Guest Editorial: Kentucky's Worsening Pension Crisis Needs Attention Before It's Too Late
Kentucky is in its greatest financial crisis since the Great Depression, and most Kentuckians are clueless. The business community in Chicago woke up recently to find their state and city in financial ruin because they were not paying attention to the wheeling and dealing and the raiding of their pensions. Frankfort has been telling us that two-plus-two equals eight for the last 10 years, and the bad math is catching up. This crisis not only affects pensions but also the solvency of the entire state.
While Illinois and Detroit are making headlines, the worst-funded pension at 23 percent is the Kentucky Employee Retirement Systems, which is two-thirds state employees and the other third a hodgepodge of nonprofits including a credit union and an insurance company. In funding levels or fiscal soundness, it is three times worse than the Detroit pension.
The cause of the Kentucky pension crisis was too much bipartisanship and too little transparency. If you put a group of bipartisan politicians in a locked room and give them three choices: raise taxes, fire teachers or screw the pensions – they will pick “screw the pensions” every time.
The Good Ol’ Boys in Frankfort have been pulling a fast one for the past 10 years. While Kentucky’s constitution requires a balanced budget, they have been running deficits starting at $500 million a year and now at $1 billion a year by raiding (or underfunding) the pensions, according to WKU economist Brian Strow.
Both state employees and teachers receive pensions and retiree health benefits, and actuaries come up with the correct number each year for those programs to function properly. Our state leaders have basically only put in 50 percent of the actuarially required contributions (ARC) for state employees and 75 percent for teachers. If you only paid half of your mortgage payment for 10 years straight, you should not be surprised that your house is underwater. And this is like borrowing on credit cards because you borrow at the assumed investment return rate of the pensions, which is 7.75 percent. Running this deficit on essentially a credit card has put us more than $35 billion in the hole.
Gov. Steve Beshear in March 2013 said “The reforms will make Kentucky’s pension system one of the healthiest in the country,” and four days later a major nonprofit in Louisville files bankruptcy to escape this so-called healthy pension. These reforms only took the $1 billion a year of raiding from pensions and decreased it to $900 million a year. While people talk of “stop digging the hole,” this so-called reform is just digging the hole 10 percent slower.
Just last week the bankruptcy judge ruled against the state and clearly blames the Kentucky legislature for creating a broken, insolvent pension system. He said, “The solvency of the fund to meet future retirement obligations is dependent upon consistent payment of the ARC. The failure to pay the ARC, as that rate is reassessed annually by actuaries employed by KRS, will almost certainly result in a fund that is insufficient to pay future retiree benefits.” Both the legislature and the governor are still defiant in opposition to the judge’s ruling and have pressured KRS to appeal the decision, which they have.
Boston College’s Center for Retirement Research head Alicia H. Munnell in her 2013 book, State and Local Pensions: What Now? thinks that the issues confronting most state and local pensions, while not trivial, are manageable. Well, maybe not in every case. In Illinois and possibly Kentucky, she says, “they should be hysterical.”
Oldham County schools passed a 6 percent property tax increase citing pension costs. This will become the new normal in Kentucky as I expect downward pressure from Frankfort on school districts to raise property taxes.
Illinois increased corporate taxes by 40 percent, leading many businesses to think of leaving the state. Other states such as Indiana and Texas have major programs to help businesses relocate from Illinois to their state. Indiana has already started using a similar strategy to take business from Kentucky based on the high likelihood of a tax increase.
Two-plus-two has equaled eight in Frankfort for the past 10 years and cannot continue. The business community in Kentucky needs to get engaged in this issue before it is too late.
Chris Tobe, CFA, has 25 years of institutional investment experience with a focus on public pension plans and is author of the best-selling book “Kentucky Fried Pensions.” From 2008-2012 he served as a trustee and on the investment committee for the $13 billion Kentucky Retirement Systems, but his involvement goes back to 1997 when he worked with Kentucky State Auditor Ed Hatchett and published a 40-page report on the investments of both the Kentucky Retirement Systems and the Kentucky Teachers Retirements Systems. In his consulting practice, he has worked with major public plans in Texas, Maryland, Oklahoma, Missouri, Michigan, North Carolina, Rhode Island and the District of Columbia.