Earlier this month, Gov. Matt Bevin released a video update on the public pension crisis facing the commonwealth. He said the unfunded liabilities are so dire that the retirement plans run the risk of becoming insolvent.
“And if they were to become insolvent, the [benefit] checks literally would not come,” Bevin warned.
But the governor also sought to reassure current retirees as well as current employees and those considering future employment with the state.
“We are going to save the pension system,” Bevin said. “We have a legal and a moral obligation to those of you who are retired to fulfill the promises that have been made to you.”
As lawmakers await the call for a special legislative session to reform the state retirement systems, KET’s Kentucky Tonight explored the roots of the pension problem and options for fixing it. The guests were Dave Adkisson, president and chief executive officer of the Kentucky Chamber of Commerce; Jason Bailey, executive director of the Kentucky Center for Economic Policy; William Smith, a member of the pension reform team at the Bluegrass Institute for Public Policy Solutions; and Stephanie Winkler, president of the Kentucky Education Association.
The Roots of the Problem
The Chamber’s Dave Adkisson says he expects a special session to be called in mid- to late October. He agrees that the state must fix the pension problem in a balanced, fiscally responsible way while honoring the promises made to public workers. He says some 550,000 active and retired state employees and teachers are directly impacted by the crisis.
As a teacher and a member of a state retirement plan, the KEA’s Stephanie Winkler says the governor’s video did provide some assurances to state employees.
“Everyone has a lot of angst (who works in the public sector) about public employee pensions,” Winkler says. “As much as I am thankful that the governor sees that this is a priority, I also didn’t hear a specific fix or a plan and that’s really what I think people want to hear.”
But how lawmakers decide to resolve the crisis depends in part on what they believe to be the source of the problem. Jason Bailey of the Kentucky Center for Economic Policy contends the unfunded liabilities stem from the state’s failure to make the full actuarially required contributions (ARC) into the systems over several years. That debt compounded over time and is now estimated to be somewhere between $30 and $80 billion.
Bailey says the state’s contribution to employee benefits (about 6 percent of employee pay) is comparable to what a private sector employer pays into Social Security. He argues that the state plans, when properly funded, are a vital component of employee compensation.
“Over time because of the investment returns of a large system like the state operates, they can earn high returns and deliver a decent – not exorbitant – benefit,” says Bailey. “So it’s a very efficient way to, at a low cost, deliver a benefit that’s valued by people and can attract qualified workers to the public sector.”
In contrast William Smith of the Bluegrass Institute for Public Policy Solutions argues that the problem isn’t so much the ARC payments as the benefits. He says the state pension plans were designed to support “actuarially prefunded benefits.” That means the benefits given to retirees were approved in advance by lawmakers and funded in advance by the contributions of employees and their employers (the state or local governments). As long as the benefits don’t change, investment returns meet their targets, and payroll contributions are properly made, the system would be fully funded, says Smith.
But the system began to unravel, he says, when the legislature approved retroactive enhancements to benefits, especially during economic boom years, without making the requisite changes to the payroll contributions and investment assumptions to ensure that the state would have the money to pay those benefits well into the future. He says that strategy assumes that future employees and employers will have unlimited moneys to cover all of the benefits retroactively awarded decades ago.
“When they had excess funds, they enhanced benefits retroactively,” Smith says. “When the market corrected, that exposed those enhancements and the unfunded liabilities were the result.”
When lawmakers failed to properly make the actuarially required contributions, they were simply slowing down the repayment of that debt, according to Smith.
Should Benefits Be Cut?
Smith takes the view that employees and teachers earn their benefits one year at a time, and those benefits are protected from any changes by the inviolable contract with employees. But benefits that have yet to be earned for future years of service are not yet protected, Smith argues, so lawmakers could change them and probably should, he says.
“The question is whether or not you can change any benefit for anyone who is actively employed, and that’s really a debate that needs to occur,” says Smith. “We think defined benefit systems are fine going forward and we think that needs to be done properly from an actuarial basis, not based on a date of hire.”
Winkler says KEA’s interpretation of the inviolable contract with teachers is that their hiring date determines what benefits an individual will receive.
“So to say that you’ve only accrued benefits up to what you’ve worked, it just doesn’t make sense to me,” Winkler says. “You’re told on day one when you start, this is how much you’re going to earn and this is what the expectation is. It’s a promise that we’re trying to renege as a state on.”
Smith is also critical of teachers who apply accumulated sick days to their last year of work. That boosts their ending salary, which raises the retirement pay they’ll receive. Smith says it’s possible for a teacher to increase their retirement benefit by $10,000 a year.
“The benefits are extraordinary,” says Smith. “A teacher can retire with 32 years of service if they accumulate enough sick days and have more spendable income post-retirement than they did pre-retirement, which means their first check after retirement exceeds the last check they received when they were working.”
Winkler acknowledges that such spiking can occur but she contends it is rare. She says educators don’t like being away from the classrooms and it’s difficult to find a substitute teacher to fill in when they are absent.
