The State’s Pension Crisis Isn’t About the Cost of Retiree Benefits — It’s About a History of Underfunding
What are the State’s Pension Systems?
Illinois has five state public pension systems: the Teacher’s Retirement System (“TRS”); the State Employee’s Retirement System (“SERS”); the Judge’s Retirement System; (“JRS”); the State University’s Retirement System (“SURS”); and General Assembly Retirement System (“GARS”).
According to the United States Government Accountability Office (“GAO”), to be considered healthy, a public pension system should have a “funded ratio” of at least 80 percent.[i] A “funded ratio” is determined by dividing a pension system’s assets by its liabilities.
At the end of FY 2022, Illinois’ five pension systems had a total of $109 billion in assets and $139 billion in total liabilities, for a funded ratio of 43.8 percent. This is significantly lower than the 80 percent threshold that the GAO considers healthy, and even lower than the 90 percent funded ratio the state is targeting. So how did we get here?
Illinois’ tax policy holds the answers as to why the state has had such difficulty funding its pension systems, and the issue has been compounding over the past forty to fifty years.[ii] Because of longstanding tax policy flaws, Illinois’ state-level fiscal system has historically failed to generate adequate annual revenue growth to cover the cost of providing the same level of public services from one fiscal year into the next.
The Structural Deficit: How it Contributed to Decreased Funded Ratios
This is known as a “structural deficit,” and it means that even when no public service programs are added or increased, the accumulated deficit grows annually. Eliminating the structural deficit would have required that elected officials, at a minimum, raise taxes to the level needed to support the inflationary cost of funding public services over time. That is so divisive politicians in both parties wanted to avoid it, which they did.
Rather than raise taxes, politicians chose to paper over the ongoing imbalance between revenue and service cost growth by intentionally underfunding the contributions owed to the pension systems, and using revenue that should have funded pensions to instead subsidize the cost of providing current services. Every year that Illinois did this, it grew the debt in the form of unfunded liabilities it owed to the pension systems — a debt it had to repay at some point with interest that was compounding annually.
Effectively, then, the state was borrowing against the contributions owed to the pension systems to cover its ordinary operating costs of funding core services like education and healthcare. Borrowing to spend on services simply isn’t responsible or sustainable. It’s much like a family using a credit card to pay for groceries, rent and utilities, and not being able to cover the balance.
Sure, this irresponsible practice helped politicians in both parties by temporarily hiding the structural deficit from taxpayers, but over time, it became the primary reason the state developed the significant unfunded pension liability.
By 1994, the state had so aggressively borrowed against what it owed in pension contributions that the overall “funded ratio” of the five pension systems was just 52.4 percent.[iii]
The Fix that Kicked the Can Down the Road
To address this problem, in 1995 the General Assembly passed, and Governor Edgar signed into law, P.A. 88–593, which is commonly referred to as the “Pension Ramp.”[iv] The Pension Ramp created a plan for repaying the debt owed to the pension systems. Supporters of the Pension Ramp claimed it would bring the pension systems up to a healthy funded ratio of 90 percent by 2045.
But, rather than represent a departure from irresponsible fiscal practices, the Pension Ramp — by design — made things worse. For starters, over the first 15 years, the Pension Ramp was in place, it required payments that were so low they not only failed to repay any prior unfunded liabilities that had accrued to date, but they were also well below the “actuarially required contribution” (“ARC”) needed to fund the new benefits being earned by then-current state workers.
So, rather than enhance the fiscal health of the pension systems, the 1995 Pension Ramp actually increased the amount of the unfunded liability Illinois owed to its five public pension systems by tens of billions of dollars and caused the funded ratio to decrease, rather than increase.
By 2003, it became apparent that pension contributions would not be adequate to ensure the pension systems had enough funding to pay out benefits over the long term. As a result, the State of Illinois issued $10 billion in pension obligation bonds under P.A. 93–0002.[v] Unfortunately, the state only used $7.3 billion of the $10 billion in total bond proceeds to retire existing unfunded liabilities owed to the pension systems.[vi] Because of the state’s ongoing structural deficit, decision-makers irresponsibly opted to divert the other $2.7 billion to cover current operating expenses — effectively continuing the practice of borrowing against what was owed to the pension systems.
As shown below, the aggregate funded ratio of the five state pension systems then remained relatively stable from 2004 until 2009, when investment losses incurred because of the Great Recession reduced the funded ratio to 39 percent.[vii]
So, after creating a payment schedule that was so inadequate on the front-end that it actually increased the debt Illinois owed to its pension systems, the Pension Ramp imposed an incredibly back-loaded repayment plan that called for annual increases in debt service payments — kicking the can down the road for future General Assembly to deal with.
