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Pension health: Is municipal reform on the way in Pennsylvania?

Widespread changes could be in mix as state's budget season nears

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Talk of pension reform in Pennsylvania often includes one big bullet point: $44 billion.

The two state-level public pension systems — the State Employees' Retirement System and Public School Employees' Retirement System — have unfunded accrued liabilities that now run north of that number, according to their latest actuarial reports.

A nearly $7 billion unfunded liability at the municipal level — Philadelphia and Pittsburgh make up all but about $1.8 billion of that total — looks like peanuts by comparison.

But the reality is that tighter state budgets and higher contribution levels in the coming years to cover growing pension debt threaten to pass more onto local governments.

And municipal budgets, funded largely by property taxes, already are spread thin dealing with arbitration awards and pension costs. On top of that, many local governments, especially core urban areas, are dealing with high levels of tax-exempt and blighted properties.

"These issues are not just local issues. They affect the core of local economies across the state," said John "Jack" Garner Jr., executive director of the Pennsylvania Municipal League, referring to collective bargaining and municipal pensions.

The PML is part of the Coalition for Sustainable Communities, a broad coalition of business and local government leaders across the state that is advocating for legislative reforms to address these major cost drivers.

With Gov. Tom Corbett's 2013-14 budget address just days away, Garner said legislation is being crafted for the early part of this legislative session to give municipal officials greater control of their pension plans.

"It will be modeled after some of the state efforts," he said.

Last year, the bulk of the pension dialogue in Harrisburg focused on a move away from defined-benefit plans in favor of defined-contribution, or 401(k)-style, plans. The private sector is dominated by this type of plan.

There also were proposals and discussions about hybrid models, including a cash balance plan. These plans generally maintain a defined-benefit system while creating a new tier.

Essentially, an employee has a retirement account also credited with interest. The cash balance plan usually provides benefits in the form of a lump-sum payment or annuity income that follows the employee.

"Conceptually, our approach was to provide for a fund that would be created in excess of interest earnings," Garner said, referring to unfunded liabilities. "If municipal earnings provide sufficient dollars to cover the accrued cost, anything in excess earned could be targeted to pay down the unfunded debt."

The governor's budget address Tuesday is expected to coincide with the administration's plans to address a number of legislative priorities. Pensions and transportation infrastructure top that list.

"Our focus will obviously be on the state employees and the public school employees," said Jay Pagni, a spokesman for the Office of the Budget. "Obviously this is a phenomenon that is repeating itself at the local level. Our hope would be that local municipalities would be able to use any reforms at the state level on a local level."

Revenue growth this year is expected to be nearly $819 million, Budget Secretary Charles Zogby said in a late-November report on pensions.

Pension costs are projected to claim about 62 percent of that, while other mandated costs also are expected to rise. Those include medical assistance, debt service and corrections.

Cost drivers, including pension obligations, add up to more than $1.3 billion in 2013-14, Zogby said, which means a $500 million shortfall.

Absent any reform, the state must continue spending reductions to balance its budget, Zogby said. That could threaten public education funding as well as public safety and transportation funding.

"Recessions always bring into crystal clarity these levels of obligations," said Sen. John Blake, Democratic chairman of the Senate Finance Committee.

The liabilities grew primarily because of down investment markets in the beginning of the last decade and the global recession in 2008. Benefit enhancements and deferral techniques that changed amortization schedules of gains and losses also contributed.

However, Blake said, he is skeptical of the Republican motives to make changes for new employees and believes Act 120 of 2010 should help ease liabilities.

"If the markets lift and perform with some greater level of stability, this conversation goes away," the minority chairman said.

Act 120 helped address an anticipated spike in pension costs by "smoothing" the increase over a longer period of time. That law also reduced benefits for new hires.

"I am concerned about the level of the alarm bell," Blake said. "If we meet our obligations and allow Act 120 to play out, we might be in better shape in three years."

Senate Democrats are crafting a package of bills under what is being called the "Growth, Progress and Sustainability," or GPS, plan to address common issues among distressed communities.

