Illinois Pension Plans 39% Funded – Taxpayers On the Hook

Editor’s Note:  When it happened in Detroit, they said it couldn’t happen in Chicago. Most Californians will agree that our economy is bigger, and more diverse and resilient than that of Illinois or Michigan. But pension fund solvency relies on perpetual bull market rates of return – and the moment the market hiccoughs again, California’s state/local pension system’s collective unfunded liability will balloon from somewhere south of $200 billion to somewhere north of $400 billion. And it could happen almost overnight. California can learn from Detroit’s solution, which preserved defined benefits but adjusted the the ongoing formulas downwards to preserve solvency. An adjustment like that now, instead of later, might leave far more for California’s retired public servants, because it would allow more time for the funds to reduce their unfunded liability before the next market downturn.

A “Special Pension Briefing” last November, shows the Illinois State Retirement Systems are in dismal shape.

Unfunded Liabilities

  • Teachers’ Retirement System (TRS): $61.6 Billion
  • State Retirement Systems (SERS): $61.6 Billion
  • State Universities Retirement System (SURS): $21.6 Billion
  • Judicial Retirement System (JRS): $1.5 Billion
  • General Assembly Retirement System (GARS): $0.3 Billion

The above numbers show actuarial (smoothed) asset valuations, as does the following chart.

Summary of Liabilities and Unfunded Ratios

Congratulations go to the Illinois General Assembly Retirement System (GARS) for having one of the worst, (if not the worst) pension plan in the entire nation. It is 16% funded.

No doubt, that increases the pressure of the General Assembly to put the burden of bailing out the system on the backs of Illinois taxpayers.

Smoothed Returns

The above chart shows “smoothed returns” that even out the 2007-2009 dip as well as the 2010-2014 blast higher. Illinois resorted to using “smoothed returns” minimize the effect of the 2007-2009 dip. But now, with the rally, Illinois wants to use actual market returns.

On a non-smoothed (market) basis the numbers are slightly better. Non-smoothed, the total deficit is $105 billion instead of $111 billion.

Liabilities Per Household

Let’s be generous and assume the lower $105 billion number. The US Census Bureau shows there are 4,772,723 Illinois households.

The potential taxpayer burden to make up the deficit is $22,000 per household. That’s not even the worst of it as the following chart shows.

Liability Trends – Not Smoothed


In spite of the massive stock market rally, Illinois liabilities increased every year since 2011.



Zero Percent Chance of Success

Its bad enough that Illinois is $105 Billion to $111 billion in the hole and liabilities have increased in spite of a massive rally in both stocks and bonds.

Illinois plan expectations are icing on the “Zero Percent Chance of Success” Cake.

I discussed this at length in my post Beggar Thy Taxpayer: Currency Wars, QE Strain Life Insurers and Pension Plans; Negative Returns With 4-7% Promises.

Europe vs. US

In Europe, pension plans and retirement funds have promised 4% returns. Future promises in Germany are now down to 1.25%. However, yields on 10-year German bonds are 0.35%.

In Illinois, the plan assumption for TRS, the biggest system with the biggest unfunded liability, is 7.5%. There has been no meaningful reduction in plan promises over the years.

7.0% to 7.5% Assumptions Will Not Happen for Two Reasons

  1. US Treasury Yield Curve
  2. Stock Market Valuations

US Yield Curve


US Promises

In the US, pension funds have not made 1.25% promises or even 4% promises, but rather 7.0%+ promises with the 10-year bond yielding about 2%. Annuities promise 6% or so.

Illinois promises range from 7.0% to 7.5%. How you get 7.5% in a 2% world?

The correct answer is: you don’t. But insurers and pension plans try, by taking risks. And the more risk they take, the higher and higher into bubble territory go stock market and junk bond valuations.

This is well understood and established behavior. And it’s precisely what the Fed has sponsored. At the end of 2012, even mainstream media recognized what was happening, as shown by the following quote from the CNBC article How the Fed Is Pushing Investors to Buy Junk Bonds

The market is thirsting for yield and the Fed is pushing people to do things like this [buy junk],” said Lawrence G. McDonald, who as head of LGM Group specializes in junk-bond trading. “So big asset managers are reaching, reaching, reaching and companies know this and are issuing, issuing, issuing all this crap.

