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PSERS investments miss mark; unfunded liability will grow

By   /   September 17, 2012  /   2 Comments

By Eric Boehm | PA Independent

HARRISBURG – Taxpayers and public school employees took another hit last week, as one of Pennsylvania’s major public pension systems released its investment returns for the most recent fiscal year.

The state Public School Employees Retirement System, or PSERS, earned 3.4 percent during the fiscal year that ended on June 30, which is better than many similar funds but still well below the 7.5 percent returns that are built into the pension system’s accounting.

Falling short of that 7.5 percent mark effectively increases the unfunded liability that must be made up in the future by some combination of future investment returns, contributions from workers and tax dollars.

With lower-than-expected returns in 2011-12, PSERS unfunded liability will grow larger.

At the end of 2011, PSERS had an unfunded liability of about $27 billion.

Evelyn Tatkovski, spokeswoman for PSERS, attributed the lower-than-expected returns to the fact that markets were down overall, and Alan Van Noord, PSERS chief investment officer, said the fund’s decision to diversify and reduce its high-risk investments helped it to out-perform many other public pension funds during the 2011-12 fiscal year.

“PSERS has developed a sound investment strategy to withstand extreme volatility in the markets and we remain confident that it will produce positive investment growth over the long term,” said Van Noord in a statement.

Van Noord also pointed to PSERS’ history — the fund has earned better than 12 percent during the past three years and more than 8 percent annually during the past 25 years — as evidence of the fund’s strength even after a bad quarter.

But PSERS is not competing against other similar public pension funds, or against its own history.

Instead, it is essentially competing against its own 7.5 percent discount rate — a financial term for the assumed returns that are built into the pension systems’ financial calculations.

Falling short of that 7.5 percent annual return — regardless of how other funds in other states performed – adds costs to the unfunded liability that must eventually be paid off.

The $27 billion unfunded liability will grow to about $31 billion when last year’s investment returns are taken into account, according to estimates by Rick Dreyfuss, a retired actuary and pension expert for the Commonwealth Foundation, a free market think tank here.

Tatkovski said the system has not determined the new unfunded liability, though she confirmed that it will increase because of the lower-than-expected returns.  Those figures will be available in December, she said.

PSERS’s unfunded liability is only one part of the public pension problem in Pennsylvania, which also includes a $12 billion unfunded liability for the State Employees Retirement System, or SERS, a $17 billion unfunded liability for retired public workers’ health benefits and a $6 billion unfunded liability in the state’s roughly 1,400 municipal pension funds.

“This is getting away from us very quickly,” Dreyfuss said.

Gov. Tom Corbett and various lawmakers have called for pension reform to be a major priority in Harrisburg for the next year, with the most likely route to include a new system for future hires that will have lower costs.

But that alone will not pay down the spiraling debt in the existing systems, which will require funding reforms in order to be brought under control, Dreyfuss said.

In the short term, taxpayers are shielded from the increasing unfunded liability by a 2010 law that capped annual state contributions to PSERS and SERS, but those costs are continuing to build up and must be paid sooner or later.

And even with the caps, employer contributions – contributions funded by taxpayers –  to PSERS will grow from $1.6 billion this year to more than $2.4 billion next year.

Those payments are split between state taxpayers and school district property taxes, with the state picking up about 55 percent of the total and school districts paying the rest.

Current projections show that contributions from those two sources to PSERS will exceed $6 billion annually by 2028 — more than a quarter of the current state budget — in order to cover the expanding costs and to make up for a decade of underfunding the plans that began in 2001.

The National Bureau of Economic Research, a New York-based research nonprofit estimates that the pension obligation in Pennsylvania will cost every household in the state more than $1,500 per year for the next 30 years.

While future investment returns can help pay down some that liability, they must exceed 7.5 percent in any future year before the extra can be applied to the unfunded liability, and PSERS officials have said investment returns alone will not be enough to fix that growing debt.

A 2010 report from Wilshire Associates, a respected national financial consulting firm based in Los Angeles, that looked at PSERS and 125 other public pension funds in the United States concluded that not a single one would achieve its discount rate over the next 30 years.

At that time, PSERS was using a discount rate of 8 percent annually, which it reduced to 7.5 percent last year.

Even if the fund managed to meet that level of returns annually, PSERS own projections show the unfunded liability will continue to grow until topping out at $43.4 billion in 2018 — at which point state and local taxpayers will be contributing more than $4.4 billion towards the debt.

PSERS is the 17th largest state-sponsored defined benefit pension plan in the nation, with more than 470,000 active and retired members.

As of June 30, the fund had net assets of about $48.8 billion to cover more than $70 billion in liabilities.

For the sake of comparison, the Nasdaq rose 4.2 percent between July 1, 2011 and June 30, 2012, the same period of PSERS’ fiscal year.  The Dow Jones Industrial Average climbed 2.3 percent and the S&P 500 grew by 1.68 percent during the same period.

Contact Eric Boehm at [email protected] and follow @PAIndependent on Twitter.