Anda di halaman 1dari 5

Saving state pensions deferral is not an option

"Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!

This exclamation from the Red Queen in Lewis Carrolls Through the Looking Glass describes the current state of the Pennsylvania School Employees Retirement System (PSERS). As school districts prepare their 2014-2015 budgets they face the sobering reality that their PSERS employer contributions will climb to 21.4% of payroll, an all-time high. An additional $562 million will flow into the systems coffers. Despite this massive increase in revenue, PSERS $32 billion unfunded liability is projected to grow by more than $3 billion and the value of its assets will shrink by almost $1 billion. Meanwhile, without structural changes to the budget, the Governor projects a deficit exceeding $1 billion, much of it attributable to rising pension costs. So liabilities are up, assets are down, and the pressure is high. Why are employers running faster and faster, yet still losing ground? The answer is short but not simple: To correct another cycle of pension underfunding and unrealistic expectations. It may not be possible. Digging the hole About 70% of PSERS revenue comes from investment income. In the late 1990s, strong earnings lulled Harrisburg to extend and increase pension benefits while reducing employer contributions to PSERS. Soft market returns in 2001-2003, however, foretold an impending shortfall; meager employer contributions couldnt cover the losses. Rather than deal with the problem, school districts and the Commonwealth deferred nearly $8 billion in PSERS contributions between 2005 and 2011, hoping a bullish market would make up the difference. With the benefit of hindsight, this policy was clearly a mistake. The 2008 market collapse added insult to injury, exploding the hole in pension system funding. Something needed to be done, and the best that legislators could muster was Act 120 of 2010. And still digging Act 120 reduced some pension costs for new employees, which should help improve the fiscal health of the system when they retire. But the damage caused by two other provisions will be felt for decades. First, legislative collars were imposed to limit the annual increase in employer pension contributions to 4.5% of payroll per year. Determined by political convenience rather than calculated need, the collars act as artificial limits on pension contributions that moderate expenditures for employers in the short term, but starve the pension system of desperately needed cash. Second, pension payments were recalculated for another 24 years, deferring

upcoming payments at the price of incurring greater costs in the long run. As a result, employer contributions have been delayed but not curbed. Theyll surpass the watermark threshold of 30% of payroll by 2018, and remain well above it beyond 2036. How collars compound the problem With Act 120, legislators essentially decided to continue to underfund an already underfunded pension plan. Their arguments were the same ones weve heard before: provide some quick relief to school districts who failed to prepare to pay their PSERS shortfall. This short-sighted response treated a symptom but worsened the disease. Had school districts heeded the warning signs, such meddling from Harrisburg might not have been necessary. Some school districts like the SCASD created reserve funds to buffer the impact of the pension tsunami. Now, were penalized for the lack of preparation elsewhere by absorbing a larger deferred liability. Its like paying someone elses exorbitant credit card fees when you were ready to pay your share of the bill. Because the Act 120 collars are in place, revenue growth cant keep pace with growing expenses. In 2013-2014, PSERS needed funding at 24.75% of payroll to meet future payments (estimates using more realistic federal reporting rules are even higher). But with employer contribution capped at 16.93%, the only way to make payments to pensioners was to sell assets. During each of the past four fiscal years, PSERS paid out over $3.5 billion more in benefits than it received in member and employer contributions, spending nearly 8% of its asset value on pension payments to make up for the shortfall caused by the collars. This strategy is unsustainable. PSERS is eating its seed corn. Investment returns arent enough you need assets to invest But PSERS investments had market returns of 8% last year and 20% two years ago. The 25-year average return is 8.71%, higher than the actuarial assumption of 7.50%. So isnt the fund recovering? The answer is no; investment returns dont tell the whole story. The problem is that as assets are sold, you reduce your ability to generate the returns necessary to fund future benefits.
Think of it this way: If my $1000 investment has a 20% return, then Ill earn $200 that year. But if my debt obligations are $500 per year, then Ill use all of my investment income and sell $300 of my assets just to cover my debt obligations. If my remaining $700 earns a stellar 25% return in the subsequent year, Id only earn $175. The return looks great but the cash flow isnt enough.

