Illinois legislators pass pension reforms

By Matthew Heimer

The Illinois state legislature voted today to pass a complex overhaul of the state’s fiscally shaky public-employee pensions. The bill, which passed with bipartisan support and is backed by Gov. Pat Quinn, a Democrat, will enact a combination of retirement-age increases and caps on  inflation adjustments for teachers, university staff and other public-sector retirees, along with other measures aimed at repairing one of the country’s most dysfunctional pension systems.

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U. of Illinois staffers will have to wait longer to retire.

The measure passed by relatively narrow margins, a reflection of the bill’s unpopularity among labor unions on one side and conservative Republicans on the other.
If the overhaul works as its drafters intend, the reforms will cut pension spending by $160 billion over the next 30 years, and the state’s pensions will be fully funded by the year 2044. It comes as many state and municipal governments struggle to come to terms with their pension expenses; earlier the same day, a federal judge ruled that Detroit could cut city employees’ pension benefits as part of a Chapter 9 bankruptcy proceeding.
Illinois’s state pension systems currently cover around 200,000 retirees and more than 350,000 current government employees, including most of the state’s public-school teachers outside of Chicago. (Chicago teachers have their own pension fund.) According to the Illinois Retirement Security Initiative, a think tank affiliated with public-sector unions, the average Illinois government retiree gets a pension of a little over $39,000 a year.
Many states’ public-employee pension programs are underfunded (see our recent piece on the 10 most threatened state pension plans). In several, including Illinois, legislatures spent much of the 1990s and 2000s putting less cash than they should have into their pension funds, hoping that exuberant stock market returns would make up the difference. (We presumably don’t need to tell you how that worked out.)
But Illinois’s system is widely considered the worst of the bunch. Taken together, the state’s five public-sector pension funds have only enough assets to cover about 45% of liabilities. What’s more, the inability of the state’s political classes to get their house in order has spooked the credit markets. Illinois now has the lowest credit rating of any state, and interest rates on the state’s bonds are 173 basis points higher than the average for AAA-rated municipal bonds, according to the research firm Municipal Market Data—an extra burden that siphons money away from other public projects. The state’s struggle to reform its system also spawned one of the nation’s more unusual political mascots: Squeezy, the Pension Python.
Illinois’s reform bill has one hallmark of a classic compromise: It has something in it to displease partisans on both sides of the debate. Conservatives argue that the bill doesn’t do enough to cut retirees’ future benefits, and they note that it commits the state to continuing to make fairly large payments to the pension fund, lowering the odds of the state being able to cut taxes or invest elsewhere in the future. Some Republican legislators had argued in favor of replacing the entire system with a 401(k)-like defined-contribution plan. (For another critique of the proposal, see this column by MarketWatch RetireMentor Chris Tobe.)
Public-sector employees and unions, meanwhile, have opposed the bill, arguing that it amounts to a steady ratcheting down of their compensation. Many protest that the new restrictions on cost-of-living adjustments will erode their buying power after they retire. The bill’s changes to its COLA rules will be applied to current retirees, not just future ones; that increases the odds that the overhaul will wind up in court, since Illinois’s state constitution can be interpreted as saying that retirees can’t be deprived of retirement benefits they’ve already accrued. (Indeed, in remarks to local reporters, Illinois Federation of Teachers President Dan Montgomery called the legislative overhaul “theft” and “blatantly unconstitutional.”)
The full text of the bill – all 327 pages of it—can be found here. Here are some of the key provisions.
Limiting COLAs. The bill’s sponsors say this is the single-biggest money saver in the reform package. Under legislation passed in the 1980s, most current Illinois retirees get a 3% annual COLA, regardless of where inflation stands. (That was more or less in line with inflation at the time, but in more recent years, with interest rates low, it created a growing financial strain; the Social Security COLA, in contrast, has been lower than 3% in 15 of the last 20 years.) The new law would leave that rate in place, but it would cap the base amount of a retiree’s annual pension to which the COLA applies, typically at $1,000 per year of service. This would have the effect of protecting the COLA’s value for lower-paid workers, but it would also mean that people who received bigger pensions would probably lose some ground to inflation.
Raising the retirement age: Workers who are currently age 45 or under would see their retirement age rise by up to five years. (The younger they are today, the higher the age will rise.) In many cases, that’ll mean an increase in the full retirement age to 60, from 55. (Nationwide, the average retirement age is 61, according to a recent Gallup poll.)
Giving funding requirements more teeth. The legislature would commit to contributing a set amount to the pension plans each year, and public-sector unions would have the right to sue if the state fell short of those commitments.
Reducing mandatory contributions. This one looks like a spoonful of sugar to go with the medicine of cuts elsewhere: Required pension-plan contribution by the workers would decrease by 1 percentage point. According to Pensions & Investments, state employees’ contributions currently average around 5%.
Creating a 401(k) option. Some employees could choose to invest their retirement savings in a self-managed retirement plan, rather than pooling it with the state retirement funds.