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Barry's Pickings | Published in June 2012

Are DBs a Dead End?

Consider the “death spiral” of the Illinois state pension fund…

By PLANSPONSOR staff | June 2012
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Could it get any worse? Consider this: The five major Illinois state pension funds are (by state estimates) $83 billion underfunded. By all accounts, Illinois’s funds are the “worst-funded” in the nation—50th out of 50. More than half ($43 billion) of that underfunding is in the state teachers fund.

To put this in perspective, the state plans’ funded ratio (assets to liabilities) is 43%—and that is using return/discount rate assumptions that are widely viewed as unrealistically optimistic. Some projections put Illinois funds in insolvency as early as the mid-2020s. According to 2010 census data, Illinois has approximately 4.8 million households; so, this pension liability amounts to about $17,000 per household.

But, of course, the reality is much worse. As noted, the assumptions used to value the state’s liabilities are unrealistic. The assumed return on assets is 8.5%; the discount rate that evaluates liabilities is about as high, and, indeed, under GASB rules, the return on assets is generally the discount rate. In corporate defined benefit (DB) plans, the typical discount rate right now is under 5%! Using more realistic rate of return/discount­ rate assumptions, Illinois’s total unfunded liabilities are a lot higher—perhaps as high as $145 billion. And, of course, not all “households” pay taxes—if Illinois is like the nation as a whole, the number of taxpaying households is probably closer to 2.5 million.

So worst-ish case scenario: Illinois has, say, $125 billion in unfunded liabilities that are the responsibility of, say, 2.5 million households. This means, realistically, that each of those taxpaying households owes something like $50,000 toward these pension liabilities. Illinois GDP per capita is $50,000.

And remember, no one will be working for this money. Whatever productivity these benefits represent has already been realized.

And there’s another problem. Illinois is a very easy state to move out of. Indeed, from 1995 through 2009, a net 800,000 people left Illinois—around a 7% reduction in population—taking with them $23 billion in taxable earnings. Is the term “death spiral” appropriate here?

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