By Daniel G. Tobben
We hope that you have found this series to be informative. In this final installment, we will eliminate some possibilities that cannot realistically be part of the solution to this problem, and then recommend other approaches that could well be part of the solution. None of this will be easy or pleasant, because this pension underfunding problem in Evanston is at, or near, crisis state. However, Evanston is not a failed and impoverished community, and very many educated, talented and resourceful people make up its population. So, if any community can solve these problems, it should be Evanston. If Evanston does solve this problem, Evanston may be perceived to be a leader in Illinois, just as we believe Springfield, Missouri, is becoming a leader in our home state. Springfield went from being a problem creator to a problem solver.
Things Can’t or Won’t Work
- The Illinois Constitution prohibits the reduction of benefits for existing police officers and firefighters, as well as for current retirees. Even absent this Illinois Constitutional provision, the Contracts Clause of the United States Constitution probably also protects them from reduction. Therefore, the idea that is being thrown about by some groups without much knowledge or sophistication, that current police officers and firefighters should get “401(k)-like” benefits can’t be done. It wouldn’t be a good idea, but even if it were, it can’t be done, so that is off the table. Governmental pension plans are, in most respects, not subject to ERISA, so the Pension Reform Acts enacted in connection with ERISA are not applicable.
- A massive tax increase to be paid only by the residents of Evanston would never be politically acceptable, or fair, so that cannot be the solution.
- Because the non-City of Chicago police and fire pension systems are governed by Illinois State Statute, Evanston cannot solve this problem by itself. To solve these types of issues in the long term, there needs to be state wide leadership that results in state legislation, in addition to the steps that Evanston itself can and must take on its own.
How will the problem be solved?
There are two sad truths with respect to the solution of this type of problem. The first is that a significant underfunding problem cannot ultimately be solved, except by large sums of money. Residents and some City officials don’t want to hear that truth, because of all that it implies.
The second sad truth raises questions about where we are as a country, as well as where Evanston is as a community. From the authors’ perspective, there will undoubtedly be an economic recovery. It may have already started. However, the United States is “in a hole” in multiple respects and “things will not return to normal”, as that term has been understood during the period from 1987 to 2007. The country faces massive indebtedness and the scenario for the next 10 years, regardless of which political party is in control, may very well lead to all of us paying higher taxes while, at the same time, receiving less in services and benefits. Also, if one looks at the major industrial unions, the goal now is preservation of benefits, not increased benefits; and the reality is that either pay cuts or benefit reductions are likely for them. Police officers and firefighters, therefore, cannot be exempt from also “taking some of the medicine”. So the second hard truth, that will be hard for police officers and firefighters to hear, is that pension benefits for new hires will almost certainly need to be reduced.
Everyone must remember that police officers and firefighters are not covered by Social Security, and that their work careers usually end some time between 55 and 60, if they are not disabled on the job before then. So benefits must be reduced, but not to a “401(k)” type status.
Because Illinois’ pension system for these public uniformed officials is operated on a statewide basis, such a law would need to be developed by legislature in Springfield. There would undoubtedly be significant, organized opposition against it. However, it is probably necessary to cut pension benefits for new hires in order to solve this problem long-term, both in Evanston and in other communities in Illinois. This may not be true or necessary in other states, but Illinois has become a “poster child” for funding problems with public pensions, so it seems necessary in Illinois.
Governor Quinn showed leadership with respect to statewide pension plans involving state employees in adopting such a program for state workers. However, if and when this is done regarding police and firefighter pension plans, it must be done in a very measured way, because of the lack of Social Security for these public servants. Furthermore, due to the nature of their occupations, many police officers and firefighters are disabled in the line of duty. In California, when Governor Schwarzenegger became aware of the magnitude of the deficit problems he faced there, the “Governator” considered moving the highway patrol officers and state firefighters (necessary in California, due to the wild fires) to a 401(k)-type system. After becoming aware of the Social Security issues, he modified the program so benefits would be reduced but still be greater than normal 401(k)s for workers in the private sector. However, his entire plan fell flat when California considered the cost of purchasing disability insurance for its highway patrol officers and its statewide firefighters. The cost of the disability insurance was so high, because of the danger of these occupations, that it wiped out any savings which could have been realized by the other changes and reductions.
