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COMMONWEALTH OF PENNSYLVANIA HOUSE OF REPRESENTATIVES
STATE GOVERNMENT COMMITTEE HEARING
STATE CAPITOL HARRISBURG, PA
RYAN OFFICE BUILDING ROOM 2 05
TUESDAY, MARCH 24, 2 015 9:01 A.M.
PRESENTATION ON PENSION REFORM
BEFORE:HONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLEHONORABLE
DARYL METCALFE, MAJORITY CHAIRMANCRIS DUSHKRISTIN HILLRICHARD IRVINFRED KELLERJERRY KNOWLESBRETT MILLERBRAD ROAERICK SACCONETHOMAS SANKEYDAN TRUITTJUDITH WARDJEFF WHEELANDMARK COHEN, DEMOCRATIC CHAIRMANLESLIE ACOSTAVANESSA BROWNMARY JO DALEYPAMELA DELISSIOSTEPHEN MCCARTERMICHAEL O ’BRIENEDDIE DAY PASHINSKIBRIAN SIMSRONALD WATERS
Pennsylvania House of Representatives Commonwealth of Pennsylvania
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COMMITTEE STAFF PRESENT:SUSAN BOYLE
MAJORITY EXECUTIVE DIRECTOR AMY HOCKENBERRY
MAJORITY RESEARCH ANALYST KAREN PENICA
MAJORITY RESEARCH ANALYST PAM NEUGARD
MAJORITY ADMINISTRATIVE ASSISTANT
MATT HURLBURTDEMOCRATIC RESEARCH ANALYST
KATHY SEIDLDEMOCRATIC RESEARCH ANALYST
LINDA HUNTINGTONDEMOCRATIC LEGISLATIVE ASSISTANT
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I N D E X
TESTIFIERS ~k k k
NAME PAGE
RICK DREYFUSSBUSINESS CONSULTANT & ACTUARY,SENIOR FELLOW, THE COMMONWEALTH FOUNDATION,ADJUNCT FELLOW, THE MANHATTAN INSTITUTE............ 8
SUSAN D. DIEHL, CPC, QPA, ERPAPRESIDENT OF PENSERV PLAN SERVICES, INC........... 21
SCOTT PORTERPRINCIPAL OF MILLIMAN ACTUARIES....................34
MIKE CROSSEYPRESIDENT OF PSEA.................................. 4 6
RICH HILLERSENIOR VICE PRESIDENT,GOVERNMENT SERVICES,TIAA-CREF...........................................60
JOHN SCHU, CFP, AIF, CLTSENIOR VICE PRESIDENT BRANCH DEVELOPMENT,LINCOLN INVESTMENT PLANNING........................7 3
JOSH B. MCGEE, PH.D.VICE PRESIDENT OF PUBLIC ACCOUNTABILITY,LAURA & JOHN ARNOLD FOUNDATION, andSENIOR FELLOW AT THE MANHATTAN INSTITUTE.......... 86
JOE NICHOLSSENIOR DIRECTOR FOR FTI CONSULTING............... 101
GARY A. WAGNER, PH.D.PROFESSOR OF ECONOMICS,OLD DOMINION UNIVERSITY........................... 113
SUBMITTED WRITTEN TESTIMONY ~k ~k ~k
(See submitted written testimony and handouts online.)
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P R O C E E D I N G S ~k ~k ~k
MAJORITY CHAIRMAN METCALFE: Good morning. The
hearing of the House State Government Committee is called
to order. And before we take our attendance, if I could
ask everybody to please rise and ask my good friend
Representative Rick Saccone to lead us in the Pledge.
(The Pledge of Allegiance was recited.)
MAJORITY CHAIRMAN METCALFE: Some have their own
way of singing the National Anthem and Rick has his own way
of saying the Pledge. Thank you, Rick. Thanks for leading
us, Representative Saccone.
If I could ask our Member Secretary
Representative Knowles to call the roll, please, for our
hearing.
REPRESENTATIVE KNOWLES: Thank you, Mr. Chairman.
(Roll was taken.)
REPRESENTATIVE KNOWLES: We have a quorum,
Mr. Chair.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Knowles.
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If everybody could make sure your mikes are off
if you’re not going to be using them. We had some feedback
coming through there, just to make it better for our
testifiers this morning if you would.
Just a few comments here before we get started
with the hearing, as Chairman of the House State Government
Committee, one of my objectives as being Chairman was to
ensure we did have hearings, that they are conducted in a
way that respected the time of our guests, our testifiers,
and our Members, and that’s what we will work to do once
again this morning is to respect that time that everyone
has that is so valuable as we go through this hearing today
that we expect to extend until about 11:30. So we will be
working to ensure that we start on time for the testimony
and on time for each testifier and then the hearing on
time.
So if any Members need to come and go throughout
the morning, you should be able to pretty much get back in
time to hear whoever was your hoping to get back for if
that is the case while there are appointments mingled in.
And for our testifiers, we’re hoping to
accommodate your schedules for your time that you’ve given
up to be with us today so that you can leave when it’s
appropriate and be here back in time for your testimony if
you have to go before you actually testify.
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I would also ask the Members to respect the
testifiers today in a way that they're here to provide
testimony and provide their expertise to us, not to be
debated with. We can debate amongst ourselves at the next
opportunity when we start to actually consider the
legislation we expect to consider this session with respect
to pension reform. That will be the time for debate.
Today is a time to gather information, so please utilize
the time of the testifier to gather the information that
actually you think might help your debate as we move
forward. So we want to show our testifiers the respect
they deserve. They're our guests and should be treated as
such.
So with that said, today's hearing is going to be
on the issue of pensions. It's a very broad issue, of
course, with two very large pension systems here in
Pennsylvania that face combined unfunded liabilities in the
$50 billion plus range. I've done some work with the
Republican Members and other Members of our caucus and
we've actually worked on trying to define and find
consensus on how you define the problem of the pensions
here in Pennsylvania.
And amongst a number of us we came to a consensus
on the following definition of the problem with
Pennsylvania's pensions: Pennsylvania State pension system
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faces a combined unfunded liability of approximately $50
billion. The problem is that the governmental-defined
benefit pension structure is subjected to short-term
political manipulation rather than economic considerations
of long-term sustainability. Increased pension benefits,
shorter vesting periods, and decreased employer
contribution rates have produced a liability that
contributed to the Commonwealth's most recent credit
downgrading.
The defined benefit pension structure is
fundamentally unsustainable. For this reason, the vast
majority of employers in the private sector have moved away
from the DB system. Underperformance of defined benefit
investments requires that the employer identify alternative
revenue sources to fulfill pension obligations. The
Constitution of Pennsylvania requires the Commonwealth
produce a balanced budget each year. Taxing future
generations of Pennsylvanians to fulfill immediate pension
obligations violates this principle.
And with that said, I'd like to invite our first
testifier to the microphone. That would be Mr. Rick
Dreyfuss. He’s a Business Consultant and Actuary, Senior
Fellow with the Commonwealth Foundation, and Adjunct Fellow
with the Manhattan Institute.
Mr. Dreyfuss, we’re ready when you are, sir.
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MR. DREYFUSS: Okay. Thank you, and good
morning.
Perspective Chairs, thank you for the invitation
to testify before you today on this very encompassing topic
of public pensions. I’m a retired Business Consultant and
Actuary, and for over 20 years I was the Human Resource
Executive for the Hershey Company, so I have broad
experience in both private and public sector pension
issues. And in my post-Hershey times I’ve spent
considerable time as a consulting resource looking at
public pension issues and have written extensively on this
for both the Commonwealth Foundation and the Manhattan
Institute.
My testimony today is comprised of 16 slides that
you have and I’m going to take about a six- or seven-minute
overview of them and highlight certain areas. If there are
any questions that you have outside the scope of this
meeting, I’d be happy to meet or discuss these individually
with you as appropriate.
On my second slide, if I had one slide to
summarize everything, I would say that the fundamental
problem is that we are trying to change a political
institution, which is why public pension reform is indeed
so hard. And the reality is that the current public
pension system simply is not sustainable in the long run,
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and that’s the reality and that’s the challenge before this
Committee and policymakers in general.
On my third slide, if we were to ask why is this
such an insurmountable problem and why is this so
difficult, I break it down into three categories. One is
poor benchmarking. Most of the comparisons that you hear
are against other public pension systems, many of which are
in equally poor States. I would suggest you need to look
at the Pennsylvania private sector in terms of their best-
demonstrated practices and moving to defined contribution
plans at a cost of 4 to 7 percent of payroll.
I would also say that the second driver is poor
liability management, and this is where we were using
economic assumptions of over 7.5 percent to project long
term costs, and that is going to be a stretch by any
measure by my standard. And we’re also funding our plans
over too long a period of time. SERS, for example, takes
30 years to amortize any deficits, which is way too long.
The average should be somewhere between 15 to 20 years.
And finally, the overriding issue that is very
difficult is the political side of this, and that’s not
just a slogan because my contention is that politics and
defined benefit plans are a toxic combination. And I say
that because of the poor benchmarking, the rosy economic
assumptions, and the underfunding that traditionally
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occurs. It is very hard to muster the necessary votes to
properly fund these plans, and we've seen that throughout
many years. So for those three reasons, my view is that
these plans remain unsustainable.
If I had to summarize my recommendations in terms
of how to proceed, I would suggest a five-step approach,
and that's shown on slide #12. I first begin by putting
new hires in a defined contribution plan at a cost of 4 to
7 percent of payroll. This will eliminate the possibility
of unfunded liabilities going forward.
Number two, I would continue with the prohibition
on pension obligation bonds. Wherever I've seen pension
obligations in place, they are typically associated with
plans that are in poor fiscal distress and I can't even
give you a single example of one that has worked
effectively.
Number three, and probably I would circle this as
well, is we need funding reforms. We need to better fund
these plans. Right now, we are on a 30-year timeline to
fund these plans and I suggest to you that that is probably
about 10 years too long. We ought to adopt adherent
pension funding policies where we fund these plans over
shorter periods of time using, in my view, more realistic
assumptions.
Number four, I think the question of unearned
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benefits for members should be on the table. I understand
there are legal issues involved, but if we are to bring
these plans back to a sustainable state, that type of
variable needs to be considered.
And then finally, it would be good to properly
fund these plans without raising new revenues.
Pennsylvania is already the 10th-highest-taxed State from a
personal income standpoint and we’re right in the middle
with regard to the business climate, and I don’t think
increasing taxes would help those profiles at all. So
that’s the five steps that I would recommend.
And conversely, I would equally recommend staying
away from five practices. I call these pseudo-reforms.
That includes pension obligation bonds, that includes early
retirement incentive plans, redefined pension costs to the
next generation, or even adopting a new type of defined
benefit plan because the problem is not the type of defined
benefit plan; it is the defined benefit plan because that
is where the ability to overpromise and underfund comes
into play time and time again. And you see it not only
playing out in this State but in others as well.
And then finally, I’d like to address some half
truths that I see from time to time. One is the issue of
transition costs. People think it will cost $40 billion to
close these plans. Well, that is an incomplete
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calculation. That needs to be done on multiple scenarios.
It needs to be expressed in terms of a present value.
That’s how actuaries compute these numbers. And if you do
that, you’ll see that that is not a significant issue to be
overcome. And as evidence of that, I’ve never seen a
private sector plan face a transition cost as an
insurmountable barrier in terms of their conversion to the
defined contribution plans.
Second, people often talk about Michigan and
Alaska, which have adopted defined contribution plans and
have said, well, their unfunded liability has rocketed
since they’ve gone to the defined contribution plan. And
the reality is that has nothing to do with why the unfunded
liabilities have increased. They’ve increased because
they’ve underfunded those plans and they’ve had poor
investment results. Again, the State of Michigan’s
Teachers’ Plan has remained open and it’s in the same sorry
state that the closed defined benefit plan is for the State
employees. So looking at other States you need to look at
the entire scenario of underfunding and poor investment
returns.
Third is you hear that pension defined benefit
plans are 48 percent cheaper, and I would suggest to you
that that conflates pooling of risk, which is an
appropriate concept with individual accounts and it’s
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simply not an apples-to-apples comparison. And again, I’d
be happy to talk more on that.
And then finally, Act 120: Act 120 was supposed
to save $3 billion cumulatively over 30 years. Well, in my
view Act 120 has already failed for the simple reason that
it was based on an 8 percent assumed interest rate. Right
after Act 120 was passed, we lowered that to 7.5 percent.
That increased the unfunded liability overnight by $6.4
billion. That is twice what we had assumed that that plan
would save cumulatively over 30 years. And moreover, the
savings were based on hiring new people. The more people
we hired, the more money we would save. It’s sort of a
perverse incentive. So while I fully acknowledge that the
benefits have been reduced under Act 120, I would suggest
to you the financial model on which that decision was made
was flawed.
So let me stop there and I would certainly be
happy to answer any questions that might come up. Thank
you.
MAJORITY CHAIRMAN METCALFE: Thank you,
Mr. Dreyfuss.
Members with questions?
Representative Pashinski.
REPRESENTATIVE PASHINSKI: Thank you,
Mr. Chairman.
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Mr. Dreyfuss, thank you very much for your
testimony.
Based upon what you just said, so there’s no
formula that would work relative to a defined benefit
concept?
MR. DREYFUSS: I think where a defined benefit
plan works is the exception to the rule. There’s nothing
wrong with the concept as is; it’s when you put it in the
political domain that you see what goes on, the
overpromising and underfunding, and Pennsylvania is not
alone in that regard.
REPRESENTATIVE PASHINSKI: Because you did say
that even the defined contribution plans in Michigan and
Alaska were underfunded, which is one of the reasons for
its failure -
MR. DREYFUSS: Defined-benefit plans -
REPRESENTATIVE PASHINSKI: — and that’s one of
the main reasons why we’re in this boat today because the
pension plan has been very solvent up until the point that
we changed the multiplier and changed the conditions.
MR. DREYFUSS: Right, but even as I speak,
looking at next year’s budget, we still underfund the plan.
I just don’t see the political will to properly fund these
plans and it’s not something unique to our State pension
systems. You see these in the municipal plans as well. So
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it's just too big a political lift to properly fund these
plans.
REPRESENTATIVE PASHINSKI: But if it was funded
properly, we'd be okay?
MR. DREYFUSS: That's correct.
REPRESENTATIVE PASHINSKI: Okay. Thank you.
Thank you, Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Pashinski.
Representative Knowles.
REPRESENTATIVE KNOWLES: Thank you, Mr. Chairman,
and thank you, Mr. Dreyfuss. We appreciate you being here.
On the second page you talk about the fact that
it's just unsustainable. I'm not quite sure. I'm going to
take a quick peek here so I can refer to -- the current
public pension system simply isn't sustainable in the long
run.
MR. DREYFUSS: Right.
REPRESENTATIVE KNOWLES: My question would be
that we continuously hear about how we got into this mess
and, first of all, the drop in the economy; and secondly,
the changes that were made by the Legislature years ago in
terms of improving benefits. My question would be, and
maybe it's not a fair question of you, but my question
would be, number one, if the economy hadn't gone south and
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the improvements for the system for employees had not been
made better, question number one is what condition do you
believe that system would be in today?
And secondly, to tie in the second factor is if
the economy had gone south and even with the improvements,
I mean it just seems like that was truly what happened
here. Can you comment on that a little bit?
MR. DREYFUSS: Well, some of the analyses I have
seen say that the number one reason for our deficit or
unfunded liability, that relates to underfunding as the
number one driver. The second is poor investment returns,
third is benefit improvements, and fourth is other changes.
We used to assume an 8.5 percent interest rate and we
lowered that. Every time we take it down a half-a-percent,
that adds about $6.5 billion to our liability. So it’s a
combination of those factors and then the inability to deal
with that sort of in real time because we are always
pushing this stuff out 30 years, which is way too far.
Obviously, if we could have addressed that back then or had
compliant funding policies back then, we wouldn’t be having
this hearing today, but this is where we are.
REPRESENTATIVE KNOWLES: But if the economy had
stayed good, even with giving of the additional benefits to
State employees, if the economy had stayed good, some
people say we would have been fine if the economy would not
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have gone down the tubes.
MR. DREYFUSS: I think that probably accounts for
about 30 percent of the problem if the economy had been
good, so you still got the other 70 through the benefit
improvements and the underfunding that remain a systematic
problem.
REPRESENTATIVE KNOWLES: Thank you, Mr. Chairman.
And thank you, Mr. Dreyfuss.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Knowles.
Representative Daley.
REPRESENTATIVE DALEY: Thank you, Mr. Chairman.
In the plans that you laid out, I think it was on
page 12 you had a list of four or five different things,
but I don’t believe that you mentioned the unfunded
liability and the fact that in Pennsylvania now the pension
funds both have unfunded liability. And how would you
address that?
