Did Illinois Slay Its Pension Dragon?
Illinois' Democratic-controlled legislature on Tuesday passed a landmark pension reform bill, choosing to address the state's crumbling finances over strong public labor union opposition to cuts in retirement benefits.Tim Jones and Mark Niquette of Bloomberg also report, Illinois Lawmakers Approve Pension Fix After Years of Gridlock:
The bill addresses problems that have built up over decades in the nation's worst-funded state pension system, which is underfunded by $100 billion. The vote comes despite union threats to challenge pension reform in state court, based on claims it would violate a state constitution provision that guards against cuts to pension benefits.
Changes in the bill include reducing and suspending cost-of-living increases, raising retirement ages, and limiting the salaries on which pensions are based.
Championed by Democratic and Republican legislative leaders, the bill passed the Senate in a 30-24 vote and the House in a 62-53 vote after lengthy and at times emotional debate. It now heads to Governor Pat Quinn, who told reporters he hopes to sign the bill into law soon, although it will not take effect until June.
"I look forward to signing it," said Quinn, a Democrat. The vote in both houses, which required support from both Democrats and Republicans, was "a bipartisan victory for the state," he added.
Union opposition was a big obstacle to securing votes, said House Speaker Michael Madigan, a Democrat. "This was difficult because of the strength of the opposition and the intensity of the calls and contacts generated by organized labor for the Democrats," Madigan said.
With the state's finances buckling under a $100 billion unfunded pension liability, House Speaker Michael Madigan and others said the bill would save the state about $160 billion over 30 years and immediately reduce the unfunded liability by at least 20 percent.
Madigan noted that pension contributions already are eating up 20 percent of Illinois' general fund revenue. The cash-strapped state can no longer afford to pay for the retirement promises made to teachers and state government, university and college workers, he said.
Labor unions called on Quinn to veto the "unfair, unconstitutional bill. If he doesn't, our union coalition will have no choice but to seek to uphold the Illinois Constitution and protect workers' life savings through legal action," the union group We Are One Illinois said in a statement.
The measure will affect nearly half a million current and retired public sector workers, according to a union spokesman. Unions argue the law violates a state constitutional prohibition against diminishing pension benefits.
Illinois will not be the first state to face a legal fight over pension changes. Rhode Island, which restructured its state pension system in 2011, is defending the move in state court.
CHICAGO NEXT?
Senate President John Cullerton said he welcomes any court challenges to the constitutionality of the reform measures in the bill.
Cullerton also said he is committed to passing reforms to ease the pension burden on local governments in Illinois.
Chicago Mayor Rahm Emanuel has pushed for reforms of the state pension system in the face of a looming state-mandated jump in pension payments for two of Chicago's four pension funds. Emanuel has indicated he cannot push forward with reform of Chicago's pensions until statewide reform takes shape.
"The pension crisis is not truly solved until relief is brought to Chicago and all of the other local governments across our state that are standing on the brink of a fiscal cliff because of our pension liabilities," Emanuel said in a statement. "Without providing the same relief to local governments, we know that taxpayers, employees, and the future of our state and local economies will remain at risk."
The affirmative vote on state reforms came after a failed effort in the legislature's spring session, a summer of wrangling by a special legislative committee, and weeks of closed-door talks among the leaders. It also followed years of discussion and study, previous reform measures that provided limited improvements or failed to pass, and numerous downgrades of the state's credit ratings.
The measure offers some sweeteners for workers and retirees. Employees would contribute 1 percent less of their salaries toward pensions, while contributions from the state, which has skipped or skimped on its pension payments over the years, would be enforced by the Illinois Supreme Court. A limited number of workers would also have the option to choose a 401(k)-like investment vehicle for retirement.
In a preamble section, the bill lays out an argument seemingly designed to thwart a potential constitutional challenge. The state's finances are so squeezed by pension payments, the section argues, that Illinois has been forced to cut funding for core services such as health care and education. The preamble also alludes to Illinois' structural budget deficit, fueled by billions of dollars in unpaid bills spilling from one fiscal year to another.
Continued inaction on pension reform has hurt ratings on Illinois debt, with credit agencies warning of further downgrades, and investors in the U.S. municipal bond market are demanding higher yields to hold the state's bonds.
"Having considered other alternatives that would not involve changes to the retirement systems, the General Assembly has determined that the fiscal problems facing the state and its retirement systems cannot be solved without making some changes to the structure of the retirement systems," the preamble states.
Some lawmakers during the floor debates worried that Illinois could be in for another round of credit downgrades should the bill fail. Its passage could brighten the prospects for a $350 million bond sale Illinois has planned for next week.
