SEC: Illinois’ Underfunded Pensions are Fraud
This week, the Securities and Exchange Commission announced it had settled a charge against the State of Illinois for civil securities fraud. The SEC accused Illinois knew it would not be able to meet its pension benefit obligations, but kept that information from bond investors. The news is disappointing, but not surprising given the crisis in public pension systems nation-wide.
The Wall Street Journal dug into the story a bit further, and explains that the legislature began intentionally underfunding the pension program in 1994, and that actuaries in the Governor’s budget office were aware of the problem but kept investors in the dark. Illinois passed a law allowing it to contribute a sum to the pension plans each year that was less than what would actually be needed to fund the system, and then published reports noting that the legal limit was met without acknowledging the much higher amount that was actuarially needed. Unfortunately Illinois is not alone on that count.
This is not the first time the SEC has accused a state of civil fraud. In 2010, New Jersey was similarly accused for operating a fake account it claimed would cover its liabilities. Many states are committing mistakes the law can’t stop: assuming that employees will retire in their 70’s and 80’s; live only a few years; or that the funds will unerringly earn more than 8% annual compounding growth in the stock market decade after decade.
Governor Pat Quinn has been calling for an overhaul of the Illinois pension system for a year now, but with projects like “Squeezy the Pension Python,” it is difficult to take his efforts seriously. They have certainly fallen short of the free-market reforms the state will need to fulfill promises to state retirees. Pension funds should be converted into “defined-contribution” funds, much like 401(k)s, where a specific amount of money is put into an account which grows in the market, rather than the much more common “defined-benefit” system, where various amounts of money are put in each year, and the retiree gets a specific benefit each month regardless of market performance. COLA’s should be tied to the cost of living, not the start of the new year.
Michigan, notably, has successfully made the switch to defined-contribution, while at the same time guaranteeing benefits already accrued by employees. A 2011 study found that the change reduced Michigan’s liability by $2.3 billion, or nearly 35%. Closing that gap means less pressure on the state budget that could push out other successful programs or raise tax rates.
The New York Times points out that everyone loses when pension funds fail. Taxpayers suddenly find themselves on the hook for significant spending increases they never anticipated. Bond investors lose their investment when the government declares a financial emergency, effectively municipal bankruptcy. And of course, retirees lose their benefits, as in the case of Prichard, Ala.
Illinois will get off light with the law, as the SEC settled the case without an admission of guilt and Illinois got credit for hiring auditors since 2009 to address the poor accounting. Taxpayers, however, are still on the hook for at least $85 billion in promised but unfunded benefits if comprehensive pension reform is not undertaken with a view for long-term fiscal health.