Report: New Pension Plan a Step Backwards
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HARRISBURG, PA (June 2, 2014) —Public pension proposals championed by Gov. Tom Corbett and Rep. Mike Tobash would make little progress reducing the state’s pension debt, while forcing draconian benefit cuts on future teachers, cafeteria workers, nurses, and state employees, according to a new report from the Keystone Research Center.
“What the Tobash proposal does is force new, mostly young employees to pay for the past mistakes of their employers,” said Stephen Herzenberg, economist and executive director of the Keystone Research Center. “What it doesn’t do is save the Commonwealth substantial money, now or in the future.”
The Keystone brief synthesizes the findings of four different pension consultants and actuaries – working, respectively, for Pennsylvania’s two pension systems, for the Corbett Administration, and for the Public Employee Retirement Commission (PERC) – released by PERC last week when it transmitted the four reports to Commission members and lawmakers.
Information in the report by PERC consulting actuary Cheiron indicates that Rep. Tobash’s proposal would make only minimal changes in what the commonwealth and local school districts contribute to the retirement systems. At the same time, many new employees enrolled in this new pension system would see their benefits cut by 40 percent or more compared to Act 120 of 2010. It’s important to remember, Herzenberg noted, that Act 120 already cut benefits for new employees by 20 percent. Cheiron summarized its overall findings: “For new employees the loss of retirement security is greater than the value of the cost savings for the Commonwealth.”
Rep. Tobash’s proposal would replace Pennsylvania’s existing pensions with a hybrid pension plan. The first $50,000 of an employee’s salary (increasing 1% annually) and first 25 years of service would be covered by a defined benefit (DB) plan, while a 401(k)-style defined contribution (DC) plan would cover the other portions of employees’ salary and service. Employees would make small contributions to the 401(k) plan below the $50,000 and 25-year thresholds.
Gov. Corbett seeks to couple savings from benefit cuts with lower state and school district payments to the pension plans over the next four years.
“Deliberately underfunding the pension plan now would repeat the mistakes of the past,” Herzenberg said. “We have already seen what happens when the state and school employers use a credit card to avoid making required pension payments.”
While advanced in the name of taxpayers, the actuaries found that, best case, the Tobash Plan would not lower future pension payments substantially and, worst case, it could dig a deeper pension hole.
- Little savings: Measured in present value terms, equivalent to dollars in hand today, the plan would save only $3.1 billion.
- A spending spree that uses up much of any savings: Using those savings like a new credit card, to lower near-term pension contributions, would eliminate over a third of them.
- A potential transition cost: Down the road, the PSERS actuary (Buck Consulting) notes, the Tobash Plan could lower investment returns of the SERS and PSERS defined benefit pension plans because it shrinks contributions from new workers, and shifts pension systems’ obligations toward retirees. A “transition cost” equal to even a small fraction of the $40 billion price tag on Governor Corbett’s immediate shift to 401(k)-style defined contribution accounts would more than wipe out any Tobash savings.
- A hidden cost for future wage increases. The benefit cuts in Tobash would make public-sector jobs wages plus benefits uncompetitive with private compensation, particularly among more educated employees. The state will likely have to raise future salaries to attract and retain high-quality teachers and other public servants.
Two pension consultants estimated the impact of the Tobash Plan on retirement benefits:
- Many new employees would see large benefit cuts. Of nearly 100 SERS and PSERS career trajectories examined by the Governor’s consulting actuary, roughly half would receive benefit cuts of 40 percent or higher, and all but a handful would experience cuts of about 20 percent or higher. Buck Consulting found similar but smaller cuts in PSERS benefits using a method that it explicitly noted is conservative.
- Benefit cuts for new employees would increase each year. Since the $50,000 salary cap on the defined benefit plan rises by only 1 percent each year, well below expected inflation and salary growth, the value of the defined benefit plan would decrease over time. In two generations, the defined benefit pension would deliver retirement income equal to one-sixth or less of most employees’ final average salary. Very long term, under Tobash, the defined benefit plan vanishes.
- There will be an erosion in the quality of public schools and services. Long-tenured employees would have less incentive to remain in public service once they reach 25 years of service, at which time they stop accruing benefits in the defined benefit plan. This will likely lead to higher rates of staff turnover among those able to command higher compensation in the private sector, eroding the quality of public schools and services.
“Now that we have these actuarial reports,” Herzenberg said, “We know that the Corbett-Tobash plan is a non-starter. We need to build on Act 120 by addressing the root cause of Pennsylvania’s pension debt, low employer contributions.”
The end of the KRC brief outlines a six-point framework for reform that would build on Act 120, including by incorporating elements of the pension proposals advanced by Representative Glen Grell and Senate Democrats. A starting point could be recapturing to shore up state pensions a portion of the $3 to $4 billion revenue lost annually because of corporate tax cuts since 2003.