Public Pension Plans and Their Importance

New Members Conference: Pensions Beverly Bunch Professor, School of Public Management and Policy University of Illinois Springfield Institute of Government and Public Affairs November 19, 2024

Disclaimer: I participate in the State University Retirement System and am a faculty fellow with the Institute of Government and Public Affairs. The views presented in this presentation are my own.

Topics Topics Importance of Public Pension Plans Types of Pension Plans Financial Aspects of Pension Plans Illinois Historical Events Related to Pensions

Importance of State Importance of State Government Pension Plans Government Pension Plans Helps recruit and retain a strong public sector workforce Contributes to the retirement for state employees Helps the state s economy by providing income to retirees who choose to remain in the state

National Aggregates National Aggregates More than 4,300 state and local government pension plans Over 34 million members Account for 21% of total retirement savings More than $4.7 trillion in assets (2023) An estimated $1.6 trillion in unfunded accrued liabilities Source: Urban Institute, n.d.

Defined Benefit Plans Defined Benefit Plans Provides a guaranteed revenue stream for the life of the retirees Employers and employees contribute to the pension plan The plan administrator invests and manages the fund Employer retains the risk contributions + interest = pension payments + administrative costs employee employer state pension plan retirement benefits for all members of the plan

Defined Contribution Plans Defined Contribution Plans Provides a means to build a retirement amount that can be used to provide funds for an individual s retirement Employers and employees contribute to the pension plan The employee selects investments Employee retains the risks employee employer individual s pension plan retirement revenue for that individual

Relationship to Social Security Relationship to Social Security About of state and local government employees participate in a public retirement plan in lieu of social security Must satisfy IRS requirements Illinois Most SERS members participate in social security and a state retirement plan Most members of other state pension plans do not participate in social security

Pay Pay- -As As- -You You- -Go Versus Pre Go Versus Pre- -funded funded Pay-as-you-go Pay current year retirement benefits primarily using current year revenues Social Security Pre-funded Set aside funds now to pay for future retirement benefits State pension plans

Financial Condition Financial Condition Unfunded accrued actuarial liabilities (UAAL) = actuarial value of liabilities - actuarial value of assets (liabilities represent accumulated value of benefits earned by plan participants) Funding Ratio = actuarial value of assets / actuarial value of liabilities Source: National Association of State Retirement Administrators, 2022.

Survey of 130 Large State and Local Government Survey of 130 Large State and Local Government Pension Funds: Funded Ratios for FY 2022 Pension Funds: Funded Ratios for FY 2022 Aggregate funded level is 76.1% Funded Levels for Individual Plans Median = 77.1% Range: 21.8% to 114.7% Source: National Association of State Retirement Administrators, 2023.

State and Local Government Pension Plan Funding Ratios 2021 Source: Board of Governors of the Federal Reserve System, 2023

State and Local Government Pension Plan Funding Ratios 2021 2017 Source: Board of Governors of the Federal Reserve System, 2023

State Pension Funded Ratios State Pension Funded Ratios Illinois vs. State Median FY 2023 Illinois vs. State Median FY 2023 75% 80% 60% 43% 40% 20% 0% State Median Illinois Source: S&P Global Ratings, 2024.

Lowest State Pension Plan Funded Ratios Lowest State Pension Plan Funded Ratios State FY 2023 Pension Funded Levels Kentucky 33% Illinois 43% New Jersey 47% Connecticut 54% Missouri Mississippi 56% Source: S&P Global Ratings, 2024.

Highest State Pension Plan Funded Ratios Highest State Pension Plan Funded Ratios State FY 2023 Pension Funded Levels Washington 100% South Dakota 100% Wisconsin 96% Tennessee 94% Maine 92% Source: S&P Global Ratings, 2024.

Bond Rating Perspective Bond Rating Perspective Bond ratings: a grade assigned by a bond rating firm to reflect the risks of default on state bonds How do unfunded pension liabilities impact ratings? Debt ratios: debt + unfunded pension liabilities relative to GDP, income, or per capita State Structural Finances Pension contributions (based on what a state needs to contribute) OPEB (other post-employment benefits, e.g., retiree health care costs)

Key Illinois Pension-Related Historical Actions Source: State of Illinois (2024). Official Statement for General Obligation Bonds, Series of October 2024.

