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Pennsylvania Pension Fund Deals With Crisis Conditions

August 30, 2016

The state of Pennsylvania is currently facing a pension crisis that has its origins in policy decisions dating as far back as 2001. The situation highlights some important factors for large pension fund managers to consider, and also parallels challenges faced by other municipalities in recent years.

Much of Pennsylvania’s current pension fund struggles can be attributed to decisions by Pennsylvania’s lawmakers in 2001 to provide nearly off-the-chart benefit increases to all public school employees, state workers, and themselves. Problems began compounding in following years when they delayed payments on the higher benefit costs. This was done in order to avoid tax hikes and to free up funding for “other state needs”.

Pennsylvania’s two pension systems serve over 700,000 active and retired workers and have a combined unfunded liability of around $56.8 billion.

According to past projections by the Public School Employees’ Retirement System, the taxpayers’ pension tab would have been less than $2 billion, or about 40 percent of what it is today had the original pension benefits been left alone.

Proposed Solutions for the Pennsylvania Pension Fund Issues

In seeking to address and remedy these pension fund challenges, one of the main proposed solutions is for Pennsylvania to switch its funds from a defined benefits to a defined contribution arrangement. This would entail a shift from benefit amounts that are predetermined using a formula to plans where the employer and workers contribute specific amounts that are invested on the employee’s behalf.

If this type of plan is introduced, courts would probably not allow current workers to make the shift, but only new hires. So while the shift might provide some general alleviation in the long run, the immediate problem is that the state is not setting aside enough money in the pension fund to keep workers and retirees paid. Over time, the state of Pennsylvania has consistently added too little to the fund amounts to support the growing amounts that are owed to workers.

Inspection by the Pennsylvania Auditor General

Pennsylvania Auditor General Eugene DePasquale, has recently announced plans to implement a comprehensive audit of the state’s two main pension systems. He aims to complete separate stress tests of Pennsylvania’s:

  • Pension systems (for state employees and for teachers)
  • State investment strategies
  • Possible solutions, such as the use of third-party managers to maximize returns

DePasquale states: “The main thing we want to answer is, are there ways they can do things better that actually saves them a lot of money, so they can put that money back into the respective systems”. At the moment, this appears to be the most efficient solution to consider, since the main problem is the underfunding issue.

In addition to these immediate concerns, the Auditor General also intends to review whether the law is being applied in a correct fashion, and whether Pennsylvania’s current laws need to be strengthened to allow for better monitoring of public officials. Again, these measures are helpful, but their effects would mostly be seen on a long-term basis.

In other Auditor General news, DePasquale has also announced that he has started auditing Penn State University, which has not been audited since 2011.

Update on Chicago’s Pension Fund System

Chicago is also facing its share of pension fund challenges. On top of similar underfunding issues as Pennsylvania, Chicago fund officials stated that the Chicago Teachers Pension Fund has overpaid retirees nearly $2.8 million over recent years due to a misinterpretation of state law. While over a fourth of the money has already been returned, officials must still continue efforts to collect the remaining sums.

Officials report that 234 retirees were paid benefits in amounts that exceeded what they were actually owed. This was due to a 2012 policy change that resulted in the fund releasing benefits based on dates before the retirees actually left the educational school system. The average overpayment was nearly $12,000, and some were substantial — between $32,000 and $217,000.

In response to Chicago’s complex pension woes, Mayor Rahm Emanuel recently announced a five-year plan to phase in city contributions to the funds, which involve increases in water and sewer taxes.

Takeaways

A possible theme emerging is an underfunding of retirement funds due to states not keeping up with contribution amounts. Such inability may be resulting from various causes, including a miscalculation of fund liability growth, misinterpretations of state statutes, and other errors. At the moment, the most immediate fix appears to be for states to rearrange their budgets to account for more contributions to compromised funds.

Another important element (for all states, perhaps) is the need to implement more frequent audits of retirement funds. Pennsylvania has not had a thorough audit of its pension funds like the one proposed by DePasquale for more than a decade. Frequent assessments of fund amounts and behaviors may be the key for states to foresee and prevent pension fund crises in the future.

Public pension fund operation and management is very complex, as the funds have very specific needs and demands to address. If you have any inquiries, concerns, or legal issues involving a public pension fund, contact us today at Kessler Topaz. We work closely with U.S. public pension funds, Taft-Harley investors, and international institutional investors to help foster financial security, strengthen fiduciary obligations, and encourage active engagement.