“To say that teachers just save up sick days to spike their pension is an insult to any teacher,” says Winkler. “We have one of the highest attendance rates for public school systems in the country and we’re there because we want to be there for those kids.”
She adds that eliminating spiking wouldn’t fix the Kentucky Teachers’ Retirement System funding crisis because she says sick days only account for $30 million out of a $1.1 billion pension system.
Since the current debts are from retirement benefits already earned, Bailey says slashing benefits going forward won’t reduce the unfunded liabilities but it would make it harder for the state to attract good workers in the future. He says state employees have already endured several rounds of benefit cuts with the reforms passed in 2008 and 2013. Enacting even more cuts could also lead some workers to retire early, such as thousands of teachers who are currently eligible to take retirement.
“We talk about these cuts as if they’re saving money, but there are consequences from doing that that absolutely have to be taken into account and they’re very dangerous,” says Bailey.
Adkisson says benefits that fall outside of the inviolable contract should be adjusted, but he agrees that lawmakers should do so very carefully.
“If you just immediately went out and did away with certain benefits and 14,000 eligible teachers retired, you’d have an unintended consequence… that would be disastrous for the system because those people wouldn’t then be paying into retirement,” says Adkisson.
Other Possible Reforms
The reform options that the Kentucky Chamber recommends include requiring public employees to reach a certain age before they receive full health and retirement benefits. Adkisson says that would put the state workers in line with how the private sector operates. The chamber also advocates having retirees pay more towards their health insurance and moving all new hires among state and local employees into a 401(k)-type system. (Adkisson says it doesn’t make financial sense to move new teacher hires into a 401(k) at this time.)
“That’s not draconian, that’s not against public employees,” says Adkisson. “We want the best and brightest to be willing to serve the public… but clearly we have problem that we’ve got to fix.”
Bailey argues against the 401(k) idea for several reasons.
“Very few states have moved workers to 401(k) because it actually costs more,” Bailey says, “and in a state like ours, where we have one plan that’s so severely underfunded, we don’t want to make it even harder to pay down that unfunded liability.”
Without new hires paying into the old pension plans, Bailey says solvency will become an even bigger issue. He says West Virginia moved their teachers into a 401(k) plan in the early 1990s, but then moved them back to the state retirement system because of higher costs, low investment returns, and much lower personal savings on the part of the teachers.
Smith says he prefers the current system so long as the benefits are adequately funded.
“There’s nothing wrong with a 401(k) plan,” says Smith, “but we think a properly managed defined benefit plan works well, gives higher benefits, and is more efficient.”
Smith says the state treasurer should administer all public employee retirement plans in conjunction with an independent actuary oversight board to ensure that the plans follow proper actuarial decisions and assumptions. He says under the current system, the actuaries serve as fiduciaries for the plan members. That can lead them to make assumptions that the members like but that may be fiscally flawed.
Adkisson supports that idea and says having independent actuarial oversight would reduce the chances that the state plans would rely on poor financial assumptions.
“Regardless of well-intentioned and how brilliant the actuary is working for either of the two retirement systems,” Adkisson says, “we need a group of actuarial experts looking that over… That would’ve helped us a bunch over the last 10 years.”
In the end, Adkisson says it will take both extra money going into the systems and structural changes to the pension plans to address the unfunded liabilities.
Which Comes First? Pensions or Taxes
The governor originally proposed one special session to address pension and tax reform at the same time. Now it looks like the two issues will be addressed separately, with pension reform coming up first. Adkisson says he has no particular preference for whether lawmakers tackle pensions and taxes simultaneously or separately so long as they get both jobs done.
“You can make a strong argument that you have to define the pension problem before deciding how you’re going to pay for it,” says Adkisson. “If you did tax reform first, you’d basically be saying how much money do we have to spend, then that will tell us how much we have to discipline ourselves later.”
Winkler disagrees with the strategy of tackling pensions before taxes.
“I don’t understand how you can reform this huge debt that we have without finding new revenue as a way to fix it,” Winkler says. “I think we’re putting the cart before the horse and I think we’re focusing on the wrong thing first.”
Whatever happens, Winkler says she hopes the governor and lawmakers will take a bipartisan approach to reform.
“We want to help them but we can’t do it with grandstanding and one-sided party methodologies where we don’t reach out across the aisle,” Winkler says. “We’ve got to work together.”
Bailey says it will take years to fully fund the plans, which is fine, he says, so long as the state gets on a trajectory to pay down the debts.
“The problem we have is we have a tax code that has been plugged full of holes,” Bailey says of the plethora of state tax breaks already on the books. “That reduces the revenue and leads to situations where we don’t make the actuarially required contribution year after year after year.
Heading into the 2018 budget sessions, Bailey says expenses will far outmatch available dollars. Unless lawmakers do something to generate more revenues, Bailey warns the budget cuts will be “massive.” Adkisson predicts that next year’s budget debates will be the hardest since the recession started a decade ago.
With public education already struggling in the commonwealth, Winkler warns that further funding cuts could have devastating ripple effects. Since school districts are often the largest employers in many small counties, Winkler says fewer teachers, administrators, and support staff on the payrolls would hurt the economies of those rural communities.