Kentucky’s new leadership tries to pull it back from the pension cliff

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Having become the last legislative chamber in the entire South to flip to Republican control last November, the Kentucky House of Representatives wasted no time this session in moving through a red meat conservative agenda.

H.B. 1 (calling for right-to-work), H.B. 2 (requiring an ultrasound prior to an abortion) and H.B. 3 (deleting various union-backed “prevailing wage” provisions and abolishing the commonwealth’s Prevailing Wage Review Board) all were signed by Gov. Matt Bevin on Jan. 9. Last week, Bevin signed H.B. 520, authorizing charter schools in Kentucky, which had been one of only seven states not to allow them.

But one issue that lingers as unfinished business on both sides of the aisle the Bluegrass State’s public employees’ pension system.  Kentucky has, by some accounts, the worst-funded state pensions in the country. That’s a pretty notable distinction, given the severe pension challenges faced by states and local governments all over the country.

And it’s despite Kentucky having already attempted several fixes in recent years.  Retiree health benefits were cut in 2004 and the Legislature voted in 2008 to abolish various pension “spiking” gimmicks that awarded much larger benefits based on increased earnings at the very end of a worker’s career.  A law passed in 2013 required the commonwealth to make its full pension payments to the system, a hybrid cash-balance plan was formulated for new employees, and cost-of-living increases were all but eliminated.

Alas, the Kentucky Employees Retirement System’s assets dropped by nearly in 2014, due to poor investment performance, and the 2015 assets were calculated to cover only 17 percent of its total liabilities over the next 30 years. The Lexington Herald-Leader reported that the funded percentage had dropped to 16 percent last year, although several of the other pension funds—for teachers, university faculty, state police and local government employees— are in better shape. Kentucky’s employer share doubled and became a full one-third of the total payroll costs for state employees.  Credit downgrades followed, but the real worry is the cash-flow problem. The point of no return will be when the assets drop in valuation to about $1.3 billion.  If this happens, the plan will be forced to convert all the assets into cash.  A cash portfolio fund can’t be fixed.

In the first month after he was sworn in as governor, Bevin announced independent audits of every state pension system. He is calling for substantive structural change, along with extra contributions to help make up the deficit.  One of the changes would be to replace the current state plan with a 401(k) retirement plan for new employees, which also would be open to any current employees who would like to transfer their traditional pensions.

The governor also proposes lowering the assumed rate of return to something more closely resembling the actual financial landscape. At 6.75 percent, even the rate of return assumed for the pension plans is much higher than the 2.344 percent risk-free rate, which reflects an average of the 10- and 20-year U.S. Treasury bond yields from March 2015 to March 2016.  Depending on whether one uses the current rate-of-return assumption or this risk-free rate of return, Kentucky’s pension systems are between $35 billion and $95 billion short of what would be required to pay off the promises made to state workers over the years.  Bevin’s plan would add another $1.1 billion in contributions, while reserving an additional $1 billion in future pension payments.

These are matters of culture, leadership and responsibility.  Putting off fixes to large politically sensitive benefit systems is a culture shared by most of the nation, and from Puerto Rico to Greece. Kentucky is certainly not the only state facing real consequences from inaction, but it is among the closest to the edge, having already stripped away many of the ancillary benefits like health care and cost-of-living increases for retirees.

Seven of the 10 largest states each have total unfunded pension liabilities exceeding $200 billion.  Why not 10 out of 10? Leadership and responsibility seem to matter more than red or blue, North or South. Ohio, Illinois and Kentucky all rank among the worst-funded states per capita in the United States, but Indiana was second-best in a study released last fall by the Center for State Fiscal Reform at the American Legislative Exchange Council.  It’s hard to blame Rust Belt economics, differences in work ethic, longevity, demographics or geography for this difference in the charts. Instead, one could speculate that having Mitch Daniels—the former director of the federal Office of Management and Budget—in the governor’s seat for several years had something to do with this. The good news for Kentucky is that Gov. Bevin does not intend to disregard the leadership imperative.

It is difficult to fault a short legislative session dominated by a new and energized Republican majority for not getting to some of the bigger picture items. But hope for the state’s thousands of state workers who were promised retirement benefits and for the taxpayers who will have to provide them lies in a bipartisan effort to shore up the pension system sooner and not later.


Image by Aaban

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