The Kentucky Pension Problem

The state of Kentucky is facing some serious problems paying its bills. All this can be largely attributed to a broken pension system for government officials. It is often said that the pensions of government employees in Kentucky are amongst the worst-funded in the entire United States. The state is looking at over $70 billion in unfunded liabilities over the next decade or so. To make matters worse, there is no money being put aside now to meet these future obligations. In 2017, the plan saw a negative cash flow of $6.9 billion. The government is staring at impending doom if it does not make changes to the budget. The numbers are just astounding. Moody’s has a negative rating on the debt of the state of Kentucky because they believe that the pension system will drag the state to insolvency.

However, it seems like the Kentucky teachers are unwilling to let the government make any changes. Gov. Bevin has signed a bill which has not even made major cuts to teacher salaries and benefits. However, the teachers union is vehemently opposed to any kind of revision of their compensation and benefits. These teachers are of the opinion that the government should raise taxes if required. However, their benefits should not be toyed with.

In this article, we will have a closer look at why the pension system in Kentucky is broken. Here are some of the important arguments made from a purely economic standpoint.

Are Kentucky Teachers Really Underpaid?

The Kentucky Teachers Association was of the opinion that the teachers are paid very low wages. They cited the fact that the average teacher earns $50,000 per year. This number has remained stagnant even though the student expenditure on education has skyrocketed during the same period. However, they conveniently forgot to mention the fact that teachers only work for about 180 days a year.

Also, when compared on an hourly basis, Kentucky teachers make more than double the minimum wage amount. The additional time because of fewer working days gives them the opportunity to work more days in another job and earn additional money.

Also, if the teachers were to invest 10% of their money in an annuity scheme for 30 years, they would only receive $10,000 per annum as a pension. On the other hand, the state is proposing to pay them $35,000.

The teachers are clearly benefitting at the expense of the taxpayer. The problem is that this has been going on for too long and the teachers have become used to it. The taxpayers are paying $320,000 in additional pension (as compared to the market annuity rate) for every teacher. It is therefore really a myth that the teachers in Kentucky are underpaid.

The Root Cause behind the Problem

The politics of appeasement is the root cause of this financial mess. When the stock market was booming, politicians tried to lure teachers to vote for them by giving them defined benefit pension plans. Also, many unrealistic expectations were made while planning for this funding. For instance:

  • A minimum of 8% growth was used for budgeting the cash flow needs
  • The mortality rate and the average age at death was drastically underestimated

This means that the today, the fund is short of money because the money put in the fund did not multiply as fast as the government had hoped. Also, the government has misjudged the number of retirees that are alive. They thought fewer people were going to live as long. As a result, now they have higher payouts and lower fund value. This has been going on for several years.

The bigger problem is that the state of Kentucky does not have the economic wherewithal to deal with this situation. The state derives a total of $10 billion in tax revenues. Hence, they would be able to get current on their pension only if they stopped every other expenditure for a period of 7 years! Obviously, that is not going to happen. In the meanwhile, poor stock market performance and increased life expectancy are wreaking havoc on the financial position of the state.

Why Did The Situation Get So Bad?

Another important question needs answering. Why is it that the politicians, as well as the teachers, are reacting so late when the problem has already been blown way out of proportion? Had this issue been raised ten years earlier, it would have been much easier to solve.

However, the problem is a textbook example of moral hazard. The politicians that made the promise did not have anything to lose. Neither did the teachers have anything to lose till they were getting paid as per the old terms. The taxpayer did not have the time or the expertise to notice that the pension system was broken. Only after the problem reached catastrophic proportions was the issue noticed and a solution sought.

To sum it up, it is mathematically impossible for the Kentucky government to not make changes to the pension program. If they have to stay away from bankruptcy, the pension liabilities need to be reduced drastically.

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