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Latest ‘Pension Reform’

Latest ‘Pension Reform’

POINT OF ORDER: ‘Savings’ from latest ‘pension reform’ proposal based on questionable assumptions.

POINT OF ORDER

A Capitolwire Column

By Chris Comisac

Bureau Chief

Capitolwire

HARRISBURG (June 2) – In an effort to save state lawmakers time that could be better spent on addressing how to develop a balanced state budget for the coming fiscal year, here’s my summation of the analyses done regarding the most recent proposal to “reform” Pennsylvania’s public pensions: it’s unlikely to do what you want it to do.

Now I’m paraphrasing quite a bit – given it was a nearly 150-page report regarding a more than 200-page piece of legislation – but of the four actuarial firms that provided information regarding the stacked hybrid plan being offered by state Rep. Mike Tobash, R-Schuylkill, the support for claims of savings – reading between the lines – is thin at best.

But the plan falls short not because the labor unions, who would represent the new hires impacted by the pension changes proposed by Tobash’s plan, say it stinks.

I know some of the detractors from the left side of the political spectrum are arguing the proposal won’t save much, and they’re correctly noting the potential savings won’t be realized until far into the future. As an aside, I find it funny how those are now arguments to not implement Tobash’s changes when those same arguments could have been used against Act 120 of 2010 since the only immediate savings realized from that effort came because lawmakers decided against paying what was properly owed to the pension plans. And why did they do that? Because of potential savings that wouldn’t be realized until decades into the future due to pension benefit changes for newly-hired employees.

That’s not what I’m saying.

I’m saying – and I’m basing this on what the actuaries wrote in their reports about Tobash’s proposal – it’s highly unlikely there will be any savings, and potentially some additional cost.

Now I know what you’re thinking: “Whoa, Chris, the actuarial reports indicate savings of the entire plan – the three-amendment package, not just the main Tobash amendment – in excess of $11 billion over the next 30 years.”

Yes, they do. However, Cheiron, the actuarial firm for the Public Employees’ Retirement Commission (PERC), clearly indicates that’s based on the current assumption the state’s two pension plans will continue to realize a return on their investments of 7.5 percent for the next three decades.

Further along in their report, they clearly state: “There continues to remain a long term risk with the discount rate assumption. The current 7.50 percent assumption has been used in many of the projections. The circumstances surrounding the need to consider this type of hybrid plan is based on the impact of cost volatility and unsustainable funding levels. If this is addressed at the source through more conservative assumptions, the underlying discount rate assumption, and potentially other actuarial assumptions, the projected revenue savings will be greatly diminished. However the overall risk of the Systems could be reduced, providing cost stabilization.”

And a bit later, Cheiron is even clearer: “Over the projection period studied, the results show small, but measurable, anticipated savings under the hybrid plan for both Systems. However alternative assumptions show material differences in the expected savings as demonstrated between Milliman and the Systems’ actuaries. The trends of systems to adopt assumptions below the 7.5 percent investment assumptions of both SERS and PSERS to reduce the overall risks of the Systems, if applied here, would likely eliminate the savings.”

So, in English, the problem here is the 7.5 percent investment return assumption is a bit too rosy, and, as I wrote last year, when that return assumption is reduced, the assumed savings are also reduced. When the pension systems reduced their 8 percent return assumption – upon which Act 120’s “savings” were based – to the current 7.5 percent assumption, an additional $6.7 billion was added to the combined unfunded liability of the state’s pension systems. But when Act 120 became law, it was supposed to save – during the next three decades, with much of those savings coming at the end of that period – $2.9 billion. So change the return assumption by even a little bit and you’re savings are gone, as they have been for Act 120 since the pension systems altered their return expectations.

So why would anyone change the return assumption? The pension systems have a 30-year average performance in excess of 8 percent, right?

But that’s what they’ve been able to do, not what they expect to be able to do in the future. The return assumption is supposed to be a projection of what will happen, which has nothing to do with what has happened in the past.

And, right now, there are plenty of people who think a more conservative estimate for future returns is in order, including Cheiron, which wrote in its report about the Tobash proposal: “What is becoming increasingly apparent among public plans is the inability to respond to the risk volatility of the underlying investments backing the benefit promises. This coupled with the increasing number of members eligible to retire in the near future have contributed to the strain on resources. The projected cost savings that do not emerge for a number of years can be impacted by the Systems’ experience. These analyses should be accompanied by projections that incorporate steps to lower the overall risk profile of the Systems to better manage the potential long term expectations of the hybrid plan.”

