Josh First's Blog

PA Senator Mike Folmer on our pension crisis

Pennsylvania’s Pension Crises

by Mike Folmer, PA State Senator

August 21, 2014

President Kennedy said: “There are risks and costs to action. But they are far less than the long range risks of comfortable inaction.”

Pennsylvania’s failure to address its public pension problems recently resulted in another downgrade of its bond rating: from Aa2 to Aa3. According to the rating agency Moody’s, “. . . the expectation that large and growing pension liabilities coupled with modest economic growth will limit Pennsylvania’s ability to regain structural balance in the near term.”

Consider where Pennsylvania’s Public School Employees’ Retirement System (PSERS) was prior to 2001 changes enhancing benefits: $9.5 Billion surplus and a 123.8% funded ratio (100% is an appropriate ratio). Using the most recent actuarial valuations, the funded ratio for the State Employees’ Retirement System (SERS) and PSERS (using an optimistic 7.5% annual asset return assumption) was 59.2% and 63.8% respectively. Further declines are expected.

Pennsylvania’s private sector has predictable and affordable pension costs while providing employees with competitive retirement benefit packages. Over 70% of these firms have defined contribution plans for new hires with average employer costs ranging from 4% to 7% of payroll. (All private sector defined benefit plans must eliminate any deficits over time – often as short as seven years).

Ignoring such facts has resulted in unsustainable plans in states from New Jersey to California. Cities like Chicago and Detroit face bankruptcy because of public pension costs.

Courts have said public pension benefits once earned are protected by Pennsylvania’s Constitution: Article I, Section 17, “Impairment of Contracts.”

I’m not part of the legislative pension system as I believe Article II, Section 8 of Pennsylvania’s Constitution doesn’t provide for elected officials’ pensions: “The members of the General Assembly shall receive such salary and mileage for regular and special sessions as shall be fixed by law, and no other compensation whatever, whether for service upon committee or otherwise.”

This same provision is why I also return my legislative cost of living adjustment: “No member of either House shall during the term for which he may have been elected, receive any increase of salary, or mileage, under any law passed during such term.”

Nonetheless, I’m regularly asked why Pennsylvania underfunds its public pension plans. Taxpayers fear proper funding policies will result in districts increasing property taxes to pay pension contributions. Schools say the alternative is cutting programs or increasing class sizes.

Failure to contribute at least the actuarially recommended contribution transfers ever-mounting debt to future generations. The combined liabilities of SERS and the PSERS are over $50 Billion – and growing. These costs are the fastest growing state budget line item.

Separate from proper plan funding are new GASB (Government Accounting Standards Board) accounting and reporting standards to assess current and future pension obligations. Unfunded liabilities will now be reflected on school districts’ balance sheets and the underfunding issue will be further highlighted. Increasing numbers of municipal and school audits will be flagged due to GASB 67 (“Financial Reporting for Pension Plans”) and GASB 68 (“Accounting and Financial Reporting for Pensions”) standards.

In 2009, legislation (which I opposed) was enacted attempting to address Philadelphia’s public pension problems: a temporary 1% Sales and Use Tax increase. This “temporary” tax was subsequently extended. Purchases in Philadelphia include an 8% Sales Tax. However, Philadelphia’s pension liabilities have continued to grow. Like Pennsylvania’s infamous “temporary” 1936 Johnstown Flood Tax, this tax continues to exist and continues to grow. Ironically, Philadelphia is being flooded with pension liabilities.

In 2010, another law was passed to address Pennsylvania’s pension issues. Act 120 made some benefit changes for new employees, including: raising the vesting period to 10 years from five, reducing the multiplier to calculate retirement benefits (to 2.0% from 2.5%), increasing the retirement age for new employees to age 65, eliminating lump sum payouts of employees’ contributions and interest upon retirement, and limiting maximum retirement benefits to 100% of final actual salary.

But, Act 120 also continued the practice of underfunding, which further deferred state and local pension contributions to future years through “collars:” below recommended actuarial levels, which reduce public pension funding by about $1 Billion to $2 Billion annually. Such sustained underfunding has resulted in numerous credit downgrades. This is why I also opposed this measure.

Supporters of the status quo urge the General Assembly to allow Act 120 “time to work.” However, since passage of Act 120, pension liabilities have grown to $50 Billion from $41 Billion; the original assumptions of Act 120 have shown Act 120 has failed to attain its goals.

This $50 Billion deficit is growing by over $10 Million a day – over $3 Billion a year. Meanwhile, the Commonwealth, municipalities, and schools are allowed by law to underfund these plans by about $1 Billion to $2 Billion a year. Every 0.5% reduction in SERS and PSERS assumed investment returns adds approximately $7 Billion to their combined unfunded liabilities. If PSERS would compute its unfunded liability using market value of assets, this change alone would immediately add about $8 Billion to the deficit.

Failure to both properly fund these plans or move new hires to a defined contribution plan will only make matters worse (the claims of unaffordable transition costs are vastly overstated). Taxpayers should fear higher taxes to continue to fund public pensions. Public employees should fear their continued solvency.

There is a cost for inaction.