Public pensions are at risk of insolvency

Long before current market volatility, state and local pension debt posed a risk somewhere between a ticking time bomb and a crate of nitroglycerin. An explosion is coming eventually, and any major shock, whether related to COVID-19 or the next recession down the road, could set it off. As USA Today reported recently: "Before (the coronavirus) crisis even began, state pension plans across the country were already more than $1 trillion short of the funding needed to pay their future obligations to retirees."

Enter COVID-19. The economic hit from the pandemic showed just how vulnerable public pensions are to investment volatility. On March 24, credit ratings agency Moody’s Investors Service predicted that if market losses continued along their trajectory at the time, the average pension fund would lose 21% of its asset value this fiscal year. This and similar warnings caused some panic that COVID-19 would be the tipping point for pension funds already on the brink.

Illinois is ground zero for mismanaged pensions and offers instructive lessons on what not to do. It spends the most in the nation on pensions as a percentage of state and local revenue collections, about double the national average. It increased inflation-adjusted pension spending by more than 500% since 2000. But despite this first-in-the-nation spending, Illinois also has the worst pension-debt-to-revenue ratio among U.S. states, according to Moody’s.

A stress test commissioned by the Illinois Policy Institute last fall showed that a 20% drop in assets would start an inevitable slide to insolvency for Illinois’ statewide public pensions. Whether COVID-19 will be the ultimate tipping point remains unclear. Markets initially rebounded more quickly than many anticipated. In April, the 100 largest pension funds in the United States regained half of their first quarter investment losses. But volatility continues and the final impact remains to be seen.

Regardless, COVID-19 was at least a dress rehearsal for how state politicians will handle the crisis when it inevitably comes. The way politicians in Illinois responded —  by asking Congress for $10 billion in pension funding as part of a more than $40 billion bailout request —  should serve as a warning for taxpayers across the nation. Pension reform needs to happen now, before the wrong shock causes the debt bomb to explode.

Our elected leaders can learn from past mistakes and build more resilient pensions that automatically adjust pension benefits to match changing economic realities. For example, Wisconsin —  which had the only fully funded pension system in the nation pre-COVID-19 — bases annual benefits adjustments on investment returns. Depending on performance, benefits can go up or down, with a floor.

In Illinois, state workers receive a compounding 3% raise each year, even in a recession. If poor investment performance creates a funding gap, taxpayers are asked to make up 100% of the difference with no shared sacrifice —  an unsustainable structure.

So how do we ensure the future of public pensions looks more like Wisconsin and less like Illinois?

Congress is widely expected to debate a fifth coronavirus relief package after they return from their July 4 recess, which might include additional money for state and local governments to make up for revenue losses. Considering the $535 billion in disaster relief already provided, any further aid should be in the form of forgivable loans conditioned on good fiscal stewardship.

To diffuse the pension bomb, sound pension systems are the most important condition. If a state has more pension debt than it can pay off over 25 years without increasing taxpayer costs, it would have to commit to making pensions sustainable and affordable to access loan forgiveness.

If Congress instead offers a blank check to places such as Illinois, they’ll be propping up some of the most irresponsible and indefensible political decisions in the nation: from court decisions preserving a lifetime pension for a lobbyist who worked a single day as a substitute teacher to six-figure pensions for retired state politicians.

COVID-19 raised awareness about the fragility of public pensions to economic shocks, but we can’t let it become a scapegoat for a problem that’s been decades in the making.

Instead, this should be an opportunity to acknowledge we’ve seen TNT being piled up for years, and build consensus around constructive changes before the destruction is uncontrollable.

Adam Schuster is director of budget and tax research at the Illinois Policy Institute, a nonpartisan research organization that promotes responsible government and free market principles. He wrote this for Tribune News Service.