Prescription for Pennsylvania's Perilous Pension Problem

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WILKES-BARRE, Pa. — As business consultant Richard Dreyfuss sees it, Pennsylvania's most compelling fiscal challenge — unfunded pension liability — is also its hardest to understand.

"I have yet to see a bumper sticker that reads: 'Elect me and I will eliminate the unfunded liability,'" Dreyfuss, an actuary who once oversaw compensation packages for Hershey Foods, told a recent Pennsylvania Economy League workshop session on the state's pension crisis.

"Pensions are mind-numbing," he said. "Many get lost in the jargon trying to translate into English. People don't understand these things."

On Tuesday, four Democratic candidates will compete in a primary for the right to challenge vulnerable Republican incumbent Tom Corbett in the November general election. They are state Treasurer Rob McCord, U.S. Rep. Allyson Schwartz, former state environmental protection secretary Kathleen McGinty and businessman Thomas Wolf.

Pension woes are still on the back burner.

"The Democratic candidates have been focusing on public education funding and jobs more than pension liability issues," said David Fiorenza, a Villanova School of Business professor and the former chief financial officer of Radnor Township, Pa. "These issues are important and pensions should be at the forefront as well as they have a lasting effect on the state operating budget."

One candidate for lieutenant governor, Harrisburg Councilman Brad Koplinski, favors an overhaul of local government pension funds to cut administrative costs, protect benefits and standardize pension programs. "Our pension system is in disarray," said Koplinski, a Democrat.

The Keystone State has about 2,200 local plans, the most of any state. "We're in no danger of falling into number two anytime soon," said Dreyfuss, a senior fellow at the Commonwealth Foundation and an adjunct fellow at the Manhattan Institute for Policy Research, both free-market think tanks.

A proposal by Corbett and state Rep. Mike Tobash, R-Schuylkill, would place new state and school employees into a hybrid plan that combines defined benefit, or traditional pension plans, with defined contribution, or 401(k)-style plans, among other changes. Plans would not change for current employees. All four Democrats running for governor are said to favor keeping defined-benefit plans.

According to Dreyfuss, the shortfall is nearly $74 billion, including the state's major employee pension funds — the State Employees Retirement System and the Public School Employees Retirement System — municipal and county pensions and other post-employment benefit, or OPEB, obligations.

Acting state education Secretary Carolyn Dumaresq said this week that spiraling pension costs impair the state's ability to reimburse local school districts for construction costs and otherwise provide aid. Speaking to the Times-Tribune of Scranton, she cited Carbondale Area, Mid Valley and Western Wayne school districts — all near Scranton and Wilkes-Barre — to which the state owes more than $2.6 million in reimbursements for projects completed as far back as three years ago.

Dreyfuss, however, called that no excuse for underfunding its pension systems.

Pennsylvania since 2005 has not paid its full annual actuarially required contribution. The ARC, which amounts to normal cost plus unfunded liability, is based on a 24-year amortization for PSERS, 30 years for SERS.

Bond rating agencies continue to lurk, notably against the backdrop of heightened budget stress. Pennsylvania's revenue department last month estimated a $425 million revenue shortfall for the current fiscal year, citing sharply reduced income tax collections.

"Rising pension-funding demands present another obstacle," Fitch Ratings said last month. Fitch downgraded Pennsylvania's general obligation bonds in July 2013 after the state let pension overhaul slide. Fitch and S&P rate Pennsylvania AA, both with negative outlooks. Moody's rates Pennsylvania Aa2 with a stable outlook.
Standard & Poor's, meanwhile, said it would monitor fiscal 2015 budget and pension overhaul efforts and said it could lower the Keystone State in the next few months "in the absence of a structurally balanced budget and meaningful pension reform."

Dreyfuss served as director of compensation and benefits during his 21 years with Hershey Co. He maintains that the Corbett plan won't stave off the rating agencies; however, he said, changing and properly funding pension plans provide low political rates of return.

Three factors, he added, drive public pension problems: poor benchmarking, poor liability management and politics.

"Market forces in the private sector are directly relevant to the public sector," he said. According to Dreyfuss, 70% of Fortune 100 companies have defined-contribution, or 401(k)-style plans, as opposed to the traditional defined-benefit plans.

Compounding the problem, said Dreyfuss, is that few absolute metrics define the affordability or reasonableness of pension costs, given the so-called perpetual life of the government entity.

"People are fine with their plans as long as they're better than, say, Pittsburgh," said Dreyfuss. "And when you talk to Pittsburgh, they're talking about Detroit."

Pension overhaul, nationally as well as in Pennsylvania, is a political hot potato. Pension liabilities have been central to bankruptcy filings in Detroit and Central Falls, R.I., and have stressed other cities, notably Chicago. Allentown, Pa., leased its water and sewer system last year to offset a pension obligation that threatened to consume 30% of its budget by 2015.

According to the Pew Center on the States, the gap between what state and local governments have promised in pension benefits to their workers and the funding to meet obligations has further widened.

Citing new data for fiscal year 2012, Pew estimates that state-run retirement systems had a $915 billion shortfall. Pew estimated the total pension debt at more than $1 trillion, factoring in promises by local governments.

Dreyfuss called for a five-step pension overhaul that would establish a defined contribution plan with an annual employer costs of 4% to 7% of pay, with a higher match for non-members of Social Security; prohibit pension obligation bonds; adopt funding changes consistent with Government Accounting Standard Board guidelines, the Society of Actuaries 2014 report and the approach by Moody's Investors Service to valuing liabilities; modify unearned pension benefits, as legally permitted; and consider funding changes only after achieving the previous steps, preferably without tax increases or new borrowing.

He advised against what he called "pseudo reforms": pension bonds, early retirement incentive plans, resetting unfunded liabilities, new and reduced defined benefit plans or so-called hybrid plans that combine defined benefit and defined contribution.

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