New Senate Pension Proposal Not Ready for Prime Time

Politically Driven Rush Leads to Unconstitutional Bill That Would Be a Step Backwards, Cutting Benefits Deeply and Ultimately Costing Taxpayers
Date of Press Release: 
May 12, 2015

At 4:30 p.m. last Friday, the Pennsylvania Senate introduced SB 1, a proposal to revamp Pennsylvania’s public pension systems for school and state employees. This morning, the Public Employee Retirement Commission (PERC) released four documents examining the pension proposals: studies of the impact of SB 1 by independent actuaries for each of the Pennsylvania pension systems; a report by the current PERC actuary, Milliman; and an overview and transmittal memo of these documents by PERC staff.

In response to these studies, Keystone Research Center economist and Executive Director Dr. Stephen Herzenberg issued the following statement:

“The Senate pension proposal released late Friday is not ready for prime time because it emerged from a rushed and non-transparent policy development and vetting process. The actuary for PERC makes the flawed nature of this process clear on page one of its letter to PERC, noting that: ‘Due to the lack of time available to complete this preliminary letter, we did not read the entire Bill nor include all the provisions contained in the Bill.’ Earlier on the same page PERC says:

Due to time constraints dictated by the Commission for providing this actuarial note, we are providing this letter without a complete review of all facets of the legislation or all actuarial cost project information used by the system actuaries in their analyses. We are disclosing that the time available for preparing this letter was insufficient to perform a complete review and thus, this letter should be considered preliminary.

In general, rushing to get a complex proposal to a vote without adequate time to debate – or even read – the proposal is a recipe for bad policies. In the case of the Senate pension proposal, even the short time available to scrutinize the proposal has revealed a number of deep flaws.

The proposal is likely unconstitutional. As the PERC transmittal note indicates, ‘the bill would be subject to challenge for impairment of the retirement benefit rights of active members of the Systems.’ Our reading of the court decisions is that the reductions in benefits required of current members would be ruled unconstitutional (as were pension cuts in Illinois last week by the Illinois Supreme Court).

No meaningful savings that will stand up in court. In the actuarial studies of the Senate proposal, almost all of the savings come from the pension system for school employees ($16.3 billion on a cash-flow basis and $5.9 billion on a present value basis). Once you remove the likely unconstitutional cuts in benefits for current employees, however, the PSERS savings fall to $3.2 billion on a cash-flow basis and $614 million on a present-value basis, about 1.5 percent of the current PSERS unfunded liability.

Cuts in benefits for young employees of 70 percent. The PSERS actuarial study estimates retirement benefits for six young employees under SB 1’s combination of a 401(k)-style retirement plan plus a “Cash Balance” retirement plan. The study finds that benefits would be cut about 70 percent compared to the current PSERS Act 120 benefit (which itself was already more than 20 percent below the Act 9 benefit). Three of the six young employees modelled, despite an expected 35 years of service in two cases, are projected to have annual pension benefits of less than $10,000.

Higher taxpayer costs long term because of a switch to less efficient retirement plans. How does the Senate proposal manage to cut benefits so deeply for young employees while not significantly reducing taxpayer costs? This unsavory combination reflects, in part, inefficiency of new pension designs: When the defined contribution and Cash Balance plans deliver lower returns and higher costs than the existing pension plan, they reduce benefits without saving taxpayers much money. Given benefit cuts of 70 percent, taxpayers would likely have to raise salaries in the future to keep public sector compensation competitive, leading to higher total taxpayer costs.

As a result of the pension benefit cuts and phased increases in pension contributions in Act 120 of 2010, Pennsylvania is finally beginning to see the light at the end of the tunnel on pensions. Gov. Wolf’s pension proposals would accelerate the move toward the light by:

  • drawing on a prior Republican proposal to pay down pension debt with a bond;
  • dedicating some future revenues to pensions, reassuring bond rating agencies; and
  • seeking to lower fees paid to investment firms.

One bit of progress in the new Senate proposal is that it signals bipartisan interest in looking at ways to lower investment fees. With this exception, however, the Senate proposal represents a step backward, risking constitutional rejection of benefit cuts, switching young employees to inefficient retirement vehicles and threatening to bring to the public sector the worst feature of the private-sector 401(k)-saving revolution – inadequate retirement savings that leave more elderly economically distressed.

The best way to protect taxpayers and public employees going forward is to build on the strengths of the current pension plans and on the legislative progress made in 2010.”

For more on Pennsylvania public pensions, go to http://keystoneresearch.org/issues-guides/pensions.

The Keystone Research Center is a nonprofit, nonpartisan research organization that promotes a more prosperous and equitable Pennsylvania economy.