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Public pension systems pose a complex challenge.  Incremental changes in benefits or assumptions today can create exponential economic impacts decades into the future.  The issue is compounded when considering the stalemate that exists among stakeholders.  We’ve spent the past several months compiling research in an effort to discern the underlying cause of the State of Illinois’ public pension systems poor condition.

Academic papers, while thorough, typically result in lengthy, technical pieces that are a cumbersome read for most.  News articles tend to only scratch the surface, limited by word count and worn thesauruses. Our approach was to present our findings in a five part series with each part examining a different important topic. We assembled a complete dataset of the State’s public pension information dating back to 1985 and cast our research net far and wide. Our final product is a compendium that provides a comprehensive and balanced understanding of Illinois’ pension issues.

Bernardi Illinois Public Pension White Paper

 

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Our series on the condition of the Illinois pension systems has hopefully provided considerable insight into the retirement system’s history, actuarial assumptions, and proposed reforms. In our conclusion we will survey the pension reform landscape, examine major pension overhauls occurring in other states, and contemplate possible next steps for the State of Illinois.

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In part four of our Illinois Pension Series, Analysis of Reforms, we examine three pieces of prominent pension legislation: Public Act 88-593 (the Pension Ramp from 1995), Public Act 96-0889 (Two-Tier System from 2010), and Public Act 98-0599 (the Pension Reform from 2013). 

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Interest rate assumptions are key variables in balancing the actuarial valuation equation.  The investment return assumption reflects anticipated returns on the pension plan’s current and future assets.  Meanwhile, the discount rate assumption is used to determine the present value of expected future liabilities. Reinforcing this relationship, generally, public pension plans match the assumed investment return and the discount rate.  Thus, should actual returns deviate from the expected values the significance will be expressed in the plan’s assets and liabilities.  In total, over the last 29 years, lower than expected investment returns and changes in actuarial assumptions have increased the State of Illinois’ unfunded pension liability by approximately $33.5 billion or roughly one third of the total increase in the unfunded liability during that period.  In part three of our Illinois Pension Series, Components of Change in the UAAL, we will elaborate on the relationship between assumed versus actual investment returns, touch upon the performance of the State of Illinois’ pension bonds, and compare the condition of the State of Illinois’ pension system relative to five other states.

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Our objective in part one of the Illinois Public Pension Compendium was to familiarize readers with common pension nomenclature.  We touched on several pension accounting principles as well as selected nuances of the Illinois pension system.  Part two of our series will concentrate on the State’s pension funding history. We traced Illinois’ pension policy research back nearly a century.  From there we chronicled influential legislative actions in order to construct a fair and balanced narrative.  We avoided defining one particular event as the decisive moment that forever changed the course of the pension system.  Numerous factors play a role in the funding and performance of pension systems, some proportionately more than others. We’ll explore the various factors in part three of our series.

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Public pension systems pose a complex challenge.  Incremental changes in benefits or assumptions today can create exponential economic impacts decades into the future.  The issue is compounded when considering the stalemate that exists among stakeholders.  We have spent the past several months compiling research in an effort to discern the underlying cause of the State of Illinois’ public pension systems poor condition.  We first assembled a complete dataset of the State’s public pension information dating back to 1985.  We then cast our research net far and wide, we found no consensus, yet almost every party agreed reforms are needed.  Academic papers, while thorough, typically result in lengthy, technical pieces that are a cumbersome read for most.  News articles tend to only scratch the surface, limited by word count and worn thesauruses.  Our approach is to present our findings in a five part series over the course of the coming weeks.  Each part will examine a different important topic with the goal of building a comprehensive and balanced understanding of Illinois’ pension issues.

The first release in our series deals with Illinois pension basics.  Its focuses on Illinois’ pension framework, governance, and actuarial valuation practices.

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The State of Illinois’ fiscal problems are well known. The State receives widespread media coverage from having the lowest bond rating of any state in the country. Does this imply that all bonds issued by local governments within Illinois are poor credits? Not necessarily so, in our view. Illinois is made up of thousands of local governments with varying economic and financial characteristics. Thorough credit analysis helps uncover solid quality bonds within the diverse universe of municipal credits. Oftentimes, these issues offer attractive yields relative to the actual credit risk. 

This paper focuses on the idea that applying blanket statements of credit risk across Illinois can lead to overlooked investment opportunities. We discuss Bernardi’s Three Pillars approach to municipal bond credit research by comparing the creditworthiness of one Illinois local government bond issuer to a similar credit issued in another state.

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Justin Formas, John Balzano

This report demonstrates the potentially detrimental effects on taxpayers and residents if municipalities are forced to issue taxable debt as a result of proposed changes to the federal income taxexemption of municipal bonds. This is a core issue for local governments, particularly in the face of current and future budget constraints. The impacts are no more evident than when viewed from the perspective of small and medium-sized issuers, who comprise the majority of financings that come to market each year. The two examples presented in this report quantify the increased financing costs that will result if the tax-exempt financing option is repealed or if a limit is applied on the value of tax-exemption. These case studies should serve as a warning for thousands of communities across the country.

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Justin Formas, Alison White

Tax-exempt municipal bonds have been a critical source of capital for states and municipalities and, as a readily available financing vehicle, support one of the nation’s most consistent and reliable sources of job creation. This paper analyzes 117 years of tax‐exempt municipal financing history to enlighten today’s debate with historical perspective. The tax-exempt municipal market does not need to be restructured. Instead, its status needs to be reaffirmed so that it can keep on doing its job without forcing new and unnecessary burdens on issuers, investors and taxpayers.

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