"Any positive step will be embraced by the market," said Dan Heckman, municipals strategist at U.S. Bank, adding Illinois may still need more reforms or higher taxes.
Decades of pension shortchanging and years of political gridlock were shoved aside in six minutes when Illinois lawmakers -- first the Senate, then the House -- approved a $160 billion rescue of the worst-funded state pension system in the U.S.
The votes yesterday in the General Assembly provided a big step in the state’s effort to rehabilitate itself from years of mismanagement that led to the lowest credit rating of the 50 states, due largely to a pension shortfall of $100 billion.
While a legal challenge from unions has been promised, Democratic Governor Pat Quinn, who had repeatedly watched lawmakers ignore his calls to restructure the system, declared victory. Quinn has promised to sign the measure into law.
“This day will always go down in history as the day where the people of Illinois, through their elected representatives and senators, took action for the future,” Quinn said in a briefing for reporters after the vote. “The people have won. We have all won.”
If the measure survives a court battle, Illinois should emerge from worst-in-the-nation in pension funding status. While U.S. states have lost ground for five straight years in setting aside money for retired workers, Illinois was among five states where retirement-funding ratios fell at least 21 percentage points from 2007 to 2012, data compiled by Bloomberg show.
Go Time
The state Senate moved first, passing the measure 30-24. The House followed suit, capping almost three hours of debate with a 62-53 vote. The votes came after years of legislative frustration that produced larger shortfalls and bigger portions of annual state spending going to pay retirement obligations.
“We have a crisis; we have a problem,” said Representative Elaine Nekritz, a Democrat from Des Plaines and a member of the committee that developed the measure approved in Springfield. “We owe $100 billion. Illinois will be better tomorrow because of our actions today.”
Senator Kwame Raoul, a Chicago Democrat, said lawmakers had to act.
“Perfection is never achieved,” Raoul said from the Senate floor. “However, we have the worst unfunded liability in the United States of America and we can’t continue to be cemented into a stalemate.”
While many Republicans and a coalition of public-employee unions opposed the measure, they couldn’t block it. For the unions, a lawsuit is the next step, challenging the constitutionality of the pension changes.
“This is no victory for Illinois, but a dark day for its citizens and public servants,” said a statement from We Are One Illinois, a union coalition.
Constitutional Question
The vote followed days of lobbying that divided Democrats and Republicans alike. Unions that represent about 760,000 workers and retirees, in pledging to challenge the measure in court, claim it violates language in the Illinois constitution that says retirement benefits “shall not be diminished or impaired.”
Dan Montgomery, president of the Illinois Federation of Teachers, said opponents plan to make their legal challenge to the bill “as soon as we find it appropriate to be in court.”
“This so-called $160 billion of savings is illusory because this is not legal,” Montgomery told reporters. “We wanted to see a solution that would pass legal muster.”
The proposal agreed to by legislative leaders Nov. 27 was designed to limit annual cost-of-living allowances and raise the retirement age for some workers. That would produce the bulk of the $160 billion of savings over the next 30 years, according to the plan.
Too TinyLastly, Mark Peters of the Wall Street Journal reports, Illinois Passes Pension Overhaul:
To some Republicans, the measure didn’t go far enough in cutting costs.
“We don’t have time for small reform, but that is what is before us,” said Representative Jeanne Ives, a Republican from Wheaton. “This bill does not go big and it is not substantial or solid.”
Investors disagreed. The penalty on Illinois general-obligation bonds has declined since legislative leaders announced the tentative agreement last week. The yield spread on debt due in 10 years, relative to benchmark munis, fell to 1.7 percentage points Nov. 29, the lowest since August, according to data compiled by Bloomberg. A shrinking spread usually signals investor confidence that state finances will improve.
The most frequently traded Illinois pension-obligation debt changed hands today at an average yield of 6 percent, down from 6.1 percent yesterday, data compiled by Bloomberg show. On Nov. 29, it traded at 5.8 percent, the lowest since Aug. 1.
Sixth Try
Illinois plans to offer $350 million in general-obligation bonds next week in a competitive sale, John Sinsheimer, the state’s director of capital markets, has said. The governor said he hopes that rating companies and bond buyers will take note of the bill’s passage.
The bipartisan votes were born of the realization that the state couldn’t continue to run up deficits as its credit rating sank. Representative Darlene Senger, a Republican from Naperville, said Illinois would have been a laughingstock had lawmakers failed again to act.
It was their sixth attempt in 16 months to repair the system.
Legislators passed an overhaul of the state public-employee retirement system Tuesday, cutting benefits for workers and retirees in a move that sets up a likely court battle with organized labor.Let me begin by stating flat out Governor Quinn is full of it, nobody has won anything because of the passage of these pension reforms. The unions are going to challenge this in court and they're right, the primary reason behind this colossal pension mess is decades of mismanagement by the state of Illinois which failed to top up public pension plans for years.