"The recession brought into stark relief the pressures local officials have to provide basic levels of service to their communities when relying almost entirely on property tax," Blake said. "This system was not built for the 21st century."

Midstate receives nearly a quarter of SERS payments

The midstate received $572.1 million, or about 24 percent, of the annual pension payments made by the Pennsylvania State Employees' Retirement System to commonwealth citizens in 2011.

In total, SERS made $2.4 billion in retirement payments to state residents that year, the latest annual data available.

Dauphin and Cumberland counties received the most in benefits by far, according to a statewide economic impact piece in the system's fall/winter newsletter.

• Cumberland: $165.5 million

• Dauphin: $258.3 million

• Lancaster: $63.7 million

• Lebanon: $35 million

• York: $49.6 million

Pension reform proposals at the state level — focused on SERS and the Public School Employees' Retirement System, or PSERS — expect to dominate the early part of the 2013-14 legislative session.

The new session will really spring to life with Gov. Tom Corbett's third budget address as governor Feb. 5.

The debate last year focused heavily on a move away from defined-benefit plans in favor of defined-contribution, or 401(k)-style, plans for new employees.

The two state systems have combined unfunded liabilities of more than $44 billion.

Pa. pension breakdown

70.3 percent*: The majority of municipal pension plans in Pennsylvania were self-insured, defined-benefit plans. These plans cover 92.2 percent of employees.

25.2 percent: Defined-contribution plans make up a quarter of municipal pension plans. However, they cover just 7 percent of employees.

27: New pension plans established since the 2009 reporting period. Nineteen of those were defined-contribution plans; five were created by closing the defined-benefit plans and establishing new plans for new hires.

68 percent: The majority of municipal pension plans have 10 or fewer members.

5.1 percent: Plans with 51 or more members.

73,974: Active pension plan members in municipal plans across Pennsylvania.

$6.98 billion: The unfunded actuarial accrued liability of all municipal government retirement systems.

*reflects 2011 pension plan data

Source: Public Employee Retirement Commission, December 2012 report

A national look

Last month, the Pew Center on the States released a report on the state of city pension and retiree health care funding.

The 61-city survey — which included the most populous one in each state plus all others with more than 500,000 people — found a gap of $99 billion for pensions in fiscal year 2009, the most recent year with complete data.

The gap continued to widen by another 15 percent in fiscal year 2010 for the 40 cities where complete data was available, according to Pew.

"There will be a turnaround point, but it won't be for a couple of years, at least," said David Draine, senior researcher at Pew. "(Typically), most state and city plans smooth out gains and losses over five years. A bad year like 2008 … it won't really be until 2013 when all losses are factored in."

The recession had a major impact on investment losses.

Pew found that cities had enough money to cover 74 percent of their pension obligations in 2009, compared with 78 percent for states.

State-run plans are falling short by $757 billion, according to a previous Pew report. Connecticut, Illinois, Kentucky and Rhode Island were the worst among states with pensions funded under 55 percent in 2010.

Pennsylvania came in at 75 percent funded in 2010 with a $29 billion funding gap, according to Pew.

"Policymakers in Pennsylvania have a long track record of not making the full contribution," Draine said. "The bill eventually comes due."

He said there is growing interest nationally in hybrid pension models to reduce costs and be more sustainable in the long run.

"I expect things to start improving in 2013, 2014 and 2015," said Hank Kim, executive director of the National Conference on Public Employee Retirement Systems, which advocates for public pensions.

Pension data from 2009 and 2010 does not paint an accurate picture of where pension plans are today, Kim said, referring to the Pew data. "We've made tremendous recovery since that low point."

The bottom was March 2009, he said.

A spring 2012 NCPERS survey of 147 public pension plans — 84 percent local plans — found a 74.9 percent average funded level. A funded ratio of 70 percent or above is considered adequate, according to Fitch Ratings.

"We think that's a good number," Kim said.

As the economy continues to rebound, so will investments, said Jordan Marks, executive director of the National Public Pension Coalition, a labor-backed group that supports public pensions.

