Pen­sions On Agenda In Pennsy

The Bond Buyer - - Front Page - By Paul Bur­ton

Penn­syl­va­nia’s Pub­lic Pen­sion Man­age­ment and As­set In­vest­ment Re­view Com­mis­sion says its blue­print could save the com­mon­wealth roughly $10 bil­lion in pen­sion debt over 30 years.

What’s within reach po­lit­i­cally is an open ques­tion.

It’s now up to Gov. Tom Wolf and the Gen­eral As­sem­bly to act on the rec­om­men­da­tions of the nearly 400-page re­port by the bi­par­ti­san panel that fo­cused on in­vest­ment-fee trans­parency, pen­sion-sys­tem stress test­ing, ac­tive ver­sus pas­sive in­vest­ment strate­gies and over­all per­for­mance.

The com­mis­sion’s Dec. 20 re­port fol­lowed a seven-month study of the two fi­nan­cially strained state pen­sion sys­tems, the Penn­syl­va­nia Pub­lic School Em­ploy­ees’ Re­tire­ment Sys­tem and the State Em­ploy­ees’ Re­tire­ment Sys­tem. The panel held three pub­lic hear­ings.

PSERS has 486,000 mem­bers, SERS about 239,000. Their un­funded li­a­bil­i­ties are es­ti­mated at $44.5 bil­lion and $19.7 bil­lion, re-

spec­tively, with re­spec­tive fund­ing lev­els at 56.3% and 60.7%.

Find­ings in­cluded PSERS hav­ing paid out just over $1 bil­lion in fees, rev­enue share and in­vest­ment ex­penses for fis­cal 201617, ex­ceed­ing all em­ployee con­tri­bu­tions to the sys­tem dur­ing that pe­riod. Ad­di­tion­ally, an anal­y­sis showed that PSERS and SERS ranked near the bot­tom in 10-year per­for­mance among 52 U.S. pub­lic pen­sion plans.

“It’s a good re­port,” said Alan Schankel, a man­ag­ing di­rec­tor at Jan­ney Cap­i­tal Mar­kets in Philadel­phia.

The panel iden­ti­fied an es­ti­mated po­ten­tial $9.9 bil­lion in ac­tu­ar­ial sav­ings over 30 years cal­cu­lated at the 7.25% as­sumed rate of re­turn for both re­tire­ment sys­tems.

Crit­ics say Penn­syl­va­nia put it­self into its pen­sion hole thanks to poor bench­mark­ing — against other state pen­sion funds, some wob­bly, as op­posed to the pri­vate sec­tor — and poor li­a­bil­ity man­age­ment. They add that too high an as­sumed rate begets an ag­gres­sive man­age­ment sys­tem that re­quires higher in­vest­ment fees.

While par­ing fees seems an eas­ier po­lit­i­cal reach, what Penn­syl­va­nia will do be­yond that is un­cer­tain as it stares at nearly $70 bil­lion of pen­sion debt, said Barry Shutt, a Lower Pax­ton Town­ship re­tiree who op­er­ates a pen­sion debt clock at the state capi­tol cafe­te­ria in Har­ris­burg. The clock mim­ics the one in New York’s Times Square that chron­i­cles the fed­eral debt.

“It’s some­thing long over­due for them to look at the fees they’re pay­ing to in­vest these funds, but here’s what I find dis­ap­point­ing: Just tweak­ing the fees isn’t go­ing to save money if they don’t pay down the debt,” Shutt said.

Shutt has pro­posed rais­ing the per­sonal in­come tax to 4% from 3.07% to raise $4 bil­lion a year over 20 years to pay down the debt. He said the move could free up the com­mon­wealth’s gen­eral fund for strug­gling lo­cal emer­gency med­i­cal ser­vices and sewer sys­tems.

“You’ve got to con­vince them of the need for new rev­enue,” Shutt said of top law­mak­ers. “If you think you don’t, you’re smok­ing the stuff you have to have a pre­scrip­tion to get.”

The re­port called for es­tab­lish­ing a con­sol­i­dated cen­tral in­vest­ment of­fice for both pen­sion funds; en­act­ing leg­is­la­tion man­dat­ing an­nual stress test­ing; and mov­ing to fully in­dex all pub­lic mar­ket in­vest­ments in both pub­lic eq­ui­ties and fixed in­come.

It also seeks to es­tab­lish trans­parency poli­cies at both sys­tem boards that fa­vor and en­cour­age more open pub­lic re­port­ing; en­act leg­is­la­tion man­dat­ing in­creased pub­lic re­port­ing of all in­vest­ment ex­penses; and adopt mea­sures to re­duce risk, in­clud­ing re­duc­ing ex­po­sure to illiq­uid pri­vate in­vest­ments.

State pen­sion leg­is­la­tion passed in 2017 un­der Act 5 es­tab­lished the com­mis­sion to con­duct a com­pre­hen­sive re­view of PSERS and SERS in­vest­ment man­age­ment. The law also re­quired new em­ploy­ees to choose be­tween a 401(k) style de­fined con­tri­bu­tion plan in which em­ploy­ees bear the risks and re­wards of in­vest­ment per­for­mance, or a new hy­brid plan that’s part de­fined ben­e­fit, part de­fined con­tri­bu­tion.

Em­ploy­ees hired af­ter Jan. 1 must use the new re­tire­ment plans.

