Kentucky currently has one of the largest pension-funding gaps of any U.S. state. According to a report by Kentucky Chamber, as of 2015, Kentucky’s government employee pension system is carrying a deficit of $36 billion and has less than half the money it needs to cover all its present and future obligations. The Chamber notes that if all 4.3 million Kentuckians were asked to pitch in to fix the $36 billion pension deficit, it would take “$8,268 from every man, woman and child in the Commonwealth.”
Kentucky has six state pension plans, which together make up the Kentucky Retirement Systems (KRS). KRS manages retirement benefits for 355,000 current and retired state employees and has generated $19 billion in unfunded liabilities.
Overpromising benefits and underfunding have created several problems the state will soon have to face. According to Governing Magazine, Kentucky’s largest pension plan “lost nearly a third of its assets, dropping to $2.3 billion in 2015 from $3.1 billion in 2014. It now has just 19 percent of the assets it needs to meet its total pension liabilities over the next three decades.” If the largest fund’s assets continue to fall, the state will be forced to convert all investments to cash. The state has already moved several of its investments to low-risk, low-return bonds to pay for retiree payments.
The growing pension debt in Kentucky has had a negative effect on the state’s credit rating. Bond-rating agencies have all lowered Kentucky’s rating to the third-lowest rating of all U.S. states. It now only sits behind Illinois and New Jersey. Maintaining a higher credit rating is important because lower ratings increase the cost of borrowing money, which could make it difficult to pay all of the state’s bills without imposing tax increases. Kentucky’s failing pension system is a testament to years of overspending and providing benefits it couldn’t afford.
Kentucky’s serious pension fund investment problems have been compounded by its unrealistic expectations for those investments. While the fund recently decreased its expected rate of return to 7.5 percent, down from 7.75, this is nowhere near the rate that should be imposed to meet realistic market expectations. Taxpayers cannot afford for states to continue overpromising and underfunding their pension plans. If the rate of return continues to fall short of expectations, the state’s pension system may be in even more trouble than is currently thought. Pension experts recommend states use an expected investment return rate of 3.1 percent, which is based on 30-year Treasury bond yields.
Kentucky has made some efforts to reform its pension system, but these reforms have not gone far enough. In 2013, the state passed new laws that created a hybrid cash balance plan for new employees, eliminated retiree cost-of-living increases, and required the state to make full pension payments. These were all positive steps, albeit small ones, toward creating a fiscally sustainable system, but they failed to address the primary problems with the state’s investments.
Recent efforts to reform Kentucky’s pension system, both good and bad, have stalled over the past two years. One proposal would have required the disclosure of investment fees and the terms of contracts entered into by the retirement systems, adding transparency to the system. While this is a good effort by state legislators, a more significant systemic reform is needed.
To protect both taxpayers and public workers long term, Kentucky should follow the private sector’s model and switch workers from defined-benefit pension systems to defined-contribution plans, such as 401ks. Defined-contribution gives retirees direct control over retirement nest eggs and enables them to move in and out of the private sector without losing accrued pension benefits. It also allows governments to budget more accurately because the benefits are paid directly to the employee and are a defined amount of money each year.
The following articles examine state pension reform from multiple perspectives.
A Citizen’s Guide to Kentucky’s Pension Crisis
This Issue Brief from the Kentucky Chamber provides background data on Kentucky’s major pension systems, reviews how Kentucky’s pension systems ended up falling into such poor shape, compares Kentucky’s performance with national averages, summarizes recent reforms in the system, and outlines recommendations that would help put the state’s pension systems on a sound and responsible financial track.
Properly Funding a Defined-Benefit Plan Requires Solid Average Returns and Some Luck
Adam Millsap of the Mercatus Center discusses the problems created by overly optimistic investment-return assumptions and how they add risk to defined-benefit pension plans. “The risks associated with the variability in returns is another reason why many pension reform advocates recommend defined contribution plans rather than defined benefits plans. Defined contribution plans don’t promise a specific amount of benefits, which means they are not subject to the same underfunding risks as defined benefit plans,” wrote Millsap.
Public Pension Investments: Risky Chase for High Returns
Truong Bui writes in Budget & Tax News about a recent Pew report that shows there has been a systematic shift with many public pension plans. Over the past 30 years, an increasing number of public pensions have moved away from fixed-income investments and toward equities and alternative investments.
Keeping the Promise: State Solutions for Government Pension Reform
This report from the American Legislative Exchange Council describes the variety of pension plans governments use today and the advantages and disadvantages of each plan. It also provides several tools legislators can use to ensure governments can affordably fund retirement benefits for their employees.
Kentucky’s Pension Challenges: Opportunities for Real Reform
This paper from the Pew Center on the States examines the challenges posed by Kentucky’s failing pension system, how those problems came to happen, and some opportunities for reform.
Research & Commentary: Defined Contribution vs. Defined Benefit Pensions
John Nothdurft of The Heartland Institute provides a bullet-point comparison of defined-benefit pensions and defined-contribution retirement plans.
The State Public Pension Crisis: A 50-State Report Card
The Heartland Institute examines problems facing public pension systems, including the enormous burdens they pose in some locations. The report ranks each state on the operation and disposition of its pension plans and suggests ways to solve states’ pension system problems.
Research & Commentary: Public Pensions and the Assumed Rate of Return
Heartland Institute Senior Policy Analyst Matthew Glans examines the problems facing state and local pension funds, how assumed rates of return affect pension fund debt, and proposals to change the projected rates of return on pension fund investments.
State Pension Funds Fall Off a Cliff
Barry W. Poulson and Arthur P. Hall consider different measures of historical and current funding shortfalls in state pension plans. Two case studies—the Public Employee Retirement Association of Colorado (PERA) and the Kansas Public Employee Retirement System (KPERS)—are examined in depth to explore the fatal flaws that have caused funding crises in these plans.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this subject, visit Budget & Tax News and The Heartland Institute’s website.
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