In the state of Illinois, tensions are high. Democratic Gov. Pat Quinn has refused to pay lawmakers in the Illinois House and Senate until they pass legislation tackling reform of the state's pension system, which is currently underfunded by more than $100 billion. While the legislators have sued, arguing such a move is unconstitutional, public employees are prepared to file a lawsuit of their own, claiming that a number of proposals currently on the table to cut their benefits violate the Illinois Constitution as well.
Like Illinois, a number of states are also facing their own potential pension showdown. As part of his effort to bring state pension reform into the public discourse, former Utah state Sen. Dan Liljenquist, a Republican, joined with the American Legislative Exchange Council, an organization of state legislators, businesses and foundations that favors federalism and conservative public policy solutions, to release a report called “Keeping the Promise: State Solutions for Government Pension Reform.” The report lays out potential solutions that Liljenquist and ALEC believe will create more sustainability for states over the long term.
"In state government, there is not a more critical issue than pension reform," said Liljenquist, who writes a weekly Deseret News column. "The reality of the situation is starting to settle in that we are way, way, way behind [having] secure retirement for our public employees."
One of the main driving forces behind pension shortfalls is that while states are legally obligated to pay out pensions, they have no obligation to properly fund those pensions, and there has been a growing gap between states’ assets and their public sector obligations. In negotiations with public employees, politicians will often promise pension benefits in the future rather than raise employees' wages in the present, but then fail to set aside the funds to meet these obligations.
But decades of failing to properly fund these pension promises combined with investment losses in pension funds and lower tax revenue from citizens resulting from the 2008 financial crisis are coming to a head in a number of states.
“Underfunding public pensions is in substance, if not in form, an example of deficit spending in which current taxpayers enjoy the benefits of government services while pushing off some of the costs to future taxpayers," according to Jack Beermann, a law professor at Boston University School of Law, who has studied public pension shortfalls.
The state of pensions
While some states have done a good job in making sure their pension obligations will be funded, numerous states are looking down the barrel of a pension shortfall gun. According to a 2012 study from the Pew Center for the States, in fiscal year 2010, the gap between states’ assets and their obligations for public sector retirement benefits was $1.38 trillion. Of that figure, $757 billion was for pension obligations, with the rest reflecting a shortfall in public retiree health care benefits.
Using 2010 data, the Pew study found that only Wisconsin had fully funded its pension obligations, meaning it will be able to meet its pension obligations as they come due. According to Pew, experts say that pension obligations should be at least 80 percent funded, but 34 states fell below this threshold. Connecticut, Illinois, Kentucky and Rhode Island had the most dire situations, all under 55 percent funded. Only three other states besides Wisconsin — South Dakota, North Carolina and Washington — were more than 95 percent funded.
The failure to adequately fund pension obligations means that taxpayers will be the ones who suffer when the bill for pensions comes due. This is because if a pension is underfunded, the state must still pay the benefit. And if the state did not obtain adequate returns to fund such a payout, the money must come from current state revenues. States will therefore be spending money that comes in from its taxpayers on pension obligations, instead of providing services for citizens. For example, in Illinois, one-fifth of the general revenue that comes in will be owed to pension plans, hurting the state's ability to provide other government services.
Like many retirement portfolios, pension funds often invest in the stock market. So when a recession hits, the funds will take a hit similar to a private employee's 401(k) that was invested in the market. While states budget to receive a return on their pension funds of on average around 8 percent, during the recession, pension funds took losses of nearly 25 percent, according to Pew. This even further decreases states' abilities to provide services for taxpayers while they struggle to make up the hits to pension funds.
Liljenquist said that when he began to look at Utah’s pension obligations, the numbers brought the situation home for him. “The Utah breakthrough came on pension reform when it dawned on us that the 2008 market crash cost us the equivalent of 8,000 schoolteachers for 25 years,” he said. “Pension costs are damaging our ability to provide basic costs.”
The potential reforms
The Liljenquist/ALEC report lays out a number of broad goals that state pension reforms should be aiming to address. These include making sure commitments to current workers are met while also ensuring that plans are predictable and defined so that states don't find themselves going effectively bankrupt over public pension obligations. To accomplish these goals, Liljenquist and ALEC suggest that states move from the current defined-benefit model to some sort of defined-contribution or hybrid model.
Essentially, under a defined-benefit model, an employer promises to pay a certain amount in retirement based on criteria like an employee’s years of service. The employer controls the management of the funds and is obligated to make the retirement payments regardless of investment returns. That means that if the state overestimates investment returns or dips into the pension funds to pay for other expenses, it will have to use current expenditures to pay for the plans. And at least some states are facing just such a situation.
Therefore, Liljenquist and ALEC propose moving to a defined-contribution plan, similar to the 401k model used in the private sector, or a hybrid model that has aspects of both defined-contribution and defined-benefit. Liljenquist says that states like Rhode Island, Michigan, Kansas and Utah have recently instituted these types of reforms and are on a path to sustainable pension packages.
But reforming pensions often means harming the public employees who have spent their lives working for the government, which is why making pension cuts can be painfully hard. "Most references to the 'public pension crisis' are to the financial aspects of the problem," according to Beerman. "This masks the most important crisis, the human crisis. The vast majority of people receiving government pensions are not wealthy."
And ALEC's proposed reforms are not free from criticism. Earlier this year, Robert Hiltonsmith at the Economic Policy Institute, a liberal economic think tank, criticized Rhode Island’s move to a hybrid pension system by saying it would cost the state more while reducing retiree benefits. According to Hiltonsmith, the new hybrid plan will result in an average benefit cut of 14 percent for future full-career employees while actually costing taxpayers more annually.
Liljenquist agrees that states cannot simply turn their backs on public employees and retirees but argued that something needs to be done going forward. “Our No. 1 goal with respect to pension reform should be that we meet our commitments to our public employees,” he said. “It’s a huge tragedy that could have been avoided but certainly should be avoided going forward.”
In Illinois, the current epicenter of pension reform battles, pension ideas similar to those proposed by Liljenquist and ALEC are currently being debated in the Legislature. State Rep. Elaine Nekrtiz, a Democrat, agrees that these issues need to be addressed.
“At first I thought, ‘Is this really from ALEC?’ ” Nekritz said to the Jacksonville Journal-Courier. “But a lot of the ideas mentioned in the report are fairly standard pension reform doctrine.”
Liljenquist believes that the public pension solutions need to come from both sides of the political spectrum. “These issues we face are not partisan,” he said. “They are not right vs. left. They are reality issues.”