The Pension Pickle, Part I: How We Got Here

By: Sarah Davasher-Wisdom, VP of Government Affairs & Public Policy

The 2016 General Assembly session is fast approaching and discussions have already begun among policymakers and stakeholders regarding a variety of topics, but one issue looms large: the state of our pension system and what it means for Kentucky’s future.

Few people disagree that we are in a pickle, but believe it or not, some people seem unalarmed.  Here is a wake-up call:  Funded at just 21.1%, the Kentucky Employees Retirement System (KERS) Non-Hazardous is the worst funded in the nation and holds $11 billion in unfunded liabilities.  The Kentucky Teachers Retirement System (KTRS) looks slightly better at 53% funded but still suffers a $14 billion funding shortfall; however, KTRS is another complex topic for a different article.  If the numbers weren’t clear enough, S&P’s recent downgrade of Kentucky’s credit rating, which will likely impact interest rates on bonds, should make us all ready to take action.

How did we get here?  We have an inviolable contract that requires state employees to be granted a definite amount of money based on the highest 5 years of earnings.  Due to an average increased lifespan, the timeframe they are paid is often longer than their career.  This is paid regardless of investment returns, so the major market downturn a few years ago greatly impacted the state of our system.  In addition, belts had to be tightened in all areas during the downturn, so the legislature did not fully fund the ARC for several years.

Significant reforms were made both in 2008 and 2013 that transitions new KERS employees to a hybrid 401K plan, ended COLA increases for the foreseeable future, reduced the amount paid to healthcare, ended double-dipping, lengthened the time needed to qualify for a pension, and provided for increased transparency by creating a Public Pension Oversight Board.  While these reforms were beneficial, we still see the tail on this is quite long.

How do we get out of this hot mess?  GLI has been actively involved in trying to answer this question.  We have brought in speakers, met with Bill Thielen, the Executive Director of KERS, and we are participating in a taskforce convened by the Kentucky Chamber.

Throughout this exploratory process, members have asked questions such as: Can we get out of the inviolable contract?  Most experts believe Kentucky’s inviolable contract language is among the strongest and most clearly delineated in the nation and that the state must honor this contract because it is both the law the right thing to do.  Not only is the language found in statute, it is reinforced in the Kentucky Constitution.  Challenging this could cost Kentucky more than simply paying up because it is very risky.  Courts throughout the nation have not upheld similar attempts to end pension obligations (keep in mind that Kentucky’s statute is one of the strongest).  Detroit remains the exception and was able to renegotiate its debts with the State of Michigan.  Kentucky does not have this luxury, nor does Kentucky benefit from claiming bankruptcy.  Can we incentivize workers currently in the pension plan to move to a mobile 401K plan?  This is a sticky wicket.  If employees leave the system the contributions they are currently making to the system are gone, leaving less money to pay current retirees.  KRS studies indicate this would cost more over the first 10-15 years.  Those same studies indicate there is a legal issue because the current plan is a 401A plan, which means there is no employee choice.  This question deserves further exploration.

Will further changes to the benefits structure harm our ability to attract and retain a quality workforce?  Not necessarily.  Private sector employees are generally offered a 401K plan, often with a company match.  This empowers employees to take charge of their own retirement while limiting the company’s liabilities.  Employees are free to take that money from job to job, building upon their careers.  Once Kentucky’s retirement system is stronger, the state could restructure both salaries and benefits to better reflect and compete with those in the private sector. Such reforms would improve the long-term solvency of the system while ensuring a skilled workforce in critical public positions.

Can Kentucky issue bonds and take advantage of current interest rates?  Yes, but this can backfire because if interest rates decrease, the situation further deteriorates and Kentucky’s credit can be irreparably damaged if the state fails to make its bond payments.

So what CAN be done?  Stay tuned for Part II of “The Pension Pickle” to be released October 21st in the next edition of News You Need to Know.

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