Reforming Kentucky’s Pension System for Public Employees

In 2011 Kentucky’s pension shortfall included a $12.34 billion gap in its state employee and state police pension plans and a $6.89 billion gap in its county and local government employee pension plan, according to statistics from the Kentucky Retirement Systems (General Assembly struggling with pension reform, 2012). Kentucky Retirement Systems pays $2 billion in pension and insurance benefits each year to more than 324,000 members on both the state and local government level. Kentucky’s pension system has been unsustainable for a very long time, but it has not always been this way. In 2000, the commonwealth’s pension debt was only $960 million. Five of Kentucky’s six public pension systems were running generous surpluses. The Kentucky pension system was among the nation’s strongest (Why the pension-debt explosion?, 2012). Reports now show that KRS could face insolvency within five years without a major overhaul (Task force calls for overhaul of KY pensions, 2012).

If Kentucky doesn’t make any changes to the pension system to meet these obligations, it will have to either reduce services or increase taxes, said David Draine senior Researcher for the Pew Center on the States, at a recent meeting of the Kentucky pension reform task force (General Assembly struggling with pension reform, 2012).

“The cost of making the recommended contributions competes with other important public priorities like building roads, hiring police to patrol our streets, and paying for teachers in schools,” Draine said. “Ultimately, states that are unable to make their full contributions will either have to raise taxes, cut services, ask employees to contribute more or reduce benefits or in some cases some combination of the above. Policy makers will need to consider ways to fairly share this burden (General Assembly struggling with pension reform, 2012).”

The $19 billion shortfall in the retirement systems of state and local government employees in Kentucky has forced cities and the state to look at cuts and ways to solve this issue. Covington had to absorb a $500,000 increase in the past year and now pays $6 million a year into the pension, 13 percent of its budget, said Covington City Manager Larry Klein. As a result, Covington won’t replace retiring police and firefighters and might consider making firefighters and emergency medical technicians separate so EMTs don’t fall under the more expensive hazardous duty classification, city officials said.

Most state agencies took an 8.4 percent cut for the next two years. The state needs to look at changing the level of employee contributions, Klein said.

“Every city and county gets a letter in December saying this is how much we must pay next July,” Klein said. “It is always an increase, but the employees pay the same. When I entered the system in 1988, I contributed five percent of my paycheck. In 2012, I still contribute five percent (General Assembly struggling with pension reform, 2012).” According to Draine many states have increased employee contribution rates, including most recently Alabama, Colorado, Kansas, Louisiana, Maryland and New Jersey. Since 2010, 10 states have reduced or eliminated cost of living adjustments for pensioners (General Assembly struggling with pension reform, 2012).

There are several reasons why the state of Kentucky is struggling with its pension obligations. One reason is that poor economic conditions have contributed to Kentucky’s pension troubles. As asset values fall, so do funding ratios for state pension plans across the board (Why the pension-debt explosion?, 2012).

Another factor contributing to the insolvency of Kentucky’s pension system is with the structure of Kentucky’s retirement system. Currently Government employees in Kentucky pay into a defined-benefit plan, where the level of benefits is guaranteed based on a formula. For example, if a Kentucky public sector employee obtains a job with the state at the age of 21-years old, then works their typical 25-30 years and retires in their late 40’s, the state of Kentucky is obligated to pay them a pension for the rest of their lives. Given the average life expectancy in the U.S. they could be expected to receive their pension up until they are 78.2-years old. This would amount to receiving pension payments as long or longer than their tenure as an employee with the state. I would like to make clear that no one is blaming state workers for taking advantage of the benefits offered to them, whether it be days off or retirement plans. The purpose of this article is to illustrate the fact that taxpayers can no longer afford to support such munificent pension plans, not blame the workers themselves who benefit from those plans.

Other states have gone to a 401(k)-style defined contribution plan, or a hybrid 401(k)/retirement account plan and a cash balance plan, which offers a retirement account but the state guarantees a minimum return. Critics of a 401(k) defined contribution plan contend that they put the retirees at the mercy of market fluctuations. In hybrid plans and cash balance plans, the state and employees share the risks. Most private sector employees participate in 401(k) defined contribution plans and therefore have to contend with market risk. These risks can be mitigated by ensuring that the investments are diversified and the employee’s portfolio is rebalanced at least once a year to ensure their investments are consistent with their retirement goals. The object is to ensure the investments are more conservative the closer the employee is to their expected retirement age so their losses are minimal during economic downturns.

