A “Pension Crisis” Mentality Won’t Help

A "Pension Crisis" Mentality won't Help

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A "Pension Crisis" Mentality Won't Help:

Thinking Differently About Illinois' Retirement Systems

February 19, 2019

Robert Bruno, PhD

Professor and Director Labor Education Program Project for Middle Class Renewal University of Illinois at Urbana-Champaign

Amanda Kass

Associate Director Government Finance Research Center College of Urban Planning and Public Affairs

University of Illinois at Chicago

David Merriman, PhD

Director Fiscal Futures Project, Institute of Government & Public Affairs James J. Stukel Presidential Professor

College of Urban Planning and Public Affairs University of Illinois at Chicago

PROJECT FOR MIDDLE CLASS RENEWAL

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AUTHOR BIOS

Robert Bruno is the Director of the Labor Education Program which hosts the Project for Middle Class Renewal. He is also a Professor for the School of Labor and Employment Relations at the University of Illinois at Urbana-Champaign.

Amanda Kass is the Associate Director of the Government Finance Research Center in the College of Urban Planning and Public Affairs at the University of Illinois at Chicago. As Associate Director she designs, conducts, and manages research in the GFRC's priority areas. Amanda also works with the faculty and external advisory panels to advance the GFRC's goals and disseminate its research.

David Merriman is the Stukel Presidential Professor in the Department of Public Administration, University of Illinois at Chicago and a Senior Scholar at the Institute of Government and Public Affairs, University of Illinois. He co-founded and directs the University of Illinois' Fiscal Futures Project, which monitors the fiscal condition of the State of Illinois. He has published many research articles on various aspects of state and local public finance.

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ABOUT THE PROJECT FOR MIDDLE CLASS RENEWAL

The Project for Middle Class Renewal's mission is to investigate the working conditions of workers in today's economy and elevate public discourse on issues affecting workers with research, analysis and education in order to develop and propose public policies that will reduce poverty, provide forms of representation to all workers, prevent gender, race, and LGBTQ+ discrimination, create more stable forms of employment, and promote middle-class paying jobs. Each year, the Project will be dedicated to a number of critical research studies and education forums on contemporary public policies and practices impacting labor and workplace issues. The report that follows, along with all other PMCR reports, may be found at go.illinois.edu/pmcr

ABOUT THE GOVERNMENT FINANCE RESEARCH CENTER

The purpose of the Government Finance Research Center at the University of Illinois at Chicago (UIC) College of Urban Planning and Public Affairs (CUPPA) is to shape and inform public policy and scholarly discourse on government and public finance by identifying, planning and executing research, providing periodic reports and informed analyses, and offering venues at which to convene national and local discussion on fiscal and governmental issues. More information may be found at gfrc.uic.edu

ABOUT THE INSTITUTE FOR GOVERNMENT AND PUBLIC AFFAIRS

The University of Illinois Institute of Government and Public Affairs (IGPA) has a unique and valuable role to play in Illinois' public policy discussions. The cornerstone of the IGPA Idea is that evidence-based and objective information, generated using the most advanced and appropriate social scientific techniques in disciplines including economics, sociology, psychology, and political science, should have an important place in all policy debates. More information may be found at igpa.uillinois.edu

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EXECUTIVE SUMMARY

The near ubiquitous claim that Illinois is facing a "pension crisis" has rarely been challenged. The failure to examine this customary framing of the fiscal condition of Illinois' five state pension systems limits how policymakers conceptualize their funding strategy. This white paper, jointly authored by researchers from the Project for Middle Class Renewal at the School of Labor and Employment Relations, the Government Finance Research Center and the Institute of Government and Public Affairs (all at the University of Illinois), argues that the "pension crisis" framework negatively influences discussions of policy options.

Our goal with this paper is to rethink the conversation about pensions and the state's finances in several ways. First, we argue that the funded ratio and unfunded liabilities, conventional ways of assessing a pension system's fiscal health, are inadequate metrics that reinforce short-term thinking. We argue that the focus should be on long-term trends and peer comparison. In addition, attention should be paid to identifying what the drivers are of negative trends and carefully assessing whether action is needed.

Second, we argue that a "pension crisis" is a situation in which the pension system is insolvent and unable to make benefit payments to current retirees. This is not the present scenario in Illinois. Nonetheless, we recognize that both the state and the pension systems face significant fiscal challenges. Third, rather than a singular problem, we contend that there are actually two, interrelated and in-conflict issues:

concern over the pension systems' finances, and operating budgets where expenses regularly exceed revenues.

We note that a tension exists between a desire to rapidly improve the finances of the pension systems (which would necessitate higher state contributions), and an interest in preventing pension contributions from crowding out other areas of the state budget.

Illinois lawmakers have long sought a silver bullet solution that will not increase (or even lower) the state's required contributions while simultaneously shoring up the pension systems' finances. We view such a scenario as unattainable and its pursuit as a distraction from the job of responsible policymaking. Moreover, because the two issues are interrelated, a policy designed to address one issue will necessarily worsen the other.

