IMPORTANT: It's a Serious Matter of Life

Report dings unfunded pension liabilities in Pennsylvania

A new report on state pension liabilities and their funding levels spotlight a lingering problem for Pennsylvania finances, but many critics argue that its modeling assumptions exaggerate the financial problems.

“Unaccountable and Unaffordable,” the latest pension report from the American Legislative Exchange Council, warns of rising unfunded liabilities that could exceed $8 trillion nationally. ALEC is a nonprofit organization of conservative-leaning state legislators that serves as a forum for model legislation and policy reports.

The pension liabilities matter because they must be paid for, either now or in the future, but they garner less attention than a tax hike.

“State governments are obligated, often by contract and state constitutional law, to make these pension payments regardless of economic conditions,” the report noted. “As these pension payments continue to grow, revenue that could have gone towards tax relief or essential services like public safety and education is spent paying off these liabilities instead.”

For Pennsylvania, ALEC doesn’t have a rosy outlook. The commonwealth was ranked 43rd nationally, with unfunded liabilities of $299 billion. The report cited Pennsylvania’s funding ratio as 23.9%, or 42nd. It did better with paying its actuarially defined contribution, however, ranking sixth with a 115% payment.

ALEC’s report also criticized state pension funds for unrealistic assumptions about rates of return, noting that “pension plans cannot invest their way out of the unfunded liabilities.” To fix pensions and avoid tax hikes or service cuts in the future, the report encourages reform by switching to defined contribution, rather than defined benefit, plans, among other changes.

The methodology used, however, differs significantly from how Pennsylvania’s pension systems calculate unfunded liabilities.

ALEC’s approach is closer to corporate pension funds, which use a discount rate (a rate to value the current costs of future obligations) based on long-term U.S. Treasury bonds. Those rates are lower when interest rates are lower, which then makes the calculated unfunded liabilities higher.

The way ALEC calculated its rates was a sticking point for critics.

“Using a current, spot interest rate to calculate a pension plan’s long-term funding requirements and to characterize the funding condition of a pension plan that will continue to operate for decades, is inconsistent with the way plans are funded,” the National Association of State Retirement Administrators wrote in a rebuttal to ALEC’s report.

Pennsylvania’s pension representatives agreed with NASRA.

“ALEC’s rate does not reflect the recent increase in long term interest rates,” said Steve Esack, press secretary for the Public School Employees' Retirement System. “If ALEC’s report calculated liability using current interest rates, the unfunded liability would be significantly lower and (the) funded ratio would be higher.”

The 10-year treasury rate is 3.17%.

Public pensions follow a different methodology for their valuations, following Actuarial Standards of Practice. Rather than a funding ratio below 25%, PSERS calculated its 2021 funded status at about 60%. The Pennsylvania State Employees' Retirement System calculated its status at 70%.

“I will note that PSERS funded status is improving thanks to strong investment returns and bipartisan budget agreements among the General Assembly and Governor Tom Wolf to provide PSERS’ full actuarial determined contribution since 2016,” Esack said.

While Pennsylvania lags behind in its funding ratio compared to other states, as other analyses have shown, the commonwealth has improved funding and reporting standards in recent years. Pension fund assumptions about rates of return have also been lowered to reflect economic trends.

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