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Long odds for major Illinois pension fix

(MCT) — There is much hype and hope in political circles that a lame-duck General Assembly will spend the next few days fixing the financially troubled government worker pension systems that threaten to drag the state over what Gov. Pat Quinn described as Illinois' own version of the fiscal cliff.

The odds appear to be long, however, that lawmakers will strike a grand bargain solving all of the state's pension woes before the new session starts Wednesday and the latest round of political pressure that's been building for months evaporates. After all, it took decades for the retirement funds to get in such bad shape, so it's likely to take longer than a week to untangle the mess, pension and political experts say.

Solutions are varied and complex — there are 17 sets of laws governing retirement funds that touch teachers, police, firefighters, state employees and others. And so far, there's little agreement on how to get there. In the short term, legislators at best might reach a narrower agreement affecting a handful of pension plans that could later be adapted for other parts of the retirement system.

The big fix remains elusive because it requires two things: more money to pay down the massive pension debts over a few decades and benefit cuts for current workers and retirees to lower the total amount owed. Without a healthy mix of the two, experts say, the funds will continue to deteriorate and the danger rises that some of them will not be able to pay for the benefits promised to retirees.

As it stands, lawmakers are focusing on cutting benefits but are less keen on generating new revenue unless it's coming from employees' pockets. Labor unions, meanwhile, are open to higher retirement contributions from their members, but only if benefits are kept intact and other new sources of money are found to shore up the pension systems.

As hard as finding a fix will be, nearly everyone agrees the current system is unsustainable. At $5 billion, the state's pension payment this year is three times larger than it was a decade ago, and it's still not enough money to catch up. The five statewide pension funds are short $96.8 billion, while Chicago's four pension funds plus the Chicago Public Schools fund have $27 billion in debt. In the suburbs and downstate, police and fire pension funds are $7.5 billion in the red.

"If you don't improve things fairly soon, you reach a sort of ... black hole, and when you get too close to the black hole at some point you will never escape," said Jeremy Gold, an independent consulting actuary who is on the board of the Society of Actuaries. "You can reach a point of no return, where they can't afford to be funded."

Here's a look at the pension system mess and some of the proposals to clean it up:

State and city money gap

Most pension experts say a key step in fixing an underfunded retirement system is to stop digging the hole deeper. That means not adding pension benefit sweeteners that will cost even more. It also means paying enough money each year to ensure that retirement promises are adequately funded.

That amount is known as the annually required contribution, or ARC. The acronym might seem arcane, but at its core are two basic components.

The first part, called the "normal cost," is like the balance on a credit card. It's the estimated amount of money needed to cover the pension costs current employees accrue in a given year — similar to the actual price of all those goods you might rack up on your credit card.

But just as with a credit card, costs balloon if you don't pay the balance off in full when it is due. And that's the situation most Illinois pension systems are in today, struggling to play catch-up on the second part of the ARC, the so-called unfunded liabilities that have grown dramatically. Since 2000, the debt for the five statewide pension plans has increased sixfold.

"Any time you don't pay the ARC, you are just increasing costs and pushing them off to future taxpayers," said Keith Brainard, research director for the National Association of State Retirement Administrators.

The ARC's importance can be seen by looking at the Illinois Municipal Retirement Fund, the only major healthy public pension plan in the state. It's also the only fund that has a law requiring cities and towns to pay the ARC every year. If they don't, the fund can unilaterally divert tax revenues to pay it.

There are no such laws for the state or Chicago, however.

Instead of paying the ARC, the state has periodically skipped pension payments, borrowed billions to fund the system and backloaded debt payments so that small amounts are paid in the early years before ballooning down the road.

The trouble now, however, is that the state pension debt is so high that there isn't enough revenue to cover the ARC. Take the Illinois Teachers' Retirement System. In 2011, the ARC was $2.7 billion, but the state contributed just $2.2 billion, according to the fund's most recent financial report.

