The Strong Case for?and Weak Case Against?Pension Reform

Pennsylvania’s public pension plans are woefully underfunded, with enough assets to cover just 60 percent of liabilities. This poor financial showing has relegated the commonwealth to the bottom of the Tax Foundation’s ranking of state pension debt. Only four states have pension plans with a worse funding ratio.

Partly to blame is the underperformance of state investments in the stock market. Couple this with years of the state failing to meet its obligations, and the result is a massively underfunded pension system putting financial pressure on state and school district budgets.

In an effort to reduce investment costs, Gov. Wolf has asked the state’s two pension systems—PSERS and SERS—to move away from money managers and toward a “passive” investment strategy. The move would reduce pension management fees, which are well above normal, according to a report from The Pew Charitable Trusts.

Yet Pennsylvania needs to do far more than a change in investment strategy to address the pension crisis. The state needs to move to a defined contribution (DC) model.

Opponents of a DC model claim it requires high management costs. Yet, high costs are already plaguing the current system. This irony was not lost on Capitolwire’s Chris Comisac (paywall):

Legislative Democrats, labor unions and others continue to contend that switching to a defined contribution retirement plan for all new state and public school employees would produce less retirement security because employees would pay exorbitant fees to private managers for reduced retirement savings, because – they claim – defined benefit plans produce better returns.

And yet, here you have the governor and the state Treasurer – both Democrats – arguing SERS and PSERS are paying exorbitant fees to active managers and getting less of a return than they could get, and should instead be more focused on passive investment strategies to both save money and produce acceptable investment returns.

In 2013, we explained why exorbitant investment fees were not a good reason to oppose DC plans. This latest news underscores this fact and further makes the case—along with the growing pension debt—for moving away from the current defined benefit model. And it looks like Pennsylvania is heading in that direction.

Last month my colleague Elizabeth Stelle wrote about the Senate’s efforts to move forward with a side-by-side hybrid pension plan. The plan, although imperfect, begins to extract politics from the pension system. It also protects taxpayers from shouldering greater financial risks and gives public employees more retirement portability.

The Senate plan is a good first step to solving Pennsylvania’s pension problem and a welcome repudiation of the idea that all we need to do is “let act 120 work.”