I’d like to begin by making sure everyone here knows just how poorly funded our state pension funds are. The State’s audited unfunded pension liability as of June 30, 2010 (the latest available) was $86 billion (based on market value). This is a record pension debt for Illinois and the third highest of any state in the nation. Our most recent audited funding ratio (which is the percent of earned benefits or liabilities covered by assets) is at an historic low of 38.3% in FY10. Illinois’ 38.3% funded ratio for all five systems combined as of June 30, 2010 is the worst of any state. As you can see in this slide, the most underfunded State systems percentage wise are the General Assembly and Judges, and the biggest dollar debt is Teachers.
The $85.5 billion in unfunded liability as of June 30, 2010 I just showed you is our State pension debt as calculated by our systems and their actuaries. That number grew by over $30 billion from the $54 billion debt as of the end of fiscal year 2008 to the $85 billion last year. Here is a chart showing differing views on our unfunded liabilities as of fiscal year 2008. In FY08, as reported by the Illinois Auditor General and the Pew Center on the States in a national survey, our unfunded liabilities were $54 billion. The group State Budget Solutions – a non-partisan reform group – contrasts that $54 billion debt figure as calculated by our systems with two much higher estimates from outside experts. As you can see, there is a $192 billion unfunded liability projection for Illinois calculated by the American Enterprise Institute and a $167 billion projection calculated by Northwestern professor Joshua Rauh and another professor, Robert Novy-Marx. The primary difference in these projections is that AEI and the professors’ study assume much lower investment returns than our systems assume. Back in 2008, most of our systems were still forecasting 8.5% earnings and discounting future liabilities for benefits back at that same percentage. These other studies use much more conservative growth rates – AEI uses the cost of put options, because AEI says the guarantee that taxpayers will cover any shortfalls is like a put option, while the Northwestern professor uses the price of safe Treasury securities. The way the Illinois systems calculate their unfunded liability is very similar to what other states do, and our auditor general has endorsed their calculations, but clearly, our debt looks worse if you use more conservative assumptions.
This graph shows the projected unfunded liabilities for Illinois systems over 30 years. These figures come from the Commission on Government Forecasting and Accountability and show projections under Senate Bill 1946, which was last year’s bill reforming new-hire benefits. As you can see, unfunded liabilities will increase from about $104 billion in fiscal year 2015 to about $153 billion in fiscal year 2035. That’s an increase of 47%. Under the current system, we reach 90% funding in 2045, and we do not drop the debt significantly until the last few years of the funding plan.
Now let’s look at where we get the money for our pensions. As you can see on this next slide, in a typical year, about 70% of the total revenues going into our State pension systems come from investment income. About 15% comes from the State’s contributions and about 15% from State employee or teacher contributions. Our pension benefits paid are over $7 billion this year, so we really do count on investment income.
Our investment income is critical especially when you consider that without it, our cash flow is negative. Our state pension funds continue to operate each year “in the red,” with $1.4 billion in negative cash flow in FY10, as shown in this chart. Negative cash flow is measured by comparing revenues from employee contributions and employers (the State and local employers such as school districts) with expenses (pension benefits paid out and small operational costs). Investment income (earnings, such as dividends and interest) earned by the systems is not counted in this measurement of cash flow. Under this measure, our systems typically are in the hole each year because their annual stable revenues from employers such as the State and employees are lower than benefit payments. To cover benefit payments, our systems use volatile investment income and in some cases sell investments (assets such as stock) to make current-year pension benefits. There is no risk of benefits not being paid in full any time soon, as the systems currently are getting substantial investment income and have sizable assets. But the nationally accepted, fiscally prudent standard is to have positive cash flow each year, to guard against possible negative investment income years (as our systems had in FY01-02 and FY08-09), and in the case of Illinois, to dedicate excess investment income to paying down our mammoth unfunded liability.