Facing the Music
As shown in the next figure, the rate of growth in pension debt payments scheduled over the FY 2023 -FY 2045 sequence is the reason the Pension Ramp is straining the state’s General Fund fiscal capacity. The “normal cost” of funding future pension benefits being earned by current state workers, however, is clearly not the cause of the fiscal strain created by the Pension Ramp. The “normal cost,” or current cost, is the portion of the present value of the pension plan benefits which is projected to be paid out by the system for the fiscal year.
As indicated previously, for at least 16 years the contributions made to the pension systems under P.A. 88–593 failed to satisfy the Actuarially Required Contribution, or “ARC”. Basically, the ARC identifies how much should be contributed to a pension system in a given year, so that over the next 30 years: (i) any debt — that is unfunded liability — owed to that system is repaid sufficiently to hit the targeted funded ratio for that system; and (ii) the cost of benefits then being earned by current workers over said 30-year sequence is covered; all while (iii) accounting for the system’s cash-flow obligations to pay benefits to retirees.
A key component of the ARC is the normal cost of the state’s pension systems. Overtime, the failure to cover normal cost can lead to serious solvency concerns for a pension system. This is because assets that the systems should have invested, and thereby producing returns on investment for the systems, are instead being depleted to cover benefit payments due to pensioners.
This, coupled with the deliberate underfunding built into the Pension Ramp, are what drove the huge growth in annual pension payments that were scheduled through FY 2045, projected to culminate in a whopping $19.7 billion final annual payment.[viii]
Pension benefit levels, and salaries paid to public sector workers, on the other hand, had very little to do with either building the unfunded liability or the dramatically backloaded design of the Pension Ramp repayment schedule.[ix]
As shown below, even after accounting for the unexpected and significant increase in aggregate pension system assets realized from investment returns during FY 2021, the primary driver of the growth in the aggregate unfunded liability since the inception of the Pension Ramp in 1996 remains insufficient employer (i.e., state) contributions into the systems. In all, underfunding contributions account for $58 billion — or approximately 42 percent of the $139 billion in the aggregate unfunded liability across all five state systems increased since 1996.[x]
Illinois cannot sustainably resolve its pension funding crisis unless it finds a way to meet the pension payments and re-amortize the pension debt in a manner that’s both affordable and grows the funded ratio of all five systems annually.
Not all hope is lost, though. CTBA has for years proposed to re-amortize the Pension systems. However, each year there is little traction to do so. The longer the state waits, the more financially strained it will be in the future. CTBA’s upcoming report proposes a policy to the reamortize the pension systems that will reduce some of the fiscal strain on the state’s General Fund.
[i] “State and Local Government Retiree Benefits,” United States Government Accountability Office, January 2008, 2. https://www.gao.gov/assets/280/271576.pdf
[ii] CTBA, “Analysis of Illinois’s FY 2024 Proposed General Fund Budget,” May 2, 2023, https://www.ctbaonline.org/reports/analysis-illinoiss-fy-2024-proposed-general-fund-budget
[iii] “Illinois Public Employee Relations Report: Volume 31 Issue 3 — Summer 2014,” IIT Chicago-Kent College of Law and The University of Illinois School of Labor and Employment, September 2014, 8. https://www.nasra.org/Files/State-Specific/Illinois/IL%20pension%20history.pdf
[iv] State of Illinois, Illinois Pension Code 40 ILCS 5, (Springfield, IL: State of Illinois).
[v] Commission on Government Forecasting and Accountability. “Illinois State Retirement Systems Financial Condition as of June 30, 2021,” September 2022. https://cgfa.ilga.gov/Upload/FinConditionILStateRetirementSysSept2022.pdf.
[vi] Julie Bae, “Illinois State Retirement Systems: Financial Condition as of June 30, 2020” (Springfield, IL: Commission on Government Forecasting and Accountability, July 2021), 34, https://cgfa.ilga.gov/Upload/FinConditionILStateRetirementSysJuly2021.pdf.
[vii] Commission on Government Forecasting and Accountability. “Special Pension Briefing,” November 2022. https://cgfa.ilga.gov/Upload/1122%20SPECIAL%20PENSION%20BRIEFING.pdf.
[viii] Commission on Government Forecasting and Accountability. “Illinois State Retirement Systems Financial Condition as of June 30, 2021,” September 2022. https://cgfa.ilga.gov/Upload/FinConditionILStateRetirementSysSept2022.pdf.
[ix] Commission on Government Forecasting and Accountability. “Illinois State Retirement Systems Financial Condition as of June 30, 2021,” September 2022. https://cgfa.ilga.gov/Upload/FinConditionILStateRetirementSysSept2022.pdf.
[x] Commission on Government Forecasting and Accountability. “Special Pension Briefing,” November 2022. https://cgfa.ilga.gov/Upload/1122%20SPECIAL%20PENSION%20BRIEFING.pdf.
