Unions Threaten Court Challenge to Governor’s Pension Reforms

With the predictable certainty of robins returning in spring, public sector unions in Pennsylvania have thrown down the litigious gauntlet, promising lawsuits against Governor Corbett’s plans to head off a financial crisis stemming from massive unfunded pension obligations.

The unions are opposed to the idea of having new employees being placed in defined contribution pension plans but they are hopping mad over the prospect of having the formula for calculating retirement benefits changed on the future earnings of current employees. The reform plan calls for the current workers to retain the benefits accrued to date but will lower the rate of payout on earnings from when the law becomes effective through retirement. Obviously, for workers close to retirement the impact will be small but for those with 10 or more years left to go to retirement there will be a significant effect. The longer the time to retirement the greater the reduction in benefits will be.

But what choice does the Governor have? The pension systems for state employees and teachers are woefully underfunded and the state government is facing the prospect of having to allocate additional billions a year of state funds to return the pension funds to a financially responsible condition. These additional payments are money the state does not have unless it raises taxes substantially.

There is another option of course. The state could cut education and other funding as well as its own employment levels sufficiently to cover the pension payments. Or it could renegotiate contracts to lower dramatically current compensation including health care, vacations, salaries, sick leave, etc. And it could urge school districts to do the same. Absent any meaningful concessions, the layoffs should begin.

The proposition must be that the excessively generous pension and other benefits promised by irresponsible governments and school districts in the past must not be allowed to wreck the current economy by forcing ever higher taxes to sustain the promises. There must be some willingness on the part of the unions to recognize the plight taxpayers are facing. If they persist in their unwillingness to make any concessions, then there is little choice but to slash the size of payrolls to compensate. If they decide to play hardball, the state and school districts must be ready to throw down their own gauntlets.

Super Predicts Pension Calamity

In discussing the financial picture of the Pittsburgh Public Schools-the director of budget, management, and operations reiterated his position that the District will be insolvent by 2015, a statement he made in November of last year-the Superintendent handicapped the Governor’s pension proposal that would affect the District as it pays into PSERS, the state retirement system covering public school employees. That proposal, which we recently wrote about, would affect future earnings of current employees and would put new hires into a defined contribution type plan on a certain date if enacted.

Noting there would be "a lot of pushback", which is not surprising since the state teachers’ union has already stated its position, the Superintendent opined that "Even if it were to go through, it would result in a rush to the exit in 2015 like this state has never seen" and then possibly causing a teacher shortage, especially in certain subject areas, and "That would be a real statewide human resources issue".

Lots of governments, state and local, have made changes to retirement benefits that have affected new hires or close the window on existing benefits but allow those that retire before the changes go into effect to leave with their benefits intact. That’s happened locally with the Port Authority and Pittsburgh police and fire. Existing teachers that could retire before changes to current benefits might; it also happens with early retirement incentives. Those seeking to enter the teaching profession now might be put off by the thought of being employed in Pennsylvania if they had to be in a 401k type defined contribution system. If so, the latest data from the National Conference of State Legislatures shows that 40 states (including Pennsylvania, as no changes have occurred) offer only a defined benefit plan to elementary and secondary teachers. Only Alaska has a mandatory defined contribution plan; Indiana, Oregon, Rhode Island and Washington have mandatory defined benefit/defined contribution hybrids; Virginia and Kansas are moving to db/dc and cash balance plans in the next few years; Florida, Utah, and Michigan allow employees to choose the type of plan.

While the PPS is certainly on hard times and has been for a while, Census data on local government employment and payroll shows that full time equivalent employment in elementary and secondary education (instruction and other) rose by about 50,000 from 1993 to 2011. Teachers, on a per 10,000 person basis, rose from 121.7 to 142.2 over the nearly two decades shown by the Census. Note that all other local government employees-police, fire, librarians, water workers, welfare employees, parks, etc. fell slightly from 131.8 to 129.5 per 10,000 people.

And what of a state like Alaska, where in 2006 the switch was made for teachers by enrolling new hires in a defined contribution plan? In 1993 there were 8,386 teachers, or about 140.2 per 10,000 people. In 2011, five years after the pension change, the Census count of teachers is 11,233, or about 155.1 per 10,000 people. Sure, many of those are still likely working under the old pension plan, but has there been a problem attracting new teachers to the point there is a shortage?

Governor’s Pension Reform: Does It Have a Chance?

Well, it is here; the Governor’s plan to stop the impending budget calamity created by unfunded pension liabilities.  To be sure, the far reaching proposals face a very uncertain future in the Legislature.

