Digging a pension hole

SPRINGFIELD — — Illinois' pension system was in precarious enough shape in 1994 that Democrats and Republicans came together to solve a crisis threatening the state's financial future.

The agreement they forged was supposed to take politics out of pension funding by requiring a steady stream of payments over the next 50 years. The law was billed as an "extraordinary measure" that would finally force the Legislature to fulfill its "constitutional responsibility" to hundreds of thousands of state workers past, present and future.

The promise proved to be an empty one.

Since then, the system has fallen deeper in debt, with the shortfall growing to more than $85 billion. The agreement that was supposed to steady the system is in tatters and the state's pension plans are running dangerously low on funds, casualties of neglect and political machinations in Springfield.

At the center of the crisis is the state's pension code, more than 1,000 pages of laws that govern how the pension plans are funded, set benefit levels and lay out criteria for who qualifies.

Pension experts say healthy pension plans require stable, well-structured rules that are rarely altered. But Illinois' pension code is a tangled, convoluted mess of provisions riddled with giveaways, funding flaws, excessive borrowing and pension holidays. Since 2003 alone, the pension laws have been revised nearly 700 times, according to a Tribune/WGN-TV analysis.

"I can tell you that changes to that extent are extraordinary, if not unprecedented," said Keith Brainard, research director of the National Association of State Retirement Administrators. "These plans need an environment of consistency and predictability in order to succeed. Changes to that extent have the potential to create havoc."

The changes, which range from minor tweaks to substantive revisions, also make policing the system difficult. The Tribune and WGN-TV already have documented how union officials landed lucrative pension deals for themselves thanks to provisions their allies in the Legislature slipped into the pension code.

But they weren't the only ones gaming the system. Time and again, lawmakers have used the huge pools of money in the state's pension plans to avoid politically difficult decisions and hand out perks to supporters.

One reason for the large number of revisions to the code is that Illinois has more than a dozen sets of rules governing hundreds of pension plans scattered throughout the state. So whenever lawmakers want to apply a change to the entire system, multiple revisions are needed. The complexity also makes it difficult to track smaller changes and determine how they affect the system as a whole.

At times, the process of enacting pension legislation has been so shrouded in secrecy that it's nearly impossible to tell who was responsible for changes.

Not all revisions captured in the review by the Tribune and WGN-TV had a fiscal impact, but the legislative record shows that more than half of the pension laws passed during the last eight years came without any fiscal analysis.

"So basically we have a Legislature that has been making decisions that potentially have billions of dollars in impact without any objective information as to what the costs will be," said Laurence Msall, president of the nonpartisan Civic Federation. "It's a frighteningly cavalier approach."

House Speaker Michael Madigan, D-Chicago, and Senate President John Cullerton, D-Chicago, declined to comment for this story.

In an e-mail, Madigan's spokesman, Steve Brown, disputed whether all the changes to the pension code were harmful. "I was unable to find anyone who felt the number of changes in a state program had any particular bearing on anything or was a predictor of anything," he wrote.

Spokesmen for both legislative leaders pointed out that recent changes to the pension code have decreased the cost of the state's pension system.

The most significant of those changes was a 2010 plan, known as Tier 2 and sponsored by Madigan and Cullerton, that cut costs over the long term by lowering benefits for those hired after Jan. 1, 2011. During the next three decades, the move is projected to lower the state's contributions by more than $70 billion and cut the total pension liabilities nearly in half, by $256 billion.

Although the bulk of the savings from Tier 2 won't begin for a number of years, the state began counting them right away and, in the process, lowered the amount it had to contribute into the funds.

Even with the savings, the state still will be hard-pressed to make its pension contributions going forward. A decade ago, contributions to the pension system cost the state about $1 billion. Next year, they are expected to reach more than $5 billion, according to the governor's budget office.

"To be blunt, governors and legislators over decades — three decades, maybe more — failed to really pay attention to this issue," Gov. Pat Quinn said this week. "So it has come upon me and the Legislature here today to solve that issue."

