Kentucky is currently considering overhauling its pension system. Sadly, the bill that recently passed the state senate — and will soon be discussed by the state assembly — cuts benefits for workers, but doesn’t shore up the system’s funding.
The bill would abolish traditional pensions for new public sector workers while cutting cost of living adjustments for retirees, yet would cost even more than the current system. The switch would cost an extra $55 million over the next 20 years, according to analysis by the Kentucky Center for Economic Policy.
The bill would also require that the state pay the full amount of its required contribution to the pension plan. Supporters claim that these changes are necessary because pension plans in Kentucky are underfunded by a considerable amount.
However, the plan does not specify where the revenue for these new contributions will come from and instructs the legislature to create a funding source in 2014 when it writes a new budget. We should be skeptical about Kentucky’s promise to fund these new contributions given its history of not paying the required contribution, a key reason its pension plan is so underfunded.
Kentucky has only paid on average 68 percent of its actuarial required contribution to the state pension plan over the past 10 years, according to CAPAF analysis of the Center for Retirement Research’s Public Plans Database. In 2011, the most recent year for which data are available, the state only contributed 52.9 percent of the ARC. This underfunding is a key reason why Kentucky’s state employee pension system is severely underfunded.
Paying the full amount of the actuarially required contribution every year is critical to making sure a pension plan is well-funded. Organizations like the Pew Center on the States, the National Institute on Retirement Security, and Standard & Poor’s have all highlighted the importance of paying the ARC every year.
To be sure, paying the ARC every year doesn’t ensure that a pension plan will be fully funded. Recessions and stock market crashes will reduce the pension’s returns. The Great Recession is a large reason — perhaps the largest reason — why many pension plans are underfunded. If public pensions had earned the very modest returns of Treasury bonds in recent years, which is far below the average return for pensions, almost the entire shortfall as of 2011 would have been eliminated.