October 25, 2017 9:25am
Myth-Busting the Pension Debate
A time machine would be great right about now. We could roll back to the days when we didn’t have a $64 billion unfunded pension liability, a debt of $15,000 for every Kentuckian. Unfortunately, many still live in the fully-funded past and are tilting at windmills trying to keep the status quo.
A key to digging yourself out of debt is recognizing the financial habits that led you to dire financial straits and creating a plan to pay off your debts. In the spirit of moving this dialogue forward, it’s important to correct some of the misinformation that distracts from Kentucky’s unsustainable public retirement system and the realities we all must face.
One myth is that “a shift to a defined contribution (DC) plan will not save money.” The fact is that 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 economic assumptions.
In the long-term, a well-constructed DC plan will save the state money by ensuring unfunded liabilities do not accrue on new employees. Recent studies by the Bureau of Labor Statistics cite an overall trend of decreased tenure with employers, particularly among younger workers. Since many public sector employees will not work long enough to earn a full pension, DC plans will enable portable retirements for those moving in and out of public employment. Using a DC plan will also reduce taxpayer risks created by the usage of unrealistic assumptions for the current plans. This means a much safer, more sustainable financial environment for all Kentuckians. It’s a lesson from the private sector, where these plans are flourishing.
The second common myth we hear is that “because pension design is not the problem, then pension redesign is not the answer to the crisis.” The fact is that the design of the plans is a major factor in the pension shortfall.
The current unfunded liabilities in Kentucky are a result of faulty 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 generosity of the defined benefit plan is not a problem in and of itself, the system in place to pay for these benefits is a problem. This means that the solution for any reform must make structural changes to pension design and eliminate the potential for policymakers to underfund long-term liabilities. This would keep legislators more accountable, and would lead to much more transparency by letting beneficiaries know where their money is going.
The third myth surrounding the pension debate is that “because the state’s existing ‘percent of payroll’ method is standard practice among many other states, this must mean that it will work here.” The fact is that, just because it is a standard practice, doesn’t mean that it is an effective strategy for our pension debt.
This is because percent of payroll relies on the assumption that total payroll will grow by the same percentage each year. That’s been a wrong assumption for Kentucky. In fact, using this accounting method for paying off unfunded liabilities has been one of the largest contributors to growth in our pension debt. As the state continues to trend towards a leaner and efficient government, this antiquated method of percent of payroll amortization has caused a “pay later” approach that has led us into the current crisis.
A better solution to this problem would be to adopt a level dollar amortization approach, instead. This financial strategy would pay down the debt by a consistent, fixed amount each year by acting essentially like a home mortgage. 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. This is the most common amortization in consumer debt and residential loans. It would also offer Kentucky a clear and consistent path to becoming debt-free, and an opportunity for Kentucky to offer wages comparable to the private sector to attract top talent.
To achieve the goal of fully funding all the pension systems, it will take many years, but we can stop digging and get back to fiscal responsibility with a bold plan. In the best interest of our Commonwealth, now is the time to tackle the public pension crisis and no longer let obligations go unfunded.