Pension for Disaster

When tough “numbers” blogs enter the fray, some people’s eyes roll over. It’s dry, hard to understand and easily dismissed. That’s exactly what special interests want you to feel and how some of the most horrific practices become unchallenged parts of the body politic. It’s also how we get into the kinds of deficit messes we are in, how we have managed to accrue $2.7 trillion (yup, trillion) in unfunded pension debt within our state and municipal governments. And believe me, if you live in the United States, even where someone actually did take care of business, you will feel this anomaly big time in the not-too-distant-future. The feds often step in to save disasters.

The first element that deserves examination is the difference between how the private sector and the public sector determine and pay pensions. Pensions have been with us since the Revolutionary War, but the most recent mega-shift in pension laws occurred in 1974 with the Employment Retirement Income Security Act (ERISA), which effectively created rules for private sector pension plans and provided a layer of pension insurance on such plans. Pension planning had generally followed two paths: defined benefit plans (your pension paid you a predetermined dollar amount, sometimes with escalators, per pay period… mirroring a salary schedule) and defined contribution plans (fixed sums were deposited into a contribution account, and when you retired, you effective got paid out according to the values that accrued in that account). Individual 401(k)s and IRAs are defined contribution plans, by the way.

Clearly, defined contribution plans did not impose a fixed payment obligation upon retirement, since the account would rise and fall with the market. On the other hand, defined benefit plans placed a hard dollar value that had to be paid no matter how negatively the retirement funds might have been impacted by market conditions. The private sector, governed by ERISA, soon learned that defined benefit plans were just too dicey, too unpredictable and could easily result in under-funding if the deposited sums did not fare well in the investment markets. Most private sector plans moved into the safer world of defined contribution structures.

On the other hand, for state and local governments, since defined contribution plans mandated on-going defined contributions (which could not fall with hard economic times), and since the strongest unions today are in the public sector, the general rule of the day let this public sector avoid having to pay into a fund altogether and garner votes from union workers for generous defined benefit plans. A recipe for a very big disaster. But wait, there’s more. Not only were these plans more generous on retirement than private sector defined contribution plans, but they vested and began paying out after a relatively short period of time (20-30 years, regardless of age), particularly for police and fire employees (so-called “uniformed services”). Folks were retiring with full benefits in their 40s and stepping into another career until they really retired in their 60s or 70s. Unsustainable.

The federal government has the same kinds of pension habits, and believe me this is a huge part of our deficit problem, but they can just “print money” to fund what they have. This is not really a good answer but a big explanation of why our national debt has spiraled so far out of control. State and municipal governments do not have that luxury, so you can look at the various municipal bankruptcies filed in the last few years – places like Detroit, Birmingham and Stockton – and see exactly how much unfunded pension obligations to retirees motivated those filings. These cases are, however, just the tip of the iceberg, and federal law only provides statutory bankruptcy relief for municipalities (non-federal government units that are less than a state) and not states.

One state, Illinois, purportedly has accrued unfunded pension obligations in excess of $100 billion. “For years, even as financial analysts warned that the situation in Illinois had reached crisis levels, lawmakers in this Democrat-controlled state have wrestled with a vexing issue: how to cut pension costs without alienating labor unions, a key bloc for political support, while also staying within the limits of the State Constitution, which bars pension benefits from being ‘diminished or impaired.’ Many states have wrestled with mounting pension liabilities, but experts have pegged Illinois’s troubles as among the worst.

“The issue has proved to be a deeply contentious one in Springfield, the capital, and even among the state’s top Democratic leaders. At one point, the Senate passed a plan. The House passed a different one. And [Democratic Governor Pat] Quinn, for his part, announced that he was stopping paychecks to lawmakers until they agreed on a plan, a move that caused the lawmakers to sue the governor.

“With elections in 2014, the political stakes of repairing the pension system are rising. Mr. Quinn, who has wrestled with low approval ratings and is expected to face a serious Republican challenge in his re-election bid next year, has for several years held out a pension overhaul as an important goal. A year ago, he campaigned publicly for an overhaul with an orange cartoon snake he called Squeezy the Pension Python, though a legislative session at the time came and went with no solution.” New York Times, November 27^th. In addition to these massive obligations, Chicago alone has an estimated additional $19.5 billion shortfall in its pension funding.

Well, the Illinois state legislature has proposed a massive restructuring of its pension obligations, one that would conquer the $100+ billion pension deficit and create stability going forward. But given the state constitutional restriction against diluting state pension benefits, you can bet that there is going to be a massive challenge to these new structures by Illinois’ employees and their unions. Change is always threatening.

What are the specifics that will now work their way through the legislative process? “The proposal includes pushing back workers' retirement age on a sliding scale, a funding guarantee, a 401(k)-style option and reducing the employee contribution… [R]etirees would continue to receive the current 3 percent annual compounded cost-of-living increases, but they would only get that rate up to a certain amount of annuity payments, based on years of employment…  [T]he new way of calculating the increases would benefit low-income workers who worked longer…

“The funding guarantee allows retirement systems to sue Illinois if lawmakers don't make the full contribution to the fund each year… The plan also would require the state to put 10 percent of the money saved annually through benefit cuts back into the pension funds beginning in 2016. It also will redirect the money the state currently uses for pension bond payments into the retirement funds once those bonds are paid off in 2019.” Further, caps on pension benefits will impact some of the government’s highest paid officials, cost-of-living increases would factor in the total number of years employed, and workers under 45 would have to wait to retire. Huffington Post, November 28^th.

War is not pretty, and the state, like so many others, is caught between vested promises made in better times and constitutional restrictions, and the harsh economic reality that the private sector dealt with a long time ago. What happens in Illinois over these issues may well be the canary in the coal mine for pensions in the rest of the country.

I’m Peter Dekom, and there are so many more shoes to drop.