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| Kentucky League of Cities Leader speaks to the Problems of Future Pension Costs |
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Courier Journal
Louisville, Ky.
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Friday, February 29, 2008
Lunch With Sylvia Lovely
Sylvia Lovely, who talks about an invisible expense threatening the livlihood of cities
The pension issue started getting public attention last year when David Williams sponsored a bill to start dealing with it. The bill didn't go anywhere, but it certainly tied things up.
It started the conversation.
The session before that, we had been warned that conversation was about to occur because the gap between what was supposed to be in the state pension fund and what was actually in it was growing, and closing that gap was going to take money from other parts of the budget.
But this issue is affecting local governments and their police departments and fire departments as well.
In the late `80s, cities and counties were required to go into the state system in order to have a defined benefit plan — a traditional pension plan. One of the reasons for that was there had been a lot of unfunded systems throughout the state, so there was a need for consistency.
To simplify it, there is the pension system for local governments and there is the state system. Both have hazardous and non-hazardous duty employees, but the local governments employ police officers, fire people — a lot of hazardous-duty employees. That's a big part of the issue.
The state and local pieces are very different in another way. The funding for the state system comes through the General Assembly. The state consists of government workers and state police and all those folks.
But the state also sets benefit levels for retirees at the local level. They set the rates and pass them down to the locals, and the local governments — the cities and counties — are paying the bills. They have to pay their bills on time. The state, on the other hand, has not been paying its bills on time. They've not been funding their retirement system completely. For that reason, we're less under funded than the state system, which is in the $26 billion liability range. We're $7 billion. On the pension side, we're not in bad shape. We're funded over 80 percent. But as Harry Moberly pointed out one day in one of those blue ribbon commission meetings, we're the precursor to the disaster that's going to happen. What's happening to the cities and counties is the rubber is hitting the road.
What is happening?
The budget crunches. The lay-offs. The raising taxes to try and pay for this.
Why is there a problem if you're mostly funded?
The bills are too high, because the rates local governments have to pay into the pension system —- 32 percent of every hazardous duty worker's salary and 15.58 percent of every non-hazardous worker's salary — are out of sight, a 50 percent increase in just the last two years. And that amount is going to double in six more years.
But the health care costs are what is really driving this. Kentucky has a very generous health benefit for current retirees. We have very little control over the cost, as we know on a national level. We have very limited ways to deal with health care costs. That is the driver.
It sounds like the pension systems have promised more than they can deliver.
That's what it's amounting to. You take a typical police officer and a salary of, I don't know, $30,000, $40,000. The employer pays a portion of their pension and health care costs, a rate of 32 percent of their salary in the coming year. But that percentage is going to double by the year 2018. That is a very high rate.
Your point is the cities have been keeping up with their pension bills.
By taking it out of their general fund.
But the state hasn't been doing the same with its fund.
So its systems are deeper in the hole.
We get bills based on a percentage of our payroll. That goes into our pension fund. The issue is our costs are escalating. We're facing the music right now. When the state will have to do that, I don't know how they're going to do that. That's the whole issue about bonding. How do you fill in the $26 billion hole on the state side? By borrowing money?
Our problem on the local level is an expense problem. We need to bring down the expenses because keeping up with payments is killing us.
Obviously, if you have to pay at least 16 percent of every salary and that percentage is escalating, then you have less money for salaries.
Thus you have lay-offs. Shively had to raise its insurance premium tax. Jerry Abramson talks about how all new revenue in the coming years will go to pay for increased pension costs if we don't do something about it. Louisville's contribution to the retirement system increased by about $12 million between FY 2007 and FY 2008. The city is currently evaluating significant cuts in public safety equipment and overtime and parks and recreation services, and a hiring freeze that would leave about 500 to 600 positions unfilled. And a lot of the money saved would go to this cost.
One of the things we believe is that in order to compete with 18,000 other communities in just the U.S. alone, and that doesn't even include competing globally, our cities are going to have to do special things.
Our dream would be to do complete tax reform at the local level. But this is our No. 1 issue because we want to solve the expense side of this. We don't want to throw money at this. What we want to do is try to figure out how to bring down the cost, which brings us back to the actions here at the General Assembly.
So what are your options? You can't just stop paying pensions.
It's complex. We have to balance the needs of local governments and their employees. What we need is a sustainable system so cities don't go out of business.
Here's the deal. What we found out, when Gov. Fletcher appointed the blue ribbon task force to go through this in meticulous detail, which we did — one of the things that we found out in that odyssey was that there is a thing called the inviolable contract, which basically boils down to this: We made a promise to employees, and that promise can't be broken. You can't touch benefits, including health benefits, that were guaranteed. Our inviolable contract is probably the strongest in the nation.
