January 17, 2014
Although the most significant change in Illinois’ new pension law consists of a reduction in annual benefit increases paid to current and future retirees, the legislation also requires the State to commit additional funding to the retirement systems through a series of supplemental payments that could total more than $40 billion.
The additional funding is intended to go above and beyond the State’s annual contributions, which are now required to be calculated using more generally accepted actuarial standards including a target funding ratio of 100% within 30 years. Under the previous State pension law, the State was on a 50-year funding plan that began in 1995, with a target funding ratio of 90%.
The new pension reform legislation mandates two additional annual payments by the State that will be transferred to the Pension Stabilization Fund and distributed among the five State retirement systems. Under the law, the additional assets from the supplemental payments will be used when calculating the funding ratios of the various pension funds but not when determining the annual contributions. The State is also prohibited from using any of the funds transferred into the Pension Stabilization Fund to offset or replace its actuarially based contribution. These restrictions are intended to make the supplemental payments a pure add-on to its required annual contributions. It is anticipated the additional funds will lead to the systems achieving 100% funding earlier than the 30-year target.
The first type of supplemental payment will begin in FY2016 and will represent a portion of the annual budgetary savings the State receives from the lower contributions expected under the new law. Each year the State is required to calculate the difference between what its contribution would have been under the old 1995 pension law and its contribution under the newly enacted legislation. Then 10% of those savings are required to be transferred into the Pension Stabilization Fund. Current estimates of these payments are not yet available. However, proponents of the pension reform legislation estimated that the total savings over the next 30 years from the changes, including the supplemental payments, would total $160 billion. If the savings estimates prove to be accurate, it could be expected that the first type of supplemental payment could total more than $16 billion over the next 30 years.
The second kind of supplemental payment begins in FY2019 and was proposed as a way of committing operating funds that will be available as the State retires its outstanding pension obligation bonds (POBs) to pay down its unfunded pension liabilities. The State sold POBs in FY2010 and FY2011 totaling $7.2 billion to make its annual contributions to the retirement systems. The annual debt service for these bonds totals more than $1.0 billion through FY2019. Under the pension reform legislation the State is required to pay $364 million in FY2019 and $1.0 billion annually thereafter to the Pension Stabilization Fund until FY2045 or when the systems are all 100% funded. If the payments continue through FY2045, these supplemental funds will total $26.4 billion. However, the State also sold POBs in FY2003 that are repaid through FY2033. The debt service for these bonds is heavily back loaded, with principal payments ballooning from $647 million in FY2020 to $1.2 billion in FY2032 and FY2033. So, despite the debt service relief when the FY2010 and FY2011 POBs are paid off in FY2020, the savings will be offset by increases in the FY2003 bond payments.
Combined, the debt related pension stabilization transfer and remaining debt service will total more than the current debt service amounts through FY2033. In FY2018 debt service on the existing POBs will total $1.6 billion. In FY2019 the combined transfer of $364 million required under the pension law with the remaining POB debt service totals $1.95 billion. In FY2020 the combined $1.0 billion pension transfer and remaining POB debt service will total $1.6 billion and this total will increase to $2.16 billion through FY2033.
The following chart shows the combined Pension Stabilization Fund transfer and the POB debt service due from FY2014 through FY2045. The dotted line in the chart indicates the debt service level in FY2018, the final year prior to the start of the debt related annual transfer to the Pension Stabilization Fund. The chart does not include the first type of transfer discussed earlier, related to 10% of the contribution savings.