Are Public Pension Plans in Illinois Too Generous?
Posted by Jeffrey Brown on Sep 22, 2009
Filed Under (Retirement Policy, U.S. Fiscal Policy)
The Chicago Sun Times has recently had a series of articles about public pensions in Illinois. One of the recent ones – “Public pensions, fat retirements” – focuses on the 4,000 retired government workers that receive pensions of at least $100,000 per year. The article quotes several people saying things like “it’s both illogical and extraordinarily expensive” to provide such pensions and noting that public pensions are “extremely generous.”
There is no question that public pension funding in Illinois is in need of serious attention. For those that have not yet noticed, Illinois pension obligations are enormous – and this is primarily the result of many decades of irresponsible budget practices on the part of Illinois politicians who have consistently chosen to underfund pensions. In essence, the State has a history of not paying its pension bills, and future Illinois taxpayers will eventually have to ante up in a big way. This is an enormous problem, and one that needs to be addressed. I will focus more on the fiscal strains of pensions in future posts.
For this post, I simply want to comment on the debate about whether public pensions are really “too generous.” What exactly does this mean? (The short answer is that such statements are largely vacuous … read on).
Some people make such statements on the basis of comparing Illinois pensions to those of retirees in the private sector or in other states. This leads to a whole host of arguments from critics and defenders, such as the fact that Illinois public workers do not participate in Social security.
At the end of the day, however, none of these arguments are the least bit helpful in answering the question at hand. The reason is that pensions are only one part of the total compensation package. To the extent that labor markets in Illinois and the US more broadly are reasonably competitive, then workers are trading pension benefits against other forms of compensation, including wages.
Most economists believe that workers bear the cost of employee benefits in the form of lower wages. Let’s suppose a newly minted PhD has been offered positions as an assistant professor at the University of Illinois and at the University of Michigan. The academic labor market is pretty darn competitive, so the University of Illinois will only be successful at hiring this person if the total compensation package is competitive. The pension is one piece of that package, but there are numerous other factors at play as well. If we were to offer an individual a less generous pension, then the University would almost surely have to compensate this person in other ways, such as higher pay, more generous health benefits, more time off, or something else.
So when pensioners say the earned their benefits, they are right. Not only did they pay their own contributions into the system, but the state contributions (yes, the ones that never actually got made!) were also funded by these very same employees in the form of lower wages. In essence, state employees accepted lower wages in return for a promised future pension benefit.
If we believe we have the mix of compensation wrong, then let’s adjust this mix for future workers (we have to focus on the future because the impairment clause of the state constitution restricts our ability to do so for current workers). But let us not be so naïve as to think that we can cut pension benefits while holding all else equal.
So at the end of the day it really makes little economic sense to suggest that pensions are “too generous,” given that the pensioners paid for these benefits throughout their careers. The problem is not pension generosity - the problem is the politicians who could not keep their hands off the money.
In future posts, I will discuss in more detail how the above analysis changes when we consider two important factors. First, that in spite of a constitutional guarantee of pension benefits, participants don’t have complete confidence in the inviolability of their benefits. Second, that the complexity of the pension benefit calculations means that very few participants, taxpayers or policymakers truly understand the true economic value or costs of the benefits that are being provided. Stay tuned …
I’ve said it before (including in a face-to-face discussion with fromer Illinois Rep (and later Congressman) Timothy Johnson) that this problem would never have arisen if the Illinois legislture had done it’s job and met it’s legal obligations to fund the pension systems, instead of postponing it as they did. Blagojevic-type borrowing doens’t solve the problem either.
Legislators are supposed to be representing the citizens and make decisions and policies on behalf of the citizens. When elected representatives use tax dollars for other purposes than for the purpose they are legally obligated to, in this case for pensions for state employees, the beneficiaries of such an action by legislators are the citizens of the state. Having established this fact it is logical to expect that the citizens of Illinois pay back what they got at the cost of the state retirees. In other words tax revenues must be increased, whether they be income taxes or some other form of taxes.
