What’s the Next Step in Public Pension Reform for Kentucky?

By John Gregory | 7/30/19 8:00 AM

Last Wednesday, as he signed the pension bill that state lawmakers had just passed, Gov. Bevin hailed the legislation as “a remarkably responsible and appropriate next step” in moving the state’s ailing retirement plans toward solvency.

But the temporary relief from soaring pension costs that House Bill 1 provides to regional universities and quasi-governmental agencies like health departments and mental health centers is fleeting at best, according to some critics. At worst, they say it could still drive some of those agencies into bankruptcy, slash retirements for thousands of employees, and further weaken the public employees pension plan.

And that’s if the new law can withstand the legal challenges that are likely to be filed against it.

To explore the pros and cons of HB 1 and other options for helping the beleaguered quasi-governmental agencies, KET’s Kentucky Tonight spoke with Sen. Stephen Meredith (R- Leitchfield), a member of the Senate Appropriations and Revenue Committee; Jason Bailey, executive director of the Kentucky Center for Economic Policy; Chris Tobe, pension consultant and author of “Kentucky Fried Pensions;” and Jim Waters, president and CEO of the Bluegrass Institute for Public Policy Solutions.

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House Bill 1 Provides a ‘Pathway Forward’

As a result of new actuarial assumptions adopted by the Kentucky Retirement Systems, the state’s regional universities and quasi-governmental agencies faced a near doubling of their pension obligations this year. That left many local health departments, rape crisis centers, domestic violence shelters, and other similar agencies with the prospect of shedding employees to cut costs or closing their doors.

House Bill 1 freezes for one year the pension payments required of these entities at the current 49 percent of an employee’s salary. Then in April 2020, those agencies must decide whether to stay in KRS and pay 84 percent of their payroll to the pension plan or exit the system.

Those that leave must pay their pension obligation in a lump sum or in installments over 30 years. They also have to move their employees, even the so-called Tier 1 and Tier 2 government employees hired before 2014, out of their existing defined-benefit pension plan into a 401(k)-type retirement plan.

The bill proposed by the Bevin Administration squeaked through the House of Representatives during the recent special legislative session on a 52-46 vote, with nine Republicans joining all Democrats to oppose the measure.

The Senate passed the measure 27 to 11, with only two Republicans breaking ranks in that chamber.

“I take some consolation that I didn’t create the situation,” says first-term Sen. Stephen Meredith, who voted for HB 1, “but I take pride in that we are trying to address it… This is a pathway forward for everyone.”

The senator says HB 1 caps the liability the quasis will face and maintains retirement benefits their employees have already earned. Plus he contends the new 401(k) they will receive if their agency leaves KRS is a better deal than their current defined-benefit pension.

“There’s a reason why the private sector has gone to 401(k)s,” says Meredith. “It’s not just because they save money, but it’s easier to administer and I think it’s more secure for people because it’s their money.”

An ‘Illegal Manipulation’ of Assumptions

Critics agree with the move to lock in the lower pension contribution rate for another year, but they otherwise argue that HB 1 seeks to solve a problem that shouldn’t exist in the first place.

“I think the real thing that set off this crisis was the, what I think, illegal manipulation of the assumption rates at the KRS board level,” says pension consultant Chris Tobe. “This is one of the most political, corrupt things that has ever happened in Kentucky government.”

In 2017 the state’s pension plans adopted more conservative assumptions about investment returns and payroll growth that are used to calculate how much the retirement systems need to stay solvent. That adjustment meant employers in the plans and taxpayers helping to fund them were immediately on the hook for more money.

“We made 10 to 15 years of assumption changes in one year without the General Assembly then following up with any way to pay for that,” says Jason Bailey of the Kentucky Center for Economic Policy. “That did trigger a crisis.”

Because quasi-governmental agencies have limited options for raising revenue to pay their suddenly higher pension costs, some considered closing, while others fired full-time employees and rehired them as contractors with no retirement benefits. Tobe says that means changes to the actuarial assumptions have been felt far beyond the pension plans.

“When we have a shock this big, it actually hurts the economy because we’re destroying public jobs faster than we’re creating private jobs,” says Tobe.

To make matters worse, according to Bailey, HB 1 doesn’t provide the quasis with any good options to resolve their funding problems. He says many of the agencies won’t be able to afford to stay in KRS at the higher contribution rate, or buy themselves out of it under the payment methods the legislation offers them. In the meantime, he says employees who fear losing their pension benefits may flee the quasi agencies to find work elsewhere in state government where they may feel like their retirements will be protected.

HB 1 will also hurt KRS, says Bailey, by taking active employees and their pension contributions out of the system.

“One of the things that pension systems need are young people paying into the system who won’t need a benefit for decades to come,” says Bailey. “So I’m very concerned about how we’re making the worst-funded pension system in the country more fragile and vulnerable.”

