Solvingtheschoolpensionfundingchallenge1

JimPawelczyk,PhD2 BoardofSchoolDirectors,StateCollegeAreaSchoolDistrict StateCollege,PA August9,2012

By2017,StateCollegeAreasSchoolDistrictexpendituresforPSERS,thePublicSchoolEmployee RetirementSystem,willincreaseby$6millionperyear.Thatequalsnearly3mills,or$200forthe averagepropertyowner.Withoutreform,costswillmultiplyevenmore.Whatcanbedonetomake PSERSsustainable?Howdoweaffordtheskyrocketingbill? ThroughPSERS,retiredschoolemployeesreceivedefinedbenefitsguaranteedpensionpayments basedontheiryearsofserviceandtheaverageoftheirthreehighestyearsofearnings.Earningsstart withbasesalaryandaddonpaymentsforovertime,extracurricularactivities,incentivesandpaidleave. Employersfinanceanypensiondeficits,typicallybyaddingmoretaxpayermoneytothesystem. Now,afteryearsofgenerouspromises,meagercontributions,andunrealisticinvestmentexpectations, PSERSshortfallexceeds$26billionstatewideand$350millionfortheSCASD.Thetotalbillwill probablybemuchlarger.Why?Becausepensionaccountantsandlegislatorstreatexpectedreturnson riskyassets(currently7.5%peryearforPSERS)asthoughtheywererisklessandcertain,thenusethat fallacytounderestimatethesizeoftheirdebtstofutureretirees.Whentheyrewrongastheyhave beenforallofthiscenturyyourtaxdollarsinsurethatallpromisedbenefitsarefunded. Thereareonlythreewaystogetthesystembackonsolidfinancialfooting:defertheliabilities,change PSERStoreducecostsandliabilities,orincreasefunding. Oneoftheseoptionsisntworthconsideringatall.Deferraliseasy,butitsnotananswer.Its generationaltheftforcingourchildrentopayforourfiscalirresponsibility. Severalreformsfornewemployees,however,areworthyofconsideration: SoftFreeze.HouselegislatorsrecentlyintroducedHB2454,whichwouldreplacePSERSdefined benefitplanwithadefinedcontributionplan,similartoa401(k).Employersandnewemployees wouldcontributefixedamounts;investmentperformancewoulddeterminethevalueofthe benefitatretirement.Itsnotthefirsttimesuchanideahasbeenproposed.Contactyour legislators.Tellthemyousupportit. AmendedAveraging.Usecareeraverageearningsinsteadofthethreehighestannualsalariesto definepensionvalue. BacktoBasics.Useonlybasesalaryforpensioncalculations;dontincludeextradutypay.

AnabbreviatedversionofthisarticlewaspublishedintheCentreDailyTimesonAugust9,2012 (http://www.centredaily.com/2012/08/09/3292859/somesolutionstoschoolfunding.html) 2 TheviewsexpressedherearemyownanddonotnecessarilyreflectthoseoftheStateCollegeAreaSchool DistrictortheentireBoardofSchoolDirectors.FactshavebeenverifiedbythedistrictsBusinessAdministrator.

Noneoftheseproposalswouldaffectcurrentemployees.Pensionreformforthemmightincludesome ofthefollowingfeatures: HardFreeze.Futurebenefitaccrualswouldcease.Earnedbenefitswouldbefrozenattheir currentvalueandstopgrowingwithserviceandsalary.Instead,benefitsforfutureworkwould becompensatedusingadefinedcontributionplan. ThestateofWisconsinusesavariationofahardfreeze.Benefitsaccrueasadefinedbenefit whiletheemployeeisworkingbuttheyconverttoadefinedcontributionwhenanemployee retires.Bymakingtheretirementbenefitanannuity,itsfuturevaluefloatswithinvestment performance;theresnoadditionalliabilitytotaxpayers.ItswhyWisconsinspublicpension systemisthebestfundedsysteminthenationandtheonemostlikelytomeetitsobligations. SensibleSalaryGrowth.Otherthanahardfreeze,themosteffectivewaytocontrolpension costsistoslowtherateofsalarygrowth.Weneedtodobetter.Overthedurationofthe SCASDslastcontractwiththeStateCollegeAreaEducationAssociation,salariesforunion memberswithlessthan20yearsofexperienceincreasedbyanaverageof7.4%peryear.Thats wellabovewhatPSERSexpects.Assumptionsforannualsalaryincreaseswererecentlyreduced from6%to5.5%peryear;evenso,theyarestillamongthehighestinthenation.Whilethat decisionshrunktheapparentsizeoftheunfundedliability,itcouldhavethemoredamaging effectofmovingevenmoredebtoffledgerunlessschoolboardsandunionsfollowsuitwith morefiscallyresponsiblecollectivebargainingagreements. Ataminimum,bargaininggroupsneedtounderstandthattheeconomicramificationsof generouscontractsextendlongbeyondtheirexpirationdate.Bydrivingupsalariesfasterthan anticipated,theyunwittinglygrowtheunfundedliability.Alternatively,perhapsitstimeto considerlegislativecapsonsalaryincreasessothattheybetterreflectactuarialexpectations. Staytoplay.Nearlyallemployeeshiredbefore2011opttoremovetheirPSERScontributionat retirement(with4%guaranteedinterest).Act120of2010prohibitedthispracticefornew employees,savinganestimated$6billionover30years.Endingitforallemployeeswould retainmorecapitalforinvestmentgrowth.

