Listen to the audio here:
William “Flick” Fornia, President of Pension Trustee Advisors, one of the nation’s leading actuaries, sits down to discuss Kentucky lawmakers’ proposed changes to the pension system with Pat Crowley, a former Kentucky journalist and current representative for the Kentucky Retired Teachers Association.
The discussion includes how a failure to fund the system has been the source of the problem, a rundown of states who have tried switching from pensions to 401k-type plans only to see their problems worsen, and some discussion of how cash-hybrid systems have been proven to have very little helping effect.
Flick also highlights that in order to fix the retirement systems, lawmakers will have to work with the employees to adjust some details of the pension, but “mostly they swallow the bitter pill of paying what they owe in arrears.” In other states lawmakers have been forced to find new sources of revenue. In West Virginia, for example, lawmakers used tobacco settlement money to pay down the debt. He added the state has to, “find a way to pay its bills, just like I do, just like any other entity does. And then be disciplined about not slacking off on those payments in the future.”
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Pat Crowley: Hello everyone I’m Patrick Crowley with the Kentucky Retired Teachers Association. Joining us today for this podcast is William Flick Fornia, President of Pension Trust Advisors, one of the nation’s leading actuaries. With nearly 40 years of experience, Flick has served as a corporate actuary for the Boeing company and has worked on numerous public pension funds across the country. In fact, he was hired by the government several years ago to analyze the Kentucky pension system. He is deeply familiar with the pension funding issues here in the state.
Flick, thanks for joining us.
Flick Fornia: Thanks Pat.
PC: Let me jump right in with these questions. Given your knowledge and your work on the Kentucky pension systems Flick, how did we get here? We’re in a tremendous hole here, how did it happen?
FF: Well Pat what I see as the biggest contributor is the government’s failure to pay what the actuary has recommended over the past decade or so. And the Governor’s consultant estimated this shortfall at about $4 billion. On top of that things haven’t turned out quite as well as the actuaries have predicted over the years. Investment return has been a bit lower than expected, and people are living longer than expected.
But the root of the problem, the fundamental root is the failure to contribute what was needed. Other retirement systems around the country who have contributed appropriately what’s needed can weather the unexpected. If you aren’t even putting in what the actuaries calculated then it’s very difficult to deal with unfavorable experience. It’s like you’re not making your adequate credit card payments, then you have some unexpected financial challenges it’s even harder to catch up.
PC: That’s a great comparison.
Some policymakers are advocating switching new teachers from pensions to perhaps a 401k or so-called hybrid plan. Is that a good idea, and would it close this funding gap eventually?
FF: Well, what we’ve seen in other states is switching to such a plan often makes the problem worse. There are some well-known failures in this approach. Nebraska and West Virginia tried this a few decades ago and they had to switch back. Alaska did this in 2005 and their situation has not improved the funding for the old plan at all. And public employees covered by the new plan are not expected to have adequate benefits which can be hurting recruiting and retention. And the worst cases of all are Guam and Puerto Rico who tried this approach more than a decade ago. Both are in terrible financial straights on the old plan and have inadequate benefits on the new plan.
Now while your proposal in Kentucky is not as ill-conceived as Guam and Puerto Rico, I just can’t see how it’s going to improve the situation. Essentially is starves the old plan of contributions, it drives up the cost to taxpayers.
And again, back to the credit card analogy, it’s like running up a debt on a credit card and then opening up a new credit card. You still have to pay out the balance of the first card.
PC: Right, right. Well now we’re starting to hear some debate about a cash-hybrid kind of account. What are those and would that provide any type of solution to this problem?
FF: Ok well the Kentucky Retirement System currently is a cash-balance-type hybrid plan. That really hasn’t helped the situation at all. And the teachers currently have the traditional pension plan or defined-benefit plan, and the proposals there are to go into a 401k-type plan.
These cash-balance or hybrid plan, in-general and dollar-for-dollar they’re stronger than a 401k approach, but they don’t have the advantages of the traditional pension approach.
PC: Ok so if you were advising Kentucky today Flick, what would you tell lawmakers to do?
FF: Well you have some really tough choices. You’re behind on your payments so you want to be as cost-efficient as possible and not dig a bigger hole, and a switch would very likely do that. In other states what we’ve seen is the lawmakers collaborate with the stakeholders and they make minor changes to the pension plan. They might modify contributions, modify employees, reduce benefit levels to some extent. But mostly they swallow the bitter pill of paying what they owe in arrears.
For example in West Virginia, they were able to use the tobacco settlement money to help do that, to help pay down the debt. I don’t know precisely what funding mechanism you would use here in Kentucky.
