Pension reform passes the House and Senate with bipartisan support

The Kentucky General Assembly has finished this year’s regular session with the enactment of pension reform legislation, together with funding that will help restore solvency to the retirement system.  The compromises made to pass the bills have left the various stakeholders concerned about whether the General Assembly did the right thing for public employees, retirees and Kentucky’s taxpayers.  I share those concerns, but I can say with certainty that I believe the reforms we passed represent the right course for public retirement policy in our Commonwealth, and I want to take this opportunity to explain why I have reached this conclusion. First, it is important to understand the serious problems confronting the pension system:

• According to Senator Damon Thayer, sponsor of the Senate’s pension plan, the retirement system (“KRS”) is now $30 billion underfunded, representing a debt of $8000 for each Kentuckian, man woman and child.
• Previous Governors and legislatures did not always fully fund the employer contribution to the employee pension plan, the “actuarially required contribution,” or, “ARC.”
• This unfunded liability is due to a combination of factors apart from insufficient ARC payments. Retiree cost-of-living adjustments (“COLAs”) that were not prefunded, changes in actuarial assumptions, and demographic and salary experience all played a role.
• Additionally, the worst economic downturn and stock market crash since the Great Depression happened in 2008.

The Kentucky Public Pensions Task Force, composed of members of both the House and Senate, spent the interim between the close of last year’s session and the commencement of this year’s developing recommendations about how to reform the system to improve its sustainability.  The main recommendation of that Task Force was the cash-balance plan contained in Senate Bill 2.  (The Task Force recommendations were adopted unanimously by the members, Senators Thayer, Jimmy Higdon, Paul Hornback, Dorsey Ridley and Mike Wilson, former State Representative Mike Cherry, and Reps. Derrick Graham, Keith Hall, Brad Montell, Marie Rader and Brent Yonts.) The House took the position that reform must be accompanied with funding for the existing system.  We consistently pressured the Senate to adopt a funding mechanism to support benefits for existing retirees and employees if we were to adopt any version of pension reform. Those negotiations resulted in House Bill 440, which will annually make available nearly $100 million extra in general fund revenue for making the required ARC payments. The Senate was equally insistent that the only condition under which they would approve additional funding was adoption of the cash-balance plan.  Since, under that condition, the Senate approved funding, the House adopted Senate Bill 2 with the cash-balance plan. Both of these bills were truly bi-partisan achievements, with House Bill 440 receiving 82 votes in the House and 35 votes in the Senate, and Senate Bill 2 receiving 70 votes in the House and 32 votes in the Senate.  The Governor also deserves commendation for his persistence in encouraging the House and Senate to lay aside their differences and do their best to achieve consensus in the interests of stakeholders and the taxpayers. Senate Bill 2 represents that hard-won consensus:

• It saves Kentucky $10 billion over the next 20 years.
•  It preserves pension solvency for our existing retirees and employees.
•  Its cash-balance plan applies only to employees hired after January 1, 2014.  It does not apply to teachers at all.
•  It preserves the ability to grant COLAs as long as KRS has sufficient funds to grant them or if the General Assembly provides the revenue to pay for a COLA up front.
• It enlarges the KRS board membership and creates an oversight board to better monitor KRS investment practice and general operations.
•   It restores the ability of retirees from hazardous duty positions to return to employment soon after retirement with a minimal sit-out period.

The cash-balance plan is neither a pure defined benefit plan nor a pure defined contribution plan.  It includes the best features from both kinds of plans to protect retirement security for new hires while limiting taxpayer exposure to risk for investment losses:

•   New hires in the cash-balance plan will contribute 5% of their salaries to a hypothetical retirement account, to be matched with a 4% employer contribution (8% employee and 7.5% employer for hazardous positions).
•  New hire members are guaranteed a 4% investment return.  For years when the return on investment is greater than 4%, the employee’s account will also be credited 75% of the excess above the 4% minimum guarantee.  The other 25% of the excess will be credited to KRS.  This means that in years when the overall system recognizes an investment loss, the system still pays the member the minimum, and in years of gain, the system keeps a portion of the excess, spreading risk between KRS and the employee.
•   The employee in the cash-balance plan will have full portability for his or her account, including both employer and employee contributions plus investment return, upon separation from employment.  With the average tenure of a state employee now being 9 years, full portability is a significant feature.
•  Finally, the employee will not be responsible for managing investments, as is usual under a traditional 401K defined contribution plan.  Research demonstrates that most individuals not trained in financial management lack the expertise to invest optimally.  Having KRS retain this responsibility places investment decisions in the hands of those most capable to make them.

Newly elected legislators and judges will also participate in the cash-balance plan, meaning their retirement plan will be the same as that offered to the social worker, or the fireman, or the bus driver, or the mine inspector. In the end, we in the House determined that the cash-balance plan was a concession we had to accept in exchange for the Senate’s agreement to secure additional funding for ARC payments in House Bill 440.  Adoption of Senate Bill 2, coupled with funding, will sustain the system for existing KRS members and employees, provide sufficient retirement security for new hires, and protect Kentucky’s taxpayers from the fiscal pressures brought on by unsustainable pension contributions. I started negotiating union contracts for the IBEW 369 Local in 1972. In my experience, with respect to this negotiation, at the end there was nothing left for us on the table.  Our best course of action was to accept the Senate’s concession on revenue in exchange for our adoption of the cash-balance plan, attain closure of the issue and avoid a special session that would not likely have yielded a better result. Thank you for taking the time to read this.  I have included some additional points on a separate attachment, and I hope you find that information helpful as well.  As always, feel free to contact me about this subject or any other that concerns you. My door is always open to you.