Updated: Oct. 1, 2017
Issue: In 2012, the TRS Board of Trustees approved a resolution which acknowledged that due to evolving circumstances that call into question the General Assembly’s ability to meet the existing statutory plan to fund TRS, drastic changes are needed to maintain the long-term viability of TRS and the other state pension systems.
Discussion: The Trustees directed TRS Executive Director Dick Ingram to inform TRS members, organized labor, legislators and other government officials that growing state budget deficits could lead to insolvency for TRS unless meaningful changes are made in the current pension funding mechanism. There are five key elements to “meaningful” pension reform.
According to projections from the Governor’s Office of Management and Budget, the state’s budget deficit is approximately $8 billion in fiscal year 2017 and may grow to $14 billion in a decade without systemic changes to the state’s fiscal practices. Pension costs are expected to grow by 73 percent during this period of time to $16.3 billion.
This bad budget news is putting real pressure on legislators to make substantial cuts in the state’s budget, which in FY 2015 totaled $69.8 billion. One target many legislators have mentioned is a reduction in the statutorily-required contribution to the state’s pension systems. (The TRS share of that contribution in fiscal year 2017 is $3.99 billion.)
Prior to 2012, TRS always operated under the assumption that state government would follow the law and make its entire annual payment to the System. But for the last several years, given the position of state finances this assumption is no longer a certainty.
Sample “stress test” scenarios calculated in 2017 show that if the state reduced its annual contribution to TRS in the future and investment returns are less than estimated, under the worst option TRS would become insolvent in 2036 when benefit obligations would exceed assets. Under the best option TRS “treads water” indefinitely with less than 60 percent of the assets needed to pay its long–term obligations. Here are three sample stress tests:
- The original TRS FY 2018 contribution of $4.56 billion is paid in full and that contribution level grows by 2 percent in each year thereafter, TRS is less than 60 percent funded in 2045, but “treads water” indefinitely.
- If only 75 percent of the TRS FY 2018 contribution of $4.56 billion is paid — $3.42 billion — and that contribution level grows by 2 percent in each year thereafter, and long term investment returns are 6 percent instead of the projected 7 percent, then TRS is insolvent in 2040
- If only 75 percent of the TRS FY 2018 contribution of $4.56 billion is paid — $3.42 billion — and that contribution level grows by 2 percent in each year thereafter, and long term investment returns are 4 percent instead of the projected 7 percent, then TRS is insolvent in 2036
In order to keep TRS solvent over the long–term, the TRS trustees have said that meaningful reform of pension financing must be enacted to better balance expected revenues and anticipated benefit costs.
The five key elements to pension reform are:
1. Use only actuarially-based math to determine contributions and liabilities. The Illinois pension math dictated in the pension code artificially lowers the state’s cost of funding pensions. These laws supersede the true calculation of the state’s annual pension contribution. We need to calculate the cost in the way the rest of the world does it. Here is a breakdown of the differences:
Illinois “Political Math”
The state’s goal is to have only 90 percent of the assets on hand to pay all future obligations and maintain a 10 percent unfunded liability.
The state’s annual contribution is reduced each year by the amount of debt service needed to pay off the bonds sold over the course of the last decade to finance the state’s annual contribution.
The state’s goal is to reach 90 percent funding in 50 years.
Future savings over several decades from reform measures are counted now before they are actually realized.
TRS must retroactively “smooth” the fiscal effect of any changes made in the TRS assumed rate of investment return over a period of five years. The “smoothing” applies to any assumption changes from 2012 on.
Total state contribution for TRS in fiscal year 2018: $4.03 billion
Standard Actuarial Math
The state’s goal would be to retire the unfunded liability and have 100 percent of the assets on hand to pay all future obligations
The state’s annual contribution is not reduced each year by the amount of debt service needed to pay off the bonds sold over the course of the last decade to finance the state’s annual contribution
Obligations are amortized over a 30 year period
The annual cost of pensions to the state is based on what is needed to fund pensions now
Total state contribution for fiscal year 2018: $6.87 billion
2. Illinois must enact funding guarantees for the pension systems into law. A statutory funding guarantee ensures that all future state government contributions are made in full when they are due. Most other states operate with these guarantees and in Illinois, the Illinois Municipal Retirement Fund benefits from this type of mandated payment.
3. The financial inequities of the Tier II funding and benefit structure must be fixed. Current law requires Tier II members to pay 9 percent of salary. That contribution fully funds Tier II benefits and subsidizes Tier I benefits. The Tier II contribution is 50 percent higher than the Tier II benefit’s value, which is 6 percent of their pay. In 20 years, when Tier II members are a majority in TRS, the subsidies they pay may cause a reduction in the state’s annual contribution. Eventually, the state will not owe any annual contribution to TRS because the members will be paying the entire cost. This is fundamentally unfair to Tier II members.
4. Any solution enacted by the General Assembly must be uncomplicated and easy to understand and administer.
5. Any solution must adhere to the Illinois Constitution’s Pension Protection Clause. Article XIII, Section 5 of the Illinois Constitution reads:
“Membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”