In this episode of WichitaLiberty.TV: Co-host Karl Peterjohn joins Bob Weeks to discuss the fight on blight and property rights, guns on campus, availability of testimony in the Kansas Legislature, and KPERS, our state’s retirement system. View below, or click here to view at YouTube. Episode 137, broadcast February 5, 2017.
Proposals in the Kansas budget for fiscal year 2018 are more evidence of why defined-benefit pension plans are incompatible with the public sector.
Kansas Governor Sam Brownback has proposed delays in funding KPERS, the Kansas Public Employees Retirement System. The delays are in both directions. The state intends to break a past promise to pay, and also to skip some future payments.
A memo from KPERS summarizes recent history and the proposed changes: “Last fiscal year, the State delayed its fourth quarter payment for School employer contributions with a promise to pay it in Fiscal Year 2018 with interest. The Governor is recommending the State not pay this contribution and skip one quarterly payment each year through FY19. In addition, the Governor recommends extending the time to pay down KPERS’ existing unfunded actuarial liability by 10 years.”1
Many will criticize the proposed reduction in funding KPERS as stealing from KPERS. That really isn’t true. KPERS has plenty of money to pay current retirees their promised benefits. The above memo also says that those near retirement won’t be affected.
But what about younger employees who may not retire for 20 or 30 years? Will they receive their promised benefits?
The answer is yes, almost certainly. Their retirement benefits are in the form of a contract, and it is very unlikely that the state will break those contracts.
So: Is KPERS being robbed? Stolen from?
No. It’s future Kansas taxpayers who will be mugged. They will have to pay the unfunded liabilities accumulated by not only the current governor and legislature, but by past governors and legislatures too. I explain in more detail in my recent article No one is stealing* from KPERS. (The asterisk notes that there is stealing in a way, but from future taxpayers.)
Further: It is entirely foreseeable that this is happening. In 2015 the state issued $1 billion in bonds to address a portion of the KPERS unfunded liability. This made the unfunded liability ratio look better, and the governor and Republicans continually boast of this. But debt has simply been shifted from one balance sheet to another. The same taxpayers will eventually pay.
This is one of the reasons why government should not offer defined-benefit pension plans. Because of the long time horizons involved, it’s easy to delay and postpone dealing with problems. Or, legislators are prone to make risky investment decisions as Kansas did in 2015 by $1 billion in bonds and transferring the proceeds to KPERS. This was — is — a risky maneuver, and it has led to undesirable behavior that was entirely predictable.
The plan was that the state would borrow $1 billion, and invest it. If the state earned more in investment returns than the interest cost on the bonds, the state wins. Barry Poulson, Ph.D., Emeritus Professor at the University of Colorado — Boulder has written on the danger of borrowing to shore up state pension funds, as Kansas has done. He explained there is the “lack of nexus between the investment of the bond proceeds and payments for unfunded liabilities in the plan.” This means that the borrowed funds may be used for current spending rather than for correcting the KPERS unfunded liability.2
Paulson explains: “If legislators see that additional funds are available to pay off unfunded liabilities in the pension plan they may choose to allocate less general fund money to meet these pension obligations.” What Poulson warned of happened in Kansas in 2016. Now, the governor proposes even more: Pushing off KPERS contributions to the future so that more money is available for spending on other stuff now.
In a way, it’s surprising that groups who advocate for public employees are upset with this. (See, for example, here from KNEA.) Instead, they should be grateful. KPERS benefits are unlikely to be cut for any retirees. But underfunding KPERS today means there is more money available for public employees and the agencies that employ them. In reality, these groups simply want higher taxes now.
“This is BS. Stupid Brownback robbed our pension plan; we have no real confidence that it will ever be paid back. Why don’t we have some kind of safety measure in place to prevent governors like him from stealing from us?”
“If the governor would keep his greedy hands off of the KPERS money that is there, we might not be having this problem. It was not set up as a lending bank when the Governor’s policies proved to be unworkable. Leave my money alone!!!!!”
