(The Center Square) — A new report on state pension liabilities and their funding levels highlights a lingering problem for Pennsylvania’s finances, but many critics say its modeling assumptions exaggerate financial problems .
“Inexplicable and unapproachable”, the last retirement report of the American Legislative Exchange Council, warns of rising unfunded liabilities that could exceed $8 trillion nationwide. ALEC is a nonprofit organization of conservative-leaning state legislators that serves as a forum for model legislation and policy reporting.
Pension commitments are important because they must be paid, now or in the future, but they attract less attention than a tax hike.
“State governments are obligated, often by contract and by state constitutional law, to pay these pensions regardless of economic conditions,” the report notes. “As these pension payments continue to rise, revenue that could have been earmarked for tax relief or essential services like public safety and education is instead being spent to pay off these liabilities.”
For Pennsylvania, ALEC does not have a rosy outlook. The Commonwealth was ranked 43rd nationally, with unfunded liabilities of $299 billion. The report cites Pennsylvania’s funded ratio at 23.9%, or 42nd. He did better in paying his actuarial contribution, however, ranking sixth with a payout of 115%.
The ALEC report also criticized state pension funds for unrealistic assumptions about rates of return, noting that “pension schemes cannot invest to exit unfunded liabilities.” To fix pensions and avoid future tax hikes or service cuts, the report encourages reform by moving to defined-contribution rather than defined-benefit schemes, among other changes.
The methodology used, however, differs significantly from how Pennsylvania retirement 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 US Treasury bonds. These rates are lower when interest rates are lower, which then increases the calculated unfunded liability.
The way ALEC calculated its rates was a sticking point for critics.
“The use of a current spot interest rate to calculate the long-term funding needs of a pension plan and to characterize the funded status of a pension plan that will continue to operate for decades is inconsistent with how plans are funded,” the National Association of State Retirement Administrators wrote in a rebuttal to the ALEC report.
Pennsylvania pension officials agreed with NASRA.
“The ALEC rate does not reflect the recent increase in long-term interest rates,” said Steve Esack, public school employee retirement system press secretary. “If the ALEC report calculated the liabilities using current interest rates, the unfunded liabilities would be significantly lower and (the) funded ratio would be higher.”
The 10-year Treasury bill rate is 3.17%.
Public pensions follow a different methodology for their valuations, in accordance with actuarial standards of practice. Rather than a funding ratio below 25%, the PSERS calculated its funding status in 2021 at around 60%. The Pennsylvania State Employees Retirement System calculated its status at 70%.
“I will note that the funding status of the PSERS is improving with strong returns on investment and bipartisan budget agreements between the General Assembly and Governor Tom Wolf to provide the full determined actuarial contribution of the PSERS since 2016,” said Esack said.
While Pennsylvania lags behind in its funding ratio compared to other states, like other analyzes have shown, the Commonwealth has improved funding and reporting standards during the last years. Pension fund assumptions regarding rates of return have also been lowered to reflect economic trends.