Here is a look at our State pension systems’ investment returns. This shows the different returns of the Teachers Retirement System, the State Universities system and the Illinois State Board of Investment which invests for State Employees, the General Assembly and Judges. The 10-year average hovers in the 3% range. Longer term averages were higher, but the 10-year number reflects the average 20% loss in FY09 and 5% loss in FY08. FY10 returns were good, and FY11 was fantastic -- everyone is over 20% for FY11. For the first two months of FY12, through August, the systems are negative. We don’t have numbers from TRS, but both SURS and ISBI report that so far, FY12 is at least 4% down. And very preliminary reports on September is that they are down again. The systems’ long-term projections are based on different rates of return. Most used to be at 8.5%, but last year SURS and SERS dropped down to 7.75%, which had the effect of adding about $200 million to the State’s required payment last year. TRS is still at 8.5% but I expect it will be dropping its long-term projection below 8.5% in the next year or two as well.
Remember that the State’s total pension costs include pension bond payments for the three sets of pension bonds the state sold, in 2003, 2010 and 2011. Adding in projected bond payments, the State’s projected total pension costs (all funds) paid with cash (and not counting bonded funds) are shown on this chart. These bond payments cover the $10 billion in bonds from 2003 (with principal payments backloaded over 30 years with payments hitting $1 billion a year by FY29) and the 2010 bonds (which were responsibly structured with equal or level principal payments over just 5 years). The $3.7 billion bonds sold in March 2011 for the FY11 GRF payment are backloaded over 8 years, and are “interest only” for three years, with the first principal payment in March 2014. As you can see, our payments are continuing to rise at a clip of about $500 million a year.
When we consider our State’s pension payments, we also need to consider our other big long-term obligation – payments on our bond debt – not just for pensions but for capital, too. Illinois has the second largest pension and bond debt of any state. Our combined bond and pension debt has grown from $54 billion in early 2003 — which translates to $4,300 per citizen— to $119 billion today (up to $9,300 per citizen). That’s a 120 percent increase in debt in less than 9 years. And annual payments on our debt have risen from $2.6 billion in 2003 to $7.7 billion this year. That’s a 200 percent increase in payments. And if you measure those debt payments against our general budget, these debt payments were 12% of that budget in 2003 and now are almost double that percent – 23% of the current budget. We all should be able to agree that we need to reduce this debt burden on our taxpayers.
Now let’s break down the numbers a bit and think about reforms. The pension experts divide our annual pension obligation into two big chunks – the “normal cost” which is the cost of each year’s newly earned pension benefit for employees and the remaining cost which is what we owe for not putting enough cash into the systems in past years to cover past years of normal cost – our debt. This slide shows the total normal costs for the systems both in total dollar amount and as a percentage of payroll or salary. And this also shows the employee contribution, again as a percent of their pay. Some of these numbers are FY10, others are FY11, but there has not been a major change in normal costs recently. Some of the systems were able to give us some information on the normal costs for the newly hired members who are in Tier 2 – those hired after January 1, 2011, who have lower benefits than the Tier 1 people who were first hired or elected before 2011. Teachers Retirement says the normal cost for Tier 2 is roughly between 6 and 7%, but those teachers pay 9.4% of pay, just like the Tier 1 teachers do even though their benefits are much more expensive. Senate Bill 512 would drop those Tier 2 contributions down to 6% for all systems. I think a good goal in looking at reforms would be for the employees and teachers to cover the normal costs of the benefit plan they choose, while the State covers the pension debt and bond payments. This means that the State would be carrying most of the burden, as normal costs are less than half of our annual benefit and bond payments. In other words, teachers in tier 1 would pay 18%, but those in Tier 2 would pay 6%. Senate Bill 512 has the same goal, though it ramps up to that level, with teachers who “pay to stay” in Tier 2 paying a little under 14%, with adjustments every three years after that. The employees contribution would be fixed, which means the State would take the market risk and make up any shortfalls on investment income.
