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Illinois and California have largest unfunded pension liabilities

California and Illinois are the largest contributors to an expected $1.3 trillion in unfunded pension liabilities for the 50 states in fiscal 2023, according to a Reason Foundation study.

California’s public pension systems are projected to be $245 billion short of where they need to be after 2023, the largest miss in the nation, followed by Illinois with $144 billion in unfunded liabilities, New Jersey with $100 billion, Texas with $88 billion and Ohio with $68 billion.

Unfunded pension liabilities are an issue nationally for state and local governments, with some faring better than others.

Based on an estimated annual investment return of 7% for public pension plans, Reason Foundation researchers used, Washington and New York are the only states that will be without public pension liabilities at the end of 2023.

California’s liability comes partly by virtue of the size of the state’s pension funds, said Zachary Christensen, managing director of Reason Foundation’s Pension Integrity Project. The California Public Employees Retirement System is the nation’s largest pension fund, and the California State Teachers Retirement System is in the top three.

Illinois’ pension overhang is a result of “decades of mistakes being made. They are an extreme case that everyone points to of doing everything wrong,” said Zachary Christensen, managing director of Reason Foundation’s Pension Integrity Project.

The Reason Foundation

Illinois’ pension overhang is a result of “decades of mistakes being made,” Christensen said. “They are an extreme case that everyone points to of doing everything wrong. The overarching theme in Illinois has been of seeing things go wrong, and not reacting.”

“They found a way to not pay what their own plan managers said they needed to pay,” Christensen said. “It’s like making the minimum payment on the credit card, and being very slow, and not nimble, in adjusting their assumptions.”

S&P Global Ratings in February raised the state’s rating to A-minus with a stable outlook from BBB-plus. Moody’s Investors Service in mid-March upgraded the state to A3 from Baa1 and assigned a stable outlook. Both cited the state’s efforts to build reserves and pay down debts with surplus tax revenues. Fitch Ratings took action in late March, lifting the state’s outlook to positive from stable on its BBB-plus rating, citing the city’s planned contributions to the rainy-day fund, which were made. The revised outlook comes on top of a 2022 ratings upgrade by Fitch.

The rating agency wants to track the state through another fiscal cycle and assess further whether it can maintain “the recent fiscal balance going forward,” said Eric Kim, Fitch’s lead analyst covering Illinois.

Pension and other-post employment benefits are one of the key factors Fitch looks at when evaluating ratings, Kim said.

“Pensions, and other liabilities like long-term debt, are challenges for the state,” Kim said. “They are a factor in why the ratings are so low compared to other states.”

Instead of having a long-term plan to get the pension funds to 90% funded by 2045, Kim said it would be better if the target were to hit 100% funded.

“In Illinois almost every public pension is underfunded,” said Amanda Kass, an assistant professor in the School of Public Service at DePaul University in Chicago. “But, the problems plaguing Chicago are not the same as the state.”

The state has a long history of underfunding its pension systems that it is trying to right, Kass said.

In 1995, it adopted a 50-year funding plan to get the system to 90% funded by 2045, but then the Great Recession in 2008 compounded the problem, she said.

“It’s decades in the making,” Kass said. “One of the challenges is it took so long to dig ourselves in, it will also take decades to dig ourselves out, and people want some magic bullet that will resolve it in a few years, and that is not the nature of the problem.”

Illinois Gov. J.B. Pritzker made solving the state’s pension crisis a priority, laying out plans to tackle the issue in his first budget address in 2019, by making bigger payments toward pensions and cutting costs to shore up the state’s five pension funds.

The statutory contribution of $9.2 billion in pension payments in his first budget comprised nearly 25% of the general fund, and that remained true for the $50.7 billion general fund fiscal 2024 budget.

While pensions have continued to be an issue, the state has paid off $8 billion in overdue bills, reducing accounts payable to $963 million, paid off short-term cash and inter-fund borrowing, built up a depleted budget stabilization fund, and won two rounds of rating upgrades.

Kass noted the state’s constitutional protections — that prevent it from making any changes to the pension benefits received by existing employees — create challenges in making headway.

“That limits reducing the unfunded liabilities” Kass said. “If you can’t cut benefits for people currently in the system, you can’t reduce the liabilities on the liability side, so that means reducing benefits for new hires, or doing things on the margins, or putting more money into the pension system.”

There is only so much Pritzker could do after taking office, she said.

One thing the state did was institute a buyout program in which employees retiring or already retired agreed to take a lump sum payment for a portion of the benefit, she said.

The administration believes the combined $700 million of supplemental pension contributions between fiscal year 2022 and 2024 will trim $2.4 billion of liabilities in addition to an ongoing bond-funded pension buyout program that will save an estimated $1.6 billion.

“What once was a state with no cushion to protect it in an economic downturn is now an Illinois on track to have a $2.3 billion rainy-day fund,” Pritzker said during his budget address in February. “What once was an Illinois with a credit rating on the verge of junk status is now an Illinois getting credit upgrades.”

The state also created a Tier 2 for incoming employees in 2011 implementing a system of lesser benefits than those received by employees hired before then.

Illinois’ police and fire unions have been pressuring lawmakers to modify its Tier 2 pension systems. Legislation is working its way through the system that would do just that.

Many states and local governments created a second tier of pensions after the 2008 economic crash that put many pension systems in jeopardy.

Illinois’ two-tiered system eliminated compounded interest for new employees and capped base salaries used to set pension payment.

State law requires local governments to contribute 90% of the total actuarial liabilities by 2040. Members of the Illinois Municipal League asked lawmakers to extend the schedule to fiscal year 2050.

The pending legislation to revise Tier 2 will address concerns the benefits offered might violate the safe harbor provision, meaning they are less than what employees would have received through Social Security benefits if they had been paying into that instead. Tier 2 has also sparked recruitment problems, since neighboring states offer better retirement benefits than Illinois, she said.

“They politically needed to something in 2011,” Kass said. “It was right after the financial crisis, and there was a sense of urgency.”

The Tier 2 system has problems that need to be remedied, she added, however, she has not seen any analysis outlining how significant of a problem exists in terms of violating the Social Security provisions.

“The problem in Illinois is that when there is an urgency, things get bottlenecked until a crisis moment hits, and oftentimes legislation is passed without robust analysis,” she said. “When Tier 2 was approved, it was motivated by the need to reduce unfunded pension and OPEB liabilities.”

The state and cities need to balance the need to solidify the pension system by reducing unfunded liabilities while not creating an impoverished elderly population or violating the safe harbor provision.

She also noted that increasing payments to speed up paying down the unfunded pension liability means either raising taxes or cutting services.

Absent what Kass called a magic bean, the state needs to just continue to make payments and be fiscally responsible year-after-year to reach its goal of 90% funded.

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