New reports on Kentucky’s public pension systems show substantial funding progress thanks to sharply increased contributions to the plans in the 2016-2018 budget. The extent to which those funding levels are getting us on the right track should be understood before the legislature makes harmful cuts to benefits or demands dramatic additional increases in contributions in the next budget.
Pension Plans on a Stronger, More Sustainable Path
In the 2016-2018 budget, the General Assembly contributed about 94 percent of the actuarially required contribution (ARC) to the Teachers’ Retirement System (TRS), after putting in only about 50 percent the prior year and underfunding the plan ever since 2009. The state also contributed $186 million above the ARC into the state Kentucky Retirement System (KRS) plans. In total, these contributions were 63 percent above what was contributed to all state pension plans in the prior 2-year state budget.
These added payments resulted in real improvements to the plans’ health. Assets grew by $1.9 billion in TRS after falling for 2 consecutive years, increasing from $16.8 billion to $18.7 billion. That system’s funded ratio increased from 54.6 percent to 56.4 percent. Assets also grew in the severely depleted Kentucky Employees Retirement System (KERS) non-hazardous plan, rising from $1.98 billion to $2.09 billion. That improvement comes after its assets had fallen in eight of the previous nine years. The KERS non-hazardous plan’s funded ratio declined, but that’s only because KRS adopted much lower actuarial assumptions for the plan.
A good investment year played a role in these improvements, but the big increase in employer contributions was critical.
Both TRS and KERS non-hazardous are still experiencing negative cash flow, but those gaps shrank considerably compared to the prior year. As the plans continue to grow assets and their returns compound over time, investment income in the form of dividends, interest and realized capital gains will increase and turn the systems’ cash flow positive.
Next Steps Should Maintain Momentum and Avoid Triggering Crisis
The decisions in the 2016-2018 budget went a long way toward putting Kentucky’s pension plans on a strong and sustainable path. Next steps on funding should differentiate between the plans and recognize their distinct needs rather than adopting a drastic, one-size-fits-all approach that could devastate the rest of the state budget.
Despite the good year for KERS non-hazardous, its low level of assets compared to the payouts for current benefits mean it needs extra funding as it gets back on its feet. One approach would provide contributions at least equal to the cost of payouts, which would allow the plan to avoid selling assets to pay benefits and allow it to maximize investment returns. In 2017, payouts exceeded contributions by $114 million. Because of new actuarial assumptions adopted by the KRS board, requested contributions for 2019 will go far beyond that: increasing by $448 million, according to Legislative Research Commission (LRC) staff. That is an aggressive level of funding. While KERS non-hazardous will certainly benefit from those extra dollars, no way to make those added contributions has been identified.
The TRS plan is on much stronger footing than KERS non-hazardous, and its $18.7 billion in assets will allow it to continue improving as long as contributions like those in the 2016-2018 budget continue. The TRS board has requested an additional $104 million in 2019 and $71 million in 2020 beyond what was contributed in the last budget to make that possible.
However, pension legislation threatens to require radically bigger contributions to TRS than the system is requesting, putting funding for education and other crucial services in jeopardy. If a pension bill moves TRS to a level dollar funding method that front-loads payment of pension liabilities, it will mean finding an additional $392 million in 2019. Also, if TRS is closed to new members and the state shifts to a 401a defined contribution plan moving forward, TRS will have to lower its investment return assumption. That’s because its membership will increasingly be made up of retired teachers, forcing TRS to maintain a more liquid and conservative portfolio than if it remained open. If its investment return assumption was lowered from 7.5 percent to 6.5 percent, it will cost another $302 million in 2019 according to LRC staff (and the TRS actuary says the assumption will drop even further to 6 percent if the plan is closed). Thus pension legislation resulting in a level dollar method and a lower return assumption could mean requiring over $694 million more in 2019 for TRS alone — money Kentucky does not have in its budget.
Kentucky’s pension liabilities need a measured approach that targets dollars where they are truly needed to nurse the plans toward better health over time. An overreaction to past underfunding could be devastating for a variety of state services, especially if no new revenue is on the table to make added contributions possible.