This is the third time in a decade that Kentucky has tried to address its woefully underfunded pension systems. Each time, the solutions have become more drastic as the financial health of its pensions have continued to decline. Now, a consulting group is recommending the state's lawmakers cut retirees’ pension checks by as much as 25 percent. Between its plans for workers, police officers, firefighters and teachers, the state owes roughly $33 billion in pension debt.
Unsurprisingly, the proposal by PFM Consulting Group has been met with some backlash from retirees. They say this would be jumping the gun and not allowing the most recent reforms to take effect.
In PFM’s presentation to lawmakers on Monday, Managing Director Michael Nadol said the prior reforms hadn’t gone far enough because the funding challenge persists at “acute” levels. “Unfortunately,” he said, “nibbling around the edges won’t get Kentucky to where it needs to be.”
Absent any changes, said State Budget Director John Chilton, lawmakers would need to find an additional $1 billion per year to keep the pension systems solvent. Without raising revenue, that would result in a 34 percent budget cut to most state agencies.
All of PFM’s recommendations are dramatic. No one is spared -- not retirees, current employees or future employees.
Under the proposal, cost-of-living raises awarded between 1996 and 2012 to state employees would be clawed back. The state would refund itself those raises incrementally each month. Cost-of-living raises would also be suspended for retired teachers.
In addition, all retirees would have to pay more for their health-care costs and the state would raise retirement ages for everyone. Police and firefighters, who are now eligible to receive full benefits after 25 years of service because of the dangerous nature of the professions, wouldn’t reach eligibility until age 60. The retirement age for everyone else would be raised to 65.
Finally, new employees would only be eligible for a 401(k)-style plan, which caps the state’s contributions to 5 percent of pay.
Donald Boyd, the director of fiscal studies at the Rockefeller Institute of Government, says that past reforms have mainly focused on future employees. That’s part of the reason why the state’s already massive unfunded liability hasn't improved. “All it does is stop the digging,” he says. “It doesn’t do anything about the hole that’s already there.”
PFM’s recommendations, on the other hand, not only cut already accrued liabilities, but they also tackle structural issues, such as the way the pension plans account for investment growth and the amount of money the state should pay in order for the plans to achieve financial health.
Jim Carroll, president of Kentucky Government Retirees, isn't buying the sudden nature of the crisis. “This is not a surprising scenario,” he says. “This wasn’t going to get better overnight.”
That’s true to some extent, says Boyd.
Prior to 2013, the accounting for all of the state’s pension plans was done in such a way that the state wasn’t paying off the interest accruing on those liabilities, which guaranteed the outstanding debt would increase.
To address the issue, Kentucky created a 30-year payoff plan for its two largest pensions: the state employees plan and its teachers plan. It also suspended cost-of-living raises for retired state employees and set up a separate cash balance pension plan for new hires, which carries far less risk for the state. Most of the reforms didn't take effect until 2014 and three years, says Carroll, is hardly enough time for them to start working.
The 2013 reform was heralded as a success, but Boyd and others say it left gaps. It didn’t, for instance, address funding for the retired teachers plan or lower any of the plans' assumed rate of return to a more conservative and appropriate assumption.The employees' plan did finally lower its rate of return last year to 6.75 percent, but PFM recommends it lower the rate even more.
The main reason for this recommendation is that the losses in the state employees’ plan have been alarming: Since 2008, it has lost more than half its value and now has just $2.5 billion in assets. The plan went from 54 percent funded in 2008 to 16 percent funded today. Meanwhile, it pays out $1 billion annually to retirees, leaving very little room for a poor return on investments.
Boyd says anemic plans like Kentucky’s should have far more conservative assumptions -- or else they run the risk of quickly becoming insolvent. "While I wouldn’t call then it wildly, irredeemably fiscally reckless,” he says, “they are close.”
