By: Mitchell I. Serota, Ph.D., Fellow of the Society of Actuaries

Last night, a group of concerned citizens of all political inclinations attended a Town Hall meeting which allowed Ralph Martire of the CTBA, the Center for Tax and Budget Accountability, to present his ideas on how to save the pension system of the State of Illinois. I was afforded the opportunity to ask a respectful question, which I repeat here for those who were not able to attend.

As a pension actuary for 40 years, I asked Mr. Martire if he was aware that if Illinois were a private corporation subject to the requirements of corporate accounting (rather than the more lax public accounting requirements), the pension plans would be required to use a discount rate close to 4% rather than the 6.75% to 7.25% that they are using currently. He replied that yes, he was aware, but that doing so would render the budget requirements for funding the pension plans untenable. Thank you, Mr. Martire, you made my point for me. I explained that the Unfunded Liabilities would no longer be $133 billion, but closer to $250 billion.

That’s a quarter of a TRILLION dollars.

Of course funding toward such a number would upset any of his plans to balance the budget. The quarter of a Trillion dollar figure has been corroborated by Moody’s, who, as a bond rating firm, uses the market value of liabilities to determine the economic viability of the State. We are talking about the market value, as distinguished from the higher discount rates currently approved by the Boards of the five State pension plans. The higher discount rates implicitly assume that the return on investment of that high a level is sustainable indefinitely. In other words, it is based on wishful thinking or worse. (Recreational marijuana is not yet legal in Illinois, is it?)

But even the wishful-thinking-discount rate generated a liability that was too high for Mr. Martire to deal with. He arbitrarily decided to target 72% of this liability as a funding goal. This after telling us that his “think tank” uses factual analysis as a basis for its conclusions. He cited a statement made by the GAO in which unnamed “experts” believe 80% funding is an adequate target. The actuarial profession, represented by the American Academy of Actuaries (“AAA”), long ago put paid to the notion that anything less than 100% was a suitable target for funding. But Mr. Martire, who is clearly not an actuary, declares that his 72% target is just fine.

The attached AAA Issue Brief, published in July 2012, explains the untenability of the 80% target. But for the reader who needs a quick understanding, consider the following application of the 80% standard to a life insurance company. If you take out a life insurance policy with a face value of $1 million and die, the life insurance company tells your estate that, “Sorry, we can only pay out $800,000 because our reserves are inadequate.” Alternatively, the life insurance company tells your estate, “Sorry, but there were 80 people ahead of you in line, so you and the next 20 will get no payment whatsoever.” This last response probably relates more closely to the situation at hand. The funds will run out of money and some very innocent people will have no, or very little retirement benefits.

Please do not blame me for alerting Mr. Martire that using a market-based approach, commonly referred to as Financial Economics, will upset his preposterous proposal. What he offers not only does not solve the problem, it kicks our proverbial can down the road further than even the Edgar Ramp would dictate. Kicking the can down the road is a metaphor for transferring the debts incurred by a previous generation of legislators to our unborn children and grandchildren. In my opinion, his proposal is more intellectually bankrupt than our State’s finances.

My solution? Let’s spread the fiscal pain of funding the public plan pensions a bit more evenly across the residents of the State. I start with the notion that the Governor and the General Assembly are proposing to ask the general public to amend the Constitution of the State to allow for a graduated income tax. I want to take this referendum one step further. I call upon the Governor and General Assembly to add that the Constitution will be amended to rescind Article XIII, Section 5, commonly referred to as the “Pension Clause.” One referendum for both—it cannot be split into two referenda.

Rather than go into a lengthy rationale, consider the following. If the Federal Government allows for a graduated income tax, the Federal Government also allows pension plan sponsors to amend their pension plan benefit structure. The ERISA law has built into place the understanding that times change and that the plan sponsor must be given the flexibility to adapt to the exigencies of new economic dynamics. So if the citizens of the State are called upon to pay more taxes for pension benefits, the recipients of exorbitant pension benefits should be willing to take a reduction. If the state employees are unwilling to bend, they may very well lose everything.

We have a crisis to deal with in this State. It is time to stop the nonsense of the past 24 years of putting a band-aid® on a life threatening fiscal wound. And what we really don’t need is to replace the band-aid® with a Post-it® note that a 72% funding target is good enough.

More on the unsuitability of Martire’s Pension Obligation Bonds in a forthcoming letter.

NOTE TO READERS: Regarding the Town Hall meeting discussed above, also see Wirepoints’ separate article, “Legislators’ ‘Town Hall’ Becomes Metaphor For Failing Illinois.”