EXECUTIVE SUMMARY

Pennsylvania government employee-benefit plans operate in a vacuum. In a world where private-sector benefit cutbacks and cost reductions occur on a daily basis, state government in Harrisburg has not responded in similar fashion. In fact, instead of reducing the potential for financial disaster, actions in recent years have served to accelerate the coming crisis.

The absence of a long-term employee-benefit strategy, other than assuming the perpetual life of the public entity (the taxpayer), is fiscally irresponsible at best. Although there will certainly continue to be minor differences in the construct of private and public benefit plans, there should be no differences in governance, benchmarking, or in the desire to control costs. In the Commonwealth of Pennsylvania, this is not the philosophy or the practice in managing its public-sector benefits plans.

The actions and inactions of policymakers should raise profound concerns about the current and future fiscal health of Pennsylvania. Logic suggests that as the private sector must continue to evolve in an ever-changing economic environment, so too must the public sector. After all, the health of the public sector is entirely dependent on a healthy private sector, not the other way around. Therefore, the best demonstrated practices exhibited within the private sector must also permeate the policies developed in the State Capitol.

Private sector plans are generally designed and managed to achieve both short and long-term business objectives. Pennsylvanians have seen key industries fail because they could not achieve predictable and affordable costs. The looming crisis in the long-term commitments made by policymakers on behalf of taxpayers is reflected in the rapid 615% increase in expected taxpayer pension contributions from $584 million in FY 2004-05 to more than $4.2 billion in FY 2012-13 for the State Employees Retirement System (SERS) and Public School Employees Retirement System (PSERS). Without significant actions affecting plan design, the Commonwealth of Pennsylvania will likely be facing unaffordable costs, some of which have yet to be fully quantified.

For example, what will be the impact of Government Accounting Standards Board statement No. 45 when it takes affect in 2007? This accounting requirement will force state and local governments to begin to recognize (but not necessarily fund) future retiree healthcare liabilities over the working lifetime of the employee (as is currently done in the private sector under FASB 106). Shedding light on heretofore hidden costs will only further reveal Pennsylvania’s looming pension and retiree healthcare benefits crisis.

Daily news reports and recent surveys reveal the negative impact of these obligations in the private sector. Such costs should be no more affordable in the public sector. Government employee benefit costs, like all operating expenses, need to be actively managed. However, in response to initiatives to achieve greater fiscal discipline within state and local government (such as “spending limits” on the state government budgeting process or “voter referendum” on local school district spending), some policymakers are seeking to exempt pension and healthcare costs from such limits or taxpayer control. Such exemptions would only further distort the true cost of government to Pennsylvania taxpayers.

Long-term benefits costs cannot exceed the state’s long-term revenue growth rate, otherwise plan design and/or staffing reductions will be needed to avoid a fiscal disaster. The state must adopt a long-term benefit strategy to control costs rather than assuming “the perpetual life” of the taxpayers’ ability to pay if it hopes to properly govern, benchmark and manage the long-term pension and healthcare liabilities.

Many of these same issues apply at the local government level as well where counties, municipalities and school districts sponsor pension and retiree healthcare plans.

