Jessica Alcorn, Abigail Lloyd, Michelle Lofton, and Jennifer Johnson

1. Crafting long-term sustainability of Public pensions in IllinoisUGA Creative policy analysisAugust 31, 2012 Jessica Alcorn, Abigail Lloyd, Michelle Lofton, and Jennifer Johnson

2. Background • Economic Climate • $85 billion shortfall and is increasing by $12.6 million daily (Tareen, 2012) • Due to Recession, revenue from taxes and risky investments (74% invested in equities; only 22% in fixed income) has decreased (TRS Report, 2010) • Returns on assets is estimated at the unreasonably high rate of 8.5% (Topinka, n.d.) • S&P recently downgraded Illinois’ credit rating from A to A-, making it harder to acquire capital (Garcia, 2012) • Political Climate • Due to strong unions, salaries have been inflated and negotiation of benefits has been challenging • Politicians are hesitant to challenge unions as it could threaten reelection prospects and result in strike • Recent failures to reform have resulted in uncertainty • Demographic Climate • As Baby Boomers reach retirement and life expectancy increases, unfunded liabilities will continue to grow

3. The Problem • The Problem: The state of Illinois has not been responsible in funding and designing decisive reform measures to ensure the long-term stability of theirpublic pension program. • Although we cannot solve the problem, we can mitigate the problem by addressing the symptoms. • Symptoms of the Problem: • Decreased economic viability of the state • The state is bound to public sector union interests • Lack of faith in government’s management of public funds

4. Option 1: Status quo • Stay with all the current features • Defined Benefit System (DB) • Employee Contribution: 9% • Retirement Age: 65 for full benefits after a minimum of 5 years • Pension annuity payment formula: (2.2%)*(years of service)*(final salary –highest average salary earned during 4 consecutive years out of past 10 years of service) • Cost of Living Adjustment (COLA): 3% compounded annually

5. Option 2: Transition to Defined contribution • Increase assets and decrease unfunded liabilities • Mitigate the problem by issuing bonds and increasing assets • Issue 8 billion in general obligation bonds • Change asset allocation: 55% equity and 45% fixed • For All Employees: • Increase retirement age to 67 • For Future Employees: • Defined Contribution (DC) plan only • For Current Employees: • Remain on the Defined Benefit (DB)

6. Option 3: hybrid model • Increase assets • Change asset allocation: 55% equity and 45% fixed • Decrease unfunded liabilities • For all employees: • Retirement age increased to 67 • Future employees must immediately enrolled in DC • Option to participate in DC is available to current employees • Immediate cash-out of DB plans by employees • Lump sum to invest in personal interest bearing accounts until retirement • If employees remain in the DB, employee contribution is increased to 13%

7. Option 3: Further Analysis • Assumptions • Public service: 10 years, 25 years, or 35 years • Average salary is based on highest consecutive salaries of 5 years of the past 10 years of service: $45,000, $65,000, or $85,000 • Retirement age: 67 • Life expectancy: 80 years • DC for current employees who switch get a lump sum transfer to be invested in an interest bearing account with a return on investment (ROI) of 3.5%, 6.0% or 8.5% • Formulas • DB: Present value of an annuity • DC: Lump sum value compounded

8. Option 3: DC plans

9. Option 3: DB vs. DC

10. Recommendation • Option 3: Hybrid Model • Creates an incentive for more employees to opt into the DC program and decrease the government’s percentage of unfunded liability • Legal Viability • If the pension plan is changed: beneficiaries “must be provided a benefit calculated under the terms of the plan at the time of their enrollment” (Monahan 2010) • Clearly, no loss in aggregate benefits under DC • Political Feasibility • Possible initial push back from public sector unions • Could gain buy in through DC investment education • Managerial Implications • Potential large costs arise from initial DC plan design, set up, and education of employees

11. Conclusions • Efficiency • The majority of the risk is shifted to state employees • The percentage of the government’s unfunded liability is decreased over a shorter time span • Equity • Employees are granted the ability to manage their own funds • Political Feasibility • Policymakers need to be responsive to the electorate • This plan will require extensive negotiation with Illinois’ strong labor unions. • Accountability • Whether entering the DB or the DC, this plan shifts taxpayer funds out of risky investments

12. Works Cited • Garcia, Monique. (2012, August 30) “Illinois' credit rating downgraded after pension reform failure” http://www.chicagotribune.com • Monahan, Amy. (2010, March 17) “Public Pension Plan Reform: The Legal Framework,” 5 Education Finance and Policy 617http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1573864. • Tareen, Sophia. (2012, August 6)“Illinois Governor Amps Up Pressure to Overhaul Pensions,” http://www.businessweek.com • Teachers’ Retirement System of Illinois. (2010, December 20) Financial Report of Teachers’ Retirement system of Illinois: FY 2010. http://trs.illinois.gov/subsections/pubs/cafr/fy10/financial.pdf. • Topinka, Judy. “Pension Obligation Bonds: A Four-Year Review.” Fiscal Focus Magazine. http://www.comptroller.state.il.us/FiscalFocus/article.cfm?ID=286.

13. Questions?