Supporters say the Illinois pension legislation is expected to save $160 billion and will fully fund the retirement system over 30 years.
"We're here today because the cost of our present state systems are simply too rich for the resources available," said House Speaker Michael Madigan, a Democrat.
Gov. Pat Quinn, a Democrat, is expected to sign the bill into law.
Illinois has seen its credit rating fall in recent years to the lowest among U.S. states as it has struggled to address a gap in its pension funds that is nearing $100 billion.
The measure also gives Chicago officials a template to follow as they move to address the city's own pension crisis; Chicago's credit rating is among the lowest for major U.S. cities.
"The pension crisis is not truly solved until relief is brought to Chicago," said Chicago Mayor Rahm Emanuel. "Without providing the same relief to local governments, we know that taxpayers, employees, and the future of our state and local economies will remain at risk."
The Illinois overhaul package relies on benefit cuts, including reducing the annual cost-of-living increase for retirees and raising the retirement age for younger workers.
But the bill also gives public-sector workers the right to take the state to court if their pension funds receive less from the government than what actuaries recommend, long a problem in Illinois. The legislation also sets up additional state payments into the system to boost funding in the years ahead.
The strongest opposition in recent days has come from organized labor, which argues the plan goes too far, and from conservatives, who believe it doesn't go far enough.
Passage of the bill came after legislative leaders from both parties reached agreement on the details last week.
Still, the floor debate in the House and Senate were rife with concerns over the legality of the measure. And while the measure passed, the margins were razor thin on legislation more than two years in the making.
Republicans such as U.S. Sen. Mark Kirk and Bruce Rauner, a businessman vying for the Republican gubernatorial nomination, have pushed back against the legislation, saying it doesn't save enough and won't fix the problem over the long term.
"Springfield politicians today voted to slap a small bandage on an open wound," Mr. Rauner said.
Meanwhile, public-sector unions say Illinois is addressing the pension system on the backs of their members even though the crisis stems largely from years of underfunding by state government. They plan to challenge the legislation in court after it becomes law.
"We are very confident the courts will reject this," said Dan Montgomery, president of the Illinois Federation of Teachers.
Unions had long argued that government workers shouldn't be punished for decades of mismanagement by state officials. But union leaders have seen support erode as concern over the state's finances grows and their sway in a statehouse dominated by Democrats ebbs.
The challenge has long been discussed by unions, with the state likely to argue that certain benefits aren't protected, particularly in light of the state's fiscal problems and certain concessions it makes in the bill.
Mr. Quinn has staked much of his tenure on righting the retirement system, making Tuesday's passage of an overhaul plan particularly important as he prepares to run for re-election next year.
The governor is seen as vulnerable in his bid for a second term, with a crowded field of Republicans vying to challenge him.
A poll conducted by Public Policy Polling in November showed 34% of those surveyed approved of Mr. Quinn's job performance.
"Today, we have won," Mr. Quinn said.
But fiscal mismanagement is only part of the story, albeit a big part. There are other problems with Illinois' public pensions. First, like so many other states, all stakeholders including unions held onto the pension rate of return fantasy, foolishly believing that they will magically consistently earn their 8% bogey on a sustained basis over many years.
That led to an even bigger problem, terrible investment decisions where public pension fund managers took on excessive risk in all sorts of exotic investments to attain their target return. Unfortunately, things didn't work out as planned. Three years ago, I asked whether pensions are the next AIG and got this response from Illinois Teachers Retirement System on my "death spiral" comments. In November 2011, I explained why Illinois' TRS is going for broke.
Things have gotten better since then. U.S. public pension assets recently hit record highs but that doesn't mean public pensions are out of the woods. Historic low interest rates and longer life spans are weighing heavily on pensions and some state plans are so chronically underfunded that no matter what they do to bolster their investments, they still need to implement major reforms to control pension costs.
The following key reforms are being proposed in Illinois:
— Raise the retirement age for people 45 and younger, on a sliding scale basis.Some of these reforms make perfect sense while others are flimsy or stupid. The retirement age needs to be raised to reflect the simple fact that people are living longer and the state should be sued if it skips pension payments. As far as capping the amount of salary on which pension benefits are based, they should make it illegal to spike pensions and use career average earnings to set these benefits.
— Guarantee the state will make its full annual contribution to the funds and allow the systems to sue if the payments aren’t made.
— Change the cost-of-living increase from the current rate of 3 percent, compounded annually, on the full annuity benefit. Retirees would receive increases at that rate only up to a certain amount of annuity benefit. Legislative leaders say the new structure would benefit lower-income workers who held their jobs longer. Employees also would miss some annual cost-of-living adjustments, depending on their age.
