Kentucky bridge-repair program may face pension-driven financial constraints

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Kentucky is struggling to fund critical bridge repairs while grappling with soaring pension costs that triggered a three-notch rating downgrade for its largest road financing program.

With more than 60 local bridges closed due to disrepair, state officials say they’ve launched a program called “Bridging Kentucky” to rehabilitate or replace more than 1,000 bridges at an estimated cost of $700 million over six years even though transportation funding is tight.

“It is one of the most aggressive bridge rehabilitation and replacement programs in the country,” state bridge engineer Royce Meredith told the General Assembly’s Interim Joint Committee on Transportation Aug. 6. “These are critical structures that affect every Kentuckian.”

Meredith, who works for the Transportation Cabinet, said the program will review structures in all 120 Kentucky counties and that construction projects are being prioritized based on the available budget and construction types.

Lawmakers this year approved spending $340 million on the bridge program through 2020, Bridging Kentucky program spokesman Ed Green told The Bond Buyer.

Additional funding for the six-year program, whether from state revenues or bond financing, will be determined by the Legislature in future sessions, he said.

Because road fund revenues are stagnant, state officials said they will initially narrow their focus to improving the condition and life cycle of existing bridges, as opposed to replacements, which would require additional revenue.

The state road fund ended the last fiscal year $7.7 million above the official revised revenue estimate of $1.5 billion, and revenues through fiscal year 2020 are projected to remain $1.5 billion per year, according to Robin Brewer, executive director in the Transportation Cabinet’s office of budget and fiscal management.

“We are not really estimating any additional growth through the biennium,” she said. “It’s pretty much on autopilot at this point.”

If the Kentucky Turnpike Authority is used to finance portions of the bridge program the state may have to pay more to borrow than it did in the past.

S&P Global Ratings downgraded KTA’s economic development road revenue bond rating to A-minus from AA-minus Aug. 29 based partly on its revised criteria for credit ratings linked to an obligors’ creditworthiness. The new criteria went into effect Jan. 22.

S&P said the downgrade also reflected its view of “increasing financial pressures, primarily pension contributions, at the state level.” The outlook is stable.

KTA has $1.2 billion of outstanding road fund revenue and refunding bonds.

Unlike other turnpikes that issue toll-backed bonds, KTA’s debt is secured by revenues from various transportation related taxes and fees, and bond payments are subject to legislative appropriation under a lease structure, according to Alan Schankel, managing director at Janney Montgomery Scott LLC.

Kentucky’s turnpike ratings are linked to the state’s creditworthiness for that reason, Schankel said in an Aug. 31 report.

KTA’s bonds are secured by lease payments from the Transportation Cabinet to the Turnpike Authority, and a lien on motor fuel taxes and surtaxes on gasoline and other motor fuels if the lease is not renewed. There are no debt service reserve funds.

“We view these bonds as having a strong relationship to the obligor since they provide funding for transportation projects that we believe are significantly important to Kentucky,” said S&P analyst Timothy Little.

Over the past five fiscal years, Little said turnpike personnel costs have increased 26% compared to a 5% increase in overall maintenance and operations, while revenues remained relatively flat.

Last year, Kentucky revised various actuarial assumptions for its pension plans to more conservative levels. For the Transportation Cabinet, the assumptions will add an estimated $50 million in additional personnel costs in 2019 and 2020.

“Personnel costs have increased despite a recent period of significant reductions in the agency's staffing levels,” Little said. “Additionally, the road fund is responsible for 50% of pension contributions for the state's weak-funded State Police Retirement System, which will add to competing claims on road fund revenues.”

As of the June 30, 2017 valuation, the SPRS plan had a 26.4% funded ratio and the Kentucky Employee Retirement System’s non-hazardous plan was 13.2% funded based on a market value of assets.

The valuation and assumption changes last year resulted in an increase in employer contributions to 154.10% of payroll for SPRS and 84.06% of salary for non-hazardous employees for pension and insurance benefits, S&P said.

In May, S&P lowered Kentucky’s issuer credit rating to A from A-plus citing increased fiscal strain on the state from rising pension costs, as well as “a constrained revenue-raising environment.”

At the same time, S&P lowered to A-minus from A its rating on the state's linked appropriation-backed obligations.

S&P said the downgrade was underscored by uneven budget management, diminished reserve levels to a projected $8 million balance at the end of fiscal 2018, a moderately high debt burden, large unfunded pension liabilities and long-term underfunding of the Teachers' Retirement System.

TRS, the state’s largest pension plan, was 39.8% funded based on calculations under the Governmental Accounting Standards Board.

“Kentucky's chronic underfunding of its pensions has translated into large unfunded liabilities and funded levels that are among the lowest in the nation,” Little said in May. “The state's overall pension funded ratio of 33.8% as of fiscal 2017 on an actuarial market value basis is weak in our view.”

Legislation spearheaded by Gov. Matt Bevin to stem retirement expenses is tied up in a court challenge.

The Legislature passed Senate Bill 151 this year to change the Teachers' Retirement System and other state pension plans. Gov. Matt Bevin signed it on April 10. It would shift newly hired educators into a hybrid “cash balance” plan instead of the existing defined benefit plan. New state employees were placed in a similar plan in 2014.

The bill also makes newly hired teachers ineligible to be covered under the state’s inviolable contract, meaning that their retirement benefits could be reduced in the future, and it increased the retirement eligibility age for new teachers to 65 from 60.

Changes to the Employee Retirement System and the County Employee Retirement System included creating an optional defined contribution plan, suspending compensation for equipment and uniforms, and ending the ability of workers to convert unused sick leave into service credit to increase pension benefits.

Teachers, who do not receive Social Security, objected to the legislation, as did other affected public employees.

Moody's Investors Service said in May that SB 151 would benefit the state, local governments and public universities even though it would result in higher costs for employers.

The state is constrained by significant long-term liabilities, including one of the highest adjusted net pension burdens in the country, Moody’s analyst Genevieve Nolan wrote in May.

“Kentucky's recently enacted credit-positive pension reforms will reduce its exposure to investment performance and longevity risk across key funds,” Nolan said. “The [pension] changes are being challenged by the state's attorney general, however, and may be overturned.”

A day after Bevin signed the bill, Kentucky Attorney General Andy Beshear filed a lawsuit in an attempt to block it from becoming law.

On June 20, Franklin Circuit Court Judge Phillip Shepherd ruled SB 151 unconstitutional because of the process lawmakers used to pass it and because it did not receive the required three readings before passage.

As originally filed, SB 151 dealt with sanitary sewers. The bill was stripped of that language late in the session and replaced with 291 pages of pension reform language.

The revised bill was approved in less than a day on majority votes in both chambers. Its first readings occurred when it was still a sewer bill.

Beshear, a Democrat who has tangled with Bevin in court many times, contended that few people, let alone lawmakers, had time to read the bill and that it didn’t get the proper number of votes.

Bevin, a Republican who has called Beshear “the ever-opportunistic” attorney general, said the bill is legal and necessary to address the state’s pension crisis. He has also said the same procedure has been used to pass other bills, and a ruling against SB 151 could endanger those measures.

Republicans dominate the legislature after taking control of the state House of Representatives in 2016.

The governor’s legal team filed a motion to take the case directly to the Kentucky Supreme Court. Oral arguments will be heard Sept. 20.

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Transportation industry Revenue bonds Infrastructure Pension reform Lawsuits Kentucky Turnpike Authority Kentucky