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Post-employment costs will darken Illinois retiree system outlook

Mark Reutter, Business & Law Editor


J. Fred Giertz
University of Illinois Photo
J. Fred Giertz, an Illinois economist specializing in state tax issues, consistently has sounded an alarm over the state’s underfunding of retiree obligations.  

CHAMPAIGN, Ill. — New accounting rules requiring state governments to disclose health-care and other non-pension retiree costs will reveal more long-term revenue shortfalls in Illinois’ retiree systems, a University of Illinois tax expert warns.

After Dec. 15, 2006, Illinois and other governments with annual revenues of
$100 million or more must recognize OPEB, or “other post-employment benefits.” These are benefits earned by employees that will not be received until after they leave government service. They generally include health insurance, prescription-drug benefits, and dental, vision and some types of life insurance provided to retirees.

J. Fred Giertz, an economist specializing in state tax issues, consistently has sounded an alarm over the state’s underfunding of retiree obligations.

For more than 20 years and across four governorships, Illinois has not paid enough into its five pension systems to cover the long-term promises made to state workers, schoolteachers, university employees and judges. The state currently faces a $38 billion shortfall in its pension funds.

Concern over the state’s pension obligations led Fitch Ratings, a leading Wall Street bond house, to issue a negative outlook of Illinois’ finances in April.

Giertz said the unfunded OPEB liabilities have, for the most part, been factored into the ratings and may not lead to a further downgrading of Illinois’ AA bond status. Downgrades generally increase the cost of state borrowing by millions of dollars.

“Bond rating agencies are well aware of the pension and OPEB liabilities in Illinois that impair its credit quality,” he said. “But the publication of OPEB costs may serve as a way of highlighting the problem to the public, which might lead to more responsible behavior by the governor and Legislature.”

The disclosure of OPEB liabilities is required by the Governmental Accounting Standards Board under Statements 43 and 45. The new rules require governments to account for benefits that employees are expected to earn in the future as well as for benefits that the employees have already earned.

The root of the state’s retiree benefits problem has been the diversion of revenues from pension funds to other state programs. Underfunding of pensions can be traced back to the governorship of James Thompson in the 1980s, Giertz said.

When faced with a pension-funding crisis in 1995, the state passed a law to bring up the retirement systems to 90 percent full funding by 2045, but left the funding ratio low for the first 15 years.

Gov. Rod Blagojevich and Democratic legislative leaders agreed to contribute only $1.4 billion to the five retirement systems in 2007, rather than the $2.5 billion required under the 1995 law. Most of the diverted funds are going to new spending.

The funded ratio of the state’s retirement systems is expected to drop to 58 percent in fiscal year 2007 and unfunded liabilities to rise to about $45 billion, according to projections by the Commission on Government Forecasting and Accountability.

OPEB costs are funded by the state on a pay-as-you-go basis, with no accumulated revenues earmarked for long-term costs, even though the cost of retiree health benefits is rising rapidly.

Unlike state pensions, OPEBs are not protected by the state constitution. The
non-impairment clause of the constitution prevents the state from reducing or otherwise altering pensions earned by employees. “The state could begin to ask retirees to pay a larger portion of health-care and other OPEB costs,” Giertz said. “That cannot happen in the case of pensions short of a constitutional amendment.”

The Illinois scholar said that while serious, the state’s funding problem is not insurmountable.

“At present, the unfunded liability represents only 6 percent of the gross state product. In comparison, private-sector pension exposure is estimated at $450 billion, or 4.3 percent of the gross domestic product, and the future liability for Medicare and Social Security is $38 trillion, which represents 362 percent of gross domestic product.”

By sticking to the state’s 1995 law (as modified in 2003) and making full annual contributions, the state could reverse the current pattern and begin to replenish the retirement funds. This in turn could strengthen the state’s credit rating, according to Giertz.

The state of Illinois funds five retirement systems for employees and retirees: State Employees Retirement System (SERS), Teachers’ Retirement System (TRS), State Universities Retirement System (SURS), Judges’ Retirement System (JRS) and General Assembly Retirement System (GRS).

The enrollment in the five systems totaled 666,952, according to the 2007 Illinois State Budget.