Having worked for 30 years at less than market wages, KNOWING and COUNTING on my pension as part of my compensation package, I’m telling you pension’s are not high. Cuts in pension packages will require higher pay or lower standards in education in this state. Too bad we could not and still can not count on our legislators to do what they are legally required to do. Too bad those that used their clout to bend the rules at ILLINOIS are still able to head their parties, committees and house and senate, UNTOUCHED by the scandals. Who is worse, the politician that uses his power to break the rules or the staff worker who “goes along” out of fear of losing his livelyhood?
retired
I do not agree that the current Illinois state pension system is in any way out of line with what employers in private industry contribute. I am an inactive participant in the State University Retirement System (SURS). Throughout my years of employment in Illinois I contributed 8% of my salary to the pension system; SURS actuaries estimate that had the state contributed about 10-12% of employee salaries in a timely manner, it would have been sufficient to fully fund the “generous” benefits currently in place. So the question, then, is whether 10-12% of employee salary towards retirement is out of line with what private industry pays? Any reasonable and fair analysis would conclude that it is not. State employees in Illinois do not participate in Social Security, and the state does not have to pay the 6.2% OASDI contribution for its employees. So any private employer that participates in Social Security, and on top of that pays 4-6% of an employee’s salary into a 401K plan, contributes as much to employee pensions as does the State of Illinois. By the way, my current employer, a private university in Virginia, contributes 10% of my salary to a 401K-type plan in addition to Social Security, and this is a fairly standard arrangement for private educational institutions nationwide. Obviously, the real problem is that the state did not properly fund pensions in the past, and is still not doing so currently. This benefited Illinois taxpayers in the past, but it will cost them in the future when taxes will have to be substantially increased so that the state can pay its contractual obligations. Legally and morally, my claim on Illinois taxpayers is no less (and no more) than those of creditors who have purchased the state’s bonds.
Thanks Andrew, Retired, Subhas and George. Just to be clear in case my initial post was not … I agree that the blame falls with the politicians, and not with the pensioners. (And, by the way, this is *not* a self-interested claim on my part - I participate in the SMP plan of SURS which is 100% defined contribution - so I am not a participant in the underfunded DB plans). My main objective was to indicate that any statement about benefits being “too generous” misses the point entirely. The point is that - whatever the level of the benefit - it is the employees who have paid for those benefits in the form of reduces wages. The fact that our elected officials decided to spend that money on other items, rather than dedicate it to funding the pensions, is what got us into this mess - not pension generosity. The politicians have implicitly been taxing state workers to fund other spending, and now the politicians have run up an enormous debt to the pensioners. I agree with Andrew that pensioners’ claims on taxpayers is akin to creditors that purchased the state’s bonds. But I would go further — given the constitutional guarantee of benefits, the pensioners’ claims are even stronger than those of creditors …
In short, I think the Sun Times missed the underlying economics here altogether …
Retired…you hit the nail on the head. For us rank and file employees who were in it for the ‘long haul’, we knew exactly what we were in for. Lower than market wages (to a degree) with great health insurance package and a retirement plan that was not dependent on the markets. I know many others that make a lot more than I did doing similar jobs BUT the rub now is their money invested privately has declined to the point that they will be working many more years to get to the same point that I am. That said, the top/bottom differential in compensation between the higher paid folks and the rank and file is terribly out of wack. And for those to retire at ‘higher than market’ rates IMHO is not a good thing
A Harvard professor, I think her name is Warren??, says that Wall St is up to its old tricks of betting on risky investments. What do you think? What are deriatives and credit default swaps?
Given that the majority of retirees stay in Illinois after retirement, what most articles on pensions fail to say is that for every dollar paid to the retirees, an amount greater than that comes back to the state in spending, etc, by the retirees. I think that’s a pretty good return on the state’s “investment” in its spending on pensions!
Robert,
The person you are referring to is Elizabeth Warren, a professor at Harvard Law School who studies bankruptcy, credit markets and the like. I (and or other faculty who post to this blog) will have more to say about complex financial securities in future posts. For now let me just say that derivatives and credit default swaps - when used *wisely by investors that understand the risks* can be incredibly useful tools that help to efficiently spread risk around the economy. Where things go wrong is when large institutions load up on them, create a lot of systemic risk, and then expect the taxpayer to come to the rescue when things go south. There are serious issues relating to the optimal regulation of these securities, but we should not start from a presumption that these products necessarily imply that Wall Street is doing something improper or bad.