We have seen that effect in Illinois pension plans as well. In our own report, 401(k)s are better than politician-run pensions, we noted pension funds often invest in riskier assets to try and boost their returns.

A look at the Illinois Teachers’ Retirement System, or TRS, portfolio, for example, reveals a portfolio of investments in junk bonds, real estate, derivatives and private equity. TRS has more than $1 billion invested in bonds that Moody’s Investors Service or S&P Ratings Services rate as junk.

Seven Year Negative Returns

As of January 31, 2015, Stock and bond prices are so stretched that GMO’s 7-Year Asset Class Real Return Forecast shows negative real returns for seven years in US equities and bonds.

The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward‐looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward‐looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward‐looking statements. Forward‐looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forward‐looking statements. U.S. inflation is assumed to mean revert to long‐term inflation of 2.2% over 15 years.

As of December 31, 2014 GMO managed $116 billion in assets.

Broken Model

In the US, pension plans have aggressively shifted from investing in AAA rated bonds to equities and junk bonds because yields in US treasuries and AAA rated corporates are not high enough.

Denial that this has happened is nearly everywhere one looks. Of course the Fed, and most others, cannot and will not see a bubble until it bursts wide open.

Even if the air is let out slowly (something that has never happened in practice), negative real returns, and perhaps zero nominal returns for seven years are the only other plausible outcomes unless one expects an even bigger bubble coupled with even longer negative returns in the future.

Simply put, numerous US pension plans are in deep, deep trouble. Illinois is at the top of the list. Plan assumptions cannot and will not be met. It’s far too late for token improvements.

Honest Discussion Needed

Not even massive tax hikes can save the system at this point. Businesses and taxpayers would flee. And Illinois is already struggling with corporate and individual flight.

The Illinois pension system is totally broken. It’s time to have a truly honest discussion of what to do about it.

Postscript- Illinois Taxes – Loser Spoils

For a look at the Chicago downgrade, please see my post Chicago’s Fiscal Freefall: Moody’s Cuts Chicago Credit Rating to Two Steps Above Junk; Snake Oil and Swaps; It’s All Junk Now.

This is my second column for the Illinois Policy Institute, where I am now a senior fellow.

The article was written well ahead of the Moody’s downgrade of Chicago pensions last Friday, with a final edit made on Friday, and posted then on the IPI website.

My first article for IPI was Right-to-Work Sweeps Midwest, Heads for Passage in Wisconsin.

Both articles are up on the Illinois Policy Institute  website where you can also learn (assuming you did not know),Illinoisans pay high taxes compared to other Midwest families.

Loser Spoils

Inquiring minds may also be interested to learn via the IPI website, that former governor Quinn Will Receive Millions in Pension Payments

When he ceded his office to Gov. Bruce Rauner on Jan. 13, former Gov. Pat Quinn gave up a $180,000 salary as well.

But that same day marked the beginning of a lucrative consolation prize: monthly pension checks that will add up to $137,000 in Quinn’s first year of retirement, according to WUIS 91.9. The former governor will receive $3 million in pension payments over his lifetime should the Illinois Supreme Court strike down Senate Bill 1, a pension-reform law passed in 2013. Should it be upheld, Quinn would still receive over $2 million.

Over his public tenure, which included stints as the state treasurer and lieutenant governor, Quinn contributed a mere $190,000 toward his pension as of November 2014, according to the Chicago Sun-Times. This contribution is not sufficient to cover even the first 18 months of benefits he will collect.

In case you were wondering how Illinois plans became so underfunded, you now have a clear picture: in general, promising far more than can possibly be delivered.

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About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.