In 2003, there were some things that were done and started to make pension costs more cost effective, like limit the health insurance benefit to a dollar amount instead of giving carte blanche.
But we have another problem: The huge baby boomer bulge is getting ready to retire, and they will retire under the current system. They're retiring younger and we're living longer, so they will be retirees for a lot longer. They're going to be retiring in record numbers, and the impact on the system is big. Yet we are very limited in our ability to do anything about present employees, one, because of the inviolable contract, and, two, because there's a moral obligation once you've made a promise to people.
Future hires, now that's the far easier issue. Already in the Governor's plan, there are a lot of things to do with future hires. You can do things like increase years of service required before retirement. For example, in his plan you have to be 55, and years of service plus age have to equal 85. Same thing on the hazardous-duty side: Instead of 20 years, you have to work 25. Think about it. People are living longer. You could potentially have three careers in three systems.
You could be retired for longer than you worked.
That's right. So those kinds of things can be done with future hires. On the current employee side, we're much more limited.
The Governor's plan does retain the defined benefit plan — the traditional pension plan. I know that's controversial. And the reason that's controversial is that people pick up the newspaper and they read about Ford Motor Co. and all the private stuff where they're getting rid of the traditional pension plan and going more with defined contribution plans like the 401(k).
Say there was a two-tiered system, one for future hires. You've got two sets of people in two systems with employers making contributions in both. And actuaries say that for probably the next five or six years, it's actually more expensive to fund two systems. In the short-run, it's more expensive. And we simply can't handle any more expense in the short-run.
What you have to do is start looking at other things. What everyone has to understand is that this can't be solved overnight. This is going to have to take some long-term looks. I think there's a good beginning, both with David Williams starting the conversation and the Governor's plan.
Those of us in the private sector who are helping pay for these public pensions are not getting anything like this kind of benefit program anymore. Unless you're a rich person, no one in the private sector can think about retiring at age 55. Social Security doesn't kick in until the mid-sixties. How can we justify this system for state employees? Even this proposed new system is so generous.
What you're dealing with is the art of the possible: What can we do in light of the inviolable contract on the part of the current employees.
But we're talking about the new employees.
People automatically go to the Ford Motor Co. example: "They can do it. Why can't you?" It's a lot more complex with these two systems in place. And actuarially, it just doesn't make a lot of sense to do it for the first five years. So moving gradually to a new kind of system...
And the other argument, and I know there are people who actually argue with this as well, is that you have more lower paid employees — people that won't put anything in a 401(k). So what's the more responsible thing to do is to retain a plan where people will have a decent retirement, because they don't put money in a 401(k) because they don't make very much. Now I know there are folks out there who look at Wal-Mart and say that's happening anyway, but I don't know that's the right way to go.
But this proposed new system is set up so people can retire pretty routinely at 55.
I think it's still a hold over. I know the salaries are evening out between the private and public sectors, but there's still some notion that you have to provide some incentives for people to stay in state government. Will you be able to attract the work force you want? There's still that idea that there need to be incentives to work for state government.
And then there's the art of the possible: what can pass.
Again, trying to move toward a model, and doing some things to make it work better: for instance, taking a look at investments, taking a look at government accounting, health plans that incent people to go into wellness programs. Those are some of the things that we're doing.
Is it true that people who retire from the public sector retain their health insurance until they qualify for Medicare?
Yes. And on the hazardous side, it's full family benefits.
And when they qualify for Medicare, the supplement continues to be paid by the public sector, while the rest of us in the private sector pick up our own tab. So isn't part of the way to deal with the spiraling health care cost to ask the pensioners to make a larger contribution toward their supplemental health insurance?
All that health insurance stuff for current employees is wrapped up in the inviolable contract. What isn't is the COLA, the cost of living adjustment. That's another proposal in the Governor's bill. The COLA will be funded at 1.5 percent. In the past, it's been based on the CPI, the consumer price index. So let's say the CPI is 3 percent. It's been automatic. We can do something about this. That's a cost driver, because it's made part of the employer contribution rate. If it's changed as is proposed to 1.5 percent annually, that's still hard, but it's half of what it was. If the General Assembly wants to increase the COLA any more, it has to fund it, and that's not likely to happen.
Another interesting thing with the new hires is that they would have to pay an additional 1 percent on the employee contribution. That would go to pay for health insurance. So for new hires, there's a new model coming.
We work with police officers and firefighters. They're considered heroes in communities. But the other thing that's happening out there is that there's a growing recognition on the part of employee groups that this system really is unsustainable. When Owensboro is laying off 20 people, Shively is raising the insurance premium tax to pay for pensions, and thus raises won't be automatic — all kinds of things are happening out there that are getting their attention as well. We've had a lot of meetings with employee groups.
