In dealing with Kentucky’s unfunded pension — which now is estimated at $33 billion and growing — the Pew Center on the States recommended the state issue pension bonds to cover the liability while approving reforms to stop the flow of red ink.
However, a legislative task force studying the state’s pension crisis rejected that recommendation and embraced other recommendations, such as repealing cost-of-living increases for new retirees and moving workers to a hybrid plan that blends defined benefits with defined contributions.
The task force’s proposal is the right approach. Borrowing money to pay for retirement benefits is risky. State, county and municipal governments in other states have attempted to solve their pension problems by borrowing, only to have their plans backfire and end up making the problem worse and costing governments more money that comes out of the pockets of taxpayers. Borrowing money to meet pension obligations is a risky path that Kentucky cannot afford to take.
Leaders of Oakland, Calif., borrowed nearly $213 million to cover pension payments instead of laying off more city staff and cutting services. Their gamble was that the pension fund’s investments would generate more money than the cost of the payments on the bonds. The city’s leaders decided to borrow the money even though a similar gamble on pension bonds 15 years prior cost the city taxpayers $250 million because the pension fund’s investments didn’t yield as much as the interest owed on the bonds.
Cities, counties and states struggling with pension obligations can choose to borrow, or they can make difficult choices, as some governments have, to raise taxes, cut services and staff, or try to reduce retirement benefits.
The Government Finance Officers Association advises state and local governments to use “considerable caution” when considering pension obligation bonds. Despite low interest rates for borrowing, the stock market remains volatile.
The Center for Retirement Research’s study, which examined nearly 3,000 pension obligation bonds issued by 236 governments between 1986 and 2009, found that most of the bonds did not work as government officials had hoped.
“Only those bonds issued a very long time ago and those issued during dramatic stock market downturns have produced a positive return; all others are in the red,” the report stated. Enough said.
Issuing such bonds can also hurt a government’s credit rating and increase the cost of borrowing. According to a December report by Moody’s, pension obligation bonds tend to reflect poorly on the quality of management and is viewed as “part of a continuous pattern of reliance on one-time resources.”
When the city of Stockton, Calif., filed for bankruptcy, it blamed its problems in part on pension bond debt.
Illinois, which has one of the lowest state credit ratings, is by far the largest issuer of pension bonds, with more than $17 billion. Much of that was used to keep up with required contributions to pension funds. Illinois issued the bonds in 2003, 2010 and 2011 but will not use the strategy again, said John Sinsheimer, the state’s director of capital markets.
Kansas, New Jersey and Oregon are among the other states that have borrowed to keep up with public employee pension costs.
Will Kentucky be next? Let us hope not.
There is no question that Kentucky’s unfunded pension liability must be addressed by the 2013 General Assembly. Legislators have tried to stop the gushing red ink with “solutions” that have been no more than Band Aids too many times. It is going to take some tough, unpopular decisions to solve the problem and a lot of public employes at all levels of government are not going to like those changes. But they are necessary, and the bipartisan task force has outlined a plan that is fair and workable. Legislators should use the task force’s recommendations to make the necessary changes without borrowing money to pay for existing obligations.