Can Gov. Rauner Put Illinois Pension Funds in the Black?

If any one state stands out in the race to the bottom of public employee pension insolvency, Illinois would be it. And GOP Governor Bruce Rauner is steeling himself to prevent a collapse. Rauner, a former private equity fund manager, was elected last November over Democratic incumbent Pat Quinn. He faces $111 billion in unfunded pension liabilities, or about $8,500 per resident. The years of greed, corruption and bad luck having taken a toll, the governor and his top fiscal policy adviser, Donna Arduin, have proposed tough measures to reverse course. So far, they haven’t won any friends among public-sector unions – or the Illinois Supreme Court, which on May 8 sided with the unions in invalidating reforms enacted in late 2013.

State-sponsored pension systems across the nation are facing a solvency crisis despite the recovery of the stock market since the 2008 crash. Numerous studies have indicated as much. Among the most telling is a report published last June by Standard & Poor’s. Using certain assumptions, the authors estimated mean and median asset-to-liability funding levels for all 50 states in 2012, respectively, at 71 percent and 66 percent. This is underfunding close to a crisis situation. And the trend during 2009-12 was one of steady decline. Granted, some states are prepared for another downturn. The five highest-ranking states – Wisconsin, North Carolina, Washington (State), South Dakota and Oregon – each had funding levels above 90 percent in 2012. But the five lowest-ranking states — Illinois, Connecticut, Kentucky, Alaska and Louisiana – were funded well below 60 percent. Illinois had the distinction of having the nation’s worst figure at 40.4 percent. Residents there, if nothing else, can take heart: Puerto Rico’s asset-to-liability level was 8.4 percent, a proportion beyond the pale of hope, especially given the island territory’s $70 billion or more in outstanding high-risk public debt.

During 2009-12, noted the Standard & Poor’s report, government contributions, employee contributions and (especially) earnings on investments each accumulated at a substantial rate. Unfortunately, liabilities accumulated at an even faster rate. And public-sector unions have been the driving force behind these obligations. State governments, fearful of strikes and the political consequences of being blamed for them, often accommodate union demands, as they do in the areas of wages/salaries and health care plans. In the face of this, however, at least there are countervailing forces. For one thing, state constitutions, unlike the U.S. Constitution, in varying ways limit government spending and borrowing capacity. For another, the 2008 stock crash and resulting recession have made many retirement plan managers wary of tying pensions too closely to the stock market, especially in industries subject to high price volatility. Moreover, the ratio of current contributors to beneficiaries is falling, a consequence of growing life expectancy and early retirement. In 2012, according to the U.S. Census Bureau, the contributor-to-beneficiary ratio was only 1.7 to 1, down from 3 to 1 in 1992. State budgets increasingly are hostage to unsustainable, and legally enforceable, agreements extending decades into the future.

Elected officials and pension fund managers, many of whom are sympathetic to public-sector unions, know this. That’s why pension reform is now a “hot” issue across the country. The Standard & Poor’s report noted:

According to the National Conference of State Legislatures (NCSL), between 2009 and 2014, all 50 states and Puerto Rico enacted some type of pension reform. According to NCSL’s pension legislation database, 45 states, Washington, D.C. and Puerto Rico introduced pension legislation and approximately 1,223 bills so far in 2014; this compares with approximately 1,433 bills for the 50 states, D.C., and Puerto Rico in 2013. Of the retirement system bills introduced this year [2014], 40 states, D.C. and Puerto Rico have enacted more than 239 bills with some state legislatures still evaluating some of the proposed bills. Although the actual number of bills introduced is not as important as the measures included in the enacted bills, the number of bills introduced reflects legislators’ willingness to address pension issues.

Reforms have assumed a variety of types. Among the most prominent are: restriction of benefit levels for future employees; increased age and service requirements; restriction of cost-of-living adjustments; increased employee and/or employer contributions; and switches from traditional defined-benefit plans to hybrid defined-benefit/defined-contribution plans. Even one of these initiatives can invite intense union opposition.

