Pennsylvania’s proposed public pension increases would be costly to taxpayers

With most public pension systems, including Pennsylvania’s retirement funds for public schools, government workers and public safety employees, still billions underfunded, state policymakers need to stop going deeper into debt to issue ad-hoc cost-of-living adjustments. 

Two bills recently passed by the Pennsylvania House (House Bill 1416 and House Bill 1379) would increase public pension benefits for about 64,000 school and government retirees and about 26,000 retired police and firefighters. The pension benefit increase ranges for government and school employees from 15% to 24.5%, depending on the date the participant retired. For eligible retired police and firefighters, a special ad-hoc increase ranging from $75 to $300 per month would be provided. The State Senate has not yet taken up these proposals.

House Bill 1416 would add over a billion dollars to the already daunting unfunded liabilities of the Public School Employees’ Retirement System, PSERS, and the State Employees’ Retirement System, SERS, to be paid for over a 10-year period. 

The already high employer contribution rates for PSERS and SERS would increase by about .81% and .74% of projected payroll, respectively. House Bill 1379 adds over $300 million in liabilities to the Pennsylvania Municipal Retirement System, PMRS, plans as well but is paid for by a one-time direct General Fund appropriation.

Retired public employees in Pennsylvania generally participate in pension systems that do not provide automatic protection against inflation in retirement, and many have certainly experienced a significant drop in purchasing power due to inflation. However, the recently proposed catch-up and ad-hoc cost-of-living adjustment (COLA) bills passed by the Pennsylvania House are only temporary Band-Aids over a problem that will occur again and again for all future generations of public employees in the defined benefit pension plans of the state.

While defined benefit (DB) pension plans for public employees are designed to provide guaranteed lifetime income in retirement, not all include protection against inflation. Even with a modest 2% Consumer Price Index inflation per year, an initial pension benefit might lose 30% of its purchasing power after 20 years of retirement. 

Many lawmakers, like those in Pennsylvania, pass legislation to give one-time ad-hoc adjustments to retirees because they understand the degrading impact of inflation on public retirees.  The reality of recent high inflation makes the problem even bigger. However, providing a built-in cost-of-living adjustment can be costly. Even a simple 3% non-compounded annual increase might cost 20% more in annual pension costs to a pension plan that doesn’t have any inflation protection now.  Not providing a built-in COLA does lower the cost of the plan, but it does mean legislators are more likely to be asked for ad-hoc increases like those proposed in these two bills.

The Pennsylvania legislature last provided a COLA benefit in 2002 when it increased benefits for retirees before 1990 by an average of about 14% and for retirees between 1990 and 2002 by an average of about 7%. Prior to that legislation, Pennsylvania adopted pensioner increases of various amounts on an ad-hoc basis about every five years since 1968.

The 2002 COLA increased unfunded liabilities by about $640 million, which was paid for over a 10-year amortization period in level dollar payments. At the time of the 2002 COLA increase both PSERS and SERS were approximately 105% funded. However, the financial picture of PSERS and SERS has changed dramatically since 2002. As of June 2023, the funded ratio of the two systems is 63.2% and 69.3% for PSERS and SERS, respectively. The unfunded public pension liabilities are $44.3 billion for PSERS and $17.5 billion for SERS as of the same date. The funded status, as reported in the 2023 actuarial valuation for PMRS, is more positive at about 99% of liabilities overall. However, the report also acknowledges that 391 of the 738 plans in PMRS are less than 90% funded and considered under financial stress.

According to the actuarial note for HB 1416, the increase in pension benefits would add about $821 million in liabilities to PSERS and $371 million to SERS—a total increase in unfunded liabilities of about $1.19 billion. These additional liabilities would be funded in equal dollar installments over a period of 10 years.

The actuarial note for HB 1379 calculates the bill would add up to $374 million in liabilities to the Pennsylvania Municipal Retirement System, PMRS. In contrast with HB 1416, this additional liability for PMRS plans would be fully paid for by an appropriation from the General Fund.

As detailed in the Reason Foundation’s analysis in Nov. 2023, HB 1416 would resurrect a COLA design not used by Pennsylvania since 2002. Both COLA bills bring back an approach to dealing with inflationary impacts on pensions that is not guided by any clearly adopted retirement benefit policy. HB 1416 is not concurrently funded or guided by any formally stated inflation benchmark. Both bills raise expectations for similar treatment for future retirees. This sets the stage for the return to the pre-2002 pattern of ad-hoc COLA bills every few years. While HB 1379 is concurrently funded through a general fund appropriation, it otherwise falls short of best practices for similar reasons.

If the General Assembly makes a policy judgment to move forward with these bills, the better approach would be to fund the cost immediately in a manner similar to that taken in HB 1379 rather than pay for it over time with money from future taxpayers. To break the cycle of continuing down this same road for future retirees, consideration should be given to establishing a policy that either supports or rejects a regular COLA benefit that is automatic and recurring, pre-funded, and also subject to change if necessary.

The retirement benefit policy should clearly define what inflation protections are or are not being provided to public employees in these pension systems to set expectations for employees and to provide concurrent funding for any promises being made. Not doing so perpetuates the unending cycle of demands for pension increases from retirees and the prospect of pushing additional pension unfunded liabilities to future taxpayers.

The minimum change to adopt is to provide concurrent funding for the proposed COLA benefits. HB 1379, as amended, takes this approach, but HB 1416 for PSERS and SERS does not.  Concurrent funding of ad-hoc COLAs is a better and more transparent way to address and pay for the impact of inflation on these particular retirees versus amortizing the cost over time, like a mortgage.

Concurrent funding allows public policymakers to make prudent fiscal decisions that more properly balance the distribution of the public treasury among all Pennsylvanians without adding to the financial strains of PSERS, SERS, and PMRS.

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Source: https://reason.org/commentary/pennsylvanias-proposed-public-pension-increases-would-be-costly-to-taxpayers/