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Illinois School Board Journal
November/December 2005

TRS solvency depends on school boards' help
by Donald J. D'Amico

Donald J. D'Amico is a retired school administrator currently engaged in private consulting. He served as superintendent of Joliet Elementary District 86 (1964-75) and in St. Charles CUSD 303 until he retired in 1987. He was appointed to the Illinois School Problems Commission by former Govs. Richard Ogilvie (1969) and James Thompson (1978).

Ten years ago, in a Journal article "School boards should help keep teacher retirement system solvent," I outlined the fiscal jeopardy facing the Teachers' Retirement System (TRS) and offered solutions, one of which school boards could put in place, to alleviate the situation. Unfortunately time has only exacerbated TRS problems.

TRS carried an unfunded pension liability of $7.6 billion at the end of fiscal year 1993, up $800 million over the previous year and up 80 percent over the unfunded liability of just five years prior. The pension plans covering state workers and retirees of Illinois are now collectively under- funded by $35 billion, according to the state comptroller's office.

Information released at a fiscal conference in Chicago in 2003, cosponsored by the Federal Reserve Bank of Chicago and the National Tax Association, cited Illinois' as the worst deficit of any state system in the country.

While the financial problems facing TRS seem enormous, school boards can take the lead and do something to alleviate one area: salary spiking.

Salary spiking — the practice of increasing a salary for the last four years before retirement — and the 2002 early retirement buyout were costly. However, the major problem dates back to the 1980s when the Illinois legislature began to short pension contributions to balance tight budgets. Currently, the ratio of assets to liabilities is a dangerously low 55 percent.

The required state contribution for fiscal year 2005 was $2 billion; however the pension system only received half of that money. The rest was used to balance the budget. In addition, Governor Blagojevich sold $10 billion in pension obligation bonds in fiscal 2005 to pay for pension liabilities.

The under-funding will not go away. It will only get worse. Ten years ago, the legislature gave itself a very generous 50 years to bring pension assets into line with liabilities. But it still remains to be seen whether a state statute can force the legislature to do tomorrow what it is unwilling to do today.

The reasons for decline in fiscal health still fall into two categories: On the revenue side, the state of Illinois still is not keeping its bargain with retired teachers. On the expense side, pension costs continue to increase due to early retirements, the longevity of retirees and improved benefits.

The cost of pension benefits also continues to be increased by measures on the part of school boards and administrators that I consider unfair and inappropriate.

Now we're at least three decades since the state last met its statutory obligation of appropriating each year an amount equal to 1.2 times the amount of employee contributions. For many years, in fact, appropriations were designed to simply cover amounts being paid out in benefits. While the unfunded liability of TRS got its start many years ago, the size of the liability continues to grow by leaps and bounds.

It's easy to blame the escalating costs of public aid, education and other state programs for the drain on pension funding. But some of the blame must rest with the extremely generous pension policies of the state and even some local school boards.

The governing board of TRS, prior to this year, has dedicated itself to increasing benefits for retirees as opposed to keeping the system actuarially sound. Witness the rapidly escalating expenses associated with the onslaught of early buy outs. I realize that part of the problem was brought about by the large number of Baby Boomers nearing retirement in the next few years. However, add to that the system of compounding the cost of living index, and lastly spiking salaries by as much as 20 percent per year for up to four years to produce outsized pensions. So while these increased superintendent and teacher salaries are paid out of local school board budgets, the pensions are not. In essence, the school board is playing with free money.

The problem starts when the salaries of TRS-eligible employees are jacked up as they approach retirement merely to increase their pension benefits. This is salary spiking. These administrators and teachers may be entirely deserving and, in fact, may have been grossly underpaid for most of their careers. In fact, therein lies much of the problem.

Pensions under the teacher retirement system are based on the average of the highest salaries paid during any consecutive four years of the last 10 years employed. An employee with 38 years of service qualifies for an annual pension equaling 75 percent of the average salary of those highest four years' salaries. (The pension would equal 68 percent of the average salary after 35 years or 57 percent after 30 years.)

Where retirement benefits are concerned, it is still in an employee's interests to earn the highest possible salaries during the final four years preceding retirement. So an underpaid employee can be rewarded with four years of huge pay raises near the end of a career and the retirement system sees it as a lifetime of high earnings.