What's really important here is getting something done — not ending up with a stalemate and not getting anything done. This is just so critical. This is the No. 1 issue, the one we get all the calls about: "How are we going to sustain this?" "How are we going to pay for the things that will make us competitive in attracting jobs and doing all the things you have to do as a community?" Frankly, we've got to solve this issue. We've got to solve this problem: looking at investment policies, looking at some combination of things. And looking at additional benefits: Right now as you go up and walk the Capitol halls, a lot of people are asking, for instance, to be added to the hazardous-duty category. That's a very common request. If there was a formal way to vet that — what's that going to cost? If you add benefits or take benefits away, there should be some sort of forum where that would be considered.
It sounds as if the need is to take people out of hazardous duty right now, not add more.
What we're hoping is that we just don't get more added.
Finance Secretary Jonathan Miller said last week that there are people in the hazardous-duty category who work in those departments, but their lives are never in danger. They're answering phones and sitting behind desks.
We would love a look at that. We think that would be a smart thing to do, but just not adding any additional people right now would be of enormous help.
The legislature loves to add people and make them happy.
But the other thing that's happening is that there's a growing concern that this is just not a good idea, that we really have reached a crisis point. I've been doing this work for 20 years, but what's clear to me is that the message really is getting through that this really is an unsustainable system and that we have to do something. There's even talk that it will run out of money at some point, and people won't get any benefits.
Well, 2021 or 2022 is the year for the state.
What will happen at the city and county level is that they won't be able to pay the bills anymore. If it gets to the point where an amount equal to 50 percent of someone's salary has to be put in a retirement fund, there won't be any money for anything else — parks, recreation, public safety. And it's heading in that direction.
Isn't there another part to this — that the system needs an injection of a lot of money?
Again, the local problem is an expense problem. We have to bring down the expenses. On the state side, that's an interesting question. There's a $26.6 billion unfunded liability, and that's a significant sum. That's where a discussion of bonding comes into play. The Senate wanted to issue bonds last year. The Governor recommends not doing that. And it is risky. Times have to be right. Yes, the infusion of cash is the answer, but there is none.
What is endangered is what they depend upon and what they have come to expect in the local communities, and that is police officers, responsiveness to fires, all of those things that people identify with. If they feel those things are threatened — and they are increasingly: Mayfield had to have an insurance premium tax increase to pay the retirement system. Owensboro has laid off 20 people. Fort Mitchell instituted a hiring freeze. The city of Paducah reduced its number of firefighters by 20 percent in the last few years. The city of Florence was facing a $2 million deficit by the year 2010, due largely to the cost of pension contributions and health insurance, so in response the city approved an increased insurance tax, which was raised from 5 to 8 percent, and payroll tax, which was increased from 1.25 percent to 2.0. Radcliff had a $525,000 deficit, almost half of which was due to the increase in pension contributions. For two years they've used reserve funds to balance general funds.
Think about this: Local taxpayers are going to have to pay two bills. They're going to have to pay at the state level, and then they're going to have to pay at the local level as well. It's pretty staggering to think about. It's a double hit.
And then you get cities like Frankfort that have antiquated sewer systems. They're going to pay for the pension problem locally and at the state level, and then get hit with a massive increase in sewer taxes to construct a new system.
There's something everywhere. It's almost a giant issue — a local, federal, state conundrum, where you've got these mandates. That's what this amounts to. It's being handed down: "Here's what you're going to pay," and there's very little local say in it.
In Louisville, the competitiveness issue is so important. We feel as if Kentucky is fighting for its position in the world.
We're falling behind just when we need to be moving ahead.
Early on when we started seeing this pension problem, we formed a coalition with the Pritchard Committee and the Kentucky Chamber of Commerce on this very issue. Because to the extent the state has to fund its pension liabilities and catch up, guess what suffers: education. So they joined with us, knowing this is an issue that's going to impact ultimately on education. The chamber is interested, because it knows this is going to impact business and the ability to recruit business in an era where you have to be competitive and every community has to be a magnet to attract people and knowledge jobs. They have this interest both as state leaders and local leaders because, again, you have to pay twice.
There are two approaches right now. The Governor's approach is very different from the Senate's approach. Do you feel as if they'll be able to resolve their differences this session?
Again, I see a growing recognition that there is this serious problem. Yes, I have every hope that they will. And we look forward to working with the Senate and the House as this moves into that arena. And I think the common thread there is the recognition that there is a local problem and there is a state problem, and they're getting calls from the Florences and the Radcliffs and the Shivelys and the Louisvilles.