39 states have enacted substantial revisions to their state retirement plans over the past two years. As you know, Illinois last year reformed new-hire pension benefits, with lower benefits for “Tier 2” members who were first hired or elected after January 1, 2011. And we are considering further reforms of future benefits of current members. There are four basic reforms that other states have enacted: Increase Employee Contributions : 25 states increased the amount employees are required to contribute since 2010. In half of the states that increased the amount employees contribute to their pension, the legislature decreased the amount the state would be required to contribute in a shift towards equalizing employee/employer rates. Changing Eligibility Rules : 23 states have increased age and service requirements for retirement. Most states have moved the retirement age closer to or to 65 years old and increased the amount of service credits to retire early. Additionally, 12 states have increased minimum eligibility requirements (vesting) by three to four years. Modifying How Benefits Are Calculated : Of the 13 states that modified how benefits are calculated, most have lengthened the time period for figuring average salaries upon which benefits are based from a person’s highest 36 months to their highest 60 months (3 years to 5 years). Revising Automatic Benefit Increases : 17 states have reduced the automatic cost-of-living adjustments (COLAS).
One of the significant issues with Illinois’ state pension system is how radically different it is from the private sector. According to the American Legislative Exchange Council’s (ALEC) Rich States, Poor States report, state and local employees cost significantly more in wages and benefits. The ALEC’s information is based on the U.S. Bureau of Labor Statistics figures as of December 2010. In Illinois, the average state employee receives a salary of $58,000 and a pension of $41,000. The figures for Illinois’ private sector are unavailable at this time, but are assumed to be similar to the national average as shown in the chart. Not only do state employees earn more in wages, but on average they receive 69% more benefits than private sector employees. Some of this is due to a higher percentage of public workers with college degrees than private sector workers, but the salaries and benefits still are higher. Much of this is because the private sector has chosen to transition away from a defined-benefit model for pensions because they were too-costly and in the end unaffordable if the companies wanted to remain profitable. Today, only 21% of private sector employees have a defined-benefit model for pensions. On the other hand, 84% of state employees have a defined-benefit model for pensions. If the private sector decided years ago that defined-benefit pensions were unsustainable, then why should government continue to use a system that it cannot afford? Everyone would like to have good benefits with their job, but with the current state budget, can the state afford to keep such benefits?
To conclude, I think the State needs a three-pronged approach to solving our pension woes. First, we need to revise our benefit structure so that employees cover the actual costs of the benefits they earn, while the State pays off our past debt and takes the market risk for those who choose the Tier 1 or Tier 2 defined-benefit plans. I like the three choices in Senate Bill 512 – what I nicknamed “pay to stay” in Tier 1, lower Tier 2 benefits for a lower contribution, or a defined-contribution plan which I have long championed. Second, the State needs to start kicking in more cash to the systems to get out of the pension hole and not hand this problem to our grandchildren or risk non-payment of full benefits to retirees. Senate Bill 512 would require at least a $500 million increase in the State’s payments next year, and according to some of the systems, as much as $1 billion more. That high amount may not be doable, but we should take a hard look at increasing our payments as much as we can. And last, we need to stop selling pension bonds and pay what we owe in cash. Payments on our pension bonds now are almost $1.5 billion this year and we shouldn’t add to the burden we’re leaving for the next generation with more bonding. One good feature of this year’s budget is that we intend to cash fund pensions. That has required some serious spending cuts after two years of bonding, but we got there. Further big spending cuts or another tax hike are not the paths to take. We need to reform benefits and responsibly fund our pensions.
