The inbox. Ralph Martire in Crain’s. A pension fix.

By: Ralph Martire
January 16, 2013

There was much wailing and gnashing of teeth when the recent lame-duck session in Springfield ended.

Why? No action was taken to address the $95 billion in debt owed to the state’s five pension systems.

This leaves the systems with just 40 percent of the funding they should have currently, which is well below the 80 percent generally deemed healthy for public systems. Good government groups and editorial boards alikelamented the Legislature’s failure to pass yet another proposal to reduce that ginormous obligation — this time by cutting almost $30 billion in benefits earned by current workers and retirees.

But rather than being dismayed, folks should be relieved. Here’s why.

A problem really can’t be solved unless the proposed solution addresses its true cause. And the proposal that failed to pass during the lame-duck session — like every other proposal introduced to date on this subject — focused its solution on benefit cuts and thereby failed to deal with this particular problem’s true cause.

See, three factors have contributed to the creation of this unfunded liability. The first two are items inherent to the pension systems themselves, like benefit levels, salary increases and actuarial assumptions; and investment losses suffered during the Great Recession. But if those were the only factors creating the unfunded liability, the systems would be around 70 percent funded today, meaning no crisis.

The vast majority of the unfunded liability is made up of the third contributing factor: debt. Indeed, for more than 40 years. the state used the pension systems like a credit card, borrowing against what it owed them to cover the cost of providing current services, which effectively allowed constituents to consume public services without having to pay the full cost thereof in taxes.

This irresponsible fiscal practice became such a crutch that it was codified into law in 1994 (P.A. 88-0593). That act implemented such aggressive borrowing against pension contributions to fund services that it grew the unfunded liability by more than 350 percent from 1995 to 2010 — by design. Worse, the repayment schedule it created was so back-loaded that it resembles a ski slope, with payments jumping at annual rates no fiscal system could accommodate. Want proof? This year the total pension payment under the ramp is $5.1 billion — more than $3.5 billion of which is debt service. By 2045, that annual payment is scheduled to exceed $17 billion, with all growth being debt service.

It is this unattainable, unaffordable repayment schedule that is straining the state’s fiscal system — not pension benefits and not losses from the Great Recession. And no matter how much benefits are cut, that debt service will grow at unaffordable rates. Which means decision-makers can’t solve this problem without re-amortizing the debt.

Given that the current repayment schedule is a complete legal fiction — a creature of statute that doesn’t have any actuarial basis — making this change is relatively easy. Simply re-amortizing $85 billion of the unfunded liability into flat, annual debt payments of around $6.9 billion each through 2057 does the trick. After inflation, this new, flat, annual payment structure creates a financial obligation for the state that decreases in real terms over time, in place of the dramatically increasing structure under current law. Moreover, because some principal would be front- rather than back-loaded, this re-amortization would cost taxpayers $35 billion less than current law.

One last thing — it actually solves the problem by dealing with its cause.