By: Mark Glennon*

 

If you think pensions for Illinois and its municipalities are in awful shape and worsening, just wait.

 

Illinois’ five statewide pensions report their positions annually, as of the end of June. Those reports will come out late this year. Most Chicago area pensions and many other municipalities report as of year end, so their 2015 reports won’t come out for another year. They will be uglier than anything we have seen. Most, almost certainly, will show funding levels deteriorating at an accelerating rate. Here’s why:

 

• The stock market has leveled off. Since the recession, we’ve had an extraordinary bull market. Stocks comprise most of pension assets. They roughly doubled over the last five years, but for the twelve months that ended on June 30, the S&P 500 rose by just three percent. Higher stock prices have mitigated pension problems, but unfunded pension liabilities have soared nevertheless across the state, consistently through the post-recession bull market. Now, that tail wind likely is gone. Sure, the market might soar further, but history says it probably won’t. It could languish for many years or drop, and that would pulverize pensions.

 

• “Negative amortization” continues. That’s perhaps the most pernicious and least understood feature in most Illinois pensions. Unfunded liabilities grow even if optimistic assumptions turn out true. A guest actuary explained in detail in this earlier article.

 

• Pension asset managers are being increasingly forced into shorter term, lower return investments. Healthy pensions invest for the longer term, focusing on stocks and illiquid assets like private equity that traditionally produce the best returns. But with badly underfunded pensions, managers must have cash available for shorter terms to pay pension obligations. That means investing in shorter term bonds that don’t pay nearly the 7.5% annual return most of them assume they will make.

 

• New accounting standards will force more realistic assumptions. New rules from the Governmental Accounting Standards Board went fully into effect for periods starting in July last year. So, we will start to see those disclosures towards the end of this year when the reports for the state pensions come out for the fiscal year that just ended. Those standards require a much lower discount rate assumption — the 7 to 8% most Illinois pensions effectively guaranty they will make on investments. Specifically, the unfunded portion of pension liability will have to be calculated using a 20-year bond rate, which will hit the most underfunded pensions — ours — especially hard.  Illinois state and municipal pensions essentially will be keeping two sets of books — one under the new GASB standards and one under the phony standards set by Springfield. They won’t get away with that very well. Reporters and the public will focus on the GASB numbers. We wrote about the insane implications of that in detail in an earlier article.

 

• The pressure to stop other actuarial shenanigans that understate pension problems is increasing. The New York Times recently wrote about the “bad math” used by some pension actuaries and a standards board hearing on the subject, in which we were quoted. Actuaries are feeling the heat.

 

• Higher interest rates won’t help much. Rates have been kept exceptionally low by the Federal Reserve since the recession, which has suppressed returns on all fixed income assets. They comprise a large potion of pension investments. The Fed is indicating that an increase this Fall is likely, but significant increases to historical norms is not in the foreseeable future. That’s because we are in a new era of lower rates, even absent central bank interference. Read what both the Fed and the International Monetary Fund have said about that.

 

• Underfunding continues. Contribution levels are set by state law and are simply too small, in almost all cases. Many politicians continue to claim they are funding pensions on an actuarially sound basis, but that’s nonsense.

 

• And higher taxes? Raising taxes to anything close to what pensions really need would obliterate the tax base. And the Springfield political establishment knows that voters won’t put up with it. A Democratic super-majority in the General Assembly with a Democratic governor couldn’t pass an income tax increase, a “millionaire’s tax” or anything else. They remain afraid even to propose an increase now on their own, passing just an unbalance budget in an effort to force the governor to propose a tax increase.

 

Locally, Cook County’s sales tax increase will plow some $450 million of new money into its pension, which will help but by no means stabilize the pension.  The county lost tens of thousands of residents and billions of revenue to flight in recent decades, which will worsen now. Chicago undoubtedly will bump up taxes, but the consequences of flight take time to materialize. Longer term, more will flee.

 

Maybe there will be a few exceptions to further pension erosion. IMRF may hold up because it has a unique funding guaranty that allows it to soak taxpayers directly in whatever-it-needs amounts, explained here. A very few other municipal funds, mostly in prosperous areas, are in good shape and will manage.

 

The biggest challenge of an accelerating collapse of our pensions may be finding new adjectives to use on this site. We’ve been using ones like impossible, unsustainable and catastrophic, but I can’t think of stronger forms for those offhand.

 

*Mark Glennon is founder of WirePoints. Opinions expressed are his own.

 

 

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Paul

But wait…..there are pensions THAT ARE funded and doing well…what about those? They seem to work O.K. And wait…..pensions have been serving us as a country for over a hundred years. Why now are they suddenly so bad? Or are the pension holliday, underfunded ones just the bad ones. Or is it private sector workers who just envy the govt. workers pensions after they realize they didnt save enuff for retirement, that suddenly make pensions so bad. Illinois is NOT overtaxed. Time to pay the bill! Dont need the tears.

