Bluegrass Beacon: Giving unaffordable pension benefits an economically fatal practice

BluegrassBeaconLogo

Like Bernie Sanders refuses to acknowledge socialism’s devastating impact on previously prosperous Venezuela, supporters of Kentucky’s pension status quo – who seem largely illiterate about how defined-benefit systems work – refuse to concede that inadequate funding is not the primary cause of the commonwealth’s pension woes.

If it was, then why is the County Employees’ Retirement System (CERS) only around 60-percent funded despite making 100 percent of its actuarially required contributions through the years?

It’s because CERS hasn’t escaped suffering the same malady – awarding and enhancing benefits in ways neither taxpayers can afford nor the system was designed to support – now infecting all state retirement plans, and which cannot be ignored by any policymaker wanting to claim the mantle of serious pension reform.

CERS through the years not only raised the benefit factor – which, along with assumed rates of return on investments and contributions of employees and their government-employer agencies, determine the amount beneficiaries receive when they retire – but also has applied those raises to previous years.

While such benefit increases make recipients feel good about voting for the good-ole-boy politician who brought home that bacon, it’s a fatal tactic if Kentucky wants to continue providing its employees with defined-benefit plans.

For example, a plan member who entered the CERS on July 1, 1958, when it was established by the legislature, was awarded an initial benefit factor of 1.25 percent.

Far from being an arbitrary figure, that benefit factor, which is the percentage of final average salary beneficiaries will receive for that year of service, was based on certain conservative assumptions regarding what the system’s investments would earn and the employees and employers would contribute.

Flash forward to 1990, when the benefit factor for CERS members, which had risen through the years, reached 2.2 percent.

Such a benefit factor in and of itself would not have been a problem if it had been applied just for that year when investment returns had risen and the plan could cover it.

However, system bureaucrats applied that benefit retroactively, so that a beneficiary who entered the plan in 1958 and retired in 1990 was awarded a pension amount based on a 2.2 percent benefit factor for all those years, even though the amount received by beneficiaries is horizontal and not vertical in a defined-benefit plan.

Huge unfunded pension liabilities, anyone?

If, in fact, the state’s retirement systems would have followed the rules by awarding benefits for each year based on the assumptions and contributions for that year and not forced higher benefits retroactively, the commonwealth would have a surplus rather than a $40 billion (at least) unfunded liability.

I have no doubt about the happiness experienced by the beneficiary who retired in 1990 with a pension check that was 42-percent higher than the one the system was designed and funded to support.

But I seriously doubt taxpayers, who carry most of the risk but have the least say of all stakeholders, enjoy anywhere near the same level of bliss in knowing that the pension check received by that retiree is nearly 73 percent of his final average salary even though the system was designed and funded to support a 51-percent benefit.

While higher-than-expected returns on investments masked for years such incompetency or shenanigans – you pick – the consequences are catching up with CERS and the other public pension plans.

Separating CERS from the Kentucky Retirement Systems (KRS) – about which there has been much buzz – is functionally the right move. But doing so will not come close to abating our pension crisis.

In fact, before being allowed to leave the KRS, policymakers must demand that CERS also end this practice of retroactively awarding enhanced benefits.

Jim Waters is president and CEO of the Bluegrass Institute for Public Policy Solutions, Kentucky’s free-market think tank. Read previous columns at www.bipps.org. He can be reached at jwaters@freedomkentucky.com and @bipps on Twitter.