Pennsylvania Pensions: Man-Made Financial Disasters
The “Process Improvement Theory” relates to the timing in a process when errors are diagnosed and fixed. As the theory goes, at each ensuing interval in which a problem is not detected the potential damage increases exponentially.
The current design of Pennsylvania’s taxpayer-funded pension is a case study of what happens when problems are either not detected or detected and not addressed. The result: Man-made financial disasters.
Unfortunately, these disasters are not limited to state government in Harrisburg, but also extend to the pension plans sponsored by county and municipal governments across Pennsylvania.
The financial calamity facing taxpayers is not in the administration of Pennsylvania’s Public School Employees Retirement System (PSERS) and the State Employees Retirement System (SERS) plan, but the result of failing to correct plan design decisions that occurred almost on an annual basis beginning in 2001 with the passage of Act 9.
Following favorable investment returns in the 1990s, the costs to taxpayers to fund retirement benefits were lowered significantly. But rather than maintaining these low costs to taxpayers, policymakers decided to increase pension benefits for employees by essentially tapping the surplus.
Act 9 of 2001, part of a political tradeoff with the Pennsylvania State Education Association (PSEA) by then-Governor Ridge, dramatically increased both pension benefits. The plan was to draw down the surplus over 10 years and cover the Act 9 costs over that same period. Later that year, the financial downturn following the terrorist attacks of September 11th negatively affected the asset returns of both PSERS and SERS.
In 2002, Act 38 increased benefits for retirees who were left out of the 2001 pension enhancements. However, another poor year of investment returns further increased the pensions’ unfunded liabilities.
To be clear, the investment losses were likely as significant as the Act 9 and Act 38 changes. The surpluses were such that the plans were financially positioned to cover either the benefit improvements or significant investment losses such as those incurred – but not both.
Therefore, with the economic downturn, the plan to use the surplus to pay for the additional costs of Act 9 and 38 was no longer feasible. In response, Governor Rendell signed Act 40 of 2003, which among other changes effectively refinanced the additional liabilities incurred from Act 9 from 10 years to 30 years.
With this financial engineering, the expected taxpayer contributions were projected to be lower in the near term then rise and spike in the year 2012-13. The strategy was that the economy of Pennsylvania would be so robust in the years leading up to 2012 that this action would prove more affordable to the taxpayers.
While the projected 2012 pension costs have diminished from the original 2003 projections due principally to asset returns, the expected taxpayer contributions will nonetheless jump from $1.376 billion in 2011-12 to $4.176 billion in 2012-13, according to PSERS and SERS latest estimates projections. As such, it remains a looming fiscal crisis.
In 2004, a Joint State Government Commission report on PSERS and SERS recognized this looming financial crisis. However, the report noted that while full funding – or having current assets meet liabilities – “may be a necessary standard for a private plan … it is not necessary for a public plan because a public entity can assume perpetual life.” [emphasis added] This operating premise, although astonishing, is nevertheless clearly reflected in the plan funding of both PSERS and SERS.
Although assets returns by PSERS and SERS have exceeded expectations in recent years, the taxpayers’ contribution continues to escalate. PSERS alone expects an increase of over $200 million, with the state paying more than its traditional share. Apparently, the taxpayer can now pay at the state level what they presumably could not afford at the school district level.
PSERS costs are currently projected to increase by another $100 million in 2007. Unless the state continues to assume these added pension costs in future years, property tax increases school districts to fund these liabilities will be inevitable.
To make fiscal matters worse, two PSEA labor union-backed bills in the House of Representatives (HB 2268 and HB 2339) would further increase the costs of pensions to taxpayers by providing current beneficiaries another cost of living enhancement.
As policymakers prepare to return to Harrisburg to address pressing issues, it is time they pay attention to the “Process Improvement Theory” and attend to problems in the pension systems. Although there is plenty of blame to go around for past mistakes, proposed actions by Governor Rendell and the public school lobby will only assure that Pennsylvania’s man-made financial disasters will continue in perpetuity.
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Matthew J. Brouillette is president & CEO of the Commonwealth Foundation (www.CommonwealthFoundation.org), a public policy research and educational institute located at the foot of the Capitol in Harrisburg. For more information on this topic, see the Commonwealth Foundation’s policy report Beneath the Surface: Pennsylvania’s Looming Pension & Healthcare Benefits Crisis by Senior Fellow Rick Dreyfuss.