Public Employee Pensions and Benefits
Pennsylvania may soon be unable to meet its pension obligations. Without additional contributions, Pennsylvania’s Public School Employees’ Retirement System (PSERS) will have only a 31% chance of sufficient funding by 2030 and the State Employees’ Retirement System (SERS) will have only a 16% chance.
Meanwhile, the Independent Fiscal Office estimates that pension payments in 2019-20 will represent 9.4% of the state General Fund budget or $3.3 billion. That’s more than double the share of pension payments in the 2011-12 budget—crowding out funding for other services.
The 2016-17 budget is in the books with a $650 million tax increase. That's a significant increase—but it could pale in comparison to future tax hikes if pension reform continues to fall by the wayside.
Meanwhile, there's a notion gaining traction that we don't need pension reform because our public pension crisis is at a climax. After all, the yearly spikes in pension contributions will moderate beginning in fiscal year 2018.
Nothing could be further from the truth.
Recent reports from the state's two pension systems (PSERS & SERS) show the crisis is far from over. In April, SERS reported an approximately $350 million jump in the system's unfunded liability, swelling to $18.79 billion in 2015. But according to their actuary, the unfunded liability is closer to $19.45 billion—a roughly $1 billion jump.
SERS assumes a 7.5 percent rate of return for investments, but the actual rate of return was only 0.4 percent in 2015. This year isn't looking any better. SERS reported a 0.7 percent investment return for the first quarter of 2016.
In June, PSERS reduced their assumed rate of return from 7.5 percent to 7.25 percent starting in fiscal year 2017. These changes will add to the unfunded liability by about $2 billion.
In the past 3 months alone, we've added at least $3 billion to the already enormous $63 billion pension liability. Now imagine the impact of a recession or another reduction in assumed investment returns.
It's clear our pension system's liabilities are still growing at a rapid pace with no protection for taxpayers. The only way to truly end the pension crisis is to change the fundamental structure of these plans from the antiquated defined benefit plan to a modern defined contribution plan.
Like the budget, small adjustments may ease tensions in the short-term, but systematic reforms are required to change our future. Right now all signs point to higher taxes for Pennsylvanians.
One government union’s insatiable appetite for more tax dollars has hit a brick wall.
The Wolf Administration is in the process of negotiating a contract with the state’s largest union—the American Federation of County, State and Municipal Employees Council 13 (AFCSME). The current contract expires at midnight, and it’s highly unlikely a deal will be reached before then.
AFSCME agreed to postpone negotiations because the sides could not reach an agreement. According to AFSCME, the Wolf Administration would not sign off on proposed wage increase and wants members to contribute more to their health benefits. The administration is making these requests in light of the state’s precarious fiscal position.
The costs of public employee compensation is exploding. Benefits are particularly out of control. They’ve risen by more than 71 percent over the last 10 years. Benefits for AFSCME members make up about 44 percent of their total compensation (see page 21). In the private sector, the average is 34 percent.
The growing costs of pensions factor into the dramatic rise in compensation, but health care costs are part of the picture as well. According to the Office of Administration, public employees pay 11.7 percent for their healthcare. The private sector average is 20 percent. To their credit, the Wolf Administration wants to reduce this inequality by requiring employees to pay more for their coverage.
The governor should continue to stand firm and protect taxpayers—especially as the legislature debates a bloated budget that will probably require tax hikes. Capitulating to AFSCME now will only compound this problem.
Fortunately, the public will have an opportunity to review the labor contract before the deal is approved.
Pennsylvania's pension problem is nothing new. Over the years, lawmakers have tried to salvage the fundamentally broken system instead of creating a system that works. The latest attempt, SB 1071, passed the state House this week.
Like Act 120 of 2010 and Act 40 of 2003, this legislation makes cosmetic changes and promises modest savings that will never materialize.
Pennsylvania's pension plan for teachers and state workers is failing because defined benefit pension plans are vulnerable to swings in the stock market and political whims, leaving taxpayers with a huge bill. In the past six years, our unfunded pension liability has grown from less than $30 billion to $63 billion.
Instead of addressing the retirement systems' exposure to politics and stock market swings, SB 1071 leaves a defined benefit plan in place until a worker reaches $50,000 in salary or 25 years of service. Stacked on top of the defined benefit plan is a defined contribution plan (similar to a 401k), but the $50,000 threshold increases by three percent each year.
Public labor unions could easily accelerate this threshold in the future, lobby to defer payments or increase the multiplier. After all, the original proposal called for a 1% yearly increase.
If that's not a red flag, the cost of the plan should have you scratching your head. The PERC actuarial note claims $5 billion in savings over 30 years, but the savings amounts to just $1 billion in present value terms. A drop in the bucket.
In fact, SB 1071's insignificant savings were wiped out after PSERS announced they are reducing their assumed investment rate of return from 7.5% to 7.25%. This change instantly adds upwards of $2.5 billion to taxpayers' tab.
It's clear SB 1071 is not a step in the right direction. Rather, it's the latest in a long line of pension reform efforts that sweep Pennsylvania's pension problems under the rug.
