This morning in Wichita Barry W. Poulson, retired professor of economics at the University of Colorado, said that Kansas legislators are finally starting to realize the importance of dealing with the unfunded liability in the Kansas Public Employees Retirement System (KPERS), but cautioned that proposals currently in the legislature don’t contain the fundamental cost-saving reforms that are needed and that other states are implementing.
Poulson’s visit to Wichita was sponsored by the Kansas Policy Institute. Poulson authored the report A Comprehensive Reform of Kansas Public Employees Retirement System for KPI.
In his introduction of Poulson, KPI President Dave Trabert said that the KPERS deficit that is usually mentioned — $7.6 billion — is too low. The real deficit is at least $12 billion, he said. The difference comes from two sources: first, there are nearly $2 billion in losses that don’t have to be included in the official figures, at least not yet. Then, KPERS uses an assumption of eight percent for its future investment returns to arrive at the $7.6 billion figure. Trabert says that even KPERS understands it will not be able to achieve that rate. Using a rate of seven and one-half percent, the deficit blooms to $12 billion, and even that rate may be too high.
In his remarks, Poulson said that the Government Accounting Office estimates that state and local governments will incur, over the next half-century, $10 trillion in debt. Most of that is due to unfunded liabilities in pension and retiree health plans for public employees, he said. Some of the debt issued by state governments has been downgraded to “junk” status. 84 municipal governments went bankrupt last year.
Poulson said that economists estimate that over the next decade, there is a high probability that pension plans in a dozen states will not be able to meet their obligations. Kansas is one of those states, having one of the worst pension plans, considering its ability to meet its obligations.
An important point that Kansans should know, Polson said, is that KPERS is in worse shape than has been reported. The “smoothing” actuarial technique used by KPERS means that $1.7 billion in unfunded liabilities are not yet officially recognized. The eight percent return on assets used as an assumption is not realistic, too. Using a return of five percent means the unfunded liabilities are much greater.
Poulson explained that under current Kansas law, the state is not able to meet the unfunded liabilities of KPERS. Liabilities grow more rapidly than assets. The contribution the state currently makes to KPERS is about nine percent of total payroll. If Kansas wants to satisfy government accounting rules regarding covering the unfunded liability, it would have to increase this rate to about 15 percent. In dollar terms, this is an additional $250 million per year. (To place that in context, the one cent per dollar increase in the statewide sales tax last year was estimated to bring in about $300 million additional revenue per year.)
This amount is what is needed to just to pay off the unfunded liability, not the total cost of providing KPERS benefits.
If trends continue, Poulson said that by the 2020s the state would have to contribute 24 percent of payroll to KPERS. Spending at this level would require large cuts to programs or large tax increases.
Some states have successfully reformed their state pension plans, and Kansas needs to look at these states as models. The most important reform. Poulson said, is to replace the present defined-benefit plan with a defined-contribution plan, commonly known as a 401(k) plan. The private sector has been doing this for the last three decades, he said.
Part of the problem is that legislators have refused to recognize the problem with state employee pension plans. Poulson recounted how six or seven years ago he told Kansas legislators that they needed to pay attention to KPERS and its problems, and to start addressing the unfunded liability. But legislators assured him that KPERS was fine, and there was no cause for worry. “I couldn’t get anyone to listen to me,” he said. Now, he said legislators in Kansas are finally addressing the problem, although still not properly, he added.
Critics say that if states offer defined-contribution instead of defined-benefit plans to new employees, they won’t be able to pay off the unfunded liabilities of their defined-benefit plans. Poulson pointed to Michigan as an example of a state that switched to defined-contribution plan, and has improved its ratio of assets to liabilities, meaning the unfunded liability problem is less severe.
Eight states have a hybrid-contribution plan, which have both defined-benefit and defined-contribution aspects. Utah was in a position similar to Kansas, and after implementing a hybrid plan, is on the track to paying off its unfunded liability.
Another reform that states, especially Kansas, must consider is that the burden of retiring the unfunded liability must be born not only by taxpayers and new employees. Current employees and retirees must help, too. Employees must increase their contributions. Retirees need to accept less generous cost of living adjustments. The retirement age and the years of service needed to qualify for benefits both need to be raised. The way that final average salary, a component of benefit calculations, needs to be reformed too. Currently workers may use overtime or other techniques to raise their final average salary so that they receive a larger pension benefit.
Poulson noted that Kansas legislators are finally starting to “get it” as far as realizing the seriousness of the KPERS problem. There are two bills active in the current session of the legislature. The bill passed by the House of Representatives places new employees in a defined-contribution plan, while the Senate bill keeps the present defined-benefit plan. Neither bill, however, includes fundamental cost-reducing reforms mentioned above and that are happening in other states.