KY Policy Blog

Underfunding Also Led to Shortfall in Local Government Pensions

By Jason Bailey
June 14, 2013

The pension system for Kentucky local government employees has a shortfall even though local governments have been required to make their annual payments each year. Some are using this fact to suggest that defined benefit pensions themselves must be unsustainable and shift the focus away from inadequate government contributions. But this claim misses several important points.

First, the funding condition of the local government pension system is far better than the state employees’ system, for which the legislature hasn’t made full payments for the last 11 years. The main County Employees Retirement System (CERS) account is 61 percent funded, while the main Kentucky Employees Retirement System (KERS) account for state workers is only 27 percent funded. CERS, unlike KERS, is not in danger of insolvency.

Second, the annual contributions that were charged local governments (as well as the state government) did not accurately reflect the cost of benefits. That’s in part because state law mandated that the payments be calculated without properly taking into account cost-of-living adjustments (COLAs) for retirees, even though the state regularly awarded COLAs in order to keep the real value of benefits from declining.

COLAs weren’t allowed to be part of the annual bill in the year they were awarded, but had to be added to the unfunded liability to be paid back over a 30-year period. And even though COLAs were regularly (and appropriately) given, the long-term projections assumed no additional COLAs in the future. Kentucky Retirement Systems Executive Director William Thielin told a legislative committee in January that “in six years, COLAs added about $1 billion to the unfunded liability of CERS.”

In addition, the legislature made changes to benefits in a few cases without allocating monies to pay for the cost. For example, when the retirement system was over-funded due to the stock market bubble in 2001 the legislature gave slightly enhanced benefits to state and local employees who retired by 2009. This change was made in part to move more-experienced, higher-paid employees off the public payroll in order to reduce budget pressure, but it just added cost to the retirement system.

State law and budgeting decisions thus led to the underfunding of the local, as well as the state, pension system. To avoid this problem would’ve required ongoing payment of the full actual cost at a time when lawmakers were looking for ways to balance budgets with weak revenues.

Poor investment returns in the two recessions of the last decade have also contributed to the gap in the local government pension system, but the system’s investment returns have been on par with its benchmarks and similar to other pension plans around the country. Investment losses alone wouldn’t have been enough to create a serious problem without the accompanying underfunding.

Tight budgets because of meager revenues have been the story in Kentucky for more than a decade. State law and budget practice have meant the full cost of retiree benefits was not being paid. That helped avoid a conversation about revenues, but just passed costs off to the future—and has now led to cuts to the already-modest pension benefits that Kentucky public workers will receive.

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