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Public pensions bet big, but low rates could prompt tough choices

Since the onset of the Great Recession, Americans have become familiar with the term “volatility.”

And they have come to know that, for many, volatile fluctuations in financial and investment markets are not just theoretical data points. They can cost real people real money, because retirement savings are bolstered or consumed, depending on the markets’ movements.

But as public pensions account for an ever-larger share of government spending in Illinois and elsewhere, the public may soon find another reason to monitor the volatility: potential tax increases – or, at the least, difficult public spending choices for a number of taxing bodies.

Before the economic crash of the past decade, generally strong economic conditions allowed investors to be bullish on the future.

And those running America’s public employee pension plans were no different, generally basing their pension plans on rates of return that at the time attracted little more than a sideways glance from many observers.

Even amid today’s economic realities, those investment return assumptions – which, at 7 to 8 percent may appear, to private investors, relatively rosy – have been maintained.

And, while those running pensions see no reason to change course at this time, any failure to meet those investment targets can leave local governments no choice but to raise taxes or cut spending to bring pension plans into balance.

“Does what happens with interest rates and in the markets impact us? Definitely, yes,” said Chris Minick, finance director for the city of St. Charles. “Each individual municipality has actuarially assumed rates of return that tell us how much we need to contribute into our pension funds.

“And if there is a shortfall, we are required to pay to make up the difference.”

This phenomenon already has been felt in local governments. The recession curtailed the investment incomes that had been enjoyed by pension funds.

The Illinois Municipal Retirement Fund – a public pension body that manages pensions on behalf of 2,900 cities, counties and other units of local government in Illinois – has, since 2009, gradually increased the average amount that those governments must contribute, from 9.27 percent of participating employee salaries to 12.09 percent this year.

Contributions to IMRF are required by law, and IMRF is empowered to garnish the local government’s tax revenue to collect. While those increases are not attributable entirely to investment returns, IMRF Executive Director Lou Kosiba said “a good chunk” of the increases are .

Local pensions for police officers and firefighters, who are not covered by IMRF, also were affected, local government finance professionals said.

Just as IMRF, those local police and fire pensions generally assume investment returns of greater than 7 percent annually over the life of the pension.

While returns have fluctuated, some cities have mitigated their pension costs by freezing wages or trimming payroll.

In Batavia, for instance, Finance Director Peggy Colby said the city has trimmed its police payroll from 45 employees to 40 in the past few years.

That allowed Batavia to limit its expected 2013 police pension spending increase to 3.3 percent, which is less than the 4.1 percent increase it paid this year.

And in St. Charles, Minick said actions to control payroll will allow the city to spend a little less on pensions in 2013 than in 2012.

Any relief, however, may be temporary.

At the county seat in Geneva, Kane County government, for instance, paid $4.05 million in IMRF contributions in 2010. In 2011, the contribution increased to $4.2 million.

And the county’s IMRF contribution is estimated to increase to $4.4 million this year, an IMRF spokesperson said.

This year, the Kane County Board opted not to increase its property tax levy. That forced county officials to dip into other funds to pay the increased pension cost this year.

But county officials and other local government finance officials have said they worry the situation may not improve in coming years, forcing difficult choices for local governments and taxpayers that may be strapped for cash.

According to information supplied by IMRF, contribution rates for the city governments in the Tri-Cities of St. Charles, Geneva and Batavia and Elburn, Sugar Grove and Kane County, are expected to increase in 2013.

In St. Charles specifically, Minick said his city estimates its pension contribution costs likely will increase again in 2014 for IMRF and police and fire pensions.

With pension costs accounting for about 10 percent of the city’s general operating budget, and 2.5 percent of its total budget, those increases could prove costly, Minick said.

Unlike other units of local government, pensions into which school districts have paid, to date, have been less affected by the market fluctuations, local school officials said, because teacher pensions are funded through the Teacher Retirement System, which is funded largely by state government and employee contributions.

But school officials said they are closely monitoring pension reform legislation in Springfield, which could shift the pension burden to local school districts and property taxpayers.

For their part, public finance professionals and pension managers, such as Kosiba, said they believe their investment return assumptions of 7 percent or more are not overly optimistic.

While returns may fluctuate year-to-year, Kosiba noted that since 1982, IMRF investments have lost money only six times. And until recent market volatility, IMRF was poised for returns of 10 percent to 11 percent in 2012.

“People ask: ‘How can you possibly think your returns are going to be that high?’ “ Kosiba said. “But the answer is that we are diversified so that we have a chance.”

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