 

 

A little background.  In the fall of 2012 the Pennsylvania Office of the Budget released “The Keystone Pension Report” detailing the steps that have produced a $41 billion unfunded liability for the state’s pension plans covering state workers (SERS) and school employees (PSERS). The report also offered suggestions as to how the state might begin a process of addressing the enormous unfunded liability.

 

Although no specific reforms were recommended by the report-a pension reform proposal was to come, and did, as part of the FY 2013-14 budget address-there was a five point framework for change:

  1. Taxpayers would be put first.
  2. Retirees who had earned their pension would see no changes.
  3. Current employees would not have their accrued benefits touched but “components of current employee’s prospective benefit” could be altered.
  4. The costs should not be shifted to the future.
  5. Experience from other states should be studied.

 

The Governor’s reform proposals, as spelled out in the 2013-2014 Executive Budget, match up fairly closely with the framework set out by the Keystone Report. Explicitly, there was no mention of a tax increase to fund pensions, so point one was clearly satisfied.  The benefits earned by retirees would remain unchanged and the benefit plan for current SERS and PSERS members would remain the same until 2015.  However, at that point, a lower multiplier for pension benefits, 2 percent times years of service, would be used instead of 2.5 percent unless the employee elected to contribute an amount sufficient to keep the multiplier at 2.5. An average of the last five years of compensation would determine the basis of pension payments. Further, pensionable compensation would be capped at 110 percent of the average salary of the prior four years when determining final average earnings. Then too, the Governor’s proposal would place a cap on the pensionable income at the maximum Social Security income on which contributions are made and benefits calculated. Thus, the reform plan has largely adopted points two and three of the framework with much detail on the changes to future pension benefits for current employees.

 

To point four, the Keystone Report stated “…any short-term prospective budget relief should be paid for by long-term reforms…” The same year when the alterations to future benefits for SERS and PSERS members are to go into effect all new hires will be enrolled in a defined contribution plan with SERS members contributing 6.25 percent of pay and PSERS members putting in 7.5 percent.  Basically, the state would be closing enrollment in the defined benefit plans offered by the systems (as of 2011 there were a combined 589,000 active, retired, and vested but inactive members) and placing new hires in a 401(a) system.  As members of the defined benefit plan retire and new employees come in the hope is that the costs of the pension system come down, albeit gradually. 

 

Lastly, the Keystone Report looked at reforms made in other states in 2010, 2011, and 2012 and classified them along the lines of “strategy” (whether the state was asking for higher employee contributions, raising retirement age or service time, and switching from a defined benefit plan to a defined contribution or hybrid plan) and who the reform(s) affected: new employees or both new and current employees.  Much of that analysis came from the National Conference of State Legislatures which has for many years detailed statewide pension reform plans.  In 2012,   Louisiana, Kansas, and Wyoming among others set into motion plans that would close existing defined benefit plans to new employees or create new tiers with higher age and service requirements for new hires.

 

Interestingly, not all change is happening at the state level.  In 2012, the California cities of San Diego and San Jose both had local ballot measures to amend their city charters’ language on retirement benefits.  In San Diego, voters approved a ballot question that (1) would put all new hires, with the exception of police officers, into a defined contribution plan, (2) permit the City to seek limits on what constitutes employee compensation (through bargaining and negotiation) for pension calculations, and (3) eliminate the ability of current and former employees to vote to change their benefits.  The San Diego Councilman who spearheaded the reform movement argues strongly that only base salary should figure in pension benefit calculations while factors such as overtime, longevity pay, etc., should play no role in pension benefits.

 

In San Jose, voters approved a question that would require employees to pay more into their pensions or voluntarily move to a plan with reduced benefits, limit benefits for new hires, and require voter approval for increases to future pension benefits.  The reforms, even though receiving a comfortable majority, face court challenges.

 

Keep in mind that this is just the proposal stage and that the Governor has stayed true to the ideas laid out in the Keystone Report.  It is up to the General Assembly to debate, modify and possibly enact the proposals. Then Pennsylvanians will see what, if any, the reforms can look like.  Would the General Assembly decide to put the issue of pension reform in front of Pennsylvania voters such as happened in cities in California?  The last time a ballot question related to pensions went before the voters was in 1981 when voters were asked if the state Constitution should be amended to allow spouses to partake of increases to benefits so long as the finances of each system extending the benefits were actuarially sound. It was defeated. 

 

And how will members react when hearing from public sector unions, who, not surprisingly, have decried the proposals in the strongest terms? A state employee union stated in a press release that by proposing a defined contribution system for new hires the Governor is “…trading the promise of retirement security for retirement insecurity” and wants to give the Act 120 legislation more time to work.  The teachers’ union stated that the “…proposal includes costly, unconstitutional changes that won’t solve the pension crisis, but will reduce your pension benefits and weaken the retirement security that you earned and you paid for.” That statement is quite ironic in that the entire motivation for the reform effort is the huge increase in taxpayer funding that will be required to meet the pension obligations.

