This summer, the Pennsylvania Department of Auditor General released its annual report on municipal pension plans, with mixed results.

The data provided by the Auditor General and reported by Pennsylvania Capital Star revealed that “22 percent of Pennsylvania’s municipal pension plans statewide are in some form of financial distress,” but “the good news is that the number of distressed pension plans has dipped since 2020.” Of the pension plans analyzed, net liabilities exceed net assets by $7.2 billion.

The data provided in the report paints an incomplete picture. Many local government pension plans are not required to provide data annually to the Commonwealth. More worrisome is that local governments have actuarial tricks at their disposal that can fudge a pension plan’s health. This should concern average Pennsylvanians and policymakers alike.

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Municipal and county pension plans must be understood within the context of local government in Pennsylvania. As I reported earlier in Broad + Liberty, Pennsylvania’s system creates a dense web of municipalities, municipal authorities, and county governments. Most of these units of local government have at least one pension plan. Many have more than one, such as having separate pension plans for police officers and non-uniform employees. This results in a high number of local government pension plans in Pennsylvania.

Pension plans are administered by retirement boards. In counties, the retirement board is composed of three commissioners, a treasurer, and a comptroller. Counties without a comptroller have the chief clerk serve on the board instead. State law does not specify who serves on the retirement board for some classes of municipalities, which can result in poor administrative control. In many cases, members of a retirement board are also future beneficiaries of the pension plan they oversee, which creates a conflict of interest.

A spokesperson for the Auditor General explained which municipalities are subject to annual reporting. “Municipalities that wish to participate in the General Municipal Pension System State Aid Program [must] certify certain information to the Department of the Auditor General each year.” The spokesperson went on to explain municipalities have an incentive to participate in the State Aid Program since it “reimburses municipalities for either a portion (or in some cases, all) of their employer contributions.”

Since not all local governments participate in the State Aid Program, a comprehensive assessment of local government pension plans is unavailable. The last time Pennsylvania’s state government did a comprehensive assessment was in 2014 when the previous Auditor General released an analysis. The analysis found that of “[t]he 1,223 local municipalities that administer pension plans” they “offer approximately 2,600 pension plans in total, of which 1,935 … are audited by the Department of the Auditor General.” That means the health of approximately 700 municipal pension plans is difficult to determine as they are not subject to the annual reporting process.

But this is just the tip of the iceberg.

Until these institutions get serious and confront the problem, Pennsylvanians can expect more fudge.

Not only are many pension plans not required to submit annual data to the Auditor General, but local government retirement boards have two powerful tools at their disposal to distort the stability of a pension. The unhealthier a pension, the more enticing these actuarial smoke screens become. This means the health of pension plans throughout the Commonwealth is likely overestimated. Just how much is impossible to quantify without additional data.

The first trick is to use an unrealistic rate of return, which means a pension plan overestimates how much money it expects to make from its investments. Return on investment is one of the three principal ways pension plans are supported. The other two are through contributions by future pensioners and employer contributions, meaning the share a local government commits on an annual basis. (As explained earlier, some municipal pension plans also receive conditions-based contributions from the Auditor General.)

The 2014 analysis explains the dangers of an unrealistic rate of return. It states, “If the assumed rate of return is not attained, the earnings on investments will fall short of expectations, and the plan could be underfunded. The shortfall in earnings will have to be offset by an increase in contributions by employees and/or the municipality. If not, the plan will remain underfunded.”

State law limits this potential abuse. As the analysis highlights, “Pennsylvania law currently requires the actuarial rate of return assumption for municipal pension plans to be at least 5 percent but not more than 9 percent.” The selected rate of return also influences via mandated calculations other actuarial assumptions, which dampens the effect.

These constraints only go so far. 

Most local government pension plans reviewed in the 2014 analysis use an actuarial rate of return of approximately seven percent, which is below the historic rate of return of approximately eleven percent for the S&P 500. However, a humble rate of return is appropriate for pension plans since they cannot risk the swings of the stock market and must remain solvent in poor financial times. As a result, a common investment strategy for retirement boards is to invest 60 percent of the pension fund in assets backed by stocks and 40 percent in assets backed by bonds. The bonds are typically safe, low-yield bonds issued by the U.S. Treasury. This investment strategy places high rates of return outside the reach of most pension plans.

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If a pension plan is projecting an actuarial rate of return well above the seven percent average, that means one of two things. Either the pension is engaging in a risky investment strategy or artificially inflating its rate of return to mask the true health of the pension. In either case, it suggests an unhealthy pension plan. The 2014 analysis found that “those pension plans that assumed a higher rate of return are more likely to be underfunded.”

The other actuarial trick is to establish an unrealistically low life expectancy for current and future pension beneficiaries. The consequences can be extreme. The 2014 analysis explained, “if a pension plan has been funded based on the employees’ anticipated average life expectancy of 70 years, that plan will incur an unfunded liability if a retiree lives until the age of 85.” Unlike the actuarial rate of return assumption, no state law reins in the practice.

County pension plans have the same issues, but the problem is magnified. As mentioned earlier, counties are not required to submit annual reports to the Auditor General that establish some level of county pensions’ health. Next, unlike municipalities, the allowable actuarial rate of return is not capped for counties. County retirement boards may exceed a nine percent assumption. The health of county pension plans in Pennsylvania is even more opaque than it is for municipalities.

Reforms have been proposed to increase pension plans’ transparency and limit actuarial malpractice. These reforms have been ignored by the General Assembly in Harrisburg. For instance, the 2014 analysis proposed reforms such as “narrowing the range of acceptable investment rate of return assumption[s]; mandate that each municipality publish its annual pension plan costs, by plan, for public review;” and encourages all plans “to consider using low cost, conservative method of investing based on index investing.”

While some local governments have adopted a mixture of these recommendations, no statewide push for reform has occurred. When asked if the Auditor General has proposed reforms, the spokesperson noted, “Part of the auditing process, particularly with performance audits, is to make recommendations on how government can be more efficient and the appropriate use of tax dollars [sic]. While we haven’t made specific recommendations to the General Assembly regarding municipal pension funds, we do make recommendations where appropriate to each entity we audit.”

The Auditor General plays a vital role in providing transparency and correcting wayward municipalities. However, the Department is limited in authority by legislation and resource constraints. The lack of transparency into local government pension plans, and the ability of retirement boards to deploy actuarial tricks to conceal the health of pension plans, can only be corrected by the General Assembly or local governments themselves.

Until these institutions get serious and confront the problem, Pennsylvanians can expect more fudge.

Seth Higgins, a native of Saint Marys, Pennsylvania, specializes in bringing conservative thought to local government. Seth is a former Tablet Magazine Fellow and is currently a Krauthammer Fellow with The Tikvah Fund.