Pennsylvania’s Public Pension Management and Asset Investment Review Commission says its blueprint could save the commonwealth roughly $10 billion in pension debt over 30 years.
What's within reach politically is an open question.
It's now up to Gov. Tom Wolf and the General Assembly to act on the recommendations of the nearly 400-page report by the bipartisan panel that focused on investment-fee transparency, pension-system stress testing, active versus passive investment strategies and overall performance.
The commission's Dec. 20
PSERS has 486,000 members, SERS about 239,000. Their unfunded liabilities are estimated at $44.5 billion and $19.7 billion, respectively, with respective funding levels at 56.3% and 60.7%.
Findings included PSERS having paid out just over $1 billion in fees, revenue share and investment expenses for fiscal 2016-17, exceeding all employee contributions to the system during that period. Additionally, an analysis showed that PSERS and SERS ranked near the bottom in 10-year performance among 52 U.S. public pension plans.
“It’s a good report,” said Alan Schankel, a managing director at Janney Capital Markets in Philadelphia.
The panel identified an estimated potential $9.9 billion in actuarial savings over 30 years calculated at the 7.25% assumed rate of return for both retirement systems.
Critics say Pennsylvania put itself into its pension hole thanks to poor benchmarking — against other state pension funds, some wobbly, as opposed to the private sector — and poor liability management. They add that too high an assumed rate begets an aggressive management system that requires higher investment fees.
While paring fees seems an easier political reach, what Pennsylvania will do beyond that is uncertain as it stares at nearly $70 billion of pension debt, said Barry Shutt, a Lower Paxton Township retiree who operates a pension debt clock at the state capitol cafeteria in Harrisburg. The clock mimics the one in New York's Times Square that chronicles the federal debt.
“It’s something long overdue for them to look at the fees they’re paying to invest these funds, but here’s what I find disappointing: Just tweaking the fees isn’t going to save money if they don’t pay down the debt," Shutt said.
Shutt has proposed raising the personal income tax to 4% from 3.07% to raise $4 billion a year over 20 years to pay down the debt. He said the move could free up the commonwealth's general fund for struggling local emergency medical services and sewer systems.
“You’ve got to convince them of the need for new revenue," Shutt said of top lawmakers. "If you think you don’t, you’re smoking the stuff you have to have a prescription to get.”
The report called for establishing a consolidated central investment office for both pension funds; enacting legislation mandating annual stress testing; and moving to fully index all public market investments in both public equities and fixed income.
It also seeks to establish transparency policies at both system boards that favor and encourage more open public reporting; enact legislation mandating increased public reporting of all investment expenses; and adopt measures to reduce risk, including reducing exposure to illiquid private investments.
State pension legislation passed in 2017 under Act 5 established the commission to conduct a comprehensive review of PSERS and SERS investment management. The law also required new employees to choose between a 401(k) style defined contribution plan in which employees bear the risks and rewards of investment performance, or a new hybrid plan that's part defined benefit, part defined contribution.
Employees hired after Jan. 1 must use the new retirement plans.
“Pennsylvania has already taken some steps toward significant reform. It just won’t show in the bottom line for 30 years,” Schankel said. “The new hybrid system giving new employees an option of a hybrid plan or defined contribution will have a huge impact.”
The commission's chairman and vice-chairman, respectively, were state Rep. Mike Tobash, R-Pottsville, and state Treasurer Joe Torsella, a Democrat.
According to Torsella, reporting and public disclosure enhancements will encourage transparency of investment expenses, performance and performance benchmarks and illustrate areas of portfolio risk.
“Unlike economic and market conditions that are difficult if not impossible to predict, costs and expenses are well within control of fund managers,” Torsella said.
The General Assembly, said Tobash, should shoulder ultimate responsibility for establishing and maintaining SERS and PSERS.
“As such, it is both the purview and the responsibility of the legislature to respond to the effectiveness of these systems, establish mechanisms for independent examination and ultimately, consider legislation to implement meaningful reform.”
One politically volatile recommendation is to create a centralized office for the two investment systems, while maintaining the existing governance structure for both.
“Depending upon the structure, some of the power would be taken away from the individual boards,” Schankel said.
Glen Grell, PSERS executive director and a former state representative, told the commission that PSERS and SERS recently found opportunities to work together.
“We’ve had a couple of instances where PSERS and SERS were both looking at the same deal, so we collaborated,” he said. “In one case, we were able to use maybe bigger buying power to negotiate a lower fee not for us, but for SERS, but we’re all in the same family, so that was a good outcome.
“We’d like to do more of that. But really there are limits to what can be done without statutory change.”
The report, while spotting red flags, praised the funds for recent improvements.
PSERS, it said, adopted important elements of stress-testing protocols, “embraced” passive-based investing strategies for public equities and has reported fully on “carried interest” on costs of private investments. SERS has adopted “comparatively robust” benchmarks and has reduced expenses in its overall investment portfolio.
“In the coming weeks, PSERS will take a very close look at the report and its recommendations for accuracy and for the viability of the proposed recommendations,” Grell said in a statement. “We expect to discuss and conduct a detailed review of the report with PSERS Board of Trustees at an upcoming board meeting.”
A further $116.3 million in possible savings cold materialize if the systems renegotiated or ended contracts with private investment companies and funds. That savings could come from lower fees with the firms or by switching investments from funds that traders actively manage to more passive funds indexed to certain Wall Street benchmarks.
Pension underfunding and budget imbalance have triggered downgrades of Pennsylvania in recent years.
Moody’s Investors Service rates the commonwealth’s general obligation bonds Aa3 with a stable outlook. S&P Global Ratings and Fitch Ratings assign A-plus and AA-minus ratings, respectively. Their respective outlooks are stable and negative.
“Pennsylvania is not as under water as some of these other states,” Schankel said. “They’re in better shape than Connecticut, Illinois and New Jersey, even though they sometimes get lumped in.”
Moody’s called Pennsylvania’s year-to-date growth in total general fund revenue a credit positive. On Dec. 3, the commonwealth’s Department of Revenue reported collection reached $12.4 billion for fiscal 2019, its highest in 10 years.
Rural Pennsylvania communities, however, bear the brunt of demographic and economic challenges, Moody’s added.
“The populations are more likely than in urban centers to be increasing in age and, in many cases, declining in number,” said Moody’s. “These developments pose economic and financial challenges for rural local governments since dwindling workforces hamper economic growth and aging populations place greater demands on government resources.”