But basically it seems the state ultimately has to find a way to pay its bills, just like I do, just like any other entity does. And then be disciplined about not slacking off on its payments in the future.
PC: Yeah that money’s been sitting there for years and they’ve been basically raiding it just session after session. In my many years down there as a reporter and now as a lobbyist, you kinda knew what was going on, but it was a well-kept secret because everyone wanted to balance the budget every year, and everybody wanted their projects. And now we’re seeing the result of that. In a broader sense, Flick how do you see the argument that 401k plans might provide better retirements for teachers and even private sector workers, or what you see in some of the government plans. Whats your view on that?
FF: Well I’m an outspoken critic of these types of plans a primary retirement vehicle. In the early 1980s I was Boeing’s corporate actuary and I helped them implement their 401k, and it was terrific, but it was only a supplement to the properly funded pension plan, defined benefit pension plan they had.
Pensions provide retirement security for your workers much more so than 401k plan, as we’ve seen in other sate in the private sector. For the wealthy a 401k can work out pretty well. But unless you have plenty of money at retirement, the 401k approach is very very difficult.
And for Kentucky teacher in particular who are not in social security, a it can be extremely challenging. I’ve written a couple papers on this subject, along with the National Institute on Retirement Security, they’re called “Better Bang for the Buck, the Economic Efficiencies of Defined Benefit Plans.” Defined benefit plans basically means pension plan – plan that pays for as long as you live.
And essentially there’s 3 reasons why the 401k approach just can’t be as cost-efficient as traditional pension, I’m talking dollar-for-dollar here. And the 3 reasons are:
First of all, each individual person doesn’t know how long they’re going to live, but a collective pension knows very well – the actuaries are very good at predicting how long people will live on the average.
I’m 59 for example, I’m self-employed so I don’t have much of a pension. Let’s say I retire at 65, the actuarial tables project my wife and I will live to 80, 85. 85. But that’s on the average. There’a 50/50 chance that I’ll live longer – that we’ll live longer – than that.
We’ve got to have extra money set aside in case we live longer than average. But if I were in a big pension plan, there’d be hundreds of other 59 year olds retiring at 65, and the plan wouldn’t have to have enough money for all of us living longer than average. So they just don’t need as much money set aside as the individual does. Because the individual can’t take the risk that they live longer than average – that’s just too hard – so they have to have extra money set aside.
The second reason the 401k approach can’t work as well as a traditional pension approach, is that the pension plan is a pooled plan. It’s got investment professionals that are more likely to have much better investment return than I am with my 401k, the best investment professionals, they’ve great purchasing power, they’ve got economies of scale. So even though I think I’m a pretty savvy investor, the chances are pretty high that a system like the Kentucky Retirement System, or any large public retirement system, or large private retirement system, the chances are very high that they’ll have better investment returns than I will.
I also have the investment expenses that they don’t have. Administrative expenses. For example I can go online and make investment decisions and trades. They don’t have the expenses of letting each individual do that. So they’re going to have better returns on the long run than compared to individuals.
And finally the 3rd reason, as I’m getting older, I can’t take the investment risk I could 40 years ago, because I don’t have the time to make up for any losses. For example the stock market is going gang busters, it wet up about 10% in 2016, it went up another 9% last year, it’s up a couple percent already I think this year. So a good pension fund was heavily in the stock market and they got good strong returns. But I couldn’t do that, you see I’m too old. I don’t have the timeframe to catch up in case it goes down. So I’m only partially in the stock market, and as a result my investment returns have been only a fraction of what the good pension funds have been.
So again, those are 3 reasons 401k’s don’t work as well.
1) We don’t know how long we’re going to live.
2) We’re not as good of investors as the big plan.
3) We have to become more conservative as we grow older, so we can’t take the risk.
PC: Well that really clears up some of the perceptions about 401k plans, that’s great. Flick, anything else you’d like to say about the situation here in Kentucky?
FF: Well, I don’t envy you. You have a challenge. You’ve got years of inadequate contributions. And it’s going to be challenging to catch up. I wish you well. I think clearly maintaining the plans you have and properly funding them with perhaps some minor changes are the minor changes are the way to go. I certainly wish you well. I know from my work several years ago, just on the Teacher Retirement System, we kind of came up with a framework. But it’s not going to be easy, and I hope the stake holders and the government are going to be able to get together and find a viable solution that works for all Kentucky citizens, as well as public employees as well as its taxpayers.
PC: So do we. William Flick Fornia, the CEO of Pension Trustee Advisors. I’m Patrick Crowley with the Kentucky Retired Teachers Association. Have a great day everybody.