A Way to Fix Illinois’ Pensions Crisis?

As Illinois lawmakers consider how to contain a pension crisis that seems to have finally boiled over in the wake of a recent state Supreme Court ruling, one option that remains in the backdrop, at least for now, would involve shifting more retirement costs onto local school districts and public universities.

Illinois House Speaker Michael Madigan advocated for such a shift in 2013, and public university and college leaders demonstrated a willingness to back this type of proposal at that time. But depending on how the cost-shift is structured, it could prove to be a heavy financial lift for school districts and universities already contending with state funding cutbacks, tight budgets and limited options for tapping into new revenue.

People familiar with the situation say that for a cost-shift to work, it would need to be phased in over time and that most school districts and public universities would probably need access to additional cash to pay for the new pension expenses.

The circumstances surrounding Illinois pension obligations changed on May 8. That’s when the Illinois Supreme Court struck down a 2013 state law designed to alleviate $105 billion in pension obligations by reducing public worker benefits.

Since then, one ratings agency has downgraded Chicago’s debt to junk status, and Gov. Bruce Rauner and state legislators are searching for a path forward as they face a financial abyss of unfunded retirement liabilities.

Proposals to address the pension problem have begun to ricochet around Springfield, but how state lawmakers will proceed remains very much uncertain.

‘They’re Going to Try It’

There is no legislation currently in play in the Illinois General Assembly that calls for shifting pension costs to school districts or universities. But Madigan’s longtime spokesman, Steve Brown, said during an interview on Monday that the House speaker still supports the idea.

“He’s talked about it for more than two years,” Brown said. “It would be an important way of getting the pension payment priorities in order.”

Brown said that it was currently not clear when a larger overall pension proposal might emerge. But speaking about Madigan’s approach toward the cost-shift he added: “I can tell you though, he’ll bring it up anytime he gets a chance in any negotiations.”

This would likely come as no surprise to Ben Schwarm, deputy executive director of the Illinois Association of School Boards. School boards from districts across the state are members of the organization. “It’s inevitable, for sure, that they’re going to try it,” he said in an interview last week.

“And probably at some point,” he added. “It’s going to happen.”

Schwarm believes the shift would be a tough nut for most districts to crack.

“The pension mess is so deep and so wide, and goes back decades and decades,” he said. “The solution is not as simple as moving the burden off of the state, who started the mess, onto the local school districts.” Schwarm added: “That by itself can’t be the answer.”

Treading Water

Public school teachers in Illinois, who work outside of Chicago, receive their pensions from the state’s Teachers' Retirement System, or TRS. There are three sources for the contributions that flow into the system—teachers, school districts and the state of Illinois. Those contributions are invested with the goal of producing financial gains.  

Teachers are responsible for contributing 9.4 percent of their "creditable" earnings. School districts are required to cover an amount equal to 0.58 percent of their total pension-eligible payroll.

After taking these contributions into account, TRS actuaries calculate the remaining amount of money needed to pay the pension fund’s costs for the next year. This amount is the state’s responsibility, and is also the cost that could potentially get shifted onto school districts.

To be clear, the teachers’ pension fund is not about to immediately go broke.

During the last fiscal year, which ended in June 2014, the Teachers’ Retirement System paid out $5.2 billion. The average annual pension payment was $51,288 during that time, and the fund’s return on investment totaled 17.4 percent after fees.

At the end of fiscal 2014, TRS had $45.8 billion in the bank, according to communications director Dave Urbanek.

But for years the state has shortchanged the payments it owes to the retirement system. And that’s where the trouble lies.

“TRS has never received an appropriation from the General Assembly, in any year, that equals what our actuaries consider to be full funding, and that goes back to the beginning, to 1939,” Urbanek said.

“That’s why we have the highest unfunded liability of any major pension system in the country,” he said.

The total unfunded liability for the system as of last year was $61.5 billion—or 59.4 percent of the amount that it would take to fully fund the system. In other words, only 40.6 percent of the system was funded. That unfunded liability amount is not due on a certain date. It represents the amount of money needed to pay full retirement benefits over a 30-year period.

