Less funding for schools. No employee pay raises. Service cutbacks for people in need. Construction projects cancelled. Job-creating programs put on hold. Still higher college tuition.
These and other stark developments could become Kentucky's future if the state fails to take decisive action to address a huge unfunded liability in its public employee pension plans.
This massive financial black hole is not unique to Kentucky, but the problem is particularly acute here. A recent report from the Pew Center on the States noted that Kentucky is one of only three states whose pensions were less than 55 percent funded in 2010; a sustainable system should be funded at 80 percent.
A recent Barron's report ranked Kentucky's financial condition 47th nationally because of our massive state debt and unfunded pension liabilities in relation to the size of the state's economy. And the country's two major bond rating agencies have taken notice and downgraded Kentucky's bond ratings, which means it is going to cost taxpayers more for public building projects.
The situation is grim, but it can be tackled successfully through the work of the legislative Task Force on Kentucky Public Pensions and the General Assembly. Clearly, the need for quick corrective action is critical.
The task force is working now to develop recommendations for the 2013 legislative session. The Pew Center on the States has provided a series of options to consider to pay down the current debt in the pension systems and to change the system for newly hired employees to ensure long-term sustainability.
None of the choices are painless. To pay down the debt, the options include:
Accelerating the rate at which the state makes its payments known as the actuarially required contributions, or ARC, to reduce the unfunded liability. This would be challenging in times of limited state resources.
Suspending cost of living adjustments for retirees until the system is 100 percent funded.
Issuing bonds to get much-needed cash into the system. This would increase Kentucky's already hefty level of bonded indebtedness.
Increasing the amount employees contribute to their retirement funds.
Taxing retirement income, which now is exempt from state taxes up to $41,100 of income.
Reining in "double dipping" by making retirees wait two years before being re-employed by state government.
Recommendations to change the system for new employees include placing employees in either a cash balance plan — essentially an IRA with a guaranteed rate of return — or in what is called a stacked hybrid plan, which combines a limited cash balance plan with a limited defined benefit plan such as the one Kentucky has now.
The task force is not bound by these suggestions, of course, and can choose among them and others in developing a plan to attack the debt. But the key is developing a package that delivers meaningful, sustainable improvement and removes the financial threat now posed by the pension systems' debt levels.
The Kentucky Chamber initially highlighted the state's public pension problems in 2007 and again with its Leaky Bucket reports in 2009 and 2011. We have appeared before the task force and have made tackling this problem one of our top legislative priorities for 2013.
No pension-system fix will be complete unless health insurance costs are also addressed. Public employee health insurance costs have increased nearly 200 percent since 2000 and make up just over half of the required pension contribution.
The Chamber suggests that state employees should contribute a minimum of 10 percent of their individual health insurance premiums, still a generous plan compared to most in the private sector, and be enrolled in aggressive wellness plans.
We also have recommended moving to a defined contribution plan. Defined benefit plans have largely been phased out in the private sector in favor of 401(k)-style plans. The Chamber recommends new employees be moved into a defined contribution plan and current employees be given financial incentives to convert to the new plan.
We believe both of these elements are needed to ensure a strong and lasting reform.
Kentucky must act now. The nature of the pension system, in which costs constantly accumulate, requires immediate action to put the system on a sustainable track. Failing to act continues the shortsighted trend of providing less money for education and economic development (where we ought to be investing) and more for personnel benefits — the result of which will be a weakened position for Kentucky as it strives to compete in a global economy.