Both of Pennsylvania’s pension systems in recent years have had liquidity issues, i.e. difficulty paying out the pension benefits of current retirees. The systems have had to liquidate some of their investment assets – which does greatly reduce risk – simply to pay out benefits.

And when you “lower the overall risk profile of the systems,” that means an investment return of something south of 7.5 percent. The question is how far south?

In a recent report it did for Rhode Island’s pension system, Cheiron indicated there was a 40-percent chance the returns for that state’s pension fund investments would continue to hit 7.5 percent during the next 20 years.

Earlier this year, the Society of Actuaries published its Blue Ribbon Panel on Public Pension Plan Funding report in which it indicated pension funds should be “using assumptions that are consistent with median expectations about future economic conditions, i.e., the assumptions are estimated to be realizable 50 percent of the time.”

So in Rhode Island’s case, to ensure a 50-50 chance of hitting their investment return assumption during the next 20 years, the state’s pension consultant, Gabriel Roeder Smith & Company, said it would require the assumption to be reduced to about 7 percent.

How would you like to bet your retirement security on a coin flip each year for the next few decades? But just to get to that, the tiny state of Rhode Island – which has an unfunded pension liability of somewhere around $5 billion (but that’s big in Rhode Island) – would have to lower its investment risk and increase its unfunded liability by about $1 billion.

In Pennsylvania, a half-a-percent drop, as shown when the return assumption was reduced from 8 percent to 7.5 percent, was good for nearly $7 billion in added unfunded liability.

Some will, no doubt, point out that Cheiron’s report estimates $11.2 billion in savings from the Tobash proposal, and 11 is greater than 6 or 7. So why wouldn’t there still be some savings left, even if the return assumption is reduced?

This is where things get a bit more tricky.

That $11.2 billion figure is projected cumulative savings during the next 30 years. However, the state’s unfunded liability is present value debt, meaning it’s what we owe as of today, not thirty years from now. Comparing the two numbers is simply mathematically wrong.

So what’s the present value of the projected savings, assuming a 7.5 percent investment return during the next 30 years? According to Buck Consultants – the actuary for the Public School Employees’ Retirement System (PSERS) – it’s about $1.5 billion. And while The Hay Group – the actuary for the State Employee’s Retirement System (SERS) – did not do a present value calculation for the Tobash proposal’s projected savings, it figures to be slightly more (given the savings from Tobash’s proposal is expected to be a bit more for SERS than PSERS).

Which means, at best, the present value of the savings that could be realized during the next 30 years is a bit more than $3 billion. But if the investment return assumption has to be reduced, by as little as a half-a-percent, that $3 billion in savings is more than erased by at least $6 billion in added unfunded liability. Even using the rosiest of savings predictions – those from the state Budget Office’s actuarial consultant Milliman, which were about $3 billion higher for the 30 year period – won’t double the present value of the savings.

This is without any consideration of the validity of the many other assumptions upon which the savings are based … and PERC’s Cheiron report questions several of them too.

That’s not to say the Tobash proposal is bereft of good ideas: the clarification that pension benefits for all new hires are not contractual rights is something that should have been in black-and-white from day one of the pensions (it would have allowed for more options to address the current situation) and increasing the reliance by employees on a limited DC retirement plan is a welcomed step, even if it’s not the complete switch to a DC – and only a DC plan – it needs to be.

But to make this incredibly simple: if PSERS and SERS are even a little bit iffy with regard to their 7.5-percent investment return assumption – and there are plenty of indications they should be – the Tobash plan doesn’t appear to deliver any savings, now or in the future, with a return rate that’s less than 7.5 percent. Under that scenario, the rest of the negatives or positives regarding the proposal’s plan cost, retirement security, other assumptions, etc. are all moot.

And if there are still state lawmakers hoping to push another plan that would allow the Commonwealth and school districts to further underfund PSERS and SERS because of assumed savings – and I’m certain there’s still some life in the “tapering of the collars” plan given current state revenue concerns – it sure seems like they might want to start looking for those budgetary savings elsewhere.

 

PSCOA Star

Robert Storm
Eastern Region Vice President
rstorm@pscoa.org

www.pscoa.org