Kentucky’s big pension mess
The Kentucky Employees Retirement System (KERS-Non-Hazardous), the nation’s most poorly-funded state pension with 23 percent of the assets needed to cover liabilities, suffered a legal blow last week. As of last June, KERS had only $3.1 billion of assets to cover the $11.3 billion in retirement commitments that it had made and $8.26 billion of unfunded liabilities.
Should the 41,000 active employees, 40,000 inactive employees and 37,000 retirees in Kentucky be worried about the security of their pensions? Given recent events, they probably should.
In a pivotal court case last Friday, U.S. Bankruptcy Judge Joan A. Lloyd ruled that an insolvent non-profit agency, Seven Counties Services, is not part of the Kentucky government and may leave KERS. This could clear the way for other financially strapped non-profit agencies across the state to flee soaring pension costs and leave KERS with more stranded liabilities. (Judge Lloyd’s opinion here). The Kentucky Courier Journal wrote:
‘The opinion, issued late Friday in federal bankruptcy court, found that Seven Counties qualifies as a private, non-profit corporation — rather than a governmental unit — and can move forward on its Chapter 11 bankruptcy case without state permission. That essentially allows Seven Counties, the community mental health center that serves 32,000 clients in the Louisville area, to withdraw from the severely underfunded state pension system known as Kentucky Retirement Systems.
It also sets a potential precedent for 12 other community mental health centers and dozens of quasi-governmental agencies, such as health departments and rape-crisis programs, that are struggling to fund pension obligations.
WDRB.com reported on the possible cost of Seven Counties leaving KERS:
Seven Counties’ exit alone would mean other employers in KERS would have to pay an additional $997 million over 20 years to deal with the unfunded benefits. If all the mental health agencies were to leave, the remaining plan employers would need to pay an additional $2.4 billion, according to the state’s expert.
The city of Fort Wright, Kentucky filed a separate class-action lawsuit to change the way the KERS Board of Trustees manages assets on behalf of the County Employees Retirement System (CERS) (funded with 60 percent of assets required to meet liabilities). WFPL.org reports:
‘What we would like to achieve by this lawsuit is that [CERS has] to be invested in separate portfolios,’ [Fort Wright’s lead attorney Ronald] Parry said.
Parry said that the basis of the lawsuit boils down to a matter of law. Assets held by the CERS cannot be legally invested into hedge funds because KRS is prohibited from doing so under state statute. Specifically, Parry said the law — KRS 386.020 — provides a list of ‘authorized investments for trust funds,’ and hedge funds aren’t included on that list.
The lawsuit would affect about 500 CERS member entities across the state. If successful, the suit could set a precedent for other city and county groups seeking to divorce themselves from KRS.
And what relief is Fort Wright seeking? Would it be costly for KERS?
The City of Fort Wright asks the court to rule that CERS assets must be invested in accordance with fiduciary standards set forth in the Kentucky Statutes and to prohibit the Board from continuing to commingle CERS funds and KERS funds for investment purposes.
The City also asks the Court to require the Kentucky Retirement System to account for the funds that have been placed into these high risk investments within the preceding five (5) years and to account for and repay all of the substantial management fees that were paid to managers of hedge funds, private equity funds and other such high risk investments.
Sounds wicked and possibly expensive.
Pew Charitable Trusts worked with the Kentucky General Assembly to pass pension reform in 2013 and has published several reports about KERS. Pew’s 2013 report included the following chart that details how much of the required actuarial contribution Kentucky had made:
Pew’s chart combines contributions from the State of Kentucky (KERS) which has been making around half of its ARC with CERS, which has contributed over 100 percent of its ARC. Specifics here (Chart: Ballotpedia):
Counties and municipalities in CERS have made their full contributions for the last five years while the state level KERS has made less than 50 percent of required contributions.
Pew detailed the 2013 KERS pension reform:
For almost a decade, policymakers had regularly shortchanged the Kentucky Retirement Systems. The 2008 pension reform legislation was supposed to remedy the system’s gaping funding deficiency, but only after a long ramp-up; the state was not required to make full payments until 2024. The 2013 reform committed the state to fully fund the public pension system beginning with the next biennial budget [fiscal year 2015-2016].
The Kentucky Legislature is already battling over cuts needed to balance the 2015-2016 budget. The Republic reports:
The [higher education tuition] increases come after the state legislature approved a 1.5 percent budget cut for higher education. And they come as Democrats and Republicans battle for control of the House of Representatives.
The increases are already an issue in the 2015 governor’s race. Democratic Attorney General Jack Conway made higher education part of his platform when announcing his candidacy earlier this week.
According to WDRB.com, Kentucky’s governor and the general assembly are going to add to woefully underfunded KERS for budget year 2015-2016:
Beshear’s proposed budget, which lawmakers are currently considering, includes an additional $101 million in the next fiscal year and $106 million in the year after for contributions to KERS and another Kentucky Retirement Systems plan, the State Police Retirement System.
The extra $101 million is good, but KERS is underfunded by $8.2 billion and the liabilities and legal risks are piling up. Kentucky faces very difficult political and legal choices as the assets in its core pension fund (KNONHAZ below) continue to decline.
Kentucky has the third-highest load of debt in the U.S. Unfunded pension liabilities as a percent of personal income are also the third-highest of any state, according to Fitch. That could increase depending on how the KERS legal challenges develop:
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