To truly get pensions on track, state must fix Tier 2 inequities

Hardly a week goes by without some media coverage of Illinois' unfunded pension liability. Heck, I wrote about it in my last column. And all this attention is well deserved. After all, according to the most recent data, Illinois' five pension systems collectively had $248 billion in liabilities, but only $109 billion in assets. That results in a significant unfunded liability of $139 billion across all five state systems.

It also means the aggregate funded ratio of the state's pension systems - that is the ratio of pension assets to liabilities - is just 44%. Many experts, including bond rating agencies like Standard & Poor's, believe a public pension system should have a funded ratio of at least 80% to be considered financially healthy. Then there's the American Academy of Actuaries, which cautions that, regardless of the funded ratio existing at any time, pension plans should always have a strategy to reach 100% funded.

Irrespective of whether 80% or 100% is your preferred standard, Illinois' funded ratio of 44% does seem to indicate the state's systems aren't in a particularly good financial place.

Which explains why it's not just the media paying attention to Illinois' pension challenges. In fact, this summer state Rep. Stephanie Kifowit is holding hearings to discuss various ways to fix one of the biggest pension funding issues the state has, which, if left unresolved, would greatly increase the state's $139 billion unfunded liability, and lower the aggregate funded ratio well below the paltry 44% level it stands at today.

The issue Kifowit is grappling with concerns the value of pension benefits Illinois provides. Contrary to popular belief, the concern isn't that overly generous benefits are straining resources, but rather that current benefits are so miserly they're hurting Illinois' ability to attract quality workers today - and will likely force Illinois to incur significant costs tomorrow. This particular pension quandary stems from Public Act 96-0889, a poorly conceived attempt to reduce pension costs by cutting member benefits.

That law created a new, "Tier 2" category of benefits that were significantly less than those available under the existing "Tier 1" plan. Among other things, Tier 2 provides lower retirement benefits and a lesser cost of living adjustment while imposing a higher retirement age.

But if you believe in a concept called "math," lowering benefits to reduce pension costs doesn't make sense, because the data show benefit levels didn't cause the unfunded liability to explode in the first place. Instead, fully 42% of the growth in the unfunded liability since 1995 resulted from Illinois making woefully inadequate contributions into the pensions. Benefits meanwhile accounted for just 4.2% of that growth.

Yet despite receiving lesser benefits, Tier 2 workers make the same out-of-pocket pension contribution as do folks with the greater Tier 1 benefits. Effectively, this means a portion of the contribution made by Tier 2 workers isn't being used to fund their future benefits, but rather to pay unfunded liabilities Illinois owes to Tier 1. That's patently unfair, and has made it harder for Illinois to attract and retain quality public sector workers generally - and teachers specifically.

Worse, it means Tier 2 benefits aren't even the equivalent of what a similarly situated worker would get under Social Security. That shortcoming could cost billions to fix, given that the vast majority of the state's public workforce currently doesn't get Social Security. The problem is under federal law, Illinois can avoid enrolling its workers in - and paying for - Social Security only if the state's pension benefits are at least functionally equivalent to Social Security.

To be clear, enrolling thousands of Tier 2 workers in Social Security would be cost prohibitive. Which means the challenge for policymakers is to enhance Tier 2 benefits to a level that not only surpasses Social Security, but is sufficient to recruit and retain a high quality workforce.

• Ralph Martire, rmartire@ctbaonline.org, is Executive Director of the Center for Tax and Budget Accountability, a fiscal policy think tank, and the Arthur Rubloff Professor of Public Policy at Roosevelt University.