articles Ratings /ratings/en/research/articles/220719-pension-spotlight-pennsylvania-12437393 content esgSubNav
In This List
COMMENTS

Pension Spotlight: Pennsylvania

COMMENTS

Hurricane Ian: Most Municipal Utility Ratings, Bolstered By Significant Liquidity, Are Expected To Be Unaffected

COMMENTS

Russia-Ukraine Military Conflict: Key Takeaways From Our Articles

COMMENTS

Cyber Risk In A New Era: U.S. Colleges And Universities Go Back To School On Cyber Security Preparedness

COMMENTS

Recent Pension Funding Gains For Largest U.S. Cities Are Expected To Be Short-Lived


Pension Spotlight: Pennsylvania

image

Credit Fundamentals By Sector

Commonwealth of Pennsylvania: S&P Global Ratings considers Pennsylvania's unfunded pension liabilities to be moderately high, compared with its population and income levels. Historically, its funding discipline was somewhat weak, but it improved in the past two years. Contribution levels in recent years have met actuarially determined levels and are now covering our calculation of minimum funding progress (MFP). However, we anticipate significant additional funding will still be required to keep the commonwealth's pension liabilities from growing.

Local governments: Most local governments (LGs) administer single-employer uniform and non-uniform plans. Funded status varies by municipality, but most are fairly well funded, therefore pension costs are not a current stress for most local governments. However, there are several poorly funded plans throughout the commonwealth and we expect the cities, townships, and boroughs with poorly funded single-employer pension plans, limited revenue-raising flexibility, and weak demographic trends will face budgetary pressure from rising pension obligations.

School districts: Budgets are pressured by rising pension costs, and long-term challenges persist, with a low funded ratio and weaker actuarial assumptions. However, contribution rate increases have leveled off somewhat, and Pennsylvania currently funds approximately 50% of district pension costs, mitigating short-term budget pressure.

Plan Summaries

Pennsylvania has three statutorily established defined benefit pension plans:

  • PSERS: A cost-sharing multiple-employer plan that provides retirement benefits to public school employees in Pennsylvania;
  • Pennsylvania Municipal Retirement System (PMRS): An agent multiple-employer plan that provides retirement benefits to participating municipalities municipal employees; and
  • Pennsylvania State Employees Retirement System (SERS): A cost-sharing multiple-employer plan that provides retirement benefits to state employees in the commonwealth.

There are also many LG-administered single-employer plans throughout the commonwealth.

Forward-Looking View Reflects Reduced Risk For All Major Plans

PSERS and SERS lowered their discount rates to 7.000% from 7.250% and 7.125%, respectively, which we believe reduces the risk of market volatility affecting contributions. However, we still view this risk as elevated as it remains above our 6.0% discount rate measure in our pension guidance. PSERS also lowered payroll growth assumptions to 3.25% from 4.00%, which reduces contribution deferrals, but we still view the assumption as a risk since it remains more than 1.0% above our long-term inflation guideline of 2.4%.

PSERS

PSERS' funded ratio dropped significantly during the 2000s because of poor investment returns relative to the high expectation as well as persistent underfunding of actuarially recommended contributions. This triggered a series of reforms to shore up the plan. Act 120 of 2010 made various funding and actuarial changes, including reduced benefits for new members hired after July 1, 2011, and a shared-risk provision that increases employee contribution rates for new members when investments underperform. Act 120 also set a schedule for increased employer contribution rates (subject to annual caps) to improve the funding of the plan. Act 5 of 2017 made further reforms including limiting new members hired after July 1, 2019, to the choice of two hybrid plans and a defined contribution plan.

In our view, these reforms helped stabilize PSERS' funded ratio but at a detriment to school district budgets. Between 2010 and 2017, the total employer contribution rate increased sharply to 30.03% from 4.78%. Today, pension and other postemployment benefits (OPEB) costs often comprise nearly 15% of a district's budget, which we view as elevated and a credit pressure. On a cash basis, total annual employer contributions to PSERS increased to $4.75 billion in 2021 from $535.3 million in 2010. 2017 was the first year the commonwealth met its actuarially required contribution in 15 years.

