No sound bite explains or solves Pennsylvania’s pension crisis. Thankfully, Harrisburg’s perennial pension debates have taken on a more serious note. Perhaps sound policy decisions will trump the political posturing that has left the Pennsylvania School Employees’ Retirement System hamstrung.
PSERS many problems are well-chronicled. They will impact public education and the economy for decades. What should the eventual reform package include? In my view, a complete solution needs to reflect the following realities:
• Investment earnings comprise more than 70 percent of PSERS’ income. Using long-term historical performance or “low risk” assumptions for investment returns suggests that the PSERS unfunded liability approaches $60 billion, not the $40 billion that is commonly reported.
• Two separate, but related, policy issues shape pension reform. First, the commonwealth’s contractual responsibility to current pensioners and employees must be fully funded. Second, the cost of investment underperformance is largely borne by school districts and the Commonwealth. Employees enjoy little or none.
• Funding fails to meet actuarial need. Because underfunding was prolonged by legislation passed in 2002, 2003 and 2010, PSERS sells assets to make ever-increasing payments, choking off opportunities for investment. If this millennium has taught us anything, it is that deferring payments is not an option under any reform scenario. Otherwise, the unfunded liability will grow. More capital is needed from higher contributions and/or new sources of revenue.
• Practices such as “spiking” salaries in the last three years of employment and lump sum withdrawals further weaken PSERS by reducing capital to invest.
• Most school districts have managed to pay their legislated share of PSERS costs, (albeit passing them on to taxpayers in the form of higher property taxes). But Harrisburg has failed to identify enough recurring revenue to fund its portion of growing, and still woefully inadequate, pension expenditures.
• Because pension payments are calculated as a percentage of payroll rather than a level amount of dollars per year, most PSERS costs are back-loaded and still to come. For the State College Area School District, more than $220 million in pension costs remains to be paid over the next 20 years.
Pension reform must redistribute risk and recapitalize PSERS to actuarial soundness as quickly as possible. This means rethinking our fundamental philosophy of pension funding, and adjusting revenues and expenditures accordingly. Here are some changes I hope to see before June 30:
• Revise the retirement system for new school employees using a “cash balance” pension plan more like the occupational pension system in the Netherlands (one of the world’s most respected). Funding should be built on the premise that each generation pays its own cost of retirement. A 401(k)-style “defined contribution” plan is based on a similar view.
• Calculate payments on career average earnings rather than final three years of salary to reduce spiking, and eliminate lump sum withdrawals at retirement.
• Change future benefits for existing employees, which could include lowering the pension multiplier on future earnings. A pension for work already performed is deferred compensation and cannot be reduced.
• Place responsibility where it belongs. Make school districts solely responsible for the “normal cost,” or annual premium, of their employees’ pensions, and make the Commonwealth solely responsible for existing and future unfunded liabilities.
• End political tinkering with pension accounting, and require actuaries and fund managers to follow “best practices” recommended by the 2014 Society of Actuaries Blue Ribbon Panel. Reduce the amortization period from 24 years to 15-20 or less, shorten smoothing periods from 10 years to 5 or less, and standardize the assumed investment rate of return at realistic levels. These practices would more accurately mirror market and employment trends, and assure that revenues and expenditures match.
• Combine revenue from a new natural gas severance tax, an increase in the personal income tax (including high value retirement income), and a new financial transaction tax to generate at least $1 billion per year for PSERS more than currently planned increases in employer contributions. This would preserve PSERS’ assets and move the system toward level payments.
• Use neutral expertise, including the commonwealth’s Independent Fiscal Office and the Pennsylvania Employee Retirement Commission, to calculate funding needs and the value of active vs. passive asset management strategies.
Many of these ideas are found in Gov. Wolf’s proposal, Senate Bill 1, and pension reform bills such as House Bill 900, introduced by Rep. John McGinnis. The pension crisis has bipartisan origins, and the solutions require bipartisan support.
Real pension reform will happen when we acknowledge the need for a comprehensive overhaul that completely funds a sustainable benefit, reduces the risk of investment underperformance, and allocates contributions more equitably. This summer, let’s hope that the legislature commits to restoring PSERS’s solvency for this generation and the next.