These comments — and many similar posted all over Facebook — accuse Kansas state government, specifically the current governor, of stealing from KPERS. But that is not happening, according to Alan Conroy, KPERS Executive Director. By email, he answered this question posed by Kansas Policy Institute: “Can you please confirm that the Legislature or the Governor cannot and have not borrowed money from funds deposited with KPERS?
Conroy’s response, in part, was “Once funds are placed in the KPERS Trust Fund they cannot be withdrawn or ‘loaned-out’ to another entity or group. The only way funds come out of the Trust Fund is to pay the promised benefits to the members.”
That ought to settle the question of whether money is being “robbed” or “stolen” from KPERS.
But you’ll notice that the title of this article contains an asterisk. That’s because KPERS does have many problems. The most important is its underfunded status, which is a chronic problem. This is because the state has not made the actuarially required contributions. This is “stealing,” in a roundabout way. Who is suffering the loss? Not future KPERS retirees, as it is almost certain they will receive their promised benefits. Instead, it is future Kansas taxpayers who will have to make extra contributions to KPERS to make up for the current and past legislatures not making sufficient contributions.
This is one of the reasons why government should not offer defined-benefit pension plans. Because of the long time horizons involved, it’s easy to delay and postpone a solution to the future. Or, legislators are prone to make risky investment decisions as Kansas did in 2015. The state’s action simply replaced KPERS debt with debt the general fund is responsible for. This, of course, is the state selling $1 billion in bonds and transferring the proceeds to KPERS. It makes the KPERS unfunded ratio look better, as the governor and Republican legislative leaders continually boast. But it’s a risky maneuver, and it has led to undesirable behavior that was entirely predictable.
The plan was that the state would borrow $1 billion, and invest it. If the state earned more in investment returns than in interest cost on the bonds, the state wins. Barry Poulson, Ph.D., Emeritus Professor at the University of Colorado — Boulder has written on the danger of borrowing to shore up state pension funds, as Kansas has done. He explained there is the “lack of nexus between the investment of the bond proceeds and payments for unfunded liabilities in the plan.” This means that the borrowed funds may be used for current spending rather than for correcting the KPERS unfunded liability.1 What Poulson warned of happened in Kansas.
There’s another way that KPERS is stealing from future taxpayers. When performing projections, a key variable is the discount rate, which is to say, the rate that KPERS expects to achieve on its investments, over the long term. Small changes in the discount rate have large impacts. The nearby illustration from the KPERS annual report for 2015 shows that using a discount rate of 8.00 percent, the KPERS unfunded liability is slightly less than $9 billion. Change the discount rate to 7.00 percent, and the unfunded liability rises to almost $12 billion.
Some authorities believe that state pension funds should use a realistic discount rate, maybe four percent or so. That would cause the unfunded liability to explode. To its credit, KPERS recently adopted a discount rate of 7.75 percent, but that adjustment is not nearly enough.
Who will have to pay to make up the deficiencies caused by using an unrealistic discount rate? Future Kansas taxpayers, not KPERS retirees.
There was a time when money was really and truly stolen from KPERS, in a way. Under the leadership of former Kansas Governor John Carlin, it was decided that KPERS would make targeted, or direct, investments in Kansas companies. A scandal erupted, and KPERS lost many millions.2
Another source described the aftermath as this: “In total KPERS faced losses of at least $138 million from its direct investment program. Moreover more than seven hundred Kansas residents lost their jobs as a result of these failures — a striking contradiction to the stimulus purpose of the Kansas investment program. In hindsight the lack of professional oversight by KPERS of its private investments program was blamed for the failure of the direct investment program.”3 The chair of the KPERS Board of Trustees pleaded no contest to one felony count of aiding and abetting securities fraud regarding a KPERS investment.4
This sounds like stealing from KPERS. Despite this happening at the urging of Carlin, he now portrays himself as a leader, a senior statesman to whom we should listen.
