Pension Reform Newsletter – May 2015

This newsletter highlights articles, research, opinion, and other information related to public pension problems and reform efforts across the nation. To find previous editions, please visit https://reason.org/newsletters/pension-newsletter/.

Articles, Research & Spotlights

• Illinois’ Pension Reforms Struck Down by State’s Top Court
• Moody’s Downgrades Chicago’s Debt to Junk Status in Wake of Illinois’s Ruling
• San Bernardino Bankruptcy: Bondholders Lose against CalPERS
• Can Public Pensions Fulfill Their Promises? An Examination of Pennsylvania’s Two Largest Public Pensions
• How Will Longer Lifespans Affect State and Local Pension Funding?
• Research Groups Launched Comprehensive Public Plans Data Resource

Quotable Quotes on Pension Reform

Pension Reform Handbook

Contact the Pension Reform Help Desk

 

Articles, Research & Spotlights

Illinois’ Pension Reforms Struck Down by State’s Top Court
By Scott Shackford, via Reason.com

Illinois’ massive pension crisis, arguably the worst in the nation, is about to probably get worse. On May 8, the state’s Supreme Court unanimously ruled that efforts to tamp down on the crisis by scaling back workers benefits are a violation of the state’s constitution. A provision in the state constitution states that benefits for government employees cannot be “diminished or impaired.”

The pension reforms Illinois enacted in 2013 to try to rein in its unfunded liabilities and more than $100 billion in debt involved curbing cost of living increases and putting a cap on how much of an employee’s salary may be used to calculate pension payments. The court determined these reforms count as diminishing or impairing benefits.

Justice Robert Karmeier rejected the argument that economic necessity overrides the constitution’s pension protections:

“Our economy is and has always been subject to fluctuations, sometimes very extreme fluctuations. [But] the law was clear that the promised benefits would therefore have to be paid and that the responsibility for providing the state’s share of the necessary funding fell squarely on the legislature’s shoulders. The General Assembly may find itself in crisis, but it is a crisis which other public pension systems managed to avoid and… it is a crisis for which the General Assembly itself is largely responsible.” – Karmeier wrote.

Both the state and government employees themselves have a very long history of skipping pension payments. The judge even criticized them for failing to keep a temporary tax hike from 2011 to bring in more revenue to the state. But John Tillman, CEO of the free-market, pension-reform-oriented Illinois Policy Institute, took a dim view of Karmeier’s call to raise taxes to fix this problem.

To read more about the issue, go here.

Moody’s Downgrades Chicago’s Debt to Junk Status in Wake of Illinois’s Ruling
By Truong Bui, Reason Foundation

Moody’s on May 12 downgraded Chicago’s debt to junk status. Specifically, the rating company downgraded the city’s $8.1 billion of general obligation debt; $542 million of sales tax revenue debt; and $268 million of authorized motor fuel tax revenue debt from Baa2 to Ba1.

One of the key rationales for the downgrade is the “expected growth in the city’s highly elevated unfunded pension liabilities”. Moody’s notes that this factor is exacerbated by the Illinois Supreme Court’s recent overturning of the state’s pension reforms enacted in 2013, since the ruling implies that the city has few options to rein in the growth in its unfunded pension liabilities. Moody’s expects that “the costs of servicing Chicago’s unfunded liabilities will grow, placing significant strain on the city’s financial operations absent commensurate growth in revenue and/or reductions in other expenditures.” In fact, contribution to the city’s Police and Fire pension plans will increase by 179 percent in 2016. As a result, the rating company places a negative outlook on the city’s debt.

Among the things that could improve the debt ratings, according to Moody’s, are halting the growth in the unfunded liabilities, and revenue growth and/or reductions in other operating expenses that could help easing the pension cost pressure. On the other hand, continued growth in the pension debt or a court’s ruling the current statute governing the city’s pension plans unconstitutional could worsen the ratings.

To read more about the Moody’s decision, go here.

San Bernardino Bankruptcy: Bondholders Lose against CalPERS
By Truong Bui, Reason Foundation

On May 11, US Bankruptcy Judge Meredith Jury dismissed an attempt by pension bond investors to win the same treatment received by the California Public Employees’ Retirement System (CalPERS) in the San Bernardino bankruptcy. The city declared bankruptcy in 2012, with a $45 million deficit.

Luxembourg-based Erste Europäische Pfandbrief-und Kommunalkreditbank AG (EEPK), which holds $50 million of pension obligation bonds issued by the city in 2005, argued that because bond proceeds were used to pay the pension liability, those bonds should be treated as if they were pension debts owed to CalPERS. The judge rejected this line of reasoning, contending that there was no evidence that the city intended to treat the two kinds of debts the same way. The rationale is that while CalPERS has the ability to reduce pension payments to the city’s employees if the pension debts are not paid, bondholders simply don’t have this power.

The ruling facilitates the city’s plan to repay its pension bondholders only a penny on the dollar, in contrast to full payments to CalPERS. The city’s action is consistent with a broader pattern found in the bankruptcies of Stockton, California, and Detroit, Michigan, where bondholders received little of what they were owned, while pensions were left unscathed.

To read more about the issue, go here and here.

Can Public Pensions Fulfill Their Promises? An Examination of Pennsylvania’s Two Largest Public Pensions
By Truong Bui, Reason Foundation

A recent study by Erick Elder and Gary Wagner at the Mercatus Center, George Mason University, examines the nexus between investment returns and pension funding levels for Pennsylvania’s two largest public pension plans, Pennsylvania’s Public School Employees’ Retirement System (PSERS) and the State Employees’ Retirement System (SERS). Having assets of more than $75 billion, the two plans are unfunded by as much as $100 billion under market valuation.