Meanwhile, the driving force behind the crisis — chronic underfunding of the system — continues. Illinois' pension system is in such bad shape that many believe it can survive in the long run only if the Legislature makes unpopular decisions like further raising state taxes or slashing retirement benefits.

"I would say that the likelihood of Illinois plan participants not getting their retirement benefits is highly remote," said Bill Atwood, executive director of the Illinois State Board of Investment. "It's still going to take either a reduction of services, budget cuts or tax increases of some sort."

Rewriting the rules

The funding plan passed in 1994 was supposed to force the state to stick to a payment schedule that would bring the pension system up to a 90 percent funding level by 2045.

That hasn't happened for a variety of reasons, including the rocky economy, serious flaws in the original plan and decisions by state officials that reneged on promises.

First, the funding plan was set up to pay down the bulk of the state's pension debt over a 50-year period — even though government accounting standards recommend that payment plans be capped at 25 years. The delay means tens of billions of dollars in extra interest on top of what's already owed.

In addition, while the plan required annual contributions to the pension funds, it allowed the state to put off starting to pay down the pension debt until fiscal year 2010, 15 years after the plan took effect. It's similar to a balloon mortgage, where steep increases in payments kick in over time.

Now the bill is coming due just when the state can least afford to pay.

State Sen. Jeff Schoenberg, D-Evanston, said the law should have included a trigger that pumped more money into the pension system when the economy was booming and the state was flush, such as during the late 1990s.

"The most damning feature was there was absolutely no correlation to what was happening in the state's economy," said Schoenberg, who co-chairs the Legislature's Commission on Government Forecasting and Accountability.

Meanwhile, lawmakers haven't even met the minimum payments specified in the original plan. Instead they have tinkered repeatedly with the formula to avoid tough budget decisions, adding to the amount needing to be paid later.

Among the examples, a few stand out.

In 2003, Gov. Rod Blagojevich pushed lawmakers to issue $10 billon in pension obligation bonds. With interest rates at then-historic lows, it was billed as a responsible move that would allow the state to reduce its pension debt.

"It's always helpful to look at history," said Blagojevich, who was sentenced this month to 14 years in federal prison for corruption. "And history tells us that we're going to be way ahead of the game."

But like several of his predecessors, Blagojevich also used the pension system to solve the state's financial problems. The Democrat had taken office vowing he would not raise sales or income taxes, but the state's budget was in deep trouble.

With the help of the Democratic-led Legislature, about $2 billion of the bond money was diverted to help cover the day-to-day operations of the state and investment fees on the bonds.

That one-time injection held back the growing pension debt for a short time. But it ultimately cost more because of billions in interest.

In 2005, with an election season looming and the state running another budget shortfall, Blagojevich cut another pension deal. This time it was with Madigan and then-Senate President Emil Jones Jr., D-Chicago, co-chairs of the governor's re-election campaign.

Rather than pay the amount required by the 1994 funding plan, the Legislature simply rewrote the pension code to lower its payment over two years. The maneuver, derided as a pension holiday, boosted dollars for schools and paid for programs that lawmakers didn't want to cut as they faced re-election.

Yet those slight changes ended up costing the system $2.3 billion, while the long-term cost added billions more.

House Majority Leader Barbara Flynn Currie, D-Chicago, defended the scaling back of pension payments in 2005 and 2006 and dismissed the notion that the coming election led to those decisions. But, she said, as legislators weigh all the demands on the state budget, there are times when the "unfunded (pension) liability may not be the most immediate problem."

With the country gripped in the worst financial crisis since the Great Depression, the Legislature continued to alter the formula for state pension contributions, further undermining the 1994 compromise. In recent years, the Legislature twice passed laws that allowed the state to borrow an additional $7.2 billion, this time to help make regular pension contributions.

That means during the last eight years, the state has borrowed $17.2 billion to make pension contributions that weren't even enough to keep the debt from growing, according to the Commission on Government Forecasting and Accountability.

Including $13.6 billion in interest on the bonds, the borrowing will add a total of $30.8 billion to the state's pension debt.

