Kentucky sponsors eight pension plans within three major retirement systems that provide pension and retiree health care benefits to over 166,000 retired public sector and nonprofit employees:
- Kentucky Retirement Systems (KRS)
- Kentucky Employees Retirement System: Non-Hazardous employees (KERS-NH)
- Kentucky Employees Retirement System: Hazardous employees (KERS-H)
- State Police Retirement System (SPRS)
- County Employees Retirement System: Non-Hazardous employees (CERS-NH)
- County Employees Retirement System: Hazardous employees (CERS-H)
- Teachers' Retirement System of Kentucky (TRS)
- Kentucky Judicial Form Retirement System (KJFRS)
- Kentucky Legislators' Retirement Plan (KLRP)
- Kentucky Judicial Retirement Plan (KJRP)
Kentucky Pension System Snapshot
(In millions $000,000)
Kentucky Pension Systems are in Crisis
- The Commonwealth currently has $33 billion in unfunded pension liabilities (pension debt) across its pension systems, as reported in pension plan annual reports as of June 30, 2016. That amounts to $10,330 for every Kentucky age 18 and older.
- The true amount of unfunded pension liabilities is likely much greater:
- Kentucky's pension plans have long used overly aggressive assumptions about investment returns, inflation, mortality, and payroll growth.
- Using more conservative assumptions, the actual amount of unfunded liabilities for Kentucky's combined pension plans is likely between $62 billion and $82 billion across all eight plans. Based on the more conservative $62 billion amount, that is almost $20,000 for every adult residing in Kentucky. Compare the U.S. Government's almost $20 trillion debt that is just over $80,000 per adult.
- This is roughly seven times Kentucky's annual General Fund spending.
- Beyond the $33-82 billion in unfunded pension liabilities, Kentucky's also has approximately $6 billion in unfunded retiree healthcare liabilities.
- Pension debt is weighing down the Commonwealth's credit rating:
- Standard & Poor's ranked Kentucky as having the worst aggregate pension underfunding among the 50 states.
- Moody's Investors Service recently ranked Kentucky as having the third-highest net pension liability as a percentage of governmental revenues among the states.
- The Center for Retirement Research at Boston College found that Kentucky has the third-highest pension-related budget burden in the nation.
- Even in years where the plans have received the full actuarially determined amount, payments towards unfunded liabilities have been less than interest accrued, meaning the Commonwealth's pension plans have been falling further behind every year.
- Previous attempts to change benefits or actuarial assumptions have not been enough to save Kentucky's pension systems.
- The combined KRS plans were 100% funded in FY2002, and the TRS plan was nearly 90% funded.
- Those funded ratios have since collapsed due to the back-loaded funding formula, negative amortization, underfunding required contribution rates, investment underperformance, and actual experience deviating from the complicated actuarial assumptions.
- Previous changes made to TRS have not robustly addressed the funding challenges and TRS' unfunded liabilities have increased nearly 600% since 2002. The previous changes have not put TRS on a path to solvency.
- Previous changes made to KRS — including the creation of a cash-balance plan for new hires in 2014 — have not materially changed KRS's insolvency risks for retirees or other active members.
- The pension plans have had negative cash flow (outflows exceeding inflows):
- KRS has had severe negative cash flow of over $100 million every year since FY2002, while TRS has had negative cash flow nine of the last 10 years.
- Negative cash flow requires liquating investment assets to meet current payouts. This reduces a plan's overall market performance (there are fewer assets on which to earn returns) and threatens plan solvency.
- The KRS plan for non-hazardous state workers had just under $2.0 billion of assets on hand at the end of FY 2016. That is enough to cover two years (783 days) of benefit payments.
Why Does Pension Underfunding Matter?
- Unfunded liabilities have been increasing, which drives up required contributions to the Commonwealth's pension plans.
- Assuming the underfunding totals $33 billion, that amounts to $
- Kentucky's pension spending has been increasing nearly five times as fast as revenues – growing 56% in FY2017 alone. This effectively reduces money available for other important budgetary priorities. (For example, K-12 education, Medicaid, etc. and public services.)
- The affordability and financial sustainability of Kentucky's pension plans bear strongly on the capacity of the Commonwealth and its local governments to address other critical needs and deliver the public services citizens expect.
Investment Underperformance and Growth of Investment Risk
- The KRS and TRS plans have taken on significantly more investment risk over the last decade in order to chase unrealistically high investment returns.
- Portfolio allocations to fixed income investments have fallen, while investments in international equity, private equity, alternatives and hedge funds have increased.
- KRS and TRS have increased their alternative investment holdings by X% over the past 15-years and reduced their low-risk, fixed-income holdings by Y%.
- When compared to other public plans, the KRS plans have had an allocation to riskier alternative investments that nearly double the peer average.
- The newly appointed KRS board has already taken steps to significantly reduce the overall allocation to hedge funds in an attempt to lower costs, increase liquidity, and improve performance. Unfortunately, significant exposure to market risks still remain.
The Need for Comprehensive Pension Reform
- The status quo is not sustainable and is seriously threatening retirement security for all public sector workers in Kentucky.
- Billions in pension debt are growing in perpetuity unless significant changes are made.
- Pension debt will continue growing even if the plans earn their expected investment return because of the "back-loaded" funding method used to pay off existing unfunded liabilities.
- Several of Kentucky's pension funds may completely run out of money with just one or two more bad years of investment returns.
- Previous changes have not fully fixed the problem.
- While shifting KRS's state employees (non-hazardous) to a cash balance plan in 2014 was a positive step (by restraining the future growth of liabilities. But that change did not solve the plan's solvency problem for retirees and most current workers.
- TRS remains on an unsustainable path and needs to pursue reforms to ensure that all commitments made will be met. This must be done by putting in place a new, sustainable plan for future workers, focused on providing retirement security while reducing the exposure of state and taxpayers to financial risk.