Crisis averted?

It appears that the state legislature is about to take action that will defer the worst of the pain that was about to hit school district budgets as a result of the underfunded state pension system for school employees (PSERS).

Even more remarkably, a compromise was reached – approved in the House by an astonishing vote of 199-0 - that at least begins to address some of the long-term issues. (For new members of the state retirement plan, the “multiplier” will revert to 2% from 2.5%, vesting will occur at 10 years instead of 5, and new members would be prohibited from withdrawing lump-sum contributions at retirement.)

Although I am surprised at the speed with which this deal was struck - in the thick of the annual budget debate - I always considered it politically inevitable. There was never any possibility that the legislature would allow the 29.3% increase in the employer retirement contribution that was projected for fiscal year 2012/13 to go into effect. School boards and taxpayers would have revolted (and blamed the legislature).

More to the point, without legislative action, the Commonwealth – which is responsible for half of the employer cost of PSERS and for all of SERS – would have had a hard time producing balanced state budgets given the projected increases of 10.6%, 29.2% and 32.1%. The corresponding increases are now expected to be 8.7%,12.2%, and 16.7%. (Next year’s rate is still up in the air.)

But before we get too happy, it should be noted that under this proposal, most of the pain will be diverted until sometime after most current legislators have left office. That’s a fair criticism - but it’s not quite as bad as its being made out to be.

(a little math..)

Some of you business/finance majors will recall the concept of “present value”. In short, what that means is that $10 in your pocket today is more valuable than having it 10 years from now. The reason is that you could invest your pocket money at 2% annual interest, and in 10 years you would have about $12.20. So the “present value” of having $12.20 10 years from now is: $10.00. Of course, this calculation depends entirely on what interest rate is used.

In the case of a school district that is likely to borrow hundreds of millions of building construction dollars over the coming decades, the better analogy is this: having 10 dollars in your pocket today is 10 dollars you won’t have to borrow. Assuming a conservative borrowing rate of 4%, $10 today is worth $14.80 ten years from now – and $30.80 thirty years from now.

What are the implications? The proposed changes to the retirement contribution rate would result in districts spending considerably less in the “near years”, but considerably more in the out years. When you add up all the numbers, under this legislation, State College could end up spending an additional $44 million dollars in retirement costs over the next 30 years.

But that doesn’t take into account present value. When you do the math, assuming a conservative 4% borrowing rate, the difference between the savings in the early years and the additional costs in the out years is about $3.3 million in 2041 dollars, or about $1 million in current dollars. (I did this by converting each year’s savings/costs into 2041 dollars, and adding them up.)

It’s not $44 million, but a million dollars is still real money. With a little more “front-loading” we might have broken even.