Other Potential Pitfalls

Critics say HB 1 also runs afoul of the inviolable contract that guarantees public employees get the retirement benefits they were promised when they were hired. They argue that switching employees from their pension plan to a 401(k) plan is a violation of that contract.

Bailey says moving a mid-career worker to a defined-contribution plan could cost them as much as $100,000 in future retirement benefits. Tobe says he considers a move from a defined-benefit plan to a defined-contribution plan to amount to a 10 percent pay cut for that employee.

But supporters of the measure say it can withstand a legal challenge. Meredith points to a state Supreme Court decision that allowed the Kentucky Bar Association to exit the state pension system and move its members to 401(k)s. He says that proves the inviolable contract only covers benefits already accrued, not those that may be earned in the future.

Bailey says the Supreme Court action in that matter was merely an administrative ruling, not a legal decision. He says the inviolable contract issue will have to be decided through an actual court case.

HB 1 supporters also contend that those who work for quasi-governmental agencies are not state employees and therefore aren’t covered by the inviolable contract. Bailey rejects that notion as well, saying the quasis are arms of state government, supported by General Fund dollars, and managed by boards that are largely appointed by the state or the governor. He says if the courts allow benefit cuts for quasi-governmental employees, then all other public employees and teachers should prepare to have their retirements reduced as well.

As lawmakers consider future pension reform plans, Meredith says he hopes they will include stricter definitions of who is and is not a state employee.

An Alternative Option

Jim Waters of the Bluegrass Institute for Public Policy Solutions agrees that people who work for quasi-governmental agencies aren’t true state employees because they don’t enjoy the same merit protections as regular government workers. He says that’s just one way the quasis are ill-served by being lumped in with larger state agencies that dominate KRS.

Waters argues that employees of the quasis have different retirement patterns and therefore very different actuarial considerations than other state employees. He contends that’s resulted in the quasis having to contribute far more to KRS than the pension obligations their employees actually create.

“That’s why we propose creating a quasi-governmental employee retirement system within the KRS,” says Waters. “If we created a separate plan that based their payments on what their liabilities are, I think many of them would remain in the system.”

“If we did that, that payment would come down dramatically and it would help greatly address the problem that everybody cares about,” he says.

From his perspective as a former KRS trustee, Tobe says he likes the idea of a separate pension plan for the quasis because he believes it would promote more transparency and accountability within the system. Tobe says he wants to see the County Employees Retirement System separated from KRS as well. The Kentucky League of Cities and Association of Counties have promoted that idea for several years without much support from lawmakers.

Waters also agrees that the revised actuarial assumptions that caused the pension payments to spike were implemented to quickly. And he says that pensions benefits already earned by employees must be maintained, but he’s not certain future benefits qualify to be protected.

More Revenues

Even as policymakers continue to debate the needs of public employees and retirees, Waters says they should also consider the needs of taxpayers. He says 15 cents of every dollar they put into the state’s General Fund already goes to the beleaguered pension systems.

Most lawmakers on both sides of the aisle agree the state needs more revenues, but they differ on how to generate that money.

“We don’t have to raise taxes, but we need to raise tax revenue,” says Sen. Meredith. “We do that by having a fairer tax code.”

The senator says the tax changes that state lawmakers enacted in 2018 were not broad enough and deep enough, but they helped generate thousands of new jobs and billions of new investment in the state. He wants to continue to move the state from an income-based to a consumption-based tax system, and he wants to get more adults into the workforce.

“If we can do this for four more years, it will be amazing what our state will be able to accomplish and that will address a lot of the woes that we’ve talked about today,” says Meredith. “So stay the course.”

Tobe says the public expects government services, but resists paying higher taxes for them because they fear Frankfort is wasting their money.

“To get the trust of taxpayers, I think we need to have more transparency here,” says Tobe, “so that taxpayers feel more comfortable if they have to pay more taxes that it’s being spent wisely.”

Bailey says tax reform needs to include a review of the numerous tax breaks the state offers, not just a slashing of corporate and individual tax rates.

“I’m glad to hear there are discussions of more revenue happening,” says Bailey, “but if we’re doing the thing where we’re cutting the income taxes of the people at the top and shifting [the burden] over to everybody else, that’s not going to be a solution that’s going to work in the long term.”

With additional revenues, Bailey says the state can continue to make the fully required contributions to the pension plans, give pay raises to state employees, and subsidize the pension payments of the most endangered quasi-governmental agencies.

Waters agrees that closing loopholes and making the tax system more transparent are critical, but he doesn’t automatically assume the state needs more money.

“How do we know we don’t have enough revenue to meet the basic obligations of our state government?” asks Waters. “I want some evidence that we actually don’t have the revenue needed to meet the primary functions that state government should be doing…. We may not, but we don’t know.”