Bluegrass Beacon: Will there be a great pension freeze?

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Editor’s note: The Bluegrass Beacon column is a weekly syndicated statewide newspaper column posted on the Bluegrass Institute website after being released to and published by newspapers statewide.

The famous Great Freeze occurred when some of the worst cold winter weather in America’s history befell the South at the end of the 19th century, destroying much of Florida’s citrus crop and the economic survival of entire communities along with it.

An interesting phenomenon occurred, however, during that winter, which stretched from late 1894 and into 1895 that may offer a hidden warning about the need to impose a freeze on benefit-accrual rates in Kentucky’s pension systems.

Florida’s Great Freeze actually was two freezes.

The first freeze in December 1894 failed to kill many mature trees and deceptively created conditions for new growth of produce during the warm months that followed, resulting in greater devastation when a harder freeze attacked months later in February 1895.The effects were so devastating that fruit froze on trees, reducing Florida’s entire citrus production from 6 million boxes to 100,000 boxes annually.

It took five years for production to again break even the 1 million box mark.

Could it be that the $1.1 billion in additional pension funding in the current state budget – intended to stabilize Kentucky’s public-retirement plans pending an independent audit – could simply have provided a temporary warming period before the nation’s worst pension crisis deepens?

When independent consultants recently released a second report on the audit of the commonwealth’s pension plans, they claimed an additional $700 million annually – on top of the $2 billion being spent on the retirement systems this year – is needed to keep them from going belly-up.

Will such additional gobs of spending follow the frequent pattern of taxing, spending and pension-benefit increases which never come to pass but always come to stay?

For too long, Kentucky’s public-pension beneficiaries have been led to believe a higher benefit for any year of service must be applied to every year of service.

However, a defined benefit system – as Kentucky has and its government workers and retirees fight to keep – only works when there’s a direct relationship between benefits, funding and investment returns.

The current practice of keeping each of those isolated in silos has created an economic disaster in Kentucky.

Beneficiaries and their political soulmates in Frankfort must understand: healthy defined-benefit systems result in the size of accrued benefits fluctuating each year because benefits are directly connected to a host of other factors, including investment returns and payroll contributions.

It’s not realistic in such a system for benefits to always increase but never decrease, and for those increases to be applied retroactively and prospectively.

Yet this has been the scenario in Frankfort.

Benefits have been handed out arbitrarily by legislators while retirement systems’ boards are relegated to dealing with investments.

In the late 20th and early 21st century, sky-high returns on investments masked the problem. Flush with cash, politicians maintained this scheme with few consequences.

But then the economic weather turned bad, leaving taxpayers out in the cold.

The fact is, if Kentucky had abided by the rules of a defined-benefit system by funding pensions based on normal payroll costs and conservative investment assumptions, the resulting greater-than-assumed rates of return on investment funds during those fat years would have created surpluses for use in leaner times.

The only way Kentucky will survive this fiscal storm is by freezing benefit-accrual rates for all members of every system, and resetting the pension plans so that beginning January 1, benefits are awarded based on their relationship with investment returns and payroll contributions rather than the warm, but deceptive, weather of political palatability.

Jim Waters is president and CEO of the Bluegrass Institute for Public Policy Solutions, Kentucky’s free-market think tank. Read previous columns at www.bipps.org. He can be reached at jwaters@freedomkentucky.com and @bipps on Twitter.