In statehouses across the country, public workers and retiree associations are pushing legislation to address the effects of rising inflation on retirement benefits, and Harrisburg is no exception. According to state law, only the Pennsylvania General Assembly can grant a cost-of-living adjustment. Lawmakers are currently weighing three proposals that sponsors claim would provide retirees with the inflation protection they are demanding. Unfortunately, the ad hoc and arbitrary nature of the retirement benefit enhancements being considered fundamentally conflicts with the best practices in cost-of-living adjustment design and Pennsylvania’s ongoing pursuit of long-term public pension solvency.
As proposed, the measures effectively offer bonus payments rather than true inflation protections for retired public workers. The following analysis reviews how the three measures stand up next to the Reason Foundation Pension Integrity Project’s Best Practices for Cost-of-Living Adjustment (COLA) Designs in Public Pension Systems while also providing insight into how Pennsylvania policymakers can truly address long-term inflation for retired, active, and future public employees.
Why is the Pennsylvania COLA such a challenge?
To first understand how lawmakers found themselves in their current situation, let’s look at the most prominent claim in support of the three COLA bills being actively considered: House Bill 1415 (HB 1415), House Bill 1416 (HB 1416), and Senate Bill 864 (SB 864). Most of Pennsylvania’s public retirees have not received a cost-of-living adjustment in nearly two decades.
Members of the Pennsylvania State Employees Retirement System, or SERS, last received a benefit adjustment of anywhere between 2.27% and 25% in 2002, while members of the Public School Employees’ Retirement System, PSERS, saw similar adjustments in 2004. During the summer hearings of HB 1415 and HB 1416, legislators from across the political spectrum voiced real concerns about the average public retiree’s ability to navigate these times of historic inflation.
SERS and PSERS offer guaranteed fixed pension benefits for life but not a cost-of-living adjustment, which is not abnormal among public pension systems.
PSERS administrators said, “COLAs are not a guaranteed part of your PSERS pension benefit. [Members] are guaranteed a pension benefit based on a formula outlined in the Retirement Code that does not include an automatic COLA.”
This benefit was not a part of the agreement made with the state’s public workers, and no funding has been saved to pay for it. Therefore, the Pennsylvania legislature would have to use taxpayer money to pay for it ad hoc.
Adding more unplanned retirement benefit adjustments like this adds more liabilities and risks unexpected cost increases to already underfunded pension systems. Since the legislature issued the last COLA, SERS has gone from fully funded to 62% funded, and PSERS has moved from 96% funded down to 68% funded. In 2017, the legislature implemented significant pension reforms that included a commission to examine fees paid to asset managers and lower assumed rates of return, which is crucial for long-term financial stability.
Employees and taxpayers also benefited from lawmakers opening two new pension tiers to prevent future generations from bearing the burden of rising public pension debt. With the ongoing challenges in paying for the base pension benefits of these systems, the legislature has rejected previous calls for cost-of-living adjustments.
What do Pennsylvania’s recent COLA bills propose?
Pennsylvania Senate Bill 864, House Bill 1415, and HB 1416 would all provide an ad hoc cost-of-living adjustment. The amount of the supplemental annuity varies by the retirees’ retirement date. HB 1415 would provide increases starting at 10% for those retiring in the 2000-2001 fiscal year (FY) and increasing by .5% for each previous year of retirement, with a maximum increase of 20% for those retiring before FY 1982. HB 1416 and SB 864 are designed similarly, with increases starting at 15% and increasing to 24.5%.
All three measures add to the estimated unfunded actuarial accrued liability (UAAL) and generate a cost that must be paid through increased employer contributions on a level dollar basis over a 10-year period beginning July 1, 2024. Senate Bill 864 differs from the House bills in that it applies only to PSERS retirees.
The Pennsylvania Independent Fiscal Office published an actuarial impact note for each of the two House bills with the following findings:
House Bill 1415:
- For SERS, unfunded actuarial liabilities would increase by $265.3 million and decrease the current funded ratio by .33%, from 69.35% to 69.02%. The employer contribution rate would increase by .53%, from 34.12% to 34.65% of covered payroll.
- For PSERS, unfunded actuarial liabilities would increase by $583.6 million and decrease the funded ratio by .31%, from 63.18% to 62.87%. The employer contribution rate would increase by .58%, from 34.73% to 35.30% of covered payroll.
- For SERS, unfunded actuarial liabilities would increase by $371.0 million and decrease the current funded ratio by .46%, from 69.35% to 68.89%. The employer contribution rate would increase by .74%, from 34.12% to 34.86% of covered payroll.
- For PSERS, unfunded actuarial liabilities would increase by $821.1 million and decrease the funded ratio by .44%, from 63.18% to 62.74%. The employer contribution rate would increase by .81%, from 34.73% to 35.54% of covered payroll.
The actuarial fiscal note included statements that the legislature should exercise caution before increasing benefits under the two bills, given the current funded ratios of the two systems, particularly with regard to recent challenges with investment returns. The bills could put the public pension systems in a negative cash flow position, and certain classes of PSERS employees have “shared-risk” contributions that could be impacted.
