As you may remember, Dropout Nation gave a preview of its analysis of the financial condition of Pennsylvania’s virtually-insolvent pension during Saturday’s report on the School District of Philadelphia. Since then, Keystone State Gov. Tom Corbett has failed to convince Keystone State legislators to pass his plan to increase contributions to the Public School Employees’ Retirement System. On Tuesday, the state’s lower house voted to effectively kill debate on the plan by steering the legislation into a committee chaired by one of Corbett’s fellow Republicans, Eugene DiGirolamo, who collected $19,750 in political contributions from public-sector unions (including $2,750 from the American Federation of Teachers affiliate there, and $1,000 from the National Education Association’s state unit) during the 2012 election cycle, according to data from the National Institute on Money in State Politics. With DiGirolamo proclaiming that he will not hold any hearings on Corbett’s plan, and with the governor himself likely to lose the state’s top executive spot in November, there is no chance that the state government will address PSERS’ insolvency until after the new year begins.
Regardless of DiGirolamo’s unwillingness or that of Democrats in the Keystone State to take action, and no matter what happens to Corbett (whose tenure as governor has been weak, especially on systemically reforming public education), PSERS is still virtually busted. And based on Dropout Nation‘s analysis, the underfunding is increasing at alarming levels.
PSERS officially reports a pension deficit of $30 billion for 2012, the latest year available. That is an 11.4 percent increase over its officially-reported underfunding for the previous fiscal year. But as your editor pointed out in last year’s analysis, the Keystone State pension’s official numbers are not to be trusted. This is because it assumes an investment rate of return of 7.5 percent, which is far higher than the 5.3 percent five-year return rate experienced on the market, according to Wilshire Associates, and much higher than the 2.5 percent five-year return rate PSERS has actually experienced. Thanks to an inflated rate of return, the Keystone State teachers’ pension is understating its virtual insolvency.
Another problem lies with Act 120, the pension law passed four years ago that has exacerbated the pension’s insolvency with such moves as boosting annuities collected by teachers to equal 75 percent of final year’s salary. The law mandates that PSERS recognizes its gains and losses over a 10-year period, instead of an already-ridiculous five years. Because this approach, called smoothing, allows for the pension to not immediately account for losses or gains, it gives the false impression that its financial condition is in good shape.
To get to the heart of matters, Dropout Nation uses a version of a method developed by Moody’s Investors Service that uses a more-realistic 5.5 percent rate of return on investments. [Moody’s uses a rolling rate based on the return on a long-term bond index; Dropout Nation uses the 5.5 percent rate Moody’s originally used in its preliminary analyses for the sake of consistency.] The result? DN determines that PSERS is underfunded to the tune of $37 billion, a 10.4 percent increase over the pension’s $33.5 billion insolvency as figured out by this publication in last year’s analysis. The $37 billion underfunding is 27 percent higher than PSERS’ officially-reported unfunded liability.
Based on a 17-year amortization rate, Pennsylvania taxpayers will have to shell out an additional $2.1 billion a year, 90 percent more than the $2.4 billion in contributions made in 2013. The Keystone State government’s plan to contribute an additional $600 million into the pension this year will do nothing to address the shortfall.
As with other teachers’ pensions, addressing PSERS’ insolvency is critical for Pennsylvania largely because of the number of Baby Boomers retiring from the teaching ranks. The number of retirees (net of deaths and other removals) added to PSERS’ rolls increased by 20 percent (from 168,026 annuitants to 202,015) between 2007 and 2012, while the payouts increased by 38 percent in that same period. Based on the pace of increases in annuitants in that six-year period, the pension will likely add 12,438 new annuitants (excluding deaths and other removals) to the rolls ever year for the next decade before retirements. With each retiree likely collecting at least $28,501 a year, PSERS will have to pay out at least $354.5 million more in annuities every year, further increasing its insolvency.
Keep in mind that the numbers only cover the pension’s underfunding alone. There’s also PSERS’s unfunded retired teacher healthcare costs with which the state must also contend. PSERS officially reports unfunded liabilities of $1.2 billion. But hold on: Unlike most pensions, PSERS uses the same inflated rate of return for the investments used to cover those costs as it uses for the pension. Using the same method applied to the pension, Dropout Nation determines that the true unfunded liability is $1.6 billion, 27 percent higher than PSERS officially reports. Based on a 17-year amortization rate, Keystone State taxpayers will have to pay $95 million more a year to pay down that shortfall, almost double the $109 million paid out last year.
At some point, given the increasing liabilities, Pennsylvania will have to deal realistically with PSERS’ insolvency. This must start with increasing contributions. But more-aggressive action must be taken.
While teachers officially pay 41 cents out of every dollar contributed last year. But as in most states, it is likely that districts are actually the ones covering the share of contributions teachers are supposed to make (on top of their own payouts to the pension). Embracing the approach taken by Detroit’s main city government to freeze the existing pension (save for paying out remaining contributions to retirees and whatever currently-working teachers are owed), and move current and new teachers to a hybrid pension. This would include a defined-contribution plan to which teachers can contribute as much toward their retirement as they so choose (with a five percent match from districts) along with a smooth accrual defined-benefit element similar to an approach advocated by Josh McGee of the John and Laura Arnold Foundation and Marcus Winters of the Manhattan Institute in a report released last month. As for PSERS itself? The state must end any cost-of-living increases for current retirees as well as reduce promised final-year salary payout percentages in order to get the pension’s financial house in order.
This move would help taxpayers and teachers by ending increases in PSERS’ unfunded liabilities as well as making the pension solvent. These moves woud also be helpful to younger teachers who are often the ones who bear the brunt of most pension reform plans. Given that defined-benefit pensions such as PSERS already do little for younger teachers because half of them are likely to leave classrooms within five years (and thus, unlikely to fully vest in the plans), moving away from the current pension would actually make teaching more attractive, both to those already working in the profession as well as to talented collegians who would otherwise look to gigs in the private sector.
But such a reform can only happen if Pennsylvania’s legislators and other political leaders actually address the long-term burdens facing the taxpayers and children they are supposed to represent. Sadly for the Keystone State, such action won’t happen anytime soon.
Featured photo courtesy of paindependent.com.