Politics of Pensions

Comments on HB 2497

Richard C. Dreyfuss
Senior Fellow
October 13, 2010
“Pension Magic” in Florida
( d elsewhere)
(and l h )

Orlando Sentinel – July 7, 2010

"Warren Buffett would close down his shop and give

his money to the city of Orlando" if it could get 8
percent,, says
p y Edward Siedle,, a former federal
securities lawyer and president of Benchmark
Financial Services in South Florida.

Cities like Orlando have three choices, Siedle says.

1)"They can cut benefits, with is politically unacceptable”,
2)"They can increase contributions from the employer and
employees which is politically unacceptable.
employees, unacceptable ”
3)“The third choice is called magic. That's what public
pension funds across the country are doing, coming up
with magic.”

2
 True Pension Reform Must Satisfy Three Basic 
Principles 
Principles –
p – Using Realistic Funding Assumptions
g g p

1. Funding must be current.
– Benefits should be funded as they are earned and “paid‐
Benefits should be funded as they are earned and “paid
up” in the aggregate at retirement 
– Achieving a 100% funded ratio
– Si ifi
Significant private sector pension reforms occurred in 
i i f di
2006. (Lower investment assumptions ~ 6%, funding 
periods <15 yrs., market value of assets) 

2. Costs must be predictable.

3. Costs must be affordable. 
– 5 7% f
5‐7% of payroll (net of employee contributions)
ll ( t f l t ib ti )
3
 Five Step Pension Reform Plan
1. Establish a Unified Defined Contribution plan for new state and local government 
workers, school employees, judges, and legislators (SB566)
– Curtails open‐ended liabilities; Eliminates long‐term commitments on behalf of 
taxpayers
– Removes politics from pensions

2. Prohibit pension obligation bonds or other post‐employment benefit (OPEB) bonds
– Prevents “generational theft” – deferment of liabilities

3. Mandate pension and OPEB liability management reforms for current and any newly 
created liabilities.
– Goal is to achieve an employer cost of 5% to 7% of payroll after using more 
conservative actuarial assumption and shorter amortization periods

4. Consider modifying unearned pension benefits (if legal and feasible)
– Reduced formula; Redefinition of eligible earnings; Increasing the normal 
retirement age; Curtailing early retirement subsidies; Eliminating COLAs and 
Deferred Retirement Option Programs (DROPs)

5. Consider funding reforms only after prior steps are achieved 
Challenge is to do this without increasing taxes or through new borrowing
Omitting steps 1,2,3,4 ≠ pension reform 4
 PA Non‐‐Reform Reform Ideas
PA Non
Reforms we don’t need and can’t afford…
Item
Pension Obligation Bonds
An early retirement incentive plan
“Fresh start” of PSERS and SERS
unfunded liability up to 30 years
A new and reduced DB plan
A new DB plan with optional DC plan
for new hires - some with annuity
payout
p y options
p affordable
A new hybrid plan or a reduced set of
new DB & DC plans
Detail Why it is a problem
Floating bonds to fund Increases risk to taxpayers
pension plan deficits with a certain incentive to
increase pension benefits
Enhances already generous
benefits. Long amortization
periods. Only works if backfill
rate is below 40%
Creates a new “mortgage” Increases generational theft
HB 2497
2 9 An easy political
li i l solution
l i
HB 2497 Even a new DB will not escape
the politics of public pensions.
Consider PSERS and SERS - 10
years ago
y g – lessons of history.y
Doubles-down on the status
quo.
Long-term taxpayer costs will
not be current, predictable or
A new DB plan which where Same politics and funding
the accrued benefit is an problems associated with
account balance defined benefit plans
5
HB 2497  ‐ Increasing Generation Theft without Solving the Political Problem
(Passed: PA House 6/16/10)

Impact of change versus current schedule of taxpayer contributions
Comparing House and Senate Versions
Source: PERC Actuarial Notes 6/15/2010 & 10/12/2010

Taxpayer  PSERS SERS Total

Contribution 
Impact:
Impact: 
FY: 2011‐2025   ‐$15.3B ‐$4.3B  ‐$19.6B        
House/Senate $‐9.4B ‐$2.0B ‐$11.4B
FY: 2026
FY: 2026‐2042
2042 +$36.8B 
+$36 8B +$9.6B
+$9 6B +$46.4B
+$46 4B
House/Senate  +$11.6B  +$1.5B +$13.1B
FY: 2011‐2042  +$21.5B +$5.3B +$26.8B
House/Senate  +$2.2B  ‐$.5B +$1.7B
Net Present  ‐$5.0B ‐$1.5B ‐$6.5B
Value @ 8%  ‐$4.3B  ‐$1.4B ‐$4.7B
@
Future Value @  +$59.1B
$ +$17.9B
$ +$77.0B
$
8% +$50.0B +$17.6B +$67.6B
6
 Funded Ratios & Selected Unfunded Liabilities on PSERS & SERS
Assuming an 8% Annual Investment Return
Assuming an 8% Annual Investment Return
Source: PERC Actuarial Note 6/15/2010 

SERS SERS SERS  PSERS PSERS

Current  HB 2497 HB 2497 Current Law HB 2497
Law House  Senate House Version
Version Version
2009 84.4%/ 84.4%/ 84.4%/ 79.2% /$15.7B 79.2% /$15.7B
$5.6B $5.6B $5.6B
2015 69.8 61.8 63.6 56.7 57.8

2020 75.5 63.9 69.6 66.8 /$37B 51.9 /$54B

2025 81.4 67.4 75.7 77.0 56.1

2030 88.0 73.2 82.1 86.5 64.0

2035 93.4 82.3 89.2 93.8 74.4

2040 97.4 94.8 96.5 97.9 87.7

7
Comments on HB 2497

1. This bill cannot be considered as reform. It is more

financial manipulation used to reduce contributions to
already underfunded plans
2 This bill sends a message that the current costs are not
2.
affordable with little attention given to funded ratios
3. 8% asset rate assumption – a significant to taxpayers –
many plans are considering lowering this key
assumption
4 Reaffirmation that defined benefit pension plans and
4.
politics do not mix
5. Risk sharingg arrangement
g for new participants
p p is over-
engineered and will prove to be an ineffective cost
management strategy 8
Comments on HB 2497 (continued)

6. Actuarial concerns relating to “collared” rates,

asset a averaging
e aging pe
period
iod
7. Continuation of “Generational Theft” –
amortization p periods should not exceed 15 years
y
8. All this increases the likelihood of significant
funding problems over the next 10 years ranging
from state budgeting to ever-increasing
ever increasing unfunded
liabilities. This presents a further risk to
taxpayers.
9. What safeguards are in place that future benefit
enhancements will not be added (such as a
pension COLA).
COLA)
10. We must be able to do better than this.
9
Final Thoughts: Implications for Sound
Public Policy
1. How does deferring unsustainable pension liabilities make future
liabilities sustainable? Whyy is ignoring
g g standard actuarial
principles while contributing less into already underfunded plans
considered reform? How is a system based upon 8% investment
assumptions deemed sustainable?

2. We have implicitly over-leveraged our pension system - now the

challenge is to finally restore proper funding while offsetting these
increased costs elsewhere within the state budget without
increasing overall spending (or borrowing).
borrowing)

3. Given all this, what are the financial incentives to live, work, or
y
invest in Pennsylvania?

4. This debate is effectively one involving self-reliance while removing

politics from pensions, protecting the taxpayer and stopping
generational theft.
theft

10