Memo to Reporters & Editors: Questions to Ask on Pensions and the State Budget
To: Editorial Page Editors, Editorial Board Members, and Capitol Reporters & Columnists
From: Stephen Herzenberg, Ph.D., Executive Director, Keystone Research Center
Date: February 4, 2013
Re: Pensions and the State Budget
Governor Tom Corbett’s proposed budget will ask Pennsylvania lawmakers to revisit the issue of state and school employee pensions. The Governor’s pension proposals must be examined carefully: Do they lower, or increase, Pennsylvania pension debts? Do they responsibly contribute required funds to Pennsylvania pensions or repeat shortsighted practices under the past three Governors that helped create the pension debt? Are they consistent with the Pennsylvania Constitution or do they risk court reversal that leaves the state uncertain of pension costs for years and then with higher pension debt? Do they condition increased education funding on pension changes to compel lawmakers to make a false choice between two unrelated policy priorities? Do they treat unfairly current employees who contribute more to their pensions than counterparts in other states and who accept lower salaries than equivalent private workers? Do they achieve low costs for managing employee pensions, or increase the costs of managing pensions to the benefit of private financial firms but at the expense of taxpayers and middle-class retirement security?
By seeking clear answers to these questions in the weeks and months ahead, editorial boards and reporters will play a key role in supporting informed discussion of public pension issues and of the practical options for the state and school districts.
Consensus on How We Got Here: There is a good deal of agreement on key pension issues, including the primary drivers of the current challenges we face. As the Corbett Administration’s pension report notes, the ingredients of the current pension situation include “short sighted” political decisions that led to “nearly a decade of underfunding by state governments and local school districts,” and “investment returns that failed to meet expectations” as a result of one of the stock market’s “most volatile periods in recorded history.”
Act 120 Generates Significant Savings for Taxpayers: The Corbett Administration also acknowledges that Act 120, the Pension Reform Act of 2010, curbed rising pension costs. The Act’s reforms included:
- Reducing pension benefits for new employees by lowering the multiplier used to calculate retirement benefits from 2.5 percent to 2 percent;
- Increasing the retirement age to 65 for new employees, extending the period for employees’ benefits to vest from 5 to 10 years, and eliminating the lump-sum withdrawal of their contributions at retirement; and
- Implementing an innovative “shared risk” provision for new employees that increases employee contributions if the actual investment returns fell below assumed returns.
The Pension Reform Act lowered the cost to the state and schools of pension plans for new employees to a very low level—about 2.2% of salaries for PSERS alone and about 3% of salaries for SERS and PSERS taken together. It would be difficult for any alternative pension plan for new employees to beat this low cost.
The Act 120 shared risk provision means that, instead of just the employer rate going up in an economic meltdown, employees too will directly share in the pain. The provision has another benefit, one that has not been recognized widely and thus deserves careful explanation: the shared risk provision protects against lawmakers in the future making short-sighted cuts in employer contributions when the economy goes south. How does it do this? By conditioning increases in employee contributions when financial markets plunge on the state and schools also increasing their contributions. We would expect lawmakers to think very hard about future contribution holidays if those holidays also lower contributions from employees. As a result, even in a financial market storm that comes along once every 75 years, such as the last decade, the shared risk feature makes it unlikely that the two pension plans would again accumulate large debts.
Pennsylvania Workers Contribute Even More to Their Own Pensions: The Pension Reform Act also strengthened an already distinctive feature of Pennsylvania’s pensions: the high rate of employee contributions. Even while employer contributions were dipping to zero in some years in the last decade, Pennsylvania employees contributed roughly 7% of their salary on average to their pension every paycheck. While employer contributions in Pennsylvania have been substantially lower than the national average over the last decade, school and state employees in Pennsylvania contribute more to their retirement benefits than most public employees in other states.