“It started as a way to use the state pension fund to boost the Kansas economy, making loans or investing in healthy businesses. But it has mushroomed into the biggest scandal in state history. Although the Kansas Public Employees Retirement System remains financially sound, with a value of about $4.4 billion, known losses exceed $230 million. Experts say total losses could double or triple.” Curran, Tim. Toto, we’re not in Kansas anymore: state pension scandal a nightmare. Associated Press. Oct. 7, 1991. http://www.apnewsarchive.com/1991/Toto-We-re-Not-in-Kansas-Anymore-State-Pension-Scandal-A-Nightmare/id-fe758e81f6b6a821076c829764cb6399. ↩
Cumming, Douglas ed. The Oxford Handbook of Private Equity. Oxford University Press. ↩
Press, A 1992, ‘Former KPERS Chief Sentenced To Probation For Securities Fraud’, Wichita Eagle, The (KS), 25 Jun, p. 4D, (online NewsBank). ↩
The problem, ALEC reports, is: “Unfortunately, many lawmakers and pension plan officials have other priorities besides doing what is best for workers. They see the billions of pension fund dollars they manage as an opportunity to advance their own agendas. Rather than investing to earn the best return for workers, they use pension funds in a misguided attempt to boost their local economies, provide kickbacks to their political supporters, reward industries they like, punish those they don’t and bully corporations into silence and behaving as they see fit.”
One form of pension fund cronyism is Economically Targeted Investments (ETIs). These are local investments “that have been selected for their economic or social benefits in addition to the investment return to the employee benefit plan.” Kansas has its own experience with this type of cronyism. During the first half of the 1980s KPERS, the Kansas Public Employee Retirement System, made numerous targeted investments that led to large losses. One newspaper article reported: 1
It all seemed so easy to many economic development planners.
In an era of hard-to-get money for business start-ups and small business expansion, why not tap into the state’s healthy $3 billion-plus retirement funds as a source for seed capital?
After all, it is there. And much of the profits earned by the Kansas Public Employees Retirement Systems have come from out-of-state investments.
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.
But three years after that decision, it is clear that KPERS money is not a panacea for economic development.
Here is one particularly egregious example of how KPERS did business.2 In this case, the chair of KPERS benefited personally from KPERS investment decisions, and in a brazen manner:
Take, for example, the $7.8 million investment in Emblem Graphic Systems, a company based in Kansas City and Denver that manufactured specialty package labels. According to court documents:
KPERS Chairman Mike Russell was on the Emblem board of directors and had personally guaranteed $200,000 in loans to the company.
Shortly before KPERS invested $5.3 million in Emblem in 1985, Russell resigned from his Emblem seat. The KPERS loan, however, was used to relieve Russell of his obligation to cover the earlier loans totaling $200,000.
KPERS continued to invest in the company until 1988, At one point, KPERS even paid $273,305 to itself to pay back the money it had lent Emblem when the company was sold. KPERS got back only $1.76 million of the $7.8 million it had lent the company.
Russell, however, was able to make a profit on his 3,000 shares in Emblem when the company bought him out for $48,330 — using KPERS money.
KPERS is suing, among others, Russell, the lawyers who approved the transactions, and Kenneth Koger, who managed the Emblem investment and about 70 percent of the investments in question.
Russell was not available for comment.
In 1992, Russell pleaded no contest to one felony count of aiding and abetting securities fraud regarding a different KPERS investment.3
In September 1991 the loss to KPERS was given as $92 million. 4 Lawsuits continued until 2003.
The governor of Kansas during the time of the targeted KPERS investments was John Carlin (1979 to 1987).
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Notes
S. Gossett/The Wichita Eagle, F 1989, ‘Disappointing returns the percentage of the KPERS fund given over to new business ventures has been reduced in light of big losses’, Wichita Eagle, The (KS), 16 Oct, p. 7D, (online NewsBank). ↩
Hobson, G 1996, ‘Full Accountability’, Wichita Eagle, The (KS), 22 Sep, p. 1A, (online NewsBank). ↩
Press, A 1992, ‘Former KPERS Chief Sentenced To Probation For Securities Fraud’, Wichita Eagle, The (KS), 25 Jun, p. 4D, (online NewsBank).} ↩
“After six years of investing in small- and medium-sized companies in Kansas, the state pension fund has 87 investments that are worth $231 million less than the fund paid for them, analysts told the fund’s trustees Friday. Considering that KPERS has collected about $139 million from those companies, however, the fund has lost $92 million in cash on its so-called ‘direct placement’ program, according to estimates by the staff of the Kansas Public Employees Retirement System.” Cross/The Wichita Eagle, J 1991, ‘Kpers Losses Put At $92 Million Lawyer Predicts ‘Monumental’ Suit’, Wichita Eagle, The (KS), 14 Sep, p. 2D, (online NewsBank). ↩
The writing of Duane Goossen, a former Kansas budget director, requires decoding and explanation. This time, his vehicle is “Rise Up, Kansas.”