Mike
If over the last 45 years the union bosses would have demanded fully funded pensions at 1970 benefit levels and reasonable salary hikes, and no special taxpayer subsidized retiree healthcare, we wouldn’t be in this mess. There’s over 600 unique pension funds amongst the 19 pension fund categories in the Illinois Pension Code so yes you can find a few individual funds that are 100% funded. Very few. None of them the largest funds, just some police and fire funds. The likelihood that all of the 600+ funds can be 100% funded is zero. The likelihood that all of the 600+ funds can be operated on a… Read more »
Adam
Mark, let’s not go off the deep end here. The unions will not be allowed to sell taxpayers homes. Cities and towns will go bankrupt well before that would happen. Plus, you would have a statewide economic collapse if that were to be allowed as well as riots. Bankruptcy is the only option and will be allowed for cities and towns once things are at a point of near collapse. If unions were to take some of my money as in out of my account for pensions that are near broke then I would just leave anyway as would many others. Not gonna happen. Collapse is much… Read more »
mark glennon

I mostly agree, and I am a bit optimistic that public opinion seems to be trending to agree with you. I am worried, however, that some municipalities will commit suicide through higher taxes. We’ve written here before about some places where property taxes are 5% or even higher. They have indeed killed themselves. Many others are on the verge. The Cook County sales tax will prove to be counterproductive in the long run, I think.

Adam

But ‘suicide’ just means they go bankrupt, as I stated. Once taxes cannot go any higher and enough people move they then go bankrupt. Sure it will be bad, but in the end bankruptcy is still what occurs and is really the only option left now. I have a good life in Illinois now but am pretty worried for the future. I am pretty worried about the entire global economy now though too.

Mike

There’s also a few IMRF “funds” that are fully funded.
IMRF is unique in that although it is a pooled fund, IMRF internally treats each municipality (and park district, library district, etc.) differently, each has it own funding level.

MS Naperville

The unions complain that the politicians failed to properly fund pensions in the previous decades. What they don’t inderstand, or refuse to acknowlege, is that had the politicians funded the pensions at the required level, the taxes needed would have prompted voters to throw them out of office ATTHAT TIME. Quite simply, all of this state’s public pensions are completely out of whack with what the 90% of workers in this state receive for their retirement benefits. Do the unions really thinlk their 8% of the workforce can strongarm the 92%??

nixit71
Absolutely right. If our politicians made the timely contributions to the pension systems all along, combined with more realistic ROR assumptions and updated mortality tables (as pointed out on Wirepoints awhile back) used by the actuaries, then the true cost of pension benefits would have been transparent long ago. The resulting flow of money paid into pensions would’ve meant less money for current employees and services, resulting in reductions of both. Less services for more money would’ve raised red flags more quickly to the taxpayers than issuing bonds. Instead, we consumed more than we should have, yet no one (the unions, in particular) wants to go on… Read more »
Downstate cynic

All bleeding stops.

Adam
It is obvious to anyone with a brain and/or not a public sector worker that many cities and towns will have to go bankrupt due to the pensions. Property taxes cannot go up much more in many places and the math simply does not work. They will HAVE to allow bankruptcy at some point or total collapse will hit Chicago and many other cities and towns. Of course total collapse is not an option. If the stock market tanks Illinois pensions will default very quickly as well. The fact of the matter is however the entire global economy looks much worse than Illinois and all this talk… Read more »
nixit71
I actually did a little bit of research on the IMRF’s “13th payment”, the additional pension compensation component that is funded 100% by the taxpayer that was put in place, according to a union coalition, because “IMRF COLAs do not compound, so the 13th payment helps compensate for the lack of a compounded COLA.” According the the IMRF documentation, for the 13th payment, everyone receives the same PERCENTAGE of their individual monthly pension, not the same $ amount. And it’s calculated based on your current pension that year, which increased under simple compounded interest from the year before. Depending on your monthly benefit, the 13th payment could… Read more »
mark glennon

You are exactly right on both your comments. And you always see their fund managers out bragging about how great they are. That “guarantied” 7.5% savings account that only IMRF members get is also a scandal, that the media ignore.http://www.wirepoints.com/get-7-5-on-a-savings-account-here-guaranteed-sorry-imrf-members-only-wp-original/

nixit71
The way IMRF is portrayed in the media cracks me up. They are put forward as the “responsible” and “fiscally sound” pension plan, yet that’s only because they, unlike the other pension funds, have a direct line into the municipal (ie taxpayer) bank accounts. Getting paid first doesn’t make it a sound plan by any means. And it’s just as susceptible to spiking chicanery as all the other pension funds. If every pension fund was setup the same way, all they’d be getting is bounced ACH transfers. Like working for an insolvent employer, the pension funds would be running over each other on their way to the… Read more »

Yup. Math sucks. So do stubborn government bureaucrats and kingmakers that refuse to change.

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