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?

A Pension System for All?

The Governor’s report on public sector pensions-which we blogged about earlier in the week-has set a lot of discussion in motion. So too have the testimonies collected by the Public Employment Retirement Commission, which was mentioned in an editorial this morning by the head of the Township Supervisors Association. Some of the presenters mentioned consolidating plans, which the Association head disagrees with, noting correctly that many of the state’s biggest plans-SERS, PSERS, Philadelphia, and Pittsburgh-have significant problems and that a solution should not "make the healthy swallow the same bad medicine as those in trouble".

We agree: in fact, in testimony we presented in 2008 to a hearing of two state Senate committees, we noted "There seems to be little interest at the state level to consolidating plans based on past discussions. It has been mentioned before, but nothing has come to pass. The problem with such an approach is that municipalities with well-funded pensions will view a merger or consolidation as a bailout of the lower-performing plans. In addition, the nationwide experience shows that it is almost non-existent for a state to assume total control and responsibility for local pension plans."

But perhaps there is another way to think about consolidation in the future which does not involve lumping the good plans in with the bad if the state were to think about the employees of the state (SERS), the employees in education (PSERS), local police, firefighters, clerks (covered by one of the 3,000 local plans administered locally or through the PA Municipal Retirement System), county employees, authority employees, etc., etc., in which enrollment in those plans is closed as of a certain future date and all new employees of the Commonwealth, its local governments, its authorities, agencies, school districts, community colleges, state universities, are enrolled in one new statewide plan with a clear employer and employee contribution mix. The existing plans would stay in place until there are no more participants in them and then the state would fully transition to the new unified plan. It would obviously take a very long time (and extends the further such a change is put off) but might be worth exploring.

Pittsburgh in Denial about Pension Assets

In yet another example of can kicking on a critical public policy issue, the Pittsburgh pension board voted down City Controller Lamb’s proposal to study whether Pittsburgh should lower the current 8 percent rate of return on assets to 7.5 or 7 percent. The Mayor is quoted as saying that lowering the rate from 8.0 to 7.5 percent would require the City to increase payments to the pension funds by an additional $9.3 million per year over and above what it is currently contributing. Refusal to undertake a study seems extraordinarily shortsighted.  A lot could be learned about the implications of the current level of unfunded liabilities and what potentially lies ahead in terms of serious difficulties for the pension plans under a scenario of continued very weak national economic growth and slow tax revenue gains at the state and local level. 


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Pittsburgh in Denial about Pension Assets

As we noted in a recent Policy Brief (Vol. 12, No.40) state experts on pension asset evaluation have called on the City to recognize that its use of an 8 percent rate of return on assets and discounting liabilities is too high in light of recent investment performance. And even using the 8 percent rate of return/discount rate, Pittsburgh’s funded ratio (assets to liabilities) is only 57 percent. The City is not alone in having pension funding problems. Note that Pennsylvania, which uses a 7.5 percent rate of return (and liability discount rate), currently faces a $14.7 billion shortage in assets relative to its liabilities and has a funding ratio of 65 percent that is projected to fall to 55 percent by 2015.

But according to pension expert Andrew Biggs of the American Enterprise Institute Pennsylvania’s problem is much worse than it is being portrayed. Mr. Biggs argues in testimony given to the State Legislature that if Pennsylvania were being held to the standards imposed on private sector firms, the state’s assets to liabilities ratio would be only 40 percent and would be facing an asset shortfall of $42 billion. Obviously, applying the private sector standards to Pittsburgh would dramatically increase its pension liabilities and lower assets to produce a markedly lower funded ratio than the current 57 percent while swelling the asset shortfall enormously.

As Mr. Biggs noted in his testimony, Moody’s has announced that it will begin evaluating pensions by discounting liabilities by the same rate of return being applied to the rate on high quality corporate bonds. Such a change is estimated to triple unfunded pension liabilities across the country.

This estimated tripling of unfunded liabilities provides some perspective on the Pittsburgh situation. Little wonder the City pension board just voted to leave the rate of return/discount at 8 percent. The Mayor is quoted as saying that merely lowering the rate from 8.0 to 7.5 percent would require the City to increase payments to the pension funds by an additional $9.3 million per year over and above what it is currently putting in. Something the City claims it can ill-afford at present. Having to meet private sector standards could easily double the $9.3 million additional annual contribution requirement created by lowering the rate to 7.5 percent.

