by RC Dreyfuss
I would like to take 10 minutes to share my perspectives as a retired HR executive & actuary (>35 years). I am currently a self-employed consulting resource to several public policy organizations.
I appreciate Barry (Shutt’s) friendship as I acknowledge his steadfast commitment to this critical issue – measured both by his countless hours as well as his personal expenditures.
Of note, Barry is a SERS retiree at a time where some of his contemporaries are emotional regarding the enactment of an ad-hoc pension COLA which would further increase the amount shown on this debt clock by perhaps $3B.
I would also acknowledge the leadership of Rep. John McGinnis (in HB 900 of last session) as well as that shown by a distinguished group of others including Reps. (Paul) Schemel & (Frank) Ryan. They are pursuing long-overdue funding reforms, a fundamental element absent in most public pension reform proposals.
Finally, I would again recognize the tireless efforts of my good friend Eric Epstein in his non-partisan pursuits of long-overdue government reforms and improved transparency.
So exactly what are we witnessing in this debt clock? In layman’s terms it is the accumulated shortfall in PSERS & SERS combined. In general, we are dealing with declining and deficient asset levels, understated liabilities coupled with poor funding practices.
Sadly, this is a national problem forcing many actuaries to analyze the likelihood of future plan insolvencies.
In fact, Barry could easily have added another debt clock for Pennsylvania’s municipal pension plans >$8B + $19B Retiree Medical liabilities for state employees (otherwise referred to as OPEB (Other Post-Employment Benefits)).
Such trends are clearly unsustainable.
In theory, pension funding is extremely straightforward. That is, pension systems should be accumulating assets such that benefits are funded as they are earned. This suggests that any deficits (unfunded liabilities) should be eliminated by the time any group retires.
With the age of the current PSERS workforce averaging 46, eliminating any current deficits over a 15 to 20-year horizon should be the state requirement. This equates to roughly the remaining careers of this workforce.
By my estimates, to accomplish this basic goal will require sustained combined incremental contributions as much as $1.7B over and above that currently scheduled. Doing nothing simply transfers such costs with interest to the next generation.
This debt management issue is mired in the budget politics at the state and local levels. Citing a familiar saying “there is a low political rate-of-return in properly funding public-sector pension systems.”
So how are we doing? This question is analyzed annually.
In PSERS alone, at 6/30/2016 members have earned approximately $100B in liabilities versus the market value of assets of about $50B. This difference of $50B is termed an unfunded liability.
Some assert this $50B PSERS unfunded liability is overstated by perhaps $7B. You should know this view is based upon a 10 year rolling asset value, established in Act 120 of 2010. To supporters of such a methodology I would quote from the actuarial note (of October 12, 2010): “It is the opinion of the (Commission’s) consulting actuary that 10 years is too long a time period over which to recognize investment gains and losses … (as this) has the potential to produce asset (values) that greatly deviate from the market value of assets.” Moreover, GASB & Moody’s use the market value of assets as their standards.
Simply stated, PSERS assets are roughly half of what they should be. Of note, these plans often experience negative cash flow – so it is particularly hard to grow an asset base faced with such fiscal challenges.
This growing debt has disturbing parallels to a legalized Ponzi scheme.
This debt is the result of several factors including chronic underfunding, subpar investment returns (versus an annual 7.25% expectation – 7.50% for SERS), retroactive benefit improvements and finally periodic reductions in the expected long-term asset returns.
In fact, many view the current investment expectations as less than 50% achievable in the long-run.
To summarize I would make the following eight observations:
1. Some continue to incorrectly believe the unfunded liability is based upon the assumption of all plan members retiring today. Rather this figure is simply today’s value of future expected retirements with average longevity. Of note, if your view is investment returns over 7% are too optimistic, to revise expectations lower results in an immediate increase in the unfunded liability.
2. There is no assumption of new future members in these figures.
3. In fact, as a general rule, new entrants do not increase or decrease the unfunded liability despite myths from some “reformers” that plan design reforms from yet-to-be-hired members will “stop-the-bleeding” or otherwise “cap the unfunded liability”. Conversely, some opposing any reforms efforts reference “transition costs”, a theoretical concept which is simply not seen in the real-world.
4. Too often policymakers use the amorphous term “pension reform” prefaced by citing the most recent unfunded liability even though their proposals do nothing to address this ever-increasing deficit. Most reform proposals retain some remnants of the all-political and hence all-problematic defined benefit plan. When I hear another amorphous phrase “hybrid-plan”, it suggests to me we need, to borrow a phrase, “reform the reformers”.
5. Despite reduced benefit levels in the post Act 120 new members, these plans are overall in worse shape as evidenced by the annual increases in the unfunded liability.
6. We have been downgraded on successive occasions by credit rating agencies (S&P, Moody’s & Fitch) due to our singular inability to manage this debt number down. We continue to contribute 100% of a deficient contribution rate masquerading as a state law. In short, we have legalized underfunding in this state.
7. You may hear the term will are contributing 100% of the “Actuarially Recommended Contribution” or “ARC”. Unfortunately, the term ARC is an obsolete and misleading term since individual states have complete latitude to define their own particular pension funding standards. There should be no joy in debt reduction periods exceeding 20 years versus the back-loaded 24-year duration in PSERS and a 30-year equal dollar schedule in SERS.
8. The inconvenient political reality is proper pension reform should begin with a DC plan with no exempted groups and include funding reforms well-above the scheduled levels based upon shorter amortization periods and more conservative asset return assumptions. (We do not have pension reform by decree.)
Absent such basic reforms, what is the incentive to live, work & invest in Pennsylvania??
Thanks again to all my colleagues for their good work.
Footnote: Fitch Ratings-New York-13 August 2015: Pension obligation bonds (POBs) will not correct unsustainable benefit and contribution practices and is not a form of pension reform, Fitch Ratings says. Issuing POBs is neutral for some governments’ credit quality and negative for others. In our view, credit quality is tied to whether governments implement reforms to make their underlying pension obligations sustainable over time.
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