This year, the Illinois legislature took steps to correct some of the festering problems of TRS:

• First, the new pension contribution rate for employees was increased to 9.4 percent from 9 percent.
• Second, salary spiking is reduced from the current 20 percent to 6 percent. If the board of education spikes more than 6 percent, the board pays the full cost. It must be noted, however that if a contract was in effect prior to June 1, 2005, the teacher under that contract who retires prior to its expiration is "grandfathered" and can be eligible for up to 20 percent increases.
• Third, there is a new Early Retirement Option (ERO) called "modified ERO." Teachers will pay 11.5 percent, up from 7 percent, for every year they are short of 35 years of service. The district will have to pay 23.5 percent versus the old 20 percent. Thirty-five years is required to waive the penalty.

These new laws are a step forward, but there are other, significant changes we can make to achieve an actuarially sound system.

The pension increase generated by a salary "spike" over the last four years of employment takes less than six months to consume the local TRS contribution generated from that same salary increase. The point is, those pension benefit increases are not supported by a lifetime of contributions to the retirement system. They are supported by contributions only for those few final years. And that, of course, is what makes them so attractive to school boards, administrators and teachers — the retirement system does the paying. In addition, qualifying credit can be increased by converting non-cash benefits, unused vacation time and sick leave.

Apart from the fact that school boards agreeing to this practice are, in effect, spending down TRS assets that are not being replenished, the practice is patently unfair. The retirement system was established as a benefit for all certificated school employees in the state. But the practice of "spiking" salaries in the final four years provides artificially escalated pensions to employees who are able to convince their school boards to do it.

I have never quarreled with legitimate salary increases or increases for true promotions. But how do we justly promote people in the last years of their careers simply as a means to collect larger pensions? School boards and employees alike must recognize that there is no free lunch; it only appears to be free.

There are many good reasons to give raises to administrators and teachers, of course. But I would again urge school boards to look very closely at all the ramifications before they agree to salary increases simply to enhance retirement benefits.

Another continuing trouble spot with the teachers' pension system is the practice of compounding annual cost of living adjustments (COLA). Considering increased life expectancies and the growing popularity of early retirement, compounding of pension increases will become a major drain on system assets, particularly for early retirees who may collect pensions for 25 to 30 years.

A $25,000 annual pension that's adjusted by 3 percent a year compounded grows to $37,800 in 15 years. A cost of living adjustment computed on the original benefit — with no compounding — would have boosted benefits to $35,500 a year over the same period. Less, but not a major difference.

The effect of compounding becomes much more significant in later years. That same 3 percent annual adjustment would raise the annual benefit to $43,000 in 25 years if based only on the original pension amount. But compounding over those 25 years adds another 20 percent to the benefit, making it about $50,800.

The compounding of the COLA is not actuarially sound. Some have jokingly said, "We have a second life and that life is on public pension." Witness the superintendent who retired 18 years ago with a salary of $56,000. Today, with compounding of the COLA, his pension is $92,500. Good for him, bad for the system.

Ten years ago, I offered the following four solutions, that some might say look easy but are not politically popular:

• Eliminate the obvious abuses of the 20 percent rule.
• Compute cost of living adjustments on the base retirement salary.
• Either fund the retirement system at a responsible level that will ensure benefits for future retirees or reduce benefits to a level commensurate with contributions.
• Alter the philosophy of the Teachers' Retirement System from one of continually seeking to add or increase benefits to a philosophy of responsibly balancing costs and revenues.

In 2005, the solutions are very similar. With SB27, the abusive "spiking" of salaries should be effectively dealt with, and school boards that ignore its provisions are destined to pay dearly. That leaves the other three of my solutions still on the table:

• Compute cost of living adjustments on the base retirement salary. Compounding is not necessary to protect purchasing power.
• Either fund the retirement system at a responsible level that will ensure benefits for future retirees or reduce benefits to a level commensurate with contributions. A system that promises benefits that it won't be able to deliver is unconscionable.
• Alter the philosophy of the Teachers' Retirement System from one of continually seeking to add or increase benefits to a philosophy of responsibly balancing costs and revenues. This probably means altering the method of selecting members for the retirement governing board, which is currently dominated by teachers unions.

It still should be painfully obvious that something must be done and that the choices we face will be difficult. This year, we have taken a small step forward. Let's continue to move in this positive direction.