Duane Goossen was Kansas budget director from 1998 to 2010.1 He is critical of the administration of Kansas Governor Sam Brownback and recent sessions of the Kansas Legislature. It’s useful to examine his writings so that Kansans may become aware of the ramifications of his recommendations, and how during his years as budget director he was unable to adhere to the principles he now advocates. Following, some language from his recent article Rise Up, Kansas.
Goossen: “This marks the beginning of a hopeful new chapter in the Kansas story. It also presents a desperately needed opening for comprehensive tax reform.”
Comprehensive tax reform. That sounds good, as “reform” has a positive connotation. It means change for the better. But in this case reform means raising taxes, and by a lot. In fact, advocates of tax increases generally won’t say by how much they want to raise taxes.
As an example, in May a coalition of spending groups called for what they termed “Option 4.” It would eliminate all tax cuts enacted since 2012. This action would reinstate the tax on pass-through business income — the so-called “LLC loophole.” But this would also raise income taxes wage income, as those tax rates also were reduced in 2012. For example, income tax rates for a married family earning up to $30,000 would rise to 3.50 percent from the current 2.70 percent. That’s an increase of 30 percent in the income tax rate. For other income levels the increase is greater.2
A spokesperson for the Option 4 coalition argued that rolling back the tax cuts could increase revenue to the state by $1 billion. By the way, the Option 4 coalition did not call for the rollback of the sales tax increase passed in 2015. I should qualify that with apparently, as no handouts explaining Option 4 can be found. In addition, an audio recording of the press conference has been removed.
Members of the Option 4 coalition included Shannon Cotsoradis of Kansas Action for Children, Bob Totten from the Kansas Contractors Association, Rebecca Proctor of the Kansas Organization of State Employees, and Mark Desetti from the Kansas National Education Association.3
With the exception of the pass-through business income tax, failing to be specific about whose taxes will be raised by how much is characteristic of spending groups. In fact, these spending groups generally shy away from using the term tax. Look at these examples of language from Goossen’s article:
damage to state finances
hemorrhage revenue
can’t start healing while still in triage mode
fix our structural revenue imbalance
broaden the tax base
means reviewing our entire tax code
modernizing all revenue sources
get our fiscal house back in order
begin with commonsense basics
new priorities
recover the opportunities we lost
senseless era of crisis
begin restoring those opportunities
rise above the political fray
find courage to make difficult decisions
imagine the possibilities
Commonsense basics. Who could be against that? Yet each of these terms is a call for more and higher taxes.
Goossen: “Three credit rating downgrades”
The Kansas credit rating has declined. In making this decision, Moody’s mentioned “revenue reductions (resulting from tax cuts) which have not been fully offset by recurring spending cuts.4 So Kansas has a decision: Offset revenue reductions with higher taxes or spending cuts. Moody’s doesn’t care which is chosen, but Goossen and the spending coalition does.
Of note, Moody’s mentions another problem: “an underfunded retirement system for which the state is not making actuarially required contributions.” This is an ongoing problem, as the nearby chart illustrates. The funding ratio of the Kansas retirement plan has deteriorated for many years, including the years when Duane Goossen was Kansas budget director. (Recently Kansas has improved the funding ratio of KPERS, but it did that by borrowing funds, which was an unwise decision. Because of the borrowing, Kansas has delayed schedule KPERS contributions, which effectively pays for current spending with long-term debt.5)
Moody’s also mentioned “In recent years the state has appropriated funds from or shifted costs to the State Highway Fund to help balance the general fund budget.” This too, is an ongoing problem.6 “Raiding the Bank of KDOT” has been a problem for many years, including the years when Duane Goossen was Kansas budget director.
