STUMP » Articles » Illinois Senate Bill 1 and the State Budget: What's This About Pension Funding? » 13 August 2017, 16:01

I’ve not really dug into SB 1 much myself, primarily because:

- the soda tax is so much more “entertaining”
- I’ve been working on multiple things this week, including a press release on Gulag historian Yuri Dmitriev that you can see here.
- and for the people who have been concentrating really hard on SB1, even many of them say it’s tough to determine what’s going on.

For example, here is something from Mark Glennon at Wirepoints:

Education Funding Bill is a Monstrosity of Unknown Proportions – Wirepoints Original

Pity Governor Rauner’s new staffers who will have to advise Rauner what to do with the new school funding bill that’s been dumped on them.

I’ve spent the better part of the last five days trying to get a handle on the bill, or even finding credible, secondary sources on what the bill would do. For the most part, that’s impossible.

SB-1, the Evidence-Based Funding for Student Success Act, passed both houses of the Illinois General Assembly. Governor Rauner indicated that, when it’s sent to him for signature, he will execute an amendatory veto to eliminate parts that favor Chicago.

The press is all over the place on what’s in the bill. That starts with big items like how large the bailout is for Chicago. That’s the key objection to the bill. That basic number ranges from as low as $215 million to almost $500 million. Even Rich Miller, who is generally friendly towards this kind of thing, scratched his head in an article yesterday and collected some of the discrepancies in the numbers claimed.

Maybe the numbers have settled down, but we end up with crap like this:

This map turned out to be close to 100% inaccurate. #twill https://t.co/oaO6uGI2LI

— Michael Lucci (@ChicagoLucci) August 13, 2017

I have no idea how misleading or not it is. I tried to make a few graphs from the official spreadsheet with estimates, but I still have no clue what’s going on.

WAIT, PENSION FUNDING?

Well, I’ve been distracted by all sorts of things, but a particular piece from an Illinois House rep ® was pointed out to me this morning:

The Pension Shift Buried in the Illinois Budget

As Nancy Pelosi famously said during the Obamacare debate: “(W)e have to pass the bill so you can find out what is in it…” That quote must also be applied to the Budget Implementation Bill (BIMP) passed by the Illinois General Assembly on July 3rd. This bill (SB 42) was the triggering mechanism needed to implement the provisions of SB 9 (revenue bill) and SB 6 (spending bill), which the Governor vetoed and which were overridden by the General Assembly.

It is no exaggeration to say that we had less than one hour to review this 742 page behemoth; even a graduate of the Evelyn Wood speed reading course would have been hard pressed to get through it with any sense of comprehension. What has resulted is things coming to our attention that we didn’t originally see, much like rocks rising to the surface of a farm field in the spring.

Lurking on page 348 of the BIMP was the following:

Beginning in fiscal year 2018, each employer under this Article shall pay to the System a required contribution determined as a percentage of projected payroll and sufficient to produce an annual amount equal to:

i. for each of fiscal years 2018, 2019, and 2020, the defined benefit normal cost of the defined benefit plan, less the employee contribution…

What this means is that when a school district hires a new teacher, that teacher’s normal pension contribution will be paid for by the school district instead of being the responsibility of the state as has traditionally been the case. This is known as the “pension shift”, something for which Speaker Madigan had been advocating for years.

The rationale for the shift is that by making districts responsible for their employees’ pension cost, school boards are forced to confront the true cost of employment. For instance, the practice of “spiking” salaries in the last 4 years of employment, which is common, increases the pension cost to the state with no repercussions to the district. Putting districts on the hook for pension payments puts them on notice as to the true cost of employing someone.

The problem with making a sudden shift in pension costs from state to school districts is that the impact on local property taxes would be catastrophic, especially to districts which are at the lower end of the pay scale and are constantly losing teachers for better paying jobs elsewhere. If a shift were to occur, some means would have to be provided for there to be a smooth transition of that cost over a period of years to allow for a less disruptive effect to the local taxpayers.

Senate Bill 1 (SB 1) does this through adjusting its “Adequacy Target” (the cost of providing essential educational elements) to provide for an additional amount to pay for benefits, including the employer cost of pensions. On Page 349 of SB 1 is the following:

Each Organizational Unit shall receive 30% of the total of all salary-calculated elements of the Adequacy Target, excluding substitute teachers and student activities investments, to cover benefit costs. For central office and maintenance and operations investments, the benefit calculation shall be based upon the salary proportion of each investment.

