STUMP » Articles » The Woefully-Underfunded Kentucky Retirement Systems » 25 April 2016, 12:16

I last looked at Kentucky in March, but there seems to be some new stuff afoot. Let’s check it out.

IN A NUTSHELL

Let’s just go to the Public Plans Database, shall we?

Oh, that one doesn’t look soooo bad. It’s not good, but….

uh. The Teachers plan is not as bad as the Kentucky ERS. Neither is particularly good.

Here are some recent stories on just how bad the financial condition of the Kentucky pension plans are:

• Kentucky pensions are “single greatest hindrance to the state’s economic development”
• Pension funding threatens state budget
• Call for pension transparency, as taxpayers have right to know
• January piece in Governing on Kentucky as having the worst-funded state pensions

Thanks to Pension Tsunami for providing links to those pieces.

GOVERNANCE BATTLES

But wait, what’s this. The governor of Kentucky has fired the pension system chairman:

FRANKFORT, KY – Republican Gov. Matt Bevin has issued an executive order removing the chairman of the Kentucky Retirement Systems board of trustees.

Thomas K. Elliott was reappointed to the board by former Democratic Gov. Steve Beshear last year. His term does not expire until 2019. Bevin said the Kentucky Retirement Systems needs ``a fresh start’‘ and said the board was opposed to transparency under Elliott’s leadership.

Or has he?

Kentucky’s massive public pension problem moved from the fiscal to the political limelight Thursday when the chairman of the state pension board refused the governor’s order to step down — presiding over a board meeting instead.

Thomas K. Elliott took his seat at the head of the board table at the meeting, a day after Republican Gov. Matt Bevin ordered his ouster from the Kentucky Retirement System’s board of trustees. Bevin’s choice to fill Elliott’s term — Madisonville dermatologist Bill Smith — observed from the audience.

Elliott listened quietly, his hands folded, as his colleagues discussed how to respond to the governor’s removal order. The system’s executive director, William Thielen, recommended the board continue with “business as usual” at the regularly scheduled meeting.

“It is our position that the governor has no authority to do that,” Thielen said.

At issue is how to deal with one of the country’s worst-funded public pension systems. The Kentucky Retirement System has an unfunded liability of more than $19 billion.

Sounds like something for lawyers to enjoy.

But what’s this about a dermatologist?

Smith, who said his college undergraduate emphasis was in mathematics, said he has spent considerable time studying pension systems. He said he wants to help “save the pension system,” making it financially viable for beneficiaries and the state.

“Big changes need to happen,” he said.

Jim Carroll, co-founder of an advocacy group called Kentucky Government Retirees, said he was “appalled” by Bevin’s selection of Smith, calling him an apparent “pension funding hobbyist.”

“It is impossible to imagine an appointee less qualified by background or philosophy to contribute meaningfully to the KRS board of directors,” Carroll said in a statement.

You could call me a “pension funding hobbyist” as well. It would be accurate.

And thanks to Chris Tobe, who wrote Kentucky Fried Pensions for sending me this background piece:

The Kentucky Retirement System (KRS) and the Kentucky Teachers Retirement System (KTRS) have driven the state to the brink of bankruptcy. The combined $48 billion of unfunded liabilities for both pension systems is the equivalent of $12,000 for every man, woman, and child in the state.

…..
The KRS pension system generates unfunded liabilities by systematically conferring benefits that exceed the benefits anticipated by KRS actuaries.

…..
Unfunded liabilities created by the disparity between the benefits anticipated by actuaries and the benefits conferred to beneficiaries are paid with revenue from new employees and taxpayers, in exactly the same manner that unrealistic investment returns are paid with revenue from new investors in a classic Ponzi scheme.

I got confused by this paragraph. I thought I originally misread that, then took a different interpretation (which is somewhat more reasonable), then read to the end and found that my first reading is what he meant: that the reason the unfunded liability in KY ERS is growing so rapidly has to do with employees/retirees playing games with their benefits. They’re cheating!

A LOOK AT FUNDING

Let’s look at the funding pattern for KY ERS from the Public Plans Database:

What the hell kind of insane funding pattern is that?

Something odd is going on there. That does somewhat bolster Smith’s argument that this looks like a Ponzi scheme-type financing. That’s when I thought that he meant — that the approach taken by the actuaries involves backloading the pension costs, which is why the costs have been climbing rapidly.

That seems plausible to me.

I am not a pension actuary, but I do know about some of the approaches taken in valuation/funding, and there are certain actuarial valuation approaches that are more like Ponzis in that it is expected that larger payrolls later will boost the funding for current retirees.

There is something bizarre about the normal cost/ARC pattern we’re seeing with the Kentucky ERS plan.

