Kentucky’s retirement system faces a funding shortfall across its pension systems of $33 billion, and could face insolvency in just five years, according to an audit report from the PFM Group.
“If the commonwealth reverts to the pattern of underfunding the system that it followed from fiscal year 2004 to fiscal year 2014,” said the report, “we project that the [Kentucky Employees Retirement System] fund will be depleted by fiscal year 2022.”
The report said that, based on alternate return assumptions for a 10-year investment horizon and increased liquidity requirements consistent with an updated KRS policy, the unfunded liability would rise to $42 billion. The audit also cited the state’s last-place ranking by Standard & Poor’s with just 37.4% of total current obligations now funded, compared to a national median of 74.6% as of fiscal year 2015, the most recent period reported by S&P.
Kentucky sponsors three major retirement systems covering state, local government, school district, and nonprofit employees across the state. Within the three major systems, there are eight total pension plans.
Although weak investment returns over the past decade contributed to the system’s decline in funding, the auditor said, “the largest single factor underlying the decline was an actuarial funding approach that effectively back-loaded payments such that – even if the commonwealth and other member employers had met all of the calculated actuarial funding requirements each and every year – these payments would still have been less than the annual interest on the unfunded actuarial liability.”
The report also said that each of the plans modified various actuarial assumptions over this period, such as adopting more conservative investment return assumptions and adjusting mortality rates that reflected improving longevity.
“Together, the actuarial back-loading and assumption adjustments drove nearly half of the aggregate growth in underfunding (47%), and led to a majority of the shortfalls in the TRS [Kentucky Teachers’ Retirement System] and CERS-NH [County Employees Retirement System Non-Hazardous] plans.”
The audit report was released just after the KRS slashed its rate of assumptions, a move that will add an estimated $2 billion in debt to the already struggling pension system.
The system lowered its investment rate of assumption to 5.25% from 6.75%, its inflation assumption to 2.3% from 3.25%, and its payroll growth assumption to zero from 4%.
The change in assumption rates means Kentucky is currently $13 billion underfunded for what it is expected to pay retirees over the next 30 years. State agencies will have to contribute nearly 78% of each employee’s salary to the pension fund, up from 50%. That means for every state worker earning $50,000 a year, taxpayers will owe the pension fund $39,000.
Changing the assumptions and making decisions based off the more realistic figures will mean a much bigger actuarially required contribution (ARC) payment will be needed from the General Assembly to shore up the system, according to the Kentucky Chamber of Commerce.