On March 10, State Treasurer Alexi Giannoulias talked to the Joint Committee on Government Reform about a plan he put forward late last year that includes some of those reforms, as well as a suggestion that we merge all five pension systems.
As a member and former Republican spokesperson of the Senate Pensions and Investments Committee, and as former chairman of the House Personnel and Pensions Committee, I welcome Treasurer Giannoulias’ input and support for these reforms. Further analysis is needed, however, on his estimated savings of this merger plan.
In my discussions with the three investment boards, they have indicated that the Treasurer has not taken into account the full upfront costs of a merger and that actual savings will be much less that he claims. A December 1, 2008, press release from the Teachers Retirement System (TRS) states “The proposal, as did its predecessors from Governor Blagojevich’s Office, fails to account at all for transition costs in calculating the “savings” associated with the new proposal.”
Treasurer Giannoulias testified on March 10th that the upfront, one-time cost of transitioning to a combined investment board would be about $25 million. Primary transition costs would be selling some investments and buying others, so that all the systems’ investments would be compatible with each other and fit whatever new investment model is developed. TRS has indicated that it would actually costs “hundreds of millions of dollars.” Other states that have consolidated have had substantial costs.
The Treasurer said the ongoing savings would be $50-80 million per year, mostly in lowered investment fees. The pension systems think the ongoing savings will be just a fraction of what the Treasurer is projecting, so it would take “hundreds of years” to recoup the initial one-time consolidation cost.
The goal of cost-saving is good – and worth pursuing – but we must carefully examine the upfront transition costs and make sure it is a net-cost benefit, so we do not further burden the pension systems. Another idea is collaboration between the boards to save on investment and broker fees; however, because the systems have different needs, it seems to make more sense for the systems to continue to have diversified portfolios and be competitive.
The bipartisan Commission on Government Forecasting and Accountability, on which I serve, has contracted with a financial consulting firm to closely analyze the projected savings and costs of an investment consolidation. I look forward to thoroughly discussing the findings of this study when they are released in mid-April and other ideas during upcoming Commission and Senate Pensions Committee meetings.
Governor Pat Quinn has also thrown a proposal into the mix, announcing March 10 that he is considering a “two-tiered” pension system that would reduce benefits for future state employees, as a way to deal with up $73 billion in unfunded obligations to the five pension systems. Current state employees, teachers and other system members would not have their benefits affected.
Recent bad investment returns by state pension systems, on top of pension funding raids and bonding in the past few years, have lead to a crushing State budget impact that will be carried by taxpayers. Negative investment returns have pushed the State’s total pension debt to $73 billion or almost $30 billion more than we owed five years ago.
Driven by the recent history of bad returns and funding shortfalls, the pension funding formula set in Illinois law will require that next year’s budget include a record-high increase of more than $1.2 billion in the State’s payments over this year into our five retirement systems. This whopping increase will bring the total State payments, including pension bond debt service, to $4.5 billion next year. That’s about 15% of this year’s general funds budget. Six years ago, our pension payments were just 6% of the total budget.
The State is required by law to make annual contributions to five State retirement systems which have about 700,000 employees and retirees: the Teachers Retirement System (TRS, for all public school teachers outside Chicago), the State Universities Retirement System (SURS, for all faculty and staff at community colleges and public universities), the State Employees Retirement System and the two smallest systems, for judges and legislators.
Historically, more than half of the total income or revenue to these systems each year has come from the investment income (interest earnings) on the systems’ investments, with smaller contributions put in by the State and paycheck deductions from teachers and employees. This heavy reliance on investment income can mask future funding problems when investment returns are high, as they have been the past five years. But when the investment markets crash, required State contributions must make up much of the difference.
Investment returns for the budget year that ended June 30, 2008, (Fiscal Year 2008) averaged negative 5 percent. So far in the budget year that began July 1, 2008, (Fiscal Year 2009), through December 31, 2008, the systems are still in the red, averaging negative 25 percent in investment returns. Our pension systems have roughly half of their assets in the stock market, but also invest in bonds, real estate and other investments.
Recent negative returns have brought down the annualized return on the State’s 2003 pension bond proceeds to about 4%. This is a dramatic drop in less than two years from the previous annualized return of about 13%. The current 4% annualized pension bond investment return is well below the break-even rate of 7% needed to cover bond interest and the bond money spent for operating pension budget payments in 2003. The bond deal is now “under water,” which indicates that the State is losing its arbitrage bet made when the Governor and Democrat leaders sold $10 billion in pension bonds in 2003.
For the past two years, former Gov. Blagojevich proposed selling $16 billion in additional pension bonds. His most recent proposal passed the Senate in May 2008 – ALL Senate Republicans voting no – but failed in the House. If the State had sold these bonds as the former Governor wanted during the summer of 2008, we would have lost billions more in just six months. We are fortunate that the final enacted budget did not rely on bonding and instead fully cash-funds our pension systems according to the statutory formula, at a total cost of $3.2 billion this year.
With the recent negative returns, the State’s unfunded pension liabilities have risen to more than $73 billion. On top of this unfunded debt is the State’s $10 billion pension bonds sold in 2003. To date, the State has repaid only $50 million of these bonds, or less than 1% of the $10 billion sold five years ago. Adding in the pension bond debt, our estimated total pension debt is at an estimated $83 billion as of December 31, 2008.
The State’s funding ratio (the percent of liabilities covered by assets) also has dropped dramatically, from 62% at the end of FY07 to an estimated 40% as of Dec. 31, 2008, according to the Commission. A handful of states have lower ratios, though they have smaller total debt measured in dollars. Illinois has the biggest state debt in dollars – we are the worst funded in the nation.
My recommendations are pretty straight forward. We must stop borrowing and pay the required payments out of our annual budgets. Any pension payments that are deferred will cost taxpayers more to make up in the future. Not only should we properly fund our pension systems to protect the retirement benefits of our teachers and others in state systems, but funding in full now means less of a burden passed onto to future taxpayers.
I am pleased that Governor Quinn is joining me in the realization that we must examine pension programs as they affect future members. We must also examine a system like a private-sector 401k model in order to protect future members, our children, our grandchildren, and now our great-grandchildren.
By working together, lawmakers from both parties, Governor Quinn and Treasurer Giannoulias can put together the best ideas to craft a solution that will address Illinois’ pension debt and help restore integrity to the system. Commonsense reforms to the state’s pension systems would not only result in greater oversight, but would ensure the state’s investments are sound and taxpayer dollars are not being squandered.