Jerry Abramson has been eloquent on this and raised it during his State of the City Address as a growing problem. You're talking about the city of Louisville that's competing not within Kentucky, but with Indianapolis and Nashville for people and jobs. And you're spending this staggering amount on just public pensions. That's a real issue.
This is a national problem as well. We are not alone in having pension systems that are not funded at the rate they're supposed to be.
We probably have one of the most serious problems, though, because of the inviolable contract being allegedly the strongest in the nation, making it difficult to get to the heart of the issue. Health insurance is the talk of the nation right now. We hear it in the presidential election. And everybody has a theory, from national health insurance to totally private sector fixes, but everybody is talking about "What are we going to do?" Our hope is that health insurance becomes a topic for the next president of the United States. That's how big this problem is, because you can't completely solve it in Kentucky.
We keep thinking it will be. Ford Motor Co. said a few years ago that its biggest challenge was health insurance. It makes it hard for them to compete with foreign manufacturers.
It's staggering. It's a huge issue. We would hope that when the new president comes along, this will reach such a deafening level of noise when you consider one in seven Americans is without health insurance.
And all of your businesses saying they can't compete internationally because of their health insurance costs. And cities and counties and states saying it's killing them, too.
I don't know what we should do, but we need to have a national debate about health insurance.
What we're trying to do is good policy — what is fair to the voting public — and the public ought to be paying attention to this. That's a hard message to get through because people hear "pension" and their eyes glaze over.
This is a poor state. The gap doesn't exist in salary anymore: State government sometimes even pays more for comparable jobs than private employers pay. So should the base retirement age be higher than 55?
It could be. Demographers and people like Ron Crouch at U of L say we ought to be working longer. Ron Crouch says 70 is the new 60. I don't know what the argument would be for keeping it 55, other than you deal with the art of the possible. You try to figure out all the various interests you've got. The system is you bring everybody together and you do what's doable.
But who is the advocate for people who haven't been hired yet? They don't exist. They're not a group.
The theory is you've got to attract bright young people.
Bright young people are going to be interested in government or not. But most jobs in state government don't pay less anymore. Those who are paid less — lawyers in the attorney general's office, for example, or social workers: Pay them more. It would be cheaper than bumping up the whole pension system. And it would be fairer than giving the bills for services provided today to the next generation.
Change happens slowly. As this conversation deepens — and this is only the beginning — there are some voices that haven't been heard yet, and they need to be heard.
Who haven't we heard from yet?
Well, David Williams. We know his original proposal, but he hasn't been heard this year.
Recognition of the problem is important, and I think that's happened. Now what do we do to make this actually come true, so we can bring down the expenses? That's our goal. It will not be solved over night. It's too big a problem. It's too complex. It has too many moving pieces and parts. But what we can see, I believe, is some real good approach to taking these issues apart, and maybe that will come up as an issue. It may still. But you start with something.
What would you hope for this year?
Using the Governor's bill for a starting point this session, we'll begin the debate. Some of the innovations for the new hires could happen. Setting up a group to look at investments, or to vet new benefits before they're agreed to, looking at health insurance incentives — incenting people to go into different plans or wellness programs could be done. All of these things bring down that escalation of costs. In the city of Louisville, the pension system contribution went up $20 million between 2006 and 2008. In 2013, it's projected to be $104.6 million.
What about double-dipping?
What happens in double-dipping is that people can retire, then there's a waiting period and they can go back and be rehired, or they can go work for a new agency, and start a whole new retirement cycle in the same system.
So they could end up with two pensions.
Two pensions, maybe even three, conceivably. If you're a police officer and went to work at 20, you could retire at 40. You see the picture.
And there's been a lot of controversy surrounding that. There's a school of thought that if you're in the system and you paid and your employer paid, you earned the right to do what you're going to do. There is some talk, though, of limiting that, and it's in the Governor's bill. You can still go back to the same agency, and the employer would continue to pay the contribution rate, which is controversial among employers because a lot of times that's where they get their employees is doing this. But the employee would not be eligible to be in the same pension system anymore and would not have to contribute.
The bottom line is we need the problem fixed. This expense could go for something else, for other needs.
The elephant in the living room is the inviolable contract. Other than that, there's going to be debate.
There will be debate over defined benefit versus defined contribution. There will be debate over bonding. Debate over what we can do. The debate over the COLA is pretty clear — that can be fixed and probably will be. Beyond that, all the other pieces for the new hires are easier. It's what you can do to bring down the current costs with the coming 20 years, until the current retirees are no longer in the system.
The state legislature has always been eager to make state employees happy. They passed the high 3 and the high 5.
I think they're a pretty important voting block, and legitimately interested in their issues.
And how well they provide services is a reflection on legislators
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