Question: What do you get when you add a bad stock market + equally bad state budgets + generous pension benefits + an enhancement of those benefits + rising health costs + an aging workforce?
Answer: A large unfunded liability.
Example A is Pennsylvania, which recently announced they will be increasing the employer contribution rate for retired teacher pension and health benefits in 2010-11 by 72 percent over current levels. The projections into the future are even worse, as the Public School Employees’ Retirement System of Pennsylvania (PSERS) is currently predicting the rate to nearly triple in 2012-13.
The graph below shows a 60 year look, 30 years back and 30 years forward, at employee and employer contributions into PSERS. The blue line is the percentage of salary that the average employee contributes, and it has been pretty steady over time, although it has risen slightly. The red line is the combined contribution of school districts and the state (determined by formula, but the state contributes a little more than half), and it has fluctuated wildly. It was in double digits from 1973 to 1997, hit a low of 1.09 (1.09!!) in 2002, and is expected to reside above 30 percent from 2014 to 2020.
*indicates future projection
The projections already include an eight percent annual investment gain for the next 30 years, but even after that assumption added to the large employer contributions, the state will still have an unfunded liability of over $7 billion in 2039, in present dollars. To put that in perspective, the state and all its school districts contributed only $617 million last year.
The options to fix this situation are not very appealing, nor are they unique to Pennsylvania. State and local governments could, and probably will, raise taxes. That’s pretty much inevitable, but it’s also politically unpalatable. Because pension benefits are considered a legally binding contract, the state cannot reduce benefits to current employees. So, instead, they’re likely to address the political problem by taking what amounts to mild budgetary solutions and reducing benefits or changing the retirement structures for future employees and requiring higher employee contributions. PSERS could also seek to increase its investment performance (they’ve averaged a 9.25 percent return over the last 25 years), but to do so would require it to take on more risk.