The North Penn and Souderton Area school districts are both trying to balance their budgets for the next school year, but a big expense is their payments — in the multimillions — into the Public School Employees’ Retirement System.
To continue funding PSERS and avoid cutting programs, the districts are both considering applying for exceptions that would allow them to raise property taxes beyond the 1.7 percent increase normally allowable by law.
It’s a problem across the state and it’s been brewing for years.
In a sit-down meeting with members of the media in the governor’s mansion Jan. 10, Gov. Tom Corbett called the pension crisis “a tapeworm in the budget” and laid the groundwork for the pension reform plan that he will announce in his budget address Feb. 5.
“People before me didn’t do what they were supposed to do,” he said. “People are getting laid off because there’s not enough money to pay the pensions and pay them. That’s the point we’re at.”
Pennsylvania administers two state pension systems: The State Employees’ Retirement System (SERS) handles retirement systems for most state employees; the Public School Employees’ Retirement System (PSERS) manages the retirement system for all public school employees.
Combined, these two systems comprise more than 815,000 total members and pay out nearly $8 billion annually in retirement benefits to more than 300,000 retirees, according to Budget Secretary Charles B. Zogby.
The pension systems are funded through a combination of employer contributions, employee contributions and investment earnings. Of these three, Zogby said, SERS and PSERS rely overwhelmingly on investment returns as the primary source of funding, with 71 cents of every dollar, or 71 percent, coming from investment earnings.
The commonwealth and independent entities pay all of the employer contributions for public employees in the SERS system. For PSERS, the commonwealth and local school districts share the employer contribution costs. The percentage varies — the commonwealth pays at least 50 percent as a general rule, but the amount increases based on the financial conditions of the district. In the poorest school districts, the state pays more than 75 percent of the cost.
In the current fiscal year, Zogby said, the state’s employer contribution costs for both systems are projected to total more than $1.5 billion — $677.4 million for SERS and $856.1 million for PSERS.
Both SERS and PSERS use a formula to determine a fixed amount to be paid in retirement benefits, taking into account years of service, final average salary and a multiplier of 2 or 2.5 percent.
“It’s ultimately the taxpayer that bears the risk of the plan,” Zogby said.
When investment returns go up, the state’s employer contribution rate declines. When investment returns drop below expectations, the state’s employer contribution rate increases to cover the entire shortfall.
Zogby gave an overview of how Pennsylvania ended up in this predicament, saying it was a combination of former administrations along with economic forces.
Retiree benefits became more generous “during the go-go ’90s,” Zogby said, when the state had, on paper, assets that exceeded more than 100 percent of liabilities. The stock market was booming, “and a decision was made to increase benefits.”
These benefits didn’t require a proportional employee match, resulting in nearly a decade of underfunding by state government and local school districts, as well as investment returns that failed to meet expectations.
“It was actions by previous governors and previous general assemblies that provided benefits that weren’t paid for, and were intentionally underfunded,” he said. “They were supposed to put in x and they put in y which was less than x, kicking the can down the road and pushing it to future generations.”
“A slew of bad legislative decisions” were passed in 2001, 2002 and 2003 to address the problems, Zogby said, but the efforts didn’t go far enough.
“What followed over the next seven years was 5.9 billion in underfunding of contributions. We were putting in 60 percent of what we should have,” Zogby said. “The cherry on the sundae was investment earnings that didn’t meet contributions. The 2000s are referred to as ‘the lost decade,’ a decade of no returns. You can see the damage that it imposed on the pension system.”
These past legislative decisions expanded retiree benefits without the funding to sustain them. Plus, there was nearly a decade of underfunding by state government and local school districts, combined with investment returns that fell short. So now the state is left with a large unfunded liability, or debt, to the tune of $41 billion, and employers are being forced to contribute more to fund past obligations.
As a result, Zogby said, these costs are taking a greater share of available money, threatening to grab funding away from core governmental programs and services. For 2013-14, this means having to cut as much as $500 million to balance the budget.
Although Corbett didn’t describe his proposal to help solve the problem, saying he would go into detail in his budget address Feb. 5, he said tax increases are off the table.
“I don’t think you can raise taxes enough to fix this without doing other stuff,” Corbett said.
There are no plans to harm current retirees by cutting their benefits, he said, and he also intends on respecting current state and public school employees. However, changes to benefits might have to be explored.
Other states have also faced this challenge, Zogby said, and Pennsylvania might borrow some ideas from them.
Possible solutions include increasing employee contributions, increasing retirement age, changing how the basic pension formula is calculated and giving incentives to longtime state and public school employees to retire without penalty.
The Corbett administration and general assembly will work with various stakeholder groups and the pension systems to come up with a workable plan on how to reform the system over the next few months.
“The vast majority of the house on the Republican side are new since all of this took place,” Corbett said. “Even on the senate side, the question is, what are they going to do? Can they sit with us and can we reach an accommodation?”