Pennsylvania faces a serious and 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.
At a recent event in Harrisburg, covered by the Pittsburgh Tribune-Review, several experts debated how Pennsylvania could reform its public pension system and slow rising unfunded liabilities. Eric Montarti, a senior policy analyst with the Allegheny Institute for Public Policy, pointed out the shortfalls for the two pension systems is about $18 billion for state employees and $35 billion for school teachers.
At the meeting, Joseph Weale, deputy director of the state’s Department of the Auditor General, made several common-sense recommendations to reform the state’s pension problems. Weale’s first recommendation is to change a state law that allows actuaries to assume up to 9 percent annual returns on pension investments, a serious problem for many state pension programs.
If the estimated rate of return for the 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 SERS and PSERS is 7.5 percent. The pension system for municipal workers uses a lower but still excessive rate of 6 percent. These are far too generous, according to PSERS’ own data, the pension fund’s rate of return on its investments for the fiscal year ending June 30, 2015, was only 3.04 percent. Pension experts recommend states use an expected investment return rate of 3.1 percent, which is based on 30-year U.S. Treasury bond yields.
In addition to the proposed changes to the expected rate of return, Weale also proposed increasing the age where workers can collect public pensions, a widespread consolidation of over 3,000 local pension funds, and the creation of a limit regarding how overtime pay is factored into retirement payment calculations.
Pushing pension reform onto future generations is not a prudent or realistic option. Numerous studies have found Pennsylvania’s pension system is one of the worst in the country. In November 2014, State Budget Solutions released a research report that used a fair-market valuation based on a discount rate of 2.743 percent. It found in fiscal year 2013 Pennsylvania had a per capita pension debt of $14,235 and a funded ratio of 32 percent. A 2015 study by the National Association of State Retirement Administrators found Pennsylvania has the second-most underfunded pension plan in the United States.
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 a 2013 report, the Commonwealth Foundation, a Pennsylvania-based think tank, 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.
The State Public Pension Crisis: A 50-State Report Card
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.
Ten Facts on Pension Reform
The Commonwealth Foundation outlines 10 facts people should know about pension reform in Pennsylvania. “Pension costs are ballooning, threatening to consume funds for education, public safety and welfare. Without timely reform, Pennsylvanians will face cuts to services, teacher layoffs, and higher property taxes. Yet there is widespread confusion about the impact of pension reform.”
Stopping the Sinkhole
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 Limits of Retrenchment: The Politics of Pension Reform
Daniel DiSalvo of the Manhattan Institute examines pension reform and argues states that are serious about keeping pension costs under control are increasingly introducing defined-contribution options or hybrid plans. As more states take this step, it will become less controversial and easier for other states.
Keeping the Promise: State Solutions for Government Pension Reform
This report from the American Legislative Exchange Council describes the variety of pension plans governments use today and the advantages and disadvantages of each plan. It also provides several tools legislators can use to ensure governments can affordably fund retirement benefits for their employees.
Research & Commentary: 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
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
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
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
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
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.
Fixing the Public Sector Pension Problem: The (True) Path to Long-Term Reform
Richard C. Dreyfuss of the Manhattan Institute examines various state pension reform efforts and recommends states borrow a page from the private sector by shifting to defined-contribution plans: “Under such plans, to which employees as well as employers may contribute, investment risk is borne by plan members, not by taxpayers. A majority of Fortune 100 companies have already adopted such plans. Only 16 percent of large companies still offer their retirees medical coverage. By sharing a complex of risks with the beneficiaries, states and municipalities would be able to devote far more of their time and resources to the more immediate concerns of today’s voters and taxpayers.”
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 website at https://heartland.org/publications-resources/newsletters/budget-tax-news, The Heartland Institute’s website at http://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 State Government Relations Manager Logan Pike at [email protected] or 312/377-4000.