By Richard C. Dreyfuss
Someone once quipped that a camel is a horse designed by committee. A perfect example of this metaphor is the "stacked-hybrid" public pension plan passed by the Pennsylvania House in mid-June. Rather than fixing our broken state pension system, this plan keeps all the problems that led to billions in debt and continues to avoid paying for the promises made to public employees.
Pennsylvania taxpayers already face an unsustainable $63.2 billion pension debt - 730 percent more than just 10 years ago. This threatens future plan solvency and transfers costs to future generations. Those seeking to live, work, or invest in our state will not be pleased at a welcome committee holding out a bill for billions in unfunded pension liabilities.
Though lawmakers should be applauded for making this critical issue a priority, this latest attempt at pension reform isn't the short- or long-term solution Pennsylvanians have been waiting for.
On June 14, the Pennsylvania House approved a defined-benefit plan integrated with a defined-contribution plan. Simply put, new employees retain a defined-benefit plan for the first $50,000 of annual income that is annually indexed. A defined-contribution plan applies to any salary over that amount.
While defined-contribution plans, like 401(k)s, are prevalent in the private sector, anything similar to this "stacked hybrid" plan is virtually nonexistent in either the private or public sector. The term "hybrid" is synonymous with pseudo-reform.
Our $63 billion combined unfunded liability for the Public School Employees' Retirement System (PSERS) and the State Employees' Retirement System (SERS) is the result of underfunding, poor investment returns, and benefit enhancements. It's measured in today's dollars and based on a number of assumptions, including an optimistic annual investment return of 7.5 percent.
Contrary to some claims, it does not assume all members retire today. Moreover, the annual unfunded liability measure is based only on current plan members. Future members are not included.
Given this, it is important to properly understand the highly politicized phrase "pension savings," often used in the context of pension reform.
True pension savings come in two ways: (1) modifying current members' earned or future benefits and (2) changing benefits for new hires. The House plan partially does the latter, meaning its changes leave the debt untouched.
Why, then, are we hearing the recent plan will save $5 billion over 30 years? These "savings" are effectively cost avoidances. In other words, they are computed against an underlying assumption of new hires and their possible future costs. Ironically, the greater the number of assumed future members, the greater the pension "savings."
Furthermore, any credible savings figures must be expressed in today's dollars, not over decades. In truth, the $5 billion in savings over 30 years touted by the House is just $1 billion.
Even this $1 billion will soon be offset by additional debt. PSERS recently announced a reduction in its assumed annual investment rate of return from 7.5 percent to 7.25 percent. This, along with other changed assumptions, will likely increase the debt by more than $2 billion - more than twice the cost avoidance "savings" touted by the House.
Since the House bill doesn't address the unfunded liability, credit rating agencies will likely be unimpressed and continue lowering our debt rating, which will raise government borrowing costs.
Are we in too deep to ever escape the burden?
While the political calculus needed to secure approval of meaningful pension changes from the House, Senate, and governor may be difficult, the actuarial math is indisputable. Public employees have paid their required contributions just as taxpayers have paid their required taxes. The problem is inherent in the defined-benefit plan itself, which can be underfunded and manipulated for political gain.
Some cite "transition costs" to say we cannot afford to close the existing defined-benefit plan, a factor that has never precluded the closing of a private-sector defined-benefit plan. Conversely, some incorrectly claim that a defined-contribution plan will somehow cap the debt. It won't. Closing the defined-benefit plan still retains the risk of asset underperformance, underfunding, and therefore rising debt.
Those looking to reduce the unfunded liability through plan design changes for new hires should know better. The debt will be reduced only by increasing contributions in the near term.
Pension reform will truly be underway when all new members participate in a stand-alone, defined-contribution plan and we commit to paying off our pension debt over 20 years.
It is far too late for a set of overengineered design changes crafted into a bill called pension reform to suffice. If we want to fix the problem, we must face it, not tinker on the margins.