Lawmakers focus on making Pennsylvania School Employees’ Retirement System hike sustainable.
Published: Tuesday, July 06, 2010
By ALEX ROSE
arose@delcotimes.comThe Pennsylvania House of Representatives overwhelmingly approved a bill early last month meant to make a looming pension crisis somewhat more bearable, at least in the short term.
But whether the fiscal gimmicks contained in the bill would actually do any good in the long run — or stand up in the state Senate — is still up for debate.
Without legislative action, Delaware County school districts are facing a total $98.5 million in pension funding payments by the 2013-14 school year, according to an analysis performed by the Delaware County Intermediate Unit.
And that figure only represents the district share even after the state pays for half of what is owed.
But House Bill 2497, which was sent to the Senate Finance Committee on the strength of a 192-6 vote, would “smooth” those payments out over 30 years while placing gradually increasing caps on employer contributions.
The standard analogy is that it’s like refinancing a mortgage. The idea is to reduce the shock to the system that would have forced districts to implement double-digit tax increases just to keep up with multimillion pension payments over the next five years, while reducing strain on a state already cutting services just to balance the budget.
There are two major pension systems administered by the state - the Public School Employees’ Retirement System, which mostly covers teachers, and the State Employees Retirement System.
There are about 547,000 active and retired members in PSERS, for which it paid $4.9 billion in benefits for fiscal year 2009. There are 220,097 SERS members with an average annual benefit payment of about $22,000.
Both systems are defined contribution plans funded by a combination of employer and employee contributions, but mostly through returns on investments in the stock market.
The employer contribution rate is tied to investment performances, so the better the market does, the less employers have to contribute. In 1986, the PSERS employer contribution rate was 20 percent. By 2001, it was 1 percent.
Following substantial investment returns in the 1990s, Gov. Tom Ridge signed Act 9 into law in 2001, which gave most legislators a 50 percent increase in pension benefits. School and state employees saw their benefits go up by 25 percent. Retirees also received a 25 percent cost-of-living allowance increase the following year.
But the market quickly turned and by early 2003, employer contributions would have had to skyrocket to keep up with the increased pension obligations.
So Gov. Ed Rendell signed into law Act 40, which artificially suppressed those payments for 10 years with the hope the market would rebound enough to cover the increased costs.
And it appeared to be working -- for a while anyway. But the market tanked again in 2008. The value of PSERS investments fell 29.7 percent. State Employees Retirement System investments dropped 28.6 percent.
Public School Employees’ Retirement System employer contributions were again expected to catapult from the current 4.78 percent to 29.22 percent by 2012-13. That rate would hit a 33.6 percent peak in 2015, remain above 30 percent until 2020, and stay well above 20 percent until 2033.
State Employees Retirement System contributions were also expected to jump from 8 percent in 2012 to 26.66 percent in 2013 and stay above 20 percent until 2032.
“You can’t make these rate increases go away because the rate increases are a result of unfunded liabilities in both systems, and that unfunded liability is debt that has to be paid,” said SERS spokesman Robert Gentzel. “But under the current methodology, rates are going to jump very drastically. … By putting the collars on, you would limit those year-to-year increases. They would still go up, but they would go up in steps.”
As the bill stands now, the rate increases would go from 1 percent in 2010-11 to 3 percent in 2011-12. The cap would go to 3.5 percent in 2012-13 and 4.5 percent in 2013-14, where it would remain until the employer cost no longer hit that mark.
Gentzel said that by 2015, the costs to the state and school districts are projected to come in under that cap, after which contributions will be given a floor of the “normal cost” — the amount need to cover benefits paid to active members for that year.
According to an actuarial note from the Public Employee Retirement Commission accompanying the bill, PSERS employer contributions would spike at about 26 percent in 2024.
But that help, such as it is, would only work in the short-term. Over 30 years, the total cost to maintain PSERS would be about $21.5 billion.
For SERS, HB 2497 would cap the 2011 rate at 5 percent. This would also make the funding more manageable in the short term — with an increase to 20.5 percent in 2015 instead of 27.72 percent — but would ultimately cost $5.3 billion.
