The Pension and Healthcare Non-Crisis

Despite the well-documented unfunded liabilities in Pennsylvania’s largest public employee pension plans (PSERS and SERS), the response from Harrisburg to the coming fiscal crisis ranges from denial to paralysis. Following the release of the February 2006 report, Beneath the Surface: Pennsylvania’s Looming Pension and Healthcare Benefits Crisis, the response was (1) a visceral reaction from the defenders of the system to the description of the situation as a “crisis”, and (2) a misappropriation of the blame for this crisis on taxpayers for “underfunding” the pension plans. Both of these responses fail to understand the problem.

The benefit improvements in Act 9 of 2001 and the refinancing of these same obligations in Act 40 of 2003 together with poor investment results led policymakers to create a pattern of contributions culminating in a significant set of sustained increases in taxpayer contributions beginning in FY 2012. This level of annual contributions is currently estimated to be about $3 billion for SERS and PSERS combined. Ironically, in the meantime, as a result of this financial engineering, coupled with the recent favorable investment results, contributions are actually projected to decline from current levels prior to 2012. Some have claimed the state has saved money by contributing less during this time while ignoring the lost investment earnings on these contributions not made. At an October 25th meeting of a special panel created to study solutions to the coming pension and retiree healthcare crisis, an astute State Representative picked up on that point and requested a quantification of the cost of this lost opportunity.

Of particular note, many defenders of the system correctly underscored the fact that the plans have exceeded the 8.5% annual investment return benchmark in recent years on a market value basis, thereby reducing expected future taxpayers costs. In fact, there was such bullishness by the defenders in response to the word “crisis” that I fully expected the annual investment assumption for SERS and PSERS would be increased to say 12%, consistent with these higher expectations. Just for the record, the national average assumption is 8.0%.

In the 2005-06 legislative session, little known House Bill 2562 sailed through the House, but did not pass the Senate. This legislation would have raised the minimum required taxpayer pension contribution levels regardless of investment performance. While it is hard to argue with the strategy of making some headway on the coming 2012 spike in contributions, the key unanswered question is, are we funding the improved pension payouts from Act 9 of 2001 (which increased the pension multiplier by 50% for lawmakers and 25% for public school employees), or are we merely prefunding the next creative way to increase pension benefits?

The answers to those questions, of course, are up to our policymakers and special interest group lobbyists. There are certainly no shortages of ideas on how to further enhance the current pension systems. The Centre Daily Times reported (December 21, 2006) that “There were more than 130 retirement-related measures introduced in the General Assembly during the recently concluded two-year session, many proposing benefit expansions that would have cost taxpayers money.”

One way to ensure adequate funding of any future enhancements would be to require full and immediate funding of the entire liability created by any new benefit improvement. For example, instead of just layering costs onto the next generation of taxpayers, funding a $3 Billion pension COLA (now referred to as a “supplemental annuity”) would require an immediate $3 Billion contribution rather than $420 million per year for the next 10 years. This strategy is consistent with the findings of the recent Auditor General’s report which recommended a moratorium on pension benefit improvements. Immediate funding is a more practical variation on that theme.

Although the taxpayers’ cost of funding SERS is part of the state’s General Fund Budget, only half of the costs of funding PSERS are paid for by the taxpayers at the state level. The remaining pension costs are allocated to the local school districts and are exempt from any taxpayer controls in Act 1, the property tax relief act passed last year. Therefore, in addition to the likelihood of higher taxes at the state level, property taxes will also increase as a result of these increasing pension costs.

Separately, it now seems there is a move afoot by some to consider changing the 8.5% investment assumption within PSERS. Given the earlier comments many are interested to learn of the amount of the expected increase in this investment assumption. However, the reality is the PSERS board is actually considering a possible decrease towards the 8.0% level. Here’s the simple equation, lower investment expectations means high expected taxpayer contributions. The word from SERS is that they are comfortable with the 8.5%, at least for now. Perhaps PSERS should consider investing some of their monies with SERS!

For some, this 8% assumption is an alternative to increasing taxpayer funding without legislative approval, or a creative way to pre-fund the 2012 required contributions or even improve benefits again. To others, it reflects the sense that the law of averages usually wins. Still others like the 8.5% just the way it is. The investment optimists referenced earlier don’t seem to be doing well in this debate. The reality is that all this political and financial discourse inevitably leads to a volatile pattern of taxpayer costs, which is one of the reasons the private sector and states like Michigan and Alaska have abandoned these types of plans in favor of the more predictable and current cost patterns of 401(k)-type plans. Is predictability and affordability of costs really too much to ask from those charged with managing our public employee retirement systems?

No matter what, citizens will be facing a continuing set of creative and non-creative ways through legislative and non-legislative means to financially engineer this non-crisis into some type of political equilibrium. Yet, it makes no sense to embark upon a financial bailout of these plans (or consider incremental reform such as a HB 2562) until lawmakers effectively manage the long-term open-ended liabilities inherent in the state’s pension plans. Based upon past experience, it is reasonable to assume every incremental dollar which increases the funds’ values either through investment gains or new taxpayer contribution will result in more than a dollar’s worth of new liabilities.

Some have suggested a hybrid plan strategy. This is nothing more than another type of defined-benefit plan. The reality is defined–benefit pension plans are magnets for poor public policy and as we have seen any benefit level can be instantly legislated into a fiscal disaster, throw in some poor investment results and yes – you have a non-crisis and another problem for taxpayers. How many times must we learn this lesson?

As if the pension crisis were not enough, this bleak outlook only gets worse when retiree healthcare benefits are also considered. The impact of statement number 45 of the Government Accounting Standards Board (GASB 45) has only begun to be quantified in Pennsylvania. GASB 45 requires governments to recognize heretofore unrecognized future retiree healthcare costs. These significant taxpayer liabilities will present even more opportunities for financial engineering. Adding another layer of financial stress, taxpayers in many local government jurisdictions throughout Pennsylvania are also facing significant difficulties with their own pension and retiree medical benefit plans.

Unfortunately, the intricacies and complexities of pensions and retiree healthcare remain rather mundane topics for most policymakers. The result is that most of the people responsible for managing the state’s pension and retiree healthcare plans are mis- or un-informed by the beneficiaries of the status quo. Hopefully, however, as citizens and concerned lawmakers become better informed about these issues, the fiscal state of Pennsylvania can be improved.

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Richard C. Dreyfuss, an actuary and pension and healthcare expert, is a Senior Fellow with the Commonwealth Foundation (, an independent, nonprofit public policy research and educational institute based in Harrisburg.