Governor’s Plan Digs a Deeper Pension Hole

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(Reblogged from Third and State)

Steven Herzenberg:

The high cost of meeting current pension obligations is often cited as the main reason Pennsylvania needs a substantial overhaul of its pensions system. So it is a little puzzling that Governor Tom Corbett has put forth a plan that will actually increase pension costs for the state, school districts, and ultimately taxpayers.

That is the finding of the first two in a series of pension primers the Keystone Research Center released this week. So how exactly does this plan drive up costs?

First some background: The Governor’s pension proposal, starting in 2015, would enroll new employees in a defined contribution plan akin to a 401(k) account. This transition away from the current defined benefit pension plans for state and school employees produces significantly higher employer costs over time — costs the Corbett administration has not acknowledged.

It is really a one-two punch for taxpayers. It increases state and school district debt for current pensions and drives up costs for future pensions. The last thing policymakers should do now is dig an even deeper pension hole.

But that is what the Governor’s plan does. As future state and school employees are enrolled in a new 401(k)-like plan, the employees who remain in the existing pension plans will age over time, and increasing numbers will retire. As the time-frame shrinks over which pension assets must be paid out in retirement checks, fund managers will shift to less risky and more liquid assets that have lower rates of return. This means the state and school districts will have to put in additional contributions to meet their pension obligations to current workers and retirees.

At the same time, contributions into individual accounts made by new employees and matched by employers will be siphoned off from existing pension fund assets, further eroding investment earnings and increasing costs for the state and school districts.

More than a dozen states, including California, Minnesota and Texas, that have carefully examined defined contribution proposals similar to the Governor’s have concluded it is not the best course of action, in part because it would increase unfunded liabilities. Studies show that incremental modifications to defined benefit plans that reduce long-term costs and increase contributions — much as Pennsylvania did with the Pension Reform Act of 2010 — are more cost efficient.

States that have actually adopted 401(k)-like plans have no better track record. Since closing its teachers’ defined benefit plan in 2005, Alaska has seen the employer contribution rate jump significantly. In Michigan, which began enrolling all new state employees in a 401(k)-type plan in 1997, unfunded liabilities skyrocketed.

Just as troubling, the per employee costs to the state and school district employers associated with the new defined contribution plans will be one-third higher than the per-employee costs of the current pension plans. The total increase in cost will be modest at first — increasing by about $5 million each year as more and more new employees enrolled. Fully phased in, the increase in cost will be $179 million each year, more than half of which will be paid by school districts and local property taxpayers.

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