MR. DREYFUSS: Well, that is actually the third
plank of my reform is that we need to have better funding
policies because that’s what’s driving our unfunded
liability. And to address that we simply have got to put
more money into the plan. So there the debate is where do
the funds come from? Do we cut programs or raise revenues?
And it’s probably going to end up being a combination of
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those two. But I would also say that Representative John
McGinnis has a plan in terms of compliant funding practices
consistent with this type of an approach, but to be sure,
under any scenario we need to have better funding policies
in place putting more money in these plans because if we
don’t do that, they will continue to remain unsustainable.
So that’s an equally important part.
REPRESENTATIVE DALEY: So how is that actually
different than Act 120?
MR. DREYFUSS: Well, Act 120 actually went the
other way. What Act 120 did is it put less money short
term into already-underfunded plans and pushed the cost out
over a new 30-year period. And what I’m suggesting is
today, right now, we need to be properly funding these
plans on, say, a 20-year schedule called an amortization
basis and putting the necessary funds in place. And by my
rough calculations, that’s probably another $2 billion over
and above what we’re already contemplating for the next
fiscal year. I mean that’s what we need to make these
plans sustainable.
REPRESENTATIVE DALEY: Okay. But we do have an
unfunded liability now.
MR. DREYFUSS: Absolutely.
REPRESENTATIVE DALEY: And I don’t hear you -
and I don’t want to debate with you but my observation is
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that we still need to address that because that’s a reality
we have in Pennsylvania and Act 12 0. And you don’t have to
answer that but that’s my observation of what you’re
saying.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Daley.
REPRESENTATIVE DALEY: Thank you.
MAJORITY CHAIRMAN METCALFE: Now, we have a
couple minutes left with this testifier. We have several
Members on the list; we’re not going to get everybody, but
if you don’t get to ask questions of this testifier, you’ll
be first on the list if you’d like to ask one of the next
testifier so we can stay on schedule here today.
The next question will be from Representative
Truitt.
REPRESENTATIVE TRUITT: Thank you, Mr. Chairman,
and thank you, Mr. Dreyfuss, for your testimony.
I want to focus on the transition to the DC plan.
I wholeheartedly agree that that has to be the first step.
Otherwise, we could work our way out of this $50 billion
hole and a future legislature could dig us right back into
another one.
Now, one of the arguments that I’ve heard in my
town halls, I have to say my constituents overwhelmingly
support the idea, including rank-and-file teachers, of
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moving to defined contribution for new hires at least. But
one of the questions that came up in one of my town halls
was is it possible for the State to underfund a DC system
or like if we use a 401(a) plan or something like that,
does Federal law guarantee that we can’t underfund the
system, or do you think we would need some kind of
provision in the State Constitution to assure that?
MR. DREYFUSS: Well, in a defined contribution
plan, it’s like meeting payroll. I mean you have to be
current with your costs and there’s no provision for
retroactive benefit enhancement or a big IOU going into a
defined contribution plan. And that’s sort of the beauty
of it is that you’ve always got to keep current. You can
always reduce a match or suspend a match based on fiscal
conditions and that happens from time to time, but the
funding is very straightforward.
REPRESENTATIVE TRUITT: So you’re saying that
there is no scenario that you could see under which the
State could underfund the DC plan?
MR. DREYFUSS: Right. That’s right. There is no
unfunded liability possible with a defined contribution.
REPRESENTATIVE TRUITT: So we would not be able
to dig ourselves back into another hole?
MR. DREYFUSS: That’s right. Now, you still have
the hole from the existing plan --
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REPRESENTATIVE TRUITT: Right.
MR. DREYFUSS: -- but going forward you would at
least go in a different direction.
REPRESENTATIVE TRUITT: Okay. And just a five-
second question. Do you think it’s possible for a State to
declare bankruptcy?
MR. DREYFUSS: I don’t know the answer to -- I
mean that’s a good legal question.
REPRESENTATIVE TRUITT: Okay. Thank you,
Mr. Chairman.
Thank you, Mr. Dreyfuss.
MAJORITY CHAIRMAN METCALFE: Thank you. That’s
all the time we have for this testifier, and we had two
questions from each side. So thank you, Mr. Dreyfuss.
MR. DREYFUSS: Thank you.
MAJORITY CHAIRMAN METCALFE: Thanks for being
with us today.
MR. DREYFUSS: Right.
MAJORITY CHAIRMAN METCALFE: Our next testifier
is Ms. Susan Diehl, the President with PenServ Plan
Services, Incorporated. Thank you, ma’am, for being with
us. You can -
MS. DIEHL: Good morning, and thank you, Chairs
Metcalfe and Cohen and the Members of the House Standing
Committee on State Government. Thank you for the
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opportunity to testify in front of you this morning with
regard to this important issue. My name is Susan Diehl and
I am President of PenServ Plan Services.
Just to give you a little bit of background so
you know where I'm coming from is we are located in
Horsham, Pennsylvania. We are an independent national
consulting firm and third-party administrator. We
administer approximately 3,000 employer plans with a total
of 564,000 participants and record-keep approximately $9
billion. We are also located, as far as administering
plans, in 25 States. We also consult to over 2,000
financial institutions and companies on various retirement
matters ranging from IRAs to employer pensions and defined
contribution plans.
In my role at PenServ, I participated on several
IRS and Department of Labor committees and also serve on a
number of IRS liaison committees, and I meet with the IRS
periodically on certain retirement and pension matters. I
also actively serve in professional organizations. I'm a
credentialed member of the American Society of Pension
Professionals and Actuaries, the immediate past President
of the National Tax-Deferred Savings Association, and a
current Board Member of the American Retirement
Association.
As you've already heard and you know, the
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Commonwealth of Pennsylvania is not unique in contemplating
redesign of its retirement and public employee retirement
system. We know that over the past three years 19 States
have actually introduced some sort of public pension reform
initiatives. Four those States have actually enacted some
form of public sector retirement plan reform.
I’d like to, and in the interest of time,
paraphrase some of the testimony and talk about some of the
State initiatives and then finally end up with an
infrastructure that is already in place in the Commonwealth
that I want to make sure you all are aware of.
You’ve already heard and talked a little bit
about the experience of Alaska and West Virginia. We know
that West Virginia converted from a pension to a defined
contribution plan, obviously did not work towards the
funding issue, and in 2003 the funding dropped to 18
percent. The result was, in order to help address the
rising required contribution and cash flow issues, they
were forced to go back to a defined benefit plan in 2006.
Alaska suffered a very similar situation.
Perhaps learning from these examples, many new
proposals are based on moving employees from a traditional
pension to a combination pension and hybrid plan, a
combination of a pension and a defined contribution, which
we commonly refer to as a hybrid plan. In fact, variations
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of the hybrid retirement plans were introduced in
Pennsylvania House last year by Representatives Grell and
Tobash. While not a silver bullet to solve the unfunded
liability, hybrid plans are seen as favorable policy
alternatives because they continue the regular funding to
the pension and introduce a defined contribution plan,
shifting some of the funding liability and the investment
risk from the State to the employees.
Two examples of State Legislatures that had
passed pension reform that relied upon State Government to
exclusively run the defined contribution component of the
hybrid retirement systems are Virginia and Michigan. I
want to focus first on Virginia.
Virginia passed legislation in 2012 to introduce
a hybrid retirement plan for State employees that was to
begin in 2014. The defined contribution portion of the
plan had a mandatory employee contribution element and
offered an employer match on voluntary employee
contributions. The Virginia Retirement System created a
plan and hired a firm to provide services that VRS thought
was necessary. The result was that 5 percent of
participants were making voluntary contributions. That
means that 95 percent of the employees, the participants,
were foregoing matching contributions, unbelievable. The
most important metrics for a successful defined
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contribution plan our participation rates and contribution
rate. By these measures, the plan failed from the start.
Virginia recognized this issue and just recently
in 2015 they passed new pension reform legislation that now
includes competitive offerings through private companies
that deliver services at the local level. Virginia
basically replaced this with a mandatory 1 percent employee
contribution, a non-elective discretionary employer
contribution of 1 percent, and then also kept a 50 percent
match up to 5 percent.
The story is very much the same in Michigan.
Michigan is now said to be following Virginia in their
legislation and moving towards allowing private local
offerings that meet the needs of participants to get the
plan working like it should.
The important learning here is that neither plan
needed to end up this way. Virginia and Michigan could
have leveraged the existing infrastructure of private local
retirement plan providers at the outset. The key point for
this Committee is that you need to understand that every
single public school district in the Commonwealth currently
has a defined contribution plan. They’re in place today.
The infrastructure is already there to launch a plan that
works without rebuilding the wheel.
What’s more, many Pennsylvania charter schools
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have already made the transition from a straight defined
benefit plan to a hybrid system that’s in place. Charter
schools in Pennsylvania offer what we refer to as the
PSERS’s Alternative, and they’re working quite well with
using the existing plans that are available to them or are
already in place.
Currently in the State of Pennsylvania we have
about 175 charter schools. Of that I think 14 of them are
cyber charter schools. Probably half of the charter
schools in the Commonwealth today have already put in place
what we refer to as this PSERS Alternative, and basically
the way it works is this. You have a lot of examples in my
testimony but I will spell it out this way.
PSERS Alternative plan is where the school will
take the existing defined contribution plan structure that
all employees have the voluntary right to defer money from
salary. The PSERS Alternative piece of that is where, for
new hires only, so, for example, let’s say we have a
charter school that decides effective July 1st of 2015 all
new hires after that date would not be put into the PSERS’s
defined benefit plan, but in lieu of that, a 5 percent
mandatory contribution will come from their salary, the
employer will then put a contribution in the plan of 5
percent. Those same employees, those new hires, would also
be able to do a voluntary deferral into the plan of up to
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$18,000 for this year. If they’re over the age of 50, they
get to do an additional 6,000. Existing employees who are
part of the PSERS’s pension plan can still participate, and
many of them do, on the voluntary side.
Some charter schools, to give employees the
option when they’re hired, will offer new hires who are
already part of the PSERS’s pension plan that choice upon
hire between selecting PSERS or the defined contribution
plan. Very few new hires will make that choice. If the
new hire is a younger worker, they look at it in a number
of different ways. They like the fact that it’s a defined
contribution plan. They like the fact that they can see
their money in there. They can have the opportunity to put
the deferral money in there as well. And the mandatory
contribution is less than the mandatory contribution that
goes into PSERS, and all young employees like to see more
in their paychecks.
So it’s working. It’s an infrastructure that’s
in place right now. Obviously only the charter schools are
permitted to use it based on the charter school law as it’s
currently written, but it is an infrastructure that’s in
place.
And with that, I will end and be happy to answer
any questions.
MAJORITY CHAIRMAN METCALFE: Thank you, ma’am.
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Our first question will be from Representative
Cohen.
MINORITY CHAIRMAN COHEN: Thank you.
Could you tell us what "working" means? I mean
any program that works in a vague sense that people
participate in the program, but besides the fact that there
are people participating in the program, how is it working
in terms of providing retirement security for charter
school teachers? That’s the question.
MS. DIEHL: Okay. The answer to that is really
twofold. First of all, we know that we want to look at
participation rates. We want to make sure the employees
are saving for retirement. The PSERS Alternative, as it’s
called right now, is something that’s approved through
PSERS for the charter school. So the first step is once -
and I’m giving you the example of 5 and 5. Some schools
have opted to give more of a contribution from the employer
side. Very few of them have opted to mandate more than 5
percent. PSERS has decided that the 5 and 5 combination is
really replacing what they would get from the PSERS pension
plan at this point. So actuarially they have decided that
that really is the replacement for what they would get from
the State pension -
MINORITY CHAIRMAN COHEN: Nothing stops PSERS
under current law from deciding at some time in the future
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where there are new members -
MS. DIEHL: Absolutely.
MINORITY CHAIRMAN COHEN: -- that they could be
cut to 3 percent or 2 percent -
MS. DIEHL: Well, I can -
MAJORITY CHAIRMAN METCALFE: -- the employer
contribution, Mr. Dreyfuss testified earlier that the
benefits of defined contribution plans is the employer
contribution can be cut or suspended at any time?
MS. DIEHL: It is true under defined contribution
plan that you could reduce, increase, or change that
employer funding or the employee funding. Currently, the
way this is working now, the plan must be approved in
Harrisburg through PSERS. It's a three-month process for
PSERS to approve it. They are not approving less than 5
and 5. Certainly in the future they could say your funding
has to be 6 percent to match what PSERS, but currently it's
a 5 and 5. Therefore, an employer could not reduce it
below 5 percent -
MINORITY CHAIRMAN COHEN: Well, I think all of
retirement security is for people to be secure, and a
retirement that depends on a whim or the will of the future
governor and a future board member is not security.
MAJORITY CHAIRMAN METCALFE: Was that a question,
Representative Cohen, or a debating point?
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MINORITY CHAIRMAN COHEN: Well, I would like to
hear a comment on that.
MS. DIEHL: Well, once again, the focus on
participation rates and the fact that employees are
participating. Beyond the 5 and 5, bringing this
alternative back to the local level where there is a
company or an individual who’s helping these teachers, who
is in front of them telling them about the voluntary
contribution, those rates are increasing as well. So
individual teachers are understanding the need to save for
their retirement and what they need to do beyond, whether
it’s a pension or an employer-provided benefit, they need
to participate as well in a plan. Without the local choice
or that plan, that defined contribution plan, you’re not
going to have the additional availability to put that money
in.
MINORITY CHAIRMAN COHEN: Well, that’s true, you
have additional availability, but in a defined benefit
plan, everybody has the option of putting additional money
in a private retirement if that’s what they want to do.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Cohen.
Our next question? Can we move on to the next
questioner, Representative Cohen? We have kind of limited
time.
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MINORITY CHAIRMAN COHEN: Okay.
MAJORITY CHAIRMAN METCALFE: Representative
Keller.
REPRESENTATIVE KELLER: Thank you, Mr. Chairman.
And thank you, Susan, for being here today.
My question revolves around the rate of return
and the normal cost. PSERS and SERS currently assume a 7.5
percent rate of return, and in testimony and the
Appropriations hearings we talked to the Auditor General
and he put a report out on a municipal pensions. And one
of his recommendations was to narrow the range of
acceptable investment rate of return assumption options to
reflect current economic conditions. In your opinion, what
would be an acceptable rate of return for that kind of
plan?
MS. DIEHL: I’m going to have to pass that to one
of the other presenters. I am not an investment company
so -
REPRESENTATIVE KELLER: Okay. Just looking back
at this, and PSERS and SERS I asked that question in
Appropriations and I wanted to know what the normal cost
would be because people are going to say later on in this
meeting that the normal cost for post-120 employees is 3
percent or less. That’s 3 percent providing that we get a
7.5 percent rate of return each and every year of the plan,
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is that correct? Would that be a correct assumption?
MS. DIEHL: Yes. Yes.
REPRESENTATIVE KELLER: Not assumption but a
fact.
MS. DIEHL: Right.
REPRESENTATIVE KELLER: So we don’t know what the
normal cost would be, so when people start saying, well,
the normal cost is below this for Act 120 employees, that
all depends on the rate of return?
MS. DIEHL: That’s correct.
REPRESENTATIVE KELLER: Okay. Thank you. And
thank you -
MAJORITY CHAIRMAN METCALFE: Thank you.
REPRESENTATIVE KELLER: — Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Keller.
Now, Representative DeLissio.
REPRESENTATIVE DELISSIO: Thank you,
Mr. Chairman.
Just a quick question for now. Do these DC plans
have a borrowing feature?
MS. DIEHL: Most of them do but only with respect
to the non-PSERS Alternative. The PSERS Alternative, the 5
and 5, cannot have a borrowing feature, a hardship
distribution. That really is to mimic the pension so those
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dollars have to stay within the plan. Voluntary
contributions that the employee may put in, that is
available for borrowing, you know, emergency distributions,
things like that.
REPRESENTATIVE DELISSIO: Okay. I have
administered both in the concern is that sometimes that
borrowing feature, which is very tempting, again undermines
-- and not to be paternalistic -- but can undermine that
concept of retirement security.
MS. DIEHL: And I’m going to say probably the
last five years employers and many defined contribution
plans, not just in public schools, have really looked at
plans to decide between the borrowing and the emergency
distributions. Many of them had both. And now, many
employers are deciding which one may work better with their
employees.
But in Pennsylvania and the charter schools
currently in these plans the PSERS Alternative is not
permitted to be taken out before really retirement or they
separate from service.
REPRESENTATIVE DELISSIO: Just the voluntary
side?
MS. DIEHL: Correct.
REPRESENTATIVE DELISSIO: Thank you.
Thank you, Mr. Chairman.
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MAJORITY CHAIRMAN METCALFE: Thank you,
Representative DeLissio.
That’s all the time we have with this testifier.
Thank you, ma’am, for joining us today. I appreciate you
sharing your expertise with us. Thank you.
Our next testifier is Mr. Scott Porter. He’s the
Principal with Milliman Actuaries. Ready when you’re
ready, sir.
