I don’t normally share the papers I write for my graduate studies on this blog, but I think this one is pretty important – particularly for those of us who live in Kentucky. I wrote this paper as my final for my Public Finance class. Here is the introduction, or click here to download the entire pdf.
A government makes promises to the public and to its employees, but what happens if the government finds itself unable to keep those promises? A private company can go bankrupt, but as of today, states are not allowed to do that.[1] So what options does a state have when they become financially unsustainable? Government intervention in the private market is often needed when there is a market failure. What happens when the government upsets, rather than stabilizes, the economy?
These are the issues facing the Commonwealth of Kentucky right now. The state’s pension system suffers from years of chronic underfunding[2] and they now find themselves billions of dollars shy of what will be needed in the near future. The working number for how much the state owes its pension system has been $37 billion.[3] However, a Moody’s report issued on July 21, 2017 doubled that number to $70 billion in unfunded pension liabilities[4]. To put that in context, the amount the state of Kentucky owes its worker’s pension funds is more than seven times the Commonwealth’s entire $10 billion annual General Fund budget.[5]
Who is this money owed to? More than 8% of the Commonwealth’s population: over 360,000 Kentuckians,[6] including firefighters, police, teachers, city, state employees, transportation employees, social workers, mental health workers, university employees,[7] are counting on these benefits for their future financial security.
Figure 1 [10]
Because of the magnitude of the debt and the size of the Commonwealth’s budget, this trend will be difficult to change. But without drastic change, the state will continue to fall behind faster than any other state.[11]
So how did this financial disaster come about? Was it preventable? What are the steps the Commonwealth might take to address it? As Governor Matt Bevin considers calling a special legislative session[12] to address this crisis (and a recently discovered budget deficit from 2016-2017 fiscal year)[13] these are some questions citizens of the Commonwealth might be asking and that are addressed in the following sections of this paper. There have been many books and articles about this issue, this paper hopes to present an easily digestible overview of the various issues and potential paths out of financial collapse that the Commonwealth might take to right its course. Let’s begin with a more in-depth overview of the history: How did Kentucky get into this mess?
To read the whole paper, download it here.
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[1] John Mauldin, “Don’t Be So Sure That States Can’t Go Bankrupt,” Forbes, Jul 28, 2016, https://www.forbes.com/sites/johnmauldin/2016/07/28/dont-be-so-sure-that-states-cant-go-bankrupt/#accda622f2d4, (accessed July 27, 2017).
[2] Ben Walsh and Travis Waldron, “Kentucky’s Hedge Funder Governor Keeps State Money In Secretive Hedge Funds,” HuffPost, June 24, 2017, http://www.huffingtonpost.com/entry/matt-bevin-kentucky-pensions_us_594bf56ce4b0a3a837be3d56, (accessed July 27, 2017).
[3] Tom Loftus, “Pension costs just jumped for Kentucky’s school districts, local governments,” Courier-Journal, July 12, 2017, http://www.courier-journal.com/story/news/politics/2017/07/12/pension-costs-just-jumped-kentuckys-school-districts-local-governments/467408001/, (accessed July 27, 2017).
[4] Moody’s Investors Service, “Kentucky (Commonwealth of) Update – Moody’s downgrades Kentucky to Aa3; outlook stable,” (July 20, 2017): 5.
[5] William M. Landrum III, Edgar C. Ross and Donald Sweasy, “Commonwealth of Kentucky Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2015,” 141, http://finance.ky.gov/Office%20of%20the%20Controller/2015CAFR.pdf (accessed July 27, 2017).
[6] “Kentucky’s Pension Crisis – Frequently Asked Questions,” (March 2016): 1, https://kypensioncrisisdotcom.files.wordpress.com/2016/03/pension-faq.pdf, (accessed July 27, 2017).
[7] Tom Loftus, “Don’t cut our pensions amid crisis, public workers tell Kentucky board,” Courier-Journal, June 26, 2017, http://www.courier-journal.com/story/news/politics/2017/06/26/stakeholders-give-their-views-pension-reforms/421347001/, (accessed July 27, 2017).
[8] Ryland Barton, “Kentucky’s Pensions Are Worst-Funded In U.S., Study Shows,” WFPL, September 15, 2016, http://wfpl.org/studies-show-kentuckys-state-pensions-worst-in-nation/, (accessed July 27, 2017).
[9] Sussan S. Corson, “U.S. State Pensions: Weak Market Returns Will Contribute To Rise In Expense,” Standards and Poor, (September 12, 2016): 7, http://www.nasra.org/files/Topical%20Reports/Credit%20Effects/SPGlobalstates1609.pdf, (accessed July 27, 2017).
