School Pension System Facing Dire Situation

Even if investment markets perform better than ever in history for the next five consecutive years, Pennsylvania taxpayers can expect to pay billions in pension liabilities for retired public school teachers, according to the chief financial officer at the state’s largest public pension system. 

The Public School Employees Retirement System, or PSERS, has an official $30 billion unfunded liability that will require steep increases in taxpayer contributions over the next three decades to pay down, after more than 10 years of underfunding the system. But it will take several decades of high contributions and good investment returns to eliminate the unfunded liability. 

Brian Carl, PSERS chief financial officer, delivered the sobering information to the board at its monthly meeting June 10. He said investments alone could not cover the liabilities at this point, even in a year with good returns. 

“Because we’re so far under what we should be contributing, the outperformance doesn’t really help us,” Carl said. “It helps, but it’s not going to eliminate the need for future contributions.” 

In pension systems, the unfunded liability is the total cost of all earned benefits. Since they are earned, the liability is essentially debt that must be paid off. It does not include future benefits which members of the system continue to earn. 

How bad is it? Over the past two decades, the state incrementally reduced the employer contribution--the part of the pension system funded directly by tax dollars--from its high of 20 percent in 1986. A 2002 law set the employer contribution at 1.15 percent of payroll for a period of 10 years, during which time two economic downturns wreaked havoc on the pension plans’ investments. 

While the contributions were being lowered and investments failed, the liabilities continued to increase. Starting this year, the direct taxpayer contribution portion will shoot up over the next decade from 5.64 percent to 25 percent. In actual numbers, the state expects to increase contributions to PSERS from $761 million this year to more than $5 billion annually by 2020 and $7 billion annually by 2030. 

Those high contributions must occur even if the markets perform better than expected, said Carl. 

The PSERS fund assumes a market return of 7.5 percent on investments. Even if markets outperform that expectation--Carl used the example of 10 percent returns for each of the next five years--the state’s contributions will exceed the 20 percent benchmark until 2035. 

State Sen. Pat Browne, R-Lehigh, one of the legislative appointees to the PSERS board, said the state should place the same importance on pension contributions as on debt service payments. He said the General Assembly has not always done so. 

“That is the fundamental change. It has to be seen as no different than debt service, and we have to make the payments,” Browne said. “The assembly needs to understand that these things are unsustainable.” 

If investments fail to produce those high returns, the state’s contribution will have to be even higher. Those funds have to come from somewhere, meaning either cuts to other state programs or higher taxes to generate revenue. 

Then there is the issue of whether such high returns for an extended period of time are possible.

Retired actuary and pension expert Rick Dreyfuss said private sector pension plans use an assumed rate of return closer to 6 percent, and even that can prove to be too high at times. 

Earlier this year, the PSERS board voted to reduce the assumed rate of return from 8 percent to 7.5 percent, a move which PSERS Executive Director Jeff Clay said resulted from more volatile markets, which made the higher-than-expected returns increasingly unlikely. 

Clay said a globalized market and the speed with which information can be transmitted worldwide makes it unlikely there will be a return to the more stable investment markets of decades past. 

During the past 25 years, the PSERS fund has averaged an annual return of 9 percent.

The other good news is the current investment returns, which have exceeded 18 percent for the first three quarters of the fiscal year, PSERS reported Friday.

Clay said the high returns were no indication that investments would continue to be positive for the next decade. 

“There are going to be times when you go above (the expectation), and there are other times when you are below,” Clay said. 

On June 10, PSERS also reported higher than average retirement figures for the current year. More than 6,500 members of the pension fund have applied for retirement in 2011, up from 4,700 in 2010 and 5,000 in 2009. 

Clay said several factors are driving the higher retirement numbers, including people who put off retiring during the recent economic recession; the “demographic bubble” created by the baby boomers and increased early retirement incentives as school districts try to save money in a tough budget year. 

He said the higher number of retirements would affect the fund, but not dramatically. 

“It does flush people out of the system, so that does increase the payroll,” Clay said. “It’s going to be an issue, but not a major issue.”