Policy Documents

Research & Commentary: Pennsylvania Pension Reform

July 29, 2014

Like many other states, Pennsylvania faces a growing problem with its public pension systems. According to Pennsylvania’s own estimates, the total unfunded pension liability is set to grow by 38 percent, to $65 billion, in 2018. The funding for all three major pension plans is also low — the Public School Employees' Retirement System (PSERS) was 59.2 percent funded at the end of 2013, and the State Employees' Retirement System (SERS) was 66.3 percent funded on June 30, 2012, according to Pensions & Investments.

The Commonwealth Foundation, a Pennsylvania-based think tank, released a report in November 2013 which examined the overall cost of Pennsylvania’s pension system for the state's taxpayers. The report found state and school district contributions to the pension system would rise from $2.5 billion in 2012 to $6.2 billion in 2016-2017. This increase would cause a significant rise in property taxes, especially in the Philadelphia region.

The pension reform proposal currently receiving the most attention in Harrisburg is a “hybrid” pension plan sponsored by State Rep. Mike Tobash (R-Schuylkill). Under the hybrid plan, state or school districts would contribute to a defined-benefit pension plan for employee earnings up to $50,000 for the year and the first 25 years of government service. Additionally, employees would be entered into a 401(k)-style defined contribution plan. The Commonwealth Foundation cautions maintaining such a large amount of defined benefit entails a great deal of financial risk. 

Increasing pension liabilities are further complicated by the reality that regulators controlling pension funds, in many instances, have overestimated the value of future investments and the rate of return they can expect from investments held by the pension fund. Regulators rely on strong investment return forecasts to reduce yearly government contributions to the fund. If the estimated rate of return for these pension funds continues to fall short of expectations, the state’s pension systems may be in even more trouble than is currently thought. 

The current rate used by ERS and PSERS is 7.5 percent. The pension system for municipal workers uses a lower but still excessive rate of 6 percent. Pension experts recommend states use an expected investment return rate of 3.1 percent, based on 30-year U.S. Treasury bond yields. 

Taxpayers cannot afford for states to continue overpromising and underfunding their pension plans. In the short term, states should change pension formulas, curtail automatic cost of living adjustments (COLAs), adjust pension rate of return assumptions to more realistic levels, and require workers to make higher contributions. 

In its 2013 report, the Commonwealth Foundation urged lawmakers to work on effective pension reform and emphasized the need to move away from defined benefit systems and toward defined contribution plans. To protect both taxpayers and public workers long term, Pennsylvania must follow the private sector’s model and switch workers from defined-benefit pension systems to defined-contribution plans, such as 401ks. Defined-contribution gives retirees direct control over retirement nest eggs and enables them to move in and out of the private sector without losing accrued pension benefits. It also allows governments to budget more accurately, because the benefits are paid directly to the employee and are a defined amount of money each year. 

The following articles examine state pension reform from multiple perspectives.
 

Stopping the Sinkhole
http://heartland.org/policy-documents/stopping-sinkhole-lessons-pension-reform-pennsylvania
Commonwealth Foundation argues evidence from the private sector and some reformed public sector pension programs shows pension reform is possible and creates significant savings to firms in the private sector and taxpayers in the public sector. Private firms, while enjoying more flexibility than public pension programs in implementing reforms, still face many of the same challenges as public sector actors. “Therefore, as Pennsylvania considers reform, it is useful to examine the pension reform trend for insights about possible costs of reform and understand the ‘best practices’ of pension reform,” the report states. 

The State Public Pension Crisis: A 50-State Report Card
http://heartland.org/sites/all/modules/custom/heartland_migration/files/pdfs/27578.pdf
This Heartland Institute report examines problems facing public pension systems, including the enormous burdens public employee pensions pose in some locations. The report ranks each state according to the operation and relative disposition of the pension plans and suggests ways states might go about solving pension problems. 

Bipartisan Panel Backs Hybrid State Pension Plan
http://articles.philly.com/2014-05-30/news/50185712_1_pension-crisis-state-and-school-employees-public-employee-retirement-commission#zjzpVd4LXy15xC8y.99
Amy Worden of the Philadelphia Inquirer examines the proposed hybrid pension system plan for Pennsylvania state and school employees. The plan was supported by a bipartisan panel, and Gov. Tom Corbett (R) has said he would support it. 

PEL Expert Promotes Pension Reform
http://thetimes-tribune.com/news/pel-expert-promotes-pension-reform-1.1682371
Writing in the Times-Tribune, Richard Dreyfuss, an actuary and senior fellow with Commonwealth Foundation, outlines a five-step plan for pension reform. 

Research & Commentary: Defined Contribution vs. Defined Benefit Pensions
http://heartland.org/policy-documents/defined-contribution-vs-defined-benefit-pensions
John Nothdurft, director of government relations at The Heartland Institute, provides a bullet-point comparison of defined-benefit pension and defined-contribution retirement plans. 

Triple Threat Pension Debt
http://www.commonwealthfoundation.org/issues/detail/triple-threat-pension-debt
This infographic from Commonwealth Foundation outlines three major threats posed by pension debt: “At more than $50 billion in debt, our pension plans for state and school workers are among the worst funded in the country. Without reform, Pennsylvanians face cuts to services, teacher layoffs, higher property taxes, and even seeing cities go bankrupt. These dire threats make pension reform urgent.” 

Keeping the Promise: State Solutions for Government Pension Reform
http://heartland.org/policy-documents/keeping-promise-state-solutions-government-pension-reform
The American Legislative Exchange Council describes the variety of pension plans that governments use today and the advantages and disadvantages of each. It also provides several tools legislators can use to ensure governments can affordably fund retirement benefits for their employees. 

The Real Cost of Public Pensions
http://heartland.org/policy-documents/real-cost-public-pensions
Jason Richwine discusses how to calculate the cost of public defined-benefit pension plans, compares the cost of these benefits to private-sector retirement plans, and refutes two of the most common arguments that attempt to prove public pension benefits are modest. 

Research & Commentary: Public Pensions and the Assumed Rate of Return
http://heartland.org/policy-documents/research-commentary-public-pensions-and-assumed-rate-return
Heartland Institute Senior Policy Analyst Matthew Glans examines problems facing state and local pension funds, how assumed rates of return affect pension fund debt, and proposals to change projected rates of return on pension fund investments. 

The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform
http://heartland.org/policy-documents/gathering-pension-storm
The Reason Foundation discusses the looming crisis created by states’ continued use of defined-benefit pension plans, offering solutions and explaining why the current system is a disaster in the making.

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News Web site at http://news.heartland.org/fiscal, The Heartland Institute’s Web site at http://www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org

Whether sending an expert to your state to testify or brief your caucus, hosting an event in your state, or simply sending you further information on a topic, The Heartland Institute can assist you. If you have any questions or comments, contact Heartland Institute Senior Policy Analyst Matthew Glans at mglans@heartland.org or 312/377-4000.