[10] ibid.
[11] Barton, “Kentucky’s Pensions Are Worst-Funded In U.S., Study Shows.”
[12] A special session would cost more than $63,000 a day, according to the Legislative Research Commission.
[13] Tom Loftus, “Can public pension benefits be cut? Kentucky officials looking into it,” Courier-Journal, July 14, 2017, http://www.courier-journal.com/story/news/politics/2017/07/14/can-public-pension-benefits-cut-kentucky-officials-looking-into/434944001/, (accessed on July 27, 2017).
Speaking of... 
Teachers are suing the state: see http://www.kentuckyteacherretirement.weebly.com I don’t see this mentioned in your blog. Did I miss it, or did you?
I did not include it so you didn’t miss it. Since I didn’t break down the different funds, and since there has been no judgment yet, I left it out. But thank you for adding that here!
I believe that the action of some teachers in filing suit, while the teacher unions remain mysteriously mute, suggests there is an undercurrent of undue – read financial – influence having an effect on the pension disaster. The unions have simply rolled over: Why?
I really would have appreciated a longer discussion of the state declaring bankruptcy and the ramifications of such a possibility.
I’m not sure we know at this point, since no other state has done so. We can look at Puerto Rico, maybe, as an example, but that can only give hints. And it is so new, itself, that we aren’t seeing the mid/long term ramifications.
As to explaining that more in the paper – I was already over on length 😉
States cannot declare bankruptcy. PR is a territory, and so it the responsibility of the Federal government.
But Illinois might challenge the rule that sates can’t declare bankruptcy – in which case PR might give us some idea what it would look like.
I enjoyed your paper. I have been following the pension situations for months reading whatever I can find on the issue. You brought out points of interest that I have been looking for.
There is one contributing factor in the Kentucky pension crisis (IMHO) that it seems everyone is missing.
In 1938 when the inviolable contract was signed and put into effect the life expectancy of a female was 65.3 years and for a male it was 61.9 years. They based on assumption that on average state workers would not live past these ages. The life expectancy at the time is also possibly why state workers are allowed to retire in some cases at such an early age.
In 2017 the predicted life expectancy of a female is 83.3 years of age and for a male it is now 79.5 years of age.
Therefore, a female public pensioner is now requiring benefits 18 years longer than they assumed in 1938. The male public pensioner now requires 17.6 additional years of benefits than in 1938 when the contract was signed.
This miscalculation of life expectancy fro m1938 until present in my opinion is playing a major role in this but it is not being address. Pensioners on average in 1938 who were assumed to need benefits for 10-15 years are now requiring benefits of up to 30-40 years according to the life expectancy differences.
Do you have an opinion on this?
Regards,
David E. Melton
Thanks, David. The change in life expectancy is an actuarially calculated number, so is considered in the ARC (Annual Required Contribution) amount that the state is supposed to be paying each year. And yes, you are absolutely right that a longer life expectancy has meant increased pension payments, which means an increasing ARC amount.
But they just lowered the ARC rate from 7.5% to 6.2%? I know that is due to they can’t average a return rate of 7.5% thus the lower ARC contribution rate. Is that not working contrary to the calculation? If life expectancy is longer shouldn’t the ARC rate be higher, even though it’s unachievable. My math education is from the school of hard knocks so I may not be framing my question properly. I retired at 62 on SS and a well funded defined contribution plan. I only had 20 years to build it but I feel that I done very well. I wouldn’t trade it for a public pension even though my wife monthly benefit is 2.6 time more than my SS, I like supplementing my monthly SS as needed otherwise keeping it invested. To me it’s a worry free retirement. I probably should have asked first but I shared your paper on the pension crisis with my legislators and a Tax Ombudsman with the revenue department that I communicate with occasionally.
Where I just retired from we discussed our 401 accounts frequently. Talking about what to invest in and why. There are some on defined contribution plans making double and even triple the returns of that of pension fund money managers. These are factory operators, mechanics and electricians. To us it was just a matter of finding a fund with a long history of positive returns. What’s the deal that they don’t want to go in a direction that could easily get returns on investment similar to these. I just don’t understand why they want the complexity of the portfolio they currently have. I seen it and to me it looks in manageable.
Hi David,
I think the confusion is around all the different terms. The ARC is how much actuaries say the state needs to contribute to cover pension commitments.
What was lowered is the amount that the state expects to get on its investment.
