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OPINION : Illinois

Defined-contribution plan could curtail pension liability

by BOB WILLIAMS | March 21, 2014

Temperatures might be all that has fallen faster or further than Chicago's credit rating these past few months. According to Moody's Investors Service, which recently reduced the city's rating again, unfunded public pension liabilities are to blame.

Last year, State Budget Solutions found that Chicago residents faced a staggering unfunded liability of $87.3 billion. Chicago's Municipal Employees' Annuity and Benefit Fund provides one example of the costs that come with such a massive unfunded liability. In 2013, according to the latest valuation, the plan required an $820 million city contribution, equal to a whopping 52 percent of payroll. Only $261 million of that total was the result of the plan's "normal cost," or benefits earned over the course of the year. The remainder was required just to service the existing unfunded liability.

Addressing this funding gap must be a top priority. Real pension reform, including implementation of a defined-contribution retirement plan to replace the existing defined-benefit systems, would allow the city to keep its promises to public employees, protect funding to keep local communities safe and strong, and take the politics out of retirement security.

That means a renewed commitment to meeting required contributions and a prohibition on future borrowing to fund pension promises. With employees no longer earning benefits within defined-benefit plans, responsible contributions and investment returns will eliminate the liability over time while guaranteeing the city can keep the promise of already earned benefits.

WHAT DOES IT TAKE?

Chicago should offer a DC plan dedicated to providing ownership, portability and retirement security. The city would contribute a certain percentage of salary into each employee's private retirement account. With professional investment advice, these accounts grow into nest eggs capable of providing a secure retirement.

DC plans offer low, consistent and knowable costs. Determining contributions is as simple as calculating a percentage of payrolls. They have proven themselves to be suitable retirement alternatives across the country, and there are examples of public-sector success, including for public higher education faculty as well as for state and local governments.

In 1997, the Michigan State Employees' Retirement System implemented a DC plan for all new employees. The Mackinac Center for Public Policy found that, from 1997 to 2010, the DC plan saved Michigan taxpayers $167 million in pension normal costs and between $2.3 billion and $4.3 billion in defined-benefit plan unfunded liabilities.

Michigan's DC plan includes an employer contribution equal to 4 percent of salary, plus a 100 percent match on the next 3 percent of an employee's own contribution. That is a far more manageable approach than the Municipal Employees' Annuity and Benefit Fund because, unlike Chicago's current approach, the DC plan cannot develop unfunded liabilities.

San Diego is a leader on municipal pension reform and an example Chicago should follow. A successful 2012 ballot initiative, passed with 66 percent of the vote, created a DC plan for all new employees. It includes a 9.2 percent cap on employer contributions and is expected to save as much as $2.1 billion over 27 years.

Chicago needs to find ways to control costs, both in terms of pensions and borrowing. The latter will only increase, as evidenced by the Moody's downgrade, if the city doesn't enact reform. While the exact costs of implementing a DC system deserve further examination, the positive impact such a move would have on the city's credit rating would help offset some of the expenses.

Officials should immediately pursue reforms that will allow the city to keep its promises to public employees, protect funding for vital services and take the politics out of retirement security once and for all.


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