THE PROBLEM

Illinois’ five state-run pension funds are more than $100 billion in debt, according to official state numbers. Without major reforms, the funds are headed toward insolvency – and that means retirees may see their pensions cut and younger workers may not have a pension at all.

One of the biggest forces behind this growing debt is the cost-of-living-adjustments, or COLAs, which retirees of the five state-run retirement systems receive annually.

In Illinois, COLAs increase state employees’ yearly pensions by an automatic 3 percent annually, driving up the costs of pensions every year. Illinois’ COLAs are:

• Annual – Retiree pensions increase each year by 3 percent.
• Automatic – Pensions grow automatically by 3 percent each year regardless of the size of a retiree’s pension or the actual rate of inflation.
• Compounded – Each year a 3 percent increase is applied to the previous year’s pension total, meaning that the pension builds upon itself every year.

Opponents of pension reform argue that COLAs are needed to protect the purchasing power of career public workers with small pensions. But these COLAs increase the pensions of all of the state’s 200,000 retirees annually – not just career workers with small pensions.

By blocking reforms, opponents of COLA reform threaten the solvency of Illinois’ pension system. As they stand currently, COLAs allow the pensions of retirees to nearly double over the course of their retirement, causing Illinois pension costs to grow unsustainably.

The pension systems will collapse if this trend continues.

As recently as May 2012, even Dick Ingram, the head of the Teachers’ Retirement System, or TRS, recognized the need to reform COLAs to avoid insolvency:

“What we’re saying is that [the unfunded liability] is so bad is that you have to start having those conversations. The reality is that if you look at the pension math, the single biggest cost is the COLA.”

How COLAs supersize pensions

To understand exactly how COLAs drive up pensions, consider the pension of Illinois’ most expensive annuitant: Dr. Leslie Heffez.

Dr. Heffez, an oral surgeon and professor at the University of Illinois at Chicago and a member of the State Universities Retirement System, retired in 2012 at age 56 with a final pensionable salary of $746,023 and a starting pension of $503,817.

In Illinois, all state-level retirees receive a COLA that increases their pensions by a compounding 3 percent each year. For example, Dr. Heffez received a pension of $503,817 during his first year of retirement in 2012, but received $518,932 in 2013. Dr. Heffez’s $15,115 pension increase is because of the 3 percent COLA.

In 2014, Dr. Heffez’s $518,932 pension will rise by another 3 percent, or $15,568, to $534,499.

His pension will continue to grow like this every year for the rest of his life.

Dr. Heffez has done nothing wrong – he is merely operating within a generous state government contract. But within just 15 years of retiring, Illinois’ pension system will allow Dr. Heffez’s annual pension to exceed what he earned his last year on the job.

And by the time Dr. Heffez reaches age 80 – the average life expectancy of a 56-year-old male – his annual pension will exceed $1 million.

As a result, taxpayers will be paying Dr. Heffez more in his retirement than they ever did while he was working for the state.

In total, Dr. Heffez will receive more than $18 million in pension payments over the course of his retirement, assuming he reaches his life expectancy. With no COLA, he would receive nearly $13 million. COLAs are supersizing Dr. Heffez’s retirement by nearly $6 million.

COLAs supersize all retirees’ pensions

COLAs, however, don’t just supersize the pensions of the state’s highest-compensated retirees. Each of the 200,000 retirees in the state pension system experience rapidly increasing pensions due to the annual, automatic, 3 percent compounding COLAs.

Just consider the average age and pension of a typical 30-year TRS worker retiring in 2013. That teacher has a starting pension of $71,000 and is on average age 59. Nearly 45 percent of TRS members with 30 years of experience retire before age 60.

The average TRS retiree can expect her annual pension to more than double in 25 years and reach nearly $150,000, assuming she reaches her life expectancy of 84.

Government retiree COLAs vs. Social Security COLAs

A comparison of Illinois’ public pensions and Social Security benefits highlights the disparity between COLAs in the public versus private sector.

Private sector retirees receiving Social Security benefits generally receive a COLA every year. But Social Security’s COLAs are limited to the growth in inflation. That means that they do not remain static each year – they can go up or down depending on inflation. The same is not true for the public sector, however. For Illinois government retirees, COLAs remain at 3 percent annually regardless of the rate of inflation.

Additionally, COLAs in the private sector are limited by the maximum benefit that retirees can receive from Social Security. For retirees who reach age 66 – the full retirement age under Social Security for 2013 – the maximum COLA benefit they can receive is $456, based on their maximum Social Security benefit of $30,396. For Illinois government retirees, however, there is no maximum COLA. Illinois government COLAs continue to be granted no matter how much a pension is worth.

The average private sector retiree in the U.S. will receive $14,760 in annual Social Security benefits. The Social Security COLA will be 1.5 percent for 2014. This means the average Social Security COLA will be $221. Since 401(k) accounts do not provide COLAs, this is the only COLA private sector retirees are likely to receive.

Private sector workers who retire at the full retirement age of 66 receive a minimal COLA as well. With a maximum annual Social Security benefit of $30,396, they will receive a COLA of just $456 for 2014.

In contrast, the average state-level retiree with a 30-year career has a pension of $63,527 and will receive an average COLA of $1,906. As a result, the average Illinois state retiree will receive a COLA that’s nine times higher than the COLA for an average Social Security beneficiary.

And some public retirees, like Dr. Heffez with his $15,568 cost-of-living increase, will receive more in COLAs than what an average retiree will receive in both benefits and COLAs from Social Security.

The state can’t continue to make such generous deals with its public sector workers. They’re driving the pension system into insolvency and are out of sync with what private sector workers receive.

THE SOLUTION

One of the key ways to reduce the state’s unfunded pension liability and save the retirements of all public workers is to suspend cost-of-living adjustments, or COLAs. Suspending COLAs until Illinois’ pension systems return to full health will allow the state to reduce its unfunded liability by nearly one-third.

But if COLAs must remain part of the pension system in some form, they should be means tested. That means restricting COLAs to the pensions of career employees who dedicated 25 to 30 years to public service and have limited annual pensions.

In addition, the Illinois General Assembly should protect the COLA benefits of those earning annual pensions of less than the maximum annual Social Security payment for a private sector worker who’s reached the full retirement age.

WHY THIS WORKS

By supersizing pensions, cost-of-living adjustments, or COLAs, are threatening the retirements of all state workers. Means testing COLAs can significantly reduce the state’s unfunded pension liability while preserving the benefit increases for the state retirees who need them the most.

Means testing COLAs will save taxpayers from having to bail out Illinois’ failed pension system. It will also save the state from being forced to increase funding for pensions at the expense of essential services upon which the poor and disadvantaged depend.

Finally, means testing COLAs will mean that public workers can feel more secure about the health of their retirements.