Goossen: “It will likely take a generation to fully recover from this horrible experiment.”
Spending in Kansas. Click for larger.Goossen is not specific as to the nature of the damage. Generally, a claim of slashed state spending is made. But it’s difficult to see the purported decline. Some programs may have been cut, but overall, spending is level or climbing, as can be seen in the nearby chart.7 Additionally, in comparison to other states Kansas spends a lot, and continues to.8
Goossen: “lifting the burden the Brownback plan forced onto our lowest-earning Kansans.”
Yes, we should sharply reduce or eliminate the sales tax on groceries. It affects low-income households most severly.9
Goossen: “And it means establishing a responsible state savings account.”
Kansas General Funding ending balance. Click for larger.Kansas doesn’t have what some states have, which is a true rainy day fund that is governed by statute as to when contributions must be made and when the fund may be used. Instead, Kansas has a simple requirement for an ending balance of 7.5 percent, which the state has regularly ignored for decades. Low ending balances are a hallmark of Kansas government, including the years when Duane Goossen was Kansas budget director. In fact, in one year his budget had a negative ending balance.10
There is a claim that a recent change in the handling of KPERS payments falsely inflates school spending. The Kansas State Department of Education says otherwise. View below, or click here to view at YouTube.
There is a claim that a recent change in the handling of KPERS payments falsely inflates school spending. The Kansas State Department of Education says otherwise.
A member of the Kansas State Board of Education has written an article that has received widespread attention. But the member, Jim Porter, is wrong on several accounts.
In his article, Porter stated that a recent change in the handling of Kansas Public Employees Retirement System (KPERS) contributions falsely inflates school spending.1
This is a standard argument of Kansas public school spending advocates, which is that because of a change in the way teacher retirement funds (KPERS contributions) are handled, it looks like the state is spending more on schools, when in fact it is not.
In response, Kansas Policy Institute noted this: “According to Dale Dennis, KPERS funding was last sent directly to KPERS in 2004; it has since been sent directly to school districts included in reported school funding totals.”2
Here, Dale Dennis contradicts Porter. Dennis is Deputy Commissioner at Kansas State Department of Education and head of Fiscal and Administrative Services.
Even though Dennis is the state’s top education finance official, we don’t have to rely solely on him to illustrate Porter’s error. Information from the Wichita public school district3 shows the same. Here I’ve plotted the funding sent by the state of Kansas to USD 259 for KPERS contributions. As Dennis indicated, in 2005 the Wichita school district started receiving money from the state for KPERS. Prior to that year it received none.
Trabert’s article explains other ways in which Porter is wrong. I have to wonder what is the underlying reason for Porter writing things like this. Is he being told incorrect information or is he simply lying?
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Notes
“Deception #2 – Until recently the state contribution to the Kansas Public Employees Retirement System (KPERS) was sent directly to KPERS. Now the funds are transferred to the public school account and then transferred to KPERS on the same day. Again, this was lauded as an increase to public school funding even though it was the same amount of money with just an additional transfer from the State of Kansas to the school to KEPRS.” Jim Porter for Kansas State Board of Education – District 9 Facebook post. Available at www.facebook.com/JimPorterKSBOE9/posts/1001536676582800. ↩
“Jim Porter’s Deception #2 – According to Dale Dennis, KPERS funding was last sent directly to KPERS in 2004; it has since been sent directly to school districts included in reported school funding totals. Again, Mr. Porter doesn’t define “recently” but most people would take it to mean within the time frame he references (the Brownback administration) and that clearly is not the case.” Trabert, Dave. State school board member should practice what he preaches. Available at kansaspolicy.org/state-school-board-member-practice-preaches/. ↩
USD 259 Comprehensive Annual Financial Report for 2015, State Revenue by Source, Governmental Funds, and USD 259 Comprehensive Annual Financial Report for 2007, State Revenue by Source, Governmental Funds. ↩
The State of Kansas was ordered to take remedial action to correct material omissions in the state’s financial statements prepared under the leadership of Duane Goossen.
