Proposed Cash Balance Pension Plan for New Workers Projected to Increase Costs

The cash balance plan for new workers proposed in Senate Bill 2 would make paying Kentucky’s unfunded pension liability harder by adding approximately $55 million in state costs over the next 20 years, according to the actuarial analysis produced for the bill.

The analysis notes that the additional cost of the cash balance plan can be calculated by comparing its projections to those included in a December 18 letter from the actuary.  That letter projects the impact of various Senate Bill 2 measures on future state contributions without a cash balance plan. Including the cash balance plan makes the state’s future payments larger than they would be if the state kept the existing defined benefit plan for new employees.

The added costs start small but grow bigger as more new employees join the cash balance plan, surpassing $1 million annually by 2018. The total additional cost is $54.6 million through 2032.

What’s more, the actuary states that the additional costs could be even higher. The design of the cash balance plan may result in a higher average rate at which individual accounts earn interest than the assumed rate of 7.75 percent. The actuary’s model predicted a range from 6.4 percent at the 25th percentile to 10 percent at the 75th percentile with a median result of 8.1 percent. The actuary notes that “to the extent the actual credit rate is higher than 7.75 percent, the costs of the legislation will be greater than shown in the enclosed tables.”

Were the plan to be more expensive than expected, it would likely mean even more benefit cuts in the future.

Senate Bill 2 sailed through the Senate this week without a substantive discussion of the potential costs and risks of moving from a defined benefit to a cash balance plan. The official actuarial analysis of the bill raises serious questions about whether the plan would make the pension funding challenge even worse.

Source: Author’s analysis of calculations for the Kentucky Employees Retirement System non-hazardous and hazardous plans and the State Police Retirement System plan in Thomas J. Cavanaugh, “Actuarial Analysis of Senate Bill 2,” February 7, 2013, http://www.lrc.ky.gov/record/13RS/SB2.htm; Thomas J. Cavanaugh, “Twenty-Year Rate Projection with Shortened Phase-in Periods and Resetting Amortization Period to 30 Years,” December 18, 2012. Additional costs are $29.8 million in the KERS non-hazardous plan, $19.6 million in the KERS hazardous plan and $5.2 million in the SPRS plan.

Costs of Cash Balance.pdf