In connection with our work in Springfield, Missouri, we raised this issue concerning disability insurance with a task force that was considering the adoption of 401(k)-type benefits. They were an open-minded enough group that they actually went out and did a request for proposal (“RFP”) concerning disability insurance for the police officers and firefighters in Springfield, Missouri. The results of the RFP were even more shocking. It was not a question of the cost of such insurance. What the trustees in Springfield, Missouri, learned was that no commercial insurance company was even willing to bid on the risk, and disability insurance couldn’t be purchased. That was the end of the “401(k)-like” approach.
Therefore, one of our conclusions is that communities in Illinois, in coordination with the state legislature, must adopt benefits for newly hired police officers and firefighters that are dramatically higher than benefits in the private sector, due to the unique nature of these jobs and the Social Security implications, but which benefits are less than those currently received. Because of the disability-related issues which are present, the ongoing pension costs for police officers and firefighters will still be higher than City officials probably expect.
This Long-Term Solution of a Two Tiered Pension Doesn’t Help Solve the Current Funding Crisis and May Only Make It Worse
We have worked with actuaries concerning plans which developed a second tier with lower pension benefits. We have learned that the benefit costs for the original tier (existing employees) actually increases, since you do not have young workers entering that pool anymore. Long-term there can be great savings with a two-tiered system, but short-term there are not. If you listen carefully to what Governor Quinn has said on the state employees new pension plan, he says that same thing, though often in a less than clear way. (People are reluctant to realize that it will take a long time to realize the large savings about which Governor Quinn speaks.)
How Then to Solve the Present Funding Crisis
1. Aggressive action needs to be taken to get not-for-profits in the Evanston community to contribute specifically to public safety
Northwestern University is one of the major assets, perhaps the major asset, of the Evanston community. However, when viewed from a taxation perspective, it is a black hole. It occupies large amounts of real estate with significant construction built upon it. Substantial economic activity occurs at Northwestern, but almost no taxes are realized by the City of Evanston. It is our understanding that sales taxes are paid, utility taxes are paid, and perhaps some additional small amounts have been paid. For PR purposes, and perhaps as a true expression of goodwill, the University apparently donated a fire truck to Evanston in the not-too-distant past. Certainly, Evanston will resist any effort to impose major taxation upon its not-for-profits, and as a matter of law, in most areas, not-for-profits could not be mandatorily taxed in any event. However, many communities receive payment in lieu of taxes (PILOTs) from their not-for-profit organizations. Because of rather desperate budget issues in the City of St. Louis, that discussion is beginning in earnest here. As a part of an article in the St. Louis Post-Dispatch concerning St. Louis’ review of possible payments from hospitals and universities, there was a comment that Princeton University makes very substantial payments to its local community, in lieu of taxes, in order to maintain high quality services in its surrounding neighborhoods.
Northwestern officials should seriously stop and think about what makes their University what it is. I cannot speak for its teachers or deans, but I know that both of my daughters looked at Northwestern University and the University of Chicago, two excellent schools, during their college searches over 10 years ago. As the parent of formerly undergraduate women, I can certainly say that my perception of what it would be like for my daughters to go walking 10 blocks off campus were dramatically different with respect to those two fine Universities. Northwestern should consider this issue, the significance of Evanston to the Northwestern experience, and realize the part that Evanston police officers and firefighters play in it.
2. Increased Taxation in Evanston
Only residents of Evanston pay property tax, and they are already perceived to be high. Many people in the Evanston community, including Northwestern students, pay sales tax. People from adjoining communities also come to Evanston to do some of their shopping. If a tax increase is necessary to solve this problem, and it almost certainly will be, I strongly recommend that the City Council adopt an increased sales tax dedicated to the limited purpose of solving the funding crisis. Our work with the City of Springfield led to the passing of a tax increase in that conservative, anti-tax community during the heart of the recession. As noted previously, even the business leaders and the Chamber of Commerce in Springfield stepped up and provided material support for the passage of the tax. The idea of sunsetting the tax when the plan becomes appropriately funded makes the idea more acceptable to the community and its taxpayers.