So, since the state lowered the expected rate of return (and made it much more reasonable), the payments they now need to make into the pension system are substantially HIGHER than they were becuase they assumed they would make more on their investments.
As to how they are investing, that I don’t know anything about. Except I do know that the investment rate returns are not as high as they were 2008/09, and many states are having to drop their estimates and pay more into their programs as a result.
I hope that helps!
It does help, thank you. I hate to keep bothering you but, yesterday I moved all dollars from equity funds into bond funds for concern over current events and squabbling over health care in Washington. I hated to since Vanguards Health care fund (VGHCX) has averaged over 16% ROI for over 30 years. The bond funds I chose survived the 2008 downturn with gains for the year. I’m retired so I have to try to protect my earning. I don’t have time for a recovery. You stated in you paper that the 2008 market correction was responsible for something like 18% of the unfunded liability and has not fully recovered. When the bleeding stopped in 2008 many equity funds had lost 35-40% or more of their value. I don’t have the number but I would guess the state pension fund fell into that 35-40% category. What happens to the pension fund if that occurs again? Regards,David
Hi David – This really isn’t my area, but I would guess that any time the market falls, the amount of equity (or whatever it is called) in the pension funds fall as well, which means the state, in order to stay current, will need to put even more in.
Where will they get it?
My understanding of the ARC is that is a calculation to also determine the amount of contribution from current state workers. Like when the money managers blundered and had to reduced the actuarial assumption rate from 7.5% to 6.2% they then had to make up the difference through contributions. I don’t understand how that factors in related to life expectancy.
There are helpful video interviews with Chris Tobe, whom Rev. Dawn mentions, and with Attorney Ted Lavit at http://www.kentuckyteacherretirement.weebly.com and these clarify many of the questions David MELTON is posing. Click on INTERVIEWS and on Daily Lawsuit update for more information.
You offer me a video of an attorney representing the teachers and their pension as an un-biased opinion on the matter? I don’t consider myself intelligent but don’t attempt to insult what intelligence I do possess. I watched the first few seconds and turned it off due to the statement right out of the gate, “teachers don’t get social security.” I could say that “I wish I had a nickel for every time I heard that” but that would make me sound like a wise guy.
On the other hand I don’t get a public pension but have invested in it greatly over the years through my taxes. My taxes assist in paying teachers salary, a portion to all of their health care and their retirement. The gentlemen in the video are there to support KTRS at whatever cost to whoever regardless of their income. My wife is a retired teacher. She retired at 55 and draws monthly 2.6 times what I draw at 62 after paying in 45 years. Longevity runs in her family. It is possible that she may need the 30-40 years of retirement benefits. If this happens, at 85 it will take $1,629,590.40 to fund her retirement. At 95 it will take $2,172,787.20 to finance her retirement. I know this is a single individual but how many others like her are out there? Her contributions, a laughable 5-6% return on her investments, and even if the state did make their required contributions, the math don’t add up even considering compounding interest. She, like all public pensioners wants her retirement benefits but after I explained it to her she agrees that it is not my place or our daughters place to do the financing. Due to the changing times the public pension system is seriously flawed and something has to be done. I mean something beside flogging the private sector taxpayers.
In the event you’ve had this thought, I do not covet my wife’s or any other public pensioner benefit packages. I like drawing my SS and supplementing it as needed through my 401K account.
Earlier this year I accompanied my wife to an alumni banquet of students and teachers. The oldest teacher was over 100 years old. I’m happy for her but maybe you see my point in relation to the life expectancy issue in 1938 and now.
On the “that’s all they have” comment; the deferred compensation program has been around for years, those who did not or don’t participate missed or are missing a golden opportunity to build wealth.
I paid into SS like teachers pay into their retirement. I financed a defined contribution plan on the side for 20 years and done very well.
I do not advocate that teachers not get their pensions or have them cut. My position is not to tax me any further in order to finance 30-40 years of another’s retirement.
I am not asking public pensioners to help fund my SS so I can retire with dignity. I would appreciate it if public pensioners would not lobby Frankfort to have their pensions funded through my SS.
This is beginning to sound like the grasshopper and the ant fable.
