Situation Report: Kentucky Unemployment Insurance Fraud and Its Disadvantage to Kentuckians' Access to Federal Funding

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Situation Report: Kentucky Unemployment Insurance Fraud and Its Disadvantage to Kentuckians' Access to Federal Funding

Executive Summary
Kentucky has faced significant unemployment insurance (UI) fraud challenges, particularly during the COVID-19 pandemic, leading to billions in improper payments nationwide and tens of millions in the state. This fraud has strained state resources, delayed legitimate claims, and prompted federal scrutiny. As of August 2025, the Trump administration's decision to terminate previously approved federal UI grants has further disadvantaged Kentuckians by cutting funds essential for fraud prevention, system modernization, and equitable access to benefits. Governor Andy Beshear has joined a multi-state lawsuit to challenge this freeze, arguing it hampers the state's ability to protect and improve UI programs. This situation exacerbates barriers for residents seeking federal unemployment extensions and related aid, potentially prolonging economic recovery in a state with persistent workforce challenges.

Background
Kentucky's UI system, administered by the Office of Unemployment Insurance (OUI) under the Kentucky Education and Labor Cabinet, provides temporary benefits to eligible workers who lose jobs through no fault of their own. The system relies on a mix of state taxes and federal funding, including grants from the U.S. Department of Labor (DOL) for administration, fraud detection, and modernization.

During the COVID-19 pandemic (2020-2022), expanded federal programs like the CARES Act led to a surge in claims, but outdated IT infrastructure and relaxed verification processes enabled widespread fraud. Nationwide, the U.S. Government Accountability Office (GAO) estimated $191 billion in fraudulent unemployment payments, with Kentucky paying out $37.6 million in confirmed fraudulent claims between April 2020 and March 2021 alone. Common schemes included identity theft, out-of-state claims, and falsified employer data. Auditors found that nearly half of sampled out-of-state claims were fraudulent, with one claimant receiving over $30,000 illicitly.

A 2022 state audit criticized OUI for slow fraud response, noting failures in implementing security controls like risk assessments and vulnerability scans, despite state laws requiring them. The system's 1970s-era mainframe contributed to vulnerabilities, allowing $195 million in suspicious out-of-state payments, of which a random sample revealed 44% fraud. Additionally, internal issues emerged, such as 54 fraudulent claims by purported state employees totaling $333,000.

Federal penalties for fraud include a minimum 15% surcharge on overpayments, criminal prosecution, and potential loss of future benefits. Kentucky's improper payment rate was 8.85% from July 2019 to June 2022, below the national average but still indicative of systemic issues.

Current Situation
As of August 2025, Kentucky's UI fraud remains a concern amid broader federal policy shifts. On January 20, 2025, the Trump administration froze disbursements of UI grants, terminating funding tied to programs like fraud protection, UI modernization, and diversity, equity, and inclusion (DEI) initiatives in workforce development. This action followed DOL audits uncovering widespread fraud in pandemic-era programs, with DOGE (Department of Government Efficiency) teams identifying $382 million in improper unemployment payments nationwide, including to deceased or ineligible recipients.

Governor Beshear announced Kentucky's participation in a lawsuit against the DOL on August 6, 2025, claiming the freeze unlawfully halts congressionally approved funds. Recent grants affected include $4 million for storm recovery workforce aid in Kentucky. State officials argue this cutback directly impairs efforts to combat ongoing fraud, as seen in persistent issues like skimming and identity theft.

Fraud reporting remains challenging; Kentuckians have reported difficulties accessing hotlines (e.g., 502-564-2387 or uifraud@ky.gov), leading to delays in flagging scams. In 2021, over 87,000 pending claims were flagged, with more than half suspected fraudulent, overwhelming the system. Recent discussions highlight national fraud recovery efforts, such as $520 million clawed back from pandemic scams, but note Kentucky's inclusion in grant cuts amid rising claims.

Impacts on Kentuckians' Access to Federal Funding
UI fraud disadvantages Kentuckians in several ways:

1. Delayed Processing and Denials for Legitimate Claims: Fraudulent claims clog the system, causing backlogs. During the pandemic, thousands waited months for benefits while fraudsters exploited loopholes, leading to "stops" on out-of-state claims and increased scrutiny that slowed approvals. This indirectly limits access to federal extensions like Pandemic Unemployment Assistance (PUA).

2. Reduced Federal Grants and Modernization Funds: The 2025 grant freeze cuts resources for updating Kentucky's antiquated system, which is prone to fraud and inefficiencies. Without these funds, the state struggles to implement AI-driven verification or enhanced fraud detection, perpetuating vulnerabilities and potentially triggering federal penalties or reduced future allocations.

3. Economic Strain and Overpayment Recovery: Fraud leads to overpayments that states must repay to the federal government, straining budgets. Kentucky has disqualified 80,000 claims since mid-2021, but victims of identity theft face IRS issues from erroneous 1099-G forms. This discourages legitimate filers and erodes trust, with employers frustrated by bogus claims inflating UI taxes.

4. Broader Federal Scrutiny and Restrictions: Ongoing federal investigations, including by the House Oversight Committee, highlight Kentucky's fraud losses, potentially leading to stricter eligibility for federal loans or grants. The Pandemic Unemployment Fraud Enforcement Act extended prosecution timelines to 10 years, increasing pressure on states like Kentucky to recover funds.

Overall, these factors hinder Kentuckians' access to timely federal unemployment support, exacerbating poverty in rural areas and delaying recovery from events like natural disasters.

Outlook and Recommendations
The lawsuit's outcome could restore some funding, but persistent fraud risks further federal interventions. Kentucky has implemented ID.me for identity verification and a task force for coordination with federal agencies. To mitigate disadvantages:

- Enhance state-federal collaboration for real-time fraud detection.
- Invest in system upgrades using available funds to reduce improper payments.
- Improve public awareness and reporting mechanisms to empower residents.

Without resolution, Kentuckians may face prolonged barriers to federal aid, underscoring the need for bipartisan reforms to secure UI integrity.