Updated: Gov. Quinn’s Pension Plan Translated

To me, the question about Governor Pat Quinn’s pension plan, released this Friday, is whether it’s constitutional. Illinois has a non-impairment clause in its constitution that 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.” As a result, many argue, attempts by the State to unilaterally cut current workers’ benefits are doomed to failure before the state supreme court.

While I work on some more thoughts on that question, I wanted to translate Gov. Quinn’s proposal from pension jargon into plain language. So, here’s my translation of each of the elements of Gov. Quinn’s public pension stabilization plan (PDF).

GOV. QUINN’S GOAL

What is the governor trying to accomplish?

Maintain a defined benefit plan

When it comes to public pensions, there are three types of plans: defined benefit, defined contribution, and hybrid.

Defined benefit means just what it says: the plan guarantees workers a defined set of benefits, such as salary and healthcare, for life once they retire.

In contrast, under a defined contribution plan, the payout is based on the performance of the investment of employee and employer contributions. Whether your investment skyrockets or tanks, that’s what you’re left with. A hybrid pension plan takes a little from the defined benefit column and a little from the defined contribution column: a less generous, but guaranteed set of benefits supplemented by a 401K-style plan.

Defined benefit plans are the most common in the country: according to the Pew Center of the States, 90 percent of public workers have access to a defined benefit plan.

While the benefits under Gov. Quinn’s proposal are less generous, they’re still guaranteed regardless of the performance of the retirement systems’ investments. That means Illinois would still offer its workers defined benefit plans.

Reach 100 percent funding for pension systems by 2042

Pension systems are funded by employee contributions and employer contributions plus the returns those contributions get when invested in things like bonds, real estate, private equity, and hedge funds.

Illinois is responsible for the employer contribution into five public pension systems: State Employees’ Retirement System (SERS) for state employees, General Assembly Retirement System (GARS) for state legislators, Judges’ Retirement System (JRS) for judges in Illinois courts, Teachers’ Retirement System (TRS) for suburban and downstate public school personnel, and State Universities Retirement System (SURS) for public university and community college faculty and staff.

The State has done an awful job at paying its share into these retirement systems. In fact, Illinois owes $83 billion to them. That’s called unfunded pension liability.

Illinois can’t pay off its pension debt in one lump sum, so it has to pay off a little each year. That annual amount plus the amount the State must pay for pension benefits earned in that year is called the actuarially required contribution, or ARC for short.

Gov. Quinn’s plan says Illinois will have to pay its ARC each year for 30 years before its pension systems are fully funded. That 30 years represents the amortization period of the plan, or the length of time the State needs to eliminate its unfunded liability.

Back in 1995, Illinois enacted a law known as the “Pension Ramp.” It laid out a 50-year funding plan for pensions which would get Illinois retirement systems to 90 percent funding by 2045. According to the governor, under his plan, pensions will be fully funded ahead of schedule by 2042.

Of course, Gov. Quinn is making an assumption about the return the retirement systems’ investments will get. In Illinois, each system sets its own target rate, ranging from 7 to 8.5 percent. If you only looked at the actual return on investment over the last three, five, or even ten years, you might baulk at those target rates. If you look at the 30-year average, though — the same as the amortization period of Gov. Quinn’s plan — those targets start to seem reasonable. That said, there is considerable debate on the subject, and it might just be the topic of a future post.

The SURS long-term average is for 25 years (as opposed to 30) because that is the only data available on their website.

Adhere to a 30-year “closed” ARC

The payment plan laid out in the 1995 Pension Ramp was optional. The State had the option to make its annual payment or to skip it — something Illinois did on more than one occasion.

Gov. Quinn’s pension plan lays out a payment plan established by actuaries as opposed to legislators. Think of actuaries as pension experts who use their knowledge of statistics and business to assess risk and design good investment strategies. So, experts will tell the State its actuarially required contribution (ARC), which each year the State is expected to pay.

GOV. QUINN’S PLAN

Those are the goals. How does the governor get there?

Changes to benefits for active and inactive members

3% increase in employee contributions

Depending on the retirement system, public workers contribute 4 to 11.5 percent of their salary to their pensions each year. Gov. Quinn is suggesting increasing that contribution by three percent for all current and future employees.

Reduce COLA to lesser of 3% or ½ of CPI, simple interest

COLA stands for cost-of-living adjustment. Each year, because of inflation, the same amount of money buys less stuff. A COLA helps to counteract the effect of inflation.

Today in Illinois, public workers who’ve retired get an automatic 3 percent COLA to their pension annually — regardless of the level of inflation. And that 3 percent is compounded instead of simple interest. That means if your pension is $10,000 in your first year of retirement, it would be $10,300 in the second year and 10,609 in the third. It goes up $309 in the third year instead of another $300 because the COLA applies to your current — not your original — pension payout.

Since a COLA is supposed to counteract inflation, it seems reasonable to tie COLAs to the actual level of inflation. That’s where CPI, or consumer price index, comes in. A CPI measures how much the price of goods and services changes. Looking at the annual percentage change in a CPI is how to calculate inflation.

Of course, Gov. Quinn’s pension plan doesn’t tie COLAs to the CPI, it ties them to half of the CPI (or 3 percent, whichever this less). This means that the real value of a retiree’s pension will never be able to keep up with inflation.