The city also has consistently failed to contribute enough to adequately cover pensions for its employees, leading to a large debt.

Take Chicago's police pension fund. For decades, the city paid a percentage of the department's payroll rather than an amount determined by an actuary to keep the fund solvent. Under that structure, the city contributed about $174 million to the police fund in 2011. The true costs of the benefits, however, were $403 million, more than double what the city paid, according to the pension plan's financial reports.

That imbalance has been the main thing driving the police plan from being 99 percent funded in 2000 to just 35 percent in 2011. The debt, meanwhile, tripled during the past decade to $6.2 billion.

A state law passed in 2010 requires the city to pay the ARC for its police and fire pension funds beginning in 2015. City officials estimate that it will add an extra $580 million to Chicago's pension costs.

Chicago Public Schools faces a similar problem. Confronted with a large budget deficit in 2010, school officials went to Springfield and brokered a deal that allowed CPS to lower its payment to the Chicago teachers pension fund over a three-year period.

That deal expires this year, yet the district is in no better shape to pay its pension bill. The district's budget shortfall is expected to be $1 billion, with $340 million of that total resulting from its pension payment nearly tripling from $196 million to more than $540 million. Meanwhile, the teachers pension plan is now less than 60 percent funded, and its debt stands at more than $6.8 billion — 16 times larger than it was a decade ago.

The sobering reality is that neither the city nor the school district has the money to cover those ballooning pension payments. So the obligations have become ticking time bombs threatening city services, taxpayers' pocketbooks and workers' retirement security alike.

Union officials are calling for the state to be required to pay the ARC as part of any fix to the statewide plans.

"The principal and the primary cause of the pension problems that we have at every level is the state's failure, the city's failure to pay their actuarially required contribution every year," said Anders Lindall, public affairs director for the American Federation of State, County and Municipal Employees Local 31. "We've got to have a way that that mistake isn't repeated and compounded."

Actuaries and bond rating agencies agree, and most of the proposals floating around Springfield this week have such requirements.

"Our intention is for the reforms to save enough money that the cost going forward is not going to eat up more and more of revenue and require continued annual cuts in public education, Medicaid, human services, public safety and so forth," said Rep. Daniel Biss, an Evanston Democrat who is sponsoring a pension solution that could be considered in the coming days.

As of Thursday, no legislation had been introduced at the Capitol to deal with Chicago's pension crisis. Mayor Rahm Emanuel's aides and union leaders have been meeting to try to find common ground on changes. The administration, however, is holding its cards close.

In May, Emanuel testified in the Illinois House, pitching lawmakers on a pension plan that includes raising retirement ages and freezing cost-of-living increases for retired employees for 10 years. The mayor also called on legislators to make city workers pay more toward their retirement, and to allow newer workers the option of joining a 401(k)-style retirement plan.

Benefit reductions

The linchpin of many plans floating around Springfield this week is to reduce benefits for current workers and retirees. The idea is to significantly cut the pension debt mountain to a more manageable size.

Developing a strategy to do that, however, is complicated by a clause in the state constitution that appears to prohibit reducing pension benefits for public employees. Opinions vary on how ironclad the clause is, but any pension fix that becomes law is likely to wind up in court.

Public-sector unions are loath to agree to benefit cuts without firm promises that adequate pension payments will be made going forward, given past actions by politicians. What's more, labor leaders contend that to reduce pension benefits, workers must receive "valuable consideration," a legal concept that requires something of equal value be provided in return for the benefit reductions.

But state and local governments don't have the money for that, so lawmakers are attempting to come up with other ways to work around the constitutional issue.

Senate President John Cullerton's approach is using heath care as leverage to get current workers and retirees to make a choice: in return for guaranteeing health care, government workers would accept lower cost-of-living increases.

Illinois' adjustments for inflation are among the most generous in the country, growing at a compounded rate of 3 percent a year. At that level, the price of each retiree's pension doubles after 20 years. With most employees living longer, cost-of-living bumps are driving up the pension price tag.

