KET Legislative Coverage

Kentucky Retirement System Has Problems yet "Fundamentally Sound"

by John Gregory | 06/17/14 5:08 PM

During the last legislative session, a teacher hoping to retire called Rep. Brent Yonts' office in Frankfort. The individual was crying because of being been told he couldn't retire because the state pension system was bankrupt.

Yonts, who is co-chair of the Public Pension Oversight Board, describes the incident as a classic example of how fear and lack of information have led some current and former public employees to assume the worst about their retirement benefits. Despite a variety of challenges in recent years, the overall Kentucky Retirement System (KRS) is, Yonts emphatically declares, "fundamentally sound."

The Greenville Democrat joined a bipartisan panel of legislators to discuss public employee pensions on Monday's edition of Kentucky Tonight.

Good Times, Bad Decisions
KRS is actually comprised of six distinct systems for state employees, judges, legislators, and police, as well as public school teachers and county employees. Each of those systems includes a pension portion and a health benefits portion. About 10 percent of the current Kentucky budget goes to funding the state pension system.

Rep. Brad Montell (R-Shelbyville) says that during some relatively prosperous years in the 1980s and 1990s, actuaries told employers they didn’t have to contribute into the systems because investment returns were so good. Montell says that led to bad decisions.

"We got too comfortable, we got too generous," Montell explains. "We began to allow things to go on within the system and make promises that, when we got into the 2000s, and investment returns weren't what we thought they would be, it began to snowball on us."

By 2012, KRS had become one of the worst-funded systems in the country with around $30 billion in unfunded liabilities. (That occurs when benefits owed to current and future retirees are greater than the assets available to pay those obligations.) Rep. Yonts attributes that imbalance to a number of factors including employee cost-of-living increases that were mandated but not funded, shortfalls in employer contributions, under-performing investments, and changes to the benefits packages. The biggest challenge, though, stemmed from the 2008 recession.

Yonts says that despite the state paying the actuarially required contributions (ARC) between 2000 and 2013, the systems still realized huge losses. As examples, he reports that the Kentucky Employees Retirement System and the County Employees Retirement system saw about a 100 percent drop in their funding levels during those years.

Major Reforms
To address escalating pension costs and the unfunded liabilities, lawmakers passed a landmark pension reform package in 2013. Senate Bill 2 requires the state to fully pay the ARC owed each year, allows cost-of-living increases only when the funds are available, and places new hires into a so-called hybrid cash-balance plan that guarantees them a minimum 4 percent return on their investment.

Another component of SB 2 improves transparency and oversight of pension funds management. Sen. Christian McDaniel (R-Taylor Mill) says he and his colleagues as well as some outside analysts are troubled by the secrecy surrounding investment activities and financial payments made to agents conducting those transactions.

"We have billions of dollars of assets to be invested and It's not too much to ask with whom we're investing those assets and what their fees are," McDaniel says.

But the larger issue of how to infuse more cash into the system in the coming years remains. "[Senate Bill 2] did stop the bleeding at the moment," says Rep. John Tilley, (D-Hopkinsville), but "we'll have to go back and revisit this every biennium, without question."

Without additional revenues from tax reform or expanded gambling, legislators are looking at other potential sources of funding to secure the pension system. Rep. Yonts proposed an option of taxing Internet sales, which he says could generate $225 million a year for the commonwealth.

Tilley agrees with that idea, saying the technology now exists for the state to easily assess and collect such revenues. He paraphrases Tennessee Sen. Lamar Alexander, who calls the levy on Internet sales "not a new tax, but a due tax."

Another even more unpopular option would be to scale-back pension benefits. Rep. Montell says the state must make good on its obligations to current retirees, but also must be responsible to future taxpayers who will ultimately fund for those benefits.

Legal Maneuvers Pose New Challenges
Earlier this month, the northern Kentucky community of Fort Wright sued the state pension system, alleging "illegal and imprudent" investment activities that have resulted in lower returns and larger fees than expected. The city wants details on how its funds have been invested so far, and future funds kept out of risky investments. The suit also requests class-action status so other cities could join the claim.

A more immediate challenge arises from the bankruptcy filing by Seven Counties Services, a Louisville-based mental health services provider. The non-profit agency requested to leave the system, saying it could no longer afford to participate. Last month, a federal judge ruled the agency could exit KRS without taking its accompanying $90 million pension liability. The trustees of the state system are appealing that decision.

Sen. McDaniel says the ruling sets a dangerous precedent. If Seven Counties is allowed to leave its unfunded liability behind, all other employers in the system will have to pay an additional 2.5 percent to cover the loss. If other mental health agencies exit, as some are considering, the cost to the remaining employers would go even higher.

"This is a question of fundamental fairness," McDaniel says of the Seven Counties situation. "They could handle their obligations and not put those off on every other employer, and by extension the General Fund and the taxpayers of the commonwealth.”

Watch the full Kentucky Tonight program.