Tobeclear,pensionsareregardedascontractsinPennsylvania,solegalprecedentrunscontraryto pensionreformforcurrentemployees.Currentdebatecentersonakeyquestion:Isthereanimplied contractthatextendspensionprovisionstofuturesalariesthathavenotyetbeenearned?InJune, votersinSanJoseandSanDiego,Californiasaidno,approvingahardfreezeformunicipalpensionsand incitingalegalchallengethatmaypromptjudicialreviewsinotherstates.

Localmechanismstoboostpensionfundingarelimited;schoolboardscanraisetaxesand/orcut servicestodivertmoremoneyfromdistrictoperationstoretirees.Thisyear,39%ofschooldistrictsin Pennsylvania,includingtheSCASD,receivedanexceptiontoincreasetheirAct1propertytaxlimitsfor pensioncosts.Whynotconsiderotherrevenuesourceslike: Higheremployeecontributions.ACentreDailyTimeseditorial(May20,2012)endorseda recommendationthatstateandschooldistrictemployees,payahigherpercentageoftheir pensioncoststoeasetheburdenontaxpayers.Itsafairwaytobepartofthesolution. Stopdoubledipping.AloopholeinPennsylvaniascharterschoollawallowscharterschoolsto bepaidtwiceforPSERSexpenses.Taxpayersputupthecashmoneythatcouldbereallocated toshrinkPSERSunfundedliability.EliminatingthedoublepaymentwouldsavetheSCASD nearly$2millionby2017andmorethan$500millionstatewide. Nonpropertytaxrevenue.Candidatesincludeshalegasincome,adedicatedsalestax,gaming revenue(aproposalendorsedbythePennsylvaniaAssociationofSchoolBusiness Administrators)andincreasesinlocalorstateincometaxes.Twoconcerns:First,anycurrently proposedlegislationincorporatingtheseideas(e.g.,HB1776/SB1400)isdesignedtoreform schoolfinance,reducingschoolpropertytaxeswithoutincreasingPSERSfunding.These revenueneutralproposalswereneverdesignedtosolvetheshortfall.Second,dependingon thetaxandthestatesdisbursementformula,localcontrolofourtaxdollarsmightdiminish. Ourlocallygeneratedrevenuecouldendupfixingsomeoneelse'sproblems.

Amongtheworkablesolutions,bewareoftheseclinkers: Eatingourseedcorn.TheSCASDhasaccumulatedmorethan$9millionforfutureretirement contributions.InarecentinterviewGovernorCorbettopinedthatschooldistrictscoulduse theirreservestoplugbudgetgaps.Redirectingdesignatedreservesforanythingotherthan PSERSwouldonlykickthecandowntheroad,fuelinglargertaxhikesinthefuture. TheHailMary.Hopingformarketrecoveryisunworkable.Overrelianceonquestionable marketperformanceistheprincipalcauseofthecrisis;itisnottheremedy! TheHouseofCards.Pensionobligationbondsaredebtinstrumentsissuedbygovernment entitiestofundalloraportionofaretirementobligation.Interestfrominvestmentsisthen usedtopayoffthebonds.Likeusingasecondcreditcardtopayoffthefirst,thereissignificant riskifthepensionplansinvestmentreturnsarelessthanthedebtcosts.ItswhyAct120s prohibitionagainstpensionobligationbondsshouldremainpermanent.

Whenwillourlegislatorsaccepttherealitythatourpublicpensionsystem,whichshouldbesecureand enduring,hasinsteadbecomeariskyfinanceschemethatisunlikelytomeetitsstatedfinancial expectations?Pennsylvanianeedsamixofsolutionstofunditsretirementsystemsadequately;the fixesofthepastarentanymorelikelytosucceedinthefuture. Anessentialpartofpensionreformmustincluderevaluingtheunfundedandfutureliability.Recent performancehasdemonstratedthattheassumedrateofreturnisapoorassumption,indeed.Reform proposalsshouldbecostedusingmarketrates,notactuarialgimmicks.

Hereisapragmaticsetofrecommendations:sloworcapsalarygrowth;instituteasoftfreezeandother pensionreformsfornewemployees;addressthelegalitiesofahardfreezeandastaytoplayoptionfor currentemployees;eliminatedoubledipping;addnonpropertytaxrevenue;and,increasethe employeecontribution.Finally,ifmorerevenueisneeded,considerincreasingtheemployer contributiontomakeupthedifference. FormorebackgroundonPennsylvaniaspensionchallengesandtheireffectontheSCASD,pleaseread http://www.scribd.com/doc/100533184/ASchoolFinanceChallengefortheDecade

MoreinformationonPSERScanbefoundathttp://www.psers.state.pa.us.