Pennsylvania’s public-pension systems face growing and serious problems. According to Pennsylvania’s own estimates, the state’s total unfunded pension liability is set to grow by 38 percent, to $65 billion, in 2018. The funding levels for all the state’s major pension plans are also low. The state’s Public School Employees’ Retirement System (PSERS) was only 58 percent funded at the end of 2015, according to a study by the Wisconsin Legislative Council. The State Employees’ Retirement System (SERS) was just 58.7 percent funded in 2015, according to its 2015 actuarial report.
Pennsylvania is now considering a proposal that would offer new state employees three retirement-plan options. Two of these plans would utilize a side-by-side hybrid model, with a portion of beneficiaries’ contributions going toward a traditional defined-benefit plan and another portion paid into a defined-contribution, 401(k)-style plan. The Independent Fiscal Office has estimated the proposal would save taxpayers about $2.6 billion over the next 30 years.
The larger side-by-side plan splits 8.5 percent of an employee’s compensation between the two plans, while the smaller uses a 7.5 percent rate.
The third plan that would be offered is a defined-contribution model, in which employees would be required to contribute 7.5 percent of their compensation to a 401(k) plan. Another key provision would give current employees the option to opt-in to the hybrid plan or 401(k)-only plan.
The vesting periods for the defined-benefit component of the hybrid plans would be set at five years of service credit for PSERS members and 10 years for SERS. The plan would also eliminate the “Rule of 92” provision, which allows employees to retire when their age and years of service add up to 92. Under the new model, employees retiring before the age of 67 would not receive full pension benefits.
Elizabeth Stelle of the Commonwealth Foundation argued in a recent article for Commonwealth these reforms would be a good first step for Pennsylvania. “The side-by-side hybrid is not perfect, but it satisfies three important goals,” Stelle wrote. “It shifts future financial risk away from taxpayers; it enhances choice and portability for new state and public school employees, and it slows the accumulation of taxpayer-backed pension debt.”
Stelle also notes defined-contribution reforms are popular with the public. A poll conducted in October 2016 by Commonwealth found 54 percent of voters – 67 percent of Republicans, 51 percent of Independents, and a plurality of Democrats – support placing new state employees in a 401(k)-style retirement plan.
In another article, the Commonwealth Foundation also highlights a major problem with Pennsylvania’s pension system: its overly optimistic projections for the returns on its pension-fund investments. Commonwealth pointed to recent data from SERS as proof. SERS recently announced a 6.5 percent investment return for 2016, a full percentage point short of its previous projection.
This isn’t only a problem for SERS. 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. If the 7.5 percent rate of return continues to fall short of expectations, the state’s pension systems may be in even more trouble than is currently thought.
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, adjust pension rate of return assumptions to more realistic levels, and require workers to make higher contributions.
The following articles examine state pension reform from multiple perspectives.
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.”
Not So Modest: Pension Benefits for Full-Career State Government Employees
Examining the benefits paid to state and local government employees, Andrew Biggs of the American Enterprise Institute argues drastic benefit reductions for current retirees would be unfair, but reforms to make public- and private-sector pensions more equitable should be on the table.
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.
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.
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.”
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.
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, and The Heartland Institute’s website at http://heartland.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 the topic, Heartland can assist you. If you have any questions or comments, contact Heartland Institute Director of Government Relations John Nothdurft at [email protected] or 312/377-4000.