Aschoolfinancechallengeforthedecade1

JimPawelczyk,PhD BoardofSchoolDirectors2,StateCollegeAreaSchoolDistrict StateCollege,PA July19,2012 ThemetaphorsdescribingPennsylvaniaspublicpensiondebaclekeeppilingup.Tsunami,train wreck,perfectstormtheypaleincomparisontoreality.By2017,PennsylvaniasIndependent FiscalOfficeestimatesthatpensionpaymentswillconsume11.6%ofthestatesGeneralFund budget,upfrom4.2%thisyear.Expenseswillrisemorethan$4billionperyear;thatequals morethan$1000perPennsylvaniahouseholdinincreasedstateandlocaltaxes.Itwontbe enough.Thereason?Investmentsarelaggingfarbehindrisingbenefitpayments. PSERS,thePennsylvaniaSchoolEmployeesRetirementSystem,hasrunupatabofatleast $85.8billionasofJune30,2011.Thatisonehugebill,andtheCommonwealthisshortbymore than$26billion.Nationwide,theunfundedstatepensionliabilitytotalsabout$1.3trillion. Basedontraditionalfinancialeconomicsitsprobablythreetimeslarger. Whythedifferenceinpredictions?Investmentassumptions;theeducatedguessesthat actuarialscientistsandeconomistsusetopredicthowmuchmoneywillbeneededtofund retirementbenefitsdecadesfromnow. Mostofushaveretirementfundslikea401(k).Yourcontributionandyouremployermatchis defined,butthebenefityouearnatretirementdependsonhowwellyourinvestmentsperform overtime.PSERSisdifferent.Itsadefinedbenefitplanthatguaranteesapensionpaymentto retirees.ThePSERSboardconsultswithitsexpertstodeterminehowmuchmoneywillbe neededwhenemployeesretireandhowmuchinvestmentearnings,employeecontributions andemployercontributionsarerequiredtofundthesystem.Shortfallscanoccurformany reasons,includingpoorinvestmentreturns,offeringmoregenerousbenefitsorunderfunding thesystem. AllofthesehavehappenedtoPSERS. PSERSassumesthatitsinvestmentswillearnatleast7.5%everyyear,withoutfail.Didyour investmentsdothatwelloverthepast10years?Doyouthinktheyllaveragethatrateinthe future?Ifyouranswertobothquestionsis,yes,thenrestassured,$250millionisallthe
1 AnabbreviatedversionofthisarticlewaspublishedintheCentreDailyTimesonJuly18,2012
(http://www.centredaily.com/2012/07/18/3264650/schoolfinancefacinganenormous.html)
2

TheviewsexpressedherearemyowndonotnecessarilyreflectthoseoftheStateCollegeAreaSchoolDistrictor theentireBoardofSchoolDirectors.FactshavebeenverifiedbythedistrictsBusinessAdministrator.

StateCollegeAreaSchoolDistrict(SCASD)willneedtopayoverthenext30yearstocoverits shareoftheshortfall.Bytheway,youroddsofbeingrightarefarlessthanacoinflip.Onthe otherhand,ifyouranswertoeitherquestionis,no,thentheunfundedliabilityisatleast 50%,andasmuchas200%,greaterthanwhatyourehearingfromHarrisburg. Sothesmartmoneyisonabiggerbill.PSERSaveragerateofreturnduringthismillenniumhas beenbetterthanmoststatepensionfundsbutitsstillwellbelowexpectations.Investments lostmoneyinfourofthepasttenyears.AndPSERSisnottheonlypublicpensionplan experiencingthisproblem.ArecentstudybytheWilshireAssociatesconcludedthatevery statepensionplaninthenationhasoverpromiseditsrateofreturn. Allofthatextradebttrillionsofdollarsnationallyiscurrentlycarriedoffbalancesheet. Toaddinsulttoinjury,benefitpaymentsarerisingrapidly.Tryingtopaymorewhilemakingup forpreviouslossesislikerunningonatreadmill:youworkreallyhardwithoutgoinganywhere. Today,PSERSassetsarelessthan$50billionaboutwhattheywerein1999despiteinfusions ofemployeeandtaxpayerdollars.Forthefirsttimein20years,PSERSfundedratioa measureofitsassetscomparedtowhatitowesislessthan70%(80%isacommon benchmarkminimum).Evenifinvestmentgoalsaremet,itsprojectedtofallbelow60%by 2017.Usingmoreaccuratefederalaccountingrules,arecentstudyfromtheCenterfor RetirementResearchatBostonCollegeconcludedthatitscrossedthatthresholdalready. Ifthefederalgovernmentbelievesthatthebillisgreaterthanwhatscurrentlyacknowledged, whenwillourlegislators?Itstimetomovepastdenial,accusationsandfingerpointingand tackletheunderfundingproblemstraightup. Addressingtheseeightmythsareagoodplacetostart: Myth:PSERSprovidesariskfreebenefit.Fact:Ariskfreebenefitassumesariskfreerateof returnoninvestments.Butriskfreeinvestments,suchas10yeargovernmentbonds(which arentreallyriskfree),earnlessthan2%thesedays.Instead,PSERSmoreaggressive investmentgoalsrequireariskyportfolio.Additionaltaxpayerdollarsactastheinsuranceto fundbenefitswhenfailinginvestmentscant. Myth:SchoolboardscreatedthePSERScrisis.Fact:PSERSbenefitsandfundingratesare determinedbyHarrisburg.Bylaw,uptohalfthecostmustbepaidwithlocalrevenue. Myth:Anemployerholidaycausedthefundinggap.Fact:Schooldistrictsandthestatehave contributed16%ofPSERSfundingoverthepast25years,althoughnotnearlyenoughduring thepreviousdecade.(Act120of2010establishedaminimumpaymentthatpreventssuch lapsesfromoccurringinthefuture.)Meanwhile,employeeshavemaintainedsteady contributionsaveraging6.2%ofpayroll,about14%ofPSERSfunding.Becauseinvestment growthgeneratedthebulkofPSERSrevenue,poorinvestmentreturnscausedthelargest portionofthePSERSshortfall.

