Kentucky greenlights pension bill that will increase the state’s liabilities

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Kentucky passed a pension relief bill reducing some state agencies’ contributions to the worst-funded plan in the country, a move that experts believe will trigger a surge in the state’s own liabilities.

Gov. Matt Bevin signed House Bill 1 into law on July 24, the same day lawmakers adjourned a six-day special session called to develop options for relieving quasi-state agencies of paying for soaring pension contribution costs.

HB 1 applies to 118 agencies, including universities and local health departments, that participate in the Kentucky Employees Retirement System Non-Hazardous Plan.

The bill lowers those agencies’ contribution rates to 49.47% of covered payroll instead of the actuarially required rate of 83.43% in fiscal 2020, a rate increase that some health departments said could have forced them into insolvency.

HB 1 also establishes a process for the affected entities to opt out of KERS, a pension plan that shelled out more in benefit payments than it received in contributions in fiscal 2018.

“This bill doesn’t by any stretch resolve the pension crisis in Kentucky. No one has presented it as doing so,” Bevin said when he signed the bill “But it is a remarkably responsible and appropriate next step in moving toward financial solvency.”

Bevin said HB 1, which became effective immediately, gives agencies “immediate relief” and provides them with options to take care of their employees. He didn’t say how Kentucky would pay for the increased costs as a result of the measure.

Tom Kozlik, Hilltop Securities’ head of municipal strategy and credit, said the options Kentucky lawmakers considered during the special session “stand to increase the amount of liabilities.”

The lower contribution rate is expected to save the agencies $121 million in 2020 and beyond, though it will underfund the actuarially determined contribution.

Employers that choose to leave the plan, which will freeze their employee’s earned benefits in KERS, could see actuarial relief of up to $827 million, according to an actuarial analysis of the bill by GRS Retirement Consulting.

The $827 million “is significant, as the remaining employers in the system are required to assume the responsibility in all future years of funding the liability attributable to the members of the withdrawing employers” from KERS, which will include years of adverse investment experience, GRS said.

The KERS Non-Hazardous Plan was 12.8% funded on a market value basis as of June 30, 2018, making it the lowest funding ratio in the country for a large state plan, according to S&P Global Ratings.

“While the enacted legislation provides budgetary relief to quasi-state agencies, the commonwealth with a 70% proportionate share of the plan's liabilities will largely bear, as a result of the risk transfer, the burden of any future actuarial losses,” S&P analyst Timothy Little said Friday.

Little said underfunding actuarially required plan contributions, which the state had done prior to fiscal 2015, is a significant contributor to pension plan instability and a cause of its extremely low funded ratio.

“The low level of assets has already resulted in liquidity pressures and negative cash flow for the plan and further underfunding contributions will only intensify these pressures,” he said.

KERS has 132,100 active, retired and inactive members.

In fiscal 2018, the system distributed $981 million in benefit payments and received $794 million in employer and employee contributions. The market value of the system’s assets was $2 billion, according to the 2018 valuation by GRS.

KERS' actuarial accrued liability is $15.6 billion, the largest of Kentucky’s six major pension plans. Collectively, the plans’ unfunded liability is $50.1 billion.

Kozlik said Kentucky continues to navigate its way through a bonafide public pension crisis.

State lawmakers considered “drastic measures” during the recent special session because KERS plan participants faced “an unaffordable 70% increase in pension contributions,” Kozlik wrote in a July 25 municipal commentary.

“There are no good politically attractive options and Kentucky has all but spent its rainy day fund,” said Kozlik. “Lawmakers will likely continue to spend time nibbling around the edges until they’re forced to make difficult decisions, and the municipal bond market is going to learn much about the state government’s willingness and ability” to pay its debts.

Kentucky had about $6.3 billion of outstanding long-term debt issued by the State Property and Buildings Commission, the Kentucky School Facilities Construction Commission and the Turnpike Authority of Kentucky as of June 30, 2018.

The state’s issuer credit ratings are AA-minus by Fitch Ratings, Aa3 by Moody's Investors Service, and S&P assigns an A rating.

Like most states, Kentucky has seen its revenue collections increase year-over-year and some of that income will benefit KERS and the Teachers Retirement System, or TRS.

For the fiscal year ending June 30, 2019 general fund receipts totaled $11.4 billion, a $550 million or 5.1% increase over 2018 collections. The intake exceeded the official estimate by $194.5 million or 1.7%.

According to State Budget Director John Chilton, the state will use a portion of the surplus to pay $70 million toward TRS’ post-retirement health insurance fund and $60.1 million toward the unfunded liability in the KERS Non-Hazardous Plan.

HB 1 is the second bill lawmakers have passed reducing the contribution rate of KERS members. In 2018, they passed HB 265 reducing the employer rate to 49.47% in fiscal 2019.

Agencies must tell the state they want to leave KERS by June 30, 2020. At that time, they must tell the state if they’ll pay off their actuarial accrued liability in a lump sum or pay it in installments over 30 years.

HB 1 requires employers exiting the pension system to provide their employees with an alternative defined contribution retirement program, such as a 401(k)-style plan. The bill prohibits them from offering a defined benefit plan.

Bill sponsor Rep. James Tipton, R-Taylorsville, said the measure will provide a reprieve for the agencies facing soaring pension costs. He also said lawmakers will continue reviewing pension issues in next year’s legislative session.

S&P said Kentucky’s general fund contributed more than 14% of expenditures toward pension costs in the 2018-2020 budget. Additional actuarial losses and the plan’s rising net pension liability from the enacted legislation are likely to further increase the state's pension costs in the next biennium.

“While we view increasing contributions in the most recent budget favorably, continued underfunding of required contributions and increasing liabilities from employer cessations as enacted [in HB 1] will likely lower the plan's funding level, heighten liquidity pressures, and could weaken the state's overall credit quality over time,” S&P said.

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Public pensions Pension reform State budgets Bond ratings Matt Bevin State of Kentucky Kentucky State Property & Buildings Commission Kentucky Turnpike Authority Kentucky