Chart 1

image

Following a period of acute stress on school district budgets, employer contribution rates have leveled off somewhat, although they remain elevated, and we believe they will continue to be a pressure for district budgets. The PSERS' board of trustees approved an employer contribution rate of 35.26% for fiscal 2023, and PSERS projects that this will increase to 37.3% by fiscal 2030, representing more gradual annual increases than those incurred between 2010 and 2017. Pennsylvania also funds approximately 50% of the district's pension costs, somewhat mitigating budgetary pressure, but this is not statutory, and therefore we believe there is risk state support could potentially diminish in the future.

Despite reforms and increased contributions, PSERS' funded ratio has not materially improved in recent years and challenges persist. Although recent contributions have met static funding levels, they have failed to meet our MFP metric, reflecting our view that the plan is unlikely to make measurable progress in paying down the unfunded liability. Employer contributions to the plan are actuarially calculated using a 3.25% closed-layered level of pay amortization over a long 24-year period, a method that we believe could defer costs and result in slow funding progress. The assumed return and discount rate was recently reduced to 7.0%, but it remains above our discount rate guideline, which we believe could lead to future cost volatility due to an aggressive portfolio that includes alternative investments comprising nearly 25.0%.

There are ongoing FBI and SEC investigations involving PSERS, concerning an incorrect calculation of investment returns (that has since been rectified), the purchase of real estate, and alleged kickbacks and bribery. At this time, it is uncertain how these investigations might affect the commonwealth or its school districts, but we will continue to monitor the situation to determine the financial impact, if any, on future pension costs.

Act 120 prohibits the use of pension obligation bonds (POBs) to fund PSERS.

PMRS

In general, LGs' PMRS liabilities are relatively small compared with budgets as the plan's overall funded ratio was 100.4% as of Jan. 1, 2019 (the most recent data available), although liabilities and funded ratios vary by LG. PMRS' assumptions are generally conservative, with the assumed rate of return at 5.25%, which limits the risk of cost escalation due to market volatility, although the payroll growth assumption varies from 2.80%-7.05%, with an average of 4.30%, depending on the LG, and we consider an assumption well above long-term inflation to be deferring costs to the future. Currently, we do not believe the plan poses a significant budgetary pressure to most participating LGs.

SERS

SERS provide pension benefits for 102 employer state agencies and other organizations. The plan does not have a crossover date since the assumption is, from now on, that contributions will be made at contractually required rates, which increased the full actuarial recommendation; in the past two years, contributions to SERS surpassed MFP, which we view positively.

In June 2017, Pennsylvania enacted pension reforms that address its long-term liabilities. The retirement age was increased and makes changes to the salary component of the pension benefit formula for these retirees. Furthermore, new employees hired after Jan. 1, 2019, have three options:

  • Contribute 8.25% of salary and split retirement benefits between a guaranteed pension and 401(k)-style investments.
  • Contribute 7.5% of salary in return for a guaranteed pension base on 1.0% of the employee's final average salary times years of service, supplemented by a 401(k)-style benefit.
  • Participation in a full defined contribution plan.

LG Single-Employer Plans

Unlike school districts, pensions are not a pressure for most LGs in Pennsylvania as liabilities are relatively small compared with budgets and funded ratios are at least adequate. Most counties and municipalities administer their own defined benefit plans, often one for uniformed employees and a second for non-uniform employees, although it varies by LG unit. Contributions are usually based on an actuarial recommendation, but assumptions are usually aggressive with the assumed rate of return often higher than 7.0%, indicating acceptance of market volatility, and payroll growth assumptions are often high as well, which directly defers costs to the future; therefore we believe there is risk of cost escalation.

Chart 2

image

For those municipalities with poorly funded systems, including the cities of Philadelphia and Pittsburgh, as well as Allegheny County, we often view their pension liability as a credit risk. About 7.0% of the municipalities in our rated universe only offer a defined contribution plan for employees which, in our view, should keep costs low in the future as there are no long-term unfunded liabilities. Funded ratios for county plans are stronger than we see at the municipal level, with nearly all plans being in excess of 80% funded.

Chart 3

image

OPEB

PSERS offers a health insurance premium assistance program for eligible retirees. The program is a cost sharing, multiple-employer OPEB plan that provides retirees premium assistance payments equal to the lesser of $100 per month or their out-of-pocket monthly premium. While the OPEB risk is partially mitigated by a benefit cap, essentially limiting this benefit to a pension-like stipend, OPEB plans are funded on a pay-as-you-go basis, which we consider negatively as deferring costs.

