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PENSION CRISIS: Finding the path to reform

With $41B in unfunded liabilities, reforms expected to dominate 2013 headlines in Pennsylvania

Gov. Tom Corbett has coined it the “tapeworm” and the “Pac-Man” of the budget.

Whatever the term, the commonwealth’s rising pension obligations make it likely everything else in future budgets runs the risk of “starving,” a top Corbett administration official said.
“We’re not borrowing, and the governor has said he is not going to raise taxes. That leaves one lever: cut spending,” Budget Secretary Charles Zogby said.
Emaciated state budgets could further shift the cost burden to municipal governments and school districts. That means higher taxes or significant restructuring at the local level, making it more difficult to do business in Pennsylvania.
“The business community is very interested and involved in this issue and is watching it very closely,” said Sam Denisco, vice president of government affairs for the Pennsylvania Chamber of Business and Industry.
The latest solution suggestions borrow ideas from the private sector — moving to defined-contribution, or 401(k)-style, retirement plans — while turning off the tap to stop the floodwaters of defined-benefit plans from rising any higher.
“There is a reason the private sector did away with the defined-benefit plan. It’s just not sustainable and not affordable,” Denisco said. “But I don’t see (how) just moving to a defined-contribution plan will solve it, because of the unfunded liability.”
That debt still will be owed, and where the money for it will come from is anybody’s guess.
“I don’t think any policymaker can cut their way to solving that,” Denisco said. “We don’t want that to fall on the backs of job creators.”
Not so rosy
On one hand, Pennsylvania’s revenue is projected to grow about $800 million, Zogby said. On the other, the commonwealth’s share of the employer contribution to its two primary pension plans is slated to increase by $668 million in 2013-14.
The state contribution to the Public School Employees’ Retirement System, or PSERS, will be $1.23 billion in the next fiscal year. That will be up from the current $856.1 million, which jumped from $600.2 million in 2011-12.
The commonwealth’s contribution to the State Employees’ Retirement System, or SERS, will be $971.3 million in 2013-14. That total increases from $677.4 million this year, which was an increase of $209.3 million over 2011-12.
As it stands now, pension obligations are about 5.5 percent of the current $27.66 billion budget. The projected PSERS share alone exceeds that total by 2014-15, according to the Office of the Budget.
The two public pensions have an unfunded liability that totals more than $41 billion.
Add in mandated cost growth in areas such as medical assistance, corrections and debt service, and any projected net gains in revenue are gone, Zogby said.
In fact, the “new normal” projections for 2013-14 have the added costs, including pensions, at $1.3 billion.
That number comes from a circular on budgetary guidelines that went out to all state agencies and departments in August. The administration estimates debt service will increase by 7.5 percent, while medical assistance and corrections are expected to increase by 6 percent and 3.5 percent, respectively.
“The reality is that, unless we do something to change the cost growth in those areas, we’ll have to go into the general fund budget and find $500 million elsewhere to cut just to balance it,” Zogby said.
Pension reform is one way to affect the general fund in a positive way, he said. But crafting a bipartisan solution to pay down legacy costs has not been on the Legislature’s front burner in discussions this year.
“I think it’s fair to say the level of dialogue has not yet shifted to options for reform,” Zogby said.
The governor is expected to address the pension crisis in his next budget proposal, the budget secretary added. Everything will be on the table.
“I think the governor is concerned we’re on a path where he can’t make the investments in, say, education or other areas of the budget that he deems a priority,” he said. “He can’t cut taxes in a way he likes and believes will make the business climate more competitive.”
Economic development and job creation remain paramount to the debate, he said.
“Clearly, we’ve got to get this economy growing,” Zogby said. “Any state is going to be tethered in large part to a national economy whose performance is not dictated here in Harrisburg.”
Future costs
The bulk of the pension focus in the 2011-12 legislative session has been on future liabilities and changing the way the state pays for new workers.
Many of the current reform proposals aim to move away from pension plans in favor of 401(k)-style options.
The private sector has gradually shifted from pensions as a better way to control costs. Defined-contribution plans provide the state with more-fixed costs and put more of the burden on employees to increase contributions as they age.