National Legal and Policy Center in December 2013 covered this issue as it applied to Rhode Island. The legislature, at the recommendation of then-Governor Lincoln Chafee and especially Treasurer Gina Raimondo, back in 2011 overwhelmingly had passed legislation to raise the minimum retirement age for state employees, suspend annual cost-of-living increases, and replace the defined-benefit system with a defined-benefit/defined-contribution hybrid that would require employers and employees sharing the load of contributions. The projected cost-savings: $4 billion over 20 years. The unions responded by hiring a private investigator to discredit the law. The eventual report accused Raimondo, a former venture capital manager, of benefiting from conflicts of interest. What the report did not do, as could have been predicted, is address the central role of unions in driving state and local governments down the road to fiscal disaster. Raimondo, who declared herself a Democratic candidate for governor in December 2013, was elected last November in a three-way race.

The response by nine public-sector unions was to go to state court to invalidate the 2011 reform law on constitutional grounds. And this past April 2, the State and six of the unions, representing virtually all of the nearly 60,000 potentially affected active and retired employees, announced a settlement. The agreement would provide flexibility to the minimum retirement age, greater possibilities for cost-of-living increases, and increases in the range of defined-benefit pensions available to longtime public employees. Though a compromise, the unions appear to have come out ahead. Governor Raimondo insists “the state had a very strong case,” but concedes that “to take the litigation risk off of the table is the right thing to do.” As of this writing, the settlement awaits approval by the Rhode Island General Assembly.

Other states, torn between prior pension commitments and current operating budget shortfalls, have been embroiled in similar court battles. In New Jersey, the State Supreme Court this April agreed to hear a case brought by several unions challenging the Christie administration’s decision to scale back payments, as negotiated back in 2011. A Superior Court Judge ruled in February that the state had to make the payments, however difficult coming up with the money might be. Republican Gov. Chris Christie and the nonpartisan Office of Legislative Services argue that restoring full  funding would be next to impossible. The governor’s fiscal year 2016 budget calls for $1.3 billion in pension payments, less than half of the roughly $3 billion required by the 2011 agreement. In Florida, meanwhile, the State Supreme Court, by a 4-3 margin, in January 2013 upheld a 2011 law allowing the government to retain a 3 percent levy on worker salaries to offset state contributions to the retirement system. A ruling in favor of the union plaintiff, the Florida Education Association, would have created a budget hole as much as $2 billion. The decision overturned a lower court ruling holding the law to be an unconstitutional violation of employee contractual rights.

Then there is Illinois. There are some good reasons why its pension system is funded at barely above 40 percent and has an estimated long-term deficit of $111 billion, up from about $20 billion in 1994. For one thing, union negotiations have produced lavish compensation packages. More than 11,000 retired Illinois state employees now collect annual pensions of more than $100,000. State officials would like to close the gap by cutting benefits, but the state constitution is very specific that this can’t be done for active plan participants (more on that, later). Second, and not unrelated, the pension system has known its share of corruption. About a decade ago, a Chicago-area businessman and board member of the Illinois Teachers Retirement System, Stuart Levine, was indicted on several criminal charges, having allegedly conspired with a number of persons including real estate developer Tony Rezko, a top fundraiser for Governor Rod Blagojevich (and Barack Obama, when the latter was laying the groundwork for his successful 2008 presidential campaign), to obtain control over lucrative union-sponsored contracts. Levine pleaded guilty in October 2006 to mail fraud and money-laundering. And in March 2013, the Securities and Exchange Commission charged the State of Illinois with willfully misleading investors who had bought $2.2 billion in pension fund-related municipal bonds during 2005-09. The State immediately settled with the SEC.

The Chicago city pension system also has been corrupt. In 2011, a top official of International Brotherhood of Electrical Workers Local 134, Tim Foley, stepped down from his post following revelations that he and many other local members had been “double-dipping,” simultaneously collecting a union and City pension in violation of state law. Formally, the Chicago system is not connected to the Illinois system. Yet given the City’s extreme fiscal distress, local officials have been prompted to ask the state government for money; i.e., money that the state doesn’t have.

