Senate Proposal Goes Backwards, Not Forwards, On Pensions

Stephen Herzenberg
Publication Date: 
June 3, 2015

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Pennsylvania accumulated pension debts in its two main public pension plans in the 2000s because of failures to make adequate pension contributions and financial market collapses. Lawmakers began to address the pension debt problem in 2010 by cutting pension benefits for new employees by more than 20% and committing to ramp up pension contributions over time to required levels. Five years later, the state is two thirds of the way to the point at which increases in pension contributions level off to a few percent per year. The state and school districts can see the light at the end of the pension tunnel.

By building on the savings achieved in Act 120 of 2010, and implementing recommendations with bipartisan support, it may be possible to level off increases in pension contributions as soon as next year. This would free up policymakers to stop talking about public sector pensions and focus instead on Pennsylvanians’ top priorities, schools and jobs.

The pension proposal rushed through the Senate in mid-May, however, would not accelerate movement to the end of the pension tunnel. Some of its elements could be incorporated into a pension reform package that moves the state forward. But its three core elements – cuts in pension benefits for current employees, deep cuts in benefits for young future employees, and the movement of future employees into two new less-efficient retirement savings plans – step backwards.

Based on actuarial studies for the two pension systems and for the Public Employee Retirement Commission (PERC), supplemented by analysis by the Pew Trust and by the research literature on pension plans, this brief evaluates the impacts of SB 1. We find that SB 1 would:

  • Cut benefits for young, future employees up to 70%. The actuary for the Pennsylvania Public School Employees’ Retirement System (PSERS) projects benefit cuts for future career employees of about 70% relative to Act 120’s already-reduced benefits.  The Pew Trust also projects large (although not as large) benefit cuts for career employees alongside either increases in benefits or little change in benefits – depending on assumptions – for employees who start young and leave mid-career.
  • Enact unconstitutional benefit cuts for current employees. SB 1 reduces benefits earned from future years of service for current employees hired before Act 120 went into effect (“Act 9 employees”). Court precedents suggest that some or all of these benefit cuts would be found unconstitutional. In 2013, Senate Republicans themselves eliminated similar cuts proposed by Governor Corbett from their own pension reform proposal because they feared they would be unconstitutional.  
  • Achieve no meaningful savings likely to stand up in court. Excluding savings from cuts in benefits to current employees, the PSERS actuary estimates savings of only $614 million on a present-value basis and $3.2 billion on a cash-flow basis. The State Employees’ Retirement System (SERS) actuary expects savings of $2 billion on a cash-flow basis but does not break this down into savings from benefit cuts for current versus future employees.
  • Increase costs for taxpayers in the long run, for three reasons.
  • Less efficient retirement plans for young employees. The two retirement plans into which future workers’ retirement contributions would go are likely to deliver lower returns and have higher costs than Pennsylvania’s current pension plans, requiring as much as twice as much in contributions for any given level of benefits.
  • A possible “transition cost” because fewer contributions for young workers would go into the existing defined benefit pool. While SB 1 would not completely close the existing defined benefit plans, it would sharply curtail the contributions into these plans on behalf of young workers. As the demographic profile of benefits owed by the existing plans ages, those plans’ investment time horizon will shorten and the investment returns they earn may fall, requiring hiring employer (hence taxpayer) contributions.
  • Increased taxpayer costs because future wages have to increase to retain and attract high-quality teachers, nurses, and other public servants. For college-educated Pennsylvania public sector workers, good pension benefits offset salaries that average 25% or more below private college-educated workers. If benefits are cut by as much as 70%, salaries are likely to have to increase to make overall compensation competitive.

The basic disconnect in the campaign to eliminate traditional Pennsylvania public sector pensions has been a rallying cry that highlights Pennsylvania’s pension debt followed by proposals that do nothing about that debt – or could even increase it. That disconnect continues with SB 1. The simple facts are that Pennsylvania’s current pension plan designs are hard to beat because they are more efficient than other retirement savings vehicles.

This does not mean that no changes should be made to Pennsylvania’s current pensions. In addition to honoring pension commitments to current and retired workers, there are two main challenges. The first is ensuring that required contributions are made every year. The second is managing the financial market risk (or “cost uncertainty”) that taxpayers bear with existing pensions. Real reform would focus on these challenges while seeking not to lose the efficiency of existing plans which benefits all parties (taxpayers, employees, and public sector employers). Such reforms could include dedicating specific revenue sources to paying annual pension contributions (as proposed by Gov. Wolf), strengthening a risk sharing provision of Act 120 (which increases employee pension contributions if financially markets consistently underperform), and seeking to reduce fees paid to outside investment managers by Pennsylvania’s pension plans (as proposed by Gov. Wolf and contemplated by SB 1). Any pension reform that builds on Act 120 should also address the real retirement security crisis in Pennsylvania: the collapse of retirement security in the private sector.

Read the rest of pension primer #12