Illinois Pension Shifts Further Pressure State Government

Seal of State of Illinois

CHICAGO – Changes in assumed investment return rates at four of Illinois’ five state employee pension funds, as well as other revised assumptions in areas like life expectancy, are raising pressure on the state to tackle pension reforms.

The Teachers’ Retirement System lowered its return rate to 7% from 7.5% late last month in a move that received widespread attention when Gov. Bruce Rauner’s administration warned ahead of the board’s vote the state could ill afford the burden of a higher payment.

State pension contributions of nearly $8 billion in the current fiscal year, up by $200 million over the previous year, come primarily from a roughly $33 billion general fund in a state that is grappling with at least a $5 billion spending gap and an unpaid bill backlog that is expected to soon top $10 billion as its fiscal 2016/2017 budget impasse progresses.

“The expected contribution increases come as Illinois is struggling with a financial crisis that has left the state with a growing pile of unpaid bills and without a complete budget since fiscal 2015,” the Civic Federation of Chicago wrote in a report this month that looks at assumption changes by two of the state’s funds and their potential impact on state finances.

“The recent decision by several of the State’s funds to lower expected rates of return to a more realistic level is reasonable, but also means that the state will have to pay even more now to stay on its funding plan,” said the federation’s president, Laurence Msall. “Staying in an actuarially sound plan is one step to limiting the cost of these plans to current and future taxpayers. Illinois needs to continue to explore all options, including a constitutional amendment clarifying that the pension protection clause applies only to accrued benefits and not future benefits.”

The action by the TRS board, which oversees the largest of the five funds, is part of national trend to reflect lower expected investment returns.

The State Employees’ Retirement System of Illinois, the second largest state fund, lowered its assumed return rate to 7% from 7.25% in July, and changed other assumptions about life expectancy and demographics. SERS actuaries said based on the fiscal 2015 valuation the state would face a $323.2 million increase in a roughly $2.1 billion payment.

Much of the higher payment is due to the change in life expectancy with the lower return rate accounting for $70 million of the higher contribution.

TRS actuaries said if a 7% rate of return was in place when the latest actuarial figures were calculated, the state would have an owed an additional $421 million on top of a $3.9 billion.

TRS executive director Richard Ingram suggested the board might revisit the rate and consider lowering it even further next spring.

Rauner spokesman Lance Trover said the TRS vote further “underscores the need for real pension reform in Illinois. The continual need to ask more and more from taxpayers proves yet again the current pension system is fatally flawed and must be changed.”

The Judges’ Retirement System lowered its investment assumption in July to 6.75% from 7% and the General Assembly Retirement System took similar action in April.

The State Universities Retirement System lowered its discount rate to 7.25% from 7.75% in June 2014 and is not currently considering any further action.

The Illinois Auditor General’s office in December issued a report citing the state’s actuary, Cheiron, that said three of the state funds’ interest rate assumptions were too high.

“For three of the systems (TRS, SURS, and SERS), Cheiron recommends the boards consider lowering the interest rate assumption next year and develop the rate taking into account the negative cash flow of the systems,” said the report.

For fiscal 2015 all the funds’ return rates fell short of assumptions. TRS experienced a 3.9% gain, SERS a 4.7% gain, SURS a 2.9% gain, JRS a 4.6% gain, and GRS a 4.2% gain. The state smooths investment return results over five years.

Investment results have weakened since with SERS’s portfolio losing 3.2% for the first six months of fiscal 2016, according to the minutes of its July meeting. TRS’ 30-year return for the fiscal year ended June 30, 2016 was 8.2% but the return for fiscal 2016 was just 0.1%.

Poor returns have been a driver of the rise in the state’s unfunded pension liability tab to reach $113 billion, for a funded ratio of 40.9%.

From fiscal 2001 through fiscal 2015, the state system’s unfunded liabilities increased by $86 billion, according to the Illinois Commission on Government Forecasting and Accountability’s last pension report. Based on a market value, the liabilities are at $111 billion with a funded ratio of 41.9%.

“The main factors for this increase in unfunded liabilities were actuarially insufficient employer contributions, changes in actuarial assumptions and lower-than-assumed investment returns over 5 years, along with other miscellaneous actuarial factors,” the nonpartisan commission wrote.

The impact of the funds’ assumption changes on state payments won’t be known until the fiscal 2018 payment is set. Under the funding schedule established by lawmakers in 1995, the state is required to make contributions as a level percent of payroll in fiscal years 2011 through 2045.

The contributions are required to be sufficient, when added to employee contributions, investment income, and other income, to bring the total assets of the systems to 90% of the actuarial liabilities by fiscal year 2045. Each system is required to certify the amount necessary for the next fiscal year by November 15 of the current fiscal year, for inclusion in the state’s next budget.

The assumed rate of return impacts the contributions because it’s used to calculate the present value of future pension obligations. Reducing the so-called discount rate increases the present value of future commitments to employees and retirees and results in higher statutorily required state pension contributions.

The schedule has faced stinging criticism for its backloaded structure. The state settled fraud charges brought by the Securities and Exchange Commission for misleading investors over the health of the pension funds because of flawed schedule.

More than half of the 127 large public pension funds surveyed by the National Association of State Retirement Administrators have reduced their return assumption since fiscal 2008 and the average rate as of February 2016 was 7.62%, according to the Civic Federation report.

A look by Merritt Research Services LLC at the fiscal 2015 fiscal results of local governments found the average 2015 city pension plan discount rate was 7.21% and the median 7.5%.

“Public pension discount rates have been tweaking down over the past few years as a number of cities have modestly lowered their assumptions” by a quarter to a half percent, Merritt president Richard Ciccarone wrote in the piece published on MuniNet Guide.com.

Pew Charitable Trusts’ latest pension review in August highlighted a $934 billion gap in state-run systems based on fiscal 2014 results. It was slightly improved from the previous year but is expected to rise to more than $1 trillion because the 2014 results don’t reflect weaker investment returns in fiscal 2015 and negative returns for some in fiscal 2016.

While lower assumed rates raise the funding burden on Illinois, they more accurately reflect a fund’s health and prospects going forward.

“Putting off the pain doesn’t change the reality…the longer it takes for solutions the more painful and expensive those solutions become,” Ingram said ahead of the TRS vote.

Illinois lawmakers have said they hope to take up pension reforms along with a budget fix early next year after the November elections are behind them. They are expected to exclude retirees while asking current employees to accept changes that would ease the state’s burden in exchange for a new benefit.

Rauner has also proposed smoothing over five years any changes in assumed return rates.

Some also support putting a constitutional amendment to voters, borrowing to pay down the liability, and re-amortizing the current payment schedule adopted in 1995.

Lawmakers previously enacted pension reforms that cut benefits and raised employee contributions but the Illinois Supreme Court voided the changes in May 2015 as a violation of the state constitution’s pension clause.

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