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Pension woes, pension successes seen in 11-state Midwest

by Tim Anderson ~ June 2015 ~ Stateline Midwest »
In 1970, when they gathered to create a new constitution for Illinois, convention delegates decided to take on a fiscal problem that had been worsening for years. Pension obligations were not being met, and as a result, the unfunded liabilities of governments in Illinois were rising at an alarming rate.
The delegates' response: Establish a new constitutional clause that would not only protect the pensions of public employers, but presumably convince government leaders to meet the funding obligations.
Forty-five years later, this 40-word clause — which says in part that accrued pension benefits “shall not be diminished or impaired” — looms larger than ever in Illinois politics. In May, the state Supreme Court struck down a 2013 law designed to shore up the nation's worst-funded pension system by providing savings of more than $100 billion over the next 30 years.
At the time of the law's signing, proponents hailed it as “historic,” a long-sought-after fix to a funding crisis 70 years in the making. One part of SB 1 established a “funding guarantee,” thus giving retirement systems the right to go to court if the state did not make its required pension payments. But other provisions included cuts in pension benefits — for example, changes in the cost-of-living adjustment and a cap on the maximum salary used to calculate a worker's retirement annuity.
These reductions, the court ruled, “contravene the clear requirements” of the Illinois Constitution and its pension-protection clause. This type of explicit constitutional guarantee is somewhat rare among the 50 U.S. states. Only six others, including Michigan in the Midwest, have it, according to a 2013 study by the Manhattan Institute for Policy Research.
Since being included in the Illinois Constitution, the pension-protection clause has helped protect workers' benefits, but it has not guaranteed sound funding of the state's retirement systems. In a national review last year of state pensions, The Pew Charitable Trusts reported that only 40 percent of Illinois' total pension liabilities were funded as of 2012. Nationally, the funded ratio in state pension systems was 72 percent; along with Illinois, five other Midwestern states — Indiana, Kansas, Michigan, North Dakota and Ohio — fell below this national average for 2012.
‘Broad awakening’ in the states
At the start of this century, most state pension systems appeared to be in excellent shape. Because of strong investment returns in the 1990s, pension funding levels were high and the required level of state contributions was at or near an all-time low (as a percentage of total state spending), notes Keith Brainard, research director for the National Association of Retirement Administrators.
But what came next was a “perfect storm”: downturns in the market and the consequences of policy choices made by state and local governments (for example, the decision to boost pension benefits during the strong economic period and/or divert contributions for other purposes).
These factors put a tremendous strain on states, which had to find a way of raising contribution levels while also dealing with larger budget crises in the early and late 2000s. But as Brainard notes in a paper released earlier this year, most states rose to this fiscal challenge.
This challenge was met in part with new laws (some affecting current employees, others impacting only future hires) designed to shore up retirement systems: for example, raising contribution rates, lengthening vesting periods, raising the retirement age, reducing cost-of-living increases, capping benefits and changing how a worker’s “final average salary” is calculated.
Nearly every Midwestern state has made policy changes of some kind over the past decade, and most of these legislative actions withstood legal challenges. But since 2001, Brainard says, states have also made a good-faith effort to fund their pension plans, and the tumultuous period of the past decade and a half appears to have had a lasting impact on public thinking about pension financing.
“There has been a broad awakening about the importance of making the necessary contributions,” Brainard says.
States have varying policies (via statute or the rules of a retirement system board) that require annual contributions to be made. This amount, known as the annual required contribution, is determined by calculating the retirement system's costs and unfunded liabilities. The strongest of these policies mandate that annual required contributions be made in full, and states with this legal structure have generally had the most success in keeping up with pension obligations, Brainard says.
In turn, the diligence of these states is paying off.
“We are really seeing a widening gap when it comes to the states’ experience,” Brainard says. “For those states that have faithfully been making contributions, states like Wisconsin, pension costs are going down. On the other hand, you have states where pension costs continue to rise.”
Indiana legislators took the first step this year to constitutionally guarantee that the state keep up with its pension obligations. They passed SJR 19, a constitutional amendment that would, in part, require every biennial budget “to actuarially fund the accrued liability of ... pension funds during the budget period.”