As a candidate for Illinois governor, Bruce Rauner promised to address the Land of Lincoln’s virtually-bankrupt defined-benefit pensions. So far, he has at least put some effort on that front. But it will be all for naught if Rauner and state legislators force the pensions — especially the Teachers Retirement System — to provide honest numbers of the extent of their insolvencies.
Last month, as part of the proposed budget for the 2015-2016 fiscal year, the private equity player-turned-politician introduced a plan in which so-called Tier 1 employees — or teachers and state employees on the payroll before the passage of the Senate Bill 1 pension reform bill last year — could volunteer remove themselves out of one of the state’s pensions and into defined-contribution plans; as part of the deal, workers would get a lump-sum payment equaling what they would get out of the pension — essentially a version of the cash-balancing approach companies have used to transition employees out of their defined-benefit pensions — that would go into the defined-contribution account.
As you can expect, Rauner’s plan hasn’t gone down well with the NEA’s Illinois Education Association and the AFT’s Illinois Federation of Teachers. Through the coalition We Are One Illinois, the two unions (along with other public-sector unions such as the American Federation of State County and Municipal Employees) have already managed to get a state court judge to halt implementation of S.B. 1, the modest series of pension changes successfully pushed by Rauner’s predecessor, Pat Quinn. [The case is now before the Land of Lincoln’s Supreme Court, whose members are also covered by a pension that will eventually be targeted by reforms similar to S.B. 1 and thus, are essentially burdened by conflict of interest.] The suit, along with efforts by the unions to force the Democrat-controlled legislature to oppose the Republican governor’s proposal, essentially make Rauner’s effort more difficult than it should be.
Rauner’s plan could still be passed in some form by the legislature. After all, State Senate President John Cullerton was responsible for making S.B. 1 a reality. There’s also the presence of Chicago Mayor Rahm Emanuel, who as I noted today in an American Spectator column, is battling against public-sector unions such as AFT’s Second City local to solve the municipality’s equally-unenviable pension woes.
But as with so many pension reform plans, Rauner’s proposal will only work if it is based on realistic assessments of the state’s public pension insolvencies. This is especially true when it comes to dealing with TRS, which accounts for half of the Land of Lincoln’s $111 billion in (officially-reported) pension shortfalls. But as revealed by Dropout Nation‘s analysis of TRS’ comprehensive annual financial report, it is still less-than-candid about its true fiscal condition.
TRS officially reports that it is insolvent to the tune of $62 billion in 2013-2014; based on officially-reported numbers, this is a 10 percent increase over the previous fiscal year. But as readers know by now, the official numbers don’t represent reality. For one, this leaves out $3.7 billion in investment gains made during the fiscal year, all but 20 percent of the gains accounted for by TRS because of smoothing, an actuarial trick the state forced the pension to adopt six years ago. This allows the pension to effectively hide investment gains and losses under the guise of keeping the volatility pensions experience with investments from wreaking havoc on state and district budgets. As a result, taxpayers and policymakers aren’t getting a full picture of the pension’s insolvency.
The bigger problem is that TRS is using overly inflated assumptions of investment growth over time. The pension assumes that investments will grow by 7.5 percent every year. Certainly, this is a tad less dishonest than the eight percent rate of return the pension assumed in previous years. But the rate is still inflated by a country mile. TRS’ 10-year rate of return on investments is just 7.3 percent — and that’s only thanks to the bull market of the last two years (which helped overcome the losses of the last decade’s global financial meltdown). In fact, TRS admits that the actuarial value of its assets increased by a mere 23.7 percent (or an average growth rate of 2.4 percent a year) between 2005 and 2014; even if you just stick to fair market value, TRS’ assets have only increased by 34.4 percent (or an average annual rate of 3.4 percent) within that time.
As you readers know, using overly-inflated assumed rates of return are problematic because pensions can report insolvencies as being lower than they actually. During good times, when the stock and bond markets are performing stellar, pensions can claim that investments can cover shortfalls. This leads politicians to abandon all fiscal prudence by increasing annuity payments and reducing contributions paid by states, districts, and teachers in the hopes that Wall Street will cover the shortchanging. During periods such as the recent economic malaise, pensions can simply continue assuming that the markets will cover those insolvencies some day; because rates of return are key in determining shortfalls, a high rate of return gooses up the value of assets even if isn’t reality.
