The gap between benefits earned by members of the Kentucky Employees Retirement System and available assets—or the system’s “unfunded liability”—reached nearly $12 billion for pension and insurance benefits combined last year and continues to grow.
If the economy stabilizes and the state makes contributions as planned to KERS, that unfunded liability will be paid off within 25 years, pension experts say. But that still leaves the KERS non-hazardous plan, specifically, “dangerously close” to insolvency with fewer than two years of benefit payments available under the plan by 2022.
Kentucky must find a way to fix this problem, and soon. And, with help from our consultants from the Pew Center on the States and the John and Laura Arnold Foundation, a group of Kentucky lawmakers responsible for finding ways to close the funding gap now knows what possible “fixes” will likely work better than others.
The Kentucky Public Pensions Task Force was told by the consultants last Wednesday that, while there will be substantial costs to state and local governments to pay for pensions covered by the Kentucky Retirement Systems over the next 30 years under all likely scenarios, raising the employee contribution rate would have the greatest impact in the short term. And one way to do that, say the consultants, is to offer employees a three-percent salary increase in exchange for a two-percent increase in their contribution.
A two percent increase in the employee contribution would save the retirement systems almost $2 billion, say the consultants, while the salary increase would help defray the cost of living for state employees, many who have gone without a raise for more than three years.
Changing the tax rules on pensions by reducing the state’s retirement tax exclusion is another way to bolster the retirement systems, the consultants tell us. We heard one chamber of commerce official testify before the task force recently that Kentucky could save around $25 million toward retirement for each $1,000 reduction in tax exclusion. But that, some say, would require protecting money saved from borrowing by future Kentucky legislatures.
The state could try to ensure that future retirement benefits are met and discourage borrowing by future lawmakers through bonding. But the consultants said while bonding would lock in the state’s payments to the retirement system, it carries the risk that returns in bond proceeds could end up below borrowing costs. Therefore, they advised that bonding only be used as part of comprehensive pension reform.
That said, the consultants explained that any plan we lawmakers come up with to inject new revenue into KRS should be coordinated with some tax rule changes.
Other proposed “fixes” that lawmakers have been considering include changing benefits for future employees, decreasing the retirement benefit multiplier, changing how salary is averaged to calculate benefits, and raising the retirement age by one year. But, as the task force learned last Wednesday, they might not fix very much.
• Even eliminating benefits for future employees (which was not advised) would only reduce the value of future contributions by $1.3 billion, the consultants said.
• Decreasing the multiplier for future and current employees by 0.1 percent would reduce the value of employer contributions by around $600 million.
• Changing the benefit calculation by averaging salary over six years rather than the current five would save around $255 million.
• Raising the retirement age by a year would not necessarily save money, the consultants said, because public pension benefits in Kentucky are back-loaded, meaning greater benefits accrue later in a worker’s career.
• There also is always the likelihood that some “fixes” will not be possible because of the KRS’ “inviolable contract” with public employees that legally assures employees that their pension benefits will be paid when they retire.
Lawmakers and many of you want to know who, exactly, is to blame for the pension mess. Well, according to consultant Dr. Josh McGee with the Arnold Foundation, blame cannot be assigned. When the economy does not perform as well as assumed, costs rise. And costs rise when revenues are falling, he said, which make it difficult for legislators to choose between fully funding pensions—as we should—and other essential budget priorities.
“The real question here,” said Dr. McGee, “is how are you going to deal with those debts now that they’ve been racked up.”
Next time in my article, we’ll look at the four plan options commonly used for public pensions and the pros and cons of each, as explained by the Pew Center and Arnold Foundation consultants.
Have a good week.