In this paper, we recommend abandoning the "crisis" narrative and moving away from only assessing the pension systems' finances with a single point-in-time measurement. Last, we urge lawmakers to shed the common practice of reducing the state's pension payments to balance the operating budget.

A "Pension Crisis" Mentality won't Help

TABLE OF CONTENTS Executive Summary I. Introduction II. Why is the Crisis Framework Bad? III. What are the Underlying Issues?

a. Restoring the Retirements Systems' Fiscal Health b. Pension payment in Context of the State Budget IV. The Pension "Crisis Bias" V. Conclusion Bibliography

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I. INTRODUCTION

By now it has become almost mandatory to describe Illinois as facing a "pension crisis" (e.g., Chicago Tribune, 2012; Davey and Walsh, 2015; USA Today, 2018). Only occasionally is there a word of protest to this substantive claim (Chicago Tribune, 2013). While this might seem, to some like an issue of semantics, we believe that the framing of Illinois' pension problems is inextricably linked to how we conceptualize their solutions. The crisis narrative makes a broad claim about public pension systems writ large in Illinois. But Illinois has nearly 700 state and local pension funds, and their issues and challenges vary widely. This white paper focuses on just the five state systems,1 and challenges the pension crisis framework.

In Illinois, discussions of a "pension crisis" are common, but an exact definition of that phrase is rarely offered. We argue that a "pension crisis" is a situation in which a pension system is insolvent (meaning its assets are depleted), and as a result benefit payments to current retirees are halted. Although that is not the current situation in Illinois, some are concerned that could happen because of the present state of the pension systems' finances. While we are not dismissive of that concern, we argue that the pension crisis narrative is problematic because it obscures underlying issues and creates the unattainable expectation that the "crisis" must, and can be solved immediately.

The phrase "pension crisis" is often invoked in discussions about the state's current and future pension contributions, with many seeing those contributions as crowding out other aspects of the state's budget. While recent cuts to other areas of state spending (like higher education and human services) are a concern, we argue that those cuts

are not a pension crisis. Some tie the budget cuts to the state's pension contributions; however, when faced with budget shortfalls lawmakers have a range of options, one of which is spending cuts. The state pension contributions in isolation do not lead to a direct decline in other areas of the budget.

Our goal with this paper is to change the

conversation about pensions and the state's

finances. We believe this is important for

addressing the challenges facing the state in a calm, thoughtful and

"...beneath the

deliberate manner. We need to crisis narrative is

understand the nature of the

actually two,

actual problems, the context in interrelated and

which they arose, and fully in-conflict issues"

consider the consequences of

alternatives. We aim to show that beneath the

crisis narrative is actually two, interrelated and in-

conflict issues: (a) concern over the pension

systems' finances; and (b) operating budgets

where expenses regularly exceed revenues. A

tension exists between a desire to rapidly increase

the finances of the pension systems (which would

necessitate higher state contributions), and the

concern that the state's pension contributions are

already crowding out other areas of the state's

budget.

In addition, the crisis framework is harmful because it facilitates reactive policies that focus on short-term solutions and metrics. Illinois lawmakers have long sought a silver bullet solution that will simultaneously shore up the pension systems' finances while not increasing the state's required contributions (and in some instances even lowering the payments). In this paper, we recommend abandoning the "crisis" narrative and urge lawmakers to shed the common practice of reducing the state's pension payments to balance the operating budget.

1 The five state systems are: the Teachers' Retirement System, the State Universities Retirement System (SURS), the State Employees' Retirement System (SERS), the General Assembly Retirement System, and the Judges' Retirement System.

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Fiscal sustainability of the pension systems and volumes", and in it Cahill critiqued Governor

structurally balanced budgets are determined by Pritzker for having "nothing to say about $130

political will and economic fundamentals. billion in unfunded pension obligations to state

Governments can only raise revenue and control employees, a yawning black hole of debt that

spending when political leaders are able to justify threatens to swallow the state budget and

hard choices and gain their constituents' trust and suffocate Illinois' economy" (Cahill, 2019). This

support. Political will requires that lawmakers crisis narrative implies that drastic action is

understand the challenges that they face and needed to immediately extinguish $130 billion

explain them to voters in a way to garner their worth of debt. Such a framing incorrectly presents

support for appropriate policies. The more scarce the issue as one that can be resolved in the short-

economic resources are, the more difficult it is for term and misunderstands the very nature of

elected leaders to devote resources to financial condition.

expenditures (like pension funding) immediate benefits to the vast constituents. Better economic fundamentals (e.g. growing economic output and widely distributed economic gains) make it easier for lawmakers to garner political support for policies that increase fiscal burdens.

that bring few majority of

One problem that it creates

"...unfunded liabilities represent a long-term form of debt, and are not something that could be eliminated in a year"

with the pension crisis narrative is a temporal mismatch between the framing of how the problem should be addressed and the actual nature of unfunded pension liabilities. This is because unfunded liabilities represent a long-term form of debt, and are not something that could be eliminated in a year (or even a few

