By: Mark Glennon*
For those of you frustrated by obscure pension reporting, here’s a simple way to look just a few numbers and get a pretty good feel on one important measure: How much would it cost per year just to stay even? That is, what does it take from taxpayers to keep a pension from falling further into the abyss? Then, compare that to what taxpayers are actually putting in. I’ll do that for Illinois pensions, which, as you will see, are falling far short.
Start with the unfunded liability. That’s what’s owed for work already performed but not covered by assets the pension has. Multiply that by the pension’s “interest rate” That’s the assumption the pension uses for how much its assets will earn every year, and sometimes called the “discount rate.” Unfunded pension liabilities don’t literally bear “interest” the way a bond or other debts do, but it works out the same way. For pensions, because the liability is not covered by an asset, the unfunded liability effectively grows at the discount rate.
Then, add what’s called “total normal cost” per year. That’s the additional liability the pension takes on for work now being performed. Finally, subtract out the “employee contribution,” which is what workers are contributing per year. What’s left is how much taxpayers must fund just to keep unfunded liabilities from growing. That’s simplified and leaves out some other items (usually, relatively small ones) but is roughly accurate.
Let’s do it for Illinois’ six statewide pensions combined:
Their total unfunded liability is about $113 billion. Their interest rates range from 7% to 7.5%. Multiply the rates used for each pension by their unfunded liabilities, add them up, and you get about $8.3 billion per year of “interest.”
Now, add the total, annual normal cost, which is about $3.6 billion, and subtract the total annual contribution paid by workers, which is about $1.5 billion.
The result is about $10.4 billion. That’s what taxpayers would need to pay just to keep the six pensions from deteriorating further. But the state in fact is contributing only $7.6 billion this year — more than ever before but $2.8 billion too little.
We will sink that much further into the quicksand, even if all else goes well with state pensions. That’s been going on for years, and it’s a big part of why the history of the state’s unfunded liabilities looks like what you see on the right, despite larger taxpayer contributions every year.
The trend shown will continue.
My numbers come from last month’s report on state pensions by the Commission on Government Forecasting and Accountability and the most recent actuary reports for each pension. That calculation of a $2.8 billion shortfall is actually a bit smaller than found in a more detailed and scholarly calculation addressing the same concept in a slightly different way, published here by an actuary about a year and a half ago. She calculated the built-in shortfall at $3.4 billion.
All these numbers assume pension assumptions are reasonable, which no reputable financial economist does. Most importantly among those assumptions, the shortfall will be worse if pension assets don’t in fact earn 7% to 7.5% per year. On that, keep in mind that the great post-recession bull market ended last summer. Once realistic returns start to show up in the reporting, the numbers will tank further.
Finally, nobody should assume that “just staying even” is how you need to fund pensions. Additional payments are needed to amortize the unfunded liability over no more than thirty years, most actuaries would say. Our failure to do that is just kicking the can to, well, I’m not sure who — whomever would still hang around Illinois in coming decades if this isn’t fixed. Amortizing the liability over 30 years would cost taxpayers another $3.5 billion or so per year.
These shortfalls will not be overcome. Illinois’ pension obligations cannot, and will not, be met in full. The sooner we accept reality and do what’s inevitable the better off all will be. That includes cutting unfunded liabilities — earned pension benefits — through constitutional amendment, bankruptcy or default.
*Mark Glennon is founder of WirePoints. Opinions expressed are his own.