— Cap the amount of salary on which a pension benefit is based. In 2013, that amount would be about $110,000.
— Decrease the employees’ own contribution to their retirement funds by 1 percent.
— Provide workers the option of participating in a 401(k)-style defined contribution plan.
The cost-of-living increase clause is debatable but the one measure which I find stupid is participating in a 401(k)-style defined contribution plan. Why would public sector workers give up the benefits of defined-benefit plans to switch over to a defined-contribution plan, pretty much ensuring pension poverty? This is bad economic policy for the state of Illinois and they really need to drop the silly idea that defined-contribution plans are the cure-all to their pension woes.
Chris Tobe, author of Kentucky Fried Pensions and founder of Stable Value Consultants, went over the 2 big myths about Illinois pension reform:
You need current pain for current gain. This spineless plan promises mostly future theoretical gain, by future theoretical pain and changing history by clawing back earned benefits. From what I have seen it most likely will have a negative impact on cash flows in 2014-16, which is likely to force more downgrades of Illinois debt.Chris Tobe is right but he left out a third myth, namely, the passage of this "spineless plan" isn't going to make an iota of a difference because it fails to reform the governance of Illinois' public pension funds in any meaningful way. As I stated in my last comment on Wall Street's license to steal, unless states implement independent and qualified investment boards and start paying their pension fund managers properly, pension reform a hopeless cause.
Politicians are using the unions as whipping boys to take the heat off their own actions.
The first myth is the cause of the deficit. This money was borrowed from pensioners to create the illusion of a balanced budget every year for over 10 years. After 10 years of making half the mortgage and allowing the house to go underwater, they now say they cannot afford the house.
Public workers for the last 30 years were paid, most thought, a fair total compensation package which included salary, health care and a defined-benefit retirement system. I don't recall many legislators in Illinois or anywhere else claiming that a single teacher, policeman or firefighter was over compensated until now. If their pensions were too high, then perhaps their salary was too low.
The second big myth is that this liability can be fixed by altering future benefits and shifting everyone to a 401(k). This makes for much theater as labor fights to keep benefits and others fight to take them away. However the bulk of the liability is from taking from the modest past earned benefits of retirees and veteran workers and is totally unaffected by all this theater.
In fact I saw that this "reform" would free up over a $1 billion for spending and/or tax cuts, and cuts worker contributions by 1% of their pay, both of which makes things worse. Solvency is based on cash flows primarily in 2014, 2015, and 2016 and this reform hurts cash flow in the critical years.
That means this reform could actually lower credit ratings instead of raising them.
As public pension expert Alicia Munnell opined in my book, Kentucky Fried Pensions, “Fiscal discipline simply appeared not to be part of the state’s culture.”
There is no one in Springfield willing to regulate or enforce any fiscal discipline. The Feds also caved into political pressure and chose not to enforce this discipline, letting Illinois mislead municipal bondholders about their financial statements. The SEC wrote up a mild slap on the wrist, but since it involved no admission of guilt and not one dollar in fines, it actually enabled Illinois to continue bad financial practices as evidenced by this proposal.
Legislatures in places like Illinois and Kentucky attempt to deflect the blame to workers while covering up their own misdeeds and dig their states into even bigger holes. Unions do their job advocating for their members. By avoiding tough budget and taxing decisions, legislators aren’t.
There is no gain without pain, but legislators know any sign of pain will most likely result in them being kicked out of office.
So while Illinois' politicians pat each other on the back for slaying their pension dragon in a pathetic display of bipartisan pandering to bondholders, I would caution everyone to take a deep breath and come to grips with the fact that this plan won't really make a difference until they get the governance right.
Below, IFT President Dan Montgomery discusses the passing of the newest 'draconian pension theft' scheme known as SB1. Illinois' public unions should contact Bernard Dussault, Canada's former Chief Actuary, to help them argue their points in court (email him at bdussault@rogers.com).
Senator Kwame Raoul (D-Chicago) spoke with the media after the Illinois Senate approves SB 1, which outlines Illinois' pension reform. Watch the clip below. He's right, pension costs in Illinois need to come under control but he fails to mention why the situation spiraled out of control.
Finally, Detroit, once the symbol of U.S. manufacturing muscle, was given the authority to try to pare billions in debt and slash employee pensions in a federal court ruling that may have implications for distressed cities across the U.S (watch clip below). I warned you, Detroit's cries of betrayal will be heard all over the United States, starting with Illinois and Chicago.
Postscript: Wall Street likes the deal but is withholding the love for now. Maybe bondholders and credit rating agencies read my comment and weren't so impressed with the latest reforms.