But as a pension system’s funding level drops, more and more of its money goes toward paying annual benefits, while less and less is available to invest and generate financial returns. “We can tread water for years,” Urbanek said. “But, the high unfunded liability that we have inhibits our ability to maximize the investment opportunities within the fund.”

Of the entire amount the state contributed annually to the system in recent years, three-fourths is dedicated to paying off unfunded liability and one-fourth goes toward paying the cost of pensions, he explained.

“The cost of benefits continue to rise, and if the General Assembly continues to under-fund us, the unfunded liability continues to grow, the funded status continues to shrink, and pretty soon, the rising cost of the benefits and the lowering of the assets on hand start to come closer together,” Urbanek said. “And that’s a dangerous situation for any pension fund.”

Not Just About Shifting Costs

Public universities, colleges and other agencies with employees covered by the State Universities Retirement System, or SURS, currently contribute nothing to the pension fund. Contributions come from employees and the state of Illinois.

The state has made its full contribution to the fund during the last three years, including a $1.5 billion payment in fiscal 2014, according to Beth Spencer, a SURS spokeswoman. But the fund nevertheless remained only 42.3 percent funded during that year.

Jeffrey Brown is a professor of finance at the University of Illinois at Urbana-Champaign. In 2013, he worked on a proposal that involved public universities and colleges contributing up to 6.2 percent of their pension-eligible payroll to SURS. Under the proposal, that contribution would have been phased in at a rate of 0.5 percent for 11 years and 0.7 percent in year 12.

“That struck me as a manageable way to do this,” Brown said referring to the plan.

University presidents and chancellors in Illinois backed the proposal at the time, but it did not ultimately get rolled into any legislation. Going forward, he suspects that the cost-shift concept will resurface as a part of the conversation about how to temper the state’s pension liabilities.

And, from his perspective, there are reasons that could be a good thing.

“This is not just about shifting the cost burden,” Brown said. “One could argue that school districts and universities are not bearing the full cost of hiring.” By this, he means that even though a university or school district may choose to hire a new employee and pay their salary, they’re not on the hook for retirement costs that the state ultimately has to shoulder.

“If you effectively subsidize the purchase of something you get more of it,” he said, referring in this case to hiring employees.

But while shifting the costs might discourage excessive hiring, Brown also acknowledged a major roadblock to implementing such a plan. “Universities and school districts,” he said, “are in no position whatsoever to be picking up significant new costs.”

As Brown sees it, any cost shift that does take place would need to occur over decades, rather than years. He still believes that a half percentage point annually might be a viable rate for transferring more of the pension cost burden onto school districts and universities.

Brown also stressed that, in his view, the only costs that should be eligible for the shift are those incurred going forward.

“The responsibility for the existing debt,” he said, “Economically, morally, legally, ethically, that’s a state obligation and that should not be shifted.”

‘We’re Just Trying to Make Ends Meet’

In Rockford Public School District 205, otherwise known as Rockford Public Schools, finances are looking taut as the 2015-2016 annual budget takes shape.

The district is putting off bus purchases and IT investments, according to school board vice president, Jude Makulec. There are plans to spend $1 million updating a 20-year-old elementary school math program. But a similar freshening up of the middle school math curriculum will likely be deferred. Makulec noted that the district is also looking at cutting the equivalent of about 102 staff positions to trim roughly $7.4 million from the budget.

“We’re going to be lean next year,” Makulec said. “We’re just trying to make ends meet.”

Located about 80 miles west of Chicago, the district had 27,498 students, 46 schools and 1,909 teachers, according to the last count published on its website. Like most districts in Illinois, the bulk of its operating budget comes from property taxes and the state.

The proposed operating budget for the next fiscal year shows $360,953,747 in expenditures. Property tax revenue is projected to provide $140,244,640 of this total, and state funding $141,008,676.

The main source of state money is known as General State Aid. Due to funding shortfalls, districts have recently been receiving only about 89 percent of their fully allotted disbursement.

“We’re already not getting all the money we’re supposed to,” Makulec said.

Asked about pension costs, she is quick to point out that the district currently covers the full 9.4 percent-of-salary contribution teachers are required to pay.

