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PA public pensions’ future may mean even higher taxpayer costs

By   /   March 30, 2012  /   14 Comments

Major private-sector pensions, investment experts suggest lowering rates
By Eric Boehm | PA Independent
HARRISBURG — Pennsylvania’s two public pension systems have a combined unfunded liability of about $37 billion, but because of the way the liability is calculated, the actual amount to be paid in coming years is likely higher.

If the funds used assumed rates of return in line with the private sector and as suggested by investment consultants, the actual liability exceeds $50 billion.
The state’s two pension systems — the Public School Employee Retirement Commission, or PSERS, and the State Employees Retirement System, or SERS — are funded by state taxpayers, employees in the system and investment returns. 
The unfunded liability is the funds’ assets minus the currently earned benefits of all members.
To calculate the unfunded liability, the pension systems must estimate their investment returns for the next 30 years and use those figures to determine how much funding the state must contribute to meet expectations. 
Currently, PSERS expects a 7.5 percent annual return on investment and SERS at 8 percent, resulting in a $37 billion unfunded liability.
But, if actual investment returns come in lower, the unfunded liability would be higher.
Evelyn Tatkovski, spokeswoman for PSERS, said the fund’s 7.5 percent long-term assumptions are appropriate, adding that if the fund was to decrease the expected rate of return, it would add to the state contributions in coming years.
“We do not have current projections,” Tatkovski wrote in an email. “Hypothetically though, it would increase the employer contribution rate even further than the current projections.
Pamela Hile, spokeswoman for SERS — which is considering lowering its rate to 7.5 percent — said the same would be true for that fund.
Here’s the rub: Those expected rates of return are out of line with similar pension systems in the private sector. 
Although pension systems are now rare in the private sector, the ones that still exist almost always use lower expected rates of return.
General Motors’ pension system has an asset value of $94 billion, comparable in size and cost to the Pennsylvania funds. Yet its board of directors recently voted to lower its annual rates of return from 8 percent to 6.2 percent.
Rich Harper, a principle at R.E. Harper Associates, an investment firm here, said expected rates of return are about 6 percent for the average private-sector pension plan.
Of course, PSERS and SERS are significantly larger than most pension systems, which gives them the ability to make investments — and get returns — smaller plans could not pursue, he said.
But SERS and PSERS are not unique. The national average for the expected rates of return for numerous large, public-sector pension systems nationwide is 8 percent.
The two Pennsylvania funds are also not unique in that like almost every public pension fund, they are unlikely to achieve that rate of return in the coming decades.
If the funds fail to achieve their expected returns, the result is an increased liability that must be made up by public employees and taxpayers.
Because employee contributions are written into collectively bargained contracts, taxpayers must make up the difference.
Lowering the expected rate of return to 6.5 percent would not only add to the funds’ unfunded liability but give a more accurate picture of the costs facing the pension systems, experts say.
Last year, when the PSERS’ board voted to reduce its assumed rate of return from 8 percent to 7.5 percent, it added more than $4 billion to the fund’s unfunded liability immediately, according to PSERS’ data.
If the fund was to lower its expectations to Wilshire and GM’s suggestion of around 6 percent, taxpayers would see the unfunded liability skyrocket suddenly from $27 billion to nearly $40 billion, according to calculations done by Rick Dreyfuss, a retired actuary and pension expert, at the request of PA Independent.
SERS’ unfunded liability, which has fewer members, also would nearly double from $9.8 billion to $18 billion, according to Dreyfuss’s estimate.
Requests for PSERS and SERS to estimate the potential growth of their unfunded liabilities with lower expectations were turned down.
At present, the funds are using assumptions that can best be described as "overly rosy," said Dreyfuss, who is also a senior fellow at the Commonwealth Foundation, a nonprofit free market think tank here that has pushed for pension reforms.
In February, Nicholas Maiale, chairman of the SERS Board of Directors, told the House Appropriations Committee that the fund’s board would consider lowering its rate of return from 8 percent to 7.5 percent.
After a “robust” discussion of the rate at the board’s March meeting, no decision to change it was reached, Hile said.
The board will revisit the issue at its May meeting, she said.
PSERS has no plans to adjust the rate again, Tatkovski said.
Both spokeswomen warned against comparing the public pension systems to private funds like GM, because every pension system has its own unique mix of assets that earn different rates of return.
Historically, PSERS and SERS have outperformed their expected rates of return. SERS has earned an average return of 8.2 percent over 20 years, while PSERS has earned a rate of 8.5 percent in the past 25 years.