IGPA Pension Presentation
Senator Bill Brady’s Remarks State Pension Summit IGPA Oct. 3-4, 2011
Our unfunded liability of $86 billion does not include the State’s $17 billion in pension bonds. This 38% funded ratio is the worst in the nation. Financial Condition of State Retirement Systems As of June 30, 2010 (assets at fair market value) ($ in Millions) Accrued Net Unfunded Funded System Liability Assets Liability Ratio TRS $ 77,293.2 $31,323.8 $45,969.4 40.5% SERS $ 29,309.5 $ 9,201.8 $20,107.6 31.4% SURS $ 30,120.4 $12,121.5 $17,998.9 40.2% JRS $ 1,819.4 $ 523.3 $ 1,296.2 28.8% GARS $ 251.8 $ 54.7 $ 197.1 21.7% TOTAL $138,798.3 $53,225.1 $85,569.2 38.3%
The Illinois systems calculated our unfunded liabilities at $54 billion for FY08, but these higher estimates for FY08 were calculated by the American Enterprise Institute and a Northwestern University professor.
The pension bond payments ($1.4 billion this year) cover debt service on the $10 billion in bonds sold in 2003, $3.5 billion sold in 2010 and $3.7 billion sold in 2011.
<ul><li>The State’s bond and pension debt has grown from $54 billion in early 2003 ($4,300 per citizen) to $119 billion today ($9,300 per citizen). That’s a 120% increase . </li></ul><ul><ul><li>The $54 billion in 2003 included $11 billion in capital bonds and $43 billion in unfunded pensions. </li></ul></ul><ul><ul><li>Today’s debt includes $86 billion for pensions and almost $34 billion in bonds. The bond debt includes $17 billion of pension bonds. </li></ul></ul><ul><li>Payments on our debt have risen from $2.6 billion in 2003 to $7.7 billion this year. That’s a 200% increase. </li></ul><ul><li>Illinois has the 2nd largest bond and pension debt of any state; 3 rd highest as a percent of revenue, and 5 th highest per citizen. </li></ul>Our Growing Debt
Normal Costs <ul><li>TRS: 18% of salary ($1.7 billion). Teachers pay 9.4% and no Social Security. </li></ul><ul><li>SERS: 12% of salary ($500 million). Employees pay 4%-12.5%. Most state employees are in Social Security. The State pays 6% to Social Security and employees pay 6%. </li></ul><ul><li>SURS: 18% of salary ($630 million). Faculty and staff pay 8.0% and almost all are not in Social Security. </li></ul><ul><li>JRS: 29% of salary ($48 million). Judges pay 9.75% and no Social Security. </li></ul><ul><li>GARS: 30% of salary ($4 million). Legislators pay 11.5% and no Social Security. </li></ul>
What Are Other States Doing? <ul><li>39 states have enacted substantial revisions to their state retirement plans over the past two years . </li></ul><ul><li>These changes include: </li></ul>* of the nine states that enacted this year Source: National Conference of State Legislatures 6* 3* 17 Revise Automatic Benefit Increases All None 13 Modify How Benefits are Calculated Most Few 23 Changing Eligibility Rules 7 18 25 Increase Employee Contribution Number of States Where Change Applies Only to New Hires After Legislation Enacted Number of States Where Change Applies to All Employees Number of States to Adopt Change (Over past 2 years) Change Enacted
Most public sector employees are not in Social Security, while private sector employees are in Social Security. More public employees have college degrees than do private employees. State and Local Government Employees Costs per Hour Worked $2.27 $2.55 $5.65 $6.57 Extra Public Cost 0.99 2.1 8.2 19.68 Private $3.26 $4.65 $13.85 $26.25 Public Retirement Healthcare Total Benefits Wages or Salaries Type of Worker
Reform Proposals <ul><li>Offer a choice of benefit plans similar to Senate Bill 512: </li></ul><ul><ul><li>“ Pay to Stay” in Tier 1 </li></ul></ul><ul><ul><li>lower contributions with lower benefits in Tier 2 or </li></ul></ul><ul><ul><li>a defined contribution plan. </li></ul></ul><ul><li>The State ideally should increase its contributions to pay down our pension debt. </li></ul><ul><li>No more pension borrowing – the State should pay in cash, on time. </li></ul>