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October 3, 2017 2:00pm

Greater Louisville Inc. Sets the Record Straight on Pension Crisis

Greater Louisville Inc. released a statement and Myth/Fact rebuttal to claims recently floated by the Kentucky Center for Economic Policy.

“A continued ‘pay later’ approach will fail future public employees, current employees, retirees and taxpayers,” said GLI President, Kent Oyler. “There’s already a $15,000 liability for every man, woman and child in the Commonwealth, and our pension spending grew at a rate of 56% in fiscal year 2017 alone.  To save our pensions, we must look to proven structural reforms that the private sector has been implementing for many years now.  States are wisely turning to a level dollar approach to paying down unfunded liabilities each year. This means more money in the plans, not less.  Kentucky should do the same.  The time for serious action is now.”

Myth / Fact on Solutions to Kentucky’s Pension Crisis

Myth: “Pension Design Is Not the Problem So Pension Redesign Is Not the Answer”

FACT: The current unfunded liabilities in Kentucky are a direct result of the assumptions and methods used by the state’s pension plans, and the failure of the state to properly pay for the benefits promised. While the problem is not the generosity of the defined benefit plan, the system in place to pay for benefits that are promised is a problem. Thus the ‘answer’ does rest on making changes to pension design. We must eliminate the potential for policymakers to underfund long-term liabilities.  That can only happen with structural reform.

Myth: “Kentucky finally stepped up to nearly paying its full ARC contributions to TRS in the 2017-2018 budget, as shown, and the state’s failure to pay the ARC before those years is the main reason TRS is underfunded.”

FACT: The main reason TRS is underfunded is because of the back-loaded method of paying off unfunded liabilities as a percentage of payroll. The second biggest reason for TRS underfunding has been underperforming investment returns. The third primary reason for TRS underfunding is missing other actuarial assumptions and needing to retroactively account for pension promises that were artificially depressed by the assumptions and methods chosen. The state’s failure to pay actuarially determined contributions is a problem, but it comes in at #4 on the list of reasons why TRS is underfunded. Just paying the actuarially required rate is not enough to save TRS if all of the assumptions and methods being used to determine that rate are wrong.

Myth: “A shift to a Defined Contribution plan will not save money”

FACT: The primary objective of offering a defined contribution retirement plan is to provide more public sector employees with a retirement benefit they can keep (since most do not wind up working long enough to earn a full pension) while also reducing taxpayer risks created by the usage of unrealistic assumptions for the current plans. In the short-term, a sound DC plan that will ensure retirement security can be provided at a lower cost than the price of a defined benefit plan using more appropriate and safe assumptions — thus it can save money compared to properly pricing a defined benefit plan. In the long-term, a sound DC plan will save the state money by ensuring unfunded liabilities do not accrue on new employees.

Myth: “state’s existing [percent of payroll] method is not controversial: actuaries consider it standard practice.”

FACT: Sure, it is standard practice to peg future pension debt payments to growth in payroll. But that does not make the practice a good one for Kentucky. The underlying assumption with percent of payroll is that total payroll will grow by the same percentage each year.  That’s been a TERRIBLE assumption for Kentucky. Using this accounting method for paying off unfunded liabilities has been one of the largest contributors to growth in our pension debt. It will likely be even worse going forward. Percent of payroll amortization is more of the same “pay later” approach that has utterly failed to the point where it has resulted in negative amortization.

There is a better way. States are increasingly shifting towards paying off unfunded pension liabilities in equal dollar payments each year, including the most recent changes for new hires in Arizona and Michigan. It means more money in plans immediately.

This “level dollar” amortization approach would pay down the debt by a consistent, fixed amount each year, akin to how most home mortgages are structured. This avoids having lots of years where interest grows at a faster rate than payments towards the pension debt. Level dollar is the most common amortization in consumer debt and residential loans.  No games or gimmicks, just a clear and consistent path to becoming debt-free.

Myth: “The legislature clearly does have the authority to change benefits for new employees. But those workers do not add to the unfunded liability”

FACT: New employees added to the status quo systems will create more unfunded liabilities. KRS and TRS have a history of under performing investment, mortality, and payroll assumptions. Every new employee added to a system that under performs its assumptions will result in additional unfunded liabilities.

Myth: “because of the Great Recession [investment] returns fell short of the target over the last 10 years”

FACT: Under performing investment returns in Kentucky are not just because of the financial crisis. Financial markets have changed fundamentally over the past 20 years. Interest rates are much lower today than they were in the 1980s and 1990s — just think about how cheap it is to get a mortgage today relative to the 20th century when rates were in the double digits. The decline in interest rates has meant the returns on fixed income and bonds are much lower too and are forecast to stay lower. Virtually every major capital market forecast suggests that investment returns will be lower over the next decade than over the last few decades.

Myth: “Only 26 percent of the $1.8 billion in additional monies PFM calls for goes to the severely underfunded KERS non-hazardous plan, as shown the graph below. In contrast, 65 percent of those monies go to plans that are nearly 60 percent funded — TRS and the CERS non-hazardous plan.”

FACT: All of Kentucky’s plans are severely underfunded. In any other state a 60% funded plan would be considered a crisis on its own terms. Any plan that is less than 100% funded is in a shortfall. And any plan that has been less than 100% funded for five to 10 years should be worried about its fiscal health. The benchmark for fiscal health is being 100% funded — not 80% or 60%. Every public sector employee in Kentucky deserves to have a fully funded pension system.