Truth about funding for retirement system painful for cities, counties

Published 8:26 am Thursday, March 29, 2018


Kentucky Retirement Systems

The accrued liability in our state pension systems is unarguably the biggest challenge facing our state economy. When reasonable assumptions are used, our total unfunded liability across all systems is more than $40 billion.

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Recently, Rep. Rick Rand tweeted, “The crisis on the pensions was created when Governor Bevin changed the assumptions by over 25%,” implying that the Governor and the appointed Kentucky Retirement System Board members are to blame for the current state of the pension system. What Rand’s tweet failed to mention, however, is that funding for CERS plans significantly decreased during his tenure as chair of the Appropriations and Revenue Committee. In this role, Rand had the authority and the responsibility to question why the actuaries and board estimates were so wrong year after year.

Unfortunately, many mayors, county judges, and their representative bodies, including the Kentucky League of Cities (KLC), were all too eager to pile on to Rand’s statement, citing KRS board members as the reason cities and counties now have to pay more into the system for their beneficiaries.

It is correct that lower actuarial assumptions means that the systems require more money for future payouts to beneficiaries. What is most important, however, is that the actuarial assumptions are realistic. In fact, the board’s number one responsibility is to set the actuarial rates on investment returns, payroll growth, and inflation. These three numbers are very important because they determine the actual liability and required actuarial payments by the legislature for state employees and employees of the cities and counties.

When the new KRS Board was appointed in 2016, one of the first things we did was to undertake an examination of 10-year historical rates for these three important assumptions.  We were shocked to find that the actuarial assumptions used by the previous board were 30 percent — 60 percent higher than the actual historical averages.

For the CERS Hazardous and CERS Non-Hazardous plans, the actual 10-year historical average from 2007 to 2016 was 5.03 percent for investment returns, 1.73 percent for payroll growth, and 1.82 percent for inflation. However, in the face of the actual data, the previous KRS Board had set the assumptions for CERS plan over the previous 10 years at an average of 7.72 percent for investment returns, 4.39 percent for payroll growth and 3.58 percent for inflation.

In 2017, the KRS board, which includes KLC board representatives, unanimously approved new rates of 2.0 percent for payroll growth and 2.3 percent for inflation. We then voted 11-5 to approve an assumed annualized investment return of 6.25 percent for CERS plans. All of these numbers were actually slightly higher than the 10-year average.

While we understand the potential negative budgetary impact of using the accurate numbers, the KRS board does not have the ability to take budget impact into consideration. The board is required by law to estimate the numbers, so the actuaries can calculate required payments.

Previous boards may have taken budgetary impact into consideration and been too afraid of the political consequences to use the accurate numbers for these assumptions. Perhaps this is why both of the CERS plans are barely 50-percent funded, even though the counties and cities were paying the previous KRS Boards’ actuarially “recommended” payments.  

Rep. Rand’s accusations against the governor and the board are akin to starting a fire and then blaming the firemen for showing up to fight it. The new KRS board members are unpaid volunteers, and we are working very hard to use accurate numbers. This is our fiduciary responsibility to the beneficiaries and the taxpayers.

John R. Farris is chairman of the Kentucky Retirement Systems. He is senior investment advisor at Centre College.