I hope that whoever is posting these great facts on our pension is also submitting them to the newspaper, especially the Sun Times, so that more than just a few employees who already agree are reading this good information, thanks.
The problem is not pension generosity - the problem is the politicians who could not keep their hands off the money. excellent-this comment says it all
This blog is most appreciated.
For comparison purposes, the retirement benefits at Michigan State University - and thousands of other higher ed institutions - are provided thru TIAA-CREF. At MSU, each employee contributes 5% of their gross pay to a TIAA-CREF retirement account, while the University contributes 10% to same. Yes, the university contribution is double the employees’. The growth effect of that 15% total annual contribution over 25 years or more is extraordinary, though as stated above, the plan is self managed. (e.g. Anyone who had a large share of their TIAA-CREF funds in equities last Fall lost a huge portion.) Then again, TIAA-CREF offers substantial advice to participants regarding asset allocation versus age and years of service.
The irony is, a defined benefit plan such as the Illinois system should offer greater security than a defined contrib. plan like MSU’s, but the irresponsible politicos and spend-happy denizens of the state capitol have made all of us in the Illinois retirement systems wish we were in TIAA-CREF. Sad situation.
Thanks Terry for the thoughtful comments. As a new TIAA Trustee, I am delighted to hear your positive views on TIAA CREF. Unlike the state legislature, TIAA CREF is motivated by one and only one thing - the best interests of the participants. It is too bad that those in charge of funding public pensions don’t have the same mindset!
It’s about time someone pointed out that those of us who remained employed in public service earned below market average! The private sector would have paid me about 25%-30% more than what I earned at the university. They would not, however, have given me a pension system upon which I could count, extra vacation and sick days, and very good insurance benefits. The retirement and benefits package is what kept me loyal to the institution for more than 20 years. During my entire tenure with the university and now, during my retirement, I have found SURS to be an excellent, caring organization. I will tell you, my pension is nothing about which to boast !
It’s a sin that the Sun Times can paint all state retirees with such a broad brush. A few individuals have manipulated the system, and now the other 99% of us, many who have a pension below federal poverty levels, must endure the the criticism of an organization that buys its ink in barrels.
In response to Terry Ruprecht about TIAA, I also get some pernsion funds from TIAA-CREF because of prior teaching at a member isntitution, and then working for three years at a non-profit vested with them.
Did you know that TIAA lost 40% market value of its funds during the past year? Compare that to SURS which lost 29%.
My experience with TIAA-CREF is that it is a poorly run organization with inexperienced people givign the wrong advice.
Top sum it up about TIAA-CREF: I’m less than impressed (and that’s putting it mildly).
You commented on only the “Liability Side of the Public Pension Mess…Yet, an additional and very important element is left out…Investment Management of Pension Fund assets…this generates the annual resources to meet annul pension payouts.
Typically, an annual “hurdle rate of return” is needed each year just to sustain the payment of “current year’s pension payouts to current year’s pension fund investment income”. The typical hurdle rate of return is 7% per year. This needs to be earned from better investment fund management.
We all should understand that under Ill Pension Code provisions many, many city and municipal funds for police and fire, Article 3 & 4 funds, have ineffective “permitted investment guidelines”.
Many funds are legally obligated under the ILL Code to keep nearly 60% of assets in US Treasury/Agency type securities that are paying interest rates of only 2-3%. And, the balance of 35% or more of fund assets are typically in “growth stock” mutual funds that pay hardly any dividend income. Hence, when the stock market is flat to lower like its been since year 2000, and the Federtal Reserrve has maintained low interest rate policy that keep Treasury securities at low yields…it is virtously impossible for a Fund to hit a minimum 7% annual hurdle rate of return.
Without being able to hurdle return rates on Fund income, Fund assets are imploding as pension payouts exceed Fund income.
This Code needs to be changed and I have provided a detailed discusion on this in my White Paper offered on http://www.PensionFundRescue.com Plse Click to the site and Download: “Undefunded Public Funds…It Can Stop Here”. If you are a Member of the Ill Public Pension Fund Association http://www.IPPFA.org you can access the White Paper under tab What’s New.