Most, though not all, counties and municipalities offer OPEB plans to employees, often on a pay-as-you-go basis, which we consider to be deferring costs. However, for most credits, we do not view these costs as a current credit pressure as costs are manageable.

Pennsylvania's OPEB liabilities present moderate risk, in our view. However, we anticipate the state's net OPEB liability (NOL) will increase in the future primarily due to the current pay-as-you-go funding approach, absent further meaningful reform efforts. Pennsylvania participates in six OPEB plans, most of the commonwealth's liability lies with the Retired Employees Health Program (REHP) and the Retired Pennsylvania State Police Program (RPSPP). Both the REHP and RPSPP are single-employer, defined-benefit plans that are provided as a part of collective bargaining agreements with labor unions.

In the past, Pennsylvania took some steps to contain growth of unfunded retiree health care liabilities. In 2008, the commonwealth created irrevocable trust accounts to advance-fund the REHP and RPSPP, but OPEB plans continue to be typically funded on a pay-as-you-go basis. Other efforts include increased employee contributions, raising the years of service for early retirement to 20 years from 15, introducing alternative plans, and offering the option for employees to enroll in a Medicare health management organization or preferred provider organization plan.

Appendix

Plan Details As Of June 30, 2021 Plan Comprehensive Annual Financial Reports (PSERS) Or Jan. 1, 2021 (SERS)
(Mil. $) PSERS SERS S&P Global Ratings' view
Funded ratio 63.67 75.50 Poorly funded plans rely more on contributions since they have less assets to grow in line with liabilities. Funded ratios below 40% are considered extremely poor and potentially face spiraling effects due to liquidity risk.
Discount rate 7.25 7.00 A discount rate higher than our 6% guideline indicates higher market-driven contribution volatility than what we view as within typical tolerance levels around the country.
Total plan ADC ($) 4,759 2,871 Total contributions to the plan recommended by the actuary.
Total actual contribution ($) 4,759 2,871 Total contributions to the plan that were made last year.
Actual contribution as % ADC 100.00 100.00 While funding discipline has improved for PSERS, payments have not, historically, always met ADC.
Actual contribution as % MFP 91.20 137.70 Under 100% indicates funding slower than what we view as minimal progress. Increased contributions in the last two years resulted in SERS exceeding our MFP calculation; however, due to statutory contributions for PSERS we expect this to continue to be under 100%.
Actual contribution as % SF 122.63 181.50 Under 100% indicates negative funding progress, but both plans have exceeded our SF contribution in recent years.
Amortization method:
Period Layered Closed A closed funding period ensures the obligor plans to fully fund the obligation during the amortization period.
Length 24 21 Length greater than 20 generally correlates to slow funding progress and increased risk of escalation due to adversity.
Basis Level % of payroll Level $ of payroll Level % explicitly defers costs, resulting in slow or even negative near-term funding progress. Escalating future contributions may stress affordability.
Payroll growth assumption 3.50 3.30 The higher this is, the more contribution deferrals are incorporated in the level percent funding methodology. There is risk not only of market or other adversity causing unforeseen escalations to contributions, but of hiring practices not keeping up with assumed payroll growth leading to contribution shortfalls.
Longevity Generational Static A generational assumption reduces risks of contribution “jumps” due to periodic updates from experience studies.
SERS--Pennsylvania State Employees Retirement System. PSERS--Pennsylvania Municipal Retirement System. ADC--Actuarially determined contribution. MFP--Minimum funding progress. SF--Static funding.

This report does not constitute a rating action.

Primary Credit Analysts:Bobby E Otter, Toronto 1-647-480-3517;
robert.otter@spglobal.com
Benjamin D Gallovic, Chicago + 1 (312) 233 7070;
benjamin.gallovic@spglobal.com
Secondary Contacts:Geoffrey E Buswick, Boston + 1 (617) 530 8311;
geoffrey.buswick@spglobal.com
Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490;
Todd.Kanaster@spglobal.com
Randy T Layman, Centennial + 1 (303) 721 4109;
randy.layman@spglobal.com
Jillian Legnos, Hartford + 1 (617) 530 8243;
jillian.legnos@spglobal.com
Christian Richards, Washington D.C. + 1 (617) 530 8325;
christian.richards@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.


Register with S&P Global Ratings

Register now to access exclusive content, events, tools, and more.

Go Back