Not All Pension Problems Were Created Equally

Eric Madiar wrote an interesting op-ed that reviews the state's long record of under-funding its pension systems. If you're following the Illinois pension crisis, you simply can't ignore Eric Madiar.

Eric is the chief legal counsel to Senate President John Cullerton. He has applied his keen mind toward addressing the state's pension funding crisis by seeking out reforms that are more likely to be deemed constitutional. A considerable amount of his time was spent researching archives of the 1970 Constitutional Convention to ascertain the original intent behind the "impairment" clause. 

While some disagree with Eric's conclusions, I can't think of a single person who questions the results of his deep water dive into the history of the constitution's "impairment" clause. Here's Eric's take on why the framers, informed by history, opted to insert the clause:

In 1917, the Illinois Pension Laws Commission warned leaders that the retirement systems were nearing “insolvency” and “moving toward crisis” because of the state’s failure to properly fund the systems. It also recommended action so that the pension obligations of that generation would not be passed on to future generations. 

The warning and funding recommendation went unheeded, as did similar warnings and recommendations found in decades of public pension reports issued before and after the pension clause was added to the Illinois Constitution in 1970. 

For decades, these reports consistently warned the public and lawmakers of the dire consequences of the state’s continued underfunding and of the significant burden unfunded pension liabilities posed for taxpayers. They advised that the pension clause bars the legislature from unilaterally cutting pension benefits of retirees and current employees. 

Indeed, one of the clause’s purposes is to prevent the state from reneging on its pension obligations during a fiscal crisis because of the burden imposed by unfunded liabilities. The clause was added at a time when the pension systems were no better than they are today.

And as it turns out, Illinois has had run-ins with the bond houses before:

These reports also reveal that as early as 1979 Moody’s and Standard and Poor’s advised Illinois that it would lose its AAA bond rating if it did not begin tackling its increasing unfunded pension liabilities. 

Further, a 1985 task force report noted that Standard and Poor’s reduced its bond rating for Illinois from AAA to AA+ because of the state’s “deferral of pension obligations,” and that another rating agency viewed Illinois’ pension funding as a future financial “time bomb.”

And his conclusion:

Given this well-documented history, it’s extremely hard to legitimately believe Illinois’ current situation is so surprising that the state constitution can be ignored and pension benefits unilaterally cut. As noted in my previous legal research, the pension clause does not support such a result.

I've written a previous post about why it's imperative to the broadest interests of the state that the Illinois Supreme Court find SB 1 to be constitutional. Go read that post for the argument, which is rooted in utilitarianism.

Suffice it to say, much of the funding crisis facing the state pension funds has resulted from deliberate under-funding. But what if we had a pension system that was eroding despite substantial funding increases? And what if that system was failing in large part because of severe structural imbalances and inefficiencies? And what if these structural imbalances threatened not only insolvency, but a combination of higher taxes and cuts to critical services in order to pay pensions?

The municipal police and firefighter pension funds meet these criteria and their problems need to be clearly distinguished from those that beset the state funds. Let's review some of the key data points:

• The overall pension payments to retired police officers and firefighters are escalating at an alarming rate. In 2012, $771 million was paid to 16,054 police and fire retirees. That is a 108% increase from payments made in 2004, which totaled $371 million over just 11,730 retirees.

• In 2000, the average funding levels for the municipal public safety pension funds were 74% (police) and 77% (fire). By 2012, these average funded ratios had declined to 56% for both the police and fire funds.

• Despite the funding level declines, employer contributions have risen dramatically and will continue to increase in the years to come. In 2004, employers contributed $109 million into the firefighter pension funds and in 2012 that contribution more than doubled to $290 million. In 2004, employers paid $138 million into the police pension funds and that number more than doubled to $339 million by 2012.

*Statistics from Illinois Department of Insurance (excludes Chicago)

In the case of the police and fire systems, more money is not solving the problem. The local funds are eroding based upon a confluence of factors aligned against their success.

I concluded the following with respect to the municipal police and fire pension crisis in the March issue of the Illinois Municipal Review:

Recent pension reform efforts have been accompanied by the blame game. This unhealthy dynamic results in harsh rhetoric and bitter accusations. And it resolves nothing. An honest analysis recognizes that all parties involved with the municipal police and firefighter pension funds bear some level of responsibility for the current problems. 

In some cases, cities have not made their full actuarial contributions. Public safety unions have made the pension systems more expensive through the pursuit of higher benefits. Previous General Assemblies have sought to accommodate the public safety unions by voting to increase the benefits without providing municipal governments with revenue to offset the higher costs. Local municipal police and fire pension boards have not been able to generate the assumed rate of investment necessary to keep municipal employer contributions from increasing. 

The dramatic growth in unfunded municipal pension liabilities was created collectively. Stabilizing the funds and avoiding the undesirable consequences of inaction will require collective solutions.  

Municipal governments and local taxpayers have a necessary interest in keeping employee pensions affordable. There’s only so much revenue that can realistically be raised to fund municipal government. Our police officers and firefighters have an interest in ensuring that the pension funds that pay their retirement benefits are viable into the future. All parties should commit to fixing the problem, not the blame.

The key takeaway from this post should be that not all pension crises were created equally. The framers of the 1970 Constitution were obviously concerned about the practice of deliberate under-funding as the principle threat to the pension funds and their participants. Under-funding is not the principal cause of the erosion of the police and firefighter pension funding levels statewide. It's been a contributing factor is some instances, but certainly not the sole cause of the problem. 

It's essential to recognize that the problems besetting the police and firefighter funds are the fruits of a very poorly designed system that was never appropriately modernized. We can't fix a deeply flawed system simply by throwing more money into a sinkhole. Arguments asserting that we should simply pump more money into the police and fire systems should be understood for what they are...demands for tax increases. That would be a slap in the face to the taxpayers. We all deserve better.