The KY Teachers plan has a more typical funding pattern:

A rapidly rising percentage of payroll needed to keep up with growing liabilities (much less pay off the unfunded portion) is a bad sign, no matter the reason driving that growth.

PEOPLE ARE POLICY

But let’s check out Smith’s background:

About the author

William F. Smith is a physician in private practice in Madisonville, Ky., with a special interest in public pension analysis. He was a Presidential Scholar at Murray State University, where he earned a degree in engineering physics with an emphasis in mathematics, biology, and chemistry, and uses a purely mathematical approach to analyze pension data.

He has worked with a number of legislators during the past few years, including several legislators who were on the state pension task force.”

Smith submitted a series of Open Records Act requests to KRS to obtain the data used to support his arguments. KTRS refused to provide the requested data.

I don’t think it’s a good idea to bring in a “hobbyist” to be head of a pension board, especially given what I will quote from him later on.

I’m a “public pension hobbyist”, and I wouldn’t accept any such position were it offered to me.

This does not reflect well either on Bevin or Smith, judgment-wise.

EXPERIENCE DOES MATTER

My judgment in this case comes from my own experience working at TIAA-CREF, a company that mainly provides defined contribution plans for higher education. Heck, even some public universities have TIAA-CREF-run DC plans.

Of course, that means a lot of the accountholders are professors. And retired professors tend to have a lot of intellectual energy that needs to be directed somewhere, and when they’ve left the university behind, they take to corresponding with various people.

In specific, TIAA used to get letters from various retired professors bitching about how we were doing everything all wrong. Anything numerical got kicked to actuarial, and I was given the fun task of replying to some of these letters. And it was fun (as an entry-level person who doesn’t really have high-value tasks).

I have some funny stories, but that’s more an “I’ll tell you when you buy me a drink” sort of thing, and not a putting-it-on-the-internet sort of thing. I will mention that while many of these people were very intelligent and numerate, they had no experience in actuarial stuff. It showed.

The one that stuck out in my mind was the guy who took a dumbass approach to determining what his annuity payments should be. By using a life insurance mortality table from the 1960s. WTF, dude.

Then there was the retired physics prof who sent us C code to let us know how we should be modeling our annuities. Okay, enough reminiscing.

Retired profs really need to get other hobbies.

NOT ALL DISASTERS ARE CAUSED BY FRAUD

So while yes, I believe Smith is very likely mathematically skilled, that is ultimately irrelevant. He doesn’t even know the questions to ask.

Because this bit shows his agenda, and it’s ugly:

It should be clear to the governor that the KRS benefit formula is actuarially unsound and does not match the funding mechanism. It should be clear to the governor that beneficiaries are allowed to manipulate pension benefits beyond the parameters established by KRS actuaries.

No, dude. First sentence seems fine, but the second? No.

There is not proof that they are doing anything nefarious with the benefit formulas. They’re not doing anything particularly nefarious with investment fees, either (another cause I’ve seen raised.)

I mean, yes, there’s spiking and there are all sorts of conflict-of-interest stuff, but those bits only add incrementally to the problem, usually. Maybe there’s widespread fraud, but that’s not my assumption. There are loads of ways for pensions to fail, and usually it’s something really boring as opposed to something that would bring on criminal trials.

The problem I have with this “there must be fraud!” attitude, which I’ve seen from multiple sides, is that it’s pretending that:

1. Culpability resides with only one party.
2. There are no trade-offs to be made when resolving the problem.
3. Whoever gets hurt by our “fix” totally deserves it.

I see lefties like David Sirota making the claim that is all the investment managers’ fault along with the politicians they collude with that caused the problem. In this case, the taxpayers need to get soaked, because the employees are blameless.

I see righties saying that the public employees are doing something nefarious (along with the wily politicians they collude with), and Smith here is saying that the employees are defrauding the system. In this case, we’re just going to whack the pensions down, because the employees are getting way more than they were promised.

There are cases where employees/retirees are abusing the system (disability retirements tend to be the worst area here, but there have been criminal fraud cases relating to those) and there are cases where there are nasty asset-side shenanigans. Again, I have seen criminal cases come out of such things — it happened with Calpers, even.

(Jeez, I post about the Calpers bribery story and then I see dude just got arrested for battery.)

But in most of the mundane cases, the point is that some very expensive promises were made to employees, various approaches and attitudes minimized the perceived cost of these benefits, and then “responsible” parties never put in enough money even under these minimizing approaches.

But that’s boring.

And that means you can’t just cut people’s pensions and say it’s their own fault. You can’t just disinvest from hedge funds and say the job is done.

And that’s when the “one clever trick” people step in…. ugh.

This is not a job for hobbyists.

This is going to take real work and real fiscal pain for this to get resolved. I wish those who work on it well, but this is only my hobby. I do not envy those with the responsibility to untangle this.

Compilation of Kentucky posts