It was an early morning interview with Mr. Clay, Executive Director of the Pennsylvania State Education Retirement System. I really wanted to know what he was going to say about the issue of teacher pensions. On my way to meet Mr. Clay, I wondered how someone I knew to be honest and full of integrity would approach the reasons for the problem faced by this issue. I was impressed by his humble and forthright manner in answering my questions.

            “How critical is the funding problem with teacher pensions?” I asked. “It is very critical,” Mr. Clay responded. “The pension fund has an unfunded liability of $29.5 billion as of June 30, 2012 and growing because it is not being funded properly, so it is serious. Moreover, while 70% of funding for PSERS comes from its investments, currently almost $50 billion, the markets are still volatile due, in part, to governmental policy decisions to both stimulate the economy and encourage investment in riskier assets, by, e.g. holding interest rates artificially low.” Mr. Clay insisted that to come to agreement about what should be done, it is first important to understand the causes of PSERS’ current funding challenges. “There has been a long history of people trying to push off paying PSERS’ long term liabilities so that the funds can be spent on other priorities that are more appealing.  Complicating the matter is that right now the public sentiment is to not raise taxes during this economic downturn. This adds to the problem of raising the needed funds to meet PSERS’ mandated pension obligations.”

            “The pension is only one piece of the fiscal puzzle that confronts the Commonwealth,” Clay explained. “It is, however, a critically big issue for school districts and is one of the factors driving school budget cuts.  Although both state and local tax payers may not understand it, in fact, they have been contributing below what was required to fund PSERS for a very long time, but at a huge long term cost. This is because the deferred payments add to PSERS’ unfunded liability, which is a debt; a debt that has a 7.5% interest rate.  Further complicating the problem is that PSERS’ sister system, the State Employees’ Retirement System, has the same funding problem. Although approximately one half the size of PSERS in assets; together they have in excess of $40 billion of unfunded liability. That number goes up or down depending on employer funding and the performance of their investment assets above or below their assumed rates of returns of 7.50%.”

            Mr. Clay further stated that “the goal will be to cut benefits to produce savings to again offset cost deferral. The last time this was done, [in 2010], it brought close to $25 billion in gross savings and a net savings of $1.25 billion after the deferral costs where factored in. It also affected only future teachers. It is likely that this reduction will attempt to impact current teachers.”

            Will it affect retirees? “Retirees are off the table; no one is talking about them.” Constitutionally the Commonwealth is required to honor not only that payment/contract, but also the pension contract for all active employees.  Notwithstanding, it appears that the Governor may try to change the benefits, either retroactively or going forward, of the existing employees. They are most likely going to attempt to change the benefits going forward first.  The earliest that would be effective would be July 1, 2014 because any adjustments will take at least a year to implement.   As noted, PSERS’ pension benefits are protected by the PA constitution, so if those changes are made, there will most likely be litigation concerning those changes. With taxes off the table, further pension reform will likely include benefit cuts.

            Last month, Governor Corbett offered his 2013-2014 State Budget Proposal. His plan aims to protect and leave untouched the benefits of current retirees and benefits of what current employees have earned thus far. However, in keeping his promise to not raise taxes, his plan calls for approximately 20% reduction in benefits to current employees and a 401(K) type system for new hires. KEYTA will keep you posted as to the details of the state budget as it progresses through the State Legislature.