By Hilary Russ
(Reuters) - Pennsylvania Governor Tom Corbett has proposed a fix for his state's poorly funded public pension systems, but some say his medicine could be worse than the illness.
Corbett's plan, presented as part of his fiscal 2014 budget, would add another $5 billion to the state's $41 billion-and-growing unfunded liability, while a measure to save money by reducing benefits could get tangled up in litigation for years.
By scaling back increases in pension contributions from the state and Pennsylvania's school districts, the Republican governor expects savings of $175 million in fiscal 2014, helping to ease immediate financial pressures for the budget that must be approved by June 30.
But that would widen the public pension gap.
"We're already putting in less than we should, so now we're going to put in less than that," said James McAneny, executive director of Pennsylvania's Public Employee Retirement Commission, an advisory group required to analyze all proposed pension legislation in the state.
To offset the reduced contributions, the plan cuts future benefits for current employees - something likely to be challenged in court - and moves new hires to a 401(k)-style defined contribution plan. Private companies often use such plans, but they are controversial in the public sector.
"A budget that's predicated on savings from changes in the pension contribution is, we think, a house of cards," said Sharon Ward, executive director of the left-leaning Pennsylvania Budget and Policy Center.
CREDIT RISK A CONCERN
Many of America's public pension systems are collapsing. Illinois' pensions are $97 billion in the red and are funded at 39 percent, the lowest rate of any state in the country. About 20 states, including Pennsylvania, are below 70 percent funded.
The challenge is to save the systems without bankrupting the local and state governments that help fund them - while keeping benefits attractive enough to lure good workers.
Pennsylvania and several other states fueled the problem by not making full contributions when investment returns were soaring during the stock markets boom. In some cases, states and cities also promised oversized benefit packages to workers when times were good.
Now, most states have made changes to create more manageable systems. Wall Street credit rating agencies are also putting more pressure on states to clean up their pension problems.
Laura Porter, who leads the U.S. state ratings group at Fitch Ratings, said Fitch's negative outlook on Pennsylvania is clearly tied to pension pressures on the state budget.
In July, the agencies warned Pennsylvania about the high cost of its pension system. Moody's Investors Service downgraded the state's general obligation debt to Aa2 from Aa1 and pointed to weak state pension funding.
A few days later, Standard & Poor's Ratings Service lowered its rating outlook on Pennsylvania's AA-rated debt to negative from stable, saying it was concerned about mounting spending pressure for public pensions amid a slow-growth economy.
Corbett's pension plan was crafted by the governor, his Budget Secretary Charles Zogby and budget staffers, with the outside consultant Milliman Inc under a $300,000, two-year contract, according to budget spokesman Jay Pagni.
TAX HIKES, POLICE OR PENSIONS?
When revenue growth is sluggish, fully funding pensions means having to choose between raising taxes or cutting services.
Though they have not made full payments for years, some states, including Pennsylvania, have been contributing more each year for the past several years. Those larger contributions are absorbing a bigger portion of revenues but still cannot keep pace with ballooning costs amid a sluggish U.S. economic recovery.
In 2010, Pennsylvania raised the retirement age to 65. It also limited how much public employers would have to increase contributions, with annual increases capped at 4.5 percent after fiscal 2013.
Corbett's proposal would push off that plan. For fiscal 2014, the increase would be limited to 2.25 percent, rising 0.5 percentage point annually to 4.5 percent.
"You might give yourself some short-term breathing room, but you're going to give your taxpayers down the line a much bigger bill," said Diane Oakley, executive director of the National Institute on Retirement Security. "They had a plan. They need to let it continue to work."
Pennsylvania's two pension funds, one for state employees and one for public school employees, are funded at about 68 percent combined, less than the 80 percent considered healthy.
"This is hardly a time to be reducing or moderating contributions downward," said Richard Dreyfuss, senior fellow at the conservative Manhattan Institute. "The liquidity, solvency and viability of the plan would be further jeopardized."
Corbett's plan would reduce benefits earned by current employees going forward, a move usually challenged by unions.
Pension reform in Rhode Island in 2011, often hailed as one of the most far-reaching, is still embroiled in such litigation.
In Pennsylvania, the reform is likely to be challenged under state contract law, said Jean-Pierre Aubry, assistant director of state and local research at the Center for Retirement Research at Boston College.
Pagni, of the state budget office, said that attorneys had advised the governor that changes to prospective benefits are permitted by law.
Without any reform, the combined unfunded liability is projected to peak at $65 billion in 2018. Alone, the proposed new limits on employer contribution would increase that liability to $70 billion that year.
With cuts to current employees' future benefits the liability would actually drop to just about $62.5 billion, budget documents show.
"You can't do one without the other," Pagni said.
(Editing by Tiziana Barghini and Leslie Gevirtz)