3. The Problem of “Backloading” and “Resets”
The detailed significance of actuarial funding is very esoteric. Many very intelligent people become befuddled when it is explained. After a number of years of working with actuaries, I certainly know the basics, but once we get past the basics, an actuary needs to slowly and clearly explain the details, the results and the assumption made. Pension liabilities may actually be larger than the actuarial calculations. Joshua D. Rauh of Northwestern University and Robert Novy-Marx of the University of Chicago have devised fair-value accounting principles and methodology. These techniques have been used by graduate students at Stanford who found hidden shortfalls in California’s public pensions, which will require even greater funding amounts than what were previously believed to be necessary.
What is clear is that the pension funding system adopted in Illinois with respect to the non-Chicago police and fire pensions is back loaded (i.e., payments start low and increase materially each year). Apparently, the Illinois Municipal League did this to keep payments low in the initial years, to make it more politically palatable and to placate City Managers and elected officials, who want to spend the money for other things. However, what this does is to create a constantly escalating cost for the cities and their taxpayers, even if there are no increased benefits going to police officers or firefighters. Also, the plan is set up on a 40-year payment schedule and already once there was a “pension reset” (i.e., after so many years the obligation goes back to year 1 of the 40 years). This meant that the low payments in the initial years were made, but when it came time to reach the higher levels, there was a “restart”. In today’s world, this can be easily analogized to the teaser mortgages with the expensive balloon payment or rate increases in later years. We all just saw where that led. Even though it may appear to be an easy way out for cities, and perhaps something that might be favored, even by police and fire associations and unions, it should not be done, at least not without dramatic limitations.
If, however, pension resets are considered, there should be a qualification that any municipality that wants to take advantage of it has to be at least 70% funded prior to the time of the reset. In a community such as Evanston, which is only about 50% funded, the funding gap would probably need to be filled by the issuance of pension obligation bonds (POBs). The money from the POBs would then be in the pension plan, which solves one problem, but would require the bonds to be paid off. This, in turn, would require an additional funding source (taxation), or further reductions in municipal services.
4. Solving the Funding Crisis Could Involve Layoffs or Furloughs for Police Officers and Firefighters
Police officers and firefighters probably need to realize that this could mean a decision by the City to cut the number of uniformed officers on both forces. It is our experience that, ultimately, public safety is the strongest concern of a governmental unit and its resident taxpayers. So the hiring freezes and potential layoffs, furloughs and other types of cuts would probably be less for police officers and firefighters than for other municipal employees, but they may well occur. That needs to be accepted by everyone as an unfortunate part of the solutions. Layoffs during a period of high unemployment are very unfortunate, but may be necessary.
5. Other Interest Groups Will Need to Take Hits Including the Developers and the Corporate Welfare Crowd
Also, some communities have become addicted to government assisted economic development, in much the same way that individuals became addicted to low rate mortgages and pulling equity out of their homes. Some small amount of economic development money spent by Evanston that produces quick and significant benefits is probably still wise policy; but large expenditures of money, or TIFs or subsidies that take a long time to produce benefits, are probably no longer viable in the new world, where everyone faces more uncertainty and downside risk. Developers and the business welfare class won’t like this, but, as we said above, there is a lot of pain to go around, and this is the part that hits that community.Finally, others are going to need to take hits. The idea that Evanston would seek to offer enhanced benefits or pension subsidies to lure or keep high level City employees, at the same time that it considers cutting benefits to police officers and firefighters, is rather disgraceful. It’s not as bad as the bailed out banks paying large bonuses to the leaders who created the problems, but it involves a related set of issues.
The Blessings that Evanston Has and Why This Set of Painful Solutions Can Work
Evanston has a relatively new Mayor and City Manager. They can claim some distance from the creation of the pension underfunding problem, and can seek to have solution of this pension underfunding problem as part of their legacies. There are no magic tricks or silver bullets, and this will be painful for all involved. But, Evanston is blessed with fairly prosperous, well-educated people, who are proud of their community. They can solve this problem, if they choose to do so. Some communities face similar problems, but lack the resources to solve them under any realistic scenario. Sacrifice, pain, lower benefits for new hires, loss of some jobs, higher taxes and less government giveaways are not popular ways to solve problems. But, Evanston, like the rest of America, has to face the new reality and figure out a way to succeed in it.
04/12/10 5:30 AM
Illinois Public Pensions | Comment (1) |
City of Evanston: Non-Starters & Possible Solutions to the Underfunding of the Police & Fire Pension System (Part 5 of 5)