Big pension changes could be on the horizon

     A major change could be coming to the County Employees Retirement System, one that will wreak havoc to city budgets. The Kentucky Retirement Systems Investment Committee is expected to recommend on Thursday that the KRS Board of Trustees make a significant cut in assumption rates for CERS and the Kentucky Employees Retirement System (KERS). The recommendations come after a study by investment consultants RVK, who reported to the committee Tuesday on the dire situation with the unfunded liability of KERS.

     Rich Robben, the interim executive director of the KRS Office of Investments, told committee members results of the RVK report were used to set the recommendation that the rate of return should be changed from the current 7.5 percent to 6.25 percent. The KRS Board of Trustees is expected to act on that, along with recommendations to set the inflation rate at 2.5 percent and to change the payroll growth rate from the current four percent to zero. No information from actuaries was included in the report presented on Tuesday by RVK representatives and they told committee members they only reviewed the KERS model, not CERS.

     Changes to the assumption rates come despite data showing CERS is performing well and set to meet its long-term goals. CERS total investments increased an average of 7.72 percent from the fiscal year 2001 to the fiscal year 2016 (see chart to right.) KERS and the State Police Retirement System saw declines each of those years of 2.23 percent.

     The County Employees Retirement System is on an upward trajectory and expected to be fully funded by 2043, the end of the current amortization period. The average rate of return on investments for 30 years shows CERS performed above the current 7.5 percent; averaging around 8.5 percent a year (see chart to left.) The long-term view for CERS is good, providing the type of growth a pension plan is expected to provide over a 30 to 40-year span. Nothing in the CERS long-term performance suggests a need for a drastic change in the assumed rate of return.  

      Per the National Association of State Retirement Administrators, the proposed 6.25 percent assumption rate for Kentucky would be the lowest assumption rate in the country. Current national assumption rates range from 8.4 percent to 6.5 percent. The NASRA warns of the need to ensure assumption rates are not set too low, saying that will “overstate liabilities and costs, causing current taxpayers to be overcharged and future taxpayers to be undercharged.” Too drastic of a change could have a long-term impact on the healthy CERS and its members.

KERS is facing an unfunded liability of around $18 billion; it is considered the worst-funded system in the country. The County Employees Retirement System (CERS) is doing much better, funded at close to 62 percent. That funding level will change, however, if the Board of Trustees adopts the new assumption rates at Thursday’s meeting. A change in the assumed rate of return, to the expected 6.25 percent, would decrease CERS funding level to roughly 50 percent and jump the unfunded liability in the plan to close to $6 billion. Cutting the payroll rate to zero will also add to the unfunded liability, forcing employer contribution rates even higher.

     Local governments, which pay employer contributions to CERS, will need to brace for what could be a major hit to budgets in the fiscal year 2019. The change to the assumption rate is expected to increase contribution rates for both hazardous and non-hazardous duty employees an estimated 30 percent or more over contribution rates that go into effect on July 1 of this year for FY 2018.  Cities will be hard pressed to continue to provide local services with such a major change in required contributions. The Kentucky League of Cities agrees it is important to be prudent when making any change to assumption rates. KLC does, however, urge the KRS Board of Trustees to consider phasing in any change made that is supported by data and sound actuarial practice. The California Public Employees Retirement System recently changed its rate from 7.5 percent to 7 percent but made the impact to employers easier to handle by establishing a phased-in approach. New Mexico and Alabama are also phasing in components to smooth the burden of assumption changes.

     The decision to change the rates to the County Employees Retirement System only highlights the need for CERS to separate from the Kentucky Retirement Systems. The KRS Investment Committee, which is comprised solely of gubernatorial appointees, made these changes for CERS after only reviewing the model study for KERS non-hazardous, presented by RVK representatives on Tuesday morning. The different plans managed by KRS were not focused on independently, despite CERS accounting for 73 percent of KRS assets. No representative of CERS is on the KRS Investment Committee, which will make the recommended changes to the KRS Board of Trustees and only 6 CERS representatives are on that 17-member board. The KRS Board of Trustees meets May 18 at 10 am in Frankfort.