Summary of Findings

• A 2004 state pension report and recent actuarial valuations of assets and liabilities ndicate the Pennsylvania taxpayers’ costs to support SERS and PSERS, assuming an annual investment return of 8.5%, will increase from $584 million in Fiscal Year 2004-05 to an estimated cost of
  • $693 million in Fiscal Year 2005-06
  • $1.000 billion in Fiscal Year 2010-11
  • $4.346 billion in Fiscal Year 2015-16
  • $5.583 billion in Fiscal Year 2020-21
• Legislation passed in 2001 and 2002 which improved pension benefits for active employees and retirees generated $10 billion in additional unfunded liability and increased taxpayer contributions by $1.2 billion annually. This, coupled with unfavorable asset performance in these same years, weakened the fiscal solvency of SERS and PSERS. Prior to 2004, these plans exhibited a surplus (based on valuation assets over accrued liabilities). Legislation in 2003 refinanced much of these costs over a 30-year period.
• A Joint State Government Commission study suggests that any reductions in pension benefits are prohibited by the Constitutions of the United States and the Commonwealth of Pennsylvania. Pension benefit enhancements, however, are acceptable and immediately deemed irrevocable.
• By 2007, under GASB No. 45, Pennsylvania state government will be required to annually recognize future retiree healthcare costs. Subsequent to 2007, smaller government entities such as cities, municipalities and school districts will be forced to adopt this change in accounting practice. [Similar requirements in the private sector under FASB No. 106 in 1993 have forced many private-sector companies to amend, restrict and even eliminate their benefits programs through cost-sharing, eligibility changes and other coverage reductions.]
• SERS and PSERS members (which include legislators, members of the judiciary, public school employees and other state employees) participate in a pension plan with provisions more generous compared with other state plans and far more generous than a representative group of major private employers in Pennsylvania.
• Cost-of-living-adjustments (COLA) for SERS and PSERS retirees are being considered in the General Assembly despite the significant liabilities inherent in the current pension system. The COLA in 2002 increased plan liabilities by $1.75 billion. This is in an environment where these same retirees pay little, if any, premium for lifetime healthcare coverage paid by taxpayers, which should be viewed as an annual “healthcare COLA” given the annual rise in healthcare costs.
• State retiree healthcare benefit programs are also very generous and surpass that found in any Pennsylvania company studied for this analysis.
• The philosophy and practice of Pennsylvania’s public pension and healthcare benefit plans demonstrate no evidence of outside benchmarking to the private sector or a long-term strategy to control costs or create public/private parity. Clear trends exist in the private sector affecting defined-benefit pension plans and retiree healthcare plans resulting in changes which yield predictable and affordable costs including greater risk/cost-sharing between employee and employer.
• The benchmarking for the design and affordability of these plans does not reflect the best demonstrated practices within the private sector.
• Legislators are legally entitled to a pension of 3% of final average pay multiplied by years of service, and are able to receive an unreduced benefit at age 50 with 3 years of service. This provision is generous (even within the already generous SERS benefits), expensive and not found in any of the 43 Pennsylvania private-sector companies studied for this analysis.
• A state legislator first elected in 2006 at age 40 and serving 20 years with pay increases of 3.3% per year would receive an annual pension of approximately $77,700, assuming no COLAs or election to leadership positions (which would increase this amount).
• Retired legislators receive benefits more generous than that of most public employees, giving them one of the best pension packages in one of the best pension systems in the nation.
• Legislators pay no premium for their active healthcare benefits, while private-sector employees pay an annual average of approximately 16% of their premium ($610) for single coverage and approximately 27% ($2,713) for family coverage, according to a 2005 national survey.
• Certain members of the judiciary participate in a higher level benefit category within SERS providing them with 4% of final average pay for the first 10 years and 3% for years thereafter. This formula yields an annual benefit of 100% of pay after 30 years, provided they are age 60.
• These judiciary members are also eligible to participate in a voluntary supplement to provide additional pension benefits for earnings over the Social Security Wage Base (which are already considered in the primary SERS pension benefit). This voluntary supplemental plan results in a net cost to taxpayers even after considering the required employee contributions. Therefore, it is no surprise that over 90% of eligible employees participate in the plan.

Recommendations

• Identify and implement a benefits cost strategy which is predictable and affordable within a responsible fiscal budget for the Commonwealth. There should be no budget exemptions or any other special considerations for state pension or GASB No. 45 costs. If these costs are deemed unaffordable, then significant plan design changes must take place.
• Obtain private-sector input and improve the oversight of these programs.
• Amend Act 9 of 2001 and Act 38 of 2002 to provide benefits which are affordable.
• Create less reliance on defined-benefit plans for retiree income. Adopt defined-contribution plans with an employer match as a replacement (in part or in whole) to the defined-benefit plans.
• Benchmark from the geographical areas comprising the labor pool. Consider benchmarking design and cost sharing to an “index of benefits” provided from a representative set of major private-sector companies based in Pennsylvania. Benchmarking only to other public plans, while perhaps an interesting academic exercise, is an attempt to ignore the realities of today’s world.
• Increase cost-sharing for active healthcare plans.
• Reduce coverage, adopt tighter age and service eligibility requirements, and implement premium caps for the retiree healthcare plans.
• Curtail any future pension cost of living increases for retirees. Consider how much of an “increase” a retiree receives each year through their healthcare plan.
• Address the question of whether elected officials should participate in any state retiree healthcare or state pension plan.

The purpose of this report is to raise public policy questions that need answers regarding the governance, proper benchmarking, and fiscal management of taxpayers’ long-term pension and healthcare liabilities. The long-term commitments and liabilities made by policymakers on behalf of taxpayers are unsustainable, particularly given the difficult economic environment facing both the public and private sectors in Pennsylvania.

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The policy report, Beneath the Surface: Pennsylvania's Looming Pension and Healthcare Benefits Crisis, can be accessed here [1] (PDF, 3.4MB). The Executive Summary can be accessed here [2] (PDF, 468KB).