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A quick analysis of the pension reform proposal

Friday, Nov 29, 2013

* I asked our resident pension expert commenter “RNUG” to take a quick look at the pension reform dot points distributed by the four leaders today. His thoughts are indented…

Funding schedule and method for certifying contributions: Establishes an actuarially sound funding schedule to achieve 100% funding no later than the end of FY 2044. Contributions will be certified using the entry age normal actuarial cost method (EAN), which averages costs evenly over the pensioner’s employment and results in level contributions.

    This is a good move but do we really need to be 100% funded? I understand that 100% sounds good to both the public and the bond rating agencies but I think it is over kill. Somewhere around 80% - 90% would be more than adequate.

Supplemental contributions: The State will contribute (i) $364 million in FY 2019, (ii) $1 billion annually thereafter through 2045 or until the system reaches 100% funding, and (iii) 10% of the annual savings resulting from pension reform beginning in FY 2016 until the system reaches 100% funding. These contributions will be “pure add on,” which means State contributions in any year will not be reduced by these amounts.

    Without seeing more details, I’m going to assume the add-on amounts in (i) & (ii) are the funds freed up by the expiration of the current pension bonds. Since that money is currently being paid out, this is “free” money as far as the GA is concerned. As to (iii), I have a problem with only 10% of the savings going into the pension funds. That tells me there are plans for the other 90% of the savings, either avoiding the need to keep the income tax at the 5% level or to cover expansion of other state program expenses or for new spending. Sorry to be a bit vague on where the 90% might go.

Funding guarantee: If the State fails to make a pension payment or a supplemental contribution, a retirement system may file an action in the Illinois Supreme Court to compel the State to make the required pension payment and/or supplemental contribution set by law each year.

    As I commented in one of the other posts, if this is the same as previous proposals, and it sounds like it is without being able to read the actual bill language, all this does is provide the retirement system with the right to sue and, maybe, giving retirees the right to sue the retirement system (not the State) if the retirement system fails to act. I don’t see it as consideration; at a stretch it might be considered a group right. It is not an individual right any retiree can exercise against the State itself, so I don’t think it meets the contract law definition of individual consideration. Brighter minds than myself may well disagree. And then there is the whole issue of it being a one sided and non-voluntary (coerced) choice.

Employee contribution: Employees will contribute 1% less of their salary toward their pension.

    That could be a valid consideration for changing the AAI for current employees, especially when you look at the GARS, TRS and SURS systems where they pay either 0.5% or 1% for their AAI (COLA).

Annual annuity adjustment (COLAs): Future COLAs will be based on a retiree’s years of service and the full CPI. The annual increase will be equal to 3% of years of service multiplied by $1,000 ($800 for those coordinated with social security). The $1000/$800 will be adjusted each year by the CPI for everyone (retirees and current employees). Those with an annuity that is less than their years of service multiplied by $1000/$800, or whatever the amount is at the time of retirement, will receive a COLA equal to 3% compounded each year until their annuity reaches that amount.

    This is where almost all the “savings” come from. For GARS, JRS, TRS, some SURS & some SERS, the $1,000 per year figure will apply. For most SERS and some SURS, the $800 figure will apply. Those figures are quite interesting. Assuming any average of 30 years for a teacher, their AAI will be based on $30,000. Assuming 35 years for an average state employee (SERS), their AAI will be based on a pension of $28,000. In other words, those numbers were picked by using some of the retirement system averages.

    While every situation will be different and there are lots of variations, we can calculate a couple of examples. Assuming a average 1.5 CPI to adjust the $800 amount, a SERS retiree with 35 years of service currently receiving $30,000 as an annual pension will receive about $47,000 less in total over the next 20 years when compared to the 3% AAI.

    If you double the current pension to $60,000, the diminishment really kicks in; that retiree would receive about $330,000 less over 20 years.

    As I noted, this is intended to kind of keep the average retiree somewhat whole while playing on the public envy of the well off state retiree. A very carefully crafted piece of work. Don’t think it is constitutional based on previously rulings, but I have to admire the thought that went into it.

    One possible problem with the $1000 / $800 per year of service formula. Since we haven’t seen the actual language, it really needs to be based on the same number of years of service the pension is based on regardless of the actual years worked. In other words, any purchased service time should be included as part of the COLA calculation.

Additionally, current employees will miss annual adjustments depending on age: employees 50 or over miss 1 adjustment (year 2); 49-47 miss 3 adjustments (years 2, 4, and 6); 46-44 miss 4 adjustments (years 2, 4, 6, and 8); 43 and under miss 5 adjustments (years 2, 4, 6, 8, 10).

    I see the logic of gradually applying it to the younger employees in order to create the illusion of fairness, but it is a apparently unconstitutional change to existing employees.