The interesting thing to watch is how the State Legislature and Governor address the gap between public rules and private accounting standards. To date, public standards have been more lenient on the grounds that if need be taxpayers can always be taxed more to meet pension payment obligations. But as we are seeing in California and other places, when tax burdens rise to unbearable levels, raising tax rates is actually self-defeating. So it is understandable that Moody’s will be adopting a stricter evaluation methodology for public pensions. The fiction that taxpayers can be forever called on to pony up more and more to cover pensions while at the same time trying to pay to maintain adequate core government functions is now being revealed for what it is.

If the national economy does not soon recover its footing and accelerate to more traditional levels of growth experienced during an economic recovery and then sustain more normal growth, public pension plans all over the country are going to be in serious jeopardy of being massively downgraded with the attendant requirement to put much more money into their plans. Will Pennsylvania’s lawmakers punt on this or get ahead of the problem by lowering the rate of return/discount rate to be used by the state, teachers and all municipal pension plans? Or will they wait and hope for a national economic miracle–a situation that could not be farther removed from the last three years’ experience.

Municipalities in Allegheny County Holding Own with Pension Plans

In our ongoing analysis and review of the financial conditions of Allegheny County municipalities, we take a look at the health of pension plans.  Much has been made of the shortfall of Pittsburgh’s pension funding and how the City averted a state takeover by pledging parking tax revenues to raise those ratios to state accepted levels (Policy Brief Volume 10, Number 57).  But how are the smaller municipalities faring with their pensions?  Are they facing similar issues as did the City?  The following analysis takes a more in-depth look.


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Is the State About to Disapprove Pittsburgh’s Pension Plan?

Last New Year’s Eve, City Council enacted an 11th hour scheme-with the ICA’s blessing-designed to prevent a state takeover of the City’s pension funds. That plan depends heavily on using parking tax revenue to create an income stream for the pensions over the next 30 years with a purported present value sufficient to boost the pension’s funding ratio to 50 percent.

As we have noted previously, it is not clear the agency charged with evaluating whether or not the City’s plan is adequate will approve the scheme. For one thing, legislative promises to allocate parking revenues sufficient to create an adequate funding stream are not permanently binding. Unlike a loan or bond debt, there is no contractual arrangement with any party forcing the City to carry out the promise. A future Council could simply ignore the 2010 legislation or rewrite it. Beyond that, the evaluating agency must decide if any proposed income stream is as good as cash on hand in meeting the 50 percent funding requirement.

Moreover, the fact that pensions are boosted to 50 percent funded still leaves the enormously difficult problem of getting them to funded ratios that can be viewed as safe or satisfactory, say 80 percent or higher.

There seems to be a fairly high probability the evaluating agency will deny the Council scheme on the grounds that it is inadequate or on the grounds that the behavior of Council vis-à-vis the Mayor in addressing the state’s ultimatum over the past year leaves a lot of questions about the motives and ability of the City to fulfill the requirements laid out by state legislation.

In that case, the state will take over Pittsburgh’s funds and will force the City to raise the annual contribution sufficient to boost the funded ratio and most likely require a lump sum payment immediately. Ironically, the payment amount might not be a great deal more than the Council’s parking tax allocation. The difference is that with the state mandating the payments, the City would have to comply or face possible sanctions.

Too bad the Mayor’s plan to lease the Parking Authority assets was so summarily and quickly dismissed by the Council. Some effort to modify the plan but that would have left over $300 million (the proposal was for $400 million) on the table would have been a tremendous step forward to fiscal sanity for the City. The implacable attitude of Council toward any and all privatization is unseemly and harmful to the City’s future well-being.

This is the same City extolled in a recent Op-ed column by Stephen Beschloss as a guide for Congress on how it might learn to set aside differences to accomplish great things for the American people. How utterly fatuous in view of the facts.

A Big Year for PAT

Tomorrow is the first day of the 2011-12 fiscal year for the Commonwealth, virtually all of the state’s school districts, and for special purpose agencies like the Port Authority. The operating budget for PAT is $322 million, with a gap between revenue and expenses covered by the final piece of the flex money Governor Rendell found and was approved by SPC as well as budgetary reserves. The employee headcount for PAT is 2,495, which is unchanged from the end of the 2010-11 fiscal year.