Will the Corbett Plan Lower Pension Debt? Will the Governor’s proposals represent a real solution or will they endanger the progress made in 2010? One option under discussion is to transition some (or all) new employees—or even some current employees—to a new “defined contribution” pension plan. This would increase Pennsylvania’s pension debt. Here’s why. If new employees switch to a defined contribution plan, the pension plan participants left in SERS and PSERS will gradually age. Just as individual investors switch to lower-risk, more conservative investments when they approach retirement, SERS and PSERS would need to do the same. This would reduce the expected rate of return on fund assets. This, in turn, would increase the amount of money needed to honor pension commitments to remaining SERS and PSERS participants—the pension debt—thereby increasing the required employer contributions. This sequence is exactly what has happened in Alaska since 2005: the employer contribution rate for the Alaska teachers’ defined benefit plan has increased from 16% to 39% since the plan stopped taking in new members.
Will the Corbett Plan Increase the Cost of Pensions for New Employees? Another question about a new pension plan for new employees is its impact on the cost to the state and school districts of new employee pensions. Recall that the current employer cost of pensions for new employees is 2.2% for PSERS and about 3% for SERS and PSERS taken together. The existing defined contribution pension plan for Pennsylvania higher education faculty requires an employer contribution of 9.29% per year. Legislative proposals for new pension plans have required employer contributions in the range of 4-7%.
Will the Corbett Plan Make the Responsible Contributions to Pensions Required by Act 120? Under three Governors, Pennsylvania built up its current pension debt in part because of the failure of the state and school districts to make responsible contributions to pensions each year. Now the bill has come due and Pennsylvania has started down a more responsible path. Will Governor Corbett’s budget follow the payment plan set out in Act 120 or divert required pension contributions to the Governor’s other priorities? Will it bank illusory (and potentially unconstitutional) future savings while failing to reckon with increases in pension debt that accompany a transition to a defined contribution plan?
A False Choice: Another question is whether Governor Corbett will condition an increase in state education funding on changes to state pensions, as he and Budget Secretary Charles Zogby have suggested in recent weeks. This approach, which creates a false choice between two unrelated policy priorities, has been rejected by several state lawmakers, including Senate President Pro Tempore Joe Scarnati. Governor Corbett has made cuts to the classroom, and we have an obligation to today’s students to restore that funding so that they are prepared to compete in a global economy—regardless of the outcome of the pension debate.
Over the next several weeks, the media, policymakers and the public need to ask the hard questions about the Governor’s pension proposals to ensure that Pennsylvania achieves real reform that is in the best interests of taxpayers, school children, local communities, teachers and public workers.
 The quotes in this paragraph are from Pennsylvania Office of the Budget, The Keystone Pension Report: A Discussion of Structural Reform and Relief to Pennsylvania’s Retirement System for Long Term Sustainability, pp. 3 and 4.
 The Governor’s pension report lists the current (2012) “normal cost” of pensions for new employees as 2.2% for PSERS and 5.1% for SERS. (Normal cost is the cost of projected benefits for the current plan year; normal cost for new employees is thus the cost of projected benefits for new employees for the current plan year. See Public Employee Retirement Commission (PERC), Funding and Reforming Public Employee Retirement Systems, p. 235.) Since PSERS has about 2.5 times as many participants as SERS, the average of the PSERS and SERS rates weighted by the size of each plan is roughly 3%. See PA Office of the Budget, The Keystone Pension Report, p. 5 and p. 2.
 According to the National Association of State Retirement Administrators (NASRA), Pennsylvania’s employee contribution rates are higher than average even before taking account of the risk premium feature that could increase Pennsylvania employee contribution rates a further 2%. The main PSERS 7.5% contribution rate is 24% above the average employee contribution rate for school pension plans in the 38 states in which school employees also participate in Social Security. The main SERS 6.25% contribution rate is 16% above the average employee contribution rate for state pension plans in the 40 states in which state employees also participate in Social Security. Employee Contributions to Public Pension Funds, NASRA Issue Brief, January 2, 2013
 Nari Rhee and Diane Oakley, Issue Brief: On the Right Track? Public Pension Reforms in the Wake of the Financial Crisis (Washington, DC: National Institute on Retirement Security, December 2012), p. 12.
 State of Alaska Department of Administration, Division of Retirement and Benefits, Teachers’ Retirement System Comprehensive Annual Financial Report For the Fiscal Year Ended June 30, 2012, online at http://doa.alaska.gov/drb/pdf/trs/cafr/2012TrsCafr.pdf.