Pension reform, Illinois style: Legislation to ‘fix’ the Tier 2 problem – Wirepoints

By: Mark Glennon*

On the long list of things wrong with Illinois’ pension system, there’s one problem that can’t be ignored: Tier 2 pension benefits are increasingly likely to fall short of minimums under federal rules. If that happens, the sponsoring unit of government would face huge, new liabilities. Those facts have long been widely agreed.

The Illinois General Assembly apparently frames the problem this way: “How could it be fixed by stacking the system further in favor of only the most senior public union members while ignoring cost to taxpayers and other, huge problems with Tier 2?”

That’s evidently how the General Assembly is thinking based on legislation now pending. They have just the right guy leading the charge: Sen. Robert Martwick (D-Chicago), whose bill is moving forward to do just that. He has long been a go-to guy for public unions to get what they want in Springfield.

By way of background, Illinois’ Tier 2 pension law created a junior pension class for state and local workers hired after 2010. Contributions required from Tier 2 workers are the same as for Tier 1 but benefits are reduced. Federal rules generally require pension benefits at least as generous as Social Security’s, and Tier 2 is increasingly at risk of breaching that minimum. The Tier 2 law caps annual pension increases at of 3 percent or one-half the consumer price index, which is less than Social Security where bigger adjustments are made, contributing to the problem by taking Tier 2 out of a particular “safe harbor” for compliance with the federal rule.

Senate Bill 1690, sponsored by Martwick, would apply only to Cook County’s pension, which holds $13 billion in assets, covering the county’s 18,000 current workers plus 20,000 retirees and beneficiaries. It holds just 67 percent of the assets actuaries say it should have to meet its liabilities, giving it an unfunded liability of $6.3 billion. That’s from its most recent actuarial report as of 12/31/2001, before recent market downturns.

However, the bill would probably be the template for Illinois’s other pensions, almost all of which have a similar Tier 2 structure. The bill sailed through committees and is scheduled for a final reading in the Senate on April 28.

The bill would address the problem by increasing the maximum pensionable salary for Tier 2 retirees from $123,489, the current maximum, to $160,000, which Social Security’s current maximum.

Here’s what’s wrong with the bill:

For starters, how much would it cost taxpayers in additional contributions to the pension? Martwick’s answer is classic Illinois government. He doesn’t know. He chairs the Senate Special Committee on Pensions, which passed the bill he sponsored, and he doesn’t know.

That’s what Crain’s reported last week. Initially, the increased pension benefit would hike Cook County’s unfunded pension liability, he told Greg Hinz at Crain’s, which is true, but taxpayers would have to make that up eventually. Martwick “conceded it would cost ‘billions’ if it were extended to state and other local government workers covered by the Tier 2 law,” Crain’s wrote, but he offered nothing further on cost.

The looming cost of bringing Tier 2 into compliance with federal rules is a topic Illinois leadership has consistently hidden. Even bond offering documents, which supposedly inform bond buyers of the fiscal health of the issuer, duck the issue.

The bill would leave the biggest Tier 2 problems in place, problems we’ve written about often. They face a later retirement age and, most importantly, a brutally unfair ten-year vesting requirement.

That vesting requirement means that if you leave an Illinois government job with less than ten years of service before age 62, all you get is a refund of money you contributed yourself plus interest of 3%. You get no benefit from any employer contribution and no Social Security based on those years of service.

That’s devastating for retirement planning. No rational young person should sign up for that.

Consider teachers, for example. Only 18.5 percent of Tier 2 teachers will reach the age requirement for vesting, according to research by Bellwether Education Partners. Meanwhile, Illinois frets about its new teacher shortage. The unfairness of Tier 2 vesting requirements makes the problem far worse. Generally speaking, teacher compensation including pension benefits in Illinois and nationally is too heavily slanted against younger teachers in favor of older ones. That should be reversed, not amplified.

The same issues apply to most of Illinois’ state and local pensions, not just teachers or Cook County workers.

Tier 2s got that bum deal because it was rammed through by Democratic leadership with no debate and support of senior union leadership who were themselves Tier 1s and, obviously, there weren’t any Tier 2s around to object.

Now we have the only meaningful pension legislation pending in years, and what will it do for Tier 2 pensioners? Help only the top earners, most all of whom will have vested, by raising the cap on their pensionable salary.

Aren’t there more equitable ways available bring Tier 2 into compliance with the federal rule requiring benefits at least as good as Social Security? Yes, apparently so, as discussed here by the Civic Federation, which references this legal analysis commissioned by the Illinois Municipal League. The safe harbor into which the legislation attempts to fit is not the exclusive route to compliance.

Tier 2 is a mess and fixing it could well blow up Illinois state and local unfunded liabilities, which already are the worst in the nation and an albatross around the state’s neck, assuring it remains uncompetitive with other states. Proceeding with legislation despite no understanding of cost is pure malfeasance.

It’s particularly dangerous to have Martwick leading the effort on any changes and heading the Senate’s pension committee. He led the recent successful efforts for sweeteners to Chicago’s police and firefighter pensions that added billions to the city’s unfunded liabilities. As a state representative in 2018, Martwick was nationally ridiculed for proposing that Illinois issue a massive $100 billion bond and give the proceeds to pensions. A “moonshot” proposal, it was called. The idea died when the obvious became apparent — nobody would buy such a bond.

We favor switching over to a form of defined contribution plan as is common in the private sector — one which is vested and portable from the start. The template for that, we’ve long said, is staring us in the face. It’s the optional plan offered by SURS, Illinois’s State University Retirement System.

Martwick’s bill contains two other goodies public unions will like.

First, it would increase annual pension benefits from Cook County taxpayers beyond that required by state law. Second, it would give Cook County Board President Toni Preckwinkle two more appointees to the pension’s board of trustees.

If you’re surprised that Martwick’s bill could be moving forward with no understanding of cost and so little other scrutiny, you must be new to Illinois. The entire Tier 2 pension law was bulldozed through in 2010 in just 12 hours with no actuarial analysis on its impact.

*Mark Glennon is founder of Wirepoints.*