MR. PORTER: Good morning, everybody.
As you probably noticed, I didn’t have any
written testimony as I understand that timing is of the
essence and I wanted to provide enough time for questions.
I just wanted to give a little bit of background
on Milliman’s work with the retirement systems. We’ve been
working with PERC probably for over -- I think we’re coming
on about 25 years in reviewing the different legislations
that have occurred with SERS and PSERS. And then in 2001
and 2006 we had done actuary audits for PSERS looking at
their assumptions and methods and the like and the actuary
calculations. We performed similar analysis for SERS in
2005, as well as the Pennsylvania Municipal Retirement
System. And then in 2006 through 2008 we had actually
worked with the Budget Office for the Rendell
Administration. A lot of that work was sort of precursor
to Act 120.
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And then in the last couple years, as you
probably have known in doing the actuary notes, we had
worked with the Corbett Administration between 2012 and
2014. So we’ve been involved with the plans in various
States over the last 25 years.
So I’m happy to answer questions from the Members
regarding the different systems.
MAJORITY CHAIRMAN METCALFE: Thank you.
Representative Truitt, do you have a question for
this testifier?
REPRESENTATIVE TRUITT: Yes. Thank you,
Mr. Chairman.
And thank you for being here to take questions
from us.
I’m curious on your take of the suggested
transition costs. I know that some actuaries have said
there would be a huge transition cost to go to a 401(k)-
style plan or DC plan from the DB plan. Others have said
it would be negligible. I know in the private sector
businesses are doing it so my gut tells me they should be
pretty small. Do you have any insight on that in terms of
why we would be getting two dramatically different sets of
numbers from different actuaries?
MR. PORTER: Yes. The transition costs come from
effectively two elements. The first one is the current
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unfunded liability is based on -- and we've heard testimony
about it, is it's based on the investment return assumption
of 7.5 percent. So if you close the plans, can you
continue to invest the assets similarly such that you would
continue to earn 7.5 percent?
One of the things that we look at when we
determine is there a "transition cost" is really, well,
does that asset allocation have to change on the day you
decide to close the plan? And so we look at what's the
percentage of the benefit payments that are being paid to
retirees who are receiving benefits versus the asset levels
and how would that ratio change over time?
As we talked about, there's a significant amount
of unfunded liabilities so there's a significant amount of
contributions that are going to be expected to come into
the plans over the next 30 years. Based on those kinds of
contributions, what we call this liquidity ratio is really
not expected to change much over the next 30 years so we
don't see the need that the asset allocation of the systems
would have to change on the day you decide to close the
plan. So it will take many, many years before you decide
to make changes from an asset allocation standpoint. So we
don't see a transition cost from that perspective.
The second perspective is from the funding of the
plans. The funding of the plans in terms of -- it was
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mentioned earlier in terms of long amortization periods and
there was a recommendation of shortening amortization
periods, and that probably should be really considered from
the standpoint that the amortization periods now are very
long and there’s a lot of new actuary literature suggesting
that those amortization periods should be shorter.
When you close the plan, it does sort of limit
how long those amortization periods can be and the way the
money is collected. But as long as you are collecting the
money and funding the plan properly over the period of
time, over, let’s say, the next 30 years, we don’t see that
the transition in terms of there’s got to be higher
contributions. Higher contributions are needed to support
the unfunded liability. Closing the plan doesn’t change
that.
REPRESENTATIVE TRUITT: Thank you, Mr. Chairman.
Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Truitt.
Representative Acosta, we didn’t get to you last
round of questions. Do you have a question for this
testifier, ma’am?
REPRESENTATIVE ACOSTA: Yes, thank you. Good
morning, Mr. Chairman, and thank you.
I have a quick question in your testimony that
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you submitted or you made a quick statement that says, "The
problem we face today is not a pension crisis but rather a
debt crisis." Can you further elaborate on that?
MR. PORTER: Who made that statement?
REPRESENTATIVE ACOSTA: Wasn’t that you?
MR. PORTER: It wasn’t me.
REPRESENTATIVE ACOSTA: Oh, he didn’t. Oh, okay.
I thought he did. I’m sorry.
But can you elaborate on that? Would you tell us
why it’s not considered a pension crisis but a debt crisis?
MR. PORTER: Yes. I mean every jurisdiction has
to fund the level of benefits that they are promising to
their employees, and so it’s a matter of being able to fund
at the level that’s required. And in terms of actuarial
funding, the funding will change over time as there’s
changes in actuarial assumptions and changes in benefit
structure. And one of the key changes was back in
2001/2002 when the benefits were increased, effectively the
cost of those benefits were not really supported by the
contributions, in fact until recently, until the last
couple of years because contributions soon thereafter were
reduced.
So if you want to make -- that’s the argument in
terms of what I would call more of a funding issue. And
then when funding levels are dropped and then they get
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exacerbated when asset levels are then decreased by 20, 25
percent, which is what happened with the Great Recession.
So when you have the funding levels that are dropped, which
will result in higher unfunded liabilities during that
period of time, and then you have a shock to the system
that decreases assets by 20 to 30 percent, it becomes a
significant issue. And so now you’re sort of in this hole
and you’re trying to find ways of how can we sort of climb
out of this hole?
REPRESENTATIVE ACOSTA: Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Acosta.
Before the next question, I just want to
recognize we do have some other Members that aren’t
necessarily Members of the Committee but I want to welcome
them here today, and if they have any questions, you would
certainly be welcome to join the Committee Members if they
have one. I know Representative Caltagirone is with us
today, Representative Tobash, and Representative Kampf.
Did I miss any Members that are out there in the
audience? Representative Brown -- well, Representative
Brown is on the Committee, right? So I didn’t miss you;
you’re on the Committee. So I was just recognizing Members
that aren’t on the Committee.
And former Representative Nichols joining us I
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see in the back there today, so welcome, sir.
Our next question will be from Representative
Dush.
REPRESENTATIVE DUSH: Thank you, Chairman, and
thank you, Scott, for agreeing to appear.
Earlier, Mr. Dreyfuss had made the comment that
there were political decisions that were involved in
getting us to where we are. I remember I was an AFSCME
member in 2000 when Act 9 was passed and prior to that
receiving information from the union encouraging us to get
a hold of the Legislators and the Governor in order to push
for this. The unions have a seat on the State Employees
Retirement Board but they were in effect lobbying to have
the other members, participants in the board getting on
board with Act 9.
My father at the time was a retired State
employee and he said that’s going to be the death of the
COLA. In SERS we were 134 percent funded at the time;
PSERS was about 120, 125 percent.
MAJORITY CHAIRMAN METCALFE: Representative Dush,
are we getting to the question there, sir?
REPRESENTATIVE DUSH: Yes. What were the
political decisions that got us -- besides Act 9, we’ve had
a series of them since then. Are you aware of the other
ones that have led us to where we are now?
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MR. PORTER: I mean from a political standpoint I
don’t think I can really comment on -- what I would say is
a lot of pension funds had large surpluses when we were
right about 1999 or so and early 2000 primarily because of
stock market returns in the late ’90s. There was about
four years there where returns were 20 plus percent. And
so certain asset levels really increased.
I think what we probably understand more now
today is that high returns can be followed by very low
returns and significantly low returns, and so they sort of
all average out, but the issue becomes is if you spend when
the assets are high, then you don’t have any buffer for
when the assets start reduce. And effectively that’s sort
of what happened. And it’s not unique to Pennsylvania.
New Jersey did it. In lots of different States, they
improved benefits because assets were high and that reduced
the amount of surplus that they had and then the surplus
got further evaporated because markets were decreased in
2001, so soon thereafter.
And the funding mechanisms weren’t in place such
that would support the higher level of benefits. It put
some jurisdictions on a pathway that makes it much more
difficult to support the plans going forward and that’s
kind of what I think we see here today.
MAJORITY CHAIRMAN METCALFE: Thank you,
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Representative Dush.
Representative Pashinski.
REPRESENTATIVE PASHINSKI: Thank you, sir.
Thank you for your testimony.
Trying to come down to this point about defined
benefits as opposed to defined contributions, and the
question that I asked Mr. Dreyfuss before was it appeared
as though he doesn’t feel as though there’s any kind of
formula relative to a defined benefit plan that would work
and then went on to say that you definitely need the
funding.
You just highlighted the fact that the fund under
the defined benefit had lasted for a long period of time,
had been 125 to 130 percent fully funded under that present
system. It wasn’t until the Legislature changed the
funding formula, that multiplier, and changed those
provisions and then did not fund it. The question that I
ask you is if we kept it the same even with the downturns
and upturns in the market, if we kept the defined benefit
the same as it was in 1999 until today, to what point would
we be in this situation?
MR. PORTER: I think you’d probably still be in a
similar situation. I think there’s two changes that
occurred back then and so I have to think through exactly
how it would play out if those two changes didn’t happen.
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And one was the benefits were increased, and two, then the
contributions were decreased. But effectively what was
happening was that the subsequent actuary losses they got
paid for over a 30-year period of time and the actuary
gains as of that money were also recognized over a 10-year
period of time.
So in year 11 when those assets gains were fully
recognized, the contribution was expected to spike up. So
it was an issue in terms of you are going to have this
contribution where it was going to be like this and that it
was going to shoot right up. So it was not a mechanism
that was really in place that was going to support those
benefits long-term.
So in terms of can you have a defined benefit
plan that can be supported? Yes. If you have a formula
that you believe is supportable and you can fund that
benefit appropriately, then defined benefit plans can work.
The question is, is the benefit level today supportable
based on today's budgets?
REPRESENTATIVE PASHINSKI: And the funding level
is dependent upon the formula that you initiate, so the
point that I was making was throughout that period of time
while it was funded up to 1999, even with the increase of
the profits from the stock market and the investments, that
was fully funded 125 percent. Now, if the State would have
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continued to fund it at the level that it should have -
remember the State for a period of 2 years funded it zero
and then underfunded it from that point on. If they funded
it at the level that it was to be funded, we would not be
in this position today.
MAJORITY CHAIRMAN METCALFE: Is that a point of
debate, Representative Pashinski, or are you asking the
testifier a question still?
REPRESENTATIVE PASHINSKI: Well, we’re still
working on trying to -
MAJORITY CHAIRMAN METCALFE: Well, we have some
other Members who would like to ask questions, so if you
want to debate, we’ll debate later. I’m ready to debate
you but -
MR. PORTER: I mean the portion -
MAJORITY CHAIRMAN METCALFE: — another time.
MR. PORTER: -- the amount of a liability would
be reduced. If benefits are at lower levels, then the
amount of liability would be reduced. But it wouldn’t have
changed what happened in 2001 in terms of stock market
crash and it wouldn’t have changed 2008 in terms of the
assets losing 20 or 30 percent, and it wouldn’t have
changed the fact that budgets were hit because of the Great
Recession as well. So those elements still wouldn’t have
changed.
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REPRESENTATIVE PASHINSKI: But the overall
downhill -
MR. PORTER: Everyone was hit that way.
REPRESENTATIVE PASHINSKI: Yes.
MR. PORTER: Yes, every fund was hit that way.
REPRESENTATIVE PASHINSKI: Everyone. It is not
unique. But thank you.
Thank you, Mr. Chairman. Thank you very much.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Pashinski.
Our final question for time constraints is
Representative Kampf.
REPRESENTATIVE KAMPF: Thank you, Mr. Chairman.
Scott, just on the subject of transition costs,
so back in 2012 and then in ’13 and ’14, you did a full
actuarial analysis on layering in a defined contribution
plan for all new hires for SERS and PSERS, right?
MR. PORTER: Correct.
REPRESENTATIVE KAMPF: And you had significant
access to all the information that is contained in the two
systems, is that correct?
MR. PORTER: Correct.
REPRESENTATIVE KAMPF: All right. And am I
correct that you concluded putting in a 4 percent match for
a DC plan, mandatory 4 percent for the employer for all new
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hires, that for the 30-year projection period you did not
see an increase in cost, is that correct?
MR. PORTER: Not in terms of -- right, those
transition costs, as I mentioned earlier, because we don’t
see the necessary need for the asset allocation of the
plans to change immediately or within that period of time
because the assets will be supported based on the benefits,
yes.
REPRESENTATIVE KAMPF: And that’s fundamentally
because even if we don’t make any change under Act 120,
over the next 30 years, the employer, the taxpayer is going
to have to put in something on the order of a couple of
hundred billion dollars to fund this system, is that right?
MR. PORTER: Yes. It’s big numbers, yes.
REPRESENTATIVE KAMPF: Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Kampf.
Thank you, sir, for your testimony today.
MR. PORTER: Thank you.
MAJORITY CHAIRMAN METCALFE: Our next testifier
is Mr. Mike Crossey, President of the PSEA.
Welcome, sir, and you can begin when you’re
ready.
MR. CROSSEY: Thank you. Good morning. Chairman
Metcalfe, Chairman Cohen, Members of the House State
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Government Committee, I am Mike Crossey, President of the
Pennsylvania State Education Association. And on behalf of
our 180,000 members, I thank you for inviting me here today
to express our views on retirement security and the various
proposals associated with pensions currently before the
General Assembly.
The Public School Employees’ Retirement System
(PSERS) was created in 1917. The State Employees'
Retirement System (SERS) was created in 1923. These
pension systems have weathered the Wall Street crisis, the
Wall Street crash of 1929, the Great Depression, the OPEC
oil price shock of 1973, both world wars, and a great
number of other significant financial crises and recessions
to successfully survive to the 20th century.
And succeed they did. At the turn of the
century, PSERS and SERS were both viewed as models of
success. PSERS was 123 percent funded, SERS was 134
percent funded, and the employer cost of pension benefits
had dropped below zero. Today, 15 years later, PSERS is
only 62 percent funded and SERS is only 59.2 percent
funded. These two large, successful state pension systems,
which have provided retirement security to millions of
Pennsylvanians over the course of their existence, are now
viewed by some critics as unsustainable. I feel it is
incumbent on all of us to understand what went wrong,
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correct the problems, make any necessary changes, and
restore these systems to financial health.
These two pension systems have also been
tremendous economic engines for the Commonwealth. They
have supported significant economic activity in many
critical sectors of our State’s economy either through
direct investment or the purchasing power of hundreds of
thousands of retired State and public school employees who
are receiving pension benefits.
Under a defined benefit model, contributions are
made by both the members of the pension system and their
employers. The plan assets are pooled and professionally
invested with the earnings from these investments covering
most of the cost of retirement benefits. If you look back
over the last 20 years, for example, you will find that
investment earnings provided 71 percent of the funding for
benefits paid by PSERS, member contributions provided
another 15 percent, and employers only provided 14 percent
of the funding.
The members of a defined benefit system are able
to slowly earn a pension benefit over a working career and
are rewarded with income security in retirement. Employers
benefit because they can defer a portion of employee
contributions to sometime in the future and use investment
earnings to offset part of the cost. This can be a win-win
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proposition for everyone, including taxpayers, if everyone
keeps their side of the bargain.
So what happened over the last 15 years?
Starting in 2001, the General Assembly intervened
legislatively, increased pension benefits and then
proceeded to take a series of actions that cut or capped
the required employer contributions necessary to sustain
the pension plans.
From 2001 to 2013, Pennsylvania ranked 49th out
of the 50 States in meeting its annual required
contributions to its pension funds. Only New Jersey ranked
lower. Anyone wishing to explore these numbers in more
depth might want to review an 82-page study comparing
pension funding among the States that was recently released
by the National Association of State Retirement
Administrators. Attached to my testimony is a NASRA press
release that includes a link to the full study.
The total employer funding shortfall over this
period was $14.9 billion. This, however, was only the tip
of the iceberg in terms of the impact on the pension
systems. Remember that earnings from investments generate
most of the funding for a defined benefit plan. In the
case of PSERS, investment earnings accounted for 71 percent
of the funding during the last 20 years. Therefore, not
only were PSERS and SERS short-funded, but they could not
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earn money investing IOUs. As a result, they lost the
earnings that would have been generated with proper
funding, which, when compounded over a period of more than
a decade, would have helped to sustain the pension systems.
Other factors cannot be overlooked, including the
investment losses of the 2008-09 Great Recession, as well
as the cost of the benefit increases in 2001. Both of
these contributed to the substantial swing in the fund from
greater than 100 percent funded to having more than $50
billion in pension debt. However, both of these factors
pale in comparison to the employer funding holiday, which
is the single largest factor contributing to the debt.
The same NASRA study I mentioned earlier clearly
demonstrates that other States with defined benefit pension
systems were able to survive the past decade without a
funding crisis similar in size to the one facing
Pennsylvania or New Jersey. These other States had one
thing in common: They made their required employer pension
payments.
For years PSEA advocated for legislation that
would have established a minimum floor for the pension
plans' employer contribution rates. Ultimately, these
efforts were not successful, due in some part to the fact
that the projected employer contribution rate spike
continued to decrease year after year. That was until the
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Great Recession when PSERS and SERS, just like every other
market investor, lost a substantial portion of their
portfolios. Once again, the projected contribution rate
spiked to near 30 percent.