Funding ratios under HB 2497 would also suffer.
Public School Employees’ Retirement System funding ratio in 2009 was 79.2 percent, which would drop to a low point of 54.2 percent in 2013 under current law. All things remaining equal, the fund would be nearly fully funded by 2040.
Implementing HB 2497 would stave off that low point to 2019, at 51.6 percent, but it would only come back up to 87.7 percent fully funded by 2040.
For SERS, funding ratios in either scenario don’t go below 61 percent and are nearly fully funded by 2040 — though under current law the pension is 90 percent funded by 2032, a mark not hit under HB 2497 until 2039.
All of this, however, is based on a large number of assumptions, said Gentzel, including an 8 percent rate of investment return, payroll growth, inflation, mortality rates, retirement numbers, specific retirement benefits and so on.
“You’re trying to look into the future, so you pretty much have to rely on some assumptions,” he said. “The one thing I can tell you with absolute certainty is these are not going to be the actual numbers when we get (to 2040).”
The bill also changes both systems by raising the retirement age to 65, increasing the “vesting period” from five to 10 years and changing the multiplier for benefit calculations from 2.5 percent to 2 percent.
Public School Employees’ Retirement System members currently contribute 7.5 percent of their salaries to the system on average, while SERS members contribute 6.25 percent.
Public School Employees’ Retirement System members could still receive the 2.5 percent multiplier, but they would have to contribute 10.3 percent. State Employees Retirement System members would pay 9.3 percent.
Retirees would also no longer be able to withdraw their own contributions in a lump-sum payment upon retirement in exchange for reduced benefits.
Because changes to pensions legally cannot be made retroactively, this would only affect new employees. For SERS, that means anyone hired after Dec. 31, 2010 and June 30, 2011, for PSERS members.
Gentzel said SERS had done a lot of analysis with the issue and worked with multiple legislative committees in both chambers and both caucuses to help draft the bill.
Neither SERS, nor PSERS offer suggestions or opinions as to what the Legislature should do; they simply offer scenarios based on assumptions.
Gentzel warned that depriving pensions of funds to invest would likely result in continually lessening returns, even in a good market, but said there really was no alternative but rate collars to deal with the impending spike.
As to the long-term, Gentzel pointed to the “normal cost” calculations for employers, which would gradually decline as new members earning reduced benefits are added into the system. For SERS, the normal cost is currently 9.5 percent.
“Under this legislation, the employer normal cost for these new employees would be 4.8 percent, so the bill cuts employer normal cost in half,” he said. “Are there other benefit reductions you could do, other changes you could make? Yes, there are.”
But whatever your druthers might lean toward defined benefit or defined contribution plans, said Gentzel, “You still have to concede it’s a pretty substantive package.”
Of course, not everyone agrees it’s the right way to go.
The Pennsylvania State Education Association, representing more than 191,000 public school teachers and support professionals in the state, officially endorsed HB 2497 as a “balanced solution” to the pension crisis.
“It eliminates the pension spike that has been looming for 2012-2013, and PSEA and many of the other public employee unions actually got behind and endorsed some benefit changes that were included in the legislation that will substantially lower the cost of future benefits,” said Steven Nickol, assistant director of PSEA-Retired.
Nickol said the education association realizes it has a vested interest in trying to get around the rate spike because the less school districts have to work with, the more that could translate to program cuts and furloughs.
While the bill would make substantial cuts to member benefits going forward, saving about $25 billion over 30 years, the overall cost of deferring debt would come to $52 billion, which is where the nearly $27 billion price tag comes from.
Pennsylvania School Boards Association Assistant Executive Director Tim Allwein said that makes the proposal “a short-term plus and a long-term minus.”
“This bill is basically a payment deferral,” said Allwein. “It makes some headway for the short term, but for the long term the system is still unsustainable. …We think there’s more that needs to be done and the key in our view is there needs to be structural changes made.”
Allwein said he simply could not embrace a plan that is essentially the same model put in place in 2003, when that clearly has not worked out.
The school boards association offered its own “hybrid” plan in Senate Bill 1185, which never made it out of committee. Among other things, SB 1185 would have rolled the multiplier back to 1 and instituted a defined contribution pension system for new hires.
