As Randy Quaid’s character in the 1996 movie Independence Day flew his plane into the alien spacecraft to destroy it, he shouted, “I’m baaaaaack!” That quote aptly describes the unfunded liability of the Kansas Public Employees Retirement System (KPERS), because it’s not only back, it still has the potential to destroy local and state government budgets.
The latest valuation report released by KPERS in July shows that the ‘official’ unfunded liability went from $8.2 billion to $9.2 billion for 2011. Sadly, that’s not the worst part. KPERS also acknowledges having another $900 million in losses that won’t be recognized for several years, so the market-value basis of the unfunded liability is $10.1 billion. But even that is not the ‘real’ unfunded liability.
The KPERS unfunded liability is based on a completely unrealistic investment assumption that says plan assets will earn an 8 percent annual return. The actual rate of return in 2011 on the market value of plan assets was less than 1 percent – incidentally, in January a leading pension expert told the California pension system to assume no more than 4 percent over the next decade.
A little over a year ago, KPERS said that a half-point reduction in the investment return assumption would add $1.3 billion to the unfunded liability. On that basis, the ‘real’ unfunded liability with an assumed return of 6 percent would be $15.3 billion; a 5 percent assumed rate of return would put the unfunded liability at $17.9 billion. An analysis last year by The Pew Center on the States put the real unfunded liability at $21.9 billion.
Each year that actual investment returns are less than 8 percent only puts more pressure on the system. Employer contributions are based on the assumed return rate; a high assumed rate of return means employers can contribute less money, which could lead to an even worse unfunded situation over time. An unrealistic investment return assumption also forces KPERS to make riskier investments in pursuit of higher returns, which makes plan assets subject to significant losses should the financial markets take a turn for the worse. One more episode similar to 2008’s losses could even endanger retiree payments over time.
The legislative ‘fix’ that was approved earlier this year helped but there is still much more work to be done to ensure the viability of KPERS. The KPERS Board of Trustees should significantly reduce the assumed investment return rate, which would provide a more realistic picture of the long term financial challenge, prompt higher employer and employee contributions and allow investment officers to assume less risk.
Legislators must find the courage to ignore the intense political pressure from current employees to maintain benefits that are much higher than those received by most taxpayers. For starters, the formula for calculating future benefits should be reduced and lifetime retirement benefits should not be available until age 65.
These changes would still provide employees a good retirement benefit (which they deserve) and ensure that adequate funds are available to pay benefits.
Succumbing to political pressure to do nothing only risks bankrupting the entire system.
Trabert is president of the Kansas Policy Institute.