New Actuarial Rules Will Force States to Admit Pension Problems

Editor’s Note:  This post by UnionWatch contributor Mike Shedlock covers familiar territory. Our parent organization, the California Public Policy Center, has published detailed analyses of the new GASB and Moody’s rules, including: “Moody’s Final Adopted Adjustments of Government Pension Data,” “How New Rules from Moody’s and GASB Affect the Financial Reporting of Pensions in Seven California Counties,” “How Lower Earnings Impact California’s Total Unfunded Pension Liability,” and “The Impact of Moody’s Proposed Changes on Government Pension Pension Data.” But in this post, Shedlock mentions one of the key reasons why pension fund return projections are overly optimistic. He writes, “Pension plans typically assume 7.5% returns. That’s  not going to happen on a sustained basis with 10-year treasuries yielding close to 2%. Yet, any significant rise in bond yields will crush existing bondholders as well as wreak havoc in equities.” This underscores a key consequence of the Fed’s policy to lower interest rates – a run that over the past 30 years has seen the 30 year T-bill go from 16.0% down to under 3.0%.  Every time the Fed lowered their rates, new bond issues and other fixed income securities lowered their coupon rates as well. This meant that all previously issued bonds, which had all been issued at higher rates of interest, became worth more. Basically, as long as interest rates kept dropping, the prices for bonds and all fixed income securities appreciated. To the extent these investments are a significant part of pension fund portfolios – and they are – they have delivered consistently high returns, especially over the past ten years. But interest rates can’t get any lower. There is nowhere left to go. Many pundits, including economists who ought to know better, claim that the dangers of debt accumulation are overstated. The inevitable end of the bull market in bonds, and how it will add yet another challenge to pension funds striving for that mythical 7.5% return per year, is a tangible refutation to anyone spewing sanguinity in the face of peak debt.

Many states, especially California and Illinois, have had severe pension underfunding problems for many years.

However, new actuarial pension rules will finally force states to admit the problem. Thus, it should not be surprising that talk of “technical bankruptcy” and “service insolvency” is growing.

Here are some pertinent ideas from California on the Brink: Pension Crisis About to Get Worse

  • Moody’s new credit standards for public pensions would nearly double the unfunded liabilities for state and local pension plans in California to $328.6 billion from $128.3 billion.
  • California has the second lowest credit rating at Standard & Poor’s of all 50 states; Illinois now has the worst. Moody’s new standards would drop the funded status of these plans to 64%, versus a previous estimate of 82%, the Center said.
  • “By standard accounting methods, some state pension funds will run out of assets within as little as five years”
  • New rules will lower expected rates of returns on their pension assets, instead of the often overstated returns they now use to paper over holes in their plans blown out by bad investments.
  • Meredith Whitney says California is papering over budget holes with gimmicks, like raising taxes retroactively, pushing state expenses onto local towns and cities that can’t afford them, and underfunding their pension funds. “It’s so much worse than the rosy picture that the headlines suggest,” the CEO of Meredith Whitney Advisory group says.
  • The Senate Joint Economic Committee reiterates what Whitney says. “Many states and localities have regularly skipped or underfunded contributions to pension plans,” the report said. “Over the past five years, state and local governments have underpaid actuarially required pension contributions by more than $50 billion. The worst culprit of all, Illinois, has underpaid its pension contributions to the tune of $28 billion over the past 15 years.”
  • Illinois’ plan is just 44% funded, or 30% using “conventional accounting standards,” the Senate committee says. Los Angeles’ combined plans would fall from 77% funded to 50% funded.
  • San Jose’s combined plans would fall from 75% to 60% funded.
  • San Francisco’s combined plans would fall from 88% funded to 69% funded.

Trouble Will Escalate

Many California cities are in serious trouble, and that trouble will grow by leaps and bounds as soon as there is a significant stock market correction.

Pension plans typically assume 7.5% returns. That’s  not going to happen on a sustained basis with 10-year treasuries yielding close to 2%. Yet, any significant rise in bond yields will crush existing bondholders as well as wreak havoc in equities.

Moody’s wants states to assume 5.5% returns, but even that is far too high. The stock and bond markets are now so bloated thanks to Fed bubble-blowing policies that 0-2% returns for a full decade is a distinct possibility. And not a single pension plan in the US is remotely prepared for such an event.

About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education. Every Thursday he does a podcast on HoweStreet and on an ad hoc basis he contributes to many other websites, including UnionWatch.