During the administration of Governor Mark Parkinson, the State of Kansas issued eight series of bonds raising $273 million. Regarding these, the U.S. Securities and Exchange Commission has determined that the state failed to adequately inform investors of significant, material, negative information.
In a nutshell, according to the SEC: The Kansas Public Employee Retirement System (KPERS) was in terrible financial condition compared to other states, and Kansas did not adequately disclose that to potential bond buyers. That violated the Securities Act. In 2011 Kansas implemented reforms to the SEC’s satisfaction.
Duane Goossen biographyOf interest to current Kansas public affairs is that the head of the Kansas Department of Administration at the time the SEC found these violations was Duane Goossen. In its findings, the SEC specifically criticized the Department of Administration for its preparation of financial statements included in bond offerings — statements that were missing materially important, and negative, information.
Since his departure from Kansas government, Goossen has remained active in shaping Kansas policy, first as vice president for fiscal and health policy at Kansas Health Institute. 1 In 2015 Goossen joined Kansas Center for Economic Growth as Senior Fellow. 2 In announcing Goossen’s appointment, KCEG executive director Annie McKay noted his “wealth of expertise and knowledge.”
KCEG advocates for more taxes on Kansans, with the Goossen announcement mentioning “unprecedented and unaffordable tax cuts.” Goossen added he was excited to continue “contributing to the conversation across Kansas about the importance of budget and tax policy and the consequences of drastic tax cuts on everyday investments critical to Kansans.”
It’s ironic that Goossen mentioned “investments,” as we now know that under his leadership Kansas violated Sections 17(a)(2) and 17(a)(3) of the Securities Act, materially misleading bond investors while other states made full disclosure.
While critics of current Kansas government — including Goossen 3 — use KPERS underfunding as evidence of failure, this incident shows that KPERS has had funding problems for a long time, under leadership of both parties, and of both conservatives and moderates.
The SEC findings
According to a press release from the Securities and Exchange Commission, the State of Kansas “failed to disclose that the state’s pension system was significantly underfunded, and the unfunded pension liability created a repayment risk for investors in those bonds.” 4
The nature of the SEC’s inquiry involved “the disclosures surrounding eight bond offerings through which Kansas raised $273 million in 2009 and 2010.” 5
In its order, the SEC found: “The failure to disclose this material information in the Official Statements resulted from insufficient procedures and poor communications between KDFA and the Kansas Department of Administration (“KDA”), which provided information to KDFA for inclusion in the Official Statements, including preparing the State’s financial statements that were included as part of the Official Statements.” 6 (emphasis added)
The SEC also found that Kansas was an outlier among the states in failing to disclose negative information: “Kansas’s practice of not disclosing the underfunded status of KPERS became increasingly inconsistent with the practice of most states issuing municipal securities, which generally provided disclosure in their CAFRs or the body of their Official Statements regarding the financial health of their pension funds. By 2008, with the exception of Kansas, the overwhelming majority of the Official Statements for state-level bond issuances at a minimum disclosed the UAAL or funded ratios of the associated state-level pension plans, particularly if those plans were significantly underfunded.”
Prior to a new issue of bonds in November 2011, the SEC found that the State of Kansas instituted satisfactory policies and procedures regarding disclosure of material information.
SEC. Administrative proceeding file no. 3-16009. Order instituting cease-and desist proceedings pursuant to section 8a of the Securities Act of 1933, making findings, and imposing a cease-and-desist Order. Available at www.sec.gov/litigation/admin/2014/33-9629.pdf. ↩
Actions considered by the Kansas Legislature demonstrate — again — that governments are not capable of managing defined-benefit pension plans.
The Kansas Legislature is considering a bill that will allow Governor Sam Brownback to defer making payments to KPERS, the state’s defined-benefit pension system for public employees. The deferred payments would be made up in future years, although there is really no mechanism to enforce this.
Also, the bill considers eliminating the requirement that when the state sells surplus property, that 80 percent must be used to reduce the unfunded actuarial pension liability of KPERS. There is also a moratorium on employer contribution to KPERS Death and Disability fund, which is much smaller than the retirement fund.