Its clear where this is heading. PSERS cant expect to pay more than $6 billion per year in benefits without selling some of its $50 billion in assets. Even spectacular investment returns wont make up for a shrinking asset base. Because PSERS sells assets to meet its obligations, things will get worse before they get better Today, the SCASD contributes $2.4 million more to pensions than it did two years ago. Statewide, the story is much the same. Despite enormous infusions of cash, the total assets held by PSERS today are less than they were in 2000. Since 2008, PSERS score on its solvency test for existing employees, or the portion of current employees pension liabilities that can be funded with its assets, has fallen from 61% to zero. Next year, for the first time, PSERS will have less than 60% of the assets it needs to fund its obligations for retirees. In other words, PSERS cant meet obligations for current pensioners, and certainly cant do so for current employees. Barring any other tinkering by Harrisburg, this underfunding could bottom out in 2018 and the fund should begin a painfully slow climb to recovery. But if investment returns arent at least 7.5% every year, the problem will get worse. How many ways can you say, Underfunded? The 2001-2003 experience should have taught the legislature that PSERS cant rely on investment performance to meet its future pension obligations. Applying such flawed logic today will get us into even bigger trouble. Why? Because PSERS was fully funded at the start of the millennium, now theres a $30 billion hole to fill as well. With the size of the unfunded liability and additional employees retiring, current obligations cant continue to be met. And so the system is in a slow death spiral that will only accelerate if the legislature authorizes more deferments. Unintended consequences In the 2000s, deferring pension obligations was touted as a tool to free up more funds to grow public school payrolls. Perversely, reducing public school payrolls has become a popular tool to feed the pension Pac-Man in the 2010s. Many school districts have trimmed their payrolls to divert more funds to pension payments. Statewide, more than 19,000 school employee positions have been eliminated or left open since 2010. In the SCASD, about 60 positions have been eliminated, usually when people retire. Sometimes this is justified by declining enrollment. Other times, tasks can be managed with a combination of technology, reconfiguration of job responsibilities, and outsourcing. Expect these trends to continue.

When the payroll contracts, however, the unfunded liability rears its head in other ways. Spreading the unfunded liability across a smaller employee base, Harrisburg must ratchet up the employer contribution rate, which is a percentage of the smaller payroll, to fund the pension obligation, which is a total dollar requirement. But the Act 120 collars keep the employer contribution rate below the actuarial need, deferring even more pension payments and worsening the unfunded liability. What to do? Because the unfunded liability is now so immense, we need more courageous decision making from Harrisburg. Lets hope that Governor Corbett can do better than his budget proposal to taper the Act 120 collars from 4.5% per year to 2.25% per year. Thats not a solution; its making the problem worse! Spirited debate on pension reform is likely to focus on future employees who are not yet enrolled in PSERS. Weve seen this before; Act 120s pension reforms apply only to new hires. However, as Robert Costrell, a professor of economics at the University of Arkansas summarized in an article for the Pennsylvania Independent, Since most of the cost growth in the next decade is due to deferred payments of benefits owed to current workers or those who are already retired, changing the benefit structure for new employees has little effect. Neither the tripling of the employer contribution since 2011 nor the recent stock market improvement provides anywhere near enough money to save PSERS. To stand any chance of solvency, the employer contribution must be doubled again, which will likely be passed on to property owners in the form of higher property taxes. Looking forward, SCASD pension contributions will rise from $701 per student to $1448 per student by the end of the decade. Some economists, including Joshua Rauh, professor of finance at the Stanford University Graduate School of Business, argue persuasively that even more money will be needed to make up for unrealistic investment expectations. Its time to face down this challenge by stabilizing the pension system with both massive recapitalization and changes in the future benefit structure for existing employees. Shared pain solutions that affect retirees, current teachers, new teachers, school districts, and taxpayers are the most equitable way forward. Unfortunately, the rate at which recapitalization occurs is no longer determined by the fiscal health of the system; its decided by legislative convenience. And changing benefits for current employees is more than just politically unpopular. In Pennsylvania, established case law recognizes pensions as deferred compensation, so changing benefits already earned may be illegal. Until a court says otherwise, a promise made is a promise to be kept. This is why fiscally responsible reform plans that

propose conversion to cash balance pension systems for current employees should be subjected to legal tests as soon as possible. Converting PSERS to a cash balance pension, by the way, has a lot of merit. In the words of Melva Vogler, Chairman of the PSERS Board, While the details of pension reform proposals may vary, there is one common fact. Any solution to the funding issue will require rising employer contribution rates. The employer rates must eventually rise to pay off the existing unfunded liability as they have been intentionally suppressed for many years. In other words, deferral is not an option. As Harrisburg weighs the unpleasant alternatives, and districts struggle to fund their PSERS obligations, expect to see continued increases in property taxes coupled with flat or reduced funding for educational services. The greatest challenge will be to keep the impact away from the classroom.
Jim Pawelczyk serves on the State College Area School District Board of School Directors. His views do not necessarily reflect those of the SCASD or the Board of School Directors. More information on PSERS can be found at http://www.psers.state.pa.us.

Anda mungkin juga menyukai