We’ve written many times about the rushed and potentially unconstitutional process Kentucky legislators used to pass SB 151, the stinking anti-pension bill. While the battle is still playing out in the courts over whether the bill was passed constitutionally, we thought we’d examine why the changes contained in the bill are bad themselves. Specifically, SB 151 guts retirement security for Kentucky teachers by forcing new teachers into a hybrid cash balance plan.
We’ve written about cash balance plans before. Cash balance plans are not defined benefit pension plans, but they are not pure defined contribution plans either. They try, and fail, to occupy a middle ground. The hybrid cash balance plan for teachers contained in SB 151 would require contributions from both teachers, 9.105 percent of pay, and their employers, 8 percent of teachers’ pay. These contributions would then be invested, but this is where things start to go bad. Rather than guaranteeing a certain benefit amount at retirement, as in a pension plan, this plan seeks to guarantee a certain rate of return on the investments. However, this plan only guarantees a 0 percent rate of return on teachers’ accounts using a 10-year average of investment returns, and gives teachers only 85 percent of returns above that 0 percent.
Let’s say teacher Smith earns a 7 percent rate of return on investments in a given year. This is more than the guaranteed 0 percent, but Smith would only actually receive 5.95 percent because the Kentucky teachers hybrid cash balance plan would take a 15 percent cut off that 7 percent rate of return. Investment returns have never dropped below 0 percent for a ten year average, which means every year Kentucky teachers would lose 15 percent of their investment returns.
Not only would future Kentucky teachers be virtually assured of losing money each year from their investment returns, but they would have even less security because SB 151 also eliminates the “inviolable contract” protection. This means the cash balance benefits could be changed at any time by future legislatures. The state could change the amount that employers contribute -for example, cutting it from 8 percent of pay to 6 percent- or they could further reduce the amount of investment earnings that teachers receive. Any teachers participating in the hybrid cash balance plan would have no legal recourse to prevent these changes.
Finally, the cash balance plan is still not a pension plan. It does not guarantee a certain benefit amount in retirement, which would deprive future Kentucky teachers of security and reliability. The amount Kentucky teachers would have for retirement would be based on market returns, minus the 15 percent that is skimmed off the top in this plan. There would also be no cost of living adjustments, as there are for current Kentucky teachers in the pension plan. Furthermore, Kentucky teachers do not participate in Social Security, so they would be particularly vulnerable in retirement if they were forced into this hybrid cash balance plan.
In addition to all the ways the hybrid cash balance plan fails to provide retirement security for Kentucky teachers, it also does nothing to reduce the unfunded liability in the current Teachers Retirement System (TRS) pension plan. If anything, it will make it more difficult for the state to reduce the unfunded liability because it will cut off contributions from new teachers into the pension fund. TRS was 56 percent funded on June 30, 2017. It is one of the better funded pension plans in Kentucky, but it still has a real challenge in reducing its unfunded liability. Forcing new teachers into a cash balance plan will do nothing to help Kentucky meet this challenge.
The hybrid cash balance plan contained in SB 151 may never be implemented. In late June, a circuit court judge in Kentucky ruled that the bill is unconstitutional based on the manner in which it was passed by the legislature. Late last week, Governor Matt Bevin announced that he is appealing the judge’s ruling directly to the Kentucky Supreme Court. It is likely that the court will hear the case and rule before the end of the year since certain provisions of the bill take effect on January 1, 2019. If the Kentucky Supreme Court reverses the circuit court ruling and determines that SB 151 is constitutional, then future Kentucky teachers will see their retirement security gutted.