I am not the author of this article but it is timely and worthwhile.
By Jason Bailey
January 11, 2013
"As Kentucky legislators consider changes that could cut pension benefits for nurses, social workers, police officers and other public sector workers, they should keep in mind four important facts.
Kentucky legislators consider changes that could cut pension benefits for nurses, social workers, police officers and other public sector workers, they should keep in mind four important facts.
1. Public sector workers in Kentucky are undercompensated compared to their private sector counterparts.
Before making more cuts to public employee benefits, lawmakers should take into account the already modest compensation levels of public workers in the state. A report we published shows that public workers in Kentucky receive 12.8 percent less in total compensation (wages + benefits) on an annual basis and 9.2 percent less on an hourly basis than comparable workers in the private sector. The report makes an apples-to-apples comparison that controls for differences—such as levels of education and experience—between the two workforces.
While public employees’ benefits tend to be better than those in the private sector, their wages are far worse, resulting in somewhat lower overall compensation. Most public employees also haven’t received raises in recent years, and the legislature has already cut their retirement and health benefits. Further cuts that widen the gap between the public and private sectors will threaten Kentucky’s ability to attract the qualified public workforce needed to carry out critical public services.
2. A shift to a defined contribution or hybrid plan for new workers wouldn’t reduce the unfunded liability.
Past bills have proposed moving new workers to a 401k-type defined contribution plan, and the legislature’s Task Force on Kentucky Public Pensions recommended a cash balance option that is a hybrid between a defined contribution and defined benefit plan. Such proposals shift more risk to workers and are usually designed in ways that will reduce final benefit levels, especially for long-term employees.
However, they don’t save the state money or do anything to lessen the major problem Kentucky faces—the unfunded liability in the existing pension system. According to materials presented to the task force, the normal employer pension cost for new employees under the existing defined benefit pension plan (after cuts were made in 2008) is only four percent of payroll. That is exactly the same employer cost as the cash balance plan proposed by the consultants and recommended by the task force. If the state does its part in making required contributions and paying for any cost of living adjustments—and if the state’s investment return assumptions are met, which historically is the case over the long term—a cash balance plan is no cheaper than the existing plan.
What’s more, consultants told the task force that even completely eliminating retirement benefits for new workers would barely make a dent in the existing unfunded liability. The liability is a debt the state legally owes existing workers and retirees, who made their contributions on time to the system every year as required by law. The state avoided its responsibility to pay the full required contribution to the system in 13 of the last 20 years. It also approved cost of living adjustments without allocating the resources to pay for them and created retirement incentives to move experienced workers off the public payroll. While those decisions helped to balance the budget at the time, they merely shifted costs forward to future years. The legislature should focus the conversation on revenue options that allow the state to make the full required contribution every year, which will limit the impact of the liability on other parts of the budget.
3. Public pension benefits are an unnoticed but important contributor to the Kentucky economy.
Public pension benefits are not generous—the average state non-hazardous retiree receives only $20,508 a year. Yet the benefits help not just those workers, but the entire Kentucky economy. Currently, 88,041 retirees of the Kentucky Retirement System (KRS) live in Kentucky and receive $1.5 billion annually in benefits. 94 percent of KRS retirees live in the state, and they reside across all 120 counties. The local impact is substantial—for example, KRS injects $269 million annually into the Jefferson County economy, $30 million into Pulaski County and $10 million into Graves County.
A good portion of that money is spent locally in stores, restaurants and doctors’ offices. The National Institute on Retirement Security estimates that each dollar in pension benefits supports $1.24 in additional economic activity. They estimate a total annual economic impact in Kentucky from state and local public pension funds of $3.5 billion.
4. Traditional defined benefit plans are highly efficient and effective retirement vehicles if political leaders manage them responsibly.
Defined benefit pension plans, if managed properly, are very efficient and effective methods of generating adequate retirement benefits at little cost. In Kentucky, 68 percent of the money that goes into an employee’s retirement check comes from investment returns that the system generates. 12 percent comes from employee contributions and only 20 percent—or one in five dollars—comes from what the employer pays in.
Defined benefit plans work well because they create large investment pools, which limit administrative costs for an individual by spreading them over many employees. By using professional investment managers, they are able to generate much higher returns than individuals can realize in 401k-type defined contribution accounts. And by spreading risk among many workers they address the problems those relying on 401ks face of potentially running out of money before they die or oversaving for retirement. For these reasons, as the National Institute on Retirement Security reports, the cost to provide the same level of retirement income is 46 percent less in a defined benefit plan than in a 401k-style defined contribution plan.
Defined benefit plans also increase retention of skilled and experienced employees and reduce turnover costs compared to plans that encourage more mobility.
Despite two recessions in the past decade, most defined benefit pension systems around the country are doing fine financially and will be adequately funded once the economy returns to full strength. Only a few states, like Kentucky and Illinois, face more substantial gaps in the funding levels of their pension systems. Overwhelmingly, these states did not make the annual required contributions and observe good fiscal management of their systems.
With proper financial discipline, traditional pension plans are a highly successful way to generate adequate and secure retirement. In fact, some states are looking a ways to expand access to their state retirement systems to workers in the private sector—such as those working at small businesses. Those plans would allow workers to gain access to more secure retirement options and take advantage of professional investment management and the pooling of some risk and administrative costs.
Discussion of pension reform should take into account the growing problem of retirement security in Kentucky and the nation. We face an emerging crisis due to the erosion of traditional retirement plans, the move to inferior 401ks and the inadequacy of relying on Social Security benefits alone. The legislature’s decisions should protect the modest pension benefits of public workers as the first step of a broader strategy to increase retirement security for all Kentuckians.
The Kentucky Center for Economic Policy is a non-profit, non-partisan initiative that conducts research, analysis and education on important policy issues facing the Commonwealth. Launched in 2011, the Center is a project of the Mountain Association for Community Economic Development (MACED). For more information, please visit KCEP’s website at www.kypolicy.org."