, ``2004 State and Local Government Employee
Retirement Systems.''
\6\ Michael Peskin, ``Asset/Liability Management in the Public
Sector.'' In Pensions in the Public Sector, (1999) ed. Mitchell and
Hustead, Pension Research Council, Philadelphia, University of
Pennsylvania Press
\7\ Georgia State Constitution, Article III, Sec. X, Paragraph V
\8\ Unannotated Georgia Code, Sec. 47-20-34
\9\ ibid.
\10\ ibid., Sec. 47-20-50
\11\ ibid., Sec. 47-20-10
\12\ Public Fund Survey, www.publicfundsurvey.org, National
Association of State Retirement Administrators and National Council on
Teacher Retirement
\13\ Public Fund Survey, www.publicfundsurvey.org, National
Association of State Retirement Administrators and National Council on
Teacher Retirement
\14\ ``Summary of Findings for FY 04,'' Public Fund Survey, NASRA
and NCTR
\15\ U.S. Census Bureau, 2004 Public Employment Data, State and
Local Governments
\16\ Anderson and Brainard, ``Profitable Prudence: The Case for
Public Employer DB Plans,'' In Reinventing the Retirement Paradigm,
(2005) Pension Research Council, Philadelphia, Oxford University Press
\17\ Parry Young, Standard & Poor's, ``Public Employers Are
Considering a Switch to Defined Contribution Pension Plans,'' November
2005
\18\ Parry Young, Standard & Poor's, ``Public Employers Are
Considering a Switch to Defined Contribution Pension Plans,'' November
2005
\19\ Paul Zorn and Norm Jones, Gabriel, Roeder, Smith and Co.,
``Questions About the Future of Public Pension Plans: Short-term
Problems or Structural Failures?,'' in Public Sector Pensions: Current
Challenges and Future Directions, Harvard Law School, October 2005,
http://www.law.harvard.edu/programs/lwp/Zorn-
Jones%20(POWER%20POINT).pdf
\20\ U.S. Federal Reserve Board, ``Flow of Funds,'' Third Quarter
2005
\21\ ibid.
\22\ ``Recent Funding and Sponsorship Trends Among the Fortune
1000,'' Insider, by Watson Wyatt, June 2005
\23\ Employee Benefits Research Institute, ``History of 401(k)
Plans: An Update,'' February 2005
\24\ National Conference on State Legislatures, ``Pensions and
Retirement Plan Enactments in 2005 State Legislatures,'' and preceding
years, http://www.ncsl.org/programs/fiscal/pensun05.htm
\25\ Callan Associates, ``Returns for Periods Ended 6/30/05''
\26\ ibid.
\27\ Parry Young, Standard & Poor's, ``Managing State Pension
Liabilities: A Growing Credit Concern,'' January 2005
______
[Slides presented during Mr. Filan's statement follow:]