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PA’s pension debacle raises fears of higher taxes

By   /   February 24, 2012  /   4 Comments

Unfunded mandate of $40B has to be dealt with regardless
By Eric Boehm | PA Independent
HARRISBURG — With Pennsylvania facing a $40 billion unfunded liability for public pensions, lawmakers said their constituents are starting to ask them questions and demand answers.

And those questions, in turn, were directed at the heads of the state’s two pension systems — the State Employees Retirement System, or SERS, and the Public School Employees Retirement System, or PSERS — who were before the House and Senate Appropriations committees on Thursday for a pair of budget hearings.
“Constituents are coming to us and they are frustrated about this situation, and they can’t afford to pay any more taxes,” said state Rep. Scott Petri, R-Bucks.
Petri asked the pension fund directors if the state could address pension costs by switching to a defined contribution plan for future employees and "take the bullet" on the existing unfunded liability.
The pension fund directors warned that such a transition will be costly if the unfunded liability is not eliminated first.
“Each time you switch to a new tier of benefits, you can’t take care of the unfunded liability without satisfying it,” said David Durban, executive director for SERS.
In a defined benefit system, pensions are calculated based on a formula that includes years worked and highest salary. In a defined contribution plan, the pension is the result of contributions made over time by the employer and employee, but is not tied to a specific formula.
State contributions to a pair of public pension funds will increase by 600 percent in the next five years. The costs will continue to grow for the next decade, as the state makes up for a decade of underfunding the pension systems and the investment losses of 2008.
Because courts have ruled that benefits earned by current or retired workers cannot be changed retroactively, any changes to the pension benefits would apply only to future hires.
Under the current system, the unfunded liability can be paid off indefinitely, since there will always be new workers joining the system and the state will continue making contributions to the funds as well.
PSERS is facing a $26.5 billion unfunded liability, which accounts for about 30 percent of the fund’s value. SERS has a $12.5 percent unfunded liability, which is also about 30 percent of the fund’s value, because the overall size of the fund is smaller.
If the General Assembly voted to create a defined contribution system for new hires, the current unfunded liability would have to be paid off before the last current worker in the system retires, probably in about 30 years or so, said Jeff Clay, executive director for PSERS.
“You need to accelerate the recognition on that unfunded liability, so instead of reducing employer contributions in the short to midterm, you have to increase them,” Clay said.
State Rep. Joseph Markosek, D-Allegheny, minority chairman of the state House Appropriations Committee, said the best course of action was to let the funds recover from the investment losses of 2008 through the current reforms.
Petri said an immediate conversion to a defined contribution plan is not feasible, but suggested that should be the ultimate goal after the systems are returned to full funding.
However, that will take decades. 
Though it will cost more in the short term, switching to a defined contribution plan will save the next generation of taxpayers from having to pay off the liability, said Frank Keegan, a pension fund expert with State Budget Solutions, a nonpartisan national policy center that advocates for budgeting reforms.
“What you have now is a system of perpetual debt that will always grow forever,” Keegan said. “Even if you froze pension plans right now, you would have to pay that off. Problem is, if you don't, it will just keep growing.”
The state’s contribution to the two pension plans is increasing by more than $300 million in the newly proposed budget, up from $705 million last year to more than $1 billion in the fiscal year that will begin July 1.
By the fiscal year that begins July 1, 2016, Pennsylvania will be paying more than $4.2 billion combined to the two pension systems. That’s an increase of 600 percent in just six years.
State Rep. Mike Peifer, R-Pike, said the state had failed to meet its obligations in the past decade, while employees continued paying into the fund and the investments exceeded expectations in most years.
“Bottom line, it looks to me like the third part, government, is not funding its obligation like it should be to its employees,” he said.
And while strong investment returns would help defray some of the cost, it is “virtually impossible” to make up the $40 billion combined unfunded liability through investment returns alone, said Anthony Clark, chief investment officer of the SERS board.
Corbett’s budget also proposes eliminating the Public Employees Retirement Commission, or PERC, which provides independent actuarial analysis to the state pension funds and oversight to the 3,000 local pension systems statewide.
The state-level functions of PERC will be taken over by SERS and PSERS, while the local oversight will become the purview of the state Department of Community and Economic Development.
State Sen. Jim Ferlo, D-Allegheny, said he was concerned about the proposal, which could limit independent review of SERS’ and PSERS’ numbers.
“I hope the majority here will understand that this is an issue,” he said. “I’m not clear what the impetus or the actual benefit is.”
Clay said the pension systems were waiting for more information on what new responsibilities they would have.
“There are some cost savings here, but what is sacrificed is that you lose an independent agency to look at these things,” he said.
Durban said PERC’s annual evaluations of the SERS fund was “a useful tool,” but needed more information from the administration about the planned changes.