Rep. Glen Grell, unveiled his new pension reform proposal
By Chris Comisac
Deputy Bureau Chief
Capitolwire
HARRISBURG (Oct. 1) – While labor unions representing state employees and public school employees were diplomatic on Monday when Rep. Glen Grell, R-Cumberland, unveiled his new pension reform proposal, the gloves started to come off on Tuesday.
The Keystone Research Center, a Harrisburg-based labor union-affiliated research group, released a report today expressing concerns about one of the components of the three-pronged pension reform approach proposed by Grell.
Economist Stephen Herzenberg, the center’s executive director, said during a Tuesday conference call that his organization wholeheartedly supports one prong of Grell’s proposal – borrowing up to $9 billion to help reduce the state’s current unfunded pension liability – feels more review is needed about a second prong – the voluntary decision by current employees to reduce their own pensions – and has “deep reservations” about the last prong – the replacement of the current version of defined benefit pensions with a cash-balance defined benefit system.
Responding to the KRC’s report, Grell said: “I appreciate the prompt analysis of the Center and both the favorable and critical observations in Dr. Herzenberg’s initial comments. We will review them carefully.”
“We are willing to look at other ideas on the new plan design, as long as they include shared investment market risk,” said Grell. “I look forward to having a further discussion with the KRC to consider these concerns.”
The report, entitled Cash Balance Pension Plan Could Hurt Public Employees and Taxpayers, identifies the KRC’s three core areas of concern regarding Grell’s cash balance idea, which Grell said would save approximately $7 billion – towards what is expected to be a more than $65 billion pension unfunded liability – during the next 30 years: expected benefit reductions, employees overpaying for their pension benefits and the potential for an increase of the current pension unfunded liability.
Under Grell’s proposal, new employees would deposit 7 percent of their salary into 401(k)-style accounts, employers would match it with 4 percent for the first 15 years of employment and 5 percent after 15 years of employment. If investment returns provide more than the guaranteed return – which Grell said would be 4 percent – those funds would be shared equally by employees and employers.
Then, upon retirement, the funds built up by the contributions would pay the retiree an annuity, and if that person died, some level of death benefit. Employees would own that account from the moment it started to accrue funds, and it would be portable, following employees to other jobs, according to Grell.
Top of the list of KRC’s concerns is that the new formula to be used to calculate an employee’s cash balance will, according to Herzenberg, result in a 20-percent loss, on average, in employee pension benefits.
Herzenberg said that current pension calculations place far more emphasis on the later years of an employee’s service, when their salaries are normally at their highest levels, which is not the case under Grell’s proposal.
Current retirement benefits are calculated using a formula based on an employees’ class of service, years of credited service, final average salary and age. That final average salary is simply an average of the three highest years of salary for an employee.
“In a cash balance plan, your final three years have the least impact because those contributions have had the smallest amount of time to benefit from compounding [interest], so it’s your salary in your earliest years that has a bigger impact,” said Herzenberg.
According to the KRC analysis, the length of employment and whether or not an individual immediately retires from all employment when leaving state employment appear to also impact on benefit totals.
“Long-term career employees who retire from their government job would experience a higher level of benefit cuts, between about 35 percent and 60 percent,” said Herzenberg. “Employees who work in public jobs for 20 years and then take private jobs for 20 years would enjoy large increases in benefits.”
“If you retire and then work ten years, twenty years in the private sector, and then draw your public sector benefit, the cash balance plan … your cash balance keeps growing all that time [you were working in the private sector],” explained Herzenberg.
Grell responded to that criticism, saying: “We were concerned about the longevity issue and that is why the proposal already includes the employer contribution ‘bump-up’ from 4 percent to 5 percent after 15 years of service. Keep in mind the cash balance plan would only apply to future employees, so the concern about losing mid-career employees is 15 years down the road.”
Herzenberg also expressed concern that this new plan would, in essence, place nearly all of the burden upon employees for their own retirement funding, with the promised employer contribution directed, primarily, to paying down the current pension unfunded liability.
Said the KRC report: “In effect, this is a not very well disguised attempt to get new employees to pay for the state’s unfunded pension liability. It is not clear why new public employees have any responsibility for paying an unfunded pension liability they did nothing to create. Nor is it clear why they should forego (or virtually forego) any employer contribution to their pension so that employer contributions can all go to the unfunded liability.”
Given that Grell anticipates $7 billion in savings from a cash balance plan, and acknowledged the costs to the employer would be lower than the current system enacted by Act 120 of 2010, it does appear employees could be “overpaying for their own benefit,” said Herzenberg.
He cautioned that those shortcomings could very well lead to “more turnover in experienced employees” which could prompt public employers to provide offsetting wage increases to retain those experienced workers, which would represent a potential cost for taxpayers.
The last of the report’s primary concerns with the cash balance plan is the assumed investment return included in the employee benefit calculation and its potential to ultimately add to the current pension unfunded liability.
Grell’s plan guarantees a 4-percent investment return as part of the employee benefit calculation, with any performance beyond that rate split between the employer and the employee, which would seem to offer an incentive for the plans to continue to maximize their investment returns. Currently, the state’s two public pension funds assume a 7.5-percent rate of return on their investments.
However, Herzenberg said that if the cash balance plan were implemented, that low rate of return expectation could cause the Commonwealth’s public pension fund managers to eventually become more conservative with their investment decisions, as the cash balance plan’s participating population grows.
But the cash balance plan’s population isn’t the only population in the state’s pension system: there are employees who are part of the Act 120 or pre-Act 120 defined benefit plans, and their benefits were built upon an assumption of a higher rate of investment return, currently 7.5 percent. If the overall rate of return, as a result of the cash balance plan, doesn’t ensure enough funds are available for the non-cash balance beneficiaries, that will add to the unfunded liability. As an example, Act 120 of 2010 was initially built around an investment return assumption of 8 percent. When that assumption was reduced to 7.5 percent, that half-a-percentage point difference in investment return added $6.7 billion to the unfunded liability.
“We encourage members of the media, policymakers and the public not to rush to conclusions about cash balance plans because they have pension fatigue,” said Herzenberg. “We should all take a page out of Rep. Grell’s book and be deliberate in examining this part of his plan.”