 

At this point it is important to ask whether the Constitution’s language means that something passed in a prior legislative session can create a suicide pact for future ones.  According to the Keystone Report the causes of the massive pension problem can be traced to promises made by laws passed in 2001, 2002 and 2003. What does the Constitution say about this predicament? Article 1, Section 17 prohibits the General Assembly from passing laws impairing contracts. Further language in Article 3, Section 26 says that “…nothing in this Constitution shall be construed to prohibit the General Assembly from authorizing the increase of retirement allowances or pensions of members of a retirement or pension system now in effect or hereafter legally constituted by the Commonwealth…”

 

So what does that mean?  To the first section, the state’s Municipal Pension Handbook notes that “the Pennsylvania Supreme Court has applied [this principle] to the rights of public employees in their pensions…as such, once a public employee has worked even a single day, he or she has not only earned that day’s pay but a guaranteed right to such future pay that formed part of the employer’s promise of compensation”.  On the second, the implication is that when times are good the Legislature could increase pensions but there is no language that allows for a decrease or a cut in a situation like the one faced by SERS and PSERS now. Obviously, the richer benefits should never have been granted because when the bill comes due as it has, the difficulties in undoing the damage will prove virtually insurmountable.

 

The question is: if it comes to a court battle, how will the judiciary interpret a plan in which the benefits earned up to a certain point are not reduced, but the pension benefits accruing based on future earnings beyond that point are reduced?  Would the courts rule that the Constitutional sanctity of contracts has been trampled?  If so, where do taxpayers go for relief from the ill-considered actions of earlier Legislatures?  Protection of employees is important, but in the private sector, when the pension benefit costs are threatening a company’s survival, relief can be sought through bankruptcy. State and local governments as well as school districts in Pennsylvania are effectively denied that option.

 

Moreover, if a Constitutional amendment becomes necessary to overcome the problem, it will almost certainly never get the required votes in the General Assembly to go on a ballot and voters have no right to petition the Commonwealth for a referendum.  And even if the Constitution were to be amended, could the new language ex post facto overturn provisions in currently existing contracts or “employer promises”?

 

If the pension reform fails, the “Pac-Man” or “tapeworm”, as the Governor’s report characterizes the increasing share of the budget going to cover unfunded pension fund liabilities, will eat away at other portions of the state budget.  If the reforms are enacted the proposal envisions that the employer contribution rates will be lowered from an expected 4.5 percent to 2.25 percent in 2013-14, rising by a half a percent per year thereafter. This is instead of rising 4.5 percent per year to top out at close to 30 percent by fiscal year 2016-17. 

 

It should be incumbent on those persons and groups who view pensions as sacrosanct and inviolate to suggest areas of the budget that can be cut substantially in order to satisfy the pension plans’ need for ever more finding. 

 

One thing is certain, with the crucial funding requirements for highways and bridges demanding more tax dollars, and with the state’s taxpayers already taxed heavily by state and local governments and school districts, asking for additional billions of dollars in revenue to cover pensions is simply not politically or economically prudent. If all meaningful reforms in the state’s two big pension plans are blocked and no significant reductions in costs are forthcoming, there will be no choice for the state and school districts but to begin slashing other personnel costs. 

 

Fewer employees, lower contributions to the generous health care benefits, fewer sick day allowances, heavier workloads, pay freezes, etc., will have to be on the table. Employees with the least seniority will take the brunt of the hits given the rules governing layoffs in most contracts. 

 

There is no free lunch.  Taxpayers cannot afford the massive additional pension burden that is coming and some relaxation of objections to all attempts to stem the tide of increasing pension fund allocations must be in the offing.  Insistence on the status quo will lead to a raft of problems the opponents of reform will not like.  The divisions between government employees and taxpayers will almost certainly widen and grow increasingly bitter.

Has the Makeup of Local Pension Plans Changed?

The Pennsylvania Public Employee Retirement Commission-PERC for short-just issued its latest status report on local pensions in the state, municipalities, authorities, and counties. There are more than 3,200 local plans in the state, and the report is a real treasure trove for those looking to find data on specific plans or the overall characteristics of local plans in Pennsylvania.

Status reports date back to 1985 when PERC was charged by Act 205 with monitoring plans (Act 293 covers counties). Back then there were 2,372 plans: thus, another 856 plans have been created, about 33 per year through 2011, the year the latest status report collects actuarial data on.