Pension Obligation Bonds Pension Obligation Bonds Pension obligation bonds (POBS): taxable bonds that are used to fund pension liabilities Based on the intent that the bond proceeds will be invested at higher rates than the interest on the bonds Government Finance Officers Association (2015) recommends that governments not issue POBs

Illinois Issuance of Pension Obligation Bonds Illinois Issuance of Pension Obligation Bonds Date Issued Amount 2003 $10 billion 2010 $3.47 billion 2011 $3.7 billion

Tier 2 Benefits Tier 2 Benefits - - 2011 2011 Created a two-tier pension system Tier 1 and Tier 2 Employees that join the pension system January 1, 2011 or later participate in the Tier 2 Plan Tier 2 Differences: retirement eligibility criteria, calculation of final average compensation, post-retirement annual increases, cap on pensionable earnings Source: State Employees Retirement System (2023).

Change in Benefits Change in Benefits 2013 Overturned by Illinois Supreme Court Case Overturned by Illinois Supreme Court Case - - 2014 2013 2014 State made revisions to funding levels, automatic annual increases, retirement ages and employee contributions for TRS, SER SURS, and GARS (Public Act 98-599) Declared unconstitutional by Illinois Supreme Court on May 8, 2014 State Constitution Non-Impairment Clause

State of Illinois Constitution State of Illinois Constitution Section 5 of Article XIII [m]embership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired (the Pension Protection Clause ).

Pension Acceleration Option Pension Acceleration Option Effective 2018, state is offering two optional pension acceleration options (1) Pension Buyout Program (2) AAI (Automatic Annual Increase) Reduction Program Authorized through 6/30/26 State authorized $2 billion in bonds to finance the programs As of end of October 2024, state had issued $1.8 billion in bonds

Extra Payments to Pension Plans Extra Payments to Pension Plans FY 2022: extra contribution = $300 million FY 2023: extra contribution = $400 million

Conclusion Conclusion Pension plans serve an important role Characteristics Defined benefits Some do not participate in social security Pre-funded Funding levels for Illinois state plans are low relative to most other state plans History of events Creation of Tier 2 Illinois Supreme Court case ruling Others

References References Board of Governors of the Federal Reserve System (2023). State and local government pension funding ratios, 2002-2021. https://www.federalreserve.gov/releases/z1/dataviz/pension/funding_ratio/map/#year:2021 Government Finance Officers Association (2015). Advisories: Pension obligation bonds. https://www.gfoa.org/materials/pension-obligation-bonds National Association of State Retirement Administrators (2022). Overview of public pension plan amortization policies. https://www.nasra.org/amortization#:~:text=The%20UAAL%2C%20or%20unfunded%20liability,ben efits%20earned%20by%20plan%20participants National Association of State Retirement Administrators (2023). Public fund survey. https://www.nasra.org/publicfundsurvey S&P Global (2024). U.S. state s fiscal 2023 liabilities: Stable debt, with pension and OPEN funding trending favorably. https://www.spglobal.com/ratings/en/research/articles/241023-u-s-states- fiscal-2023-liabilities-stable-debt-with-pension-and-opeb-funding-trending-favorably-13280644

References References State Employees Retirement System (2023). SERS annual comprehensive financial report for the fiscal year ended June 30, 2023. https://ilsrs.illinois.gov/content/dam/soi/en/web/srs/sers/resources/financial- report/annual-sers-2023.pdf State of Illinois (2024). $600,000,000 State of Illinois general obligation bonds, $150,000,000 taxable series of October 2024A, $150,000,000 Series of October 2024B, $300,000,000 series of October 2024 C. Official Statement. https://capitalmarkets.illinois.gov/historical-bond-offering-information/official- statements.html Urban Institute (n.d.). State and local government backgrounder: State and local government pensions. https://www.urban.org/policy-centers/cross-center- initiatives/state-and-local-finance-initiative/projects/state-and-local-backgrounders/state- and-local-government-pensions