The pension system in Illinois is broke, both literally and structurally. According to Bloomberg, while the national median funding ratio for state pension systems is around 71.7 percent (for the year through June 2011); Illinois funding ratio is much lower, with the weakest funding ratio of any state at 43.4 percent.
The recent decision by the Illinois Teachers Retirement System to lower its expected rate of return for its pensions fund investments, and its push for cost-of-livings benefits cuts are a positive step, but it doesn’t go far enough to address many of the real problems built into the pension system.
For years, pension funds relied on strong investment returns to allow them to cut back on the dollars placed into the fund up front. Pension fund regulators and lawmakers are beginning to notice this problem and are moving to set more reasonable expectations for investment returns. According to the National Association of State Retirement Administrators, since 2008, 19 public pension plans have lowered the assumed rate of return below 8 percent, and others, including Minnesota and New York, are considering doing so.
Decreasing the expected rate of return does have consequences. By lowering the expected rate, which is used to determine the present value of benefits which will be paid to retired workers in the future, pension fund regulators increase the apparent level of obligations. While this does increase liabilities, it informs those responsible for managing the fund about the real problems the pension fund faces.
Growth in this funding gap is important because it will eventually need to be filled either through benefit cuts or tax hikes. While there is no silver bullet for where the assumed rate of return should be set, a good baseline, recommended by Veronique de Rugy of the Mercatus Center, would base projected rate of return numbers on the rate offered on 15-year Treasury bonds, or around 3 to 3.5 percent.
Despite these setbacks, maintaining the status quo is not a viable option. Even if state and local pension funds were to accept the current high rates, it would take large scale increases in contributions from pension holders to bring them into actuarial balance. Without adequate reforms, taxpayers may be stuck with the bill for years of pension fund mismanagement.
The primary goal of any pension fund should be to ensure that the returns that they receive on any investments covers future benefit payments. Pushing the funding of public pensions down the road only serves to delay the problem; pension holders are entitled to the benefits they pay in, shortchanging the pension fund helps no one.
Without an overhaul of the current, unsustainable pension system, Illinois taxpayers will continue to be burdened by substantially higher taxes to bail out legislators and special interests for their imprudent policies. The TRS’s modest decrease in its expected rate of return is simply not enough. If the estimated rates of return for these pension funds continue to fall short of expectations, then pension systems across the country may be in even more trouble than is currently thought.