Jan Murphy & Charles Thompson

Pennsylvania’s two major public pension systems are in for a real shake-up under the legislation that the Legislature is expected to send Gov. Tom Wolf by the end of this week.

Starting in 2019, only hazardous-duty state employees, such as state troopers and corrections officers among others, will be eligible to participate in the current defined benefit system that has been part of public school and state employees’ compensation package for decades.

State employees hired after Jan. 1, 2019, and school employees hired after July 1, 2019, will be forced to move into a new plan that offers them three retirement savings options. Employees hired before that date will have the option of making a one-time switch to one of the new retirement savings plan options.

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There's retirement savings options in this plan

Two of the three options are a combination of a guaranteed pension plan and a defined contribution, or 401(k)-style plan. The third option is a straight defined contribution plan. You'll find more detail on each plan below.

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Charles Thompson | cthompson@pennlive.com

Sadly, there's no break in sight for taxpayers

What the new pension plan doesn't change, for the near-term future anyway, is the budget-crushing payments the state and school districts are required to make now to keep the existing plans solvent.

Here's a before / after look at how closely the taxpayer-funded contributions into the two major state pension plans match up.

Believe it or not, there are two lines here.

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Option 1

The first option offered to future employees would be a hybrid defined contribution/defined benefit plan that would require workers to contribute 8.25 percent of their pay for retirement, split between the guaranteed pension and the new 401(k)-style plan. Upon retirement, they would receive a guaranteed pension based on 1.25 percent of their final average salary (see below for how that is calculated) times years' service, plus whatever they earned through their 401(k)-style account.

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Option 2

This is another hybrid plan in which workers could reduce their payroll deduction to 7.5 percent (also split between the guaranteed pension and 401(k)style plan), and receive a guaranteed pension based on 1 percent of final average salary times years of service, also supplemented by the new 401(k)-style plan.

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Option 3

This is a full defined contribution plan which is similar to what most workers in the private sector have. It would require a minimum employee payroll contribution of 7.5 percent. The employer contributes 2 percent of salary for public school employees and 3.25 percent for state government employees.

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Charles Thompson | cthompson@pennlive.com

Benefits for the pension systems "unborn" will be lower

Under all scenarios, the fiscal analyses tell us, the workers coming into employment will rest on a new third-tier benefit that is lower than the pension kings living off of Act 9 from 2001, and the post-2011 hires using Act 120.

The Independent Fiscal Office found that under the best-case scenario, a career worker with a final year salary of $60,000 would see a benefit that equals from 82 to 84 percent of a similar worker hired today.

That would equate to a replacement of pre-retirement income of about 55 percent to 57 percent. Coupled with Social Security, that would get our worker to about 90 percent.

Supporters of this bill note that is a good benefit, still well above the 80 percent level than many financial advisors say workers should shoot for. But critics of Senate Bill 1 see a fundamental unfairness in making today's teenagers pay for the mistakes of past elected officials.

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File photo/PennLive.com

Other differences affecting employees

Even though employees have several options, one thing they can't do is change their mind. Once in a plan, they are there to stay for the duration of their employment with state government or a public school.

Anyone who leaves state or school service and later returns must go back into the retirement savings option they previously chose. There's no switching allowed.

Those opting for hybrid plans wouldn’t become vested for the defined benefit component until after 10 years of service. They become vested for the employer contribution to the 401(k)-style components of the hybrid plans or the standalone defined contribution after three years of employment but would vest immediately for the employee contribution to a plan.

The pension bill also changes the way the final average salary is calculated. It would be the equal of the average of the five highest years of compensation, instead of three years which is used to calculate benefits in the current system.

Another big change is the normal retirement age for full pension benefits is pushed back two years, to 67, or any combination of age and years of service that adds up to 97. The 97 is five more than what is the current rule that is used to determine eligibility for full pension benefits.

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What about lawmakers and judges

Starting in 2019, state lawmakers and judges would be treated no differently than state and school employees in the proposed pension bill. Those taking office after Jan. 1 that year will be eligible to participate in any of the three new pension plan options.

Those in office before that date have the option of switching to one of the new plans or they can remain in the guaranteed pension system.

Senate Majority Leader Jake Corman, R-Centre County, said in describing the bill on the Senate floor: “I want to be very clear because I know how much attention is paid to this. The Legislature is treated like every other employee that comes under these two systems. I think that’s important to note. We advocated for this and we think we needed to live by it as well.”

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Dan Gleiter | dgleiter@pennlive.com/file

Who can stay in the current pension plan?

Exempted from the new plan are most uniformed or hazardous-duty state employees such as state police, correctional officers, game wardens, state park rangers and Capitol police, among others, which make up about a quarter of the state workforce. They would remain in the defined benefit plan that provides a guaranteed pension benefit.

Corman explained they are exempt because state police don’t collect social security and other hazardous-duty employees’ careers are “shorter than normal state employee because of the nature of their job.”

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Saving money on investment fees

The proposal establishes the Public Pension Management and Asset Investment Review Commis- sion, which must develop recommendations to reduce expenditures on investment fees to generate actuarial savings of $1.5 billion for each system over 30 years.

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www.pahouse.net/mccarter

Argument against the plan

After pointing out PSERS was created in 1917 as a humanitarian effort to provide some retirement security for school employees, Rep. Steve McCarter, D-Montgomery County, told the House State Government Committee it seems lawmakers no longer have the will to “have that humanitarian aspect to look forward when people will actually be to the point of retirement and what they will have at that particular juncture.”

He said the options, with their 401(k)-style component, provided under the pension bill will likely provide less retirement income than the current system and does little to reduce the pension systems’ unfunded liability.

