Pension Consolidation in Illinois: A tradeoff between the short and long term.
Nov 11, 2019
By Amanda Kass
Associate Director, Government Finance Research Center
Illinois currently has over 600 unique public pension funds for police officers and firefighters (referred to as “public safety funds”). The public safety funds are all governed by independent boards of trustees, which runs the risk of duplication of effort and too-high administrative bills. There’s also concern that having so many individual funds invest their own assets leaves money on the table from lower than possible investment returns. State lawmakers are considering changing this through consolidation.
Is this a prudent idea? It could be, but that depends on the policy goals, the exact consolidation design, and a number of other factors. There are few models for Illinois to look to on this issue, though. This is, in part, because Illinois is an outlier in the number of unique public pension funds that exist in the state. Only Pennsylvania has more state and local pension plans than Illinois.
Illinois lawmakers are specifically considering legislation that would combine the assets of the public safety funds—this is a form of partial consolidation and could help shore up the public safety funds’ finances and save taxpayer money.
Proponents argue that pooling the assets of Illinois’ public safety funds will boost their finances through higher investment returns. Under state law, the public safety funds are restricted on the types of investments they can make based on their size—the smaller funds have less discretion and more conservative strategies. Combining the assets would mean more investment discretion, and, it is assumed, less conservative strategies, which would result in higher returns. The increased assets from higher investment returns would in-turn reduce governments’ contributions.
Higher investment returns, however, are often achieved by taking on more risk. Riskier investments have higher (potential) returns than safer investments (like fixed income). Research indicates that higher investment risk can create greater volatility in pension fund assets and an increase in unfunded liabilities. That volatility can cause government contributions to swing significantly from year-to-year, creating budgetary and long-term fiscal forecasting challenges. Relatedly, a pension system’s financial status is an important issue in crafting an investment strategy. Illinois’ public safety funds range widely in their funded status—some are extremely underfunded, while others have assets that exceed liabilities. In general, the least funded pension funds should take on the least amount of investment risk. Research has shown that in practice this is not the case, and it is often the least funded pension systems that take on the greatest amount of risk.
Over a quarter of Illinois’ public safety are less than 50% funded, and across all funds the median funded ratio—the ratio of assets to liabilities—was 58% in 2016. This low level of funding is a concern not just for the solvency of the pension funds and beneficiaries, but also the fiscal pressure it creates for local governments. In general, a government’s annual pension contribution is tied to the pension system’s finances, and contributions increase as the pension fund’s finances deteriorate. Under state law, each Illinois public safety fund must achieve a specific level of funding by 2040, and because of this, local governments’ contributions are going to increase over time. Local governments throughout Illinois are already struggling to make their annual pension payments, and are looking for budgetary relief.
While few places have consolidated their public pension systems in recent years, the idea has been considered in a number of places grappling with large unfunded pension liabilities. State governments have looked to consolidation as a cost saving measure in the wake of the significant increases in unfunded pension liabilities tied to the 2008 financial crisis. New York City Mayor Michael Bloomberg and City Comptroller John Liu proposed merging the five NYC pension funds in 2011. The Oklahoma Pension Commission considered pooling the assets of its seven pension systems in 2012. That same year, Ontario, Canada issued a report recommending the assets of its local pension systems be combined, and the Investment Management Corporation of Ontario was formed in 2016. Consolidation has even been previously considered for Illinois’ pension systems before (in 2003, 2009, and 2012). Consolidation was also proposed in Pennsylvania in 2012 and 2018.
Research indicates that consolidation can be a lose/win proposition. Such actions are likely to generate long-term savings. On the other hand there are upfront, transition costs, and most estimates indicate that the costs of consolidation exceed savings in the short-term. At a time when many municipalities throughout Illinois are facing fiscal stress, this is a difficult tradeoff to consider. While the long-term benefits of consolidation may mean it is worth pursuing, it is important to have a thorough understanding of how individual communities will be impacted in the transition.