By Eric Boehm | PA Independent

At the same time taxpayer contributions to Pennsylvania’s largest public pension system are set to increase, the pension fund is lowering its expectations for investment returns.

But a national pension advisory firm says even the lower expectation might be too high.

The state can contribute only less than half of what the pension fund’s actuaries say would be necessary to keep the fund solvent, thanks to contribution caps placed on the funds last year that do not expire until 2015.

It could combine into a perfect storm of pension woes for the state, and lawmakers are unwilling to address it less than six months after a difficult battle on the reforms last fall. The delay ultimately will cost taxpayers billions.

State Senate Appropriations Chair Jake Corman, R-Centre, said any additional effort at reforming the public pension systems would have to be pushed by Gov. Tom Corbett.

The Corbett administration has hinted at the pension issue, but the governor has not gone on record calling for changes and did not return calls for comment.

States around the country, including Pennsylvania, are facing shortfalls of billions of dollars in public pension funds because investments failed to do as well as promised in recent years. A recent national study suggests the earnings estimates are part of the problem.

The study, completed by Wilshire Associates, a national independent investment advisory and services firm, examined 126 state pension plans and found that not a single one is expected to meet its actuarial rate of return during the next 10 years. That means taxpayers will have to pay more.

Most public sector pension plans — including Pennsylvania’s State Employee Retirement System, known as SERS, and Public School Employee Retirement System, known as PSERS — have an expected rate of return of 8 percent annually, while the private sector is required to use an index under the 2006 Federal Pension Protection Act. That index currently holds private sector pension plans to an expected rate of return close to 6 percent annually.

If returns fall short or the state lowers the expectation — or both — higher contributions have to make up the difference.

However, contributions from the state have been capped by legislation passed in November. The pension reforms contained in Act 120 of 2010 requires that contributions cannot increase by more than 3 percent in fiscal year 2011, 3.5 percent in fiscal year 2012 and 4 percent in fiscal years 2013 and 2014.

At the March 11 meeting of PSERS, which includes 260,000 current members and 164,000 retirees, the board voted to decrease the expected rate of return from 8 percent to 7.5 percent. The board also voted to update the expected costs for retirees to reflect longer life spans.

The changes will take effect in June, when the new fiscal year begins.

Taken together, the changes will amount to an estimated $3.5 billion in additional unfunded liabilities for the PSERS plan, said Rick Dreyfuss, a retired actuary and pension consultant. The lower expected rate of return requires additional contributions to make up the difference and retirees’ living longer means a larger drag on the pension system, he said.

The changes to the expected rate of return come on the heels of the pension reform, which capped contributions for the next five years to avoid a “contribution spike” that would have begun with fiscal year 2012.

Reducing the expected return on investments does not immediately impact the pension funds liabilities, said Evelyn Tatkovski, spokesperson for PSERS, but the half percentage point drop will have to be made up with higher-than-expected investment returns or higher contributions.

In an assessment of the PSERS fund, Wilshire Associates said only one of the funds’ 10 asset classes was expected to earn an 8 percent return over the next 10 years. That report directly contributed to the board’s decision to lower expectations, said Tatkovski.

To make matters worse, private market funds were the only asset class expected to earn the 8 percent rate. Traditionally, they are some of the most volatile funds on the market.

“Basically, what that means is that in order to get an 8 percent return, you have to take bigger investment risk, and that is something the board does not want to do,” said Tatkovski.

PSERS re-evaluates the expected rate of return each year, usually in March. Pennsylvania’s other public pension system, SERS, recently recertified its expected rate of return at 8 percent.

While shortfalls in investment returns, forecasted or not, have to be made up with contributions from elsewhere, the 2010 pension reform measure tied the hands of the Legislature by capping the coming the state’s contribution increases.

According to PSERS’ actuaries, the state government should increase contributions to the fund from 5.64 percent this year to 18.9 percent next fiscal year. However, because the caps forbid an increase of more than 3 percent this year, next year’s contribution will equal only 8.64 percent.

As a result, the official unfunded liability in the PSERS fund will continue to grow, ballooning from $23 billion this year to an estimated $27 billion next year. Under the new pension laws passed in November, the unfunded liability is expected to peak at $47 billion in 2020 before gradually declining.

Even with the caps on taxpayer contributions in place through 2015, the annual contributions from the state are expected to climb from $761,000 this year to more than $4 billion annually by 2017, finally topping out at nearly $8.6 billion in 2035.

Dreyfuss said the funding rate passed by the Legislature and signed by former Gov. Ed Rendell last year ignores the reality of the situation.

“All we’re doing is funding an arbitrary rate,” said Dreyfuss. “The act predetermined the funding requirements regardless of what the actual environment would require.”

While last year’s pension reform prevents the Legislature or the governor from increasing contributions above the cap, Corbett’s preliminary budget does plan to fully fund up to the cap.

State Rep. Glenn Grell, R-Cumberland, said the state budget will include a fully funding the pension plan at the 8.65 percent rate allowed by the law passed last year. Grell supported the pension reforms last year, but said the issue should be revisited by the Legislature — and soon.

“I would say that’s hopefully a second half of the year issue,” said Grell.

Even with such dire numbers on the horizon, members of the state Legislature said the problem is not immediately on their radar.

Corman said he would be “open to the conversation” about long-term changes to the state pension plans, such as moving from a defined benefit plan to a defined contribution plan.

“That’s something we would want the administration to look at first,” said Corman. “In the short term, there’s nothing you can really do short of changing the current employees’ retirement package, and that would be seriously challenged in court.”

The Pennsylvania State Education Association, the state’s largest teacher’s union, would oppose any attempt to change the pension plans from a defined benefit to a defined contribution plan, said spokesperson Wythe Keever.

State Sen. John Wozniak, D-Cambria, said the changes made by the pension reform package last year addressed the immediate concerns and the state Senate did not have plans to address pensions this year. Those reforms have no impact on the existing liability.

Recent estimates of the state’s pension shortfall range from almost $14 billion to $114 billion, according to Sunshine Review.

For more detailed information on PSERS funding levels and expected contributions in coming years, click here.