This week the Kansas Legislature may work on the problems facing the Kansas Public Employee Retirement System, or KPERS. Past legislatures have failed to enact reforms necessary to put this system on a sound financial footing, and the legislature has shown itself incapable of managing a system where it’s easy to pass on the problem to future generations. Now Kansas faces an unfunded liability of some $9.3 billion in KPERS. The most important thing the state can do is to stop enrolling new employees in this failing system.
When confronted with the realities of the finances of KPERS, the response of state government employee representatives is first, attack the messenger. This is taking place now in response to a report released by the Kansas Policy Institute (A Comprehensive Reform of Kansas Public Employees Retirement System). It also happened in 2009 when Art Hall and Barry Poulson released their research in The Funding Crisis in the Kansas Public Employee Retirement System.
The second response of state government employee representatives is to attack the only solution (short of massive tax increases) to providing for workers’ retirements: the defined-contribution plan. These plans, often called 401(k)-style plans, allow workers to contribute into a special type of tax-advantaged retirement account. Usually employers, in this case the State of Kansas, make additional contributions on employees’ behalf. Employees generally have a variety of investments to choose from. Employees also own their retirement accounts and their assets. The value of the account — and therefore the benefits available to retirees — depends on the performance of the investments.
KPERS is a defined-benefit plan, sometimes called a traditional pension plan. When employees retire, they are paid a benefit based on their final average salary, number of years of service, and a multiplier. KPERS funding relies on employee contributions, employer contributions (these are the state’s taxpayers), and investment returns.
The main problem is that the legislature has not provided enough funding to KPERS to keep it in balance. That’s easy to do, as retirement systems like KPERS operate on time horizons of decades, and it’s easy to say let’s deal with the problem next year. It’s also easy for legislators to promise and write into law a higher level of benefits than they’re willing to fund. Problems with lack of funding may not show up until long after the legislators who voted for them are out of office. With defined-contribution plans this isn’t possible. Each party — worker and employer — funds the plan each pay period, and that is the extent of the obligation of each party.
Misinformation spread
In its message to its followers, Kansas National Education Association (KNEA, the teachers union) wrote this about the problem with defined-contribution plans: “First, they claim that a DC plan gives the employee control over their own retirement. And if you have lots to invest and have the time and knowledge to do so effectively, that might be true. Of course, even if you do, you can end up like the folks who found Enron to be a great investment or trusted Mr. Madoff. The fact is most of us are not prepared to do our own analysis and investment.”
There’s quite a bit of misinformation here. But before that, a huge irony is that this information is aimed at Kansas schoolteachers, and their union assumes they are not intelligent enough to plan for their own retirement.
In fact, planning for retirement is quite easy and simple. All one needs to do is select low-cost index stock and bond mutual funds, of which there are many. These funds, over the long time horizon appropriate for retirement investing, beat the performance of all managed funds, meaning funds managed by professionals who attempt to analyze markets and earn greater than average returns through an active trading strategy. This is not disputed by anyone except by those who sell actively-managed mutual funds.
“The evidence is clear. Low-cost index funds regularly outperform two-thirds of actively managed funds, and the one-third of actively managed funds that outperform changes from period to period. Even the very few professional investors who have beaten the market over long periods of time — Berkshire Hathaway’s Warren Buffett and Yale University’s David Swensen, for instance — are quick to advise that investors are likely to be much better off with simple low-cost index funds than with expensive actively managed funds.” (Burton G. Malkiel, ‘Buy and Hold’ Is Still a Winner. Also, see the author’s book The random walk guide to investing: ten rules for financial success.)
Generally, most investors would select just one or two funds in which to place their contributions. Over time, investors may want to change the balance or characteristics of the funds they invest in. This again is easy to do. In fact, large mutual fund companies like Vanguard have index funds that automatically shift the balance between stocks and bonds as investors move along towards retirement.
The idea that the teachers union believes that professionals like schoolteachers are not capable of becoming informed and making these decisions is laughable if it weren’t the actual belief of the union. Suggestion: An actually useful and productive role for the teachers unions would be to help their members learn to invest for their retirement.
The problem cited about Enron and Madoff is that some people placed all or nearly all their investments with these two firms. That’s a bad strategy for anyone to follow with their retirement investments. Using index funds will not expose investors to the risk of losing all their money.
The claim by the KNEA that “lots to invest” is required is false. The companies that manage defined-contribution retirement plans accept new employees into the plan no matter how little they have to invest, and they accept their periodic contributions each pay period no matter how small. Scale — the amount available to invest — is not an issue, contrary to the assertions of the teachers union.
One claim made by KNEA is true: defined contribution plans give workers control over their retirement savings. This is a benefit. If a worker has a low tolerance for risk, they can keep their contributions in cash (actually treasury bonds would be the choice for these people). Others who wish to take an active role in the retirement investing can do so, as most plans offer funds that have targeted goals such as real estate, growth stocks, short-term bonds, long-term bonds, etc.
