Kentucky Provides a Lesson in How Not to Run a Pension Fund

A June 24, 2017 article in the Huffington Post written by Ben Walsh and Travis Waldron outlines the sorry state of the Kentucky Retirement Systems' (KRS) Pension Funds. In 2016 the overall funding of the five funds overseen by KRS stood at 37%, placing the fiscal status of the system's funds among the worst in the nation. Even worse, however, was the fact that the largest of the funds - the Kentucky Employees Retirement System, which covers virtually all state employees except teachers, legislators, judges and state police was only 17% funded.

The reason for the poor funding levels of these funds was straightforward. While the employees covered by these funds had been contributing their required payments to the funds on a regular basis, the state legislature for many years had not been appropriating sufficient funds to cover the employers share of the contribution. Over time this had placed the Kentucky pension funds in a precarious position. In an attempt to improve the funding ratios KRS was investing heavily in alternative investments that included private equity funds and hedge funds, both of which were high-risk, high-cost investment vehicles only open to sophisticated investors. (Private equity funds invest in companies that are not traded on the public stock markets, while hedge funds employ a variety of techniques aimed at producing positive returns regardless of the direction that the public stock markets take.) At the time that KRS was investing heavily in hedge funds, most major U.S. public pension funds including CalPERS were reducing their hedge fund holdings because of the high costs and high risks associated with this type of investment.

At the end of 2015 Kentucky elected a new governor, Matt Bevin (R), who was a part-owner of a hedge fund. Though Bevin did not express concern at the high level of "alternative investments" that were held by the Kentucky pension funds, he ran on a promise to reform the Kentucky pension system and to put the pension funds on a more secure footing. Some of the changes that Bevin engineered included expanding the KRS board from 13 to 17 members and appointing two hedge fund managers to the board, which continued to invest heavily in alternative investments.

Though KRS had relatively good returns during fiscal year 2018, the funds managed by KRS remain seriously underfunded, and the Kentucky legislature recently passed a bill that would impose crushing pension payments - up to 83% of salary - on several of the public agency employers. The governor currently is trying to negotiate a deal that would reduce that burden for a year.

The primary take away from all this is that there is no quick way for a pension system to recover from years of mismanagement.