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IGPA experts on Governor Quinn’s pension plan: Missing an opportunity for comprehensive reform
Illinois’ leaders are contemplating big changes to the state’s public pension policy. There is an urgent need for reform. In the past, the state has neglected to make required annual contributions to Illinois’ pension fund, which has resulted in a lack of money to cover the long-term costs of future retirement benefits for public employees. This neglect has had serious consequences. Illinois is currently ranked 50th among the states in terms of the severity of unfunded liabilities, which prompted Moody’s Investor Service to downgrade Illinois’ credit rating to the lowest of any state at the beginning of this year.
This unsustainable situation presents an urgent challenge for the state’s legislators, but also an opportunity to rethink the system as a whole. How can the state ensure retirement security for its public employees, and provide a competitive compensation package, while also aiming for long-term fiscal stability?
On April 20, Governor Quinn announced a plan to tackle pension reform. The governor’s office estimates the plan will save between $65 and $85 billion by 2045, although it is not clear how these estimates were garnered. IGPA experts on pension policy agree that the proposed changes do not take advantage of an opportunity for comprehensive reform. Rather than modernizing the pension system, the governor’s plan largely focus on shifting the costs of pensions to employers, effectively ending the state’s role in funding future retirement benefits for public sector workers.
“Governor Quinn’s primary goal is to reduce the normal costs of the public pension system for the state. That is what his proposal has done,” said IGPA director Robert Rich. “Yet this proposal too narrowly defines the pension issue; he has concentrated on the fiscal side alone. This proposal does not take into account the broader issues associated with compensation for all public employees in Illinois.”
An unfair “choice” may not pass legal scrutiny
One problematic component of the legislation is the presentation of a “choice” for current public employees. The proposal offers current employees two options: 1. Change their pension to be based on their current salary, not their final year’s salary, or 2. Receive no subsidy for health care in retirement.
“By persuading employees to choose cuts in benefits in order to keep the health care benefits they will receive in retirement, the governor believes he has found a way to make these reforms ‘voluntary,’” said Jeffrey Brown, IGPA expert on pensions and director of the University of Illinois Center for Business and Public Policy. “This tactic is really an attempt to circumvent constitutional protections, and it remains to be seen whether the courts would accept this approach.”
By making the reform measure “voluntary,” the governor hopes to avoid violating the non-impairment clause.
The Illinois Constitution’s non-impairment clause has been a central constraint on any reform measures. The clause creates a contract between the state and employees, protecting against the impairment of already-accrued pension benefits. One possible interpretation is that the state cannot fundamentally change the pension benefits that employees were promised when enrolled. (For more on legal issues surrounding pension reform, see Section 2 of IGPA’s report on public pensions).
By making the reform measure “voluntary,” the governor hopes to avoid violating the non-impairment clause. Yet Rich and Brown agree this tactic has several drawbacks. First, they argue that the choice is not truly voluntary due to the severity of the penalty imposed on the individual, despite the option they choose.
“A court will ask if the choice presented to employees is fair and equal,” Rich said. “The proposal at hand penalizes the employee for staying with their current benefits by decreasing their retiree health insurance. The individual is forced to choose between two bad options. This does not seem like a choice at all.”
Further, Brown said that forcing this particular choice might not be as effective for fiscal reform as expected. “Why would an individual elect to take a cut in their constitutionally protected pension benefits in order to save their non-protected healthcare benefits, if they believe that the state could still turn around and further reduce those health care benefits or shift the premiums to retirees at any time in the future?” Brown asked.
Another unintended consequence of linking together health insurance and pensions is that it fails to take advantage of the opportunity to optimally design either system individually. Brown said that the state should be having a conversation about ways to reduce the cost of retiree health care. “But by linking retiree health care to pension reform in this way, we may forego the opportunity to carefully reform retiree health insurance on its own terms,” Brown said.
What about Tier 2?
When the state reformed the public pension system in 2010, new employees were offered a considerably less generous pension program. Employees hired on or after January 1, 2011 were enrolled in the Tier 2 system, which includes a higher retirement age, decreased cost of living adjustments, much longer vesting periods, and other changes in how benefits are calculated.
Brown notes, “By any measure, Illinois public institutions now provide an inferior pension package relative to nearly all of the institutions with whom we compete for new faculty and staff.
These changes have placed the University of Illinois, and other higher education institutions in the state, at a significant comparative disadvantage compared to other Big 10 schools with whom they compete for new faculty.
Brown notes, “By any measure, Illinois public institutions now provide an inferior pension package relative to nearly all of the institutions with whom we compete for new faculty and staff. Unless we compensate them in other ways, or unless this Tier II problem is addressed, it will adversely impact our ability to hire.”
Governor Quinn’s proposal does not address the issues with the Tier 2 system, reflecting a missed opportunity for comprehensive reform.
Impacts on the state’s public employers
The proposal would shift an enormous financial burden onto public schools and universities. Specifically, the proposal would require employers to take on 100 percent of the normal costs of their employees’ retirement benefits.
Currently, this would amount to an increase in University costs of approximately 13% of payroll (minus any additional contributions made by participants).According to analysis by Avijit Ghosh, Special Assistant to the President of the University of Illinois, if all normal costs were transferred to the employer, the University of Illinois would have to find $165 million in payroll funds.
This is equivalent to 25 percent of the university’s current appropriation from the state, and comes at a time when state appropriations are already declining. This would lead to higher tuition, cuts to programs, loss of faculty and staff, and increased class sizes. “It would have a major impact on the university, making us less competitive nationally and internationally,” said Rich.
Further, the university would have to absorb this cut without being given any increased control over the benefits they are offering. “It represents the worst of all possible worlds,” Rich said. “The state would require that the university take over the employer contribution while retaining the right to define what the benefit will be, and the structure and level of the benefits.”
Similarly to other states, changes in Cost of Living Adjustments (COLA) and increased employee contributions will guarantee a state Supreme Court challenge
Part of the current pension benefit is a guaranteed COLA increase of 3 percent every year. The governor’s proposal would reduce this so that employees would receive the lesser of 3 percent or half of the consumer price index. Rich said that unions would challenge these changes to current employees’ benefits at the Illinois Supreme Court under the non-impairment clause. Other states have grappled with similar legal questions.
Arizona’s recent legislation increasing employee contributions went into effect in July of 2011. This cost-saving move was designed to cut $60 million from the state budget. Seven teachers sued, and a Superior Court judge ruled that the state constitution protected the “contractual relationship between the state and its employees.” Rich said Arizona’s law is very similar to the non-impairment clause in Illinois.
Rich said that unions would challenge these changes to current employees’ benefits at the Illinois Supreme Court under the non-impairment clause.
Another important example can be found in a reform measure recently struck down in Florida. Aiming to address a $3.6 million budget deficit, the measure ended COLA for current employees. A judge ruled that these changes violated the state workers’ employment contracts.
If the governor’s plan were to pass, “the conversation will not be over,” Brown said. Moving forward, comprehensive reforms will need to be implemented to create a more fiscally sound system that does not compromise employee retirement security and public employer competitiveness.
For all of IGPA's research and analysis on pensions, visit igpa.uillinois.edu/pensions.
Published May 8, 2012