We offer this white paper as a critique of the years). However, in the crisis framing, unfunded

rarely challenged and ill-defined "crisis" pension liabilities are often put in context of how

narrative. We begin with conceptual critiques of much money is needed today to fully pay off the

the crisis framework. Next, we unpack the crisis debt. A Bloomberg headline from last spring

framing to show how instead of a singular concern succinctly captures this misguided perspective:

there are actually several, interrelated issues. "Every Illinoisan Owes $11,000 for Pensions

Moreover, we show that these issues are in With No Fix in Sight" (Campbell, 2018). Stating

tension with one another. A fourth section how much every Illinoisan would need to pay

provides three examples of how a "crisis bias" today to wipe out unfunded liabilities in one year

approach has largely failed to reduce unfunded reinforces a short-term thinking that is

liabilities and kept Illinois locked in a seemingly disconnected from the nature of pension

endless "pension crisis". We conclude with liabilities. It also ignores the fact that a pension

recommendations about how to approach the system's finances are in constant flux. Since

state's pension systems.

assets and liabilities constantly change, the

elimination of all unfunded liabilities today (even

II. WHY IS THE CRISIS FRAMEWORK BAD?

if possible) does not prevent unfunded liabilities from arising tomorrow.

The short-term thinking of the crisis narrative also

The crisis framing was captured in a recent Crain's Chicago Business piece that criticized newly sworn-in Governor J.B. Pritzker's inaugural speech (Cahill, 2019). Cahill's piece was headlined, "Pritzker's pension silence speaks

implies that there is an acute threat of benefits not being paid to retirees. A pension fund's liabilities are the estimated cost of pension benefits being paid out now and benefits that will be paid out decades in the future. Unfunded liabilities are

A "Pension Crisis" Mentality won't Help

liabilities that are currently not matched to assets. A pension system's fundamental obligation is to pay claims to retirees and other claimants such as beneficiaries. As currently structured and funded Illinois' pensions systems are not projected to go insolvent, meaning there is not an immediate risk that retirees will stop receiving their benefits. Unfunded liabilities are a form of long-term debt, and there is a plan in place to manage this debt. By the very design of this plan, the systems' unfunded liabilities will continue to increase for the next decade and then start to decrease after 2029.

The crisis framework obscures that A) unfunded liabilities are a long-term debt to be paid off over decades, and B) Illinois has a payment schedule for its unfunded liabilities already in place. This is not, however, to say that the existing funding plan is perfect. The current funding plan is a backloaded debt repayment schedule in which unfunded liabilities increase for another decade before beginning to decrease. The structure of the funding plan also requires the state's contributions to increase from year-to-year by an average of 3 percent under current projections. Last, future contributions could be much higher than current projections because actual contributions are determined each year and are impacted by changes in assumptions, investment performance, and the accuracy of actuaries' assumptions. In Section 3 we discuss criticism of that funding plan and highlight budgetary challenges it creates.

Another issue with the crisis framework is that it conceives of financial condition as a singular thing that can be "solved." A pension fund's fiscal health is often represented by one or two metrics, most commonly its unfunded liabilities or funded ratio (the ratio of pension assets to liabilities). A funded ratio of 100 percent means assets are sufficient to pay estimated current and future liabilities. While a funded ratio below 100 percent is often used as an indicator of a poorly financed system, there is no single threshold that

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distinguishes a healthy versus unhealthy

retirement system (American Academy of

Actuaries, 2012). More broadly, financial

condition is multidimensional and cannot be

assessed with one point of

data at one point in time.

Instead,

financial

condition is something to

"Another issue with the crisis framework is that it conceives of

consistently monitor and a financial condition

attend to over time. The

as a singular thing

pension crisis framework that can be `solved'"

simplifies the complexity

of financial condition and gives the false

impression that it is something to move on from

once solved.

Focusing on one metric also obscures legitimate debate concerning the optimal level of funding for a retirement system. A funded ratio target is commonly used in a funding policy that sets a government's annual pension contribution. In many cases, a government's required annual pension contribution equals the employer portion of the normal cost plus the expected cost to retire any unfunded liabilities. The "normal cost" is the cost of benefits earned that year by current employees. Employees' contributions typically cover a portion of the normal cost, and the remainder is the employer's share of the normal cost. The "expected cost to retire any unfunded liabilities" is determined by a combination of policy choices and actuarial assumptions. Policy choices include what is an acceptable level of debt (in the form of unfunded liabilities), how debt repayment should be structured, and over what time period all (or a portion) of unfunded liabilities should be paid. In Illinois, lawmakers enacted a plan that requires each state retirement system to achieve a 90 percent funded ratio by 2045. Pension fund actuaries calculate the state's required contributions each year to achieve that goal.

Many observers advocate a funded ratio target of 100 percent, and this is often treated as a fundamental principle in actuarial science but it is

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