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May 24, 2017

UPDATE: Pension Reform Must Include Funding Reform

pension reform

UPDATE: The Independent Fiscal Office (IFO) released an actuarial note on HB 778 last week. According to their analysis, the legislation would save taxpayers $18 billion dollars by 2050. That may seem like a long time horizon, but the bill works to pay off the $70 billion in unfunded liabilities of the two state-run pension funds over a 20 year period. Currently, the two pension funds have a 24 year (PSERS) and 30 year (SERS) pay-off period for their unfunded liabilities. To calculate the savings, it is necessary to extend the time horizon. Because HB 778 pays off the unfunded liabilities faster, it necessarily requires more funding up front.

One of the chief objections from Republicans and Democrats, as illustrated here, is that there isn’t enough money available to pay down the unfunded liability without a tax increase. That argument is false. Paying off the unfunded liability is possible with current revenues, but it requires lawmakers to make some “tough” choices and prioritize how money is spent. For example, why don’t they redirect money from the $250 million Race Horse Development Fund?

Please, contact the General Assembly today and tell them to make sure funding reform is included in any pension reform discussions.

ORIGINAL ARTICLE: No matter what pension plan design reforms the legislature enacts for future employees, the Commonwealth will still have a massive unfunded liability. The unfunded liability is the result of over-promising retirement benefits, poor investment performance, optimistic investment return assumptions, but mostly a willful redirection of necessary pension contributions by the Pennsylvania government to other purposes. This gross negligence on the part of elected officials has been bipartisan. It started with the 2001 pension increase signed into law (Act 9) by Governor Ridge and continued through the Rendell years when he signed legislation that purposefully underfunded the pension systems (Act 40 in 2003 and Act 120 in 2010).

Decades of mismanagement have resulted in a combined unfunded liabilities currently estimated at over $75 billion, based on the market value of assets. The longer the unfunded liability persists, the worse it becomes. It’s helpful to look at the unfunded liability as a loan. The annual interest cost on this “loan” is over $5.4B per year. In other words, the unfunded liability grows year after year unless the payment made exceeds interest and the cost of newly earned benefits.  And, just like any other loan we need to be making payments on the principal.

The loan example conveys the basics of the problem. Rep. John McGinnis introduced HB 778 this year to address the unfunded liability. In his co-sponsorship memorandum, McGinnis states:

When Act 120 was passed, the liabilities of PSERS exceeded the market value of its assets by $33.4 billion with a corresponding funding ratio of 57.8%. At the close of FY 2016, the PSERS unfunded liability was 50% larger at $50.1 billion with a funding ratio of 49.9%. Similarly, the liabilities of SERS exceeded the market value of its assets at the end of 2010 by $13.3 billion, with a corresponding funding ratio of 66.1%; five years later, the SERS unfunded liability had grown to $20.3 billion, with a funding ratio of 56.2%.[Emphasis added]

There are likely scenarios where the pension assets will become exhausted in the next 8 to 15 years.  When that happens, benefits paid to retirees may well consume 40% to 50% of the general fund.  The consequences for our future only get worse as we delay dealing effectively with this problem. Unless funding reform like HB 778 is included with pension reform, it is unlikely that Pennsylvania will avoid this looming fiscal catastrophe.

Every day the General Assembly does not act, the unfunded liability grows. HB 778 is currently in the House State Government Committee.

Please, contact your representative today and urge them to take action.