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Why a COLA Cut to Half-CPI Puts Retirement Security at Risk
This brief illustrates: • why the current 3 percent compounded COLA tracks inflation better than a Half-CPI COLA • why cutting COLAs to Half-CPI is essentially as harmful as the COLA cut proposed in SB 1 • why the move to a Half-CPI COLA is legally dubious Illinois’ public university presidents and chancellors have backed a proposal authored by the University of Illinois Institute of Government and Public Affairs (IGPA). The IGPA proposal would change the cost-ofliving adjustment (COLA) for Tier 1 public employees and retirees from the current annually compounded 3 percent to one-half the annual change in the consumer price index (Half-CPI).1 The Current 3 Percent Compounded COLA Tracks Inflation Better than Half-CPI The current 3 percent compounded COLA is based on appropriate actuarial projections and has, in fact, proven to be a remarkably accurate adjustment for changes in the cost-of-living. Several points prove this, particularly in contrast to the IGPA’s proposed Half-CPI COLA. First, actuaries for two major state retirement systems, the Teachers’ Retirement System (TRS) and the State Employees’ Retirement System (SERS), have projected annual inflation at 3.25 percent and 3 percent, respectively. This is consistent with inflation projections from other major pension systems in the public and private sectors and is, essentially, a consensus inflation projection from experts in the actuarial sciences. Second, the IGPA report goes back more than three decades to use a high inflation era to justify the proposal, but recent economic history tells a more relevant story. A review of the COLA applied to Social Security benefits (which is also based on a measure of CPI) finds that only twice in the last thirty years has the COLA exceeded 5 percent. In fact, none of the last thirty annual adjustments exceeded 6 percent. A simple arithmetic average of the last thirty annual adjustments to Social Security benefits (1984 to 2013) shows an average annual increase of 2.9 percent – right in line with the Illinois retirement systems’ 3 percent compounded COLA.2 In other words, the IGPA proposal would cause retirees to lose a COLA that has historically kept pace with inflation for the illusion of inflation protection. The premise that employees should lose their current COLA for “valuable insurance protection” from events that have not occurred in thirty years is not pertinent to modern economic times. Lastly, the current COLA does not enrich retirees, but serves its purpose by protecting pensions from the ravages of inflation over time. The Half-CPI COLA results in the loss of pensions’ purchasing power every year because it does not keep pace with inflation by its very design as a half-measure. Yet, seniors face greater inflation risk than other demographic groups because they purchase goods and services, such as health care, that have higher inflation rates. The Half-CPI COLA Essentially Cuts Modest Pensions as Deeply as Senate Bill 1 (SB 1) A Half-CPI COLA would significantly erode retirees’ purchasing power and standards of living. The harmful effects of the IGPA proposal increase over time. Using the actuarial assumptions of each plan, the
Brown, Jeffrey, et al. “Six Simple Steps: Reforming the State Universities Retirement System.” Institute of Government and Public Affairs. University of Illinois. March 12, 2013. http://igpa.uillinois.edu/system/files/Six-Simple-Steps-for-ReformingSURS.pdf 2 United States. Social Security Administration. “History of Automatic Cost-Of-Living Adjustments.”October 26, 2012. http://www.ssa.gov/cola/automatic-cola.htm
percentage loss in purchasing power caused by a change to a Half-CPI COLA to members of TRS and SERS is demonstrated in the chart below: Table 1: Half-CPI COLA Cuts Pension Value Between 23.6% – 25.4% Years in Retirement TRS Purchasing Power Loss SERS Purchasing Power Loss 5 6.5% 7.1% 10 12.6% 13.6 % 15 18.3% 19.8% 20 23.6% 25.4% In a December 2012 report, We Are One Illinois studied the effects of a SB 1-style COLA cut and found the following results: Table 2: SB 1-Style COLA Cuts Pension Value Between 28.1% - 30.7%3 Years in Retirement TRS Purchasing Power Loss SERS Purchasing Power Loss 5 13.7% 13.7% 10 19.3% 18.2% 15 25.0% 23.0% 20 30.7% 28.1% Teachers, nurses, caregivers, public safety officers, and other public employees and retirees would substantially face the same COLA diminishment as SB 1 under the IGPA plan. The Constitutionality of a Half-CPI COLA Is Questionable at Best The IGPA report acknowledges that the change in COLA could be considered a diminishment of benefits. To counter such arguments, the authors assert,“[i]n our view, it would be constitutionally permissible to reduce the expected average future increase in exchange for the valuable insurance protection that individuals would receive during periods of high inflation.” However, the authors cite no legal opinion and testified before the pension conference committee that no legal opinion had been sought to support this view. Further, this argument fails to recognize that the IGPA proposal does not truly or fully protect public employees and retirees from inflation but, instead, locks in the loss of purchasing power every year because annuities are adjusted at Half-CPI. Conclusion Cutting COLAs from the current 3 percent compounded rate to a formula based on Half-CPI is a substantial reduction in benefits like other extreme measures, such as SB 1. Counter to proponents’ claims, it is not balanced by enhanced benefits to participants, and it is of dubious legality. Experience over the last three decades shows that partial protection from hyper-inflation is of little value compared to the way the current COLA preserves pensions’ purchasing power by accurately adjusting annuities according to increases in the cost-of-living in modern economic times. The Half-CPI “diet” COLA offers no more than the illusion of inflation protection or retirement security to those who have faithfully contributed toward their pensions and served the public.
We Are One Illinois. “Analysis of Worker and Retiree Pension Benefit Cuts under the Quinn Plan and HB 6258.” December 17, 2012. http://www.weareoneillinois.org/documents/studies.pdf