If at any time the responsibility for funding the employer normal cost of teacher pensions is assigned to school districts, then that amount certified by the Teachers’ Retirement System of the State of Illinois to be paid by the organizational Unit for the preceding school year shall be added to the benefit investment. For any fiscal year in which a school district organized under Article 34 of this Code is responsible for paying the employer normal cost of teacher pensions, then that amount of its employer normal cost plus the amount for retiree health insurance as certified by the Public School Teachers’ Pension and Retirement Fund of Chicago to be paid by the school district for the preceding school year that is statutorily required to cover employer normal costs and the amount for retiree health insurance shall be added to the 30% specified in this subparagraph (U).

Set aside for a moment the fact that even before the cost shift is included, the adequacy target is being increased by 30% to cover benefits (how many of you in the private sector have a benefit package amounting to 30% of your pay?). Suffice it to say that SB 1 provided for a smoother landing for the shift than would otherwise be the case. If you think that districts should be responsible for the entire cost of their employees, then this is an accommodation to that.

When the Governor amendatorially vetoed SB 1, he removed the highlighted language, thus removing the additional amount meant to ease the blow to local taxpayers.

This is a prime example of how bad legislation gets passed. We wait until the last moment to vote on something none of us has seen, and then we spend months figuring out what we did and how to fix it. There has to be a better way of doing this.

Oh, yeah. I see an issue right now, and I think I understand part of the issue with Chicago.

Chicago is not part of the Illinois TRS. The state has not been directly picking up the Chicago pension contribution.

EXPLAINING: NORMAL COST AND HOW ILLINOIS TRS WORKS

Before I begin, note that I am NOT a pension actuary of any sort. My experience is life insurance, annuities, and reinsurance.

Second, I am going to be greatly simplifying explanations, because:

via GIPHY

Okay, there are people who have time for that, but they’re paid a lot of money to be detail-oriented people on this matter. And I’m not. So I will get you there approximate-ish-ly.

What’s this normal cost thing with regards to pensions? Is this related to ARCs (actuarially required contributions)?

Essentially, there are two pieces to the ARC:

- the normal cost
- the amortized cost of the unfunded liability

The normal cost is essentially the actuarial present value (so, that includes all the life contingent items, discount rate, etc.) of the pension benefit accrued for the current year.

Here’s an official communication from one public pension plan:

The annual cost of providing retirement
benefits for services performed by today’s
members is called the normal cost.

The amortization of the unfunded liability is the portion of the unfunded liability you’re paying down, assuming a certain amortization. I will come back to that later.

So let’s consider Illinois TRS: this covers all the non-Chicago school systems. So evidently, Illinois has been set up so that all pension contributions to Illinois TRS are straight out of the state budget. That’s the normal cost and whatever amount Illinois has deigned to throw in for the unfunded liability.

Of course, Chicago Teachers have an entirely separate pension plan, and the Chicago Public Schools is responsible for the pension contributions.

The argument has been that because the districts aren’t responsible for the pensions costs, some of the districts look the other way with respect to very questionable practices that boost pension cost: particularly spiking, where people run up pensionable salary in the last few years of service in order to gain a much bigger pension.

There’s a “penalty” charged against districts for allowing spiking, but it’s dinky — it definitely is nowhere near the extra larded on.

I did a post on it in May 2015: Illinois Pensions and Spiking: Not All Penalties are Deterrents

The issue is that most public pension benefit formulas are based on final salary amounts, though sometimes also final income from the job. So in some cases, the employees work boatloads of overtime the last couple years to give their pensions a spike.

Another way involves collusion of one’s superiors: you get a raise just a couple months before you retire, and your benefit is calculated at that new level.

There are multiple ways to combat all of these types of spiking, but it seems the version Illinois chose is pretty ineffective:

…..
High level statistics:

The average penalty per educator was $5K
There were a total of 7,618 educators involved – Looking at the 2014 CAFR, that represents about 15% of TRS retirees in the past decade
That comes to a total of $38 million over about a decade of these penalties being applied
This is very small compared to the about $60 billion unfunded liability for TRS — less than 0.1% of the UL

So yes, let’s get a grip — these penalties themselves are barely adding to the costs.

However, the spiked pensions do have a cost. Obviously, a pension that is 10% higher than it otherwise would have been is boosting the liability by 10%.

The penalties are teeny. The increased liabilities, not so teeny.

So the idea was to move the normal cost to districts, which could be more of a spiking deterrent.

HOW BIG IS THE NORMAL COST ANYWAY?

