Fri January 24, 2014
Kentucky's Zombie of a Pension Problem
“They was saying on the news, some kind of virus… things got crazy… man, you won’t believe the panic… the broadcasts stopped, and that was the last we heard.” —AMC's "The Walking Dead"
AMC’s hit zombie apocalypse melodrama "The Walking Dead" is a story about a deadly, shambling mass of cannibal undead that brings human civilization to its knees.
But Chris Tobe argues that the show is an apt metaphor for the financial Armageddon he believes the state is inching toward as a result of declining revenue and unfunded pension liabilities.
Gov. Steve Beshear’s $20 billion budget included nearly $190 million for Kindergarten-through-grage 12 education, even at the expense of broad 5 percent cuts to almost 20 state agencies. But while Beshear is being praised for his commitment to reinvest in education in actuality, he’s paying for that investment with $800 million dollars owed to the Kentucky Teachers Retirement System.
That pension’s unfunded liability could wreck financial apocalypse for the state.
Tobe is a former trustee of the Kentucky Retirement Systems turned whistleblower with over 30 years of public and private experience in financial investments.
For more than a decade, Tobe said, legislators and governors from both parties have underfunded the Kentucky Employee Retirement System—which provides pensions to state employees—to its current abysmal rate of 23.2 percent funding for non-hazardous pay, making it one of the worst in the nation.
“I think we’re going to be 'The Walking Dead' for a long time," Tobe said. "We’re all gonna keep saying, ‘Oh, we’re just fine,’ and we’re gonna be ‘The Walking Dead’ for a long, long time. … The KERS is definitely a zombie pension, and then we’ve got others that are working their way to that area.”
The effect has caused the state’s credit rating to plummet, increased interest rates on bond debt used to fund construction projects and forced lawmakers to seriously consider tax reform.
In other words, Tobe says, the undead chickens are coming home to roost: Kentucky’s pension liability remains one of the worst in the nation, at upwards of tens of billions of dollars, and Tobe says that an attempted legislative fix pass by the General Assembly last year is only slowing the decay in lieu of massive structural changes in Kentucky’s revenue stream.
Tobe has written a book called "Kentucky Fried Pensions." In it, he alleges willful ignorance by the executive branch regarding improprieties within KRS, which included playing exorbitant fees to private middlemen to secure investment opportunities.
The federal Securities and Exchange Commission investigated KRS, and while it criticized the pension for its lack of transparency in its employment of highly paid "placement agents," it did not find evidence of pay-to-play schemes. The investigation remains open and concluded that parties at KRS are not exonerated.
But for our purposes, Tobe’s book details how elected officials from both parties systematically underfunded the pension to balance the budget. Since then, he’s been interviewed by journalists from Rolling Stone magazine to The New York Times, and works as a private consultant on investments from public pensions to hedge funds.
“If you take all the pensions for teachers and retiree health together, you probably have to put in, I think it’s around $2.5 billion a year to make what the actuaries say is a normal payment. We’ve only been putting in $1.5 billion, so we’ve been shorting it a billion a year. And the people in Frankfort have been doing it so long, they think that’s the normal.”
Last yea,r the General Assembly passed a pension reform bill that aims to contribute $100 million toward the KERS pension according to the actuarially recommended contribution, which is accountant-speak for the amount of money needed to pay into the pension fund in order to make it solvent.
But the pension reform bill only stipulates that that money be deposited straight into the state’s general fund without mandating that it be spent on the pension liability.
And even if the money is spent on the pension, $100 million isn’t enough to cover the total $1.5 billion a year liability that KERS initially requested from the legislature, Tobe said. Pension advocate Jim Carroll, a state retiree, agrees, but said the pledge to start funding system is a step in the right direction.
But without a much larger, dedicated revenue stream, the pension issue becomes a problem that threatens to drag two of the state’s other largest pension systems—the Kentucky Teacher Retirement System and the County Employee Retirement System—down with it.
By underfunding pensions to such low levels, Tobe said, the pensions can enter a "death spiral" whereby a pension doesn’t have enough money to make investments, and instead drains money from other areas just to keep the checks going out the door. And in the interconnected world of finance, large liabilities can impact the state’s credit rating, making it more expensive to issue bonds, therefore impacting toll rates on construction projects like the Ohio River Bridges or the Mountain Parkway Expansion.
Here’s Tobe again:
“Basically, the deficit’s been like a billion a year, and then you know when the governor comes forth and says, 'Well, I’ve got another $100 million for pensions,' that doesn’t mean it’s a hundred million: It means we’re only going under $900,000 instead of a billion a year.”
Gary Harbin, head of the teachers retirement system, told lawmakers in September that that pension will need $800 million over the next two years to prevent it from ballooning into a $23 billion liability due in part to changes in federal accounting practices.
“This is our projections for what we need into the pension plan for the next biennium: $390 million in the first year, and $400 million in the second year," he said.
The situation is dire enough that Harbin told lawmakers he is considering selling state land to shore up the fund.
But Beshear’s budget proposal passed on the issue, which affects about 140,000 current and retired educations, effectively kicking the can down the road to whoever is unlucky enough to get elected governor of Kentucky in 2015.
When asked why, Beshear said, simply:
“Where’s the money gonna come from?" he said. "You know, the short answer is we don’t have any extra money to infuse into that system.”
The state’s budget director, Jane Driskell, explained that the governor’s budget proposal does include language to address the issue, just not any time soon.
“The language expresses our intent to create that mechanism that will eventually start putting money in there. But, uh, in all honesty, over the next two years, there is no money created with that intent to put into the system.”
Harbin has said that he will ask lawmakers to borrow more money in the form of pension obligation bonds to help shore up the pension.
In order for the state to finally get serious about putting its financial house in order, Tobe said, it must commit itself to transparency when it comes to decisions that affect Kentucky’s economy.
He said decisions made in darkness only cause concern for national credit ratings and investors who might be wary of doing business with a state that doesn’t disclose the totality of its finances.
Beyond that, lawmakers would have to raise taxes well beyond even the most extreme tax increases recommended by the state’s Blue Ribbon Commission on Tax Reform. Or, at worst, federal bailouts that come in the form of spending programs not unlike the state’s Medicaid expansion under the Affordable Care Act.
“People don’t believe you when you say you need money because they felt they’ve been lied to for so long," Tobe said. " So there is a whole cultural thing there that I think we need to at least get started on trying to get honest with people about what the situation is. And maybe the next governor probably might be doing that. Because, I mean, he is starting in a very big hole.”
But as both chambers of the General Assembly gear up for closed-door budget talks, it’s more likely you’ll run into a zombie first.