In summary, it may be a lot more helpful at this time to review the “entirety of the pension fund problem” that includes actions to boost pension fund annual income to Hurdle Rates of return…7% minimum. Chuck Dushek
You commented on only the “Liability Side” of the Public Pension Mess…Yet, an additional and very important element is left out…Investment Management of Pension Fund assets…this generates the annual resources to meet annual pension payouts.
Typically, an annual “hurdle rate of return” is needed each year just to balance the payment of “current year’s pension payouts to current year’s pension fund investment income”. The typical hurdle rate of return is 7% per year. This needs to be earned from better investment fund management.
We all should understand that under Ill Pension Code provisions many, many city and municipal funds such as police and fire, Article 3 & 4 funds, have ineffective “permitted investment guidelines”.
Many funds are legally obligated under the ILL Code to keep nearly 60% of assets in US Treasury/Agency type securities that are paying interest rates of only 2-3%. And, the balance of 35% or more of fund assets are typically in “growth stock” mutual funds that pay hardly any dividend income. Hence, when the stock market is flat to lower like its been since year 2000, and the Federal Reserve has maintained low interest rate policy for years, that keeps Treasury securities at low yields…it is nearly impossible for a Fund to hit a minimum 7% annual hurdle rate of return using growth stocks and Treasuries.
Without being able to achieve hurdle return rates on Fund income, Fund assets are imploding as pension payouts exceed Fund income and Fund assets are being cashed in to meet pension obligations.
This Code needs to be changed and I have provided a detailed discussion on this in my White Paper offered on http://www.PensionFundRescue.com Plse Click to the site and Download: “Undefunded Public Funds…It Can Stop Here”. If you are a Member of the Ill Public Pension Fund Association http://www.IPPFA.org you can access the White Paper under tab What’s New. I am a Member of IPPFA.
In summary, it may be a lot more helpful at this time to review the “entirety of the pension fund problem” that includes actions to boost pension fund annual income to Hurdle Rates of return…7% minimum. Chuck Dushek
George,
I’m afraid you are comparing apples to oranges. First, to be clear, the TIAA general fund did not come anywhere close to losing 40%, as it avoided the worst of the subprime debacle and the general fund is not invested heavily in equities. Yes, many of the CREF equity funds lost significant value, but given that they are in fact stock funds, one has to expect that they will lose value when the market crashes. The SURS returns you quote are from a diversified portfolio of stocks, bonds, and other assets. If one wishes to compare the returns, it is important to first condition on the asset class …
Chuck,
Thanks for your comment. I can certainly agree with your statement that “it may be a lot more helpful at this time to review the ‘entirety of the pension fund problem’.” But allowing a greater equity allocation is not the answer. Indeed, given that the liability side of the balance sheet is constitutionally protected and known with a high degree of certainty, one could make a pretty good case for suggesting that asset-liability matching using relatively riskless assets would be a better strategy. Of course, one cannot do a very good job of asset-liability matching when the assets are so much less than the liabilities! But to suggest that we can invest our way out of a funding problem is to ignore the substantial funding volatility that would result. Unless you believe that long-run stock returns are positive correlated with long-run wage growth for state employees and thus provide some hedge, simply investing in a higher expected return portfolio will increase both expected returns and risk. There is no free lunch in the equity premium …
Jeff
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http://www.youretirementstrategies.co.uk/pension.php
The Illinois participants that contribute to such DB plans seem to be running somewhat of a similar risk that 401(k) participants have… they’re counting on an underfunded DB plan as their source of retirement income. A question I have is.. Can the PBGC bail out state plans such as this?
Amanda,
The short answer is that state and local public pensions plans are not covered by ERISA. Therefore, they do not pay premiums to the PBGC, and the PBGC does not insure them. So either state and local governments are “on their own” to solve the funding problem, or Congress would have to pass special legislation to bail them out using federal tax dollars.
Jeff
I would like to refer to this quote from the initial post…”The problem is not pension generosity - the problem is the politicians who could not keep their hands off the money.” I agree with this evaluation, but question why there is no regulation to ensure that state public pensions are not significantly underfunded. It seems simply illogical to not have a minimum funding requirement. Additionally, I am confused as to why there is no “watchdog” or governing body to ensure that politicians have limited ability to access to this money.