In this graph, I assume a worker’s pension starts at $10,000 in her first year of retirement. I also assume a 2.7 percent rate of inflation, which is the current rate today. Obviously the rate of inflation would go up and down over time, but that doesn’t change the reality this graph illustrates so well: the real value of a worker’s pension will take significant cuts over the course of her retirement under Gov. Quinn’s proposal.

Please note, I’ve corrected this graph since first publishing this post. In the original, our worker’s annual pension under Gov. Quinn’s proposal looked flat (staying the same over time) when it should have been linear (increasing the same amount each year). In this current and correct graph, you can clearly see that of all the changes the governor suggests to COLAs, what will hurt workers the most is indexing them to one half of the CPI. Compound versus simple has an impact, but it’s not nearly as significant.

Increase retirement age to 67 (to be phased in over several years)

Gov. Quinn’s pension plan also calls for bumping up the retirement age — which is 55 years in Illinois today — to 67. That’s a big jump. To put it into context, New York recently enacted a one-year increase from 62 to 63 years after their governor proposed a retirement age of 65.

Public sector pensions limited to public sector employment

In the fall of 2011, the Chicago Tribune and WGN-TV discovered some labor leaders were counting their union time and salaries toward their City of Chicago public pensions, even while they were on leave of absence from their city jobs. There was also a story about two workers who counted their years as union employees toward teachers’ pensions after they spent a day in the classroom as substitutes.

These practices might sound like an abuse of the system, but they were OKed by the legislature in 1991. Gov. Quinn wants to stamp them out in his reform package.

Employer responsibilities

State makes required payment each year

As we’ve already discussed, Gov. Quinn’s plan commits the State to pay its actuarially required contribution (ARC) each year for 30 years until 2042 when Illinois’ retirement systems are fully funded.

Employers take responsibility for their normal costs

Illinois’ history when it comes to pensions is riddled with mysteries. Here’s a big one. Even though it’s not the State of Illinois that negotiates contracts with K-12 public school teachers, state university staff, or community college employees, ultimately the State is responsible for making the employer contribution into these workers’ pension funds. So, a local school board negotiates the retirement benefits of its educators, but it doesn’t pay a dime into the retirement system — that’s up to Illinois.

This dynamic is true of all state universities and all community colleges. For K-12 public schools, it only applies to suburban and downstate teachers. Chicago Public Schools makes the employer contribution for CPS employees.

What’s incredible is that these contributions — for TRS and SURS members — make up about 3/4 of the State’s annual pension payment.

There’s been a lot of talk lately about changing this. Both the speaker of the Illinois House and president of the Senate are supportive. Members of the Assembly from suburban and downstate districts, though, worry that suddenly shifting this liability to local governments will force them to raise property taxes, which is usually the only way municipalities can raise revenue.

In the press conference where Gov. Quinn unveiled his plan, he made it clear this wasn’t an essential aspect of this plan, but it’s a change we should expect him to continue to push for.

“Considerations” for public workers

As regular readers know, Illinois has a non-impairment clause that ties the State’s hands when it comes to restructuring the pensions of current public workers and retirees. So, you’d be right to wonder whether Gov. Quinn’s pension plan is even constitutional. After all, it’s clear the proposal cuts current workers’ benefits.

The governor argues his pension plan is in-bounds because he offers workers the option to opt in or to opt out. But — and this is a big but — if you choose to opt out of the new plan and stick with the current plan, there will be consequences. None of your future raises or promotions will count toward the final salary used to calculate your pension payout. And when you do retire, you’ll lose your subsidy for healthcare.

Right now in Illinois when it comes to health insurance, the State offers its retirees a traditional plan where participants can choose any doctor or hospital as well as a managed care plan, like an HMO. Public workers who retire with at least 20 years of service can choose either plan, and they don’t have to pay any premiums.

According to the Civic Federation, 91 percent of the 81,900 retirees receiving health insurance from the State as an OPEB (or other post-employment benefit) aren’t paying any premiums. In fiscal year 2011, while coverage cost retirees $12 million, it cost the State close to $500 million. Moreover, Illinois makes these contributions on a pay-as-you-go basis, meaning they’re not pre-funded like pensions are.

If you stand by your current pension plan, you can kiss this coverage good-bye if Gov. Quinn has his way. Nonetheless, the governor estimates that 3 out of 4 public workers will opt into his plan.

Not surprisingly, the unions are not a fan of Gov. Quinn’s proposal. Here’s an excerpt from the response of the AFL-CIO:

We strongly disagree with the proposals made today. Considering that the subject at hand is the ability of hundreds of thousands of Illinoisans to support themselves in retirement, we believe the proposals are insensitive and irresponsible.

Forcing public servants to choose between two sharply diminished pension plans is no choice at all. It is a clearly illegal attempt to solve the problem caused by past governors and the legislature solely on the backs of teachers, caregivers and other public workers.

One thing I think everyone — lawmakers and unions alike — would agree on: Gov. Quinn’s pension plan, if enacted, will end up before the seven justices of our state supreme court.

Of course, whether we make it that far depends on the legislature. Does the General Assembly have the will and the power to pass this package in an election year when Democrats have a chance of picking up seats in the House, the Senate, and Congress?