An actuarial impact note on SB 864 has not been released as of the date of this analysis. Additionally, the legislative memoranda describing HB 1416 includes a statement from the sponsor that another bill will be introduced to provide an automatic recurring COLA based on the Consumer Price Index for All Urban Consumers (CPI-U) for PSERS and SERS starting in 2024 and every three years after that. The Pension Integrity Project has not yet reviewed this companion COLA legislation.
How do Pennsylvania’s proposed bills stack up to best practices in COLA design?
When ad hoc COLA benefits are issued irregularly or sporadically, stories of retirees suffering in times of inflation create an urgency to act. However, determining the best course of action can be challenging, often leading to expediency as the deciding factor. By reviewing Pennsylvania’s current cost-of-living adjustment effort through the Gold Standard in Pension System Design framework, policymakers and stakeholders can gain a clearer view of the value presented by the current COLA measures.
Best Practice: Participants Receive Continuous COLA Benefit Education
Retirees should have a firm understanding of their pension plan’s COLA benefits to better manage their retirement assets and income most effectively. The ad hoc nature of the proposed PSERS and SERS cost-of-living adjustment benefits is inconsistent with predictable inflation protection expectations and leaves retirees with no long-term assurances to examine or learn about. The bills do not meet best practices in this area.
Best Practice: Adjustments Are Pre-Funded as Part of a Retirement Plan’s Normal Cost
Pre-funding COLA benefits ensures the consistent delivery of inflation protection to retirees and avoids transferring unfunded liabilities to future generations of taxpayers. The proposed bills do not meet gold standards in this category. While the General Assembly has ultimate discretion to award COLA increases under the current ad hoc approach, the resulting cost creates new unfunded actuarial liabilities that must be amortized over future years. All three of the proposed measures require the resulting unfunded actuarial accrued liability (UAAL) to be paid for by increased employer contributions, amortizing the UAAL on a level dollar basis over a 10-year period beginning July 1, 2024.
A better approach is to pre-fund COLA benefits in the normal cost component of the systems’ actuarial funding methods, and this should occur for at least one full year before a COLA is allowed to be granted to ensure that COLA benefits are fully prefunded.
Best Practice: COLA Benefit Objectives Are Clearly Defined
Public pension plan sponsors that integrate a formal COLA benefit policy into the overall objectives of a retirement plan provide retirees with clarity, set transparent expectations, and guide future policymakers facing changing circumstances.
Pennsylvania statutes governing PSERS and SERS do not include a formal statement of purpose or objectives for providing COLA benefits. The Pennsylvania General Assembly, however, has provided ad hoc supplemental annuities in the past. No COLA benefit has been provided since a supplemental increase was awarded to certain retirees retiring in FY 2001 and before. The absence of a formal statement regarding COLA benefits for PSERS and SERS contributes to the past and current practice of making such awards only on an ad hoc and unpredictable basis.
Best Practice: COLA Benefit Eligibility, Amount, and Procedures Are Transparent
Clearly specifying eligibility, applicable benefits, and payment dates protects the value of benefits while avoiding costly and arbitrary cost increases. The current and prior attempts to issue an ad hoc COLA benefit clearly identify eligibility and amount of the COLA awards.
Best Practice: Objective Inflation Benchmarks Determine COLA Benefit Amount
Cost-of-living adjustments should reflect an objective inflation benchmark to provide a more predictable amount of inflation protection and equitable distribution of benefits for similarly situated retirees. The ad hoc approach to providing COLA benefits for PSERS and SERS does not reflect adherence to an objective inflation benchmark as the basis for determining the amounts provided.
Each historical supplemental annuity and the current amounts under consideration are disconnected from inflation benchmarks. There is no policy statement clarifying the basis upon which amounts are being set. Policymakers in the General Assembly are left to make these important benefit-increase decisions without consistent underlying measurements, data, or goals.
Best Practice: COLA Benefits Adjust Under a Ceiling
For best practices, limiting COLA benefits distinguishes between normal inflation and periods of high inflation that are more difficult to predict, providing for more sustainable COLA funding approaches.
Using an ad hoc approach to providing COLA benefits provides some control over funding impacts on PSERS and SERS. However, no limit is established as a matter of benefit policy under any of the proposed measures, save for the maximum increase amount set on the ad hoc increase itself. This creates the possibility of increases being made in an amount or when such increases are not affordable.
None of the three Pennsylvania bills—SB 864, HB 1415, and HB 1416—establishes a cost-of-living adjustment that aligns with best practices.
The historical ad hoc nature of COLA benefits for PSERS and SERS does allow the General Assembly discretion to make or not make such awards as it deems appropriate. However, the result would be another level of unfunded liabilities that must be paid for.
If the General Assembly makes a policy judgment to move forward with these bills, a better approach would be to fund the cost immediately rather than pay for it over time with money from future taxpayers. Further, to break the cycle of continuing down this same road for future retirees, consideration should be given to establishing a policy that either supports or rejects a regular COLA benefit that is automatic and recurring, pre-funded, and also subject to change if necessary.
While the intentions behind the SB 864, HB 1415, and HB 1416 supplemental annuity increases are understandable, and it is desirable to protect retirement income security for retired public employees, the current poor funding condition of PSERS (68% funded) and SERS (62% funded) should give lawmakers pause in taking these actions without first evaluating how the costs of these supplemental benefits fits within the core retirement benefit and other funding priorities for Pennsylvania.
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