In 2010, PSEA was approached by legislators from
both parties in the Senate and House, and we worked with
them to try to address the impending employer contribution
rate spike. Over a period of months, we focused our
attention on reducing the cost of benefits and establishing
a responsible payment plan.
Ultimately, these collective efforts resulted in
the passage of Act 120 of 2010. This legislation rolled
back benefits for new employees to a level lower than had
existed prior to the benefit increases changed by the
Legislature in 2001. Not only was the pension multiplier
reduced back to 2 percent, but in addition to other
changes, vesting went up to 10 years, and the retirement
age was increased, requiring State and school employees to
work years longer before they can collect a full retirement
benefit.
Most notably, Act 120 pension members share the
investment risks associated with pension funding with their
employers. If the pension systems suffer significant
investment losses, these employees are required to make
additional risk-sharing contributions to reduce the impact
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on employers and taxpayers.
It is important to note that while employee
contributions under Act 120 remained the same, the benefits
were reduced, which effectively equates to a rate increase
for those same employees. The result of these changes mean
that new employees now carry 70 percent of the cost their
own retirement benefits. This isn’t readily noticeable
yet, because employers pay a blended rate that includes
both pre- and post-Act 120 employees. However, if PSERS
were to break out the employer cost for pension benefits
earned by employees since Act 120, you would see that it is
now less than 3 percent of payroll.
PSEA is not aware of any lower employer normal
cost rate for new employees enrolling in any other State
pension plan in the Nation. If you know of one, please
bring it to our attention as we would be anxious to examine
it.
Ultimately, PSEA and other public employee unions
agreed to these changes because the Legislature was willing
to commit itself to responsibly step up funding to the
pension systems and eventually pay off the pension debt.
The current crisis, as you can see, although
referred to as a "pension crisis," was really not caused by
the pension benefits earned by school employees moving
forward. These costs are presently less than 1/3 of the
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total employer contribution rate as set for next year. As
Act 120 kicks in and new hires replace current members of
the system, the cost of pension benefits is projected to
eventually fall to less than 3 percent.
There has been considerable legislative debate
over benefits for new hires with various legislators
proposing to put new hires in a 401(k)-style, cash-balance
or hybrid plan. One might think with all the debate
focused on plan design that instituting such changes would
make a major difference and solve the current pension
funding crisis. The fact of the matter is that all of
these proposals fail to address the real problem, which is
the cost of paying off the pension debt that the
Legislature has run up like an unpaid credit card bill over
the last 15 years.
The fact of the matter is that even if we were to
ask new hires to pay 100 percent of the cost of their own
pension benefits moving forward and require no employer
contributions toward their benefits, the most the
Commonwealth and school districts combined would save is 3
percent of payroll in 30 years as these new hires gradually
replace all the current members of the pension system.
This would be only a drop in the bucket to solving the
current funding crisis that will see the employer
contribution rate paid by school districts peaking at over
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30 percent within the next several years. At the same
time, it would create significant problems with the
Commonwealth’s ability to attract and retain talented
individuals within the education system.
The problems we face today is not a pension
crisis, but rather a debt crisis. What options does the
Legislature have to deal with this debt?
Accelerated payments: There are legislators,
like Representative John McGinnis, who wants to pay down
the more than $50 billion in pension debt sooner than
required under Act 120. This would indeed save taxpayer
dollars in the long run, but it would also require
substantially higher pension payments today and over the
next decade.
Longer payoff period: There are other
legislators who follow the line of former Governor Corbett
and are willing to lower the Employer Contribution Rate
over the next several years in order to provide short-term
budget relief. This would defer payment and essentially
run up even higher charges on the credit card with future
taxpayers having to pay an even larger bill. This is
exactly how we got into this mess in the first place.
I congratulate Chairman Metcalfe and his
colleagues who stood firm against proposals like these when
advanced by the Governor of his own party. I mention this
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because critics of the position -
MAJORITY CHAIRMAN METCALFE: Mr. Crossey?
MR. CROSSEY: Yes.
MAJORITY CHAIRMAN METCALFE: You’re about 10
minutes into your 15 and you’re a little more than halfway
through your testimony so I don’t think we’ll be able to
wrap it all up in the time, but if -
MR. CROSSEY: I will be glad to stop. You have
my testimony in writing.
MAJORITY CHAIRMAN METCALFE: Yes, we’d love to
have a chance -
MR. CROSSEY: I would be glad to answer
questions.
MAJORITY CHAIRMAN METCALFE: — to interact. A
couple Members I’m sure have some questions. I mean you
can stop where you want to. I just wanted to let you
know -
MR. CROSSEY: I can stop anywhere and I’d be glad
to answer your questions.
MAJORITY CHAIRMAN METCALFE: A good point to stop
when you just congratulated me so I figured that was an
ideal spot.
MR. CROSSEY: Very well timed.
MAJORITY CHAIRMAN METCALFE: Thank you.
Representative Cohen, first question. Do you
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have a question for this testifier? You were on the list
for the last one?
MINORITY CHAIRMAN COHEN: Yes, Mr. Chairman.
Could you discuss how we compare with other
States with which you’re knowledgeable? Are other States
more reliable partners of the pension system in terms of
making annual contributions than Pennsylvania is?
MR. CROSSEY: As the NASRA study mentions, we are
second to the bottom in the Nation in terms of paying our
annual required contribution rate.
MINORITY CHAIRMAN COHEN: So we the Legislature
have caused this problem essentially?
MR. CROSSEY: It’s the largest cost -- 49 percent
of the pension debt is caused by unpaid employer
contributions.
MINORITY CHAIRMAN COHEN: Forty-nine percent of
the total pension debt?
MR. CROSSEY: Yes.
MINORITY CHAIRMAN COHEN: Thank you very much,
Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Cohen.
Representative Roae.
REPRESENTATIVE ROAE: Thank you, Mr. Chairman.
Prior to 2001, the multiplier was 2.0 for every
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year of service, so after a 35-year career, the pension for
a school employee or a State employee would be 70 percent
of the final average salary. That was changed with Act 9
in 2001 so now it's 87.5 percent of final average salary
after a 35-year career. It's a 2.5 percent multiplier now.
My question is what's the position of PSEA if the
multiplier was changed in 2001 for future years of service
for current employees at the time? If we wanted to, as
we're looking at pension reform, why couldn't we change the
multiplier for future years of service for current
employees in 2015?
MR. CROSSEY: There's a constitutional provision
stopping impairment of contract. The increase with Act 9 I
believe the cost of that was 27 percent of the pension debt
because it was applied retroactively instead of
prospectively, and at that time, had I been sitting here, I
would have said let's do it prospectively instead of
retroactively because that did contribute to the pension
debt. But at this point there's an impairment of contract
constitutional provision that prevents that from happening.
We did in Act 120 move that back for all new employees to
the 2 percent.
REPRESENTATIVE ROAE: Now, for further
clarification, when you impair a contract, that means
you're changing a contract. And again, 2001, the contract
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was changed to a 2.5 percent multiplier that used to be 2
percent. The Constitution doesn’t say you can impair a
contract one day but you can’t impair it the next day. I
mean what’s the basis -- how was it allowed to be changed
in 2001 if you can’t impair a contract because it changed
it from what it used to be.
MR. CROSSEY: The answer to that, sir, is that in
2001 I was in my classroom teaching, and when the
legislation was proposed, it required every single
participant in PSERS and SERS to affirmatively sign the
piece of paper saying that they agreed to the modification
in their contract. They agreed to change from a 2.0 to a
2.5 multiplier and they agreed to make an additional 1
percent, I believe it was, contribution into the PSERS plan
going forward. So you would have to go out and have every
single State and school district employee in the State of
Pennsylvania agree to that change in the benefit.
MR. CROSSEY: Like 200 or 300,000 people all
signed that paper?
MR. CROSSEY: Yes, sir. I believe because I know
I was a local president at the time, and I went from member
to member explaining the change to them, explaining what
Act 9 was and said to them do you want to make this change?
And I believe there was one person in my school district
that said, no, I don’t want to do that. But, yes, you
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would have to go to every single employee, which is what we
did in 2001.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Roae.
REPRESENTATIVE ROAE: Thank you.
MAJORITY CHAIRMAN METCALFE: Representative Sims
for our final question.
REPRESENTATIVE SIMS: Thank you, Mr. Chairman.
Mike, thank you for your testimony and I’ll be
very brief.
MAJORITY CHAIRMAN METCALFE: Yes, Representative.
REPRESENTATIVE SIMS: Can you speak to PSEA’s
position with respect to Governor Wolf’s proposal to remove
this funding from a line item in the General Fund to a
restricted receipts account?
MR. CROSSEY: We think that that’s a very good
idea. One, it would take the politics out of it. It would
take it out of the general appropriations. We are very
much in favor of looking at the proposals made by Governor
Wolf, whether it’s the bonding provision, using the
modernization of the wine and spirit shops to pay for those
bonds so that the taxpayers aren’t stuck with that cost. I
think that’s a very nice way to tie the budget together.
It’s a very comprehensive budget, and to remove it from the
general appropriations process and say this is our line
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item for mandatory cost that we have to pay, I think it’s a
good idea.
REPRESENTATIVE SIMS: Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Sims.
Thank you sir, for your testimony today. I
appreciate you -
MR. CROSSEY: Thank you for having us.
MAJORITY CHAIRMAN METCALFE: Thanks for being
with us.
Our next testifier is Mr. Rich Hiller. He’s the
Senior Vice President of Government Services with TIAA-
CREF. Thank you, sir, for coming today. You can begin
when you’re ready, sir.
MR. HILLER: Thank you, Chairman Metcalfe,
Chairman Cohen. I’m Rich Hiller with TIAA-CREF, Senior
Vice President. I’ve spent the better part of the last 30
years traveling around the country and meeting with people
in public higher education, as well as broader State
Government, on appropriate pension design.
A little history of our company might be
appropriate. We were founded by Andrew Carnegie in 1918.
Our actual roots with Carnegie go back to something called
the Carnegie Free Pension System, which goes back to 1905.
But the purpose of the founding of this system by Carnegie
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and it’s not true; you might hear this -- that I was his
first hire. I think I was number four or five -- but was
to recognize the employment patterns of professors in
higher education, and that was that they were encouraged to
move several times during a career. And the reality was
that as they moved, they didn’t have accrued benefits and
they basically worked until they died.
And Carnegie said something’s wrong with this.
We need to be able to recognize this important work and
have these people retire with dignity. And from that point
in 1918 the nonprofit TIAA Retirement System was founded in
order to recognize this mobility of employment. And a
number of things were done. First of all, what they
established without calling it at the time was a defined
contribution retirement system that had many defined-
benefit-like features, and I’ll explain what those are.
They also, as time went on, noticed a number of
other important things. One was that this system worked.
It provided guaranteed lifetime income to people in this
profession after a career in employment. The second thing
was that there were no unfunded liabilities. There could
not be by design. And third and very importantly, it
provided complete budgetary predictability for both the
employer and the employee. They knew exactly year-over-
year what this was going to cost. There were no wild
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swings in it so you could create a budget and manage that
budget effectively.
Interestingly, plans like this had existed in
Pennsylvania since the early 1970s, so better than 40
years. And those are with Penn State and with the
Pennsylvania System of Higher Education, government
employees, State employees in those systems. And those
plans have worked extremely well.
And one of the things that I’m going to try to do
for you is take this out of theory and projections and
actuarial calculations and talk to you about real-life
experience, how this has actually worked here in the State
for the last 40 plus years. Using data that exists, real
data from Penn State and from the PASSHE system and use
data such as salary-accumulated benefits and other things,
the expected income replacement ratios in retirement for
the folks in those systems today range from 80 to 98
percent of their final average salaries, the point being
that this is a system that works extremely well, and
through all that there have never been any unfunded
liabilities.
So for almost 100 years this TIAA-CREF system has
provided portability, created no unfunded liabilities, had
full budgetary predictability, and provided guaranteed
lifetime income.
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If you fast-forward to today, if you look at
Carnegie’s founding principle of looking to meet the
portability of that specific workforce, today, based on
Department of Labor Bureau of Labor Statistics numbers,
most recent numbers, the median tenure of an employee in
State Government nationally is a little over seven years.
Again, a little over seven years, State Government
employees nationally, meaning that everyone today is in a
portable profession.
And you can talk about the problems with one type
of plan or another, but the reality is that in a mobile
profession which, again, these days is everyone, this type
of defined contribution plan serves them better than any
other type of retirement plan as long as it’s designed
properly.
And let me talk for a minute about how you
properly design a defined contribution plan to be a
retirement plan. And you’ll notice one of the things I
haven’t said yet is 401(k)-like, and that’s because there’s
nothing 401(k)-like about this plan. 401(k) plans, the way
they’re typically -- and people understand 401(k) and I
understand that’s why they’re often referred to, but
typical corporate 401(k) plan is what I would call an
unmanaged plan. You have basically the whole universe of
investment options available, typically retail share
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classes of mutual funds, which are very expensive. You
don’t have communication education provided to employees,
and very importantly you don’t have any control of how
those assets are distributed in retirement. What we’re
talking about here is 180 degrees from that.
So three main principles for designing a defined
contribution retirement plan, one is the investment design.
You have pooled and professionally managed assets in that
retirement plan. For example, at TIAA-CREF we’re managing
close to a trillion dollars. Most of that is in retirement
benefits for higher education, government, and other
nonprofit organizations, and we operate as a nonprofit
ourselves.
Looking at the Pennsylvania public higher ed
systems, the total cost -- and this is administrative and
investment costs combined -- is well under 50 basis points
for the cost of that plan, about 45 basis points at last
check. That’s less than half of 1 percent. And that’s
because the pooled professionally managed assets, because
these are a limited number of funds that are provided
within a plan, and those would include 1) decision choices
like target date funds, which make it easy for the
participant to not have to be a sophisticated investor in
order to properly invest for their own retirement.
The second major principle, communication
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education and advice. What's important here is that you
have a comprehensive plan that addresses what a participant
in the plan has to do, how they have to do it, what their
choices and responsibilities are, and then you provide
specific investment advice. And the provider of that
advice becomes a fiduciary for the provision of that advice
and takes that fiduciary responsibility away from the
State.
And third and maybe most importantly is asset
distribution. And here is where I think there's often a
lot of confusion. A plan sponsor, in this case the State,
can set provisions for how a defined contribution plan
works. You can say that a certain amount of the
accumulated assets in the plan at retirement has to be
received as a guaranteed lifetime income, an annuity if you
will or other form of lifetime income. You as the plan
sponsor can make that a provision of the plan, and many do.
So, again, it's not like a 401(k) plan where what
happens at retirement is most people cash that money out
and put it in an IRA and do whatever with it. The plan
itself can provide lifetime income and you can control the
distribution methods within that plan, and we would
strongly recommend that you do that. So the distribution
of assets, including lifetime income, would be the third
main principle.
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In short, what you’re talking about here is a
defined contribution approach that looks a lot like defined
benefit in many ways in that it provides lifetime income,
pooled and professionally managed assets, certain other
features, and also that does not have any ability to create
unfunded liabilities, is low-cost, and is proven over a
century.
So what I would say that this is is a retirement
plan designed to replace income in retirement, not a
defined contribution plan whose sole purpose is to
accumulate assets.
Thank you, Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you. Thank
you, sir.
We have a number of Members from the previous
list.
Representative DeLissio, did you have any
questions for this testifier? You were on the list from
before.
REPRESENTATIVE DELISSIO: Thank you,
Mr. Chairman.
I’ve been a fan of TIAA-CREF for a long, long,
long time.
Mr. Hiller, I appreciate your presentation here
today, particularly those three points about design, cost,
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and guaranteed lifetime income because I think some of our
concerns are truly secure retirement and ensuring that.
And if our society has a literacy level that’s not where it
should be, their financial literacy level is even more
diminished or is below that.
How would this system aid our current situation
here in Pennsylvania? We have this unfunded liability. Is
this you’re just explaining your system? Is this something
we could use going forward? Is this something that can
somehow retroactively be worked out to remedy what is -
the taxpayers paid their tax dollars, the employees paid
their contributions, the employer -- in this case the State
-- was deficient in its responsibility. So we talk about
pension reform. Actually, I think it’s a pension solution.
And if this were to be identified as something as
a reasonable solution that met all of the goals
collectively, do you see a vehicle to have this help us
remedy and identify the solution we need now to sort of dig
ourselves out?
MR. HILLER: Well, what I’d say is, I mean the
unfunded liability exists and it has to be dealt with. I’d
use the analogy of the oil spill in the Gulf of Mexico a
few years ago. The first thing you’ve got to do is cap the
well. And that’s what this does. What this will ensure is
that going forward for the participants in this plan, new
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hires into the State, that you will not create any more
unfunded liabilities. And then you can deal with the
liability that you have.
