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.
A majority of Pennsylvanians want pension reform. In a poll conducted from October 4th to 9th, 54 percent of voters supported placing new state employees in a 401(k)-style retirement plan. Pension reform isn't a partisan issue: 67 percent of Republicans, 51 percent of Independents and a plurality of Democrats are in favor.
Lawmakers appear to be obliging voters. According to Capitolwire (subscription), legislative leaders are considering a side-by-side hybrid plan for new employees. The proposal is similar to the plan defeated in December, which was linked to a major tax hike.
As we've noted before, this type of pension reform fails to fully remove politics from pensions, but takes an important step in the right direction. Under a hybrid system, new employees enroll in a defined contribution plan and a defined benefit plan. Only the defined benefit component would be subject to political manipulation.
The details of the plan are still murky, but pension reform that moves towards a defined contribution, or 401(k)-style plan, is an improvement upon the status quo.
In the past six years, Pennsylvania taxpayers’ unfunded pension liability has more than doubled from less than $30 billion to $63 billion.
While the legislative debate over reform continues, Pennsylvania taxpayers and state workers are sinking deeper into the pension crisis. A recent Moody’s report on state pension liabilities concludes states with large gaps, like Pennsylvania, will be forced to direct more money toward their pension systems just to keep unfunded liabilities from growing. That means fewer dollars for schools, roads, and other basic services.
A big reason for the growing funding gap is lower than expected investment returns.
The State Employee Retirement System (SERS) assumes a 7.5 percent rate of return for investments, but the actual rate of return was only 0.4 percent in 2015. In the first half of 2016, SERS reported a 2 percent investment return.
The much larger Pennsylvania State Education Retirement System (PSERS) isn’t fairing much better. The fund earned just 1.29 percent for the fiscal year, ending June 30th. Recognizing the reality of today’s economy, the system reduced their assumed rate of return from 7.5 percent to 7.25 percent starting July 2016.
Unfortunately, Governor Wolf vetoed reform back in June 2015 which included a defined contribution, alongside a “cash-balance plan”, for new employees only. This legislation was itself a compromise from a straight 401k-style plan that would provide adequate retirement benefits while being, by definition, fully funded.
By December, the Senate crafted a side-by-side hybrid pension model. The hybrid model allowed new employees have both a (smaller) defined benefit pension and a defined contribution plan from dollar one. While less than ideal, the plan would significantly reduce taxpayer risk, a step in the right direction.
In June, a different reform proposal passed the state house. This stacked-hybrid plan includes a defined benefit plan for workers until they reach $50,000 in salary (or 25 years of service), followed by a defined contribution plan. However, the $50,000 threshold would increase by 3 percent annually--greatly limits the number and extent of employees participating in the defined contribution plan.
There’s no question pension reform is urgent. Lawmakers must prioritize proposals with a stronger defined contribution component while preventing political manipulation of pension payments. Anything less will keep government budgets squeezed and taxpayers exposed to tremendous risk.
Pennsylvania’s state budget is three months old and showing signs of a major budget deficit.
Actual revenue collections are already behind $218.5 million through the first quarter, according to the Pennsylvania Department of Revenue. In July, the legislature passed and Gov. Wolf signed a $1.3 billion revenue package, which includes $650 million in higher taxes, to help pay for a $1.6 billion increase in government spending.
The revenue assumptions built into the billion dollar package are now proving optimistic. The chart below shows revenue collections lagging official estimates in each of the first three months.
In August, the Independent Fiscal Office identified problems with certain revenue projections used to balance the budget—at least on paper. Here are their major assumptions:
- The IFO deducts $95 million to pay for the expenses of the Commonwealth Financing Authority (CFA) from sales tax revenue. The legislature moved this line-item out of the General Fund Budget and created a new fund via the fiscal code. Legislative leaders have expressed an interest in passing gambling expansion to generate $100 million to cover CFA spending, but no enabling legislation exists.
- IFO assumes Act 39 (wine modernization) will raise $73 million in 2016-17. The legislature predicts an increase of $149 million—a $76 million difference.
- IFO projections of tobacco tax revenue (includes taxes on cigarettes, e-cigarettes, loose & roll-your-own tobacco) are approximately $38 million less than the official projections.
- $75 million from the Philadelphia casino is not included in the IFO’s official revenue estimate. They do not expect it will generate revenue for the current fiscal year.
Moreover, the budget was unbalanced from the start. The budget counts on $260 million in one-time revenue and transfers from other funds, and a $200 million loan from the Pennsylvania Professional Liability Joint Underwriting Association.
Borrowing money to pay our bills is the very definition of unbalanced.
If current revenue trends continue, lawmakers and the governor will need to focus on reducing government spending to balance the budget. Such as,
- Cutting back on $800 million in arbitrary corporate welfare,
- Immediately imposing a (real) hiring freeze and travel ban, and
- Reviewing funds outside the General Fund budget for savings.
As the fiscal year progresses, and more revenue collections are announced, we will continue to update our Deficit Watch.
APSCUF—the union representing faculty at state-owned universities—has begun a vote to authorize a strike.
One of APSCUF's complaints with the proposed contract is higher health care expenses. In a recent email to faculty members, APSCUF touted the fact that employees would now have a deductible with their health insurance plans--$250 for singles and $500 for families. That is, their current contract offers a ZERO deductible.
In contrast, the average deductible nationwide for employer-provided coverage is more than $1,300 for single coverage and more than $2,000 for family coverage, according to the Kaiser Family Foundation.
Likewise, APSCUF is complaining about out-of-pocket limits on health care since employees currently pay $0 out-of-pocket. The proposed contract would limit out-of-pocket expenses to $1,000 for single coverage and $2,000 for family coverage.
Nationwide, 83 percent of employee-sponsored individual plans have an out of pocket maximum of more than $2,000, according to the Kaiser Family Foundation.
If students and parents wonder why tuition costs so much, they should look to faculty health care benefits that are out of whack compared to the private sector.
Pennsylvania's pension debt stands at $63 billion or more than $4,900 per resident. It's a big number to be sure, but what does it mean for the average Pennsylvanian? What does it mean for lawmakers struggling to close budget gaps?
We've broken down the pension debt by state agency to show how many tax dollars are being diverted from services and taxpayers to personnel costs.
For instance, the share of pension debt for corrections officers is $3.3 billion—about $1 billion more than this year's entire corrections budget. Human services personnel account for about $2.3 billion in pension liabilities. Likewise, the state currently has a $1.7 billion obligation to transportation workers.
These obligations will command a large portion of future tax dollars, which means state government will be providing fewer services at a higher cost to taxpayers. Any system that charges taxpayers more to provide people with less is broken.
State workers deserve a decent retirement, but many may not see one unless the current unsustainable system is reformed. If pension reform isn't taken up soon, pension payments will be reduced again and eventually deteriorating finances will cause retirees and current workers will lose benefits.
Pension reform that protects benefits from politics isn't just fiscally prudent; it's about making our government work for all Pennsylvanians.
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
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