Investment returns fall short at state pension funds, raising concerns

Kentucky's two public pension funds fell well short of their assumed rates of investment return over the tumultuous last decade, raising more retirement concerns for public workers — and for taxpayers who subsidize their plans.

The $14 billion Kentucky Retirement Systems, which covers 324,000 state and local government workers, expected a 7.75 percent rate of return but earned only 5.51 percent over the past 10 years. The $15 billion Kentucky Teachers' Retirement System, which covers 125,000 public school teachers, expected to earn 7.5 percent while getting only 4.8 percent over the past 10 years.

"In this climate, with everything so volatile — the stock market, bonds, real estate, really every area of investment — I think we have to admit that it's unrealistic to assume that we're going to get 7.75 percent a year," said state Rep. Jim Wayne, D-Louisville.

Wayne and other members of the legislature's Interim Joint Committee on State Government will meet in Frankfort on Wednesday. Lawmakers are expected to ask pension officials if their investment income will be adequate to pay lifetime pensions and health insurance for half a million people.

It's a potentially expensive question. If Kentucky's pension funds adopt lower assumed rates of return to reflect a weaker modern economy, public workers and their employers — the state, counties, cities and school districts — would have to put billions of dollars more into the funds over the long run.

The funds already face a combined $26 billion in unfunded liability, which is how much money they'll need for future retirees that isn't expected to be there unless somebody starts digging deeper.

This year, for example, the legislature agreed to put an extra $52 million into the largest KRS plan for state workers, with more money expected next year despite painful budget cuts across state government. That plan, covering 115,000 people, has been shortchanged by state leaders for years and now is only 38 percent funded.

Senate Republicans, led by Damon Thayer of Georgetown, say the state cannot afford to pay lifetime benefits for state workers, many of whom retire in their 40s and 50s. This week, Thayer said lackluster investment returns are another reason to support his plan to put future state workers in private retirement accounts, shifting to them the burden of saving enough.

"This whole model is just unsustainable," said Thayer, co-chairman of the state government committee.

Thayer's privatized pension bill passed the Republican-led Senate last winter but died in the Democratic-led House. Democratic Gov. Steve Beshear has resisted calls for changes to the state pension system, saying that reforms made in 2008 will prove sufficient.

This debate is happening nationally, said Dwight Denison, who teaches public finance at the University of Kentucky Martin School of Public Policy and Administration.

Some public pension funds rely on earning as much as 8 percent. Like Kentucky's, they have suffered during the two recessions and economic malaise of the 2000s, Denison said. Their hope is that the U.S. economy soon will boom again, with market returns easily beating 8 percent, but their fear is this could be "the new normal" for a while, he said.

"The biggest challenge all of us are facing is trying to determine whether recent events — in particular, the financial losses of 2008 and 2009 — have settled things for now, or if we're looking at increased volatility down the road," Denison said.

Nationally, the states collectively face an unfunded liability of $660 billion in their public pension funds, according to an April report from The Pew Center on the States. (Kentucky is in worse shape than most states, The Pew Center said.)

Some experts suggest the states adopt a "riskless" assumed rate of return tied to the 30-year U.S. Treasury bond, which fluctuates with the market, according to the report. If the economy sours, public pension funds would be expected to produce less. But given a 4.38 percent bond rate in March, that means the states' collective unfunded pension liability would have more than tripled this year, from $660 billion to $2.4 trillion.

Lower assumed rates of return may be more realistic, but they are harder for elected leaders to stomach, Denison said.

"There is political pressure to minimize the contributions to the funds as much as possible," Denison said. "Obviously, the higher a rate of return that you assume, the less money that everyone has to put into the fund today."

Officials at the pension funds say change isn't necessary, at least not yet.

They take a longer view than one-, five- and 10-year returns. Their boards of trustees adopt the assumed rates of returns based on several decades of performance, they said. By the year 2030, the period from 2000 to 2011 should look like an unfortunate aberration, they said.

"The current flat market returns cannot last forever. Things do change," said Robert Barnes, general counsel for KTRS.

Under pressure to produce better returns, KTRS and KRS are diversifying their portfolios beyond the usual domestic stocks and bonds. For example, KTRS now invests significantly in international stocks, Barnes said. KRS in 2009 agreed to place $200 million in a start-up hedge fund.

Public workers say the real problem isn't a shaky stock market, it's the failure of government — primarily Kentucky state government — to adequately fund its pension plans.

The KRS plan for state workers is in poor shape because governors and legislators have failed to put even half of the required money into it since 2001, they said. Instead, politicians diverted hundreds of millions of dollars into more popular projects, while workers paid every penny they were required to through paycheck withholdings, according to a recent report from the American Federation of State, County and Municipal Employees, which represents the workers.

KRS has supported state retirees since the 1950s, through several economic downturns, and it could continue if the state paid into it at the recommended levels, the union wrote.

"KRS is designed for the long haul," the union wrote. "With discipline, there is no reason to believe the system will not be able to rebuild its assets."

This story was originally published October 26, 2011 at 12:00 AM with the headline "Investment returns fall short at state pension funds, raising concerns."