So has the nature of plans changed much in that time? In the public sector pension lexicon there is the overarching distinction between defined benefit plans (where the employee is promised a defined retirement benefit that depends on retirement age, service length, and final average salary) and defined contribution plans (where the employee is promised a fixed contribution that is often matched by the employer and what is in the employee’s account upon retirement is the benefit).

In 1985 the PERC status report shows that 75% of plans were self-insured defined benefit plans, 21% were defined contribution, and 4% were "other". In 2011 the distribution of the pie (which had gotten bigger) shifted slightly with 70% of the plans defined benefit, 25% defined contribution, and the remaining 5% "other".

The number of employees covered by a specific plan has remained largely unchanged: in 1985 slightly over 94% of employees were participating in a defined benefit plan. By 2011 the percentage was 92%. There was a corresponding rise in the number of employees covered under defined contribution plans, rising from 5% to 7% over that time frame.

It is fair to conclude that the public sector plans at the local level in Pennsylvania are thus still defined benefit in nature. It is also fair to say that the majority of the plans are small: in 1985 67% of the plans had 10 or fewer members, and in 2011 68% had 10 or fewer.

PA’s Pension Tab: $1,550 per Household

Almost everyone knows there is a pension crisis in the public sector, but very few can see how that affects them directly. Sure, there have been municipalities across the country that have filed for municipal bankruptcy in order to reorganize, but none have sold off police cars or park benches as a result of a liquidation. People in western Pennsylvania know that Pittsburgh has a low funded pension and that the money it takes to be put toward pensions and other legacy costs means fewer dollars for traditional public services.

But what does the pension crisis mean for the typical household? A recent academic treatment of the topic examines what it would cost for pensions to be fully funded over the next thirty years assuming no policy changes to the nature of pensions. The paper points out that most public sector pensions are defined benefit plans, where an employer promises the employee an amount at retirement based on age, length of service, and final salary calculations as opposed to defined contribution plans like a 401k or 403b where the employee saves for retirement often with a match from the employer. The report notes that the longer it takes for states to reform pensions the liabilities keep accumulating.

So the paper sets out to calculate the required increase per resident household to pay the existing liabilities off over a three decade period. Or, as the authors of the paper posed the question in an editorial, "how much will your taxes have to increase?" The U.S. average for the fifty states is $1,385 per year, with Pennsylvania coming in slightly above that average at $1,550. New York is the highest at $2,250, and Indiana is the lowest at $329. The states nearby to southwestern Pennsylvania are quite different, with Ohio at $2,051 and West Virginia at $600.

Confused Blather from Mayor’s Spokesperson on Pensions

Pittsburgh’s Controller asserts in newspaper accounts that Pittsburgh has not sufficiently addressed its pension problems or reduced expenditures enough to warrant having state financial oversight of the City terminated. A sentiment shared by the oversight groups-the Intergovernmental Cooperation Authority and the Act 47 coordinator-and the Allegheny Institute.

The Mayor’s office fired back with its usual rejoinder claiming enough has been done and says the following about the pension situation, "The Controller knows all too well that the City’s inherited pension problem can only be solved at the state level." Okay, what is wrong with this statement? There are two huge obvious fallacies in one sentence.

First, the City did not inherit the pension problem. Who died and left the pension plans to the City in their will? Of course, this part of the spokesperson’s comment is nonsensical. Pittsburgh created the pension crisis through its own behavior of overpromising and underfunding the pension plans over the course of many years. Granted, the union favoring Act 111 binding arbitration law was a key factor in egregious contract settlements during the last thirty years.

However, the Act 111 problem was known about decades ago and nothing was done about it. How many mayors, city council members, state representatives or civic leaders went to Harrisburg to lobby heavily for reforming Act 111 to reduce the extraordinary advantage the public safety unions have in the contract bargaining process? It is safe to say not more than one or two and only after the City was declared to be in financial distress. Indeed, how many would stand up for reform even now? Act 111 reform has been and continues to be anathema to the unions and is a political non-starter in union dominated precincts across Pennsylvania but especially in Pittsburgh.

To further add to the silliness of the spokesperson’s response, she continued with the claim that only the state can fix the problem. How is that? The pension obligations were entered into by the City and it must deal with its self- inflicted wound by adequately funding the pensions, curbing all expenses and supporting meaningful labor regulation changes and lobbying for authority to offer 401(k) type plans to all unvested employees.

