Underfunding Pensions A Lingering Problem
As recently witnessed in neighboring New Jersey and Maryland, the unfortunate yet anticipated inexorable drive to further underfund Pennsylvania's statewide pension systems remains alive and well. The most recent developments involve the subterfuge of a hybrid plan for future employees to further mask the significant continued underfunding for current members. The euphemism for this scheme is “pension reform.”
Underfunding has been an official state standard since 2005, with the most recent policy reaffirmed as an essential component in Act 120 of 2010. This continued the practice of contributing 100 percent of a wholly-deficient, non-compliant contribution rate disguised as a state law. History provides new insights into the definition of a “balanced budget.” How many homeowners claim to balance their family budgets by intentionally shortchanging their mortgage payments?
Not surprisingly, several bond rating agencies have proceeded to downgrade Pennsylvania's debt and have recently requested such financial manipulations be immediately replaced by compliant funding practices.
Sadly even considering the hybrid plan design for new employees, there are profound shortcomings and political influences that have already compromised this plan to exclude certain classes of employees including the State System of Higher Education, state police with an anticipated legal challenge from the state judiciary. How many other groups will ultimately be accommodated to win legislative support?
Despite daily references to the “pension practices of the Pennsylvania private sector,” this over-engineered plan coupled with the absence of sound funding practices has little bearing to any U.S. private sector norms. In fact, such underfunding would be in direct violation of federal statutes governing private sector defined benefit plans.
In general, any pension analysis which references “cumulative costs or savings” such as $11 billion over 30 years reflects a process hijacked by politics since pension analyses are predicated on a present-value basis reflecting the net impact of anticipated future events measured in today's dollars.
Applying this concept to the recent hybrid plan proposal results in combined present-value savings of $3.3 bilion based upon customary and proper actuarial standards. Any savings are essentially cost avoidances associated with lower pension benefit of yet-to-be-hired employees. This subjective methodology creates a perverse incentive to assume aggressive hiring patterns to maximize pension savings. These little known facts are buried within the 149 pages of the actuarial note.
Pivotal to this entire analysis is the current 7.5 percent annual investment return assumption. A recent Rhode Island study quantified their 7.5 percent assumed rate as being only 40 percent probable. One should logically believe that Pennsylvania's pension assets are facing a similar challenge.
Other significant observations from Cheiron Actuaries within the PERC analysis include:
“Therefore, what is driving the cost and the reason why contributions are high and reaching over 30 percent for PSERS and PSERS, is the cost of paying for the unfunded liability. The unfunded liability will still need to be paid regardless of plan design.”
“Given the long-term nature of SERS and PSERS, it is imperative to consider this analysis using conservative assumptions to determine the potential savings.”
“The trend of the systems to adopt assumptions below the 7.5 percent investment assumptions of both PSERS and SERS to reduce the overall risks of the system if applied here would likely eliminate the savings.”
Such salient observations conflict with the political goal of continued underfunding. Given that financial standards have been fully compromised by legislative fiat, often with actuarial concerns summarily dismissed, perhaps the next goal is to statutorily prohibit credit downgrades.
These shortcomings are so acute that the supporters of “reform” now maintain that pension funding considerations are independent of plan design reforms. This means we are dealing with a political dodge as the long-overdue funding reforms identified by many will likely not occur anytime soon. This is analogous to subordinating expenditures from revenues during the annual state budget process. Pension systems operate based upon long-term revenues and expenses with an implicit expectation that annually determined actuarial contributions will be made. Instead we are dealing with a pension contribution based upon an ever-changing political equilibrium.
A single scenario of savings based upon hypothetical employees using optimistic asset return assumptions while continuing deficient pension funding policies hardly reconciles to the long overdue reform actions. This represents more of the same pseudo-reforms that state taxpayers are accustomed to witnessing.
It is ironic that Oklahoma Gov. Mary Fallin recently signed a bill placing future state employees in a defined contribution plan. Any transition costs associated with closing the defined benefit plan have not presented sufficient obstacles in OK or elsewhere in the U.S. private sector but are alive and well in Pennsylvania.
At some point policymakers will need to cut spending so that state and local entities can make their required pension payments – otherwise long-term solvency will continue to be at the forefront of every discussion. Consistently making these required actuarial contributions is the only definitive standard indicating that pension reform is underway.
This piece originally appeared in The Mercury
This piece originally appeared in The Mercury