The need for reform by the current decade was recognized by leaders in both parties, including Democratic Governor Pat Quinn, who owed his job to the impeachment and then expulsion from office of his union-friendly predecessor, Rod Blagojevich, in January 2009 following Blagojevich’s arrest and indictment in December 2008 on federal corruption charges. The man they called “Blago” would be convicted by a jury on 17 of 20 criminal counts in June 2011 and then given a 14-year prison sentence. The pension situation, meanwhile, was continuing to deteriorate. Though beholden to union supporters, Quinn knew he couldn’t ignore the growing demands for reform. Somehow he managed to coax action from the Democratic-majority legislature. Lawmakers in 2012 passed a bill that enabled the State of Illinois to charge retirees for health insurance premiums. Then, in December 2013, more dramatically, the legislature overhauled the pension system, instituting needed constraints on rapidly rising commitments. The law curtailed future cost-of-living adjustments, raised the age of retirement for certain workers, capped pension payouts for employees with the highest salaries, and created a 401(k)-style defined-contribution system for certain employees. It also reduced mandatory employee contributions by one percentage point. The expected taxpayer savings was $160 billion over 30 years.

It looked like a winning move. “The people have won,” declared Governor Quinn immediately after the 2013 overhaul; the vote, he said, was a “great day for the taxpayers of Illinois.” Public-sector unions didn’t think so. They challenged each law in court. And they won. In July 2014, by 6-1, the Illinois Supreme Court ruled that the state government could not diminish or impair health insurance premium subsidies for retired state employees. The case, a consolidation of four lawsuits, would be a preview of a ruling on the comprehensive law. This May 8, with Bruce Rauner now governor, the Illinois Supreme Court, by 7-0, overturned the new law. The overhaul, wrote Justice Lloyd Karmeier, violated the Illinois state constitution, which stipulates that promised pension benefits for public workers “shall not be diminished or impaired.” The 38-page decision concluded: “The financial challenges facing state and local governments in Illinois are well-known and significant. In ruling as we have today, we do not mean to minimize the gravity of the state’s problems or the magnitude of the difficulty facing our elected representatives. It is our obligation, however, just as it theirs, to ensure that the law is followed.”

Governor Rauner was disappointed by the ruling, but isn’t about to be swayed from his mission of putting the state pension system on firm ground. His preferred approach is an amendment to the state constitution, one that makes a clear distinction between guarantees of accrued benefits and changes to future benefits. “Rather than spend years in court,” said Rauner, “we’d rather do a constitutional referendum and try to clarify that benefits earned should be protected, but the future is unknown and it can be higher or lower.” He added: “If Illinois were a corporation, it would probably need to file for bankruptcy.” If he’s exaggerating, it’s not by much. The current state budget is running a deficit of $1.6 billion, a figure projected to rise to $6.2 billion during the coming fiscal year, which starts in July.

In seeking to get the situation under control, Governor Rauner is relying heavily on his chief financial adviser, Donna Arduin, a veteran of state government turnarounds. A business partner of renowned supply-side economist Arthur Laffer, Arduin for varying durations over the years has served as a top official in the administrations of John Engler (Michigan), Jeb Bush (Florida), Arnold Schwarzenegger (California), Rick Scott (Florida) and Sam Brownback (Kansas). Uninhibited about delivering bad news, she knows she’s not going to win any popularity contests. Yet what matters ultimately are results. And her advice has resulted in states balancing their budgets without having to raise taxes or slash core services. In Illinois, she is focused on expanding the state sales tax base. By increasing business activity, she believes, total tax revenues can rise even with sales tax kept at its current 6.25 percent (though cities and counties have the authority to impose a surcharge of up to 3.5 percent), and possibly even lowered.

Someone like Arduin, only with even thicker political skin, might be just the ticket for Chicago, home to about 20 percent of the state’s 13 million people. Mayor Rahm Emanuel, re-elected for a second term this April, is determined to fight for his city, whose four pension plans (police, firefighters, laborers and municipal workers) now face a combined nearly $20 billion funding gap – and that’s not even including the separately-managed Chicago Teachers’ Pension Fund. While formally these are not state plans, approval from the legislature is necessary for changes to funding formulas. And organized labor is proving a formidable obstacle. Referring to the Illinois Supreme Court’s view, Emanuel recently stated that the city’s approach “fully complies with the state constitution because it fundamentally preserves and protects worker pensions rather than diminishing or impairing them.” He’s finding out how determined the unions are to block him anyway. In April 2014, the Illinois legislature approved a mayoral initiative to close the funding gap in two City pension plans covering about 57,000 beneficiaries that would impose higher worker/retiree contributions amounting to about $1,500 per beneficiary, lower scheduled cost-of-living increases, and a higher minimum retirement age for municipal employees. Gov. Quinn, though somewhat reluctantly, signed the measure (SB 1922) in June. Immediately thereafter, a coalition of unions called We Are One vowed to go to court to block the new law.

