States, Cities Tackle Pension Liabilities; Watch Illinois, Detroit for Lessons

Throughout his first four years in office, Illinois Gov. Pat Quinn (D) gave a consistent stump speech--a pledge to overhaul the worst-funded public sector retirement system in the country.

Quinn honored his vow in December 2013, when he signed a sweeping new law projected to bring the state's five public pension system to full funding in 30 years and slash Illinois's long-term pension obligations by $160 billion.

S.B. 1 (Illinois Public Act 98-0599) aims to achieve its goals by injecting new state dollars and cutting retiree benefits. But the greatest savings will be realized under provisions that replace automatic annual cost-of-living adjustments (COLAs) with a new formula linked to retirees' years of service.

“This is a serious solution to address the most dire fiscal challenge of our time,” Quinn said during the bill-signing ceremony where the Democratic governor stressed that the state's financial future was indelibly linked to reforms codified under the legislation.

Three months later, S.B. 1's place in Illinois history is uncertain at best.

Four lawsuits have been filed by public employee unions and retiree associations challenging the constitutionality of the new law. By all accounts, the future of S.B. 1 will only be determined after the challenges are hammered out by the Illinois Supreme Court.

Illinois, with about $100 billion in unfunded pension liabilities, is not alone in this struggle. Across the country, cash-strapped states and municipalities are taking different measures to control public employee pension obligations, which have escalated in recent years, for many different reasons.

Identifying the Problem

The “immediate cause” of most pension systems' problems was the stock market collapse of 2008, said Stephen Eide, senior fellow at the Manhattan Institute's Center for State and Local Leadership.

During the boom years of the 1990s, “a lot of systems were skimping on contributions or increasing benefits, because they thought the good times were going to continue indefinitely,” he said. “California was notorious for that.” At the same time, the systems moved their funds into riskier investments, believing the higher returns would allow them to pay their benefits, he said.

Despite raising employee contributions to pension plans, cutting benefits or renegotiating pension contracts, many jurisdictions may be failing to inject enough of the kinds of mechanisms that would bring the significant changes needed to achieve long-term fiscal stability, and that leaves many places, along with those counting on their pensions for retirement, still at risk.

“All of the underlying factors are still there,” said Jeffrey R. Brown, a professor of finance at the University of Illinois College of Business and an expert on retirement security issues, in an interview March 13 with Bloomberg BNA.

“We are still underestimating the problem. We are still invested in very risky portfolios that will go bad if we hit another downturn. Many states are still not making good on their fundamental commitment to invest money. States have undertaken reforms, but I don't think we are out of the woods at all.’’

What's at Stake?

State and local government retirement systems cover more than 14 million workers, about one-sixth of the U.S. workforce, and more than 8 million beneficiaries, according to a January report from the Nelson A. Rockefeller Institute of Government.

With about one-fourth of state and local government workers not covered by Social Security, these workers and their families largely rely on their public pensions for retirement security, according to said the report, “Strengthening the Security of Public Sector Defined Benefit Plans.”

Aside from the millions of families affected, the situation also extends into the world of investors, who pour money into municipal bonds, which help fund public pensions. And now court rooms across the country are seeing legal challenges to state and local efforts to cut public pension liabilities and must decide whether these jurisdictions even have the ability to reduce COLAs.

“The funding system is very seriously flawed. It allows things like understatement of liabilities, giving a false sense of security, increasing benefits on the mistaken belief that a system is well funded,” said Don Boyd, senior fellow at the Nelson A. Rockefeller Institute of Government, and co-author of the January report. “Governments, really particularly at the state government level, have the ability to underpay even what the actuaries ask for. And what the actuaries ask for often is both too low and smoothed out in ways that postpone obligations to the future.”

Looking for Solutions

Illinois ranked as the state with the largest pension burden in fiscal year 2012, according to Moody's Investors Service report, “U.S. State Pension Medians Increase in Fiscal 2012.” After Illinois, are Connecticut, Kentucky, Hawaii, Louisiana, Maryland, Massachusetts, Maine, Texas and Kansas according to the report released Jan. 30, which said its adjusted net pension liabilities (ANPLs) in FY 2012 may have reached its cyclical peak.

Moody's Associate Analyst John Lombardi, who wrote the report, said the widening in ANPLs in FY 2012 was mainly the result of minimal investment returns and a decrease in the interest rate used to derive the present value of liabilities.

States with the lightest pension burdens by the same measure were Nebraska, Wisconsin, New York, Tennessee and Washington, the report said. In aggregate for all the states, the adjusted net pension liability rose 24 percent to $1.2 trillion in FY 2012, up about 20 percent from $998 billion in FY 2011, the report said.


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With assistance from Martha Kessler in Connecticut, Laura Mahoney in California, Chris Marr in Georgia and Susanne Pagano in Texas

To contact the reporters on this story: Mike Bologna in Chicago at, Nora Macaluso in Michigan at and Marvin Anderson in Washington at

To contact the editor responsible for this story: Sue Doyle at