A publication of the Kentucky Center for Public Service Journalism

Jason Bailey: Time for sensible approach to paying pensions in Kentucky with total transparency

The long pension saga of the last year gave rise to the largest mobilization of Kentuckians to the Capitol the state has seen in decades. The unpopularity of proposals led lawmakers to try sneaking the final pension bill into sewage legislation, which the Franklin Circuit Court declared unconstitutional last week.

The whole episode will mean a halt to more legislative attacks on pensions for the time being. That presents an opportunity for a fresh start on the issue — one that fully protects pensions and also lessens the strain now facing state and local budgets, where pension payments will jump next year to as much as 83 percent of what is spent on employees’ salaries.

A new approach requires discarding the myths and misinformation that have plagued the pension discussion over the last year. Those seeking pension cuts regularly exaggerated the size of liabilities and the urgency with which they must be reduced. Proponents used overstated claims to argue for ideas that actually cost more money rather than less, unnecessarily choke the budget in the short-term, have no impact on the unfunded liability or are patently illegal.

For instance, the governor-appointed majority on the Kentucky Retirement Systems board spurred a crisis by suddenly lowering the retirement plans’ assumptions to the most conservative in the country. Employers will be making pension payments next year that are as much as 82 percent above the already-high actuarially required contributions made in the last budget. That is resulting in big cuts to vital public services.

Jason Bailey

The truth is Kentucky’s pension debt, while a serious issue, is not nearly as big nor as unsurmountable as has been claimed. In addition to raising more revenue to help fund the plans — which everyone knows Kentucky needs — we can take commonsense steps to ease the pressure we face.

Contributions are so high in part because we are trying to get all 16 pension and retiree health plans to full 100 percent funding in less than 3 decades. While full funding makes sense for private businesses that can come and go, it is not ultimately a necessity in government where states like Kentucky are at no risk of disappearing. Pensions owed are not paid all at once, so there will never be a point in time where full pre-funding is required.

Rather than emphasizing our distance from a goal that is not essential to meet, we should put more focus on the health of the plans today. The important question for Kentucky is what contribution amounts will ensure pension plan assets are on a positive growth trajectory while avoiding the deterioration caused by underfunding in the past. An approach aimed at steady progress will result in more manageable annual contributions, and feasible long-term targets will mean less is owed in unfunded liabilities.

Part of that approach will require re-thinking how we fund retiree health plans. Kentucky has saved far more money in those plans than most all other states, putting aside nearly $6 billion. Many states still make the practical choice of managing retired employee health plans on a pay-as-you-go basis, which means they are not prefunded at all.

Added together, retiree health plans across the country are only 7 percent funded, but Kentucky’s are much higher at 48 percent funded. Despite that, new more austere assumptions will cause contributions to the Kentucky Employees Retirement System non-hazardous health plan to jump 49 percent next year.

Recent events create an opportunity for a turning point on the issue. We can finally stop cutting workers’ already-modest retirement benefits or squeezing their salaries through requiring them to contribute more, as happened in 2003, ’08, ’10, and ’13 in addition to the 2018 changes now thrown out by the court. Funding will get us where we need to be—and less painfully than has been claimed. We can target a sweet spot between the inadequate funding of the past and the demands that pension opponents’ manufactured crisis have forced on us today.

A commonsense approach would protect benefits, get the plans on a steady path to greater health and make more room for other public investments Kentucky needs to prosper.

Jason Bailey is executive director of the Kentucky Center for Economic Policy, www.kypolicy.org.

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One Comment

  1. Let me begin by stating that I am glad the pension debate is staying in the forefront of the news even though I disagree with the conclusions and recommendations made by the author of this article. As an unbiased bystander that has a keen interest in Kentucky pension reform, it appears that the political, legal, media, and now public policy think tanks in Kentucky support the continuation of two large public retirement systems that are doomed to fail and in the process bridle the State of Kentucky for many years given the financial dilemma that is tied to the current plan design and funding status of the retirement systems.

    Keep in mind that it was only about one year ago when Moody’s downgraded the debt issued by Kentucky’s state government by one level, to a Aa3 rating, warning bond investors that the state does not collect enough revenue to resolve its $37 billion public pension shortfall. Amazingly, this article downplays this problem and ignores the impact that a rising cost of debt will have on Kentucky.

