Mitchell I. Serota, Ph.D., Fellow, Society of Actuaries

 

The Attorney General, though her Solicitor General, needs a more potent argument to convince the Illinois Supreme Court that pension legislation enacted in December 2013, which prospectively reduces defined benefit plan accrual rates for State employees, is constitutional. After last year’s judgment that even post-retirement medical benefits cannot be reduced once promised, the Supreme Court has indicated that the attempt at pension reform is not likely to pass Illinois Constitutional muster. Even though the pension legislation appears to be on the verge of being struck down, the Solicitor General is not compelling in her arguments on behalf of the citizens and finances of the State because she has failed to distinguish between accrued benefits and future benefits.

 

The primary thrust of the Solicitor General’s argument last week is that the Great Recession turned the stock market sour in 2008-9 and therefore, we can no longer pay the bills for funding the five State-sponsored pension plans while keeping the State’s services intact. Instead, the State will declare an emergency and use its inherent police powers to trump the Constitution. Counsel for the pension recipients rightfully pummeled that argument into the ground as beneath pathetic. His counter-argument was taken directly from the Yiddish explanation-by-example of “chutzpah” (meaning, “unmitigated gall”): it is akin to a child murdering his parents and then pleading with the judge for mercy on account of his being an orphan. Gov. Edgar instituted a non-funding plan in 1994 and Gov. Blagojevich followed through with a few pension holidays. After playing those games for 25 years, the Great Recession had little to no impact on the Trust– there wasn’t any money there to begin with! OK, a snarky exaggeration, but the point is that the State systematically underfunded the system and caused the problem itself. It continually made promises that it could not keep and the next generation would have to foot the bill.

 

An argument that better serves the interest of the people of Illinois is to return to what was being debated at the Constitutional Convention, but with attention to the distinction between accrued and prospective benefits. Here is what the authors penned for us to deal with:

 

Article XIII, Section 5 (i.e., the “Pension Clause”) of the Illinois Constitution, 1970

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 [emphasis mine].”

 

The question is, what is a “benefit?” Concurrent with the Constitutional Convention, the American Congress was wrestling with language to guarantee benefits for participants in defined benefit plans. They came up with the following:

 

ERISA: IRS Code Section 411(d)(6), September 1974

“A plan shall be treated as not satisfying the requirements of this section if the accrued benefit of a participant is decreased by an amendment of the plan [emphasis mine]. . . .”

 

The concept of “accrued benefit” is very specific. It means the benefit that has been earned to date. In effect, one measures benefits attributable to past service, but definitely not future service. Relying on this interpretation of Section 411(d)(6), numerous plan sponsors have successfully frozen benefits prospectively and terminated defined benefit plans in the ensuing forty years.

 

We can speculate as to the intended difference of meaning between the Illinois language and the ERISA language. Did the authors of Section 5 reject the word “accrued” as too narrow for their purposes: that they wanted to include benefits that were already earned AND benefits that would be earned prospectively? Or were they not really aware of the precision that using the adjective brought? After looking at transcripts of the debates at the time, I am convinced the Illinois authors were simply not aware of the power and specificity of the word, “accrued.”

 

The speeches were all gloriously telling the listeners about the protections that Section 5 would bring, but there was not a glimmer of clarity that the authors were considering future benefits as well as past benefits. They were totally ambiguous because a distinction between past and future benefits was never addressed. No one spoke out against Section 5. Could it remotely be the case that no one drafting the Constitution was willing to protest the protection of benefits to be earned in the future? I am not proposing that the drafters were ignorant, just that they were unsophisticated in how defined benefit pension plans work. These were pre-ERISA days and precious few people had a clue about how they functioned. So what did the drafters intend to mean by “benefits?” It’s worth asking the Supreme Court justices, but no one is asking them that question.

 

The sorrowful language that we are stuck with in Section 5 is paralleled by the sorrowful arguments of the Solicitor General. It doesn’t take a lot of chutzpah to call her out on it.

 

 

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paul

The Supreme Court Judges arent stupid. They will decide the case on the LAW and not on the strenth or weakness of the lawyers arguements. I wonder why nobody trys to answer the questions Justice Thomas posed….like how can the State cry poor after it just let the income tax go down….or if the State creates its own emergency by not funding pensions and then uses police powers to break the contract, isnt every contract then vulnerable…..or has the State broken other contracts or why just the pension contract, if its in such dire straights….good questions….hard answers …but no one wants to try?

Mike
Those issues have been addressed on this blog. Here are a few personal thoughts. Lisa Madigan is not likely to diminish public sector pensions in Illinois, the legislation and defense was a ruse. Very unlikely judges will diminish hiked pensions. Taxpayers will have to change the constitution to strip out the sentence added in 1970. It is now the question do taxpayers want to take the time and effort to change the constitution, or will taxpayers say I have had enough and move out of state. This game is turning into how high can taxes go before taxpayers leave, a concept known as the Laffer Curve. Taxes… Read more »
Mark
Who would want to live or own property in a state where the 18 pension fund “contracts” are changed every year but two from 1971 – 2011, in most of those there were many changes to the pension fund “contract”, where the price of the pension fund “contract” keeps raising in the name of legislative benefit hikes and local salary hikes, where the union labor force gets to vote on whether or not to accept the proposed collective bargaining “contract” but taxpayers do not get to vote on the proposed collective bargaining “contract”, where the collective bargaining “contract” hikes and the legislative pension fund “contract” hikes, hike… Read more »
paul

But yet the same lawmakers are suddenly trusted when they pass pension reform(i.e. pension cuts)? Isnt the above arguement a case to disregard our laws? Do we not elect our own government? Do we not live by laws? Do we not respect our Constitution?

