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The Difficult Problem of Pension Funding and Finances in Illinois

Updated: November 15, 2020

Issue: Due to evolving circumstances nationally and in Illinois – especially the economic problems caused by the COVID-19 pandemic in 2020 – it is growing more probable that the General Assembly may not be able to meet the funding requirements of a 50-year law designed to boost the TRS funded status to 90 percent.

Discussion: The coronavirus effect has exasperated an already challenging financial picture for state government. The state government’s $42.9 billion budget for fiscal year 2021, which began on July 1, 2020, was impacted by a $1.1 billion drop in state revenue during FY 2020 caused by the coronavirus. The state’s budget office estimates that in fiscal years 2020 and 2021, state revenues will fall by a combined $6.5 billion. The state’s budget deficit is expected to be $4.8 billion at the end of FY 2021 and $4 billion at the end of FY 2022.

While it is estimated that state revenues in the future will grow by 2 percent annually, the state’s statutorily-required contribution to TRS and its other public pension systems is expected to grow by 3.4 percent annually. The state’s total pension contribution is $8.6 billion in FY 2021. That’s 20 percent of the state general funds budget; clearly one of the highest portions of the government’s annual spending plan. The state’s pension contribution is expected to reach $10.6 billion in 2026.

This bad budget news puts pressure on legislators to make substantial cuts in the budget in order to help make ends meet. One target many legislators have mentioned is a reduction in the statutorily-required contribution to the state’s pension systems. (The TRS share of that contribution in fiscal year 2021 is $$5.7 billion.)

Sample “stress test” scenarios calculated in 2020 show that if the state continues to reduce its annual contribution to TRS in the future and investment returns are less than estimated, under a worst-case option TRS would become insolvent in 2033 when benefit obligations would exceed assets. Under the best-case option, TRS “treads water” indefinitely with less than 60 percent of the assets needed to pay its long–term obligations.

There are four core problems that, over time, have created this situation:

The State of Illinois, by law, does not use actuarially-based math to determine contributions and liabilities. The Illinois pension math dictated in the pension code artificially lowers the state’s cost of funding pensions. These laws supersede the true calculation of the state’s annual pension contribution. Here is a breakdown of the differences:

Illinois “Political Math”

  • The state’s goal is to have only 90 percent of the assets on hand to pay all future obligations and maintain a 10 percent unfunded liability.
  • The state’s annual contribution is reduced each year by the amount of debt service needed to pay off the bonds sold over the course of the last decade to finance the state’s annual contribution.
  • The state’s goal is to reach 90 percent funding in 50 years.
  • Future savings over several decades from reform measures are counted now before they are actually realized.
  • TRS must retroactively “smooth” the fiscal effect of any changes made in the TRS assumed rate of investment return over a period of five years. The “smoothing” applies to any assumption changes from 2012 on.
  • Total state contribution for TRS in fiscal year 2022 under this formula: $5.7 billion.

Standard Actuarial Math

  • The state’s goal would be to retire the unfunded liability and have 100 percent of the assets on hand to pay all future obligations.
  • The state’s annual contribution is not reduced each year by the amount of debt service needed to pay off the bonds sold over the course of the last decade to finance the state’s annual contribution.
  • Obligations are amortized over a 30-year period.
  • The annual cost of pensions to the state is based on what is needed to fund pensions now.
  • Total state actuarial contribution for fiscal year 2022 under this formula: $8.9 billion.

Illinois law does not include a statutory funding guarantee for TRS. A statutory funding guarantee ensures that all future state government contributions are made in full when they are due. Most other states operate with these guarantees and in Illinois, the Illinois Municipal Retirement Fund benefits from this type of mandated payment.

The financial inequities of the Tier II funding and benefit structure. Current law requires Tier 2 members to pay 9 percent of salary. That contribution fully funds Tier 2 benefits and subsidizes Tier 1 benefits. The Tier 2 contribution is 50 percent higher than the Tier 2 benefit’s value, which is 7 percent of their pay. In 20 years, when Tier 2 members are a majority in TRS, the subsidies they pay may cause a reduction in the state’s annual contribution. Eventually, the state will not owe any annual contribution to TRS because the members will be paying the entire cost. This is fundamentally unfair to Tier 2 members.

Any solution to the state’s pension funding problem must adhere to the Illinois Constitution’s Pension Protection Clause. Article XIII, Section 5 of the Illinois Constitution reads:

“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.”