Some conservative organizations have taken issue with legislative pensions. A recent report by the free market think tank Bluegrass Institute for Public Policy Solutions criticized the formula set forth by 2005 legislation that increased the pensions for some legislators. (General Assembly struggling with pension reform, 2012) The final reason the pension system is in trouble is due to our greedy politicians in the General Assembly that have contributed to the problem. House Bill 299, which is discussed in the report, “Future Shock: Kentucky Politicians’ Opulent Pensions Have Become A Modern-Day Gold Rush,” illustrates how greedy legislators have voted themselves generous pensions. However, the abuse of the system does not end there. A collection of other perks have been accumulating for years:

  • Legislators’ automatic enrollment in the KERS after maxing out their legislative pensions.  “Future Shock” also shines the light on politicians whose retirements have doubled or tripled as a result of HB 299.
  • State employees’ ability to buy “air time” — years of service not actually worked — to beef up their pension calculations.
  • State legislators also receive full health care compensation … and they are better benefits than most of their constituents can afford (Why the pension-debt explosion?, 2012).

HB 299 changed the way legislators qualify for their pensions in a way that significantly benefited any legislator who held another job that was eligible for a non-federal government pension (Current Pension Culprits, 2011). As described by Kentucky Roll Call, HB 299 allowed legislators to enrich their pensions...

...through a little-known law they passed in 2005 without any public hearings, in seemingly a planned maneuver to take advantage of the confusion during the mad rush of bills in the closing days of the session. The main element of the bill allows legislators to base their legislative pensions on the average of their highest three years of taxable income in local or state government jobs after (or before) their legislative service.

Roll Call provided a few examples of how it worked:

Rep. Harry Moberly, had a second pension at KERS, but he dropped that plan so he could enroll in the Kentucky Teachers' Retirement System -- not as a legislator -- but as an Eastern Kentucky University employee. This means Moberly's legislative pension will be based on his university salary, not his legislative pay. As a result, his legislative pension from serving part-time as a member of the General Assembly for 25 years will be at least $168,000 a year, a lifetime increase of around $2.4 million.

House Speaker Greg Stumbo's four years as attorney general boosts his legislative pension about $1.1 million.

Sen. David Boswell's four years as commissioner of agriculture boosts his legislative pension about $700,000.

Former Rep. Joe Barrows' Homeland Security job, which he started last month, will boost his legislative pension about $850,000

Former Rep. J.R. Gray's $136,000-a-year job as secretary of the Labor Cabinet boast's his legislative pension about $1.8 million -- all for working three years.

In 2010, Sen. Jimmy Higdon, Damon Thayer and Jack Westwood introduced legislation RS10 SB 51 that would have undone HB 299. Additionally, Representatives Brad Montell, CB Embry, Brent Housman and Tim Moore introduced HB 54, a more ambitious piece of legislation that would have completely closed the legislative pension plan and put legislators on a defined-contribution plan. House leadership killed both bills (Current Pension Culprits, 2011). The co-chairs of the pension reform task force, Sen. Damon Thayer, R-Georgetown, and Rep. Mike Cherry, D-Princeton, said the changes they make to the public employees' pension system will apply to legislators. (General Assembly struggling with pension reform, 2012) A group of first-time Republican candidates for the Kentucky House and Senate is calling for reforms next year in the legislative pension system for new lawmakers. About 20 Republicans and one independent candidate pledged to support legislation that would replace the defined-benefit pension model for lawmakers with a defined-contribution plan – similar to 401(k) plans in the private sector. The proposed bill would only apply to new lawmakers who take office beginning in January, but it would give those already serving an option to transfer into a 401(k)-style plan. The candidates said they plan to file the bill before any others in the 2013 General Assembly. Chris McDaniel, of Taylor Mill, a candidate in the 23rd Senate District, estimated that the proposed changes could save millions of dollars for Kentucky’s troubled pension systems, which have more than $30 billion in unfunded liabilities.

“We recognize that tough choices will have to be made in the years and decades to come with regard to our pension systems.” he said. “We know that we are in no position to review such items without first demonstrating a spirit of servant leadership.”

McDaniel said a majority of new Republican candidates support the proposal.  But speakers for the group – when questioned at a news conference to announce the platform – stopped short of calling for elimination of legislative pensions. Others have called for similar reforms, and last week, Rep. David Floyd, R-Bardstown, pre-filed a bill that would end the legislative retirement plan for any new member after Aug. 1, 2013 (First time Republican candidates call for reforms to legislator pensions, 2012).

The Task Force on Kentucky Public Pensions made up of state lawmakers from both houses and parties started meeting this summer and made recommendations in December to handle the shortfall in the pensions of state and local government employees. The Courier-Journal and the Lexington Herald-Leader report that the options were presented to a state task force by the Pew Center on the States and the Laura and John Arnold Foundation. Their recommendations included decreasing tax credits, issuing pension bonds, requiring bigger employee contributions and paying out less to future workers. Democratic Rep. Mike Cherry of Princeton co-chairs the task force and said members will discuss options and vote on recommendations late next month. He said lawmakers thought they had addressed the pension shortfall with legislation passed in 2008, but those changes have been inadequate to address the problems. Some lawmakers said they are hesitant to change retirement benefits or ask workers to contribute more their retirement plans.

