Kentucky Gov. Matt Bevin (R) is proposing to allow regional universities and quasi-state agencies to reduce their future pension costs.
Bevin’s plan would provide a discount on the required contributions to agencies that leave the current system, elect to freeze the pension benefits their employees have earned, and move them into 401(k)-type plans going forward. The agencies could pay off their existing funding obligations by making a lump-sum payment or periodic contributions over 30 years. The legislature was unable to come to a consensus during their regular session, but Bevin was expected to call a special session in July or August.
Regional universities and quasi-state agencies—such as local health agencies—now contribute an amount equal to 49 percent of every employee’s salary to the system. Their required contributions rose to about 84 percent July 1—potentially leading to bankruptcies, layoffs, and cuts in government services unless a special legislative session adopts reforms before the end of August.
The cost of Kentucky’s underfunded pension system now accounts for about 14 percent of all state spending. Most state agencies already pay an amount equal to 83 percent of employee salaries into the pension system.
Ending Dubious Projections
Kentucky has a traditional defined-benefit pension system in which government employers contribute to a fund that promises to pay the retirees’ pensions based on their salaries and years of service. By contrast, the private sector and some public pension plans have moved to a defined contribution model, says Merrill Matthews, a resident scholar at the Institute for Policy Innovation.
“Gov. Bevins is on the right side of history and financial stability by trying to provide regional universities and quasi-state agencies with a buyout option of the state’s defined-benefit retirement plan if they transition to a defined-contribution—that is, a 401(k) type—plan,” Matthews said.
The defined-benefit plans are underfunded because they make unrealistic projections of investment returns and benefit costs, Matthews says.
“The National Conference of State Legislatures reports that 48 states revised their retirement plans between 2009 and 2018,” Matthews said. “That’s because almost all of the defined-benefit plans, which are still the majority, routinely overestimate their investment returns and underestimate their costs.
“Most state defined-benefit plans estimate a 7 percent to 8 percent annual return, even though actuaries encourage them to estimate in the 4 percent range.”
Underfunded State Pension Plans
Kentucky has the worse-funded state pension system in the country, the Tax Foundation reported July 17. Kentucky had funded 34 percent of promised pension benefits, based on projected revenue from invested contributions to the system as of the end of 2017, the latest data available.
Underfunding means benefit cuts could be required in the future. Other state systems are also underfunded: Illinois’ system has funded 38 percent of projected benefits; Colorado and Connecticut, 47 percent; and New Jersey, 49 percent.
In contrast, the best-funded systems are Wisconsin, 103 percent; South Dakota, 100 percent, Tennessee 97 percent, New York 95 percent, and Idaho 91 percent.
Nationwide, states had a combined $1.28 trillion deficit in pension plan funding. Some states have made legislative changes since 2017 that will improve their financial condition, the Tax Foundation notes.
‘Better Financial State’
Public employees could earn higher pension benefits by contributing to 401(k)-type accounts that invest in funds that track stock market indices, says Matthews.
“Ironically, the S&P 500 and the NASDAQ have a long-run average annual return of about 9 percent to 10 percent,” Matthews said.
“States that transition to a defined-contribution retirement plan limit their long-term financial obligation,” Matthews said. “And if they were to encourage—or limit—employee investment to funds that track the S&P 500 or the NASDAQ, the state and the employees would both be in much better financial shape.”
Bevin’s plan could be voted on in a special session of the Kentucky General Assembly called by the governor this summer.
Joe Barnett ([email protected]) is a research fellow with The Heartland Institute.
Kentucky Gov. Matt Bevin (R): https://governor.ky.gov/contact/
Janelle Cammenga, “How Well-Funded Are Pension Plans in Your State?” Tax Foundation, July 17, 2019: https://taxfoundation.org/state-pension-plan-funding-2019/