The study finds that while the two plans have a 100 percent probability of having sufficient assets to pay benefits without increasing contributions for the next five years, the probability drops after the five-year period. In 15 years from now, PSERS and SERS will have only a 31 percent chance and a 16 percent chance, respectively, of sufficient funding. In 50 years, the probabilities are only 4 percent for PSERS and 1.5 percent for SERS.

Based on financial modeling for the two plans, the study illustrates key ideas applicable to all public pension plans:

– Investment return volatility implies a high chance that even fully funded plans may have insufficient assets to cover their future benefit obligations.
– A proper discount rate should reflect the riskiness of future pension liabilities, not the expected returns of pension assets.
– Overfunding pensions can lead to political pressure for benefit increases.

To read the full study, go here.

How Will Longer Lifespans Affect State and Local Pension Funding?
By Truong Bui, Reason Foundation

Accurate estimates of lifespans play an important role in pension funding. As longer lifespans mean larger pension benefits, underestimation of workers’ life expectancy may cause insufficient funding. For example, a revision of longevity assumptions in 2014 reduced CalPERS’s funded ratio by five percentage points. A recent study by Alicia Munnell and others at the Center for State and Local Government Excellence explores the funding challenges faced by public pensions due to longevity improvement.

Using data from 150 state and local pension plans, the study analyzes how differences in life expectancy affect public plans’ funded status. It finds that if public plans adopted the new mortality table that private plans are legally required to use, the public plans’ estimated life expectancy would increase by 0.5 years, decreasing the average funded ratio from 73 percent to 72 percent. However, if public plans used the generational method, which incorporates anticipated future longevity improvements, the life expectancy increase would be 2.3 years, dropping the funded ratio to 67 percent.

Additionally, the analysis reveals that using the new mortality data causes the biggest decline in funded ratios for the smallest plans, and that worse funded plans tend to use more outdated longevity assumptions.

To read the full study, go here.

Research Groups Launched Comprehensive Public Plans Data Resource
By Truong Bui, Reason Foundation

Looking for pension data may often be arduous and time-consuming. Fortunately, a recently launched website provides easy access to comprehensive data on 150 state and local pension plans in the US. The site is the product of a joint effort by the Center for Retirement Research at Boston College (CRR), the Center for State and Local Government Excellence (SLGE), and the National Association of State Retirement Administrators (NASRA).

One can find on the website a complete data set covering all the key pension variables, including funding levels, contributions, plan expenses, investment returns, asset allocation, plan provisions, and many others. The site also provides interactive tools for users to select specific plans, variables, and graphs. For example, one can quickly generate a graph detailing the annual required contributions (ARC) over the last decade for the State Employees’ Retirement System of Illinois, and see how those required contributions compare to the US average ARC as a percentage of payroll.

In addition, users can download comprehensive annual financial reports and actuarial valuations directly from the site.

To access the website, go here.

 

Quotable Quotes on Pension Reform

“Our economy is and has always been subject to fluctuations, sometimes very extreme fluctuations. [But] the law was clear that the promised benefits would therefore have to be paid and that the responsibility for providing the state’s share of the necessary funding fell squarely on the legislature’s shoulders. The General Assembly may find itself in crisis, but it is a crisis which other public pension systems managed to avoid and… it is a crisis for which the General Assembly itself is largely responsible.”
– Lloyd Karmeier, fifth district justice on the Illinois Supreme Court

“Basically the court is saying you can solve it, but the only way you can solve it is by throwing more money at it, and that’s just not in the cards. The real issue is we’re talking about amounts of money no taxing and revenue gets close to, in what’s available to us, so there really needs to be a rethinking in how this gets done. So, it’s going to be an interesting year.”
– Patrick O’Connor, Chicago City Council floor leader

“This action by Moody’s is not only premature, but it is irresponsible to play politics with Chicago’s financial future by pushing the City to increase taxes on residents without reform.”
– Rahm Emanuel, Mayor of Chicago

“You can’t blame “Wall Street” for the financial challenges facing pension funds, yet demand benefits based on financial assumptions that only those you taint as Wall Street charlatans are willing to promote.”
– Ed Ring, Executive Director, California Policy Center

“The borrowing is taking the pressure off politicians from actually facing the actual reforms that need to happen on these pension systems. You’ve got a situation where the system is no longer sustainable, whether it’s New Jersey or Illinois.”
– Ted Dabrowski, Vice President of policy, Illinois Policy Institute

“This isn’t how we think our education dollars are being spent. We’re told the money is going into the classrooms and, increasingly, it’s not.”
– Mark Bucher, President, California Policy Center

 

Pension Reform Handbook

For those interested in the process and mechanics of pension reform, Lance Christensen and Adrian Moore published a comprehensive starter guide for state and local reformers. This handbook aims to capture the experience of policymakers in those jurisdictions that have paved the way for substantive reform, and bring together the best practices that have emerged from their reform efforts, as well as the important lessons learned.

To access the handbook, go here.

 

Contact the Pension Reform Help Desk

Reason Foundation set up a Pension Reform Help Desk to provide information on Reason’s work on pension reform and resources for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.

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Adrian Moore
Vice President, Policy
Reason Foundation