So it doesn’t directly do anything to the
unfunded liability except ensure that you’re not going to
create new ones.
REPRESENTATIVE DELISSIO: A new one. So we still
are in need then of a more comprehensive solution that
deals with that very large unfunded liability, no magic
there unfortunately.
MR. HILLER: There is no silver bullet, no.
REPRESENTATIVE DELISSIO: No silver bullet.
Thank you, Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative DeLissio.
Representative Truitt.
REPRESENTATIVE TRUITT: Thank you, Mr. Chairman.
Thank you, Mr. Hiller.
So it sounds like you met my first criteria of
any reform plan and that is that we stop digging the hole
any deeper. I just want to understand how this is similar
-- I know you said it’s not a 401(k)-style plan but I’m
still trying to draw a picture in my head of how this
works. And one area I’m wondering about is if it’s pooled
assets, does that mean when you die, whatever money you
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didn’t use just stays in the plan or is there something
that goes to your heirs?
MR. HILLER: Well, it absolutely goes to your
heirs. When I say it’s pooled and professionally managed,
what we’re talking about here is large sums of money. In
the case of TIAA-CREF, like I said, we’re managing close to
a trillion dollars. And there are economies of scale.
That’s why we can do it for the low cost that we do, and
not even just our proprietary funds but funds from Vanguard
or American funds, whatever, can be part of that platform
but at a very low cost, at the lowest share classes
available because we’ve got that purchasing power if you
will. But it’s all segregated into individual accounts and
that individual has control of that money, as do their
beneficiaries.
REPRESENTATIVE TRUITT: Okay. Thank you. That’s
one of my second criteria. I like the idea of defined
contribution plans. If I put a million dollars into my
plan and I die three days after I retire, at least my
family will get some of the benefits of that.
MR. HILLER: Yes. There are many different ways
to receive that distribution that you would choose. I know
most all would provide for beneficiaries.
REPRESENTATIVE TRUITT: Thanks for helping me to
understand that.
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Thank you, Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Truitt.
Representative Daley.
REPRESENTATIVE DALEY: Thank you, Mr. Chairman.
Mr. Hiller, thank you for being here today.
Can you just talk a little bit about what the
employer contribution is typically?
MR. HILLER: A typical plan like this, when the
employer and the employee also participate in Social
Security, the total contribution rate will typically be 10
to 12 percent split either half-and-half or some other way
depending on the employer. But it’s usually total
contribution in that 10 to 12 percent range if you’re in
Social Security.
REPRESENTATIVE DALEY: So I didn’t understand
what you meant by split half-and-half.
MR. HILLER: Well, it could be 5 percent
employer, 5 percent employee.
REPRESENTATIVE DALEY: Oh, so the total employer
and employee contribution would be 10 to 12 percent?
MR. HILLER: yes.
REPRESENTATIVE DALEY: Okay. Okay. The current
contribution for a post-Act 120 employee in Pennsylvania is
in the range of 3 percent for the employer, so that’s less
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than what your typical contribution would be, right?
MR. HILLER: Yes. I mean that's into defined
benefit plan, right?
REPRESENTATIVE DALEY: Yes.
MR. HILLER: And so defined benefit plans,
there's two different parts of the cost. There's your
normal cost, which is future benefits, and then any
contributions towards your unfunded liability. I think the
total is considerably more than that 3 percent -
REPRESENTATIVE DALEY: Oh.
MR. HILLER: -- but this is what this would
always be, this total 10 to 12, and that's to produce an
income in retirement that's in that 75 to 80 percent income
replacement range.
REPRESENTATIVE DALEY: Right. Okay. Well, thank
you. But there is a difference. And your point is that in
the TIAA-CREF you would not be able to accumulate an
unfunded liability -
MR. HILLER: Right.
REPRESENTATIVE DALEY: -- because the employer
and the employee would always be putting their money into
the plan?
MR. HILLER: Well, and the State's obligation is
met when the contribution is made.
REPRESENTATIVE DALEY: Right. I agree. Thank
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you.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Daley.
Our last question, Representative Tobash.
REPRESENTATIVE TOBASH: Thank you.
Thank you, Mr. Hiller, and thank you,
Mr. Chairman, for allowing me to have a question and a
comment. I appreciate it.
And it really goes really in reference to a
previous Representative’s line of questioning, but goes
back to the previous testifier, the President of PSEA,
Mr. Crossey. He talked about his belief that the systemic,
most fundamental problem of the underfunding that we’ve got
right now is a result of the lack of the employer
contribution. That’s what I heard from the last testifier.
But in the plan that you’re talking about, because it’s a
defined contribution plan, you do not have an underfunding
issue, is that correct?
MR. HILLER: Yes, that’s correct.
REPRESENTATIVE TOBASH: So the Legislature’s
decisions that were made in the past to underfund
consciously this defined benefit program would not exist if
the State moved to a defined contribution program? Is that
your belief?
MR. HILLER: It would not create an unfunded
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liability.
REPRESENTATIVE TOBASH: Okay. Thank you very
much.
Thank you, Mr. Chair.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Tobash.
Thank you, sir, for joining us today. I
appreciate your expertise.
Our next testifier will be Mr. John Schu. He’s
the Senior Vice President with Branch Development, Lincoln
Financial. Ready when you’re ready, sir.
MR. SCHU: Good morning, Chairmen Metcalfe and
Cohen and Members of the House Standing Committee on State
Government. And thank you for allowing me to testify
today.
My name is John Schu and I’m the Senior Vice
President in Branch Development with Lincoln Investment
Planning. On the agenda it says Lincoln Financial. That’s
a different company, a common mistake. We don’t have a
sign on a football field. But we are located in the same
general vicinity outside of Philadelphia.
MAJORITY CHAIRMAN METCALFE: Lincoln Investment
Planning.
MR. SCHU: Lincoln Investment Planning.
MAJORITY CHAIRMAN METCALFE: Thank you.
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MR. SCHU: We’re a broker/dealer. We’re an
independent investment advisor. We’ve been in business for
nearly 50 years. It’s a family-owned business. Currently,
we have over 375 Pennsylvania public school districts that
we serve and we’re helping 31,000 employees managing about
$1.2 billion in assets. And we’re spread out over the
State with about 15 different offices throughout
Pennsylvania.
Lincoln Investment is also a member of the
National Tax-Deferred Accounts Association, which is the
Nation’s only independent nonprofit association dedicated
to 403(b) and 457 plan marketplace. NTSA was formed in
1989 as the National Tax Sheltered Annuities Association
and joined the American Retirement Association in 2009.
Today, it’s 3,300 plus members include practitioners,
agencies, corporate, and employer members, and their
mission is to provide high-quality education, technical
support, information resources, and networking forums for
professionals in the 403(b) and 457 marketplace.
Every Pennsylvania public school has a retirement
plan that works. This committee has the important task of
shaping policy and legislation that will impact every
citizen of the Commonwealth for decades to come. And I'm
certain that the fact that any decision is likely to
displease some, if not all, constituents only makes this a
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more difficult task.
What I’d like to offer the Committee is that
there are many businesses like Lincoln Investment Planning
throughout Pennsylvania, other firms like ours that work
directly with individuals in their local school districts.
Every Pennsylvania public school offers a defined
contribution plan outside of PSERS. Those plans are
specific types of defined contributions known through their
Internal Revenue Code sections, which is 403(b) or 457.
The plan type is not as important as the fact
that every public school employee already has access to a
defined contribution-type plan and approximately 1/3 of
public school employees are already actively using those
plans today.
The local plans really work the best. Despite
the success of the local plans, previous proposals to
replace the existing public pension system with either a
hybrid or straight defined contribution plans included
provisions that would all but wipe out these local plans.
Prior proposals sought to replace the existing structure
with a new State-run defined contribution plan. It’s sort
of a "destroy the good in want of the perfect.” The
problem is that the perfect on paper isn’t always
translated into reality. And here’s why that is certainly
true in this case.
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In 2007, the Iowa Legislature passed legislation
that led to the elimination of the local school district
defined contribution plans. Local plans were replaced by
State-sponsored programs run out of Des Moines. The theory
was that the department that supported the defined
contribution plan for the State employees in Des Moines was
able to offer the same service to public schools throughout
the State. The State would negotiate lower fees and
streamline administration, et cetera.
In 2009, the State launched its new retirement
program for public school employees and all but a few
districts signed on. The plan was perfect in the eyes of
the department running the program. The fees were indeed
low and everything, including investment education was run
through a central office in the capitol. The program was
heralded for all the investment expenses it would save
employees.
As it turned out, the State was right in that
many employees saved even more money in investment expenses
that were projected, but just not for the expected reasons.
What happened is that more than half of the participants
that had been contributing to their retirement plan stopped
making contributions into that plan. You see, they saved
fees because they stopped saving.
Iowa is now issuing an RFP to reintroduce local
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retirement plan provisions back into the public schools’
defined contribution plan system in hopes of getting back
to the savings rates where they were at in 2009.
Also, I’m here to tell you that local investment
professionals really matter. This example illustrates what
Lincoln knows from 50 years of experience. People need to
understand why it’s so important to save pre-tax for
retirement and where and how to invest for retirement. And
when given no choice, people choose not to invest. And the
Iowa State plan is just one example.
In Southern California, around half the workers
stopped contributing when their plan went to a single
provider. Colorado, similarly, they had 55 providers that
went down to one. They lost about 54 percent of their
participants. And in Pennsylvania there was a school
district that lost 40 percent participation when they did
the same thing.
The data shows that disrupting or trying to
replace the defined contribution plans that are already in
place in Pennsylvania public schools could likely cause
half of the current savers to drop out of the system. A
reform measure that results in less people saving for
retirement is simply a big step in the wrong direction.
And don’t forget, many of the firms and advisors that are
successful in helping public school employees in
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Pennsylvania are Pennsylvania businesses like Lincoln
Investment.
It’s the effort to replace the local support with
bungee-jumping enrollers from Charlotte or Texas that just
don’t work. It’s not likely that many of the people here
today started their retirement savings plan online or by
dialing an 800 number.
Defined contribution participants need
professional assistance. One of the policy issues
discussed when it comes to pension reform is how much of
the risk should be shifted from the State to the employee.
A hybrid plan that includes a defined benefit and defined
contribution plan has some level of risk-sharing and a
straight defined contribution plan shifts all of the risk
of investment to the employee.
Now, Lincoln doesn’t have a position on what if
any plan design changes should be made. What we do know is
that it’s not right to shift any portion of the investment
risk to the employees without making sure that they have
access to investment advice from professionals they choose
and trust.
You see, local investment professionals are not
only key to getting people to save more money, investment
professionals can also help participants manage their
investments. A study by CIRANO found an increase of 58
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percent more in assets when people got to work with an
advisor of their choice over a period of four to six years.
Working with an advisor for 7 to 14 years shows an increase
of 99 percent over those not using a financial advisor.
One example for consideration is the Federal
Thrift Savings Plan. The TSP is considered a model of low-
cost retirement plans, although part of the reason the
costs are low is because the plan is subsidized by tax
dollars. Local advisors are not incorporated into the plan
support. The result is that the investment with the most
plan assets, nearly 50 percent of the plan assets, is the
guaranteed account. That means that half of the retirement
savings in the plan have missed out on the growth in the
equity market and their entire plan is likely growing only
slightly faster than inflation. A similar result would not
deign well for the retirement preparedness of Pennsylvania
public school employees under a hybrid or defined
contribution plans.
Local plans and investment professionals are a
valuable resource. Local school districts' control of
403(b) and 457 plans work because employees are able to
work with the advisor of their choice. That's why I'm
testifying today in support of retaining school district
control over these plans and not sweeping 403(b) and 457
plans out of the mix when considering pension reform.
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Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you, sir.
Our first question will be from Representative
McCarter. Are you ready?
REPRESENTATIVE MCCARTER: Thank you,
Mr. Chairman.
Thank you very much for your testimony.
Wasn’t the original use of 401’s and 403(b)’s to
supplement the idea of defined benefit plans?
MR. SCHU: Yes. Back in 1958 because at that
time to entice people into public education where salaries
were lower than you could get in the private sector, 403(b)
was created to entice people to have a supplemental vehicle
to save.
REPRESENTATIVE MCCARTER: What percentage of
school employees currently, let’s say, who are in the PSERS
system participate in 403(b)’s at the present moment? Any
idea?
MR. SCHU: Yes, it’s about 30 to 40 percent.
REPRESENTATIVE MCCARTER: Thirty to forty
percent. So 60 percent or more do not participate?
MR. SCHU: Six out of ten don’t do it because
they’re uninformed.
REPRESENTATIVE MCCARTER: The previous testifier
suggested under a hybrid plan that replacement income could
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be had at 70 to 80 percent under this pooled managed system
taking place. Is your experience in terms of advising the
employees even that participate in 403(b)’s at this
particular point, do they have the expertise to be able to
do without a managed plan that would take place, a
completely managed plan to be able to make those
investments successfully to get a rate of return of
something that would be sustainable?
MR. SCHU: I’ll give you my own experience. I’ve
been in the industry 33 years working with individual
clients and also managing other people doing the same.
First off, someone has to motivate you to start to save.
And then the returns that you get, you have to understand
the risk you’re taking in order to get those returns. So
our job is to help them understand risk and invest
appropriately and to stay with the discipline over time.
REPRESENTATIVE MCCARTER: We heard from an
earlier testifier also that in the Virginia plan, when
given the option of whether to join or not to join into a
voluntary system, that that was somewhere in the
neighborhood of roughly 95 percent chose not to join.
MR. SCHU: That’s correct.
REPRESENTATIVE MCCARTER: And if that’s the case,
would we be putting at risk people’s futures by going into
a mandatory system like the one you described, not your own
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system but the one in which -- yours is a supplemental
system, but taking the place of the defined benefit plan,
wouldn’t we be putting large numbers of people at risk to
not be able to have that sustainable income when they do
retire?
MR. SCHU: The basic shift from a defined benefit
to a defined contribution puts the risk of the retirement
on the backs of the individual. They’re now in charge of
the most important pension plan in the world -- their own.
Each individual decides how to invest, both the amount and
where to put it, and they’re responsible for the income
that whatever they accumulate generates when they’re ready
to take distributions. So they’re in charge. And that’s
why I’m suggesting that participation goes down because
most are frozen. They’re not sure what to do. And advice
on an 800 number is not the same as me sitting at a kitchen
table with a husband and wife and talking about benefits
and retirement long-term and providing education over a
long period of time.
REPRESENTATIVE MCCARTER: So my last question
would be then a successful plan would need literally an
advisor for every individual, the roughly 250,000 people
covered by both the PSERS and the SERS system to be
effective?
MR. SCHU: A lot of people are able to do this on
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their own. They are comfortable dialing an 800 number and
saying put my money in these accounts and this is how much
I want to contribute. But in our experience about 8 out of
10 seek professional help.
REPRESENTATIVE MCCARTER: Thank you very much,
Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you.
For a single question, Representative Kampf.
REPRESENTATIVE KAMPF: I learned this in talking
to you but just so everyone’s clear, you operate in the
space above 7.5 percent of the employees’ salary because
the 7.5 percent is what they contribute in to PSERS, is
that right?
MR. SCHU: Yes, that’s correct, because all the
contributions into 403(b) plans are supplemental, meaning
voluntary payroll reduction contributions.
REPRESENTATIVE KAMPF: Okay. Thanks.
MAJORITY CHAIRMAN METCALFE: Thank you.
Representative Pashinski for a question.
REPRESENTATIVE PASHINSKI: Thank you,
Mr. Chairman, very kind.
And thank you very much, sir. I think you’ve
really hit on a very important point here, and it’s the
management of that particular investment that is key. And
I think all of us can admit we do not have the expertise
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that you would have or the other financial advisors that
we’ve heard from throughout this entire process.
The defined benefit that the State has provided
for the employees is a forced savings very similar to
Social Security, which is a forced savings, and the reason
it’s in place is because, as you’ve pointed out, most
people don’t take it upon themselves to do that. So this
is a way to preserve life in your senior years and provide
some quality of life.
The question that I wanted to ask you was
relative to the testimony that you heard today on the
positive effects of defined contribution, my question was
are you aware of anyone that was in a defined contribution
system, what their outlay, what their output, what their
retirement dollars were before the collapse of 2007/8,
during the collapse of 2007/8, and immediately after the
collapse of 2007/8, because I suspect that those people in
those plans lost money, and when they retired at that
point, they had severe loss of their income. Would that be
a correct thing to say?
MR. SCHU: Of course. Anyone in a defined
contribution plan is responsible for their own account,
where it’s invested. We have 350,000 clients at Lincoln
and I’d say every one of them participated in the down
markets both in 2000 with the tech bubble and in 2008 and
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in 2009. Our client retention was in the high 90 percent
because people stay with their discipline when they have
someone to hold their hand and ensure that their asset
allocation is appropriate so that they don’t buy in at the
top of the market and sell out at the bottom because that’s
the formula for failure. So that’s really the reason we
exist is to educate and help people achieve their
retirement goals.
