Budget Secretary Offers Plan to Address Rising Commonwealth Pension Cost

HARRISBURG – Budget Secretary Michael J. Masch released a plan to eliminate the dramatic increase in employer contributions to the commonwealth’s two pension plans that is currently forecast to occur in 2012-13.

“Time is running out to make the changes necessary to keep pension costs from increasing by 190 percent in 2013 – a potential single-year increase in pension costs of $1.6 billion for the commonwealth and Pennsylvania’s school districts,” Masch said.

The plan is explained in a white paper on pension reform that was released today by the Governor’s Budget Office. Masch said the plan solves the 2012-13 pension “rate spike” problem through changes in state pension funding policy and incremental changes in contribution amounts that will enable the state and local school districts to gradually absorb the impact of higher pension contributions over a manageable period of time.

Pensions for Pennsylvania’s state and public school employees are administered by two agencies – the Pennsylvania State Employees’ Retirement System, or SERS, and the Pennsylvania Public School Employees’ Retirement System, or PSERS. The plan calls for the implementation of new policies to determine the annual employer contribution rate to the pension systems.

The recommended new policies would:

-Eliminate the projected 2012-13 rate spike by phasing in graduated increases in employer contributions to the pension systems;
-Moderate future peaks and valleys in employer contributions to the pension systems;
-Protect the systems’ assets during any protracted downturns in the investment markets; and
-Retain useful features of the state’s current pension funding program wherever possible.

The administration’s funding plan is actuarially sound, and it addresses all the key issues surrounding the projected rate spike, Masch said.

“This plan provides for incremental changes in contribution amounts so future state and school district budgets can gradually absorb the impact of higher pension contributions and continue to meet their future pension funding obligations.

“Equally important,” Masch added, “this plan keeps the commitment we have made to our current and former state and school district employees to provide them with benefits that allow for retirement with dignity. This plan addresses both the relatively short-term issue of the 2013 rate spike and the larger issue of the long-term solvency of the state’s public employee pension plans.”

The budget office white paper projects that, without corrective action, commonwealth contributions to SERS and PSERS could increase to $1.57 billion in 2012-13. That would represent a $980 million, or 168 percent, single-year increase over 2011-12.

Under the same scenario, pension contributions from Pennsylvania’s 501 school districts could increase from $260 million in 2011-12 to $890 million in 2012-13. That would represent a 240 percent increase in a single year.

“Increasing contributions that much in a single year would jeopardize the financial health of the commonwealth and our school districts,” Masch said.

Retiree benefit enhancements approved by the General Assembly before Gov. Edward G. Rendell took office, stock market losses in 2001 and 2002, and actuarial adjustments approved by legislators in 2002 and 2003 that postponed large increases in employer contributions have all contributed to the looming crisis in state pension funding, Masch said.

“We must address this issue quickly because the time is short in which we can implement a solution that solves the rate spike problem with relatively little pain,” Masch said. “The administration’s plan provides the commonwealth and our school districts with a feasible, manageable and responsible way to meet our future pension obligations to retired state employees and retired public school teachers.”

The budget office white paper proposes a set of changes to SERS’ and PSERS’ current funding rules designed to avert the dramatic increases in employer contributions that will otherwise occur in 2012-13.

The key changes are:

· A new, higher minimum contribution rate for PSERS through 2011-12, which would be set at the 2007-08 rate. Although this action by itself will not prevent the spike, the higher minimum rate will prevent contributions from falling over the next four years, only to increase dramatically in 2012-13.

· A permanent higher minimum contribution rate for both systems that more closely correlates with the actual cost of the retirement benefits being earned by current employees. For SERS, this will reduce the large discrepancy that now exists between the actual cost of current employee retirement benefits and the level of employer contributions made each year. For SERS, the new permanent higher minimum contribution rate will be phased in over four to five years. Because the PSERS discrepancy is currently much smaller, the PSERS employer contribution rate does not need to be adjusted to address this issue.

· A method of limiting annual contribution rate increases and decreases based on the ratio of assets to liabilities in each system. This would enable state and school district budgets to absorb the impact of higher contributions over a period of years with less disruption to their annual budgets by permanently protecting against severe peaks and valleys in annual contributions. This method would build up each system’s assets during strong market periods, allowing the systems room to avoid dramatic contribution increases during and after bear markets.

· A fail-safe mechanism to protect system assets if there is a prolonged market downturn. This provision would require additional contributions from employers if investment markets were to experience an unusually long period of weak or negative returns.

PSERS currently has 264,000 active school employees and 168,000 retirees. The commonwealth pays slightly more than half of the cost of the employer share of retirement benefits for school employees, with school districts providing the remaining portion of the employer share. PSERS’ total employer contribution in 2007-08 is $820 million, with the commonwealth directly contributing about $450 million and the 501 school districts contributing the remaining $370 million.

SERS has 110,000 active members and 107,000 retirees. Most participants in SERS are current or former state government employees, and the commonwealth is the primary employer contributing to SERS. The total employer contribution to SERS in 2007-08 is approximately $220 million.

Most of the income that SERS and PSERS use to pay for pension benefits comes from investment earnings realized on employer and employee contributions to the two pension plans. Over the last 10 years, nearly 81 percent of PSERS pension assets and nearly 85 percent of SERS pension assets were generated by investment returns. Since the end of the bear market of 2001-02, both systems have generated several years of strong returns.

“Although investment returns have been strong over the long term for SERS and PSERS, there have been several periods of below-average returns lasting more than one year,” Masch said. “If a similar dip were to occur between now and 2013, the effect on commonwealth contribution rates would be disproportionately large due to the actuarial adjustments enacted in 2002 and 2003. Therefore, the prudent course of action is to change the rules governing commonwealth pension contributions as soon as possible to reduce the chance of a destabilizing rate spike.

“This is a solution that works for Pennsylvania taxpayers and for our retirees, and that is why lawmakers need to work with the governor to make the necessary legislative changes as quickly as possible,” Masch said. “Complacency is not an option. If we do not act now, we are likely to face a full-fledged pension crisis in 2012-13, with no time to correct the problem before the required increases in contributions become due.”

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