Underfunded public pensions are undoubtedly the biggest threat facing America's long-term economic stability. As we've argued numerous times in the past, the size of the aggregate underfunding, $5-$8 trillion depending on your assumptions, is simply too large for even the overly generous American taxpayer to cover.
Of course, one of the biggest contributors to this inevitable crisis is the state of Kentucky which has a funding hole of $33-$84 billion, depending on your discount rate assumptions, according to an analysis recently conducted by PFM Group.
The problem is that the aggregate underfunded liability of pensions in states like Kentucky have become so incredibly large that massive increases in annual contributions, courtesy of taxpayers, can't possibly offset liability growth and annual payouts. All the while, the funding for these ever increasing annual contributions comes out of budgets for things like public schools even though the incremental funding has no shot of fixing a system that is hopelessly "too big to bail."
So what can Kentucky do to solve their pension crisis? Well, as it turns out they hired a pension consultant, PFM Group, in May of last year to answer that exact question. Unfortunately, we suspect that PFM's conclusions, which include freezing current pension plans, slashing benefit payments for current retirees and converting future employees to a 401(k), are somewhat less than palatable for both pensioners and elected officials who depend upon votes from public employee unions in order to keep their jobs...it's a nice little circular ref that ensures that taxpayers will always lose in the fight to fix America's broken pension system.
Be that as it may, here is a recap of PFM's suggestions to Kentucky's Public Pension Oversight Board courtesy of the Lexington Herald Leader:
An independent consultant recommended sweeping changes Monday to the pension systems that cover most of Kentucky’s public workers, creating the possibility that lawmakers will cut payments to existing retirees and force most current and future hires into 401(k)-style retirement plans.
If the legislature accepts the recommendations, it would effectively end the promise of a pension check for most of Kentucky’s future state and local government workers and freeze the pension benefits of most current state and local workers. All of those workers would then be shifted to a 401(k)-style investment plan that offers defined employer contributions rather than a defined retirement benefit.
PFM also recommended increasing the retirement age to 65 for most workers.
The 401 (k)-style plans would require a mandatory employee contribution of 3 percent of their salary and a guaranteed employer contribution of 2 percent of their salary. The state also would provide a 50 percent match on the next 6 percent of income contributed by the employee, bringing the state’s maximum contribution to 5 percent. The maximum total contribution from the employer and the employee would be 14 percent.
For those already retired, the consultant recommended taking away all cost of living benefits that state and local government retirees received between 1996 and 2012, a move that could significantly reduce the monthly checks that many retirees receive. For example, a government worker who retired in 2001 or before could see their benefit rolled back by 25 percent or more, PFM calculated.
The consultant also recommended eliminating the use of unused sick days and compensatory leave to increase pension benefits.
Even if all of that is accomplished, State Budget Director John Chilton said Kentucky would still need to find an extra $1 billion a year just to keep its frozen pension systems afloat. Moreover, absent tax hikes the state will ultimately be forced to cut funding for K-12 schools by $510 million and slash spending at most other agencies by nearly 17% to make up the difference.
Meanwhile, PFM warned that the typical "kick the can down the road approach" would not work in Kentucky and that current retiree benefits would have to be cut.
“This is the time to act,” said Michael Nadol of PFM. “This is not the time to craft a solution that kicks the can down the road.”
“All of the unfunded liability that the commonwealth now faces is associated with folks that are already on board or already retired,” he said. “Modifying benefits for future hires only helps you stop the hole from getting deeper, it doesn’t help you climb up and out on to more solid footing going forward.”
Of course, no amount of math and logic will ever be sufficient to convince a bunch of retired public employees that they have been sold a lie that will inevitably fail now or fail later (take your pick) if drastic measures aren't taken in the very near future.
Nicolai Jilek, the legislative representative for the Kentucky Fraternal Order of Police, said expecting first responders to work until they are 60 is problematic given the physical requirements of the job.
“We’re very grateful that PFM is just offering recommendations … that they are not lawmakers because his plan would be horrible for first responders,” Jilek said.
Stephanie Winkler, president of the Kentucky Education Association, shared a similar sentiment.
“The PFM had some pretty drastic recommendations that we think are not what’s in the best interest of public school employees and public school students,” Winkler said.
Jim Carroll, president of Kentucky Government Retirees, said his group would likely sue if the legislature proceeds with PFM’s recommendation to roll back the cost of living adjustment that retirees received between 1996 and 2012.
“We think its very clear that the cost of living adjustments that were granted to us are ours as long as we are retirees in the system,” Carroll said.
As such, no matter the long-term consequences, the "kick the can down the road" approach to pension reform will continue to win right up until the plans actually run out of money...then we'll all lose together.