Pensionable salary cap: Applies the Tier II salary cap ($109,971 for 2013), which is annually adjusted by the lesser of 3% or ½ of the annual CPI-U. Salaries that currently exceed the cap or that will exceed the cap based on raises in a collective bargaining agreement would be grandfathered in.

    I’m going to assume the bill language will be similar to what we have seen earlier this year. They are applying the SS salary cap. But then they limit the pensionable salary growth with a 1/2 CPI or 3% cap, so it will gradually fall below the SS cap. The grandfathering of salaries exceeding the cap is probably not as clear as the bullet point states. In the previous proposals, that exemption only applied until the end of the current contract.

Retirement age: For those 45 years of age or under, the retirement age will be increased on a graduated scale. For each year a member is under 46, the retirement age will be increased by 4 months (up to 5 years).

    It’s a reasonable approach to changing the retirement age but it rules counter to previous ISC rulings for existing employees.

Effective rate of interest (ERI): For all purposes, the ERI for SURS and the rate of regular interest for TRS will be the interest rate paid by 30-year U.S. Treasury bonds plus 75 basis points.

    Insufficient knowledge of that specific program to give an informed opinion. I do know someone who might be able to answer it, but I probably can’t get an answer quickly.

GARS Tier 2 fix: Brings GARS Tier 2 salary cap and annual adjustment in line with other Tier 2 benefits.

    Insufficient knowledge of that specific program to give an informed opinion quickly.

Pension abuses: Prohibits future members of non-governmental organizations from participating in IMRF, SURS, and TRS. Prohibits new hires from using sick or vacation time toward pensionable salary or years of service (applies to SERS, SURS, TRS, IMRF, Cook County, and Chicago Teachers).

    Good move closing a loophole that has been abused in the past. Changing it for new hires also passes the constitutionality test. It will result in the new hires, if career employees, receiving about 1/2 year less in service time than under the current rules.

Defined contribution plan: Beginning July 1, 2015, up to 5% of Tier 1 active members have the option of joining a defined contribution plan. The plan must be revenue neutral and employee contributions will be equal to those for the defined benefit plan. If a member chooses to opt into the defined contribution plan, benefits previously accrued in the defined benefit plan will be frozen.

    Basically offering a 401K style plan (assume it will actually be a 403b variation) to existing employees. It’s been discussed at length on this blog, but such a plan is probably a bad choice for most employees, and especially so for those near retirement. The only people it would benefit are non-career employees who only work at the state for a few years. In other words, this could be a sweet deal for political appointees that won’t be around long enough to earn a Defined Benefit pension.

Collective bargaining: All pension matters, except pension pickups, are removed from collective bargaining.

    Can look at this two different ways. On the one hand, it pretty much acknowledges that the union can not negotiate for the retirees. On the other hand, it prevents the unions from throwing the retirees under the bus in exchange for additional employee considerations.

Healthcare payments: Prohibits the State pension systems from using pension funds to pay healthcare costs.

    Not really anything new; just explicitly states it. Health insurance has always been paid out of either the State’s General Revenue Fund as an annual expense (SERS, GARS, JRS, some SURS) or partially subsidized by the separate TRIPS program (TRS, some SURS). but I think this is intended to slam the door on health insurance being considered a pension benefit ala Judge Nardulli’s ruling in the consolidated ‘Maag’ case. Mostly closing the barn door in case the ISC rules in favor of the retirees.

* And here’s his summary…

It is apparent a LOT of thought went into this proposal. Not only is it crafted to solve the pension “funding” problem but it is also crafted to provide the illusion of fairness to employees near retirement age and the retirees. As such, it is a fairly masterful piece of public relations. Not enough so to prevent employee / retiree outrage, but enough to delude the uninformed public (dare I say low information voter?) into believing the GA proposal is more than reasonable and fair.

Some of the items proposed, especially those affecting only new hires or offering a voluntary choice, will easily pass contract and constitutional muster.

A lot of what is proposed does not seem to meet contract law or constitutional muster based on the clear language of the pension clause and the various rulings by the ISC, both before and after the 1970 constitution. I’m having a problem reconciling any changes to either retirees or current employees with the previous rulings that, in effect, state the rules in place at hiring plus enhancements granted by the General Assembly at what is protected by the pension clause.

So the real question is what is Madigan’s real end game? Is it to railroad this through and twist the arms of the ISC to buy a “police powers” arguments? Is it to try to get the ISC the change their “rules are time of hiring …” logic to “only benefits already earned are protected” like in a number of other states? Or is it an intentionally unconstitutional bill in an attempt to get ISC coverage for a tax increase? Only time will tell.

- Posted by Rich Miller        

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