This claim raises a discrepancy that requires explaining. There’s a longstanding difference of opinion between some school districts in Illinois and TRS about what it means to “pay” teacher pension costs. Under state law, teachers, not school districts, are required to pay the 9.4 percent contribution. But some districts, such Rockford Public Schools, choose to “pick up” the costs.

The “pick up” more or less amounts to adding 9.4 percent of a teacher’s base salary to their paycheck. But it is contributed pre-tax to the pension fund. In the view of TRS the pickup is seen as additional income, basically a raise of sorts, and factored into the amount a teacher needs to contribute, according to Urbanek. In other words, a teacher earning $100, who receives a $9.40 pickup, would need to make their 9.4 percent contribution based on $109.40, rather than $100.

The semantics of this don’t matter when it comes to a cost-shift, which would create new expenses for districts regardless of how they now handle pick-ups.

“Where’s the money come from?” asked Illinois Association of School Boards’ Schwarm. “It’s going to be massive cuts in programs and staff.”

Despite that dire warning, he outlined some steps state lawmakers could take to help districts handle the expense of a cost-shift. One is relaxing state program requirements so that local districts would have more leeway when spending their money. Another was a long phase-in period like the one Brown, the finance professor, described. And the third was granting an additional property tax levy to help districts pay for any shifted pension costs.

Most districts, he said, are already bumping up against limits on property taxes. And he also noted that the governor has proposed a two-year freeze on property tax increases.

But in Rockford, Makulec doesn’t think raising property taxes locally is an answer to the fiscal dilemmas the cost-shift might create. “That is not a even a viable option,” she said. From her perspective, upping taxes would drive down home values, undermining revenue gains.

So what is her preferred solution? Getting the district’s General State Aid funded at its full level. Makulec said: “That would be survival for us.”

‘Not as Hypothetical as You Think’

The financial implications of the cost-shift are comparably sticky at the university level.

Northern Illinois University is already hesitant to raise tuition, which along with fees provides its main source of revenue. “We’re concerned that we don’t price ourselves out of the market,” said Alan Phillips, the university’s vice president of administration and finance. “As tuition has increased enrollment has declined.”

Basic economics is behind this phenomenon. “If you continue to raise tuition and fees,” Phillips explained, “you lose more students.”

If a cost-shift does take place, Northern Illinois University’s leadership is hoping it will involve a phase-in. Phillips noted that paying the total cost of the state’s current pension expenses for university employees who are eligible for SURS would amount to about $24 million to $25 million. Ponying up that sum would require new revenue or, possibly, program cuts, he said.

The university is already dealing with declines in state financial support, and the governor’s budget has proposed further cuts, Phillips said. “Any additional costs that are shifted to the universities are a concern because, in an era of declining resources, that just makes your funding problems more difficult,” he added.

Credit analysts are keeping an eye on the universities as the pension situation develops, looking for negative signs like deep state funding cuts, or steep drops in enrollment.

Asked about how a cost-shift would affect public universities in Illinois, Edith Behr, a vice president and senior credit officer for Moody’s Investors Service said: “It’s not as hypothetical as you think.”

She pointed out that trends illustrating how Illinois has directed money toward public universities over the last seven years show that contributions to support operating costs had gone down, while money going toward employee health care and pensions had gone up.

“Some are more pressured than others,” she said, referring to public universities in the state.

Up in the Air

Whether Illinois will wind up shifting more of its pension burden onto school districts and public universities is one of many unknowns these days in Springfield.

“Everything is completely up in the air right now,” said Christopher Mooney, director of the Institute of Government and Public Affairs in the Department of Political Science at the University of Illinois at Springfield.

A close watcher of the state General Assembly, he is skeptical there will be an immediate, tidy solution to all of Illinois fiscal woes. “Given the incentive structure for politicians,” he said, “it seems unlikely to me everything’s going to get solved this year.”

According to Brown, the finance professor, if the cost-shift were to be a part of eventual pension legislation, the results would to some extent depend on lawmaker intentions and what other policy changes it is accompanied by.

“If the state views this as just a way of washing its hands of funding responsibility, and doesn’t provide the resources to the school districts and the universities to do it, then all they’ll really succeed at doing is creating a financial crisis,” he added. “If it’s done slowly, wisely and with some additional resources, then in the very long run it could actually be a positive thing.”