Myth:EitherGovernorRidgeorRendellinstigatedthecrisis.Fact:Thegapwascreatedbythe combinationoftoomuchrelianceonmarketgrowth,overpromisedbenefitsandan underfundedsystem.Bothadministrationscontributed,indifferentways.Fourfactorshelped fuelthedramaticincreaseinPSERScontributions: Pensionfundinvestmentlossesduring2001,2002,2008and2009 Legislatedincreasesinpensionbenefitsin2001,followedbyacostoflivingadjustment in2002 Legislationin2003and2010thatcompoundedthedeficitbydelayingpension contributions Legislationredirectingmorefundingtobasiceducationattheexpenseofpension contributions.

Myth:Thesystemisbankruptandwillrunoutofmoneyovernight.Fact:Payoutscurrently exceedcontributionsbythreefoldbutthecurrentlyprojectedincreasesinemployer contributionscouldmaintaincashflowfor1015yearsbeforePSERSgoesbroke.Werenot alone.ANorthwesternUniversitystudyportraystheproblemnationally:pensionfundsin sevenstateswillrundrybeforetheendofthedecade.Additionalcashinfusionstotaling trillionsofdollarswillbeneededtopayallstatespromisedpensionbenefits. Myth:Recentlegislationfixedschooldistrictsfundingproblems.Fact:Act120reduced pensioncostsfornewemployees.Butitincreasedcostsforcurrentemployeesbyrefinancing theirpensionbillforanother24years,stretchingassetsmoothingperiodsfromfivetoten yearstowhitewashrecentlosses(goingagainsttheadviceoftheCommonwealthsPublic EmployeeRetirementCommission),andslowingemployercontributions(adecisionbasedon politicalconvenienceratherthanactuarialsoundness).Theneteffectisalargerunfunded liabilityratherthanasmallerone. Myth:PSERSfundingplanisadequate.Fact:Basedonearningsthismillennium,projected increasesinemployercontributionswontkeeppacewiththeestimatedriseinbenefit payments.LagginginvestmentreturnscoupledwithAct120sdeferredcontributions compoundthefutureliabilityintwoways:Employersmustmakeupforinvestment underperformance,typicallybyaddingmoretaxpayermoneytothesystem;andPSERSmust selloffassetstomakeitspayments,reducingitsworkingcapitalforfutureinvestmentgrowth. Myth:Marketperformancecanrestorethesystemtohealth.Fact:DoublingtheDowovernight wouldnteliminatethemountainofpensiondebt.AndwithcurrentFederalReservepolicy depressinglongterminterestrates,anemicinvestmentearningswillputevenmorepressure onpensionsystems.Inthisenvironment,pensionfundsfacethesameproblemasanysaver: generatingenoughcashflowfrominvestmentstomeetincomeneeds. Sowhatdoesallthismeanforthefutureofpubliceducation?EmployercontributionstoPSERS willtripleby2017;theSCASDssharewillincreasebyabout$1.5millioneveryyearforfive

yearsormore.Paymentsareprojectedtoreachhistoricalhighsapproaching,ifnotexceeding, 30%oftheSCASDs$60millionpayroll. Thesoberingtruthisthatthe$250millionbookvaluefortheSCASDsPSERSbilleasilyexceeds $350millionwhencalculatedusingmorerealisticmarketreturns.Districtcostscouldgrowby morethan$1.5millioneveryyearbeyond2017untilcontributionsapproach45%ofpayroll! Makenomistake,PSERSisinmuchdeepertroublethanyouveheard.Thecostwillbea staggeringfinancialblowtoourpubliceducationsystem.Absentsignificantpensionreform, themoneytofundthesystemmustcomefromsomewhere;eitherreallocationsfromexisting programsorhighertaxes.Inmanyschooldistricts,justpayingthepensionbillwillconsumeall theallowablegrowthinpropertytaxrevenue. Thesolutionswillrequiremajorchangestocurrentpolicy.Forareviewofsomeofthebestand worstideasandtheirimpactontheSCASD,pleaseread
http://www.scribd.com/doc/101477210/SolvingtheSchoolPensionFundingChallenge
MoreinformationonPSERScanbefoundathttp://www.psers.state.pa.us.