Illinois leading states facing a pension crisis

State pensions are badly underfunded – and the situation is getting worse, fast.

That's the upshot of a study released this week by the Pew Center on the States, a nonprofit, public-policy think tank located in Washington.

In 2009, 31 states were underfunding their pensions. The year before, 22 states were in the same boat, according to the report, which tracked retirement benefits of state employees over the last two years.

The divide between the amount states owe and the money they’ve set aside over the decades yawns even wider than previously suspected: Nationwide, state pensions were underfunded by $600 billion in 2009. That accounts for about half of the $1.26 trillion gap in overall retirement benefits owed to public employees that year.

Don't blame the economy

The struggling economy can no longer serve as a convenient scapegoat to mask decades of insufficient planning, says Kil Huh, director of research at Pew. States were “kicking the can down the road in good times as well as bad” when it came to their legally-bound retirement obligations, he says.

“Some research suggests the great recession was the main culprit … but by looking at trends over time, we found that the recession made a bad problem worse,” he says.

The worst offenders

Illinois ranks the worst, having set aside only half – 51 percent – of what it needed to for pensions in 2009. Just behind was West Virginia, at 56 percent.

In December 2009, the Illinois Commission on Government Forecasting and Accountability estimated that the amount of unfunded liabilities stood at $77.8 billion.

Illinois legislators developed a pattern of “habitual underfunding that magnified over the years” regarding its pensions, says J. Fred Giertz, who teaches economics at the University of Illinois at Urbana-Champaign and who is an elected member of the State Universities Retirement System Board of Trustees.

Consistent skimping on retirement obligations has locked Illinois into a losing cycle of having to dedicate more of its annual budget to rising pension costs. For instance, pensions costs account for $4.2 billion in the next state budget – that's two-thirds of the state's new revenues from a recent 45 percent income tax hike.

“Underfunding has come back to haunt us,” says Professor Giertz.

Attempted fixes

Last year, Illinois Gov. Pat Quinn (D) attempted to plug the gap by signing a reform bill that applied to all state employees hired beginning in January 2011. Measures in the bill included capping salaries that would be eligible for pensions at $106,800, and raising the retirement age to 67 – the highest in the nation at the time.

The reforms were not enough, says Giertz. Because the state constitution only forbids changes to benefits already earned, Illinois legislators could change benefits for future earnings of current employees – a direction that also invites legal challenges from unions and other advocate organizations.

According to Pew, Rhode Island was the only state in the last five years that dared to modify benefits for current employees.

New York has the highest funding level, at 101 percent, according to the Pew report, “The Widening Gap: The Great Recession's Impact on State Pension and Retiree Health Care Costs." However, Giertz says the state was able to pull that off by heavy borrowing and other “creative financing,” which makes the comparison to Illinois unfair.

“You can argue Illinois is in no worse shape than New York, but New York has bond problems and Illinois has pension problems,” he says.

Besides the underfunded pensions, most states have failed to put aside enough money to cover their mounting retiree health care costs. According to Pew, states have only set aside $31 billion to cover the health care of its retirees – just five percent of the $635 billion they already owe.