Obviously PAT is waiting with anticipation for the results of the Governor’s transportation task force, which is to deliver its recommendations on how to fund all of the state’s transportation needs in a month. Already increases in registration and licensing fees have been floated as a real possibility, but it is unclear if the revenues from those sources will be tied to a particular use. PAT’s budget presentation opines that "unless statewide transportation funding crisis resolved satisfactorily over the next 14 months, massive unfunded deficits will be projected in FY13".

Unfortunately as we have pointed out on many occasions there are numerous cost-side drivers behind PAT’s funding problems. First and foremost is the cost of labor, which is front and center in the next year as the authority is entering the final year of its four-year contract with the Amalgamated Transit Union. This year workers get a 3% raise (non union workers’ wages are frozen), and there is projected to be a jump in pension contributions from PAT ($20 million to $33 million) and healthcare expense for active and retirees are still around $70 million. It is also important to look at the ratio of retirees to actives at the agency: in 2002 there was 0.71 retirees to every 1 active; now there are 1.13 retirees to every 1 active. If PAT and, by extension, County officials, feel the 2008 contract did "good" things then the 2012 contract is going to have to be even "better".

And last, but certainly not least, let us not forget that spring of 2012 will mark the commencement of service via the North Shore Connector. If the timeline holds as well as cost projections did, look for the first trips to occur well after the anticipated launch of service.

Hoping for a Miracle

Pittsburgh’s City Council and Mayor must be hoping for a miracle. They have rejected each other’s plan to avoid a state takeover of the City’s pension funds. As a result they are looking down the barrel of a financial howitzer in January if they cannot cobble together a plan to raise $220 million over the next few weeks. And even if the $220 million can be raised, the pension problem will still require bigger City contributions going forward.

Yesterday’s briefing by the Pennsylvania Municipal Retirement System officials pointed out just how massive the unfunded pension problem is and the staggering amount of money the City will have to come up with over the next 30 years-as high as $3.6 billion in one scenario.

And Council’s response? One idea is to renegotiate the terms of the rejected lease agreement offered by the LAZ-JP Morgan group: unlikely to happen because reopening the terms would require another bidding process. Otherwise lawsuits would be flying. Another idea is to sell parking meters to the Parking Authority, a plan strongly rejected by the Mayor. Yet a third idea is to have non-profits pay more in payments in lieu of taxes. Good luck with that one.

Indeed, the Council seems to be praying for a miracle. Having rejected privatization with such gusto and self-righteousness a month ago, they have boxed themselves in. There are no other good choices and the bullet will have to be bitten. There will be no bailout coming from the state; it has its own problems. And as we noted in a Policy Brief yesterday, the Pittsburgh school district will need more revenue soon as well. Pittsburgh taxpayers cannot be happy at the prospect of a double hit in their tax bills.

This is what happens when tough problems are kicked down the road year after year. Where has the Act 47 management team been for six years that it has allowed the City to get to this point?

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?

The $452 Million Question

After opening the two high bids yesterday afternoon a partnership of LAZ Parking/JP Morgan emerged as the winner with a bid of $451.7 million for a 50 year lease of the City’s parking system-a combination of garages, surface lots, and metered spaces that the Mayor has viewed as the way out of the pension morass.

As of the last actuarial statement the three pension funds contained $339 million for $989 million, a funded ratio of 34%. Under the terms of Act 44, the state required the City to get the funds to a 50% funded level. As part of the deal from the inception of the idea the Mayor wanted to retire the Parking Authority’s $108 million debt.

So let’s assume that $452 millionis handed over to the City. After taking $108 million to pay the Authority’s debt, there is $344 million remaining. In order to get to the bare minimum 50% level under Act 44, the City would need to take $160 million which leaves $184 million. Plowing all of the money after paying off the Authority’s debt would mean the pension funds would have $683 million in assets. Measured against current liabilities the funding level would reach 69% under this scenario.

Clearly City officials are pleased that the bids came in well above what they expected. What the City needs to do is have a twofold realization: one, there will be endless demands and suggestions for what to do with $184 million if the City only aims to get the pension funded at the 50% level (that is, taking $160 million of the $344 million and putting it to the pensions). Realize that that the $184 million overage basically equates to two years of debt service payments for the City. Two, the City needs to look at short term history to know that in the mid to late 1990s (after selling pension bonds) that the funding level did reach 70%. That was frittered away by benefit enhancements, stock market losses, etc. The City still needs to pursue pension reform and has to cut costs. What does the above expectation bid do for those goals?