Pension Update – Time to Go Back to the Drawing Board

Stephen Herzenberg |

We’re closing in on the end game of the Pennsylvania budget process and lawmakers are considering two different pension proposals—both of which would be a step backward. Here’s an update on these options, with links to where you can find more information.

Most discussion over the past several months has focused on the Corbett-Tobash “hybrid pension plan.” This would replace existing pensions with a much smaller guaranteed pension and 401(k)-type savings accounts that cover any salary over $50,000 and service over 25 years. The governor favors combining this pension re-design with reductions in state and school district pension contributions over the next five years.

The bottom line on the Corbett-Tobash plan is that it doesn’t solve Pennsylvania’s pension underfunding problem, but it does cut pension benefits deeply for new employees. It achieves this unsavory combination because savings from benefit cuts are offset by four cost increases.

  • First is the long-term cost of the governor’s proposal to cut pension contributions (to “lower the pension collars”) in the next five years.
  • Second is the inefficiency of 401(k)-type accounts which have higher costs and lower returns that translate into a third to nearly a half fewer retirement benefits for the same contributions.
  • Third is a potential “transition cost” because the Corbett-Tobash pension plan drains contributions for new employees into the existing defined benefit plan; with the pension obligations of these plans shifting over time towards retirees and near-retirees, the PSERS actuary (Buck Consulting) suggests that the funds would invest in more conservative ways, lowering investment returns—leading to a need for more taxpayer contributions.
  • Fourth is that higher future wages will likely be necessary to retain employees given low public-sector salaries, a slashed pension, and a weak incentive to stay beyond 25 years.

For more information, you can find our talking points on the original Corbett 401(k)-type plan here. You can find our brief on Corbett-Tobash here. And an op-ed here.

Now to the second pension proposal reportedly being considered: with the Corbett-Tobash plan unable to command a winning majority so far, there are rumors that lawmakers might go back to the governor’s proposal to switch new employees completely to 401(k)-type savings accounts. Don’t go there, girlfriend! Or lawmakers.

Here’s why: with an immediate closing of the existing defined benefit pensions to new employees, actuaries estimated the transition cost from lower investment returns under the original Corbett 401(k)-type plan at about $40 billion (on a nominal dollar, cash flow basis—it’s lower, but still large, measured in dollars in hand today). Add to this the inefficiency of 401(k)-type savings plans, the deep cuts in benefits (even with the same contributions, remember, a third to a half less in benefits), and an erosion in educational and service quality (because of higher employee turnover)—and you’ve got another clunker.

As we said in the title of this blog. It’s time to go back to the drawing board on pensions.

Our proposed framework for addressing Pennsylvania’s pension debt is at the end of our brief critiquing the Tobash plan.