REPRESENTATIVE PASHINSKI: And the key point is
that the people that retired during 2008 collapse and 2009
in the defined benefit plan really lost nothing. Their
monthly income was stabled?
MR. SCHU: A defined benefit plan is just that.
It says this is the benefit you’re going to get. The
funding is the other issue. Defined contribution, it’s all
based on your account balance.
REPRESENTATIVE PASHINSKI: Correct. I thank you.
Thank you, Mr. Chairman. Thank you, Mr. Schu.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Pashinski.
That’s all the time we have for this testifier.
Thank you, sir, for your testimony.
Our next testifier is Mr. Josh McGee, Ph.D., Vice
President of Public Accountability, Laura & John Arnold
Foundation; Senior Fellow of the Manhattan Institute. You
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can begin when you’re ready, sir. Thanks for being with
us.
DR. MCGEE: Thank you very much. Thank you,
Chairmen. Thank you, Members of the Committee. I
appreciate the invitation and I look forward to questions
after my testimony.
So this testimony is educational and nonpartisan
in nature. This should not be construed as support for
legislation or opposition to legislation.
Retirement benefits are an important part of
workers’ compensation packages. The Laura and John Arnold
Foundation is committed to ensuring that all workers have a
fair and secure retirement. We have worked on public
retirement systems. We have also supported secure choice
plans, so the expansion of retirement benefits to private
sector workers who don’t currently receive benefits through
their employer.
Across the Nation, cities and States are facing a
looming pension crisis that is threatening workers’
retirement security and critical investment in education
and public safety and other essential public services.
Governments have failed to responsibly manage their
retirement systems. Over the past several decades, and
this is true of Pennsylvania, policymakers have engaged in
a number of practices that threaten the sustainability of
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these systems. They have used accounting gimmicks, made
insufficient contributions, and provided retroactive,
unfunded benefit increases.
As a result, rising pension costs, particularly
that service costs on the pension debt, are now straining
State and local budgets. Services have been cut, workers
have been forced to endure benefit cuts, wage freezes, and
job reductions. I would put to you that when the State
runs up an unfunded liability, it is not taxpayers who bear
most of the burden; it is workers. They bear it through
wage freezes; they bear it through benefit cuts, both of
which have happened in the State of Pennsylvania.
There was discussion of the Act 120 new tier that
was put in place. It's 3 percent normal cost. That 3
percent normal cost is quite low. It is quite low because
the benefits are pretty terrible for most employees. The
cost is low because most employees never make it to
retirement under that system, and so we place most people
who enter public school employment -- teachers, your
principals -- on an insecure retirement savings path. They
turnover before they ever get there; they don't have enough
savings and were counting on their next job to make up the
difference. The 3 percent is low because it is a bad
pension plan.
People on both the right and the left have
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recognized the urgent need for reform and we are interested
in working with all who are pursuing reforms that are
comprehensive, lasting, and fair. By taking steps to
address the issue today, we can avoid a crisis tomorrow.
So I’ve got a couple of paragraphs here that I’m
going to skip over that say what pension reform should
accomplish. I’m not going to read those.
I think that there are two primary things that
you have to focus on. One is paying down the pension debt.
The State owes public employees a significant amount of
money and they have to pay that. You’re not going to be
able to avoid it. There is no silver bullet. You have to
pay for benefits that have been promised and the State
needs to adopt a reasonable, responsible funding plan on
that debt as soon as possible, and that plan should pay
down the pension debt as quickly as possible.
The second issue, the State should consider
putting in place a retirement plan that modernizes the
pension system for today’s workforce for a workforce that
is more mobile than it has been in the past and also
improves the political economy issues, the "holding
government accountable for making responsible contribution"
issue.
Right now, the current pension system is very
back-loaded. Like I said, it doesn’t put all workers on a
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path to retirement security. We should go to a system that
places all workers on the path to retirement security and
fully funds that benefit.
A variety of different plan designs can meet
those principles. There is no one-size-fits-all solution.
I would put to you, though, that cash balance and defined
contribution are the simplest solutions. They’re easier to
understand. You remove a lot of the assumptions from the
equation. It’s easier for employees to hold government
accountable for making required contribution to those
plans.
Unfortunately, reform opponents have often used
spurious technical and financial arguments to derail
potentially productive reform discussions, and I think that
has happened in this State. This is especially true when
the jurisdictions are considering moving employees to a
defined contribution plan. Policymakers in Pennsylvania
experienced this in 2013 when they were considering
legislation that would replace new State and public school
employees in a DC plan. You’re likely to hear those same
complaints this time around if you consider similar
proposals.
There are two primary complaints that are raised.
One is that somehow defined benefit plans are more
efficient than defined contribution plans, and the second
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is that there are transition costs. The primary proponent
of the cost-efficiency myth is the National Institute for
Retirement Security, a Washington-based nonprofit created
by public retirement plans and their interest groups. They
assert that final average salary DB plans have inherent
cost advantages and the conclusion reached in the NIRS
policy briefs are not just overstated but they are simply
incorrect. The NIRS results are not supported by the
empirical evidence. They are largely driven by the
authors’ very strong assumptions about annuitization in
particular and completely ignore pension debt as a
significant cost driver in final average salary DB systems.
What’s more, there are numerous examples of well-
designed, cost-efficient, public-sector DC plans that
deliver adequate secure benefits to plan members, including
plans sponsored in Oregon. Oregon is interesting because
the last presenter was talking about how often -- if left
up to the individual, people make bad choices. In Oregon
there is only one investment option and that’s the pension
plan. It’s managed by the plan.
As a government sponsor, you should realize that
you have complete control to design whatever system you put
into place. You can completely eliminate borrowing from
the system. You can require participation. You can
require a forced savings rate that would lead to an
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adequate retirement. You can manage the investments in a
pooled way at low cost. So Oregon, Colorado, Michigan,
Alaska, Ohio, the Federal Thrift Savings Plan, there are
more than 20 public-sector DC plans that exist in the world
today, and most of them operate at low cost and provide
adequate benefits.
Most of them offer annuities through their plan.
This is one of the big assumptions that NIRS and others
make on the efficiency argument is that there is no
annuitization. Most of these public-sector plans offer
annuitization, lifetime income at retirement.
The second false critique raised by reform
opponents is transition cost. It has been perpetuated by
the cottage industry of actuarial and investment
consultants who work for retirement plans. The costs that
would supposedly result from a transition to DC are a
product of incomplete cost comparisons based on poorly
justified methodological choices and assumptions. The two
transition cost claims that have been raised in
Pennsylvania are the State must pay off the pension debt on
an accelerated schedule if the existing plan is closed; and
two, winding down the system would require more
conservative liquid investments over time.
So I’m going to skip over the GASB paragraph. I
don’t think that right now it’s being advanced that GASB
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would require an acceleration. But it’s important to
realize that moving employees to a new system wouldn’t
really change anything for the current system, for the
legacy system. The pension debt is the sole responsibility
of the sponsoring government. Employees don’t pay down the
pension debt. That’s your responsibility. Just like any
other debt of the State, you have to have a payment plan,
you have to stick with it, and it has to be adequate.
It is up to the government to adhere to a prudent
payment policy for the pension debt. In the end, a State’s
choice of amortization schedules must match the duration of
the debt. And the way the State chooses to pay down the
debt service is a matter of public policy over which you
have complete control.
The previous analysis did not present an
empirical justification for accelerating the amortization
schedule. Regardless of any proposed change in the plan
design for new employees, it is imperative that
Pennsylvania adopt a responsible, sustainable pension debt
repayment schedule that is consistent with the
recommendations of the Society of Actuaries’ Blue Ribbon
Panel on Plan Funding. I would recommend that the Members
of the Committee look up the Society of Actuaries’ Blue
Ribbon Panel on Pension Plan Funding. I think that the
State of Pennsylvania would do well to adopt all of the
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recommendations of the panel.
On amortization, they recommended amortization
schedules that were closed and no longer than 15 or 20
years, so shorter than what Pennsylvania has today. If
Pennsylvania adopted such a recommendation, there would be
absolutely no need to accelerate the pension debt repayment
schedule because the duration of that debt would be shorter
than the duration of the liabilities.
The second transition cost claim, which I think
Milliman dealt with quite well, is that over time you have
to move it to a lower discount rate because you would have
to shift to more conservative, more liquid investments.
The key point here is that the actuaries, in
their previous analyses, simply assumed that they would
have to move it very aggressively to a lower discount rate,
in fact, moving to a discount rate that would result in the
plan investing essentially at the risk-free rate. This is
an assumption. It was not backed up with any empirical
evidence. There was no justification for that change. It
was purely an assumption. When Milliman looked at this,
the empirical results of their study showed that there was
no greater liquidity concern in the future over the
projection period than there was today.
MAJORITY CHAIRMAN METCALFE: If we could take a
few questions.
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DR. MCGEE: That would be great.
MAJORITY CHAIRMAN METCALFE: If you wouldn't
mind. I appreciate your testimony. And I know we've got
several Members -- Representative DeLissio.
Oh, excuse me. Representative Cohen first. He
was on the list from a previous testifier.
MINORITY CHAIRMAN COHEN: Thank you,
Mr. Chairman.
Has your positions and in the Arnold Foundation
changed over time? There seems to be a difference in
emphasis from what I've heard from the Arnold Foundation in
the past.
DR. MCGEE: No. Our position has not changed.
There are people who would like to define our position for
political purposes. Our position has been the same the
entire time. I'm interested in retirement security. I'm
interested in the well-funded plans. I'm interested in
retirement income.
MINORITY CHAIRMAN COHEN: Do you support greater
State funding for pension plans as it now stands?
DR. MCGEE: Without a doubt the State of
Pennsylvania needs to put more money into their pension
plan. They cannot ignore the unfunded liability, the money
that is owed to public workers through their pension plan.
MINORITY CHAIRMAN COHEN: What is your feeling
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about TIAA-CREF? Does TIAA-CREF meet your criteria?
DR. MCGEE: Well, you’re asking me about a
particular provider of a defined contribution plan. I
think that TIAA-CREF does a great job managing defined
contribution plans. They have done so for higher Ed for a
very long time. I think you had an earlier question about,
well, what in government have the opportunity just to
reduce contributions over time in defined contribution
plans? I think if you look at CREF plans, even through the
downturn, what we’ve seen is very high contribution rates
in government. The empirical results are contributions
remain flat because the sponsors of those plans have
consistent contributions and they can plan for those
contributions.
MINORITY CHAIRMAN COHEN: TIAA-CREF is broad
management by a single source and it’s not just individual
decision-making. Do you support single-source management?
DR. MCGEE: I’m not sure quite what you mean by
single-source but there are -
MINORITY CHAIRMAN COHEN: I mean -
DR. MCGEE: -- a limited number -
MINORITY CHAIRMAN COHEN: -- centrally directed,
centrally directed management.
DR. MCGEE: Yes. I do not recommend that members
of a plan have the authority to pick individual stocks or
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trade in Russian currencies in their primary retirement
plan. I think that a primary retirement plan should offer
members a limited set of well-managed, pooled,
professionally managed investment options that are good for
them and the defaults need to be set so they’re good and
that’s relatively easy to do.
MINORITY CHAIRMAN COHEN: And the Lincoln
Financial gentleman was worried about the loss of
supplemental retirement accounts. If people have two
defined contribution plans, his feeling is that a
significant number of them will give up the supplemental
retirement accounts and therefore lower the retirement
security. Do you have any evidence or feelings on that?
DR. MCGEE: Yes, I think it entirely depends on
the savings rate in the primary plan, the required savings
rate in the primary retirement plan. I think it has
nothing to do with private management. I think it has
nothing to do with things being provided locally. I think
it’s all about savings rate.
MINORITY CHAIRMAN COHEN: Thank you very much,
Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Cohen.
Representative Roae.
REPRESENTATIVE ROAE: Thank you, Mr. Chairman.
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All companies want to earn a profit. Companies
usually make decisions to do things in a more cost-
effective way, so over the years almost all the Fortune 500
companies have switched from a defined benefit plan to a
defined contribution plan for new employees. Most smaller
companies have done the same thing. Have you done any
research? Are you familiar with any Fortune 500 companies
that have switched back to defined benefit pension plan
because they found transition costs going to a defined
contribution plan were too much? Do you have any knowledge
of small businesses cancelling their 401(k) plan and moving
to a defined benefit pen plan?
DR. MCGEE: I have no knowledge of a private
sector employer that has moved from defined contribution to
defined benefit and I also have no knowledge of any
transition costs that have been experienced in the public
or the private sector.
REPRESENTATIVE ROAE: I’ve tried to research and
I haven’t been able to find anything. I just wondered if
you have because it seems like if it’s expensive to switch
from a defined benefit to defined contribution plan, it
seems like companies would be scrambling to go back to the
good old days when they had a lower-cost defined benefit
plan. Well, from what I understand and I guess from you’ve
seen that that’s not the case, so I think that’s almost
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proof that there is no such thing as a high transition
cost. Otherwise, companies wouldn’t continue to get rid of
defined benefit plans, and companies that already did,
they’d be moving back to that plan.
DR. MCGEE: Yes, I think that’s accurate. I
think to put a finer point on this, I think that one of the
big pushes for the private sector moving to defined
contribution plans is similar bad behavior that’s happened
in the public sector. Through the ’80s and ’90s, corporate
raiders viewed overfunding as an asset of the company.
They took those assets and used them in merger and
acquisitions. Companies underfunded benefits and there was
a trend of cut, cut, cut, eliminate.
And right now, one of the biggest problems that
we face in the private sector is not that there are
401(k)’s. That is not the biggest problem. One of the
biggest problems is people are under-saving. Contribution
rates just aren’t high enough. That’s going to be a
problem in your current Act 120 plan. Contribution rates,
3 percent is not enough to save for retirement. There is
no magic formula, no magic black box that you could put 3
percent in and expect a reasonable retirement out.
MAJORITY CHAIRMAN METCALFE: Representative Roae,
thank you for your couple of questions. We have one last
question. Representative DeLissio will be our final
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question.
REPRESENTATIVE DELISSIO: Thank you,
Mr. Chairman.
Dr. McGee, you talked about the ability to design
a plan. We’ve heard some discussion about avoiding an
unfunded liability as a result of defined contribution
because of almost sort of a forced contribution. Could
that same design feature not be built into a designed
benefit plan?
DR. MCGEE: So ask your question again real
quick, please.
REPRESENTATIVE DELISSIO: Could the plan be
designed to ensure that under a defined benefit plan that
that contribution also had to be made? I heard a question
about defined contribution ensures to this high degree that
the employer can’t take a pass when in fact those
contributions can be deferred and delayed. So they can be
deferred and delayed; it may not be able to build up to the
same unfunded liability as we have currently but I just
want to understand whether a defined pension plan, since we
are able to design it, we could design in a feature that
ensures that that contribution occurs.
DR. MCGEE: I think because these are State-
sponsored plans that it’s very hard for you to bind the
hands of future legislatures. So while you can decide to
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make appropriate payments, it is very difficult for you to
require future legislatures to make appropriate payments.
And that's what we've seen in Pennsylvania. There is a
pushing out of this cliff payment over time with the
assumption by past legislatures that future legislatures
would deal with it -
REPRESENTATIVE DELISSIO: So how does it —
DR. MCGEE: -- and it will be better in the
future. I think you can have a defined benefit plan -- a
cash balance is a defined benefit plan -- that can be
managed well. I think a final average salary plan is just
not very good for workers. It's back-loaded. I think it
is complex, hard to manage. I think we've seen that play
out in government-sponsored plans and in the private
sector. And I think the consequences, we've talked about
this being a defined benefit that workers get no matter
what. I think that misrepresents the point.
I think if you look at the trajectory in
Pennsylvania, we've seen one of the defined benefit plan
benefits being enriched and then slashed. Current workers
coming on the job today have pretty terrible benefits.
They currently have terrible benefits because the State did
not pay for the benefit increases that they made in the
past.
So there is not this stability in defined benefit
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plans that doesn’t exist in the defined contribution world.
You can design any plan to meet retirement needs. My case
is that defined contribution and cash balance are simpler
and easier to manage.
REPRESENTATIVE DELISSIO: Thank you,
Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative DeLissio.
Thank you, Dr. McGee, for your testimony today.
DR. MCGEE: Thank you.
MAJORITY CHAIRMAN METCALFE: We appreciate it.
Our next testifier is Mr. Joe Nichols, Senior
Director, FTI Consulting. You can begin when you’re ready,
sir.
MR. NICHOLS: Thank you. Good morning, Chairs
Metcalfe and Cohen and Members of the House Standing
Committee on State Government. Thank you for taking the
time for my testimony.