    Assuming that most people trust Moody’s as a valid source for providing an unbiased liability estimate for the pension plans, how does one propose to downplay the mammoth public pension debt level facing Kentucky? The state only has about 2 million workers and their per capita income is only about $26k. Therefore, I trust that everyone would agree that the public pension debt load cannot be repaid by the workers of the Commonwealth. Moreover, increasing the sales tax is not an option because it only puts more of the regressive tax burden on individuals to pay for the mammoth unfunded pension liabilities. This means that corporate income taxes would have to be raised significantly to have any impact on the public pension debt level. Even then, the tax burden would need to be paid by products made and services provided to people outside of the Commonwealth in order to have a material impact on the unfunded pension liabilities. I can only hope that Kentuckians do not intend to rely on tax revenue from gaming, or perhaps casino gambling or marijuana to provide the necessary funds, as such solutions are naïve and delusional pipe dreams (e.g., where is tax revenue going to be generated from by people that grow their own marijuana?)

    The proposed solutions offered in this article supports lowering the funding status requirement for the retirement systems and lengthening the time horizon for paying off the liabilities over multiple generations. Unfortunately, that is not how the real world works, particularly for states that rely on debt financing for their capital projects. The proposal outlined in this article will raise inter-generational inequity issues that have legal implications, and will definitely affect the State’s ability to borrow money at an attractive rate in the future. This in turn means that the public pension debt issue will constantly be a drag on the State’s economy, and dissuade corporations from setting up their operations in the Commonwealth. As a result, such a proposal will always keep the State in the bottom tier of the Nation, which means that the need for pension reform will always be in the news. Accordingly, such a solution will keep the Commonwealth mired in a spiral of poverty that will ultimately be addressed by outward migration.

    While the powers that be appear to have an upper hand in controlling the direction of the pension resolution at this point (ie., keep retirement benefits at the current level and find new tax revenue sources), what they fail to understand is that they do not have the power to control the global capital markets. It also appears that the powers that be do not have the foresight to understand how the global capital markets will eventually resolve the pension issue in Kentucky in an uncompassionate manner.

    Simply explained, when the global capital markets correct, the market value of the pension plan assets will decline. When asset levels reach a minimum level, additional investment assets will have to be held in liquid investments in order to be available to pay retirement benefits. Eventually, the asset base will not be at the level that is required to provide the retirement benefits to retirees. At that time, the retirement system will try to use current benefit contributions that are being made by active employees to pay the benefit obligations to retirees (parenthetically speaking, many people state that one of the big problems with the retirement systems is that more people are taking money out of the system than paying in. Unfortunately, that is not how a pre-funded DB plan operates, but that is a topic for another day). Once this situation occurs, the inflection point in the pension crisis will come to fruition, because active retirement system members will see the inevitable end to their pension system and subsequently sue the retirement system in order to protect their contributions from being used to pay retiree benefits. This in turn will pit active retirement system members against retirement system retirees. Once this happens, the pension crisis will be resolved according to the rules of capitalism, where benefits are cut for retirees, and active members will simply receive a return of their contributions.

    I truly hope that the scenario that I just explained does not come to fruition for any of the retirement system members. However, if I were a member of one of the retirement systems, I would ask myself why so many people say there is a funding problem with the retirement plans and I would also ask myself why people keep saying that the benefit levels need to be reduced for all members. Perhaps it’s simply because of politics, perhaps it’s because people are jealous of public employee benefits, or perhaps it’s simply because people are just mean spirited and want to take what you have. Nevertheless, since no one seems to agree on the level of the unfunded liabilities for these retirement systems, and they don’t seem to understand that there are no new viable tax revenue sources, and they continue to ignore the impact that a rising cost of debt will have on the growth and standard of living of the majority of the people in the Commonwealth, perhaps they should simply compare retirement plan assets in relation to the number of retirement system members. I believe that once people look at this complex issue from this simple perspective, they will understand the gravity of the problem.

    In closing, I would like to say that at least the author of this column is addressing this very important issue at the right time of the year. Hopefully such a solution can be outlined in a bill that is submitted at the beginning of the next legislative session.

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