The pensions at the center of the storm for Illinois and its localities are “defined benefit” plans — pensioners receive fixed amounts each month for the rest of their lives. Those amounts are usually subject to automatic annual increases or cost of living adjustments. Here are five reasons why defined benefit plans are hopelessly flawed and should be scrapped and replaced as rapidly as fairness and the law allow:
• They are irrational at their core. They promise to pay out a fixed stream of income but to meet that promise they must invest in long term, variable, risky assets like stocks that “should” earn enough to meet obligations. That’s a bit like signing a mortgage with a fixed interest rate then going to Vegas to try to earn the interest you will need to pay. Maybe it will work out, but we can’t gamble the solvency of the government and the retirement security of its workers on whether it will. And experience shows that this gamble usually loses — few public pensions are adequately funded, including those that received all the payments they were projected to need.
• They are impossibly opaque. Their solvency turns on obscure and hard questions used in their actuarial assumptions like discount rates, long term inflation rates, mortality tables, frequency of job changes and the like. Those variables are moving targets and expert opinion on them varies widely. Meredith Whitney, a respected financial analyst who has tried to tackle pension impact on municipal finance, called them the “darkest pool” of data she has ever dealt with. In Illinois we know that deficits in the five state sponsored plans are about twice as large as the state admits, but exactly how much worse they are is obscured. That’s exactly why politicians and union leaders like them — the more obscure the easier to abuse.
• They are easily corrupted. It’s worse than the scores of stories of abuse widely reported in recent years. First, those obscure variables that determine how much money a pension really needs are provided by consultants, and those consultants are hired by the government itself. Honest consultants, not just crooked ones, are pressured to give the answers that those who hired them want to hear. Second, there’s an obvious reason why unions are by far the largest contributors to political campaigns: They buy off politicians to get bigger pension promises.
• They are corrupting. Even the best public servants become obsessed as they grow older with preserving and maximizing not only their own pensions but those of their friends at work, so concern for the state’s interests gets trumped by their pension concerns. If you don’t believe this, you have never spent time in a Springfield bar with some of them.
• Conflicts of interest are blatant. The “pension reform” debate taking place is a negotiation among government people and the unions, all of whom are in the pension system. And if it goes to court? The judges are, too!
Most of these reasons applied in the private sector, which is why it started the painful process of junking them some 25 years ago. But in Illinois, many members of both parties and the unions are moving towards enacting an “ironclad guaranty” that the state make its contributions to defined benefit plans, thus assuring their continuance. For the sake of retirees and the state they should be doing precisely the opposite: Scrap defined benefit plans as rapidly as fairness and the law allow.