Kentucky's Pension Crisis

I've been reading quite a bit about the pension crisis in Kentucky, and there have been a lot of strongly worded, emotional pieces. That's not surprising, since people's futures are at stake in whatever decisions are made. Heck, as a recent Kentucky K-12 retiree, MY future is at stake! The emotions began thanks to our governor, who chose from the outset to attack teacher and state workers by claiming that they were "hoarding" sick days by not using every one of their sick days every year of their employment. That initial statement--oft repeated by the governor and his allies in the Legislature--sort of set the tone for the conversation, and it's been definitely heated.

However, despite the fact that I just said that I have a vested interest in this whole conversation, I'd like to talk as dispassionately as possible about the key decision that is being made. The reason I want to do so is that I feel like the key decision that is being made is being drowned out by the emotions behind statements like "keeping a promise made" and "severe cuts are coming to all state programs if something isn't done" and "trying to dismantle our educational system" and everything else that's getting thrown around. While there are lots of little details that need to be worked out in this pension reform, there is a single decision at the heart of it all: Who is going to bear the risk?

With ANY retirement system, whether it's a defined pension system (what Kentucky has now) or a 401(k) or just sticking money into the mattress of a bed, there is always the risk that enough money won't be saved now to cover future needs. Maybe the saver wasn't regularly putting enough away, or maybe the saver WAS putting enough away regularly based on initial market conditions, but the stock market has gone down and the saver is no longer getting the expected return. In any event, sooner or later, because financial systems change, it's possible that there will be a shortage and not enough money available.  And the question that we're deciding as a state right now is who is that takes on that risk, the organization (in our case, the state of Kentucky) or the workers?

With a defined pension system like the ones we have now, the risk belongs to the state. Since the system promises a fixed amount to its workers, there is a risk that there won't be enough money on hand to make those payments. The state will have to find the money somewhere. That's what's happening right now in Kentucky. The Great Recession and its slow recovery over the last ten years have eaten away at the investments of the retirement funds. And yes, I know, that the problem was exacerbated by the state spending surplus funds in the good years, but even had that not happened, because of the vagaries of the economy, sooner or later the day was going to come when the state did not have enough money to meet its retirement needs. And when that happened, a day of reckoning for the state of Kentucky would have to come, because the state--in our current system--owns the risk.

On the other hand, with a system like a 401(k), the risk belongs to the individual. If, after 27 years of working, the stock market returns have stayed low and the employees don't have enough saved in their accounts to actually retire, that's THEIR problem, not the state's. It will not cost the state of Kentucky anything if the state poorly managed the 401(k), if the investments that they presented as options (assuming there will be any choice for employees, which I would think there would be) performed poorly, if they didn't initially require a large enough percentage of contribution from employees, or if the fees that the state paid to investment firms were too high. All of these problems would be the fault of the state, but the risk would be borne by the employees--it would be THEIR problem, not the state's.

At its core, that's the decision that is being made with pension reform. And while there are certainly other decisions that have to be made, the place to start is by looking at this all-important first decision. If you feel that the state should never again be put in a situation like it's in now, where there isn't enough money to cover the promised pay of it retirees and where new money needs to be found, all because of vagaries in the financial markets over which the state has no control, then you're in favor of the governor's pension reform and moving new employees to a 401(k) type of plan.

On the other hand, if you find it unfair to place the burden for investing retirement funds on state employees themselves--the vast majority of whom are not finance experts and have limited understanding of investments--and if you find it immoral for the state to set up a retirement system that allows it to wash its hands of the responsibility if, in the end, that system doesn't provide sufficiently for its retirees, then you'll be against the idea of new employees moving to a 401(k).

Before you decide anything else, that's your first and most important decision.