My name is Joe Nichols. I’m a pension actuary
with FTI Consulting. FTI Consulting provides independent,
innovative advice to governments and businesses globally.
I’m also President-elect of the American Society of Pension
Professionals and Actuaries, a sister organization with
NTSA, part of the American Retirement Association.
Opinions stated in my testimony today are mine
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and not those of FTI Consulting or ASPPA.
I wanted to be a pension actuary at 16. I got my
actuarial degree in 1988 and started consulting about
pensions to government entities in 1990. My public pension
experience covers a wide range of plans, including small
municipalities up to State funds and through many economic
cycles.
In all my experiences, there’s one common element
that separates sustainable pension plans from those with
eventual cash flow issues: consistent funding. There are
other factors that help plans succeed: good governance,
affordable benefits, and efficient expenses, to name a few.
However, rarely do any of these other factors solely affect
the ability of the plan sponsor to pay promised benefits
like consistent funding.
There have been multiple studies regarding
Pennsylvania retirement systems over the last decade. All
of these studies were precipitated by funding issues.
However, instead of squarely tackling the funding issues,
plan design changes were wrapped into projections that
complicated the discussions and established funding collars
that pushed contributions down the road again and again.
To make matters even worse, the lower funding
plan was not followed. In fact, over the last 12 years,
Pennsylvania has only contributed 41 percent of the
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suggested actuarial contribution amounts. Only New Jersey
has contributed a lesser percentage than Pennsylvania over
the last decade.
Pennsylvania’s dismal funding history is nothing
new to this committee. I repeat it here because funding is
the topic of my testimony, not plan design, not budget, not
even expenses; it is funding. Lack of adequate funding is
the single largest contributor to the growth of the
unfunded liabilities. The growth in unfunded liabilities
leads to credit downgrades, which leads to increased cost
of borrowing.
I’ve heard from people close to Pennsylvania
policy circles that virtually everyone agrees that benefits
accrued to date by participants in SERS and PSERS cannot be
decreased. Since the current underfunding is based on
benefits accrued to date, the focus of current pension
reform must be primarily on funding.
The other issues of pension reform -- most
notably, how future benefits are to be earned, mortality
risk, investment risk -- should be separate issues and not
used as leverage that keeps "kicking the can down the
road.”
In the last published valuations SERS and PSERS
have total unfunded liabilities of approximately $53
billion. If amortized over 30 years as a level dollar
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amount, the annual payment would be just over $4 billion.
Any contribution short of this amount is continuing the
practice of passing the responsibility on.
Many will argue that using a level dollar
approach puts too much pressure on the current taxpayers.
However, since over $15 billion in employer contributions
have been skipped in the last few years, the sooner the
unfunded liabilities are paid off, the less that gets
unfairly pushed to future generations.
So my suggestion is to first tackle how to pay
for the benefits earned to date. After that is tackled,
then worry about the more polarizing issues that affect
benefits to be earned in the future, like whether the
system’s future structure should be DB, DC, or a hybrid.
So far in this year’s debate a couple of
suggestions have surfaced about how to fix the funding
issue: pension obligation bonds and a move to passive
investing. I’m neither a bond nor an investment expert but
I’ve spoken to both so I have an opinion on these issues.
In regards to the pension obligation bonds, the current
interest rate environment is definitely advantageous to the
borrower.
However, there is concern regarding timing and
how any potential shift in the current environment might
eliminate the expected savings. Even if a POB transaction
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were to go exactly as planned, and assuming a 4.5 percent
arbitrage in interest rates, the first year savings would
generate approximately $135 million per year before any
transaction fees. Also note that many bond rating experts
tend to be agnostic in regards to using POBs to fund
pension plans, meaning it typically has no effect on the
plan sponsor’s credit rating.
The second suggestion is to switch investments in
both plans from using active to passive management. There
are very fervent arguments on both sides of this
discussion, so any potential net expense savings are less
determinable versus the POB discussion. However, those
that favor passive investment management do admit that it’s
not prudent to invest in just one asset class or style.
Asset allocation is still critically important.
As a result, the savings cannot be determined by just
comparing fees within one asset class or style. Fees in
passive funds also vary for the different asset classes.
Even if the purchase of POBs and a move to
passive investing worked exactly as planned, the amount of
additional funds only make up 10 percent of the
contributions necessary to fully fund the unfunded
liability. In an order of magnitude, the impact of funding
far exceeds the impact of the next four items combined:
future benefit accruals, investment returns and expenses,
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cost savings, and plan design for future employees.
In closing, I would like to thank the Committee
again for listening to my testimony. Actuaries are many
times blamed for presenting complex, hard-to-understand
solutions. Today, mine is easy. With the assumption that
accrued benefits cannot be changed, there is no amount of
plan design -- whether DB, DC, or hybrid -- that will lower
the contributions needed to pay off the unfunded
liabilities. A funding policy that stops pushing
responsibility to future taxpayers is the only fiscally
responsible solution. All other pension reform discussions
are just noise until the funding of the benefits already
earned are set and followed.
Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you, sir.
Members? Representative Daley.
REPRESENTATIVE DALEY: Thank you, Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you. I should
use a first name.
REPRESENTATIVE DALEY: Pardon me?
MAJORITY CHAIRMAN METCALFE: Maybe I should just
use the first name.
REPRESENTATIVE DALEY: You know what? I just
didn't hear you. You know what? My ears could be clogged
up. I have a horrible cold, which --
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MAJORITY CHAIRMAN METCALFE: I know. I heard you
yesterday.
REPRESENTATIVE DALEY: So thank you.
Mr. Nichols, thank you for your testimony.
The way I’m understanding what you’re saying is
something I’ve been saying as I learn more about the
pension problem. I’m in my second term as a State Rep and
so and I’m on the Appropriations Committee so we’ve had
lots and lots of discussions about this issue. But we look
through a chart of PSERS and why they have debt and benefit
enhancements account for 25 percent of it, employer funding
deferrals, 45 percent, so that’s 70 percent which are
policy decisions made by the General Assembly. And then 29
percent is investment underperformance, which some of that
could be accounted to the fact that there were employer
funding deferrals I would think. So we say 70 percent is
policy.
And what I’m hearing you saying is that the most
important thing that we need to do is to continue to pay
down the unfunded liability and that any discussion about
what kind of pension plan we should have in the future we
can’t really have it until we actually resolve the issue of
the unfunded liability. Do you agree with what I’m saying?
MR. NICHOLS: I agree that the funding of the
unfunded should be the first priority and separate, and a
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separate discussion needs to be made about what you want to
do with future contributions.
REPRESENTATIVE DALEY: Exactly, because every
time we start to talk about the two issues together, then
it’s what we should or shouldn’t do, but really the main
point is that we need to pay our debt. It’s like if you
had a credit card and you weren’t making a payment on it,
at some point you have to face the fact that you’ve got a
debt and you have to make your payment. And you may decide
that you want to do this or you want to do that in the
meantime, but as long as you have the credit card debt or
the pension debt, you’re kind of precluded from having a
really solid conversation about -- like you can’t mix the
two things together.
MR. NICHOLS: Right. I mean it would be like a
family having the credit card debt and having to pay it and
arguing whether they need a 36-inch TV or a 72-inch TV.
REPRESENTATIVE DALEY: Exactly.
MR. NICHOLS: And by that argument happening, not
paying off the credit card.
REPRESENTATIVE DALEY: Exactly. Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Daley.
Representative Hill.
REPRESENTATIVE HILL: Thank you, Mr. Chairman.
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Mr. Nichols, thank you for being here today, and
I commend you for recognizing that you wanted to be an
actuary at 16. That’s really quite something.
You made a statement, and to sort of follow up on
what Representative Daley was saying that we need to stop
pushing this responsibility down the road to future
taxpayers. I grew up near the water, spent a lot of time
on boats and it seems to me that if you take your boat out
and it starts taking on water, the first thing you need to
do is plug the boat, right? So approximately 30 percent of
existing school district workforce, educators, employees
are in that tail end of the Baby Boomer Generation and
they’re going to retire, so school districts will hire more
people. And those people, if we don’t put the plug in the
boat, are going to be put into this system that is
underfunded and failing.
So are you certain that what we really need to do
is just address that unfunded liability or do we need to
take a two-prong approach? Address the unfunded liability,
put the plug in the boat, and make that transition to a
system that is not failing?
MR. NICHOLS: We could have three days of
hearings on DB versus DC and you hear a lot of anecdotal
evidence on both sides. There’s an action and reaction for
every single argument. And what I’m saying is we need to
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separate them. I’m not saying that you shouldn’t decide
where you want to be going forward. All I’m saying is that
you have to pay off that unfunded.
Part of doing it together is the reason we have
a two-tiered approach and that the new employees are paying
more for the unfunded than the current employees because
that was a way to pay for the unfunded was to lower the
benefits and increase employee contributions. That’s an
example of why it shouldn’t be done together.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Hill.
Representative Cohen.
MINORITY CHAIRMAN COHEN: Thank you,
Mr. Chairman.
Mr. Nichols, I deeply appreciate your very clear
statement that the important thing is to pay off the
unfunded liability. I think other people agree with that
but you’ve been the most clear of all the witnesses we’ve
had and one of the clearest spokespersons generally on the
subject. Do you have any suggestions for us as to how we
pay off the unfunded liability?
MR. NICHOLS: No, fortunately that is not an
actuarial opinion.
MINORITY CHAIRMAN COHEN: Okay.
MAJORITY CHAIRMAN METCALFE: Not even starting at
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16.
MINORITY CHAIRMAN COHEN: The actuarial
profession I think is limited -
MR. NICHOLS: Yes.
MINORITY CHAIRMAN COHEN: -- including that
within its discipline.
MR. NICHOLS: We may have some economists on
staff that might have some opinions on that but not the
actuaries.
MINORITY CHAIRMAN COHEN: I would like to know
what other States have done. How many States have taken
your general formula, the first thing we have to focus on
is paying off the unfunded liability? How many States have
focused on that as opposed to focusing on future benefits?
MR. NICHOLS: Well, I guess in a roundabout way
the ones that have approached it that way are the ones that
didn’t change their benefits and just assume the higher
contribution rate. Beyond that, the ones that have made
changes, I think the majority of them, if not all of them,
have gone the approach of the two-tiered benefits.
MINORITY CHAIRMAN COHEN: And the two-tiered
benefit system is inadequate to pay off the debt, and
Mr. Arnold suggested earlier that it’s also inadequate for
retirement security. Do you agree with Mr. Arnold that the
second tier is inadequate for retirement security?
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MR. NICHOLS: Well, I agree that it’s a lower
benefit. I think that’s a different discussion as to
whether it’s inadequate. I would like to clear up that the
employees are getting more than a 3 percent benefit.
That’s what they’re getting from the employer. I think
they’re getting about a 10 percent when put with employee
contributions.
MINORITY CHAIRMAN COHEN: Yes, I agree with you.
MAJORITY CHAIRMAN METCALFE: Okay. Thank you.
MINORITY CHAIRMAN COHEN: I think that was a
misstatement.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Cohen.
I think you were referencing Dr. McGee from the
Laura & John Arnold Foundation was who he was referencing
previously just to -
MINORITY CHAIRMAN COHEN: I made a misstatement
referring to -
MAJORITY CHAIRMAN METCALFE: -- correct the
record -
MINORITY CHAIRMAN COHEN: — Mr. Arnold, yes.
MAJORITY CHAIRMAN METCALFE: -- on whose
testimony that was we were talking about.
MINORITY CHAIRMAN COHEN: That’s correct.
MAJORITY CHAIRMAN METCALFE: Thank you, sir, for
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your testimony today. We appreciate it being very clear.
MR. NICHOLS: Okay. Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you.
Our final testifier will be Gary A. Wagner,
Ph.D., Professor of Economics from Old Dominion University.
You can begin when ready, Doctor.
DR. WAGNER: Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you for
joining us today.
DR. WAGNER: Yes, thank you very much. I
appreciate it.
Chairman Metcalfe, Representative Cohen,
distinguished Members of the Committee, thank you for
inviting me to testify on pension reform in the
Commonwealth.
As you heard, I'm a Professor of Economics at Old
Dominion University. A lot of my research today, my
testimony will be based on a forthcoming paper that will be
published by the Mercatus Center at George Mason
University. It's also coauthored with Dr. Erick Elder, a
Professor of Economics at the University of Arkansas.
Pension reform is an extremely important topic
for the fiscal health of the Commonwealth and for the more
than 700,000 active and retired members of PSERS and SERS.
I certainly commend you for your willingness to address
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these challenges.
My objective this morning is to try to assist you
in understanding the tradeoffs that are involved in any
pension reform decision so that you can make the best
choice for the Commonwealth in view of the fact that the
current unfunded liability in PSERS and SERS is a
staggering $135,000 per active member. That gap needs to
be closed. But the issue of the benefits for future
employees and the treatment of future taxpayers need to be
addressed as well.
The most common metric for gauging the health of
a pension plan is the actuarial funding ratio or sometimes
called funded ratio. An easy way to think about this
funding ratio is the ratio of 100 percent means that if the
actuarial assumptions turn out to be true, then the plan
could play all of the promised benefits and would have zero
dollars remaining at the end of your time horizon.
The current funding situation for PSERS and SERS
is at a near-critical stage. Based on each plan’s current
funding ratio and the distribution of investment returns,
the plans are only guaranteed with 100 percent certainty to
be able to pay benefits that have already been earned, not
new benefits, benefits that have already been earned for
only the next five years. By 2030, which is just 15 years
from now, the probability that each plan will be able to
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meet their promised obligations, again, the benefits that
have already been earned, drops to 31 percent in PSERS and
just 16 percent in SERS.
So the most important point that I can make to
you today is that while a pension’s funding ratio gives you
some information about the solvency of a plan, it does not
measure what is really the most important piece of
information, which is what is the probability the plan will
be able to make its promised benefit payments without
additional contributions going forward?
Even if we were to assume that PSERS and SERS
were 100 percent funded today in an actuarial sense,
there’s only a 42 percent probability the funds would be
able to make their promised benefit payments going forward
over the next 65 years without requiring some additional
contribution. The main reason is the volatility in
investment returns, what’s sometimes called "investment
risk” and the effect it has on the asset side of the
ledger.
So just as a real simple example, from the 2013
SERS CAFR, the plan had investment returns of 24.3 percent
in 2003, losses of 28.7 percent in 2008. More recently,
the returns were 2.7 percent in 2011 and 13.6 percent in
2013. So in an 11-year period you can see the volatility
in asset returns was more than 50 percent. This is pretty
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significant because 70 percent of the plan’s funding comes
from investment returns.
So given that the pension plans are forward-
looking and that investment returns are uncertain, the
really correct way to look at the funding issue is in a
probabilistic sense. Standard pension accounting, GASB
rules, and actuaries do not take into account this
investment risk when looking at pension funding.
Once you take that investment risk into account,
the funding calculus changes quite dramatically, and
unfortunately, not in the Commonwealth’s favor. For
example, if the Commonwealth wanted to be 90 percent
certain that you could make your promised benefit payments
going forward, PSERS and SERS would need actuarial funding
ratios of 180 percent, roughly three times where they are
now. In dollar terms, that amounts to having $150 billion
additional today in order to make the benefit payments that
have already been earned going forward. If you simply
wanted a coin flip, a 50/50 chance to be certain that you
can make your already-accrued benefit payments going
forward, the Commonwealth needs $65 billion additional
today in order to do that.
So of course if the investment returns were to be
significantly higher than normal for a significant period
of time, this could reduce the size of the funding
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shortfall. However, based on historical returns, PSERS and
SERS are imposing a considerable risk on future taxpayers
and future employees, sometimes referred to as a contingent
liability, because of the uncertainty in investment returns
over the long-term.
It may be natural to simply think you could shift
to a safer investment portfolio to deal with some of this.
The problem with such an approach is that moving to a safer
investment portfolio would raise the likelihood that you
could make your promised payments in the near-term and it
raises the likelihood that you would fail in the long-term
because you’re assets are not growing at the same rate as
your liabilities.
So unfortunately, there is no way for the
Commonwealth to avoid closing the funding gap on the
benefits that have already been earned. The only true
issues are when do you close the gap and how do you close
the gap? Do you address this by increasing employer
contributions, the Commonwealth contributions, or some
combination of approaches?
While the current funding shortfall cannot be
avoided, even if the defined benefit plans are closed, that
shortfall cannot be avoided. The Commonwealth can
eliminate the possibility of this investment risk going
forward protecting future taxpayers and future employees by
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moving employees into a defined contribution plan.
Another considerable advantage to a defined
contribution plan is that short-term and long-term
employees in those plans are treated much more equitably
than in the current defined benefit plans.
And finally, I would encourage you to keep in
mind the broader picture when considering reforms. The
Commonwealth’s bond ratings have been lowered twice by
Moody’s and twice by Fitch since 2012 with pension funding
cited as a contributing factor. Given the volume of debt
that the Commonwealth issues and has outstanding, this is
not a trivial matter.
