Kentucky Retirement Systems, the state pension agency that officially faces an $18.1 billion unfunded liability, might be in far worse financial shape than previously thought. That means taxpayers could be on the hook for much more money to honor pension commitments to about 365,000 public employees.
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.
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.
By giving inaccurate numbers to its actuarial advisers, KRS got back inaccurate numbers concerning its liabilities and how much the state and local governments needed to contribute, Farris said. He called for a new analysis of KRS’ financial health so the next state budget, covering fiscal years 2019 and 2020, reflects the pensions’ true needs.
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“It doesn’t make any sense,” said Farris, a Lexington economist whom Gov. Matt Bevin appointed to the KRS board last year. “We wonder why the plans are underfunded. It’s not all the legislature’s fault. It’s the board’s responsibility to give the correct numbers.”
Some of the other KRS trustees protested that they had thought that the assumed numbers were correct because the agency’s actuarial adviser, Cavanaugh Macdonald Consulting, did not balk when it received them.
“I rely on the actuaries to, on some level, verify our assumptions,” trustee Joseph Hardesty said. “I’ve never heard our actuaries say that our assumptions were unrealistic.”
“Payroll growth was negative and you assumed 4 percent (growth)?” Farris asked. “Were any of you paying attention?”
Bevin’s personnel secretary, Thomas Stephens, who sits on the KRS board, said the optimistic numbers were approved by then-Gov. Steve Beshear’s personnel secretary, Tim Longmeyer, who previously sat on the board. Longmeyer knew perfectly well that the state workforce was shrinking and that most state workers had not received raises in years, yet he went along with the assumed 4 percent payroll growth rate, Stephens said.
In coming weeks, KRS will select a company to perform a more accurate assessment of its financial health so the board can decide by December what contribution rates to recommend to the state and local governments. The next two-year state budget is scheduled to be adopted next spring.
The state and local governments paid $950 million to KRS last year for their contributions as employers; public employees matched that with $307 million from their paychecks. Those contributions will need to grow if KRS acknowledges that it used overly optimistic assumptions, KRS executive director David Eager told the board.
“It’s going to be an immediate impact on costs,” Eager said. “A big one. And the board shouldn’t shy away from this, in my opinion.”
In a statement Thursday, Bevin praised the KRS board for discarding the “alternative data” it previously used. Bevin rebuilt the board last year by removing its chairman, Louisville banker Thomas Elliott, and adding four more gubernatorial appointees. Several of the agency’s top employees since have been replaced.
“Today’s unsettling revelations reaffirm that our state pension system is indeed in much worse shape than many stakeholders realize,” Bevin said.
“I commend chairman Farris and the new board for making transparency a priority and for exposing the truth about our pension crisis by using real data. As I have said repeatedly, our failing pensions are the most significant financial challenge facing Kentucky, and we cannot adequately address this challenge until we accurately understand its full scope,” Bevin said.
Last year, KRS paid $1.9 billion in pension benefits, up from $1.8 billion in 2015. There were 102,725 public retirees collecting pensions and 261,985 more people who would be owed pensions by KRS when they retire.
In his State of the Commonwealth Address last week, Bevin warned that Kentucky needs to raise more revenue to address its unfunded pension liabilities. Bevin said the state owes $82 billion to KRS and its other major pension agency, Kentucky Teachers’ Retirement System, which covers educators, not the $33 billion that is officially owed to the two systems using their own assumptions.
KRS reports that its primary state pension fund has only 16 percent of the money it’s expected to need to honor its future commitments.
“That’s not a pension system,” Bevin said. “That’s a checking account, and it’s about to go bankrupt.”
To get the $82 billion estimate, Bevin assumed that KRS and KTRS will earn investment returns of about 3 percent, which is about what “risk-free” 30-year treasury bonds are paying, Farris said. That’s a realistic assumption, he said. KRS is so badly funded that it no longer has enough assets available for long-term investments that pay generous returns, he said.