The PFM Group today presented an alarming report to the Public Pension Oversight Board detailing the factors that made Kentucky’s pension systems the worst funded systems in the United States. The report revealed that the systems have had a combined $6.9 billion negative cash flow since 2005 as benefits paid to retirees plus program expenses greatly exceeded appropriated funding. According to the report, if this negative cash flow is not corrected, the ability to make payments to current and future retirees is at risk.
“PFM’s analysis is the most comprehensive and detailed look at the many factors that contributed to the massive unfunded pension liabilities crippling our state,” stated John Chilton, Kentucky’s State Budget Director. “It is important that we fully examine the facts of how the state got into this mess so we can establish guideposts to take the necessary steps to address the pension crisis facing the Commonwealth.”
The report highlighted the need to meet the actuarially required contributions (“ARC”) going forward. Reverting to past practices of underfunding the ARC would put Kentucky’s largest pension programs (KERS Non-Hazardous and the Teacher’s Retirement System) in jeopardy of collapsing. Combined, those systems have nearly 225,000 active and retired members.
According to the report, if the past patterns of underfunding the required contribution were followed, KERS-NH would become insolvent by FY 2022. The Teacher’s Retirement System (TRS) could become insolvent in twenty-seven years if the ARC is not fully funded and the necessary investment returns are not met.
In the early 2000s, both the Kentucky Retirement System (KRS) and the Kentucky Teacher Retirement Systems (TRS) were nearly fully funded. Currently, both systems face staggering unfunded liabilities. The PFM report revealed the factors over the past decade that led to the cumulative combined growth in the state’s unfunded pension liabilities:
The largest contributing cause was “negative amortization” caused by using a “level percentage of payroll” funding method and inaccurate assumptions about payroll growth. This “actuarial back-loading” accounted for 25 percent of the growth in the retirement systems’ unfunded liabilities.
Underperforming investments relative to assumed rates-of-return and market benchmarks were responsible for 23 percent of the growth in unfunded liabilities.
Changes to actuarial assumptions intended to align with revised expectations contributed to 22 percent of the current recognized unfunded liabilities.
Failing to fund the ARC caused 15 percent of the growth in unfunded liabilities.
Nine percent of the growth is attributable to granting, but not paying for, retiree cost of living adjustments (“COLAS”).
While these factors contributed to each individual system’s unfunded liability growth, the individual factors had different impacts on each system. Actuarial back-loading was responsible for 32 percent of TRS’s unfunded liability growth while failing to fully fund the ARC created 28 percent of the problem for KERS-NH.
PFM’s analysis makes clear that the current trajectory is unsustainable and growing more costly every year. The retirement systems have placed significant strains on the state’s general fund with pension contributions increasing at five times the rate of revenue growth. This has led to severe constraints on investments in other general fund supported priorities like K-12 education, public health and public safety.
The report further revealed:
Absent reforms and fully funding the ARC going forward, negative cash flows at KERS-NH and TRS are projected to continue unabated for the next 10 years.
Moving from a “level percent of payroll” to a “level dollar” amortization methodology would add hundreds of millions of dollars to the system’s required annual contribution in the near-term, but decrease the system’s unfunded liabilities more rapidly.
$2.9 billion of TRS’s growth in unfunded liability was a result of underperforming investments, equal to 29 percent of the growth in that system’s unfunded liabilities.
In addition to its pension liabilities, Kentucky has nearly $6 billion of unfunded OPEB (“other post-employment benefits”) obligations, primarily associated with retiree health care.
“Without fixing our state’s pension programs and putting into place a more competitive tax code to grow Kentucky’s economy,” Chilton said, “there simply will not be enough money to adequately invest in our children’s education or provide services for our state’s most vulnerable citizens. It’s that simple.”
The Commonwealth of Kentucky contracted with the PFM Group Consulting, PRM Consulting Group and Stites & Harbison PLLC to conduct a comprehensive review of the state’s public pension systems. Earlier this year, the Bevin administration released an interim report on transparency and governance. A third report with detailed recommendations for reforming the pension systems is forthcoming.
A copy of the report can be found at the Office of the State Budget Director’s website: www.osbd.ky.gov.