"These are long-term investments. Over 25 years, they make money," he said.

Pennsylvania is expected to be one of the biggest pension fights of the year, Marks said.

"These are not taxpayer giveaways," he said, adding that he is concerned what 401(k)-style proposals could mean for middle-class workers.

The average annuity paid by the State Employees' Retirement System is $24,448, according to its most recent member newsletter.

The Public School Employees' Retirement System paid an average annual benefit of $24,122, according to its 2012 actuarial valuation.

Municipal plans improve slightly

Pension funds that are less than 90 percent funded are considered "minimally distressed," according to the state Public Employee Retirement Commission, or PERC.

The "moderately distressed" plans are less than 70 percent funded, while "severely distressed" plans have pension fund assets of less than 50 percent of liabilities.

In PERC's December distress score report, which is based on 2011 actuarial valuations, about 45 percent of the 1,454 reported municipal pension plans were at least minimally distressed.

That was a slight improvement from the 2010 scores, which were based on 2009 valuations. About 46 percent of the 1,438 municipal plans were distressed at some level, according to PERC.

In the 2012 report, there were 27 severely distressed pension funds compared with 26 in 2010. Minimally distressed plans increased to 499 from 474 in the new report, but moderately distressed plans decreased from 162 to 126, according to PERC.

There were 160 Central Pennsylvania municipalities, authorities and regional police departments included in the 2012 report. Of those, about 44 percent were at least minimally distressed.

Here is a breakdown of local plans by county:

Cumberland

8 minimally distressed, 2 moderately distressed, 12 not distressed. Most distressed in the county: Mount Holly Springs (67 percent fund ratio; 9 active members)

Dauphin

9 minimally distressed, 1 moderately distressed, 13 not distressed. Most distressed in the county: Susquehanna Township (61 percent fund ratio; 69 active members)

Lancaster

21 minimally distressed, 26 not distressed. Most distressed in the county: Strasburg (70 percent fund ratio; 10 active members)

Lebanon

7 minimally distressed, 3 moderately distressed, 1 severely distressed, 13 not distressed. Most distressed in the county: Swatara Township (42 percent fund ratio; 3 active members)

York

16 minimally distressed, 3 moderately distressed, 25 not distressed. Most distressed in the county: York (62 percent fund ratio; 357 active members)

DCED becomes more proactive

Hoping to limit the number of fiscally distressed municipalities in its Act 47 program, the state Department of Community and Economic Development is being proactive.

DCED last year was able to get funding for its early intervention program — a pre-Act 47 initiative that aims to diagnose and fix the problems before they get worse — more than doubled for the current fiscal year.

The program is funded at nearly $1.8 million, up from $685,000.

Early intervention provides match grant funding up to $100,000 so municipalities can bring in a consultant and develop short- and long-range financial plans.

"It opens a municipality's eyes to where the current budget situation is and where they are headed if they don't make changes," said Steven Kratz, a DCED spokesman.

Since 2004, 11 counties, 27 cities, 15 boroughs and seven townships have participated in the early intervention program. Only four — Nanticoke, New Castle, Reading and Harrisburg — have entered Act 47, Kratz said.

"Certainly legacy costs are part of it," he said, adding that distress factors run the gamut.

Shrinking tax bases and high levels of tax-exempt property, crumbling infrastructure and increasing health care costs are common issues among local governments, especially urban communities. Collective bargaining and poor long-term financial planning are other factors.

"Every municipality is different," Kratz said. "It can be a combination of things. The recession certainly hit municipalities hard."

He said he doesn't expect DCED's budget request for the early intervention program to be lower than its current total. That request will likely be finalized by the time Gov. Tom Corbett addresses the legislature Tuesday, Kratz said.

"Over time, we would like to see more municipalities in early intervention as opposed to Act 47," he said.

Jason Scott

Jason Scott

Jason Scott covers state government, real estate and construction, media and marketing, and Dauphin County. Have a tip or question for him? Email him at jasons@cpbj.com. Follow him on Twitter, @JScottJournal. Circle Jason Scott on .

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