Kentucky is one of 11 states that do NOT allow teachers who would receive Social Security, to receive it if they have a pension. It is called the Social Security Pension Offset Law.The fact that you turn off the video after a few seconds, of the attorney, Ted Lavit, and the CFA, Chris Tobe – shows you don’t understand the issue, and do not care to understand it. As the law currently stands, you are mooching off of MY earned social security, as I am not allowed to receive it, even though I paid into it for 10 years before working as a teacher. Also, had the KY legislature listened to the actuaries, who well knew people would be living longer, and had the KY legislature contributed what the actuaries indicated – much as they have in other states such as Wisconsin, which is 98% funding, even with teachers living longer and longer – there would not be this funding crisis. One last thing: the ARC, actuarially required contribution, takes into account improved lifespans, and slower financial growth periods, so by ignoring it, the legislature has simply worsened the problem. I would suggest you listen to the experts, rather than tuning them out after a few seconds. You might learn something new about this crisis.
Kentucky is also one of 37 states that is listed as having un-healthy public pension plans that operate in the same manner as Kentucky. Doesn’t that tell you anything? What you don’t understand is the math. You can blame the legislature all you want, as it is this issue will never be resolved due to there isn’t enough revenue. The unfunded liability is estimated by some as high as 70 billion. Do you really think, even with compounding interest, that the funds the state failed to make is responsible for that 70 billion? You don’t look at this logically.
I understand this issue more-so than you think. Public pensioners are just pissed off because the private sector has started paying attention and are trying to protest our salaries, earning and retirement from you.
Why is it that states such as Wisconsin have the same population, about 5 million, and have 98% funding level of what is needed longterm for their public retirees?
In the private sector, as you might know, it is against the law to underfund pensions. That is why private sector pensions are healthy, unless undermined by corruption.
As the KY legislature has ignored the recommendation of the actuaries, a fiduciary breach, which have served Wisconsin and other states just fine, the liability has ballooned. As the pensions were raided (read underfunded) in order to claim a balanced budget over the last 10 or so years, the funds that could have been compounding over a 30-year period have not been there, hence the huge unfunded liability. So the KY taxpayer got off easy, and many in the private sector, who paid into social security are benefitting at others’ expense, meaning those who are excluded by the Social Security Offset Law.
In any case, if you listen to the interviews, which seem to irritate you since they don’t comport with what you want to believe – you will learn that the contract signed with the teachers and the other public workers is inviolable, and protected by section 19 of the KY State Constitution, and by Article 1 Section 10 of the US Constitution. Sorry – but that seems to be the part you don’t understand, and the math, of course, is also daunting. Again – I would suggest you listen to the experts in the video interviews, much as I suppose you would listen to your physician. These experts, Tobe and Lavit, are trained, degreed, widely recognized as experts, and have spent the bulk of their professional lives immersed in this. But I have a sneaking feeling you are closed to any other information but that of your own manufacture.
So, in your mind the only experts are those that support the public pension plan? How much are you paying them for that support? As you evidently do not know, very few private sector companies offer defined benefit plans any more. They are taking lessons from the Kentucky public pension fiasco. They don’t have the option of a taxpayer bailout. Being proactive they are doing something before they enter crisis mode.
An example, where I retired from they terminated their defined plan 43 days before I hired in. Prior to that a previous employer bought out my pension. All due to predicted unsustainability. I funded my own defined contribution sometimes contributing half my salary and maxing out my annual contributions knowing I could not count on SS for a “dignified” retirement r if SS would even be there.
February 16, 2017,
Why are you ignoring KRS part in this pension issue? You are full of explanation, explain this one to us. Or will you consider this something I manufactured?
“KRS made serious math errors in recent years by relying on overly optimistic assumptions about its investment returns, the growth of state and local government payrolls, and the inflation rate, KRS board chairman John Farris told his fellow trustees Thursday at a board meeting.”
And,
“For example, KRS assumed that it would earn an average of 6.75 percent to 7.5 percent on money it invested, but it earned an average of 4.75 percent, Farris said. KRS assumed that public payroll would grow by 4 percent a year through pay raises or more government hiring — a larger payroll means larger pension contributions by employees — but public payroll has dropped overall because of repeated budget cuts, he said.”
Read more here: http://www.kentucky.com/news/politics-government/article133142369.html#storylink=cpy
I have said all along that I do not advocate that public pensioners lose their pensions or even have them cut. I advocate not to fund their retirement any further on the backs of the private sector. They/we cannot afford to fund our own and your.
Your elitist attitude and tone are making me rethink that decision.
It likely helps Wisconsin’s 98% funding due to their average retirement benefit for teachers is $22,911.00 whereas Kentucky’s average benefit for teachers is $34,685.00.
Thank you Rev. Dawn for your logical thinking on this issue. I will re-read your paper as I go forward with my concerns on this issue.