Illinois’s Pension Mess

Josh Barro has a lengthy post at Bloomberg explaining Illinois’s public pension mess and how it got so bad:

This month, the Teachers’ Retirement System of the State of Illinois made a dire announcement to its members. TRS, which covers most public-school teachers in Illinois outside Chicago and has more than 360,000 members, said the following:

“If the General Assembly does not continue to provide all of the funding called for in state law, calculations done by TRS actuaries show that the System could become insolvent as soon as 2030. Preventing insolvency may include significant changes for TRS — new revenues must be generated and if they are not benefits may have to be reduced.”

The teachers’ fund is one of the country’s worst-financed statewide pension systems, reporting that it is only 47 percent funded. And that’s if you buy the system’s rosy accounting assumptions, including that it will achieve 8.5 percent annual returns on its assets. This level is tied for the most aggressive investment assumption among state pension funds in the country, and the fund has had to get creative in an effort to meet it. Pensions & Investments magazine says it has the fourth-riskiest pension investment portfolio in the U.S., with less than 17 percent of its investments in fixed income and cash.

Perhaps the teachers’ fund will be fabulously lucky, and rich investment returns will cover pension costs so taxpayers won’t have to. But the odds of that are vanishing. Indeed, the system’s funding status is so poor that it achieved a 23.6 percent return on investments in 2011 and still managed to shave only $2 billion off its $46 billion unfunded liability. And it’s not as though the fund can make such gangbuster returns consistently — in 2009, it returned negative 22.7 percent.

Closing the TRS funding gap — and the gap at the State Retirement Systems of Illinois, which is only 36 percent funded — will depend on taxpayers’ willingness to start paying far more than they ever did for pensions. And as the TRS statement makes clear, that is far from a sure bet, meaning that pensioners may see their benefits cut.

Read the whole thing (if you have a strong stomach). Hat tip: Mike Shedlock.

I gather that Mr. Barro has never lived in Illinois. If he had he might be familiar with Article XIII, Section 5 of the Illinois state constitution:

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.

It’s my understanding that this provision has been fully litigated. My interpretation of that is that, at least in theory, Illinois taxpayers’ willingness may have little or nothing to do with it. An Illinois court, exercising its powers in equity, could order that the pensions be paid. If funds are not available, the court could raise taxes without a by-your-leave from the legislators. Illinois Supreme Court justices are appointed, serve for a term of 10 years, and are themselves members of the retirement system of the state.

Legislators might amend the constitution. I strongly suspect that Illinois judges will not be amused.

I honestly don’t think it will go that far. I think it’s more likely that future government employees in Illinois will bear much of the burden in the form of reduced pension benefits. However, the idea that there’s any easy or painfree way for the citizens of Illinois to escape the consequences of decades of legislative and executive incompetence is just plain wrong.


I would also draw your attention to Article I, section 10, clause 1 of the U. S. Constitution:

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

which I interpret as explicitly denying to state legislatures the power to alter contractual terms after the fact. That’s what I meant by “not be amused”, above. Prudently, Medicare and Social Security benefits are explicitly not contractual obligations. But under Illinois law public employee pension benefits are. The Illinois legislature doesn’t have the power to release Illinois from the bonds they’ve put it in. The courts do have the power to do so but I strongly suspect that judges will go to some lengths to keep that from happening.

12 comments… add one
  • Drew Link

    In part this relates to your previous essay entitled Spoiled Investors. The Fed has driven down fixed income rates and encouraged yield chase in equities trying reflate a bubble. This is a precarious situation and almost without doubt the projected portfolio return is aggressive.
    It’s just one mans opinion, but Gary shilling has predicted a big sell off in equities with the end of QE.

    (it’s one of the reasons I really didn’t understand where you were going with the “why complain.” line).

    In any event this is fiscal mismanagement of monumental proportions, driven mostly by the Illinois way, and single party dominance. One wonders if the teachers will come with pitchforks and torches for the Democrats in French Revolutionary style as Michael would have us believe, or if the nihilists might be able to reset the long term funding vs obligation trajectory and salvage the system as best as possible. Given Mr Madigans hold on the state, I suspect the answer to the latter is “no.”

  • michael reynolds Link

    Great, there goes my plan to apply for a Letter of Marque and Reprisal and then sail from the pirate port of Tiburon to prey upon passing container ships. Stupid constitution!

  • jan Link

    Dove-tailing into Illinois’s pension problems, one must not forget California’s fiscal follies.

    Largest US Teacher Pension Fund Underfunding Increases By $9 Billion To $64.5 Billion, Only 69% Funded.

    These iron-fisted defined pension plans are like putting cement blocks in the hull of a ship, and then wondering why it is sinking.

  • Drew Link

    For those of those familiar with what pension and endowment fund asset allocation looks like, it can cause one to speculate that with the massive adjustment from fixed income weighting to equity weighting if mr Bernanke, perhaps at the behest of his political bosses, haven’t broken out into a cold sweat at the prospect of a lackluster equity market.

    Onward, bubbles!

  • Jimbino Link

    In Calder_v._Bull, SCOTUS held that the ex post facto provisions in the Constitution applied only to criminal law, not civil contracts. That is still the law, apparently.