“We don’t want to hit the employees any harder than they’ve already been hit. If we do, we’re going to lose our employees,” said Rep. Brent Yonts, D-Greenville.

Republican Sen. Damon Thayer of Georgetown, who co-chairs the panel, said it’s not reasonable to ask taxpayers to pay more to finance public pensions that are better than many have in the private sector.

“The taxpayers who fund public pensions … we have to be cognizant of their role in this equation,” he said. “We’ve got some tough decisions to make (Pension reform recommendations revealed in Frankfort, 2012).”

In its key recommendation, the task force urges the state to fully fund pension contribution payments beginning in fiscal year 2014-15, rather than only funding a percentage of the contribution, as Kentucky has done for years. That would raise the annual cost for health and pension benefits in the state’s main plan to $832 million that fiscal year from $505 million the previous year, and to more than $1 billion by 2020. But it would reduce costs in the long run, according to a state analysis. The group also supports placing new employees in a hybrid cash-balance plan rather than the traditionally defined benefit plan provided for current workers. The new approach would guarantee a 4 percent annual return for employees but have them assume some of the risk for market downturns — similar to a 401(k) (Task force calls for overhaul of KY pensions, 2012).

Leaders of cities and counties in Kentucky hope the proposed pension reforms by state lawmakers will mitigate the high pension costs that have spurred some to layoff employees and cut services. If they work, cities hope it might mean they can fill positions that have gone vacant in the past several years due to layoffs or attrition to cut costs.

“If they deal with the pension costs, it could translate into additional police officers, road projects, lower taxes and could translate into other economic development projects,” said Covington City Manager Larry Klein (Local officials hope pension reforms will give a boost to city, county budgets, 2012).

Some critics argue that the recommendations are an attempt to undercut benefits for state workers. The Kentucky Public Pension Coalition predicted disastrous effects for public workers and for the state’s economy if the recommendations are approved.

“It’s important to know that Kentucky public employees don’t make a lot of money, and the pension benefit is very modest — one of the most modest in the country,” said National Public Pension Coalition Executive Director Jordan Marks.

“We are appalled that the (task force) proposes to break the pension promise by specifying that future hires in the proposed new pension plan would not be protected by Kentucky’s long-established inviolable contract,” Kentucky Government Retirees said in a statement   The Kentucky Government Retirees also argued that lawmakers created the crisis by failing to fund pension contributions for years and should not resort to creating a separate plan for new employees (Task force calls for overhaul of KY pensions, 2012).

No one is advocating revoking the pensions of current, active state workers. The commonwealth not only has a legal obligation but a moral responsibility to honor contracts made with both current workers and retirees. Unfortunately, the pension debt is nearly four times the size of the commonwealth’s General Fund budget. It’s a debt that must — and will — be paid, because public employee pensions, under the laws of the commonwealth, are inviolable contracts, arguably guaranteed by the U.S. Constitution, in Article I, Section 10, the Commerce Clause (Courier-Journal takes a look at HB299, 2012). The Kentucky state pension system in its current form is completely unsustainable. As a result, we must consider more modest benefit packages for new state workers hired in the future.  A report by the Bluegrass Institute estimates that the state could save more than $635,000 on each “mid-management” career employee by switching to a 401(k)-style retirement plan. While state workers are indeed taxpayers whose taxes contribute to the pension system just like those without state jobs, the fact remains that the vast majority of the tax money that goes into the state retirement system fund comes from Kentuckians who are not state workers (Bluegrass Institute strikes a nerve with pension points, 2012).

The state of Kentucky’s pension system is insolvent and thus, in serious trouble. The Task Force on Kentucky Public Pensions has made a plethora of recommendations to lawmakers in order to reform Kentucky’s pension system, including moving future employees into a hybrid cash-balance plan whereby the state shares the risk in economic downturns. These recommendations did not go far enough to reform the pension system. What can you do? The General Assembly is going to take up the issue of pension reform in its January 2013 session. Contact your state representatives at the website http://www.lrc.ky.gov/ and urge them to adopt a defined contribution plan for new incoming city and state employees just like Kentucky tax payers have in the private sector. Further, to repeal HB 299 which contains a reciprocity provision that allows our state representatives to set their pension based on jobs they held prior to and after serving as a state legislature. We need to ensure that the retirement system is solvent so that state and local employees can invest for retirement. At the same time allow our state and local governments to be able to provide the vital services for Kentucky tax payers.