Question 1
There are several different factors that contributed to the underfunding of the Illinois' pension system. The most important factors that greatly affected the funding of the Illinois pension system is the economic recession in the state as well as the decrease in the equity market as it reduces the funding ratio of the Illinois' pension system. Furthermore, misallocation of assets as there are inadequate assets in the pension system to meet the liability obligations.
The higher discount rate allocated by the state’s order to discount its pension liabilities is another contributing factor. As well, inability of the state to make yearly payments in to the pension system for the eventual retirees. Lastly, the financial crises of 2009 that result stock market losses also largely impact the Illinois' pension system underfunding.
Question 2
Under the applicable rules of the accounting, the Illinois is facing vast gap between the current fund availability and the investment that is required to fund the pension system of the state. As, the state is not making the obligatory amount of yearly support for the pension plan in order to finance the future payments of the retirees. In addition to this, these estimates are showing realistic effects on the performance of the Illinois' pension system as the funded ratio indicated the fluctuation during the past few years and showed the major decline in 2003.
Moreover, the state have to make $3.9 contribution to the pension system as according to the funding law 1994 for the fiscal year 2010 and this contribution should require yearly increase till the pension funds for the year 2045. Despite the positive situations during the time period 1995-2000, the state was only able to generate the payments that are required by the law of 1994.The state also uses higher discount rate for their long term investment expectations that is much higher as compared to the interest rate on the U.S treasury bond of 3.5% in 2003. The state also allocated an amount for its employees that was of $2.4 billion for the early retirement plans but this amount was also not funded.
Question 3
The current allocation of the Pension funds of the state is not distributed effectively and appropriately due to which they become one of the key factor that results in the underfunding of the Illinois pension system. In addition to this, the current funds of the Illinois pension system are not enough to finance the long term requirements of their retirees’ benefits as well as fulfil the liability payments.
Moreover, the current allocation of the funds is mostly in the equity market about 58.5% that included U.S Equity 31.2%, Private Equity 8.2% and International Equity 19.1%. As, well due to the economic recession conditions in the state equity market is hugely affected and result in the inadequate funds for the future payments required for the Illinois pension system.
Yes, the fund needs to take more risk by reallocating the amount of percentage of each invested fund in different sectors as the value of these funds are diminished by the continuous adverse financial conditions in the state. Additionally, it is also important to take more funds risk as it would provide with the opportunity to increase the investment performance of these funds that currently showed the declined. Therefore, it would be more favorable to make an investment in the hedge and private funds as these could provide the return above than the risk free rate regardless of the market condition.
Question 4
There are five options available for potential reforms. Given below are the pros and cons of each available option:
Pension Bonds
Financial Implication
The issuance of both the $20 billion and $8 billion pension bonds would impact the pension funding of the state. As, the issuance of $ 20billion would rise the cost of debt above the 8.5% that is above the expected return on the assets. While issuance of $ 8 billion pension bonds would increase the interest rate from 5% to 7 %.
Pros
- The main gain of the pension bonds is that it is helpful in order to increase the fund ratio of the pension system.
- The pension bonds are a useful option during the economic recession as well as early stages of economic recovery.
- Beneficial in the conditions when stock prices are down.
Cons
- Issuance of pension bonds increases the borrowing cost of the state.
The pension bond option may affect the credit rating as the Illinois is currently placed lower in rating by the rating agency..................
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This case describes the precarious financial situation of the public pension systems of Illinois in the spring of 2009 and accounting for pension plans nonfederal municipalities in general. In February 2009, in the midst of a recession, the newly appointed Governor Quinn had put its budget for the next fiscal year and to address inadequate state government pension, the biggest responsibility. Immediately, the governor needed to raise funds to make an annual contribution to the state pension plan, and at the same time he needs to make a plan of the pension reform to prevent future state failure. Governor Quinn has had a number of levers it can use, including changes in asset allocation of pension funds, directly addressing the rights through a specific benefit or defined contribution plan, or implementing a package of pension bonds, taxes and contributions of employees. Through this case, students are required to more fully understand the accounting of pension and difficult choices that many states will face because of their outstanding liabilities. "Hide
by Robert C. Pozen, Brij Khurana Source: HBS Premier Case Collection 19 pages. Publication Date: June 27, 2011. Prod. #: 311139-PDF-ENG