To get to the true level of TRS’ insolvency, Dropout Nation uses a version of a technique developed by Moody’s Investors Service, which assumes a more-realistic 5.5 percent rate of a return. [Moody’s bases its rate of return on the Citibank Pension Liability Index, which is based on the yield for AA-rated corporate bonds.] Based on the calculation, TRS’ true insolvency is likely $78 billion, or 27 percent more than officially-reported. When compared to the likely levels of insolvency calculated by Dropout Nation last year, TRS’ insolvency increased by 2.6 percent over the previous year. [The increase would have been even higher if not for the pension’s move to reduce its assumed rate of return.]
If Illinois state government was forced to pay down the insolvency over a 17-year period of amortization, taxpayers and teachers would have to contribute an additional $4.6 billion to eliminate TRS’ insolvency. This is more than double the $4.5 billion poured into the pension in 2013-2104. This would also hit hard Illinois’ already-strapped budget. If the state paid an additional $3.5 billion in contributions in 2013-2014, the percentage of the state budget dedicated to TRS would increase from 3.7 percent to 7.7 percent.
As Dropout Nation noted last year, state legislators along with Rauner need accurate numbers on TRS’ pension woes because even more Baby Boomers are heading into retirement than in previous years. Some 6,443 teachers covered by the pension retired in 2013-2014, 4.2 percent more than the average of 6,182 who have left classrooms in the past decade. With each retiree collecting annual annuities of $48,339 a year, TRS will have to pay out at least an additional $299 million a year.
None of this, by the way, even accounts for the three percent annual cost-of-living increases that TRS must pay out, which essentially means that a retiree can collect an annuity that it 30 percent higher than when they first retired; S.B. 1 put an end to those increases, but thanks to a state court ruling invalidating the plan late last year, those out-of-control raises continue to increase the pension’s insolvency.
When a pension system is so terrible for both teachers and taxpayers that its executive director admits it publicly and bluntly, it is time for a governor and state legislature to scrap the entire system altogether. This can be done constitutionally. Illinois is required to provide workers with retirement benefits, but it can be done in better ways than it does now.
With the We Are One coalition suit complicating matters, Rauner has no easy solution for this crisis. Any step he and legislators take must be bolder than those taken by Quinn in previous years. This includes wrestling control of the boards of TRS and other state pensions from public-sector unions; figuring out how to end the cost-of-living increases that are fiscally senseless; and requiring teachers to pay more into their retirements than the 21 cents of every dollar they current contribute. Rauner must also force legislators to stop making deals with teachers’ unions such as one contained in a 2007 pension bill that allowed AFT affiliate lobbyist David Piccioli to garner a pension despite having just spent one day working in a classroom as a substitute teacher.
At the same time, Rauner should scrap his current plan and embrace an approach touted by Dropout Nation as well as by pension researchers such as Josh B. McGee of the John & Laura Arnold Foundation and Marcus Winters of the Manhattan Institute. This would mean moving both existing and new employees out of defined-benefit pensions into hybrid approach that features defined-contribution accounts as well as cash-balanced accounts that guarantees an annual savings rate. [Rauner could still allow existing workers the ability to cash out of the old pensions and put that money into the new accounts.]
Particularly for younger teachers who have been forced by S.B. 1 to subsidize veteran colleagues (through contributions as well as taxes they also pay), and lose out on opportunities to truly save for their own retirements, such a plan would actually allow them to fully benefit from their hard work in classrooms. This, by the way, would also benefit younger workers currently paying into the state’s other pensions.
But the most-important step of all Rauner must take starts with forcing TRS and other pensions to offer honest data on their fiscal condition. Simply requiring them to issue special report to him and the legislature using the approach developed by Moody’s would go a long way toward accurate disclosure. Rauner should also demand the legislature to rescind the state law passed six years ago requiring TRS and other pensions to smooth out gains and losses; this means moving to fair market value assessment of assets and liabilities that are honest and clear for everyone.
Through moves such as issuing an executive order ending the ability of public-sector unions to forcibly collect dues from workers who aren’t in their rank-and-file, Rauner has shown so far that he is willing to take tough action that can help taxpayers and public employees alike. Demanding honest numbers from TRS and other pensions is another tough step he can — and should — do.