“People who have 401(k)s today, the average amount of money in the 401 in this country is under $100,000 that will buy you one year of retirement,” McCarter said. “What comes after that?”

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www.repgabler.com

Argument for the plan

Rep. Matt Gabler, R-Clearfield County, said the bill is not intended to significantly pay down the pension systems’ unfunded liability. Rather, he said it is intended to shift the risk from taxpayers to the employees if financial markets take a downturn.

He said the new plan designs get with the times and are better suited to today’s workforce where people don’t stay at the same job throughout their entire career.

“Today’s young people that are entering the workforce will, on average, have in excess of a half dozen jobs,” he said. “They will climb the ladder and do different things but they would still have a public sector benefit. Under current law [the pension system] is structured in such a way . they’ll feel trapped in the benefit they are in. Why should public sector workers feel they have to stay where they’re trapped just to validate a benefit that is not flexible. This is a very competitive benefit that provides some aspect of portability.”

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What about the rest of us?

That's the story of what the plan changes mean for future state workers and school employees. What about the rest of us?

That's a complex question, but here's what the analysts say.

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Mark Pynes | mpynes@pennlive.com

So, for the immediate future, budgetary times will stay tight

That problem, of course, is that that steady climb in costs is putting more and more school districts, which shoulder about half of the pension costs for teachers, into a perpetual dilemma of choosing between higher property taxes or larger classes, deferred maintenance or program cuts.

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Charles Thompson | cthompson@pennlive.com

Nor does Senate Bill 1 dramatically change the funded status of the plans

That's because the last pension reform, Act 120 of 2010, had already mapped out a course to put the state's major pension plans on sounder fiscal footing.

Here's the fiscal analysts' view of the difference, or similarities, in the future "funded ratio" of the school teachers' pension system as the changes take effect over time.

Again, two lines looking like one.

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Here's a ripped from the headlines example of how this works.

Gov. Tom Wolf has proposed a $100 million increase in the state's basic education subsidy line for 2017-18 - the main state aid line that is available to districts to help pay for the operation of their educational program.

The combined local cost to school districts of their contributions to the retirement system, meanwhile, is estimated to jump by $140 million.

So the districts find themselves $40 million in the hole before buying their first new student laptop, or paying any raises to professional employees.

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Charles Thompson | cthompson@pennlive.com

The savings story

One perplexing thing about this plan is that it actually raises costs, before it lowers them. See the table above, which breaks down the change in taxpayer-funded contributions to both of the major plans over time under Senate Bill 1.

The IFO estimates a net increase of $56 million through the first four years of implementation; plus another $496 million from 2023 through 2034.

Then, the tide turns as the new system accounts for more of the state and school district workforce. From 2035 through 2050, the bill produces cumulative savings of $1.95 billion.

The net? A reduction of nearly $1.4 billion on a cost load of about $215 billion.

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Squeezing blood from a stone is tough

One of the reasons the cost savings are small is that lawmakers are essentially wringing out the same washcloth for the second time.

With Act 120 of 2010, Pennsylvania largely stopped digging the hole as it pertains to new hires, because that law reset benefit levels for new state and public school hires to pre-2001 levels.

Workers could still buy into the more expensive benefit plan, but they would have to pay more up front through higher payroll deductions. The effect was to lower what's known as the "normal cost" that employers should expect to pay for a retirees' benefits.

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Charles Thompson | cthompson@pennlive.com

Act 120 worked well, as the graph above from the Public School Employees Retirement System shows - note how the red line has been sliced in half.

Nearly 30 percent of the current state workers and the current workforce in PA's public school districts have come on board since the new law took effect in 2011.

The normal cost for these teachers is so much lower because most of them are at pre-2001 benefit level. In the event of a string of poor investment returns in the future, cost-sharing provisions would require them to make larger payroll contributions into the system.

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Charles Thompson | cthompson@pennlive.com

The law of diminishing returns

One of the frustrations of this pension reform chase is that projected savings have steadily come down over time, to the point where, last year, proponents started emphasizing the transfer of future risk instead.

The Senate's 2015 bill that attempted to correct the original sin from 2001 by rolling back the benefits enhancement for all current employees for future service time actually achieved saving of $18.3 billion, according to actuarial analyses at the time.

A bill Wolf vetoed in 2015 would have saved $11 billion, but ran afoul of the governor because of smaller changes to current worker benefits.

Finally, the conference committee report that reform supporters unsuccessfully tried to rally votes for last fall was at $2.6 billion.

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Charles Thompson | cthompson@pennlive.com

High marks for hedging our bets

The final result is a kind of least common denominator program - even Pennsylvania's major public sector unions have declared a truce on this - that would actually do its best work in the case of a problem that hasn't occurred yet.

Meaning that, if after the new bill takes effect in 2019, if the state's retirement systems missed their 7.25 / 7.5 percent investment return goals by 1 percentage point on average for 30 years, that $1.4 billion savings could grow by an additional $5 billion.

Make no mistake, there would still be added costs in such a scenario.

But that risk-sharing is seen as an important enough insurance policy for taxpayers and other core government services in the case of severe economic downturn that it's earned the bill the endorsement of one leading independent think tank, the Pew Charitable Trusts.

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Will the insurance ever be needed?

Hard to tell. But history tells us this.

Over the last 30 years, a bumpy cycle that included the "peace dividend" bull markets of the 1990s, two recessions in the first decade of this century, and a long slow recovery through the Obama years, PSERS has registered a 30-year average return of 8.22 percent.

SERS, the state workers' fund, said its 30-year return is 8.6 percent.