Mike
The history of legislative pension hikes is in the 1,500 pages of Illinois Pension Code. The history of retiree benefit hikes is buried in that code The pension and retiree hikes were not explained to taxpayers by state legislators or Governoirs. The Governors and local board members who approved collective bargaining agreement and administrator pay and benefit hikes, typically did not explain the hikes to taxpayers. The unions did not explain the above hikes to taxpayers. A few transparency websites and Bill Zettler who wrote Illinois Pension Scam are exposing what happened along with some investigative journalism reports. The constitution and laws were changed to hike pay… Read more »
paul
Who would want to live in a state that did not honor its contracts? If the state contracts with an employee to provide a pension at X amount of dollars in exchange for 30 years of work…..how can the state then break that contract 10, 15 or 25 years into the contract without losing also losing the integrity that we as a society demand our States to uphold. There is a U.S constitutional provision…the contracts clause…that restricts a State from breaking a contract. But nobody wants to live in a State or Country where the State can make a contract…and then break it…when fiscally inconvienant. So not… Read more »
Mark Glennon

Where was all this union concern about the sanctity of honoring contracts when claims against Chrysler and Ford were slashed far more than pension benefits?

Mitchell Serota
Paul, you blatantly misstate one of the facts, not opinion, that I presented. Just to make myself clear, an accrued benefit is the deferred annuity earned by an employee based on service to date and final average salary according to the terms of the Plan formula. You are totally incorrect when you assert “an accrued pension benefit is the defined monetary benefit a pensioner receives for surrendering 8-10% of his pay . . etc.” You choose not to understand that while you are contributing, not surrendering, 8%, the employer is contributing an additional 20 to 30% of your pay for your benefit. So basically, Paul, you have… Read more »
Pam(Pauls wife)

Awe Mitchell, why do you assume Paul is a pensioner or has an employee handbook? You seemed a tad personel in your response. He must have touched a nerve.
Also, If the State employer contributed 10 to 20 %, as you claim, in addition to the 8 % that the employee contributed over the years for every State worker pension in the State we wouldnt be is pickle now would we?

Mitchell Serota

I’m glad you’re in awe, Pam. You have finally realized that the State’s obligation to its pension plans are really expensive. Official funding projections from the State indicate that I understated the 10% to 20% or salary range. The State is on the hook to contribute in the 30% to 40% of salary range for the next 30 years. Now do you understand there is a desperate need for for pension reform?

Jim Palermo

No mention of Government Accounting Standards Board (GASB) calculation of the actuarial liability using the assumed rate of return, which today dramatically understates the funding level of Illinois’ state and municipal pension plans? As bad as we think funding levels are, were we to use private sector methodology, funding deficit levels would be far worse.

Mark Glennon

Evidently, Mr. Palermo, you are not reading WirePoints closely. We covered that topic as it relates to Illinois here http://wp.me/p2Oseh-3LP , which Jack Dean described as an “excellent analysis.” Please, Mr. Palermo, try to keep up ;-}

paul
Thanks for your comment Mitchell. I am glad you were able to give clarity to your definition for accrued benifit. Its hard to imagine that a pension freeze could survive the pension clause, as its hard to argue a pension freeze is not a “pension impairment” and would thereby be unconstitutional. There is no distinction of accrued or future benifits in the pension clause, it makes interpretation allot more clear. Any attempt at such constitutional reconstruction may have been addressed by Judge Thomas, or another, quite simply: your attempting to add words that arent there and confussing what you want the clause to mean with the clairity… Read more »
Jim Palermo

Why should bondholders be subject to losses and pensioners immune?

Jim Palermo
Mr. Serota points out that when the constitution was amended in 1970 the concepts of accrued and future benefits were not considered. At the time it was difficult to predict the effect of the amendment-as ‘dark ages’ as it sounds, even primitive hand held calculators were a rarity and spreadsheets and PCs were not yet part of the American business lexicon. Only highly trained experts could prepare a scenario analysis to anticipate what might take place. But what should have been expected was that the tax payer backstop created by the amendment would allow political leaders to short-fund the plans, overtly by contributing less than the Actuarial… Read more »
Mike

At this point the only chance for long term sustainability in Illinois is for a Constitutional amendment to repeal the pension sentenced that was added in 1970.

The constitutional amendment will only pass if it’s exposed, in a manner Average Joe can readily understand, all the ways the pension system has been gamed at taxpayer expense.

That requires basically calling the politicians and unions a bunch of liars which is pretty much what they are.

Maybe some of the rank and file don’t intentionally lie but they sure don’t tell the whole truth, knowingly or unknowingly.

Constitutional amendment or bust.

The Illinois political process is corrupt and broken.

Bruno

I have always wondered why the state of Illinois is so constrained to follow the State Constitution when it comes to the absolute sanctity of negotiated pension benefits. The requirement to balance the budgets required by the constitution……and? Thank you Lisa.

A. Green

You have to wonder whether Mr. Madigan’s daughter deliberately blew the case, or maybe her staff lawyers who are all pensioners.

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