When Kentucky last year required employers to stop shortchanging state pensions for the first time, its largest mental-health agency filed for bankruptcy.
Seven Counties Services Inc. in Louisville couldn’t pay the mandated 38.7 percent of payroll to the Kentucky Employees Retirement System, up from 6 percent in 2005, said Gwen Cooper, the agency’s lobbyist. The bankruptcy may let it escape obligations to the retirement plan, potentially costing other participants $100 million during the next 30 years, according to Moody’s Investors Service. If other agencies follow, that could swell to as much as $2.4 billion.
“What happened at Seven Counties is just a microcosm of what is going to happen,” said Jim Waters, president of the Bluegrass Institute for Public Policy Solutions, a free-market research and advocacy group in Lexington. “They can’t afford to pay that much of their payroll to benefits and still provide the services they are supposed to.”
The pressure on the nonprofit, which pulled 1,100 employees from Kentucky’s pension, shows the challenge of bolstering retirement systems for state and local governments, which routinely fail to save enough to pay for benefits in the years ahead.
In New Jersey, Governor Chris Christie this year went back on a pledge to put an additional $2.5 billion into the pension system after tax collections trailed forecasts. When Tennessee forced Memphis to reserve more for retirements this year, the city moved to cut retiree health benefits to cover the cost, prompting protests by police.
“The problem for pensions is the unfunded liability and the cost,” said Keith Brainard, the Georgetown, Texas-based research director for the National Association of State Retirement Administrators. “For Seven Counties, the cost was so high they wanted to get out of it.”
So far, they’ve succeeded. In May, a U.S. Bankruptcy Court judge ruled that the nonprofit no longer had to pay into the pension and that the state had to continue benefits to qualified employees. Kentucky is appealing.
Other pensions have faced pressure. In Orange County, California, the council of Villa Park, a 6,000-person town, moved forward Sept. 23 with plans to pull out of the California Public Employees’ Retirement System, which has also battled bankrupt San Bernardino in court over debts. A hospital in Colorado Springs, Colorado, that sued to drop out of the state retirement system agreed this week to pay $190 million to do so.
Few are under as much pressure as Kentucky. It has the third-highest pension liability relative to revenue, behind Illinois and Connecticut, according to Moody’s. The Kentucky Employees Retirement System is the most underfunded U.S. state pension plan, according to the Center for Retirement Research at Boston College.
The plan, which covers most state workers, has 23.2 percent of the assets needed to meet promised benefits and has sold investments to cover retirement checks, said William Thielen, the executive director of Kentucky Retirement Systems, which oversees the five state-run pensions. The liability has grown because of investment losses and the state’s failure to contribute enough for 15 of the past 22 years, Thielen said.
In April 2013, Democratic Governor Steven Beshear signed legislation aimed at ending that practice.
“This is going to stop at the feet of our children,” said Waters, of the Bluegrass Institute. “It’s going to crowd out funding for education and public safety.”
With the state’s own contribution set to rise, the governor asked that $99 million be cut elsewhere to make up for the cost.
Investors view the overhaul as a positive development.
Kentucky, which has about $6.4 billion of revenue-backed securities, doesn’t sell general-obligation bonds. Its debt gained as the average yield on a property-and-buildings bond maturing in 2031 fell to 2.78 percent Sept. 16 from 2.995 percent on Sept. 8, according to data compiled by Bloomberg. The yield was near top-rated benchmark general obligations at 2.77 percent for that day.
“The reforms were positive, but they didn’t contemplate withdrawals from the system,” said Gene Gard, a money manager with Lexington-based Dupree & Co., which manages about $1.4 billion, including some Kentucky debt. “We’re concerned about the withdrawals, but right now they seem limited.”
About 15 percent of the fund’s members are employed by nonprofits. Mental-health agencies joined after Kentucky replaced psychiatric hospitals about 50 years ago with the organizations, many of which were staffed with former state workers wanting to keep their pensions. By 1974, the legislature allowed the governor to admit any nonprofit employer.
Last year’s overhaul required members to offer new hires retirement plans whose payoffs vary according to what the worker puts in.
Employers, including the state, paid more starting in July to reduce the liability over 30 years and cover the new plans.
Seven Counties filed for bankruptcy last year, unable to bear the increase.
“We would have gone out of business,” said Cooper, its lobbyist.
The state is subsidizing the increased contribution for nonprofits for two years, said Steve Shannon, director of the Kentucky Association of Regional Programs, which represents mental-health agencies. Without that help, he said, others might drop out, too.
Other nonprofits are looking to avoid the higher payments and at least two ended up in litigation with the state.
Bluegrass.org, a Lexington mental-health agency, sued to keep some employees it has hired since 2011 out of the Kentucky plan. While Bluegrass.org won an initial ruling in court, Paul Beatrice, the agency’s chief executive officer, said it has decided to drop the case.
Another, Kentucky River Community Care, which operates in eight counties, went further. It refused to pay into the fund for employees whom it fired and then rehired through an employment agency it set up. The state sued to stop it.
J. Whitney Wallingford, attorney for Kentucky River, declined to comment, citing the litigation.
“We consider it a sham,” said Thielen, the executive director of Kentucky Retirement Systems.
© Copyright 2021 Bloomberg News. All rights reserved.