The Commonwealth currently has roughly $47
billion in outstanding debt. If one assumes that the
borrowing cost for the Commonwealth rise by 25 basis
points, so a quarter of a percentage point due to the
credit rating downgrades, that’s 1/3 of the estimated
increase that Illinois has already experienced. This will
cost the Commonwealth an additional $120 million per year
in extra interest costs alone once all this debt is rolled
over.
Thank you for your time. I hope you find my
testimony to be helpful in deliberations and I’d be happy
to try to answer any questions you have.
MAJORITY CHAIRMAN METCALFE: Thank you,
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Dr. Wagner.
Questions from Members?
Representative Roae.
REPRESENTATIVE ROAE: Thank you, Mr. Chairman.
Thank you for your testimony. My question is our
multiplier in the Pennsylvania PSERS and SERS plans is 2.5
percent for most employees. Is that normal or is that high
or is that low compared to what the multiplier is for
future service for a lot of different plans that you’ve
cited, that you’ve seen?
And just for the sake of argument, if we lowered
the multiplier to 2 percent for future years of service for
current employees rather than the current 2.5 percent that
got changed in 2001, what kind of impact would that make on
our unfunded liability?
DR. WAGNER: Sure. In terms of the funding, that
multiplier of 2 to 2.5 percent is normal for most of the
plans. I’m not up to date on what every particular State
has done, especially in the last couple years. One of the
things I can tell you, if you were to lower that multiplier
to 2 percent or, say, increase the State’s contributions,
certainly those additional contributions and a lower
multiplier could help improve the funding ratio.
But the broader point I’m trying to make to you
today is that even if you had an actuarial funding ratio of
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100 percent, there's still roughly a 50/50 chance that
you're going to need additional contributions down the road
because of investment returns and the volatility that they
have. So a lot of the fixes and the reforms that you hear
being talked about are really changes that, yes, on the
surface can improve the funding ratio but they're never
going to eliminate that investment risk from future
taxpayers and future workers. You're simply contributing
to a problem that's just going to grow over time.
REPRESENTATIVE ROAE: All right. Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Roae.
Representative Daley.
REPRESENTATIVE DALEY: Thanks, Mr. Chairman.
So I just want to go to the bond ratings that
were lowered twice by the rating agencies. It's my
understanding that the bond rating was lowered because
Pennsylvania was not making its payments to the pension
fund, which were policy decisions, and not because of any
inherent issue in the pension fund. And I think that
that's an important difference.
DR. WAGNER: Yes, I think that's correct. My
reading of Moody's and Fitch's statements suggest that's
also the case. I mean there were some policy decisions
made -- Act 9, Act 40 -- which really contributed to some
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of the underfunding that you’re experiencing now.
But the point that I was trying to make with the
bond ratings is that that’s a cost that people often don’t
consider in that if you don’t somehow shore up the pension
funding, this is an additional $120 million that the
Commonwealth will incur every year for essentially poor
fiscal management.
REPRESENTATIVE DALEY: Well, absolutely. And I’m
in favor of shoring it up and reducing the unfunded
liability.
Thank you.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Daley.
Representative Truitt.
REPRESENTATIVE TRUITT: Thank you, Mr. Chairman,
and thank you, Professor Wagner, for your testimony.
I want to ask a question about how fast we should
be paying this back. I’ve looked at this from the
perspective that the folks who benefitted by underfunding
the system were the citizens of this Commonwealth over the
last 10, maybe 12 years. We benefitted in other areas by
putting less money into the pension fund, so I see it as a
moral imperative if you will to pay it back as rapidly as
possible so that the same people who benefitted from the
underfunding are the ones who pay it back.
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What do you think is a reasonable amortization
period for repaying this debt and what’s the basis for
that?
DR. WAGNER: Well, let me rephrase your question
a little bit if I can. I think what you’re asking or at
least what I’m interpreting is what’s the greatest
likelihood of being able to make these payments going
forward and keep the promises that we’ve already made? So
I think it’s a little bit different. One of the first
things you want to make sure that you’re doing is making
the annual required contributions so that you’re at least
funding the benefits that have already been earned 100
percent.
So if the benefits that have been earned this
year, for example, if you underfund those, you are simply
compounding the problem. You’re making the probability
that you’re going to be able to make these payments going
forward drop even faster. So as a first step you need to
make sure that you are funding the benefits that have
already been earned, meeting that required contribution.
Once you meet that required contribution, then you can talk
about how to shore up and pay some of these unfunded
liabilities.
I think the real challenge for you is you should
do so as quickly as possible. It’s certainly going to help
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the State’s bond rating. But I think, again, getting the
funding ratio to 100 percent doesn’t solve any long-term
problem in that you’re still likely to require additional
contributions at some point down the road.
REPRESENTATIVE TRUITT: Very good. Thank you.
Thank you, Mr. Chairman.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Truitt.
Any other Members?
Representative DeLissio.
REPRESENTATIVE DELISSIO: Dr. Wagner, I just have
a question when you talk about the long-term. Your numbers
here reflect a period of roughly 10 or 12 years. These
funds were started at the beginning of the last century.
Government is I think reasonably expected to be in
existence in perpetuity. So when you talk about that
concern about the long-term, have you looked at those rates
of return that go back to the beginning and take that truly
long view. Ten years is not a long view in the history of
an entity such as a government that has a couple of hundred
years under its belt.
DR. WAGNER: Sure. I haven’t looked at funding
ratios that long in the past. I know the actuarial funding
ratio that you have today, the way that those numbers are
calculated, they look at the assets you have on hand today
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and the benefits that have already been earned on hand. So
in other words, the view that you’re just describing is not
how actuaries even look at the pensions.
So the way that we were looking at the pensions
is similar to the actuaries. Based on the assets you have
today and the benefits that have already been earned,
what’s the likelihood that these assets can make those
payments going forward?
Now, what you’re describing is a situation I
think where you’re essentially taking dollars from current
employees to pay out future retirees. So you’re funding a
system on the backs of current workers. In other words,
it’s a rotating scheme where the retirement benefits today
are being contributed by the workers today because you
don’t have sufficient assets on hand to pay out the
benefits that you promised.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative DeLissio.
Representative Kampf.
REPRESENTATIVE KAMPF: Thank you, Mr. Chairman.
I did hear a comment earlier, which was we really
need to focus on paying the unfunded liability, which I
agree with, but it was characterized as really to have to
pay down the credit card. It seems to me that this family
who’s paying down their credit card could also at the same
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time, simultaneously, make a decision to cut up all the
rest of the credit cards that are in the drawer or coming
in the mailbox.
Dr. Wagner, I see there’s a paper from Dr. Biggs
in here. He was not able to make it, as I understand it.
Could you just briefly tell the Committee what that is?
DR. WAGNER: Sure. Dr. Biggs’ work addressed the
issue of transition costs in closing a defined benefit plan
and moving to a defined contribution plan. His research
shows that at no point in time do the liabilities increase
if you close a defined benefit plan because essentially
what happens is you are eliminating these highest long-term
liabilities that come from the youngest workers. And so
certainly the duration of the liability shortens a little
bit and your investment portfolio has to change slightly,
but this occurs gradually over a significant period of
time.
I think the broader issue that I hear in that
question is there’s no reason that you couldn't start a
defined contribution plan for new employees while still
closing out a defined benefit plan that you have if that’s
the option that you need to consider.
The issue is with a defined benefit plan that you
have, you’re going to incur those costs at some point in
time. It’s not a question of "if"; it’s a question of
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"when." So you could incur those costs sooner or you could
incur those costs later. That's your decision to make.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Kampf.
Our final question I believe from seeing Members
-- Representative Pashinski, are you going to have a final
question?
REPRESENTATIVE PASHINSKI: I think —
MAJORITY CHAIRMAN METCALFE: We're going to go to
Representative McCarter first but we're kind of finalizing
the list. So Representative Pashinski will be the final
question I believe after Representative McCarter.
REPRESENTATIVE MCCARTER: Thank you very much,
Mr. Chairman.
I appreciate your testimony, Dr. Wagner, and if
we could go back and look at the -- and I don't know if you
have or not -- the pension crisis that we had back in the
early 1980s when in fact the system was again facing a
large unfunded position and the funding of both PSERS and
SERS had dropped considerably down into the 50s at that
particular point, 50 percent.
If you used your assumptions that you used at
this point looking forward at that particular time, would
you have said the same thing and knowing the outcome as we
do and the fact that the funds became 123 percent funded or
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more by 1999?
DR. WAGNER: Sure.
REPRESENTATIVE MCCARTER: I mean what is the
difference today that you’re seeing versus what we saw in
the future so that the outcome was only 50/50? I mean that
normally I think is the assumption, too, even if we take
for PSERS and SERS that they assume that the 7.5 is a 50/50
ratio in terms of what happens. So I’m having trouble
understanding that. So if you can use the history to
explain how you’re looking out to the future.
DR. WAGNER: I mean just what you said makes a
lot of sense with PSERS looking at it as a 50/50. I don’t
know the specifics of the early ’80s. I don’t know the
specifics of the early ’80s. I can tell you that one of
the things that we saw through the economy from 1991
through 2001 was the longest continuous period of economic
growth in U.S. history. So -
REPRESENTATIVE MCCARTER: Only second to -
DR. WAGNER: -- through the 1960s -
REPRESENTATIVE MCCARTER: -- actually second
being the current on that’s taking place.
DR. WAGNER: No. Well, I mean in terms of just
the U.S. economy. So we had a period in the 1960s where we
had a significant period of growth, from 1991 to 2001 we
had 10 consecutive years of economic growth, longest in
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U.S. history, which had a significant effect on the stock
market. So I think you saw very much higher-than-average
returns in probably PSERS and SERS during that time. I’d
have to go back and check the numbers.
I think what we looked at is the historical
returns on investment, what’s likely to happen going
forward. Certainly, there’s a 42 percent chance your
pension could be way overfunded in the future but there’s a
58 percent chance it’s going to be underfunded. And a lot
of that is just the investment risk. So the main point
that at least when I think about trying to get you to
consider is that a defined benefit plan, any type of
defined benefit plan has this inherent investment risk that
you’re imposing on future taxpayers and future workers. A
defined contribution plan does not carry this inherent
investment risk.
REPRESENTATIVE MCCARTER: Thank you.
MAJORITY CHAIRMAN METCALFE: Representative
Pashinski.
REPRESENTATIVE PASHINSKI: Thank you,
Mr. Chairman.
I hope this is a good question since this is the
last one.
MAJORITY CHAIRMAN METCALFE: For the good final
question, as interpreted by you, final interpreted by me.
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Thank you.
REPRESENTATIVE PASHINSKI: And thank you. And
thank you very much for your testimony.
Obviously, we’re all concerned about this issue
very much. When we talk about transitioning to a defined
contribution, if we were to do that, the actuarial note I
thought was 40 billion because you have no money coming
into the present defined benefit system. So you’re going
to choke that off. It already has an unfunded liability of
billions of dollars and yet you say that transition costs
aren’t grave? How do you make up that difference in this
transition period?
DR. WAGNER: I will tell you I did not look at
the issue of transition costs. That’s in the written
testimony of Dr. Andrew Biggs. So what I tried to do is
just illustrate a couple of the major points that he looked
at with the transition costs. That’s not an issue that I
addressed in my own research. I’ve heard the $42 billion
number; I have not seen that actual report so I don’t know
how those numbers were calculated. I’d be happy to take a
look at those and give you my thoughts on that.
REPRESENTATIVE PASHINSKI: But it seems to me if
we’re going to start a new defined contribution, okay,
we’re going to start it. So everybody coming into the
system, you’re going to go into that. Now, we have the
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system right now, the defined benefits that’s in the hole X
number of billions of dollars and we’re going to have no
input, no income coming into that whatsoever.
DR. WAGNER: Right.
REPRESENTATIVE PASHINSKI: So every year it’s
going to decline dramatically. So you’re going to have
that cost there plus the operation of your -
DR. WAGNER: But that’s a cost that you would
incur one way or the other. So the fact that your defined
benefit plan is underfunded now, if you close the plan, you
have to close that funding gap. If you keep the plan
open -
REPRESENTATIVE PASHINSKI: So the point is you
got to pay that?
DR. WAGNER: You have to pay that at any point -
REPRESENTATIVE PASHINSKI: Okay.
DR. WAGNER: -- in time. It’s a question of do
you pay it now or do you pay it later. That’s a cost that
you’re already going to incur so if you were to think about
anything that’s related to the idea of transition costs
that people talk about, you should not take into
consideration what you’re unfunded liability is because
that’s a cost you will bear no matter what. You should
look at any additional cost that you may incur as a result
of that.
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REPRESENTATIVE PASHINSKI: All right. Fair
enough. Fair enough. Thank you, sir.
MAJORITY CHAIRMAN METCALFE: Thank you,
Representative Pashinski.
And thank you, Dr. Wagner, for your very
thoughtful testimony.
Before the Members take off, I’d like to, on
behalf of the Members as a Committee and myself and
Representative Cohen, the Minority Chair, to thank all of
our testifiers today for the very thoughtful testimonies,
the expertise that was shared. And I had a lot of
questions throughout the testimony today. I had a lot of
commentary throughout the questioning today and I
restrained that for the benefit of the Members to get in as
many questions as possible with our limited time that we
had with each testifier based on the large number of
testifiers, larger than we normally have, and the
importance of this topic to Members on both sides of the
aisle. And Representative Cohen joined in asking some of
those questions so I’d take the liberty as Chairman here at
the end to summarize a couple of thoughts as we part ways
here before we enter into a vigorous debate on this issue
as legislation is moved through this Committee in the near
future.
Some of the testimony I think there was a common
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theme to paying off the debt and the unfunded liability.
And I think Representative Truitt had talked about the
moral obligation, and I agree with that wholeheartedly. I
think Members on both sides of the aisle would agree that
we have both a moral and a constitutional responsibility to
pay off this unfunded liability.
I would take it a step further and say that we
have a responsibility, not the future generations, and that
was another common theme that we saw through some of the
testimony from Mr. Dreyfuss and others to say we should
look at the period of time that we’re paying this off and
shorten that down to a 15- to 20-year time frame so that
the current generation so to speak is paying that debt off
and not creating a situation of generational theft in
requiring our children and grandchildren to continue to pay
what we should have paid for.
And beyond that, the sinking boat analogy that
was used by Representative Hill has been used in the past.
Remember, Representative Evankovich used it regarding his
own boating experience with forgetting to put the plug in
his boat. I’m sure he’ll appreciate that I’m reminding him
of that today, and watching his boat start to sink and
having to jump off and put the plug in and find the hole.
And then the analogy used with the credit cards,
cutting up the additional credit cards, we have an inherent
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flaw in this defined benefit system because it is
politically manipulated. This defined benefit system will
always be politically manipulated because politicians are
the ones responsible for it. So corporate America has
moved away from DB plans because it doesn't make sense for
their profit margins. We must move away from DB plans
because it does not make sense if we're going to try and
protect taxpayers and future taxpayers from the damage
that's done by a politically manipulated system that's the
current defined benefit system.
So the defined benefit system is broken. We can
fund it. I mean we can make the sacrifices. We can make
the contributions and fully fund it again but it doesn't
mean future legislators won't continue to enhance benefits
when things are looking well like was done back in 2001.
It doesn't mean that we won't experience market downturns
that the taxpayers are going to be on the hook of dealing
with because during the market upturns, legislators decided
they're going to put the money elsewhere like was done
through several cycles over the years.
We watched school districts stop contributing.
We watched the State stop contributing, as employers, a
very irresponsible decision, while they funded other
projects and programs both at the local level in the school
districts and at the State level. That money was spent
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elsewhere. It’s gone forever and taxpayers now are being
asked to make up the difference.
As long as we have a politically manipulated DB
plan, taxpayers will always have the wrong end of the stick
in this agreement. That’s why it’s important to shift the
responsibility to the individual employee and have the
State and school district act like responsible employers,
give a responsible contribution rate to a defined
contribution plan so that every employee has a chance for a
good retirement and saving and a responsible way for that
retirement.
And we need to mandate it. If we’re going to
switch to defined contribution plan, there has to be
mandated rates of investment because if not, we’ve seen
from the testimony today, that investment won’t occur with
those that are young and looking to a bright future and not
realizing how quick life goes.
So thank you for the Members’ time today. Thank
you for our testifiers and for the audience. And we’ll
look forward to the vigorous debate that will occur. I’m
excited about having that debate because I think the facts
are on the side of making a change that’s needed to protect
the taxpayers of Pennsylvania.
Everyone have a great day. Motion to Adjourn by
Representative Dush, seconded by Representative Truitt.
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1 I hereby certify that the foregoing proceedings
are a true and accurate transcription produced from audio
on the said proceedings and that this is a correct
transcript of the same.
Christy Snyder
Transcriptionist
Diaz Data Services, LLC