Still, the best thing it could do would be to adopt private sector growth enhancing policies in order to shore up and expand its tax base while keeping a tight rein on spending. The ability to generate additional revenues from real growth as opposed to more taxes and higher tax rates is crucial to solving the underlying financial problems in the City. Of course, what we see emanating from the City are a steady diet of policies aimed at top down directed economic development, cronyism, and forays into every progressive, anti-free market notion coming down the pike. Too bad. The controlling political powers never seem to get it.

Are Public Sector Pension Changes Coming?

It is not going to get any easier on the pension front in Pennsylvania.  Just this week, as the state put the final touches on the 2012-13 budget, the warning bells on the costs associated with the two statewide pension systems (one for state employees, the other for school employees) tolled  louder.  Doing nothing means the percentage of the state’s budget dedicated to pensions will grow to 10 percent according to one published newspaper report. 

 

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Governor Wants Pension Reform—Good Luck with That

Looming like the sword of Damocles are the huge increases in state spending needed to keep state pensions adequately funded-there is a $37 billion gap between assets and liabilities. This has prompted the Governor to announce that pension reform will be a priority on his to-do list.

And what is the Legislature with its lucrative pension plan going to do about pension reform? Little or nothing would be a good bet. Kick the can down the road or look around for a nuisance fee or tax to make a small dent in the deficit. But meaningful change? Not until the roof is caving in. The legislators gave themselves a big boost in 2001 and are unlikely to take money from themselves. Public sector unions will not agree to any reforms that touch their benefits. So where is the impetus to do anything serious? This problem has been known about for years and Harrisburg has chosen to study the issue to death and then study it some more.

The Executive Director of AFSCME Council 13, which represents the bulk of state unionized employees, says bluntly, "the state must continue to uphold its obligation to current employees." In other words, taxpayers should get ready for more purse pillaging. Ironically, the union leader reminded that this problem was known about ten years ago and now the bills have come due and its time to talk about raising revenue. That’s so rich it would make your hair hurt. When over the last ten years have any public sector unions ever argued for reduced government spending so more dollars could be set aside for pensions? Indeed, all we hear is that more money is needed for education, social programs, higher pay, better health care benefits, etc.

Unions will never take any of the blame for government fiscal problems nor will they voluntarily agree to help solve them. Instead, they will blame the problems on elected officials who do not have the backbone to stand up to unions and their spending demands.

The union influence combined with the self- aggrandizing motives of the legislators does not bode well for any meaningful action on pensions any time soon. The track record of the Legislature in doing anything remotely restrictive of union power and influence is not one to inspire confidence that they are on the verge doing the right thing for the Commonwealth.

No Silver Bullet

A newspaper article recently wrote of the efforts in many states to move from a defined benefit type pension to a defined contribution type plan. Our most recent report points out the differences in these two models and shows that statewide, as well as in Allegheny County, defined benefit plans are far more predominant in the public sector.

Most places that have switched or are contemplating a switch often target it to new employees, and that’s due to language in many state constitutions that prevent abrogating contracts like pensions where people are vested. A 2009 report by the National Conference of State Legislatures showed that three states and the District of Columbia had closed down defined benefit plans and offered defined contribution plans as the primary option while six other states had a defined contribution plan as an option.

An analyst with one of the major bond rating agencies said in the piece "It is no doubt the proper thing over the long term to…consider reforming the level of benefits…[however] it’s not to be forgotten that these existing benefits don’t just go away."

A micro-level example is the retiree health care benefit in the City of Pittsburgh that was closed to new entrants hired on or after January 1, 2005. The 2009 Controller’s report shows an unfunded liability of $359 million as of January 1, 2008. The next CAFR will have an updated number but the City contributes around $20 million a year on a pay-as-you-go basis for its retiree health care liability.

Another Pension Transition Hits Home

A pension fund that went from a healthy fund ratio (assets/liabilities) to one where there is now $0.79 in assets for every $1 in liabilities. A contract negotiation involving a labor union that represents a third of the work force. A desire to move away from defined benefit pensions to a defined contribution system under a 403b.

While this sounds like a description of the pension situation that is faced by any number of municipal governments in southwestern Pennsylvania, it is the one that one of the region’s largest health care providers, Jefferson Regional Medical Center, grapples with rising costs and renegotiates labor contracts.

The head of the labor union said that the preference to move to a 403b was limited to professionals and that hourly workers would be less likely to invest in a defined contribution system. "That becomes a problem in negotiations" he said.

True, and the union is free to go on strike over the pension issue. But unlike their public sector counterparts in the schools or transit systems there is a chance that the employer can bring in replacement workers. And the union likely does not enjoy the same leverage with lawmakers to forestall pension changes as happened when Act 44 was being formulated. Will the medical center become part of the larger trend in the private sector where the defined benefit pension is becoming extinct?