Mayor Emanuel knows he may be making enemies out of natural allies. But right now he’s cornered. On May 12, Moody’s Investors Service downgraded the City of Chicago’s credit rating to junk bond status, thus threatening its future ability to borrow. The City is facing a June 30 deadline to make a scheduled $634 million payment to the Chicago Teachers’ Pension Fund. And though property tax hikes are an option, Emanuel wants to avoid that route. “You cannot put all the burden on the taxpayers alone,” he said in an interview on WTTW-TV. Chicago’s property taxes already are among the highest of any U.S. city. As an alternative, Emanuel is seeking state approval to build a downtown City-owned casino whose revenues would defray contributions to police and firefighter pension plans. The proposal, which would generate about 4,000 jobs, has won an endorsement from hospitality employee union UNITE HERE. Take a few guesses as to how many new hires would be UNITE HERE members.

Governor Rauner, like Mayor Emanuel, will do anything to avoid the stigma of presiding over a deadbeat debtor state. But his ace in the hole isn’t a casino; it’s public opinion. A growing portion of Illinois residents, like people around the country, have become aware of the extent to which union pensions have been diverting public funds that otherwise would go for police, fire protection, parks and recreation, infrastructure, hospitals and other core amenities. They have come to realize that public employee unions are an usually powerful interest group. In Wisconsin, Republican Governor Scott Walker successfully took the fight to the unions, persuading a bitterly divided legislature to pass a budget reform bill that, among other things, required public employees to contribute far more toward their health care and pension plans. Governor Rauner, though facing a Democratic supermajority in both the House and Senate, might be able to pull off similar action at some time during his term if public opinion swings his way.

It is highly improbable that the Illinois pension system can survive if it continues to be funded at only 40 percent. The benchmark for “critical status” in private-sector plans insured by the federal government’s Pension Benefit Guaranty Corporation, for example, is 65 percent; anything below that is an invitation to disaster. To shore up the system, Governor Rauner is prepared to exercise brinksmanship. “We have to make big decisions,” he told reporters. “The state is in dire financial straits. Chicago is in big, big challenges. And everybody’s a little bit on edge.” But at the same time, he is confident a fiscal turnaround will take place. “We have the hardest-working people in America,” he recently remarked. “We have the best location of any state. We have the most fertile farms. And we have some of the best infrastructure and many of the greatest universities in the world. We have every reason to thrive.” That said, Illinois also has some less than salable features: extensive public corruption; a large, unproductive and crime-prone lower-class (especially among Chicago blacks); and entrenched political interests who are quick to invoke the rhetoric of “the public interest.” Public-employee labor unions are a key element of that political class.

The legislature adjourned at the end of May in a highly rancorous stalemate. The showdown will come shortly. Lawmakers in the state House and Senate last week passed a budget. But revenues are well over $3 billion short of expenditures, even with proposed large tax hikes. And Rauner has vowed not to sign an unfunded budget. The governor’s allies are preparing to launch a $34 million ad campaign to win over public opinion to oppose pro-union Democrats, especially Illinois House Speaker Michael Madigan and Senate President John Cullerton, as principally responsible for the state’s fiscal woes. And even if the two opposing sides reach an agreement, long-term challenges still would remain. Whether in the form of a state constitutional amendment, a modification of the 2013 statute, a special public authority such the one set up back in 1975 (Municipal Assistance Corporation, or “Big Mac”) to sell New York City bonds and take control of the City’s finances, or an austerity budget, a reform plan cannot work without public-sector employee unions being willing to yield ground. And that’s something they’re not about to do.


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