  • it’s an absolute shame how Illinois officials have run our state into the ground on all financial fronts….and a greater shame that it is likely that the biggest burden from the pension mess will be borne by teachers & other public employees.

    if you want to never worry about the future of your Illinois pension benefits again, read this letter:

  • Dave–

    I am familiar with the pension provision in the Illinois Constitution. Its meaning is not so clear as you suggest. Governor Quinn takes the position that current workers’ pension credits to be earned in the future cannot be reduced, due to this provision. But Speaker Madigan, backed up by a legal opinion from Sidley Austin, contends that the provision only protects benefits previously accrued. Reforms that change benefits prospectively for current workers would certainly be litigated, but they are not necessarily DOA.

    It is also not clear what happens if a pension fund in Illinois runs out of money. Article XIII, Section 5 prohibits the reduction of certain promised pension benefits. But it is not clear who backs up those constitutionally required pension promises– the state government, or just the pension fund. A pension fund may not be allowed to nullify promises, but if it contains no money with which to satisfy them, it is not necessarily true that the state will be forced to cover the gaps.

    Finally, I am also familiar with the Contracts Clause of the U.S. Constitution. Yet several states have passed laws that cut pension benefits– not just benefits that current workers can earn in the future, but those earned in the past, even by workers who have already retired. Workers suing to block these changes have made claims that they are protected by the Contracts Clause but so far have not been successful. (They have sometimes been successful in their claims under state constitutions.)



  • Josh:

    Thanks for commenting. My point is actually quite simple: Illinois’s pension problems will be resolved in the courts. The legislature and the voters will only have a limited role.

    Now to some detailed responses. The Illinois TRS, for example, is not a private corporation. It is a state department, the instrumentality by which teachers’ pensions, other than teachers who work for CPS, are paid. That it has a fund is not really relevant. So do Illinois HFS and the highway department. Their debts are all the state’s debts.

    I assume that Speaker Madigan’s views will prevail. That’s the crux of Illinois’s problem: the fund is inadequate to pay the pensions already accrued—at current funding levels the TRS is predicted to be in the red in 2030. Because the assumptions are so outlandish I expect it will be somewhat sooner.

    Other states’ experiences are only relevant to the extent that they replicate Illinois’s constitutional provision, which is distinctive if not unique.

    The court’s powers in equity are nearly unlimited. It can levy taxes or alter spending priorities, for example. I don’t think that it’s likely that the court will go that far in Illinois’s case. I think it will just tell the state to pay the bill for present pensioners and the pensions of present Illinois public employees when they retire.

  • PD Shaw Link

    I think part of the Sidley Austin argument is that government unions have been unsuccesful in court in ordering the pension to be funded under this Constitutional provision. The right to receive benefits is treated differently that the right to ensure the state funds the pensions. There has been some suggestion in these decisions that in a default situation, funding might be compelled in order to given effect to the right to receive earned benefits, but its dictum.

    Frankly, its hard for me to imagine the courts taking that step if a default arose. I’m trying to imagine what the circumstances would be when a default arose; I’m guessing after making considerable efforts over the years, the political will to fund the pensions erodes in the face of an unimagably high bill that jeopardizes too many existing services and would require too high of a tax burden. The judges that order a doubling of marginal tax rates and cutting of services would be taking on a public role that would run them out of elected office.

    Retirments in state government are up 50% over last year. I think the workers see the writing on the wall.

  • I see a distinction between compelling the state to fund fully a fund that’s still able to meet its commitments allowing the fund to default. As I suggested in the body of the post and in comments I think it’s more likely that the court will simply order the state to pay and leave the details to the legislature.

    I have some difficulty in making a distinction among the various things the state government pays for: payrolls, pensions, healthcare, contractors, etc. Why should the state be obligated to pay physicians for services rendered under Medicaid and not pay teachers the pensions to which they are contractually obligated? I think that both are obligations.

    Additionally, consider that teachers, for example, have been mandatorially contributing about 10% of their salaries to TRS, in some cases for decades. If at the very least the employee contributions are not honored, that would seem to present a case for takings grounds as well as contracts.

    My key point is that I think it will be very, very difficult for Illinois to escape the problem it has built for itself over decades and which it has compounded over the last decade. I don’t believe it will be as simple as walking away.

  • PD Shaw Link

    The situation is certainly unfair. The state didn’t fund these obligations as they were incurred. And speaking of aribitray outcomes. I think its largely conceded that judge’s pensions are secure regardless of the pension clause because another clause in the Constitution specifically protects the judiciary from having compensation diminished by the legislature. The teacher, ineligible for a Social Security pension, is far more at risk and in need of protection.

    BTW/ Scott Walker was in Springfield today, campaigning to continue as governor with a beautiful backdrop provided by the Illinois Chamber of Commerce. I had trouble parking for all of the protestors. The started off the protest with “Street Fightin’ Man” by those notirious tax avoiders.

  • What happens to the liabilities if the state declares bankruptcy? Lots of unhappy people, I’m sure, but wouldn’t that get the state out from under Gibraltar?

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