Cullerton's proposal would lower such yearly increases to half the rate of inflation or 3 percent interest, whichever is smaller.

The Chicago Democrat already has won Senate approval of such a plan, but it would apply only to pension funds for lawmakers and state workers. The House, however, has not taken up the measure.

Another proposal put forth by rank-and-file House lawmakers would apply cost-of-living hikes to only the first $25,000 of pensions for current employees and retirees and delay the start of such bumps until workers turned 67. It's a partial solution, however, lowering the state pension debt by about $28 billion, or 29 percent.

Union officials counter that the cost-of-living adjustments are necessary to offset the risk of inflation and vowed to fight any "forced choice" plan in court.

Private sector plan?

Another potential way to cut costs is in pension overhaul sponsored by Biss, the Evanston Democrat, and Rep. Elaine Nekritz, D-Northbrook. The key point is to get a certain percentage of workers out of the pension system entirely by switching them to a cash-balance plan, a kind of hybrid of a traditional pension and 401(k)-style private-sector retirement option.

Under a 2010 law, state workers hired after Jan. 1, 2011, face increased retirement ages and limits on how big their pensions can be.

That has done little to alleviate the pension funding problem because those employees represent such a small portion of the public workforce. It also wasn't the best deal for those workers, some of whom could end up paying more into the pension system than they'll end up getting in benefits.

The Nekritz-Biss bill would provide a guaranteed benefit based on investment returns rather than a percentage of their salary, which is how the current pension system is structured. The measure would apply to recently hired and future state university workers and downstate and suburban teachers.

Each employee would have an account in which contributions accumulate. Those accounts would then be pooled for investment purposes, and the return on the contributions would be guaranteed to fall between a floor and a ceiling of roughly 4 and 7 percent. Anything above 7 percent would go to the fund to pay down the overall debt. Once an employee retires, his or her account is converted to an annuity that would provide monthly payouts.

The benefit to the state? A reduced overall pension debt because a slew of workers no longer would be part of the system.

Finding more money

Benefit cuts alone are only part of the pension puzzle. It's also going to take more money to save the system, pension experts say.

Some lawmakers want workers to kick in more toward their own retirement. Labor leaders say their members stand ready to contribute an additional 2 percent of their paychecks for pensions to generate about $350 million a year.

In return, however, they want benefits for retirees to remain intact and for the state to put more skin in the game. Unions suggest raising $2 billion a year by closing tax loopholes for corporations and creating new taxes on digital purchases and satellite television. The union view is that the state doesn't have a pension problem but rather a revenue problem.

New taxes are a tough sell in a state where Democratic leaders increased the income tax rate by 67 percent but still didn't fix the money problems. Asking businesses, which have powerful lobbyists, for more money to pay for government worker retirement checks likely would prove even more difficult to pass.

House Speaker Michael Madigan's idea for changing how to pay for some pensions: gradually shifting billions of dollars in teacher retirement costs onto local school districts and universities. That strategy would affect only the Illinois Teachers' Retirement Fund and the State Universities Retirement System, which together make up about 75 percent of the state's unfunded liabilities.

Downstate and suburban lawmakers, however, opposed the cost-shifting measure because of fears that it would lead to higher property taxes as their school districts pick up pension costs. As such, it's unclear whether the approach could attract enough votes outside Chicago to pass.

Chicago taxpayers are footing the entire bill for their teachers' pension plan, however, even as their state taxes go to pay for the retirement of suburban and downstate teachers. At a time when every dollar matters, it's a discrepancy that has attracted Emanuel's ire.

But Emanuel has indicated he's also unwilling to solve the pension crisis by increasing taxes.

"As long as I am mayor of Chicago, that is a burden I refuse to put on the backs of our taxpayers," Emanuel told a House pension committee in May. "Businesses and families would flee, not just from our city but from our state, and that's not the way to win the future."

Tribune reporters John Byrne and Bob Secter contributed.

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