A botched plan

Even as unfunded liabilities soared, Democrats found room in the 2006 post-election fall veto session to allow two lobbyists from the Illinois Federation of Teachers to qualify for public pensions by working one day as substitute teachers, a deal revealed by the Tribune and WGN-TV in October.

At the time, the Legislature's fiscal arm projected that the costs would be minimal. But the Tribune/WGN-TV analysis found that their pension benefits could cost as much as $3.9 million over their lifetimes.

The same legislation created an opening for officers and employees of statewide labor unions to become part of the State Employees' Retirement System, with their pensions based on union salaries that often are higher than those paid to most state workers.

Although the costs are small compared with the size of the problem, adding private workers to the state pension system exacerbates the pension debt because there isn't enough money to cover promises already made by the Legislature. Similarly, when traditional state workers have their benefits increased, the system goes deeper into the red unless enough money is provided to pay.

Since the funding plan began in the mid-1990s, the Legislature provided more than $5.8 billion in benefit increases and giveaways that weren't paid for, accounting for about 10 percent of the total increase in the state's pension debt during that time, according to the Legislature's forecasting commission.

By far, the largest of those increases came in the form of a 2002 early retirement incentive aimed at trimming the state's workforce during tough budget times. Such incentives, which reduce payroll costs, can be a useful budget tool if they are properly structured and the pension costs are paid for upfront.

But in this case, as with so many pension machinations in Springfield, political considerations botched the plan.

Coming at the tail end of Republican Gov. George Ryan's term, the early retirement incentive was part of a larger plan to ease budget woes caused by post-9/11 revenue declines and the bursting of the dot-com bubble.

But there were political reasons for the incentive as well.

Engulfed in scandal but not yet charged with a crime, Ryan wanted to provide generous retirements to loyal party members who had served under Republican administrations. Democrats, meanwhile, liked the idea of open positions that a Democratic governor could fill, assuming the party could secure the office in the wake of Ryan's scandal-plagued tenure. He ended up being convicted on federal corruption charges.

The original plan targeted up to 7,000 state employees and had a relatively modest price tag of about $550 million. But as Ryan and legislative leaders gathered around the negotiating table to finalize the incentive, a variety of perks were thrown in. The cost estimates, meanwhile, were not updated in time for legislators to weigh the full impact of the program.

"I don't think there were very many lawmakers who knew that the package was sweetened so much after the actuarial projections were completed," said Schoenberg, who is stepping down from his Senate post after about two decades in Springfield. "Virtually nobody anticipated the profound effect the proposal would have."

Among the new perks were the lowering of age and service requirements and the ability to purchase up to five years of service credit, which dramatically boosted the amount of money retirees would receive during their lifetimes.

In the end, more than 11,000 state employees took advantage of the lucrative deal, which caused the immediate cost of the incentive to climb to $2.3 billion, a fourfold increase from the original cost estimate.

When lawmakers realized how expensive the incentive turned out to be, they asked the staff of the Commission on Government Forecasting and Accountability for options. The commission offered various scenarios to pay down the debt over time, but the Legislature opted for the most costly — stretching out payments over 40 years.

That sent the ultimate price tag to $10.3 billion.

"From a budget standpoint, it's like a time-release explosive that shatters our capacity to devote necessary resources to education and health care," Schoenberg said. "For years, it's been like a fire consuming all the air in the room."

Today, Illinois' funding ratios for its pensions are among the lowest in the country, affecting everything from the state's bond rating to its ability to pay its bills. The pension debt will continue to grow unless something is done to stem the tide and pay down the unfunded liabilities.

"If you've lived in Illinois for a long time, you may not realize how far away it is from other states," Msall said. "It's not just that we are the worst of the 50 states, it's that we are so far behind the rest. The cost to taxpayers, the cost to government workers for this kind of fiscal irresponsibility is enormous."

Grotto reported from Chicago and Long from Springfield. WGN-TV producer Marsha Bartel, WGN-TV reporter Mark Suppelsa and Tribune reporter Joe Germuska contributed.



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