In defined benefit plans (the kind currently in place), the risk of low investment returns is squarely on the employer, which is obligated to make member pension payments regardless of asset performance.
Defined contribution plans are basically the same as 401(k) plans in the private sector. They maintain individual investment accounts for each member, meaning the risk of poor asset performance is significantly higher for the employee.
The changeover to a defined contribution plan was something state Rep. Steve Barrar, R-160, of Upper Chichester, said he wanted in the bill.
“I didn’t think the bill did enough to address the true seriousness of the pension crisis that we’re currently in,” said Barrar, one of the six House members to vote against the bill.
Barrar said House Republicans tried to include the kind of measures the school boards association was looking for, but their amendments were ruled out of order for lack of financial note attachments. His vote was in protest of that process.
“I felt our vote was more a symbolic vote, so we could go tell the taxpayers, ‘Hey look, we did something!’” he said. “But the something we did wasn’t good enough.”
The education association is squarely against implementing a DC plan moving forward. One needs only look to the market crash of 2008 to understand why.
But Nickol said doing so could also have the unintended consequence of actually accelerating the rate of payments employers would have to make to fund the already accrued debt.
“If you close off the plan and put all new hires into a new contribution plan, effectively your payroll starts to shrink,” he said. “If you didn’t have unfunded liabilities, you wouldn’t have the same problems with the change over. … It’s not the normal cost of retirement benefits that’s driving the rate spike, it’s the unfunded liabilities, the debt that’s been accumulating over the last 10 years, that will have to be paid off regardless of how you fund benefits.”
Education association Spokesman Wythe Keever was not available for this story, but previously said switching to a defined contribution plan could also result in increased administration costs because each member would have an individual fund, likely managed by an outside firm.
Education association President James P. Testerman additionally told the state Senate Finance Committee earlier this year that cutting retirement benefits for new employees would make it more difficult to recruit and retain new teachers going forward.
But intermediate unit legislative council Chairman Lawrence A. Feinberg, who has been studying the pension crisis, said he doesn’t buy that argument.
A pension is the last thing on the mind of a 25-year-old starting a career as an educator, said Feinberg, and research still needs to be done to determine just how much overhead or administration costs would actually increase with a switch to a defined contribution plan.
He agreed with Allwein’s assessment that the bill does little to address the underlying problems in the system, such as unsupportable Cadillac pension plans for public employees that the private sector has long since abandoned.
“I think they still need to look at talking about a sort of hybrid plan,” said Feinberg. “We’re still hoping that at some point there may be some other funding stream and we also are hoping the discussion as to the type of benefit plan is not put on the shelf.”
Allwein said his organization would “absolutely” be petitioning the Senate to retool the bill with that in mind.
Erik Arneson, a spokesman for Senate Majority Leader Dominic Pileggi, R-9, of Chester, said he expects the Senate will take the bill up by the fall.
“The Senate Finance Committee has started looking at all those options as well as some other potential ways to reduce costs,” he said. “Once we have the benefit of that full analysis then the Senate will be in a position to take action on that bill.”
State Sen. Ted Erickson, R-26, of Newtown, said his proposal to allow small games of chance in taverns at a 30 percent tax rate could be part of that analysis.
That tax could generate between $100 million and $200 million annually, he said, which could be funneled into the pension system.
Erickson said there is also a proposal to have the pension systems buy whole life insurance policies for their members, which could then be entered on the books as assets for their total value over time, not the value at point of purchase.
It’s essentially like buying a commemorative plate from the Franklin Mint that is “guaranteed to increase in value,” then claiming in 2010 that it should be viewed as an asset under its 2040 worth.
Gary Tuma, press secretary for Gov. Ed Rendell, said if HB 2497 were to leave the Senate looking more or less the same as it did leaving the House, the governor would likely sign it.
Tuma would not say, however, whether a defined contribution or hybrid plan being added to the bill would be a deal breaker for Rendell, who is in the final year of his term-limited role as governor.
“That’s more of a philosophical discussion,” said Tuma, though he added Rendell does think that discussion should take place.
