Illinois reports that it owes $83 billion to its five public pension funds. That amount represents the chronic failure of the state to fully fund its pension systems, overly generous retirement benefits for state workers, and the inability of those funds to meet their investment targets. Unfortunately, this $83 billion figure grossly understates the pension crisis facing Illinois.

New reporting requirements by both the Governmental Accounting Standards Board and Moody’s Investment Services reveal hundreds of billions more in state and local pension liabilities for pension and other retirement debt.

The state’s five pension funds officially report $146 billion in accrued liabilities for earned benefits.  But $146 billion is not the amount of money that the state will actually pay out for those benefits. Instead, $146 billion is the money that the state should have in the bank today to earn enough investment income to pay out earned benefits.

The amount of money the state will actually spend on pensions is far greater. Altogether, the state will pay more than $632 billion for pension benefits between now and 2045.

Annual state pension payouts will more than triple (in billions of dollars)


Source: Commission on Government Forecasting and Accountability

The state should have already set aside enough money so that the funds’ assets can grow over time to cover the required payouts. Unfortunately, the state has only set aside $63 billion to pay for these future benefits.  Because the pension plans are so underfunded, they would need to see average investment returns of nearly 19 percent per year to cover future payouts.  The state predicts its pension funds will earn investment returns between 7 and 8.5 percent per year.  Even these returns may be overly optimistic.Over the last decade, the pension funds have earned average investment returns of only 4.5 to 6 percent per year.  The funds’ unrealistic investment targets have already increased the state’s total pension debt by more than $14.3 billion since 1996.State and local governments all over the country have used inflated return predictions to hide billions of dollars of retirement debt. A recent report by Moody’s Investment Services found that, using more realistic investment targets, state and local governments owe three times the total pension debt that they officially report.

In response to growing concerns over public pension debt, the Governmental Accounting Standards Board, GASB, and Moody’s have both revised government reporting rules to make state and local governments acknowledge the real scope of their pension problems.Under the new GASB rules, governments will be required to use more appropriate investment targets than most public pension plans have been using, bringing them more in line with accounting rules for private sector plans.  Pension plans can continue to use current investment targets for the amounts the plans are actually funded. But for the unfunded amounts, pension plans must use more reasonable investment forecasts, such as the yield on high-grade municipal bonds, currently between 3 and 4 percent.  Under these new rules, the five pension funds will see their combined unfunded liabilities more than double.Moody’s has also proposed new rules to require states to use more appropriate investment targets.  The new rules require pension plans to use investment targets based on the yield of high-grade, long-term corporate bonds, currently just over 4 percent. –  Under Moody’s new reporting rules, the five pensions funds will see their combined unfunded liabilities grow to more than $200 billion.

State and local taxpayers are on the hook for far more than the pension debt owed by the state’s five pension funds. The state also owes $54 billion in unfunded retiree health benefits and another $15 billion the state borrowed to make its annual pension payments and shore up investment losses.

Taxpayers are also on the hook for at least $50.9 billion in local retirement debt. Like the state’s pension plans, local pension funds will see their unfunded liabilities skyrocket under the new reporting rules. Under the new GASB rules, for example, the pension fund for Chicago Teachers would see its pension debt grow to $20 billion, nearly four times the $5.4 billion it officially reports. –

Pension reform cannot merely tinker at the margins. If Illinois is ever to get its fiscal house in order, serious long-term changes are needed to the structure, incentives and accountability within government retirement systems. Any serious solution to Illinois’ pension crisis must:

Move to defined contribution plans for future work. Each year of service means additional pension benefits – but state and local governments cannot afford to keep awarding benefits as currently structured. Pensions should be frozen at their current levels, and future retirement savings should be structured differently.

The only sustainable solution is one heavily centered on defined contribution plans, similar to the 401(k) plans used in the private sector.

Freeze cost-of-living increases for all retirees. Most Illinois government pensioners receive a 3 percent compounded, annual increase to their pensions. This cost-of-living adjustment, or COLA, becomes an automatic raise, provided at taxpayer expense. The COLA, as currently structured, doubles the annual value of a pension over 25 years, making pensions even more unaffordable.

State lawmakers recognized this fact when they enacted changes to pension COLAs for future employees, or “Tier 2” employees, reducing the COLA to one-half of the inflation rate or 3 percent, whichever is lower.

Given the severity of the crisis, all COLAs should be frozen until the pension funds are sufficiently funded. Thereafter, the COLA formula should be restructured in line with inflation and actual pension fund returns.

Raise retirement age for future retirees. Workers are living longer and the labor force’s demographics are changing, meaning that retired workers are collecting more retirement benefits for longer periods than in the past. State lawmakers recognized the need for increasing the retirement age when they enacted changes to the pension program for Tier 2 employees.

The retirement age was raised to 67 for all Tier 2 employees. Further pension reforms should adopt similar requirements for those not covered under Tier 2, while protecting near-retirees.

Tinkering at the margins, as some pension reform proposals would do, cannot solve the state’s retirement debt crisis. The state has already tried to tax and borrow its way out of its pension debt, failing disastrously. The only way to rescue the finances of state and local governments is to dramatically reform the structure, incentives and accountability within Illinois’ government retirement systems.

Government employees were promised security in retirement. The financial picture of Illinois’ pension funds tells a difficult story: their retirements are deeply in danger. If lawmakers act swiftly, it is possible to maintain a reasonable system of benefits for government retirees. If lawmakers fail to act, the retirement systems could become insolvent. The longer the state waits to reform its massive retirement debt problem, the more likely the state will fail to meet its obligations to government retirees.