But in KPERS, all members are invested in the mix of investments that the KPERS trustees decide on. (When Jane Carter of Kansas Organization of State Employees asks “Do you really want to take your retirement security and gamble it on the stock market?” she may not be aware that KPERS is invested in the stock market, and those returns are essential to funding KPERS benefits.) The investments that the trustees choose may not be suitable for each individual member. But KPERS members have no choice.
By the way, the KPERS investment fund has proven irresistible to politicians seeking to invest in Kansas for various reasons. In the 1980s a series of bad investments were made in Kansas companies. As reported in the Wichita Eagle on October 16, 1989: “For many Kansas legislators, the lure of using KPERS money for economic development was tempting. So KPERS, under considerable legislative pressure, agreed to target nearly 10 percent of its fund for business expansions in Kansas.” Many of these investments lost money, and lawsuits went on for years.
The point is that the worker is in control, not the KPERS trustees or the legislature. That’s important, as the legislature, over the years, has not made sufficient contributions to KPERS. They keep pushing the decision down the road to future legislatures, and the burden on future taxpayers who will need to make the necessary contributions. But in a defined benefit plan, employees, through their employers, make contributions each pay period. If for some reason the employer fails to make the contribution, it’s easy to notice it before years go by.
New members needed to prop up existing
Reading the material put out by KPERS defined-benefit supporters, it becomes clear that KPERS depends on the contributions of new members to pay for the benefits of those already in the system. Here’s a claim made by KNEA, the teachers union: “If all new employees came in under a defined contribution or 401(k) plan, their investments would be essentially personal investments and not used to contribute to benefit payments to current or future defined benefit members. This means that each person who retires will be replaced by someone who is not paying into the defined benefit system.” (emphasis added)
The KNEA has also written to its members: “The state would have the obligation to continue funding the defined benefit (DB) plan since it depends on new employees contributing to fund at least a portion of the benefits to retirees. (emphasis added)
This claim was echoed in testimony given by Coalition for Keeping the Kansas Promise, which states: “In fact, the creation of a defined contribution plan for KPERS, which will remove revenues used to reduce the unfunded actuarial liability, will only accelerate the insolvency of the KPERS fund for current KPERS members and retirees from FY 2033 to an uncertain, though more immediate, date in the future, and place the entire KPERS funding obligation upon Kansas taxpayers.”
There could be no clearer admission that the KPERS contributions of young workers are used to fund the benefits of retirees. Instead of the new members’ contributions being invested and growing to provide for their own retirement, their contributions are needed to pay for current retirees. This is a system that guarantees being perpetually under-funded.
Who is the employer?
The Kansas Policy Institute report states: “Employers in the state/school plan currently contribute 9.37 percent of payroll. To fully fund that part of the plan at the market value of assets employers would have to contribute 15.26 percent of payroll. Employer contributions into the state/school plan would have to increase from $393 million to $640 million annually, a 63 percent increase.”
Now when most people read this and other information about KPERS they probably don’t associate “employer contributions” with what this term means. Since KPERS covers government employees, the employer is the state’s taxpayers.
That’s right. It is the taxpayers who will be called upon to correct the unfunded KPERS liability. The KPI report is accurate but understates the political reality when it concludes: “Kansas legislators are not likely to find an additional $247 million in the current budget to fully fund the KPERS pension plan; and they are even less likely to find the money to fully fund the plan in future years as unfunded liabilities accumulate, especially if the plan fails to generate the projected 8 percent rate of return on assets.”
Most Kansans realize that KPERS is part of the cost of having state employees. Citizens pay taxes so that these employees can be paid, and KPERS is part of their package of pay. The problem is that citizens expect that the cost of paying employees be paid each year. But now we learn that the legislature has not been doing this. The legislature has not been paying all that is required into the KPERS system. Essentially, taxpayers will be asked to pay now for payments not made in years past for work that was performed years ago.
Investors or combatants
The current system of retirement for state employees creates a situation where there is conflict. We see it right now, where state employees and their lobbying groups insist that the state make good on its promise to its workers. The pushback comes from those who realize that taxpayers are tired of ever-increasing spending. This is especially true when taxpayers are being asked to make up for the deficits of legislatures past. So there’s conflict. One class is trying to extract payment from another. It isn’t pretty, and it’s not productive. It’s the political system at its worst.
Advocates for state employees say there’s nothing wrong with KPERS that can’t be fixed by funding it properly. In other words, more taxes and more spending: more conflict. We need to find a way out of this trap, and enrolling new state employees in defined-contribution retirement plans is the way.
The benefit of defined-contribution plans is that people, including state employees, become investors. They own something. They have a rooting interest in the success of the economies of Kansas, America, and the world.
Kansas state employees have a choice to make. Do they want to become investors in America and own their retirement funds, or do they want to continue to rely on the political system for their retirement?
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