The next step for SB 1071 is consideration in the state Senate. However, the Senate seems less than keen to advance the bill in its current form. Senate Majority Leader Jake Corman noted, "I'm not going to pat myself on the back and say, 'I did pension reform' and end up accomplishing nothing."
Senator Camera Bartolotta expressed her reservations as well, saying, “We need to put some more teeth into it, we really do.”
There's no easy way to fix our pension system, but going back on our promises to state workers or saddling future generations with debt isn't an option.
On the heels of bipartisan wine reform, the PA House is reportedly considering a pension reform plan that could actually increase pension costs.
Known as a stacked-hybrid plan, the current bill retains the current defined benefit plan on first $50,000 of salary or 25 years of service. Salary earned above $50,000 would apply to a defined contribution plan.
However, Democrats have floated an amendment to increase the defined benefit limit to $70,000 in salary and index the threshold to the national average wage, further minimizing the critical defined contribution component.
In their actuarial analysis, PERC estimates the Democratic-favored amendment would cost more than the current pension plans.
Even if this amendment fails, it would be relatively easy to revisit in future years, allowing another way to politicize pension benefits.
Lower than expected investment returns could also wipe out any savings under a stacked-hybrid plan. This week SERS reported disappointing first quarter returns of 0.7 percent, a far cry from the assumed yearly return rate of 7.5 percent. These poor investment returns mean taxpayers shoulder the burden of additional costs.
As noted in Rick Dreyfuss's latest policy memo, the failure to enact pension reform over the last decade led to a $60 billion unfunded pension liability—which families will be paying for generations.
Both the pension reform bill vetoed by Governor Wolf and the plan negotiated in December, as part of the infamous framework budget, are somewhat better alternatives to this stacked-hybrid plan.
Passing pension reform under Governor Wolf will require compromise. But the closer we can move to a defined contribution plan—a proven model that provides substantial retirements and cannot be underfunded—the better taxpayers and state workers will be protected.
If Pennsylvania were a ship, say the Titanic, then the iceberg that ship is bearing down on is the commonwealth’s public pension funds.
At a combined $63.2 billion in debt, the two funds threaten to sink Pennsylvania’s finances, according to a new policy memo authored by CF senior fellow Richard Dreyfuss.
Dreyfuss warned about the unsustainability of the state’s pension systems back in 2006. In his paper, Beneath the Surface, he outlined the problems with the pension funds and called on Harrisburg to act before the retirements of hardworking public employees were put in jeopardy:
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.
Unfortunately, public employee unions like the American Federation of State, County and Municipal Employees (AFSCME) denied the realities of the pension systems’ structural problems. Here’s what AFSCME wrote in 2006: “Pennsylvanians should rest assured that Pennsylvania is not the Titanic, and there are no icebergs in our pension fund’s future.”
Since that statement, the unfunded pension liabilities have grown by 730 percent while the market value of assets has fallen by 10 percent. In 2010, the legislature did attempt to stop the bleeding by passing act 120. The law limited reform efforts to new hires and deferred state contributions to the pension systems. That proved to be an imprudent decision.
“Letting Act 120 work” is no longer an option. The commonwealth must rise to the occasion and change our ship’s bearings. Harrisburg must reform pensions by moving all employees to a 401k style plan and fully fund all of our pension obligations without further burdening taxpayers.
posted by HUNTER L. AHRENS | 11:01 AM | Comments
Today, the House State Government Committee passed a pension reform bill featuring an unproven “stacked hybrid” plan. This proposal falls short of the pension reform taxpayers needs to protect them from political manipulation and investment risk.
In the stacked hybrid system (for new hires only), the plan retains the current defined benefit plan on the first $50,000 of salary. Salary earned above $50,000 (or after 25 years) applies to a defined contribution plan. That is, the maximum defined benefit pension is $25,000.
The stacked hybrid is an unproven model; no state has ever implemented this type of plan. In contrast, ten states have side-by-side hybrid plans, as has the Federal Employees Retirement System.
All of the problems with defined benefit pensions—increasing benefits, deferring employer payments, and underperforming the assumed 7.5 percent rate of return—remain a risk to taxpayers. Additionally, the $50,000 salary cap could easily be raised (as Gov. Wolf has proposed) under public sector unions pressure for a Cost-of-Living adjustment, which would further minimize the defined contribution component.
This plan falls well short of the goals of a defined contribution plan. It represents a significant step backwards from the responsible pension reform plan passed by the legislature last year, and even a step back from the hybrid proposal considered late last year.
Moreover, this model provides poor plan design for workers. Public employees should be contributing more toward a defined contribution plan at the front end of their career to give their investments time to grow. Under a stacked hybrid, workers invest more in a defined contribution plan as they near retirement.
Research shows defined contribution plans provide stable and substantial retirements when workers invest over their career.
Lawmakers should continue to promote a defined contribution plan for new hires. This is the only way to remove politics from pensions.
In truth, SERS' unfunded liability grew by about $1 billion this year due to artificially low employer payments. A more accurate calculation comes from the SERS actuary, The Hay Group. They estimate an unfunded liability of $19.45 billion as of December 2015.
