The causes of Pennsylvania’s pension debacle are all too clear. Overpromised benefits, underfunded programs, and underperforming investments have left the commonwealth in a $45 billion hole that grows deeper every day. The impact is staggering. By 2017, 10 percent of the state’s budget will be committed to pension funding; that’s more than $1,000 per year for every Pennsylvania household. Both Moody’s and S&P have down rated the commonwealth’s credit ratings because of pension liabilities. For the State College Area School District, the pension bill is more than $275 million over the next 30 years.
The ongoing collapse of the Public School Employees’ Retirement System (PSERS) is an unintended consequence of “relief” for school districts, also known as “kicking the can down the road.” Despite its 7.9 percent rate of return last year, PSERS paid out $3.6 billion more than it took in. Because school districts cannot increase their employer contributions more than the caps legislated by Act 120 of 2010, PSERS must sell its assets to generate enough cash flow to meet its pension payments. Coupled with investment losses that wiped out a decade of earnings, PSERS will remain in negative cash flow for the foreseeable future. With fewer dollars to invest, it’s simply impossible for PSERS to earn its way to health. Instead, PSERS is now fulfilling an old metaphor by “eating its seed corn.”
A new proposal percolating through the state House of Representatives presents a suite of reforms that could help refloat the good ship PSERS. Rep. Glen Grell’s three-pronged approach provides funds to reduce the existing unfunded liability and controls future growth in pension costs. Current retirees would not be affected.
Strategy one would establish a new benefit plan for all future employees. Employees would contribute 7 percent of income; employers, 4-5 percent. These funds would be invested with a guaranteed return of 4 percent. If investment returns were better than 4 percent, employees would share half of the windfall. Upon retirement, the cash balance would be converted to a fixed, monthly annuity. It is a solid plan that guarantees a reasonable retirement income for life.
Strategy two would recapitalize PSERS and the State Employees’ Retirement System with up to $9 billion of new “pension bond” proceeds. It is a speculative strategy based on the idea that the commonwealth would make money if investment returns were higher than its payments on the bonds, netting up to $6 billion in savings. Because of the economic downturn experienced over the past five years, however, most borrowings of this type have lost more money than they’ve earned. Losing the flexibility to adjust payment schedules could add additional stress to the budget, a problem that Detroit is experiencing. Boston College’s Center for Retirement Research notes that those that are least able to handle the risk are the ones that tend to issue pension bonds. Municipalities in California are defaulting on their debt partly because of pension bond deals gone bad. Illinois, which issued pension bonds in 2003 on the scale proposed by Grell, remains the least funded state pension system in the nation.
Strategy three would lower contributions for existing employees in exchange for two concessions: First, pension payments would be calculated by averaging five instead of three highest years of salary in order to curb the practice of “spiking” a person’s salary during their final years of employment to generate a higher pension. Second, about 90 percent of retirees choose to withdraw some portion of their contributions at retirement, opting to receive a slightly lower pension for the rest of their life. It’s a convenient way for an employee to start his or her retirement. However, the payment costs more than the pension reduction that funds it, putting even more strain on the pension system. Under the Grell plan, if future retirees opted to withdraw their contributions, then pension payments would be reduced to be revenue neutral.
The Grell plan has advantages and disadvantages. School districts’ pension contributions would still increase by more than 50 percent by 2020, but the pension plateau would decrease from 31 percent of payroll (more than $10 million per year for the SCASD) to 26 percent of payroll, reducing the district’s future pension payments by about $1.5 million per year. Statewide, it would help fill in the unfunded liability, albeit by creating a new debt. Issuing $9 billion in pension bonds would increase the commonwealth’s annual debt service by more than 50 percent, a liability that would be borne by our children for decades. This part of the plan is a gamble; the risks are very real. If successful, the plan would provide limited relief to school districts and help keep PSERS intact for current and future employees. But if investment targets were not met, the commonwealth could be painted into the same fiscal corner as Detroit.
Jim Pawelczyk lives in Ferguson Township and serves on the State College Area School District Board of School Directors. His views do not necessarily reflect those of the district or the entire board.