“We need to stop adding people to the current system. I don’t believe the taxpayers should bail out the plan when the market tanks,” Rep. Warren Kampf, a Chester County Republican, said at a joint House committee hearing last month.
Kampf has proposed twin bills that would require new state and school employees to enroll in defined-contribution plans. Existing employees would be incentivized to freeze their pensions and move to the new plan.
“The defined-contribution plan is the better plan going forward, because the liability doesn’t continue to grow,” said Andrea Caladie, a partner in Philadelphia-based ParenteBeard’s Wilkes-Barre office. “But the risk does shift to the employee.”
Other bills on the table include a hybrid approach that would create a “cash balance” plan, which would keep the defined-benefit system in place while creating a new tier.
That new tier would provide an annuity for retirees equal to the amount of their account balance. The cash balance would follow the employee and could be rolled into a 401(k) plan, said Rep. Scott Boyd, R-Lancaster County, the bill’s sponsor.
But the underlying question remains: What about the current cost of benefits, which are protected by the state constitution?
“Changing the level or system of benefits going forward will not change the level of debt already incurred,” David Durbin, SERS’ executive director, said in testimony at the August hearing.
Neither SERS nor PSERS takes a position on legislation. They are the technical experts that help with drafting and identifying policy issues.
“I think the debate is not fully formed enough,” Heather Tyler, SERS’ director of communications and policy, said about a front-runner at this point. “The list of pros and cons for any system will be long. It’s not inherently that one system is better.”
The question policymakers need to answer, she said, is this: What is right for Pennsylvania taxpayers?
2010 change
Lawmakers made a change nearly two years ago with the passage of Act 120. That law reduced benefits for new hires and reamortized the unfunded liabilities, which delayed an even steeper spike in state contributions.
If the commonwealth honored the prescribed payment schedule under Act 120, the systems could get back to being fully funded over several decades, Tyler said.
However, pension spending would occupy an unsustainable proportion of the budget.
“Ignorance is a big cost of government,” said Richard Dreyfuss, a senior fellow with the conservative-leaning Commonwealth Foundation. He considers Act 120 to be nonreform because it just delayed paying what is still owed.
The unfunded liabilities are likely much higher than the estimates due to optimistic assumptions on investment returns, Dreyfuss said.
He is advocating for lower investment assumptions and shorter amortization periods. The reforms would have to be coupled with at least $2 billion more per year in general fund spending to cover current obligations, Dreyfuss said.
Funding reform is just as essential as plan reform, he said.
Stephen Herzenberg, executive director of the left-leaning Keystone Research Center, has warned lawmakers not to emulate “the erosion of retirement security in the private sector” by switching to defined-contribution plans.
Preliminary analysis of proposed bills suggests defined-contribution plans will slightly increase retirement costs due to higher plan-management fees, he has said.
A combination of solutions that requires substantial funding infusions and consistently higher levels of employer funding over time to make up for long-term underfunding is the obvious answer, according to PSERS. Finding the money remains the challenge.
PSERS Executive Director Jeffrey Clay said he believes that, with their backs against the wall, policymakers will pass some sort of reform.
With a limited number of session days this fall, lawmakers and Corbett have punted pension debate to 2013.
“There is definitely going to be a major push next year. When a gun is put to their head, they do try to get things done,” he said.
Business leaders are optimistic the can kicking will come to an end.
“I have a lot of hope,” Denisco said.
But again, the sidebar is that, while the state might not have the appetite for tax increases, local school districts could be forced to propose bigger tax hikes and program cuts to cover pension costs. Some of that already is happening.
“You can see the public pressure. It plays out here in Harrisburg, but every school district is dealing with this as well,” Zogby said. “This is a very predictable path we’re on, absent any reforms.”
While PSERS is a cost-sharing, multiemployer plan, every school district is affected differently as it faces unique challenges over revenue and expenses.
“If nothing happens, it just pushes it off further in the future,” said Eric Montarti, senior policy analyst for the Pittsburgh-based Allegheny Institute for Public Policy.
And another major policy issue — transportation funding, for example — might crop up and demand attention, he said.
“If it comes together and doesn’t happen, it might never happen,” Montarti said.

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