A recent Wichita Eagle editorial written by Phillip Brownlee urges caution in proceeding with changes to KPERS, the Kansas Public Employees Retirement System. The editorial has two areas that we should be concerned about, as the facts Brownlee provides leave time for proceeding cautiously. The actual facts leave no such margin for maneuvering.
Brownlee cites $7.7 billion as the shortfall or unfunded liability in KPERS. This is highly misleading. It’s true on a certain technical level, but on an economic level — meaning what really counts — it is dangerously misleading. Neither Brownlee or the KPERS Fiscal Impact Report he refers to mention $1.7 billion in asset value losses that don’t have to be included in reports. (It’s possible with recent rises in financial markets that some of theses loses have been recouped, but we don’t know that at this time.)
Additionally, the $7.7 billion figure is based on an unrealistic assumption: that KPERS investments can earn an annual return of 8.0 percent. Since most calculations involving retirement plans involve long periods of time, even a small change in the rate of return can produce some large changes in values. KPERS actuaries say that if the rate of return was 7.5 percent instead of 8.0 percent, that small change would cause an additional unfunded liability of $1.3 billion.
Adding these factors together — the reported unfunded liability, the unrecognized losses, and a more realistic rate of return — and we come up with an unfunded liability of $10.7 billion. And some would say a 7.5 percent assumed rate of return is too high, which adds even more unfunded liability. For example, the Employees Retirement Income Security Act (ERISA) recommends that private employers assume a 6.1 percent return on assets in private pension plans. And with a note of irony, in illustrations of what benefits from a defined contribution plan would look like, the KPERS report uses 7.0 percent return prior to retirement and 5.0 percent return following retirement.
Illustration of how the rate of return impacts the growth of a stream of contributions over time: Small changes in rates produce large differences in ending balances. KPERS uses 8.0 percent in its assumptions, while some authorities recommend 6.1 percent.What we’re not facing is the fact that the KPERS unfunded liability is much larger than reported by Brownlee and by most of the other news media in Kansas.
A second problem is the largely successful attempt by state employee unions to convince Kansans that the KPERS unfunded liability can be paid off only if the present defined-benefit system is maintained. Supporters of the present system say that if a defined-contribution plan is established for new employees, it will be too expensive to pay off the unfunded liability.
But the fact is that unless the state wishes to renege on its promises, the unfunded liability must be paid off. It doesn’t matter whether it’s paid off as part of a reformed defined-benefit or new defined-contribution plan, or even if the state were to appropriate funds apart from payroll contributions. The bill must be paid.
And since the Kansas Legislature has shown itself incapable or unwilling to funding the promises it has made, its vital that we stop enrolling new employees in the present defined-benefit plan.
While the present legislature seems intent on solving the problem, it’s hard to place much faith and trust in their seriousness. Consider the motives and incentives of legislators: If legislators were to give state employees raises, that would require them to raise taxes or cut services. But granting generous retirement benefits is another matter. The bill for these benefits doesn’t come due until many years later — as we are now painfully aware. Except, of course, that the legislature should be paying, on an annual basis, the amount necessary to provide the promised benefits. The Kansas Legislature hasn’t done this for a long time, and that’s part of the reason why KPERS is in a mess.
Promises by lawmakers to behave well in the future must be discounted. The present defined-benefit retirement plan allows them to make promises they don’t have to pay for. With the discipline of a defined-contribution plan — the 401(k)-type plans that almost all private sector workers have — we don’t have to worry about present legislators heaping debt on yet another future generation.
Note: Today’s editorial by Brownlee holds this conclusion: “The state may also need to make additional reforms to limit future liabilities for new employees, such as reducing plan benefits or possibly switching to a 401(k)-like plan. Climbing out of this hole will be a struggle. But the sooner the state starts, the better. At the very least, it needs to stop digging the hole even deeper.” Canceling the defined-benefit plan for new employees is the best way to “stop digging.”