So it sounds like only the normal cost is getting shifted to the districts — so only newly accrued benefits — not the ginormous pension underfunded amount. Would have been interesting if they had tried to shift that cost to the districts (Calpers does that in California, for example.)

So I went looking at the most recent actuarial valuation for Calpers, and extracted the following items:

The normal cost was about 18 – 19% of payroll (slide number 4, or pdf page 9)

But the members themselves contribute 9% of their salary. So it’s not like the districts absorb the full 18 – 19%.

So… about that 9% member contribution. Take a look at slide #11 (pdf page 16) — Tier I vs. Tier II

Some of the member contributions for Tier II are for the unfunded liability…. aka mainly Tier I participants. When people mention the iffy aspect of Tier II, constitutionality- and federal-law-wise, that is the sticking point. The normal cost for Tier II is much lower than for Tier I, and the 9% member contribution rate is higher than their normal cost (for now). So Tier II is paying for stuff that’s not their own benefits!

What if a particular district has more or fewer Tier II participants? How, exactly, would these contributions work out? Would there be this cross-subsidy?

Almost definitely.

NORMAL COST VERSUS ENTIRE REQUIRED CONTRIBUTION

So recall that the full “required” contribution is the normal cost, plus some extra to pay down the unfunded liability.

That unfunded liability has been growing for years. As far back as the Public Plans Database goes, they’ve never paid full contributions for Illinois TRS.

So the unfunded liability has kept growing. And the percentage of payroll that is “required” to pay down the unfunded liability keeps growing as well.

So if NC (normal cost) was about 18% in 2016, and total ARC was 47% of payroll — that means 29 percentage points were for the amortization of the unfunded liability. The payment for the unfunded portion (if it were paid) is 60% higher than the normal cost!

I’ve done a profile of Illinois TRS in the past, oh, and Chicago’s pensions aren’t quite as screwed, but both of these together are the largest portion of the Illinois/Chicago unfunded pensions because so many government workers are teachers.

IT’S A MESS

No, alas, I don’t really have time to do an in-depth look at the pension-related funding in SB1. This really is getting into the “you have to pay me to do this” territory to untangle something as messy as that.

I’m pretty sure that there are some important details I’m missing above.

For one, I didn’t mention this bit from the actuarial valuation:

Funding Adequacy

The member and employer contribution rates are determined in accordance with the funding policy specified under the Illinois Pension Code (40 ILCS 5/16). The member contribution rate is 9.0%, which is comprised of 7.5% toward the cost of the retirement annuity, 0.5% toward the cost of the automatic annual increase in the retirement annuity and 1.0% for survivor benefits. The employer contributions are determined such that,
together with the member contributions, the plan is projected to achieve 90% funding by 2045. The 2045 funding objective of 90% was set in 1994 as a 50-year objective. TRS members have always contributed their share. The State funding has been inadequate, resulting in TRS being among the worst funded public employee retirement systems in the United States. We strongly recommend an actuarial funding method that targets 100% funding where payments at least cover interest on the unfunded actuarial accrued liability and a portion of the principal balance. The funding policy adopted by the Board, referred to as Actuarial Math 2.0, meets this standard.

……
Recommended Funding under Actuarial Math 2.0

The Actuarially Determined Contribution under the Board’s funding policy, called Actuarial Math 2.0, is
comprised of an employer normal cost payment and a payment on the unfunded actuarial accrued liability. The amortization of the unfunded accrued liability is a closed 20-year period effective June 30, 2015, and will decline by one year in each subsequent valuation. Sources of unfunded actuarial accrued liability that emerge in subsequent valuations are amortized over 20-year closed periods. Contributions toward the unfunded actuarial accrued liability increase by 2% each year, the estimate of increase in future State revenue growth. The actuarial cost method is the entry age method. The minimum contribution is the normal cost.

By the way, that last sentence is key. You may wonder why.

It’s because some plans like Calpers, when the plan was >100% funded, didn’t even contribute the normal cost to the plan. Whee! Contribution holidays for everybody!

That didn’t work out too well in Calpers’ situation. Because they also used it to argue they could retroactively boost benefits for free.

It wasn’t free.

Anyway, pensions costs are huge in Illinois, primarily because they chose not to fully fund their pensions. For decades.

They’d always pay more tomorrow.

Remember I’ll gladly pay you Tuesday for a hamburger today? Everybody knew that Wimpy would never pay, even though the promised payment was less than a week away.

People need to understand that the “I’ll gladly pay you in 20 years for a skipped pension payment today” is about as sincere.

Well, tomorrow is here.

Where’s that money?