“Penn­syl­va­nia has al­ready taken some steps to­ward sig­nif­i­cant re­form. It just won’t show in the bot­tom line for 30 years,” Schankel said. “The new hy­brid sys­tem giv­ing new em­ploy­ees an op­tion of a hy­brid plan or de­fined con­tri­bu­tion will have a huge im­pact.”

The com­mis­sion’s chair­man and vice-chair­man, re­spec­tively, were state Rep. Mike Tobash, R-Pottsville, and state Trea­surer Joe Torsella, a Demo­crat.

Ac­cord­ing to Torsella, re­port­ing and pub­lic dis­clo­sure en­hance­ments will en­cour­age trans­parency of in­vest­ment ex­penses, per­for­mance and per­for­mance bench­marks and il­lus­trate ar­eas of port­fo­lio risk.

“Un­like eco­nomic and mar­ket con­di­tions that are dif­fi­cult if not im­pos­si­ble to pre­dict, costs and ex­penses are well within con­trol of fund man­agers,” Torsella said.

The Gen­eral As­sem­bly, said Tobash, should shoul­der ul­ti­mate re­spon­si­bil­ity for es­tab­lish­ing and main­tain­ing SERS and PSERS.

“As such, it is both the purview and the re­spon­si­bil­ity of the leg­is­la­ture to re­spond to the ef­fec­tive­ness of these sys­tems, es­tab­lish mech­a­nisms for in­de­pen­dent ex­am­i­na­tion and ul­ti­mately, con­sider leg­is­la­tion to im­ple­ment mean­ing­ful re­form.”

One po­lit­i­cally volatile rec­om­men­da­tion is to cre­ate a cen­tral­ized of­fice for the two in­vest­ment sys­tems, while main­tain­ing the ex­ist­ing gov­er­nance struc­ture for both.

“Depend­ing upon the struc­ture, some of the power would be taken away from the in­di­vid­ual boards,” Schankel said.

Glen Grell, PSERS ex­ec­u­tive di­rec­tor and a for­mer state rep­re­sen­ta­tive, told the com­mis­sion that PSERS and SERS re­cently found op­por­tu­ni­ties to work to­gether.

“We’ve had a cou­ple of in­stances where PSERS and SERS were both look­ing at the same deal, so we col­lab­o­rated,” he said. “In one case, we were able to use maybe big­ger buy­ing power to ne­go­ti­ate a lower fee not for us, but for SERS, but we’re all in the same fam­ily, so that was a good out­come.

“We’d like to do more of that. But re­ally there are lim­its to what can be done with­out statu­tory change.”

The re­port, while spot­ting red flags, praised the funds for re­cent im­prove­ments.

PSERS, it said, adopted im­por­tant el­e­ments of stress-test­ing pro­to­cols, “em­braced” pas­sive-based in­vest­ing strate­gies for pub­lic eq­ui­ties and has re­ported fully on “car­ried in­ter­est” on costs of pri­vate in­vest­ments. SERS has adopted “com­par­a­tively ro­bust” bench­marks and has re­duced ex­penses in its over­all in­vest­ment port­fo­lio.

“In the com­ing weeks, PSERS will take a very close look at the re­port and its rec­om­men­da­tions for ac­cu­racy and for the vi­a­bil­ity of the pro­posed rec­om­men­da­tions,” Grell said in a state­ment. “We ex­pect to dis­cuss and con­duct a de­tailed re­view of the re­port with PSERS Board of Trus­tees at an up­com­ing board meet­ing.”

A fur­ther $116.3 mil­lion in pos­si­ble sav­ings cold ma­te­ri­al­ize if the sys­tems rene­go­ti­ate or end con­tracts with pri­vate in­vest­ment com­pa­nies and funds. That sav­ings could come from lower fees with the firms or by switch­ing in­vest­ments from funds that traders ac­tively man­age to more pas­sive funds in­dexed to cer­tain Wall Street bench­marks.

Pen­sion un­der­fund­ing and bud­get im­bal­ance have trig­gered down­grades of Penn­syl­va­nia in re­cent years. Moody’s In­vestors Ser­vice rates its gen­eral obli­ga­tion bonds Aa3 with a stable out­look. S&P Global Rat­ings and Fitch Rat­ings as­sign A-plus and AA-mi­nus rat­ings, re­spec­tively. Their re­spec­tive out­looks are stable and neg­a­tive.

“Penn­syl­va­nia is not as un­der water as some of these other states,” Schankel said. “They’re in bet­ter shape than Con­necti­cut, Illi­nois and New Jersey, even though they some­times get lumped in.”

Moody’s called Penn­syl­va­nia’s year-to­date growth in to­tal gen­eral fund rev­enue a credit pos­i­tive. On Dec. 3, the com­mon­wealth’s De­part­ment of Rev­enue re­ported col­lec­tion reached $12.4 bil­lion for fis­cal 2019, its high­est in 10 years.

Ru­ral Penn­syl­va­nia com­mu­ni­ties, how­ever, bear the brunt of de­mo­graphic and eco­nomic chal­lenges, Moody’s added. “The pop­u­la­tions are more likely than in ur­ban cen­ters to be in­creas­ing in age and, in many cases, de­clin­ing in num­ber,” said Moody’s. “These de­vel­op­ments pose eco­nomic and fi­nan­cial chal­lenges for ru­ral lo­cal gov­ern­ments since dwin­dling work­forces ham­per eco­nomic growth and ag­ing pop­u­la­tions place greater de­mands on gov­ern­ment re­sources.” ◽

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