Counting Chickens Before They’re Hatched: Will Illinois Botch Pension Consolidation?

Not much more than a month ago, Illinois Gov. JB Pritzker’s task force released its report recommending that asset management at the 650-odd pension funds be consolidated, while leaving benefit administration (and jobs, and decision-making about disability-eligibility) to the local entities.

And when Illinois doesn’t drag its feet on making changes due to inter- or intra-party squabbles or the desire to avoid making any hard choices, when its politicians think they’ve found a free lunch, they rush headlong into it. The Chicago Tribune reported last night that

“The Illinois House voted overwhelmingly Wednesday to approve Gov. J.B. Pritzker’s plan to consolidate nearly 650 local pension funds for suburban and downstate police officers and firefighters.

“The measure, which was approved on a bipartisan vote of 96-14, now goes to the Senate. If that chamber approves the bill before adjourning Thursday, it would hand another victory to Pritzker after he accomplished nearly all of his legislative priorities in the spring.”

Now, the fundamental concept of consolidation is entirely reasonable – as it is, the smallest of pension plans see lower asset returns because of investment restrictions and comparatively high expenses, which should be solved with consolidation. In the best case, they should see returns of as much as 2 percentage points higher in a consolidated system due to economies of scale.

But Ted Dabrowski and John Klingner at Wirepoints point to a serious concern not being reported elsewhere, an additional boost in benefits:

“[I]t makes sense to pool the funds of the 650 pension plans in an attempt to increase investment returns and lower transaction fees. Everything else equal, not doing so would be irresponsible.

“But the consolidation bill being debated on the floor today isn’t just about consolidation of fund assets. It’s also become a vehicle for changes to pension benefits, with increases for Tier 2 public safety workers. Pensions are the biggest issue that the state faces – and lawmakers are about to make significant changes with no debate as to their merits and no public actuarial analysis calculating their cost.”

More specifically, the bill – by means of deleting two words and changing two numbers – changes the averaging period for Tier 2 worker (hired 2011 and later) from 8 years to 4 years, and modifies the pensionable pay cap increase rate from half of CPI to the full CPI (with a maximum of 3%). (See page 73 of the Amendment 5 text.) This latter change in particular remedies an element of Illinois pensions which would otherwise, over time, have a particularly harsh impact as the real, inflation-adjusted level of the cap declines from year to year.

And I’ve written repeatedly that Tier 2 benefits for all Illinois workers need reform. But, as Dabrowski and Klingner write,

“For sure, benefits for Tier 2 workers – those who started work after January 2011 – will at some point have to be fixed. We’ve written about that in the past. It’s a real mess.

“But this bill is not the place to do it. If Tier 2 is changed, it should be part of a dedicated pension reform bill that fixes all the funds at once, not snuck in as part of unrelated legislation.

“Supporters of the Tier 2 reform in the bill argue that the costs of the increased benefits – estimated at some $70 to $95 million over the first five years – are covered by the expected higher investment returns generated as a result of consolidation.

“But higher returns aren’t guaranteed by the bill. Yes, the consolidated funds will be able to take more risks in the stock market – but those greater risks can lead to better returns or bigger losses.”

The pair also point out that this sets a precedent for simply increasing Tier 2 generosity in other systems without any sort of funding. What’s more, this was done without any concrete analysis of the degree to which the various Tier 2 benefits – for teachers, state and municipal workers, and public safety worker statewide – are in violation of Social Security’s “safe harbor” laws, analysis which has never taken place for any of these benefits.

Now, I myself should acknowledge that in my prior article on the pending consolidation, I was perhaps overly excited by the task force’s acknowledgement of this issue, so as to not recognize at the time the danger of pairing the consolidation with a benefit enhancement.

But the folks at Wirepoints are right – this has the potential from going from a success story to yet another cautionary tale of Illinois’s bad governance.

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