Artificially low employer payments aren't the only reason the unfunded liability has grown. SERS assumes a 7.5 percent rate of return for investments, but the actual rate of return has been far less, only 0.4 percent in 2016.
Keep in mind that SERS liabilities represent less than half of the overall pension liability taxpayers will pay. The larger Public School Employees' Retirement System is carrying a $37 billion liability for a total of $56 billion.
Clearly, letting Act 120 work means more debt for taxpayers. Giving state workers greater control over their retirement is the only way to boost worker security and stop the flood of red ink.
Pennsylvania’s nine-month budget saga has concluded, but not everyone is pleased with the ending. The Philadelphia Inquirer published a caustic editorial criticizing state lawmakers for failing to surrender to the governor’s unreasonable budget demands.
Rather than providing clarity, the partisan editorial adds to the mountain of misinformation casting a shadow over the budget debate. For example, the editorial board writes,
Gov. Wolf has succumbed to Republican obstruction and agreed to a plan that keeps the state in the fast lane toward fiscal instability and educational decline.
Far from being obstructionists, Republicans advanced numerous balanced budgets, liquor privatization, and pension reform. The governor is the one clinging to the status quo. His insistence on higher taxes and spending will chase more people out of the state, leaving fewer taxpayers to cover the growing costs of government. Does this sound like fiscal stability?
But tax increases are necessary, some say, to stave off educational decline. The truth is more complicated. No correlation exists between higher education spending and educational outcomes. Lack of funding is not the problem. Misplaced control is the problem. Pennsylvania’s educational system will improve when parents, not government officials, are in control of education.
The editorial continues:
Of the many disappointments of this budget, the greatest is its failure to address the state's structural deficit, the stark difference between the state's spending and receipts. This deepening hole, expected to approach $2 billion next year, is sapping the state's ability to function.
Leaving aside the hyperbolic ending, the board’s preferred plan does not eliminate the deficit despite including a $2.3 billion tax increase over two years. Furthermore, if the state is facing a deficit, adding billions in new spending makes little sense. Why add new bills if the state cannot pay its old ones?
In keeping with its partisan tone, the board writes,
That seems to be of no concern to the legislature's least reasonable Republicans, who can return to a never-ending campaign trail to gleefully proclaim that this budget raises no taxes. But the problem is that it does raise taxes. Local property taxes throughout the state are bound to rise because the state is failing to properly fund schools, leaving districts to make up the difference.
Leading readers to believe lawmakers have no alternatives to tax hikes is disingenous. Reforms like voter referendums, school choice, and mandate relief can ensure education funding, which is at record levels, is spent more efficiently.
Finally, the board attempts to paint the governor as a reasonable negotiator who can’t get anywhere with obstinate Republicans:
This budget doesn't address the looming pension crisis or reform the state's absurd grip on wine and spirits sales, supposed Republican priorities that, despite belated and begrudging concessions by the Democratic governor, remain as untouched as Wolf's agenda.
These “concessions” were token at best. Republican legislators preferred a pension plan that moved all new public employees into a 401k plan. The governor said no. On liquor, they requested complete privatization of the system. The governor said no.
After having their top two priorities rejected, the legislature still increased spending by more than $880 million, with $230 million added for education—the governor's top priority. Republican lawmakers passed these increases even though many preferred reductions in government spending.
Nevertheless, the 2015-16 budget impasse is history. Focus will now turn to the 2016-17 budget and lawmakers will have another opportunity to redesign government so that working people aren't harmed by the consquences of overspending.
State employee compensation costs have soared to nearly $93,000 per worker per year, with health care and pensions the largest contributors.
Meanwhile, costly EPA mandates on carbon and mercury emissions will cause strife for Pennsylvania's coal industry. Other mandates could cost farmers millions.
Nathan Benefield recently joined George Toth on WNPV's Regarding Your Money to discuss how the rising costs of state workers and EPA mandates will burden Pennsylvanians.
Click here or listen below to the interview:
The state pension boards testified before the General Assembly this week and reported a combined unfunded liability of more than $56 billion. Contrary to claims that “we should let Act 120 work,” the outlook for Pennsylvania’s state pension systems continue to worsen.
Here’s a glimpse at how the unfunded liability has increased since 2010:
The Pennsylvania School Employee Retirement System (PSERS) Budget Report explains that its unfunded liability is due to a combination of funding deferrals, subpar investment performance, and benefit enhancements:
Each year, PSERS payments consume a growing percentage of the Pennsylvania's ever-increasing education spending. In 2010, pensions accounted for roughly 3 percent of state education spending. In the current fiscal year, they account for 16 percent of the total education share:
The State Employees Retirement System (SERS) announced decreased investment fees, from 96 to 59 basis points. Although this results in modest cost savings, the 59 basis points are still significantly higher than many passively managed mutual funds.
Also of note, from The PLS Reporter:
Both systems said they are keeping their current 7.5 percent assumed rate of return despite not meeting that amount in a short-term look back.
Certainly, the public pension crisis is the most urgent policy challenge facing the commonwealth. It is driving property tax increases and credit downgrades across the state. The sooner Pennsylvania moves to a defined contribution retirement plan for new hires, the better.
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