That unfunded liability is a big problem. It refers to the difference between what KPERS expects to pay compared to the revenue it expects to receive. In recent years the Kansas pension fund has been among the worst in the country, based on the funded ratio. The nearby charts shows the trend of this funded ratio through 2014, the latest date for KPERS valuation reports.
Last year the state issued $1 billion in bonds to address a portion of the unfunded liability. While this helps KPERS, it simply means that the state owes another billion dollars on a different balance sheet. But it’s the same taxpayers that will eventually pay.
Barry Poulson, Ph.D., Emeritus Professor at the University of Colorado — Boulder has written on the danger of borrowing to shore up state pension funds. As explained below, there is the “lack of nexus between the investment of the bond proceeds and payments for unfunded liabilities in the plan.” This means that the borrowed funds may be used for current spending rather than for correcting the KPERS unfunded liability.
He further explains: “If legislators see that additional funds are available to pay off unfunded liabilities in the pension plan they may choose to allocate less general fund money to meet these pension obligations.”
This is what is happening in Kansas. The borrowing of a billion dollars has let legislators and the governor feel — incorrectly — that there is breathing room, and that the state can slack off making the contributions it should be making this year. This is highly irresponsible and reckless.
Following, from Dr. Paulson:
A major flaw in the proposed issuance of pension obligation bonds is the lack of nexus between the investment of the bond proceeds and payments for unfunded liabilities in the plan. The experience in other states is that sometimes bond proceeds are earmarked for other state expenditures. The most egregious example of this problem is the state of Illinois which issued $10 billion in pension obligation bonds and then used the proceeds to meet current expenditures rather than to pay off unfunded liabilities in the pension plan.
Even if the state of Kansas would not commit this form of fraud on the taxpayers the fungible nature of state funding makes it impossible to guarantee the nexus between bond proceeds and the payment for unfunded liabilities in the pension plan. If legislators see that additional funds are available to pay off unfunded liabilities in the pension plan they may choose to allocate less general fund money to meet these pension obligations. The state has not allocated the annual required contribution (ARC) to KPERS for several decades and is not projected to do so for the foreseeable future. Legislators continue to promise pension benefits without allocating the funds required to meet these obligations. We should expect this moral hazard to be even greater with the issuance of pension obligation bonds.
Even if the proceeds of pension obligation bonds could be set aside in a lock box and earmarked to pay off unfunded liabilities in the pension plan the state must still address the accumulation of unfunded liabilities in the defined benefit plan. Without fundamental structural change, including shifting public employees to some form of defined contribution pension plan, these unfunded liabilities will continue to accumulate. Legislators should not be diverted from this difficult task by non-reforms, such as the issuance of pension obligation bonds.
There’s another way that KPERS is stealing from future taxpayers. When performing projections, a key variable is the discount rate, which is to say, the rate that KPERS expects to achieve on its investments, over the long term. Small changes in the discount rate have large impacts. The nearby illustration from the KPERS annual report for 2015 shows that using a discount rate of 8.00 percent, the KPERS unfunded liability is slightly less than $9 billion. Change the discount rate to 7.00 percent, and the unfunded liability rises to almost $12 billion.
Of note, Moody’s mentions another problem: “an underfunded retirement system for which the state is not making actuarially required contributions.” This is an ongoing problem, as the nearby chart illustrates. The funding ratio of the Kansas retirement plan has deteriorated for many years, including the years when Duane Goossen was Kansas budget director. (Recently Kansas has improved the funding ratio of KPERS, but it did that by borrowing funds, which was an unwise decision. Because of the borrowing, Kansas has delayed schedule KPERS contributions, which effectively pays for current spending with long-term debt.5)
There’s another way that KPERS is stealing from future taxpayers. When performing projections, a key variable is the discount rate, which is to say, the rate that KPERS expects to achieve on its investments, over the long term. Small changes in the discount rate have large impacts. The nearby illustration from the KPERS annual report for 2015 shows that using a discount rate of 8.00 percent, the KPERS unfunded liability is slightly less than $9 billion. Change the discount rate to 7.00 percent, and the unfunded liability rises to almost $12 billion.
