Addressing Pennsylvania’s pension crisis is a top legislative priority for PSBA and school directors across the state, as it must be for the General Assembly in the 2017-18 legislative session.
The fact is that the state and school districts cannot afford the high employer contribution costs needed to sustain the current retirement system. These mandated expenses continue to increase significantly, taking larger shares of already-stretched budgets. In the coming fiscal year, both the state and school officials must figure out how to pay pension obligations that continue to mount, with the total employer contributions for 2017-18 projected by the Public School Employees Retirement System (PSERS) at nearly $4.4 billion. Beginning on July 1, 2017 the annual employer contribution rate that must be paid by the state and school districts will jump to 32.57%, up from 30.03% in 2016-17, and from the 2015-16 rate of 25.84%. The contribution will continue to climb over the next few years to a staggering 36.40% by 2021-22.
According to PSERS, those rising rates means that over the next five years the projected total employer contribution will surge from about $4.4 billion to about $5.2 billion, an increase of over $864 million. While half of that amount is a state responsibility, the other half must be paid by school districts.
Clearly, pension costs are taking a greater and greater share of school district budgets, leaving less funding for true basic education costs directed toward student learning. In 2008-09, pension contributions were at about 2% of a district’s total expenditures. In 2016-17, pension costs are estimated to climb over 11.5%. Without meaningful reform or more state funding to offset these rising costs, districts have no option but to cover these soaring costs at the expense of the rest of their budgets. Although various reform plans have been introduced, the General Assembly has not reached agreement on a specific approach.
From PSBA’s perspective, school districts have been in compliance with the law by making the mandated required contributions to PSERS each year, but the system is unsustainable and must be fixed now. While some changes were enacted under Act 120 of 2010, they did not fully address both long-term and short-term concerns for the funding of the retirement system. Without pension reform, the costs just continue to climb. PSBA believes that allowing Act 120 to play out without further refinement is not a tenable solution.
Meaningful changes must involve identifying another funding source for PSERS, decreasing or cutting the costs and liabilities of the system, including benefit levels, and examining the possibility of adoption of a hybrid pension plan that would reduce employer costs over time. A hybrid plan combines elements of a defined benefit plan and a defined contribution plan in some manner. The state must enact meaningful school employee pension reform with the dual purpose of reducing projected employer contribution rate increases and reducing projected costs to school districts and taxpayers over the next two decades, while maintaining an appropriate pension benefit for school employees.
Defined benefit versus defined contribution plans
In a defined benefit (DB) plan, such as PSERS, the pension benefit to be provided at retirement is defined, while the contributions to be made over the period of employment are variable based on the experience of the pension fund. Upon retirement, a defined benefit plan participant is entitled to receive a definitely determinable benefit that is calculated using a formulation that considers factors such as age, duration of service with the employer and compensation. The formula takes the employee’s final average salary times years of service times a multiplier to calculate the annual pension amount. Because the benefit is defined and calculated using a formula and is not dependent on an individual’s account balance, members of defined benefit plans are largely insulated from both negative and positive fluctuations of the investment markets.
By contrast, in a 401(k)-type defined contribution (DC) pension plan, the contributions to be made over the period of employment are defined, while the pension benefit to be provided at retirement is variable based on the experience of the pension fund. Upon retirement or separation from the employer, a defined contribution plan participant is generally entitled only to the balance standing to the credit of the individual’s retirement account. Market performance directly impacts the value of an individual’s retirement account.
The distinction between the defined benefit and defined contribution approaches is most significant in the placement of the risk associated with investment earnings over the period of employment.
The fixed benefit in a defined benefit pension plan means that the investment experience impacts the contribution requirements, increasing them when investment earnings are lower than anticipated and decreasing them when earnings are greater than anticipated. The fixed contributions in a defined contribution pension plan mean that the investment experience impacts on the benefit amount, increasing it when earnings are higher and reducing it when earnings are lower. Therefore, the employer bears the investment risk in a defined benefit plan, and the employee bears the investment risk in a defined contribution pension plan.
For most employees, defined contribution plans are generally regarded as more valuable for those in the early stages of their careers or for those who are employed in careers that entail greater mobility. Defined contribution accounts are portable and can readily move with the employee as that employee moves from one employer to the next. In contrast, defined benefit plans are relatively more valuable for those employees who tend to remain with one employer and to long-service employees in the later stages of their careers, because the value and cost of the defined benefits earned each year increase as employees approach retirement age.
Hybrid plans are worthy of consideration
According to the National Association of State Retirement Administrators, nearly every state has made various types of changes in recent years to the structure of their public employee retirement plans. Many are moving from a defined benefit model, which PSERS now uses, to a hybrid plan that combines defined benefit and a 401(k)-type defined contribution plan. (http://www.nasra.org/files/Spotlight/Significant%20Reforms.pdf)
Hybrid retirement plans can take many forms. For example, in a side-by-side hybrid plan, all employees get both smaller DB and a DC benefit that each apply to their entire salary. In a stacked hybrid plan, the traditional DB plan is the primary benefit up to a specified income level, then a DC (401) k-style plan covers any income above that income threshold. Another hybrid design is a cash balance (CB) plan that relies on a guaranteed interest rate over the course of employment combined with fixed employee and employer contributions.
The Pennsylvania General Assembly reviewed a number of hybrid pension reform plans that were introduced in the Senate and House of Representatives during the previous two sessions (2013-14 and 2015-16). One plan was referred to as a “three buckets” model that addressed current and future employees. The plan included these components: a cash balance benefit plan for future employees, voluntary modifications for current members, and a provision for the state to borrow funds through a bond to make up for past underfunding of the retirement systems. Other plans introduced were variations of either the side-by-side and stacked hybrid models, and they included widely different components. These proposals affected benefits only for future employees amid concerns that a plan affecting current employees would be challenged in the courts.
While no agreement among legislators was reached on any of these plans, PSBA supported the concepts within them as potentially viable solutions. Each of the plans produced different amounts of savings for the state and districts, and each affected the amount/reduction of pension benefit received by employees.
School directors continue to press for legislation to address Pennsylvania’s pension crisis. In October, 2017 PSBA members voted for pension reform as a top priority issue for the association with this statement: PSBA believes that the state must immediately enact meaningful public school employee pension reform with the dual purpose of providing long-term relief by reducing projected employer contribution rate increases and reducing projected costs to school districts and taxpayers over the next two decades, while maintaining an appropriate pension benefit for school employees.
This is an enormous investment of taxpayer dollars, so the stakes could not be greater. If not addressed, the pension crisis will have a crippling effect on the state’s economy and a devastating impact on local school district budgets.