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Kentucky Urged to Tackle $30B Pension Liability with Bonds

SEP 5, 2012 4:16pm ET
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BRADENTON, Fla. — With Kentucky’s unfunded public pension liability at more than $30 billion, a legislative task force has begun examining how to reform its systems and close the unfunded gap.

A number of organizations and unions are urging lawmakers to recommend issuing up to $4.3 billion in pension obligation bonds to reduce the unfunded liability, in addition to other measures.

Such a large issuance, particularly if it were not backed by a comprehensive reform plan, could impact the state’s bond ratings and ability to issue debt for other needs, according to Tom Howard, director of the state’s Office of Financial Management.

“I think that a debt issue of this magnitude would have a significant crowding-out effect on other capital needs of the commonwealth,” said Howard, who has not appeared before the task force. “A $4.3 billion issue would almost double the amount of general fund appropriation-supported debt outstanding.”

While that amount of debt may also be of concern to rating agencies, the state’s unfunded pension liability is already a concern and has been for some time.

Kentucky is rated AA-minus by Fitch Ratings and Standard & Poor’s, and Aa2 by Moody’s Investors Service.

Standard & Poor’s places a stable outlook on the Bluegrass State’s debt. Fitch and Moody’s have negative outlooks on their ratings.

Both agencies have cited budget stress related to the economic downturn as well as the state’s large and growing pension liability, related partly to the underfunding of its annual required contribution over a number of years, despite previous attempts to shore up the system.

In 2008, the state instituted some reform measures to reduce increasing pension costs and help ensure adequate funding of the actuarially required annual pension contributions by 2025.

The commonwealth reduced benefits for new hires, required a longer service period to qualify for benefits, limited annual cost of living and sick leave adjustments, and eliminated “double-dipping” for employees who retire and then later return to work.

“However, funded levels have been steadily decreasing as a result of the commonwealth’s failure to make the full annual required contribution over the past several years, early retirement incentives, increasing health care costs, and poor investment performance,” Moody’s said in a report last October.

The Kentucky Retirement Systems cover 475,000 employees and elected officials.

The KRS system includes the Employees Retirement System, the County Employees Retirement System, the State Police Retirement System, the Teachers’ Retirement System, the Legislators’ Retirement Plan, and the Judicial Retirement Plan.

The combined unfunded liability of the six traditional defined-benefit plans for retirement and retiree benefits exceeds $30 billion.

In recent years, the liability has risen faster than anticipated because of the effects of the economic downturn on investments in addition to phased-in funding of the annual contribution.

Earlier this year during the regular legislative session, lawmakers established the Kentucky Public Pensions Task Force to address the pension system’s deteriorating finances.

The task force is charged with studying benefits, investments and funding of the state-administered retirement systems and developing recommendations to improve their financial stability.

A report on the task force’s findings and recommendations is due to be made public by Dec. 7.

Along with urging the task force to consider ways to revamp the pension program, the suggestion of issuing pension bonds was widely supported at the task force’s meeting two weeks ago.

The Kentucky Chamber of Commerce as well as the state’s Professional Firefighters Association, Association of Transportation Engineers, and the American Federation of State, County and Municipal Employees, or AFSCME, all supported issuing pension debt.

Dan Doonan, a labor economist from AFSCME’s Washington, D.C., office, said the funded level of the state’s plans have become troublesome, and bonding could make up for the shortfall.

If $4.3 billion of pension bonds were issued, Kentucky’s annual interest costs would fall to 4% or 4.5% from the current 7.75%, saving $141 million to $163 million interest costs a year, according to Doonan.

That move could bring the funding level of the plan for non-hazardous employees to 69% from its current level of 33%, he said.

Bonding would bring the funding level of the plan for hazardous-job workers to 91% from 71%.

“I realize that bonding can have a negative … connotation,” Doonan said. “But this is debt. Essentially, to me, it is more like refinancing debt.”

The key in using bonds is borrowing at costs lower than the investment returns over 30 years, he said, noting that borrowing costs are very low in today’s market.

Doonan also said that using bonds would provide the state with fixed payments while taking out about half of the unfunded liability.

As a payment stream for the bonds, he suggested that lawmakers look for budget savings by prioritizing expenses funded with tax dollars.

“Floating a bond issue for the [pension] systems might be a consideration,” said Paul Guffey, president of the Kentucky Public Retirees. “Please find solutions that do not punish us. We did not cause the problems.”

Using pension bonds as an element of the overall reform effort is a tool that should be considered, said David Draine, a senior researcher at the Pew Center on the States who is assisting the task force.

While Draine said he was not advocating for or against the use of pension bonds, he did say that some states have used debt to mask problems, and that such debt adds an element of risk that should also be considered.

If Kentucky considers bonding as part of its reform program, Draine advised the panel to build in safeguards to ensure that future contributions are required.

He cited Connecticut, which issued pension bonds for its teachers’ retirement plan.

Connecticut structured its pension deal so that it would be in technical default if the state failed to make its annual contribution at an actuarial rate, Draine said.

“Connecticut hasn’t missed a payment for its teachers’ plan,” he said

Draine went on to say that pension reform is a complex issue that has consequences for state and local workers, taxpayers, and the people who depend on public services.

“Kentucky faces major funding gaps for its retirement promises and current policies are unsustainable,” he said. “But there are solutions that will secure the benefits being promised to public workers while protecting taxpayers.”

Several task force members indicated that they are interested in studying the use of pension bonds. Their next meeting is Sept. 18.

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